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 16. 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 15, 2010 for the fiscal year ended May 2, 2010.
The company’s six months ended October 31, 2010, and November 1, 2009, represent 26 week periods, respectively.
2. Significant Accounting Policies
As of October 31, 2010, there were no changes in the nature of our significant accounting policies or the application of those policies from those reported in our annual report on Form 10-K for the year then ended May 2, 2010.
Recently Adopted Accounting Pronouncements
ASC Topic 860
In June 2009, the FASB amended certain provisions of ASC Topic 860, Transfers and Servicing (previously reported as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140”). The amended provisions of ASC Topic 860 eliminate the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures in order to enhance information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and an entity’s continuing involvement in and exposure to the risks related to transferred financial assets. The amended provisions of ASC Topic 860 are effective for the first annual reporting period beginning after November 15, 2009 and for interim periods within that first annual reporting period. We adopted the provisions of ASC Topic 860 in the first quarter of fiscal 2011. The adoption of this standard did not have a material impact on our consolidated results of operations or financial condition.
ASC Topic 810
In June 2009, the FASB amended certain provisions of ASC Topic 810, Consolidation (previously reported as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)”) which revised the consolidation guidance for variable-interest entities. The amendments include: (1) the elimination of the exemption for qualifying special purpose entities, (2) a new approach for determining who should consolidate a variable-interest entity, and (3) changes to when it is necessary to reassess who should consolidate a variable-interest entity. The amended provisions of ASC Topic 810 are effective for the first annual reporting period beginning after November 15, 2009 and for interim periods within that first annual reporting period. We adopted the provisions of ASC Topic 860 in the first quarter of fiscal 2011. The adoption of this standard did not have a material impact on our consolidated results of operations or financial condition.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Recently Issued Accounting Pronouncements
ASC Topic 605
In October 2009, the FASB issued ASU 2009-13, which amends ASC Topic 605, “Revenue Recognition”, to revise accounting guidance related to revenue arrangements with multiple deliverables. The guidance relates to the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting and modifies the manner in which the transaction consideration is allocated across the individual deliverables. Also, the guidance expands the disclosure requirements for revenue arrangements with multiple deliverables. The guidance will be effective for our fiscal 2012. Because the Company historically does not have revenue arrangements with multiple deliverables, the adoption of this standard is not expected to have a material impact on its consolidated results of operations or financial condition.
3. Stock-Based Compensation
Common Stock Awards
On October 1, 2010, we granted a total of 3,114 shares of common stock to our board of directors. These shares of common stock vested immediately and were measured at $10.02 per share, which represents the closing price of the company’s common stock at the date of grant.
We recorded $31,000 of compensation expense within selling, general, and administrative expense for these common stock awards for the six-month period ended October 31, 2010. There were not any common stock awards for the six-month period ended November 1, 2009 and, therefore no compensation expense was recorded on fully vested common stock awards.
Incentive Stock Option Awards
We did not grant any incentive stock option awards through the second quarter of fiscal 2011.
At October 31, 2010, options to purchase 360,974 shares of common stock were outstanding, had a weighted average exercise price of $6.27 per share, and a weighted average contractual term of 4.5 years. At October 31, 2010, the aggregate intrinsic value for options outstanding was $1.4 million.
At October 31, 2010, outstanding options to purchase 263,574 shares of common stock were exercisable, had a weighted average exercise price of $6.28 per share, and a weighted average contractual term of 3.5 years. At October 31, 2010, the aggregate intrinsic value for options exercisable was $1.0 million.
The aggregate intrinsic value for options exercised for the six- month periods ended October 31, 2010 and November 1, 2009 was $742,000 and $11,000, respectively.
The remaining unrecognized compensation cost related to incentive stock option awards at October 31, 2010, was $263,000 which is expected to be recognized over a weighted average period of 2.1 years.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We recorded $77,000 and $210,000 of compensation expense for incentive stock option grants within selling, general, and administrative expense for the six-month periods ended October 31, 2010 and November 1, 2009, respectively.
Time Vested Restricted Stock Awards
We did not grant any time vested restricted stock awards through the second quarter of fiscal 2011.
We recorded $83,000 and $71,000 of compensation expense within selling, general, and administrative expense for time vested restricted stock awards for the six-month periods ending October 31, 2010 and November 1, 2009, respectively.
At October 31, 2010, there were 195,000 shares of time vested restricted stock outstanding and unvested. Of the 195,000 shares outstanding and unvested, 115,000 shares (granted on January 7, 2009) vest in equal one-third installments on May 1, 2012, 2013, and 2014, respectively. The remaining 80,000 shares (granted on July 1, 2009) vest in equal one-third installments on July 1, 2012, 2013, and 2014, respectively. At October 31, 2010, the weighted average fair value of these outstanding and unvested shares was $3.62 per share.
At October 31, 2010, the remaining unrecognized compensation cost related to the unvested restricted stock awards was $433,000, which is expected to be recognized over a weighted average vesting period of 2.7 years.
Performance Based Restricted Stock Units
We did not grant any performance based restricted stock units through the second quarter of fiscal 2011.
On January 7, 2009, and under our 2007 Equity Incentive Plan, certain key management employees and a non-employee were granted 120,000 shares of performance based restricted stock units. This award contingently vests in one-third increments, if in any discreet period of two consecutive quarters from February 2, 2009 through April 30, 2012, certain performance goals are met. As of October 31, 2010, the performance goals as defined in the agreement were met and as a result, all of the performance based restricted stock units have vested.
The fair value (the closing price of the company’s common stock) of the performance based restricted stock units granted to key management employees is measured at the date of grant (January 7, 2009) and was $1.88 per share. The fair value (the closing price of the company’s common stock) of the performance based restricted stock units granted to a non-employee is measured at the earlier date of when the performance criteria are met or the end of each reporting period. As of October 31, 2010, the performance based restricted stock units granted to the non-employee vested in one-third increments on August 2, 2009, January 31, 2010, and August 1, 2010, respectively. The restricted stock awards vested on August 2, 2009, January 31, 2010, and August 1, 2010, were measured at $6.59, $13.01, and $10.42 per share, respectively, which represents the closing price of the company’s common stock at the date in which the performance criteria was met.
We recorded $12,000 and $159,000 of compensation expense within selling, general, and administrative expense for performance based restricted stock units for the six-month periods ended October 31, 2010 and November 1, 2009, respectively.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Of the 120,000 vested shares, 105,000 and 15,000 pertained to key management employees and a non-employee, respectively. The total fair value of the 120,000 performance based restricted stock units that vested was $348,000 with a weighted average fair value of $2.90 per share.
Other Share-Based Arrangements
We have a stock-based agreement with a non-employee that requires the company to settle in cash and is indexed by shares of the company’s common stock as defined in the agreement. The cash settlement is based on a 30-day average closing price of the company’s common stock at the time of payment. At October 31, 2010, this agreement was indexed by approximately 68,260 shares of the company’s common stock. The fair value of this agreement is included in accrued expenses and was $702,000 and $821,000 at October 31, 2010 and May 2, 2010, respectively. We recorded a decrease in this accrual of $119,000 to reflect the change in fair value for the six-month period ending October 31, 2010. The company recorded an increase in this accrual of $130,000 to reflect the change in fair value for the six-month period ending November 1, 2009. We did not make any payments under this arrangement for the six-month periods ending October 31, 2010 and November 1, 2009, respectively.
4. Accounts Receivable
A summary of accounts receivable follows:
| |
|
|
|
|
|
(dollars in thousands)
|
October 31, 2010
|
|
May 2, 2010
|
|
|
Customers
|
|
$ |
16,328 |
|
|
$ |
21,678 |
|
|
Allowance for doubtful accounts
|
|
|
(912 |
) |
|
|
(1,322 |
) |
|
Reserve for returns and allowances and discounts
|
|
|
(606 |
) |
|
|
(534 |
) |
| |
|
$ |
14,810 |
|
|
$ |
19,822 |
|
| |
|
|
A summary of the activity in the allowance for doubtful accounts follows:
|
|
|
|
|
|
|
|
|
| |
|
| |
Six months ended
|
|
|
(dollars in thousands)
|
October 31, 2010
|
|
November 1, 2009
|
|
|
Beginning balance
|
|
$ |
(1,322 |
) |
|
$ |
(1,535 |
) |
|
Provision for bad debts
|
|
|
415 |
|
|
|
234 |
|
|
Net write-offs, net of recoveries
|
|
|
(5 |
) |
|
|
502 |
|
|
Ending balance
|
|
$ |
(912 |
) |
|
$ |
(799 |
) |
| |
|
| |
|
|
A summary of the activity in the allowance for returns and allowances and discounts accounts follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
Six months ended
|
|
|
(dollars in thousands)
|
October 31, 2010
|
|
November 1, 2009
|
|
|
Beginning balance
|
|
$ |
(534 |
) |
|
$ |
(442 |
) |
|
Provision for returns, allowances
|
|
|
|
|
|
|
|
|
|
and discounts
|
|
|
(1,152 |
) |
|
|
(1,846 |
) |
|
Credits issued
|
|
|
1,080 |
|
|
|
1,800 |
|
|
Ending balance
|
|
$ |
(606 |
) |
|
$ |
(488 |
) |
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
5. 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)
|
|
October 31, 2010
|
|
|
May 2, 2010
|
|
|
Raw materials
|
|
$ |
6,153 |
|
|
$ |
5,639 |
|
|
Work-in-process
|
|
|
2,233 |
|
|
|
2,160 |
|
|
Finished goods
|
|
|
21,049 |
|
|
|
18,203 |
|
| |
|
$ |
29,435 |
|
|
$ |
26,002 |
|
6. Other Assets
A summary of other assets follows:
| |
|
|
|
|
|
|
|
(dollars in thousands)
|
|
October 31, 2010
|
|
|
May 2, 2010
|
|
|
Cash surrender value - life insurance
|
|
$ |
1,318 |
|
|
$ |
1,312 |
|
|
Non-compete agreements, net
|
|
|
626 |
|
|
|
843 |
|
|
Other
|
|
|
334 |
|
|
|
413 |
|
| |
|
$ |
2,278 |
|
|
$ |
2,568 |
|
We recorded non-compete agreements in connection with our asset purchase agreements with International Textile Group, Inc. (ITG) and Bodet & Horst. These non-compete agreements pertain to our mattress fabrics segment. The non-compete agreement associated with ITG is amortized on a straight line basis over the four year life of the agreement. The non-compete agreement associated with Bodet & Horst is amortized on a straight line basis over the six year life of the agreement and requires quarterly payments of $12,500 over the life of the agreement. As of October 31, 2010, the total remaining non-compete payments were $187,500.
The gross carrying amount of these non-compete agreements was $2.1 million at October 31, 2010 and May 2, 2010, respectively. At October 31, 2010 and May 2, 2010, accumulated amortization for these non-compete agreements were $1.5 million and $1.3 million, respectively. Amortization expense for these non-compete agreements was $243,000 and $259,000 for the six-month periods ended October 31, 2010 and November 1, 2009, respectively. The remaining amortization expense (which includes the total remaining Bodet & Horst non-compete payments of $187,500) for the next five fiscal years follows: FY 2011 - $171,000; FY 2012 - $198,000; FY 2013 - $198,000; FY 2014 - $198,000; and FY 2015 - $49,000. The weighted average amortization period for these non-compete agreements is 3.8 years as of October 31, 2010.
Our cash surrender value – life insurance balances at October 31, 2010 and May 2, 2010, are payable upon death of the respective insured.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. Accounts Payable – Capital Expenditures
At October 31, 2010, we had amounts due regarding capital expenditures totaling $253,000, of which $188,000 was vendor-financed and $65,000 was non-vendor financed. Our vendor-financed arrangement bears interest at a fixed interest rate of 7.14%. The total outstanding amount of $253,000 is required to be paid in full during fiscal 2011.
At May 2, 2010, we had total amounts due regarding capital expenditures totaling $567,000, of which $377,000 was vendor-financed and $190,000 was non-vendor financed.
8. Accrued Expenses
A summary of accrued expenses follows:
| |
|
|
|
|
|
|
|
(dollars in thousands)
|
|
October 31, 2010
|
|
|
May 2, 2010
|
|
|
Compensation, commissions and related benefits
|
|
$ |
3,958 |
|
|
$ |
7,460 |
|
|
Interest
|
|
|
185 |
|
|
|
187 |
|
|
Other accrued expenses
|
|
|
1,522 |
|
|
|
1,966 |
|
| |
|
$ |
5,665 |
|
|
$ |
9,613 |
|
9. Long-Term Debt and Lines of Credit
A summary of long-term debt and lines of credit follows:
| |
|
|
|
|
|
|
|
(dollars in thousands)
|
|
October 31, 2010
|
|
|
May 2, 2010
|
|
|
Unsecured senior term notes
|
|
$ |
11,000 |
|
|
$ |
11,000 |
|
|
Canadian government loan
|
|
|
605 |
|
|
|
687 |
|
| |
|
|
11,605 |
|
|
|
11,687 |
|
|
Current maturities of long-term debt
|
|
|
(2,396 |
) |
|
|
(196 |
) |
|
Long-term debt, current maturities of long-term debt
|
|
$ |
9,209 |
|
|
$ |
11,491 |
|
Unsecured Term Notes
In connection with the Bodet & Horst acquisition, we entered into a note agreement dated August 11, 2008. This agreement provided 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 August 11, 2011. The principal payments are payable over an average term of 4.8 years through August 11, 2015. This agreement contains customary financial and other covenants as defined in the agreement.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Government of Quebec Loan
We have an agreement with the Government of Quebec for a term loan that is non-interest bearing and is payable in 48 equal monthly installments (denominated in Canadian dollars) commencing December 1, 2009. The proceeds were used to partially finance capital expenditures at our Rayonese facility located in Quebec, Canada.
Revolving Credit Agreement – United States
On August 13, 2010, we entered into a sixteenth amendment to our revolving credit agreement. This agreement currently provides for a loan commitment of $6.5 million, including letters of credit of $3.0 million. This agreement expires August 15, 2012 and provides for a pricing matrix to determine the interest rate payable on loans made under this agreement (applicable interest rate of 2.26% at October 31, 2010). As of October 31, 2010, there were $425,000 in outstanding letters of credit (all of which related to workers compensation). At October 31, 2010 and May 2, 2010, there were no borrowings outstanding under the agreement.
The sixteenth amendment to this revolving credit agreement also increased the annual capital expenditure limit from $4.0 million to $10.0 million.
Revolving Credit Agreement – China
We have an unsecured credit agreement that provides for a line of credit of up to approximately $6.0 million and expires on March 2, 2011. This agreement bears interest at a rate determined by the Chinese government. There were no borrowings outstanding under the agreement as of October 31, 2010 and May 2, 2010.
Overall
Our loan agreements require, among other things, that we maintain compliance with certain financial covenants. At October 31, 2010, the company was in compliance with these financial covenants.
At October 31, 2010, the principal payment requirements of long-term debt during the next five years are: Year 1 – $2.4 million; Year 2 - $2.4 million; Year 3 - $2.4 million; Year 4 - $2.2 million; and Year 5 - $2.2 million.
10. Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, short-term investments, accounts receivable, other current assets, accounts payable and accrued expenses approximates fair value because of the short maturity of these financial instruments.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The fair value of the company’s long-term debt is estimated by discounting the future cash flows at rates currently offered to the company for similar debt instruments of comparable maturities. At October 31, 2010, the carrying value of the company’s long-term debt was $11.6 million and the fair value was $10.6 million. At May 2, 2010, the carrying value of the company’s long-term debt was $11.7 million and the fair value was $11.1 million.
11. Derivatives
Canadian Dollar Foreign Exchange Contract
On January 21, 2009, we entered into a Canadian dollar foreign exchange contract to mitigate the risk of foreign exchange rate fluctuations associated with its loan with the Government of Quebec. The agreement effectively converted the Canadian dollar principal payments at a fixed Canadian dollar foreign exchange rate compared with the United States dollar of 1.21812 and was due to expire on November 1, 2013. During the first quarter of fiscal 2011, we elected to terminate this contract due to the current favorable Canadian dollar foreign exchange rates in comparison to the fixed contractual rate noted above.
In accordance with the provisions ASC Topic 815, Derivatives and Hedging, our Canadian dollar foreign exchange contract was designated as a cash flow hedge, with the fair value of this financial instrument recorded in other assets and changes in fair value recorded in accumulated other comprehensive income. ASC Topic 815 requires disclosure of gains and losses on derivative instruments in the following tabular format.
| |
|
(Amounts in Thousands) |
|
| |
|
Fair Values of Derivative Instruments As of,
|
|
| |
|
October 31, 2010
|
|
May 2, 2010
|
|
| |
|
|
|
|
|
|
Derivatives designated as hedging instruments under ASC Topic 815
|
|
Balance
Sheet
Location
|
|
Fair
Value
|
|
Balance
Sheet
Location
|
|
Fair
Value
|
|
| |
|
|
|
|
|
|
|
|
|
|
Canadian dollar foreign exchange contract
|
|
Other assets |
|
$ - |
|
Other assets |
|
$103 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives in
ASC Topic 815
Net
Investment
Hedging
Relationships
|
|
Amt of Gain (Loss)
(net of tax)
Recognized in OCI on
Derivative (Effective
Portion) and recorded
in Other assets
and Accrued Expenses
at Fair Value
|
|
Location of
Gain or (Loss)
Reclassified
from
Accumulated
OCI into
Income
(Effective
Portion)
|
|
Amount of Gain or
(Loss) Reclassified
from Accumulated
OCI into Income
(Effective Portion)
|
|
Location of
Gain or (Loss)
Recognized in
Income on
Derivative
(Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing)
|
|
Amount of Gain (net
of tax) or (Loss)
Recognized in Income
on Derivative
(Ineffective Portion
and Amount Excluded
from Effectiveness
Testing)
|
|
| |
|
October 31, 2010
|
|
November 1, 2009
|
|
|
|
October 31,
2010
|
|
November 1, 2009
|
|
|
|
October 31, 2010
|
|
November 1, 2009
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Canadian Dollar
Foreign Exchange
Contract
|
|
$(103)
|
|
$58
|
|
Other Expense
|
|
$5
|
|
$ -
|
|
Other Expense
|
|
$79
|
|
$ -
|
|
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
12. Cash Flow Information
Payments for interest and income taxes follows:
| |
|
|
| |
Six months ended
|
|
|
(dollars in thousands)
|
October 31, 2010
|
|
November 1, 2009
|
|
|
Interest
|
|
$ |
454 |
|
|
$ |
713 |
|
|
Net income tax payments
|
|
|
840 |
|
|
|
420 |
|
Interest costs of $17,000 for the construction of qualifying property, plant, and equipment were capitalized for the six month period ending October 31, 2010. No interest costs were capitalized for the six month period ending November 1, 2009.
During the six-month period ending October 31, 2010, 33,835 shares of common stock were surrendered to satisfy withholding tax liabilities and other costs incurred in connection with 40,000 shares of common stock issued and related to the vesting of performance based restricted stock units and the exercise of 72,000 options to purchase common stock. The total withholding tax liabilities and other costs incurred totaled $329,000.
During the six-month period ending November 1, 2009, 9,064 shares of common stock were surrendered to satisfy withholding tax liabilities totaling $51,000 in connection with 40,000 shares of common stock issued and related to the vesting of performance based restricted stock units.
13. 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-based compensation 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)
|
|
October 31, 2010
|
|
November 1, 2009 |
|
|
Weighted average common shares outstanding, basic
|
|
|
12,932 |
|
|
|
12,671 |
|
|
Dilutive effect of stock-based compensation
|
|
|
235 |
|
|
|
181 |
|
|
Weighted average common shares outstanding, diluted
|
|
|
13,167 |
|
|
|
12,852 |
|
Options to purchase 6,000 and 193,750 shares of common stock were not included in the computation of diluted net income per share for the three-months ended October 31, 2010 and November 1, 2009, as the exercise price of the options was greater than the average market price of the common shares.
The computation of basic net income per share for the three-months ended October 31, 2010, did not include 195,000 shares of time vested restricted common stock as these shares were unvested. The computation of basic net income per share for the three-months ended November 1, 2009, did not include 195,000 shares of time vested restricted common stock and 80,000 shares of performance restricted stock units as these awards were unvested.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| |
|
|
|
| |
|
Six months ended
|
|
|
(amounts in thousands)
|
|
October 31, 2010
|
|
November 1, 2009 |
|
|
Weighted average common shares outstanding, basic
|
|
|
12,901 |
|
|
|
12,662 |
|
|
Dilutive effect of stock-based compensation
|
|
|
285 |
|
|
|
142 |
|
|
Weighted average common shares outstanding, diluted
|
|
|
13,186 |
|
|
|
12,804 |
|
All options of common stock were included in the computation of diluted net income per share for the six-months ended October 31, 2010, as the exercise price of the options was less than the average market price of the common shares. Options to purchase 205,750 shares of common stock were not included in the computation of diluted net income per share for the six-months ended November 1, 2009, as the exercise price of the options was greater than the average market price of the common shares.
The computation of basic net income per share for the six-months ended October 31, 2010, did not include 195,000 shares of time vested restricted common stock as these shares were unvested. The computation of basic net income per share for the six-months ended November 1, 2009, did not include 195,000 shares of time vested restricted common stock and 80,000 shares of performance restricted stock units as these awards were unvested.
14. 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.
A summary of comprehensive income follows:
| |
|
|
| |
Six months ended
|
|
|
(dollars in thousands)
|
October 31, 2010
|
|
November 1, 2009
|
|
|
Net income
|
|
$ |
7,749 |
|
|
$ |
4,755 |
|
|
(Loss) gain on cash flow hedge, net of income taxes
|
|
|
(103 |
) |
|
|
58 |
|
|
Comprehensive income
|
|
$ |
7,646 |
|
|
$ |
4,813 |
|
15. Segment Information
Our 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.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We evaluate the operating performance of our segments based upon income (loss) from operations before restructuring and related charges or (credits), certain unallocated corporate expenses, and other non-recurring items. Cost of sales in both segments include costs to manufacture or source our products, including costs such as raw material and finished goods purchases, direct and indirect labor, overhead and incoming freight charges. 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 non-compete agreements associated with certain acquisitions. The upholstery fabrics segment also includes assets held for sale in segment assets. Financial information for the company’s operating segments follows:
| |
|
|
|
| |
|
Three months ended
|
|
|
(dollars in thousands)
|
|
October 31, 2010
|
|
|
November 1, 2009
|
|
|
Net sales:
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
28,335 |
|
|
$ |
28,202 |
|
|
Upholstery Fabrics
|
|
|
20,544 |
|
|
|
21,514 |
|
| |
|
$ |
48,879 |
|
|
$ |
49,716 |
|
| |
|
|
|
|
Gross profit:
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
5,030 |
|
|
$ |
5,896 |
|
|
Upholstery Fabrics
|
|
|
2,579 |
|
|
|
3,281 |
|
|
Total segment gross profit
|
|
|
7,609 |
|
|
|
9,177 |
|
|
Restructuring related charges
|
|
|
- |
|
|
|
(43 |
) (1) |
| |
|
$ |
7,609 |
|
|
$ |
9,134 |
|
| |
|
|
|
|
Selling, general, and administrative expenses:
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
1,704 |
|
|
$ |
1,856 |
|
|
Upholstery Fabrics
|
|
|
1,777 |
|
|
|
2,183 |
|
|
Total segment selling, general, and
|
|
|
|
|
|
|
|
|
|
administrative expenses
|
|
|
3,481 |
|
|
|
4,039 |
|
|
Unallocated corporate expenses
|
|
|
721 |
|
|
|
1,346 |
|
| |
|
$ |
4,202 |
|
|
$ |
5,385 |
|
| |
|
|
|
|
Income from operations:
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
3,326 |
|
|
$ |
4,041 |
|
|
Upholstery Fabrics
|
|
|
802 |
|
|
|
1,097 |
|
|
Total segment income from operations
|
|
|
4,128 |
|
|
|
5,138 |
|
|
Unallocated corporate expenses
|
|
|
(721 |
) |
|
|
(1,346 |
) |
|
Restructuring and related credit
|
|
|
- |
|
|
|
141 |
(2) |
|
Total income from operations
|
|
|
3,407 |
|
|
|
3,993 |
|
|
Interest expense
|
|
|
(225 |
) |
|
|
(342 |
) |
|
Interest income
|
|
|
49 |
|
|
|
16 |
|
|
Other expense
|
|
|
(30 |
) |
|
|
(103 |
) |
|
Income before income taxes
|
|
$ |
3,201 |
|
|
$ |
3,504 |
|
|
(1)
|
The $43 restructuring related charge represents other operating costs associated with a closed plant facility. This restructuring related charge relates to the Upholstery Fabrics segment
|
|
(2)
|
The $141 restructuring and related credit represents a credit of $200 for employee termination benefits, offset by a charge of $43 for other operating costs associated with a closed plant facility, and a charge of $16 for lease termination and other exit costs. This restructuring and related credit relates to the Upholstery Fabrics segment.
|
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
| |
|
|
|
| |
|
Six months ended
|
|
|
(dollars in thousands)
|
|
October 31, 2010
|
|
|
November 1, 2009
|
|
|
Net sales:
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
59,253 |
|
|
$ |
54,476 |
|
|
Upholstery Fabrics
|
|
|
45,538 |
|
|
|
40,717 |
|
| |
|
$ |
104,791 |
|
|
$ |
95,193 |
|
| |
|
|
Gross profit:
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
11,020 |
|
|
$ |
10,658 |
|
|
Upholstery Fabrics
|
|
|
6,298 |
|
|
|
6,076 |
|
|
Total segment gross profit
|
|
|
17,318 |
|
|
|
16,734 |
|
|
Restructuring related charges
|
|
|
- |
|
|
|
(14 |
) (4) |
| |
|
$ |
17,318 |
|
|
$ |
16,720 |
|
| |
|
|
Selling, general, and administrative expenses:
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
3,701 |
|
|
$ |
3,665 |
|
|
Upholstery Fabrics
|
|
|
3,878 |
|
|
|
4,216 |
|
|
Total segment selling, general, and
|
|
|
|
|
|
|
|
|
|
administrative expenses
|
|
|
7,579 |
|
|
|
7,881 |
|
|
Unallocated corporate expenses
|
|
|
1,837 |
|
|
|
2,399 |
|
| |
|
$ |
9,416 |
|
|
$ |
10,280 |
|
| |
|
|
Income from operations:
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
7,319 |
|
|
$ |
6,993 |
|
|
Upholstery Fabrics
|
|
|
2,420 |
|
|
|
1,860 |
|
|
Total segment income from operations
|
|
|
9,739 |
|
|
|
8,853 |
|
|
Unallocated corporate expenses
|
|
|
(1,837 |
) |
|
|
(2,399 |
) |
|
Restructuring and related credit
|
|
|
8 |
(3) |
|
|
329 |
(5) |
|
Total income from operations
|
|
|
7,910 |
|
|
|
6,783 |
|
|
Interest expense
|
|
|
(435 |
) |
|
|
(699 |
) |
|
Interest income
|
|
|
87 |
|
|
|
28 |
|
|
Other expense
|
|
|
(83 |
) |
|
|
(617 |
) |
|
Income before income taxes
|
|
$ |
7,479 |
|
|
$ |
5,495 |
|
|
(3)
|
The $8 restructuring credit represents a credit of $15 for employee termination benefits and a charge of $7 for lease termination and other exit costs. This restructuring credit relates to the Upholstery Fabrics segment
|
|
(4)
|
The $14 restructuring related charge represents a charge of $64 for other operating costs associated with a closed plant facility offset by a credit of $50 for the sale of inventory previously reserved for. This restructuring related charge relates to the Upholstery Fabrics segment.
|
|
(5)
|
The $329 restructuring and related credit represents a credit of $169 for employee termination benefits, a credit of $113 for sales proceeds received on equipment with no carrying value, a credit of $61 for lease termination and other exit costs, a credit of $50 for the sale of inventory previously reserved for, offset by a charge of $64 for other operating costs associated with a closed plant facility. Of this total restructuring and related credit, a credit of $343 was recorded in restructuring credit and charge of $14 was recorded in cost of sales. This restructuring and related credit relates to the Upholstery Fabrics segment.
|
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Balance sheet information for the company’s operating segments follow:
| |
|
|
|
|
|
|
|
(dollars in thousands)
|
|
October 31, 2010
|
|
|
May 2, 2010
|
|
|
Segment assets:
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
|
|
|
|
|
|
Current assets (6)
|
|
$ |
23,491 |
|
|
$ |
22,307 |
|
|
Assets held for sale
|
|
|
34 |
|
|
|
34 |
|
|
Non-compete agreements, net
|
|
|
626 |
|
|
|
843 |
|
|
Goodwill
|
|
|
11,462 |
|
|
|
11,462 |
|
|
Property, plant and equipment (7)
|
|
|
29,592 |
|
|
|
26,720 |
|
|
Total mattress fabrics assets
|
|
|
65,205 |
|
|
|
61,366 |
|
|
Upholstery Fabrics
|
|
|
|
|
|
|
|
|
|
Current assets (6)
|
|
|
20,754 |
|
|
|
23,517 |
|
|
Assets held for sale
|
|
|
89 |
|
|
|
89 |
|
|
Property, plant and equipment (8)
|
|
|
959 |
|
|
|
989 |
|
|
Total upholstery fabrics assets
|
|
|
21,802 |
|
|
|
24,595 |
|
|
Total segment assets
|
|
|
87,007 |
|
|
|
85,961 |
|
|
Non-segment assets:
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
|
15,262 |
|
|
|
18,295 |
|
|
Short-term investments
|
|
|
4,035 |
|
|
|
3,023 |
|
|
Income taxes receivable
|
|
|
477 |
|
|
|
728 |
|
|
Deferred income taxes
|
|
|
1,567 |
|
|
|
474 |
|
|
Other current assets
|
|
|
1,234 |
|
|
|
1,698 |
|
|
Property, plant and equipment (9)
|
|
|
674 |
|
|
|
694 |
|
|
Other assets
|
|
|
1,652 |
|
|
|
1,725 |
|
|
Total assets
|
|
$ |
111,908 |
|
|
$ |
112,598 |
|
| |
|
| |
|
| |
|
Six months ended
|
|
|
(dollars in thousands)
|
|
October 31, 2010
|
|
November 1, 2009 |
|
|
Capital expenditures (10):
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
4,720 |
|
|
$ |
1,753 |
|
|
Upholstery Fabrics
|
|
|
120 |
|
|
|
- |
|
|
Unallocated Corporate
|
|
|
110 |
|
|
|
23 |
|
|
Total capital expenditures
|
|
$ |
4,950 |
|
|
$ |
1,776 |
|
|
Depreciation expense:
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
1,822 |
|
|
$ |
1,779 |
|
|
Upholstery Fabrics
|
|
|
275 |
|
|
|
273 |
|
|
Total depreciation expense
|
|
|
2,097 |
|
|
|
2,052 |
|
|
(6)
|
Current assets represent accounts receivable and inventory for the respective segment.
|
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
(7)
|
The $29.6 million at October 31, 2010, represents property, plant, and equipment of $20.8 million and $8.8 million located in the U.S. and Canada, respectively. The $26.7 million at May 2, 2010, represents property, plant, and equipment of $18.8 million and $7.9 million located in the U.S. and Canada, respectively.
|
|
(8)
|
The $959 at October 31, 2010, represents property, plant, and equipment of $767 and $192 located in the U.S. and China, respectively. The $989 at May 2, 2010, represents property, plant, and equipment located in the U.S. of $887 and China of $102, respectively.
|
|
(9)
|
The $674 and $694 at October 31, 2010 and May 2, 2010, represent property, plant, and equipment associated with unallocated corporate departments and corporate departments shared by both the mattress and upholstery fabric segments. Property, plant, and equipment associated with corporate are located in the U.S.
|
|
(10)
|
Capital expenditure amounts are stated on the accrual basis. See Consolidated Statement of Cash Flows for capital expenditure amounts on a cash basis.
|
16. Income Taxes
Effective Income Tax Rate
We recorded an income tax benefit of $270,000, or (3.6)% of income before income tax expense, for the six-month period ended October 31, 2010, compared to income tax expense of $740,000 or 13.5% of income before income tax expense, for the six-month period ended November 1, 2009. Our effective income tax rates for the six-month periods ended October 31, 2010, and November 1, 2009, 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 affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and foreign sources versus annual projections, as well as changes in foreign currencies in relation to the U.S. dollar.
The income tax expense for the six-month period ended October 31, 2010, is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
●
|
The income tax rate was reduced by 37% for a reduction in our valuation allowance recorded against our net deferred tax assets. Of this 37% reduction in our income tax rate, 20% and 17% pertain to the company’s operations located in the U.S. and China, respectively. The 20% reduction in our income tax rate from our U.S. operations is due to the realization of our U.S. net deferred tax assets from ordinary taxable income projected for fiscal 2011. Since the realization of our U.S. net deferred tax assets are from ordinary taxable income in the current fiscal year, its tax effects are included in the computation of the annual effective rate for fiscal 2011. The 17% reduction in our income tax rate from our China operations is due to a change in judgment about the realization of our China net deferred tax assets in future years. Since the realization of our China net deferred tax assets is a result of a change in judgment about future years, we recorded an adjustment of $1.3 million that represents a discrete event in which the full tax effects were recorded for three-month and six-month periods ended October 31, 2010.
|
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
●
|
The income tax rate was reduced by 6% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
●
|
The income tax rate was reduced by 4% for adjustments made to our Canadian deferred tax liabilities and associated with our election to file our Canadian income tax returns in U.S. dollars commencing with our fiscal 2011 tax year. Our Canadian income tax returns were filed in Canadian dollars for fiscal years prior to fiscal 2011. This adjustment totaled $315,000 and represents a discrete event in which the full tax effects were recorded during the six-month period ended October 31, 2010.
|
|
●
|
The income tax rate increased 9% for an increase in unrecognized tax benefits. This 9% increase in the income tax rate also includes an income tax benefit of $58,000 or a reduction in the income tax rate of 0.8% for the subsequent recognition of unrecognized tax benefits that were effectively settled during the second quarter of fiscal 2011. This adjustment of $58,000 represents a discrete event in which the full tax effects were recorded during the three-month and six-month periods ended October 31, 2010.
|
|
●
|
The income tax rate was increased by 0.4% for stock-based compensation and other miscellaneous items.
|
The income tax expense for the six-month period ending November 1, 2009, is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
●
|
The income tax rate was reduced by 34% for a reduction in the valuation allowance recorded against substantially all of the company’s net deferred tax assets. This reduction in the valuation allowance is primarily due to the U.S. taxable income generated by the repatriation of undistributed earnings from our subsidiaries located in China and the resulting utilization of the U.S. net operating loss carryforwards.
|
|
●
|
The income tax rate was reduced by 10% for the tax effects of foreign exchange losses on U.S. denominated account balances in which income taxes are paid in Canadian dollars. The Canadian foreign exchange rate in relation to the U.S. dollar has been very volatile due to global economic conditions.
|
|
●
|
The income tax rate was reduced by 6% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
●
|
The income tax rate increased 17% for the recording of a deferred tax liability for estimated U.S. income taxes that will be payable upon anticipated future repatriation of undistributed earnings from our subsidiaries located in China. During the first quarter of fiscal 2010, we received authorization from the Chinese government to repatriate additional funds that would not be subject to withholding taxes payable in China.
|
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
●
|
The income tax rate increased 11% for an increase in income tax reserves for unrecognized tax benefits.
|
|
●
|
The income tax rate increased 1.5% for stock-based compensation and other miscellaneous items.
|
Deferred Income Taxes
In accordance with ASC Topic 740, we evaluate our deferred income taxes each reporting period to determine if a valuation allowance is required. ASC Topic 740 requires that companies assess whether a valuation allowance is necessary based on the consideration of all available positive and negative evidence using a “more likely than not” standard, with significant weight being given to evidence that can be objectively verified compared with evidence that represents future events and therefore, is more subjective. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, taking into account the effects of local tax law.
United States
Our net deferred tax asset regarding our U.S. operations primarily pertains to incurring significant U.S. pre-tax losses over the last several years, with U.S. loss carryforwards totaling $64.0 million at May 2, 2010. Due to the favorable results of our multi-year restructuring process in our upholstery fabric operations and key acquisitions and capital investments made for our mattress fabrics segment, on a cumulative three-year basis ending October 31, 2010, our U.S. operations have earned a marginal pre-tax income (achieved in the second quarter of fiscal 2011). Although our U.S. operations have earned a marginal pre-tax income on a cumulative three-year basis ending October 31, 2010, this did not represent sufficient positive evidence to demonstrate future pre-tax income, due to the significance of the cumulative pre-tax losses that have been incurred over a much longer time period. In addition, the significant uncertainty in the current and expected demand for furniture and mattresses, increasing raw material prices in both our upholstery and mattress businesses, and the prevailing uncertainty in the overall economic climate, has made it very difficult to forecast our financial results associated with our U.S. operations. Based on the significant negative evidence noted above, we maintained our position that it is more-likely-than-not that our U.S. net deferred tax assets will not be fully recovered. As a result, we recorded a full valuation allowance totaling $20.6 million against our U.S. net deferred tax assets as of October 31, 2010.
China
Our net deferred tax asset regarding our China operations primarily pertains to the book versus tax basis difference associated with our China operations’ fixed assets. This book versus tax basis difference resulted from our impairment losses and fixed asset write-downs associated with our September 2008 upholstery fabrics restructuring plan. In order for this net deferred tax asset to be realized, our China operations must have sufficient pre-tax income levels to utilize tax depreciation expense each of the next four fiscal years. Due to the favorable results from our restructuring activities and profit improvement plan initiated in the second quarter of fiscal 2009, our China operations have been profitable, reporting pre-tax income of $3.6 million for the first two quarters of fiscal 2011 and $7.9 million in fiscal 2010. In addition, our China operations have earned a pre-tax income of $6.8 million over a cumulative three-year period ending October 31, 2010. As a result of the improvement of our China operations’ pre-tax income levels that have been demonstrated over a cumulative period of three-years, there is sufficient positive evidence that our China operations can provide sufficient pre-tax income levels to utilize tax depreciation expense each of the next four fiscal years. Based on this significant positive evidence, we did not record a valuation allowance against our China net deferred tax assets at October 31, 2010, and recognized an income tax benefit of $1.3 million in the second quarter of fiscal 2011 to reduce the valuation allowance of $1.3 million recorded at May 2, 2010 (the beginning of our fiscal year). The $1.3 million income tax benefit was treated as a discrete event in which the full tax effects of this adjustment were recorded in the three-month and six-month periods ended October 31, 2010 as it pertained to a change in judgment about future years.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Overall
The recorded valuation allowance of $20.6 million has no effect on our operations, loan covenant compliance, or the possible realization of the U.S. income tax loss carryforwards in the future. If it is determined that it is more-likely-than-not that we will realize any of these U.S. income tax loss carryforwards, an income tax benefit would be recognized at that time.
At October 31, 2010, the current deferred tax asset of $176,000 represents $78,000 and $98,000 from our operations located in Canada and China, respectively. At May 2, 2010, the current deferred tax asset of $150,000 represents $84,000 and $66,000 from our operations located in Canada and China, respectively. At October 31, 2010, the non-current deferred tax asset of $1.4 million pertains to our operations located in China. At May 2, 2010, the non-current deferred tax asset of $324,000 pertains to our operations located in China. At October 31, 2010, the non-current deferred tax liability of $622,000 pertains to our operations located in Canada. May 2, 2010, the non-current deferred tax liability of $982,000 pertains to our operations located in Canada.
Uncertainty In Income Taxes
At October 31, 2010, we had $10.8 million of total gross unrecognized tax benefits, of which $3.9 million represents the amount of gross unrecognized tax benefits that, if recognized would favorably affect the income tax rate in future periods. Of the $10.8 million in gross unrecognized tax benefits as of October 31, 2010, $6.9 million were classified as net non-current deferred income taxes and $3.9 million were classified as income taxes payable –long-term in the accompanying consolidated balance sheets.
We estimate that the amount of gross unrecognized tax benefits will increase by approximately $1.5 million for fiscal 2011. This increase primarily relates to double taxation under applicable tax treaties with foreign tax jurisdictions.
17. Statutory Reserves
Our 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 October 31, 2010, the company’s statutory surplus reserve was $2.5 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.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Our subsidiaries located in China can transfer funds to the parent company with the exception of the statutory surplus reserve of $2.5 million to assist with debt repayment, capital expenditures, and other expenses of the company’s business.
18. Commitments and Contingencies
We 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. We continued to make our 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 paid lease payments through March 10, 2008 but the Landlord has not accepted the company’s position. We 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. We dispute the matters described in this litigation and intend to defend ourself vigorously. For these reasons noted above and because management does not believe there is a liability, no reserve has been recorded.
A lawsuit was filed against us 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 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. we leased and operated the Site as part of our 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, plus unspecified future environmental costs. 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 plaintiffs also assert that we tortiously interfered with contracts between them and other defendants in the case and diverted assets to prevent the plaintiffs from being paid monies owed to them. We do not believe we have any liability for the matters described in this litigation and intend to defend ourselves vigorously. In addition, we have an indemnification agreement with certain other defendants in the litigation pursuant to which the other defendants agreed to indemnify us for any damages we incur as a result of the environmental matters that are subject of this litigation, although it is unclear whether the indemnitors have significant assets at this time. For these reasons, no reserve has been recorded.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.
At October 31, 2010, the company had open purchase commitments to acquire equipment with regards to its mattress fabrics segment totaling $258,000.
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, income taxes, 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. 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 15, 2010 for the fiscal year ended May 2, 2010.
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.
General
Our fiscal year is the 52 or 53 week period ending on the Sunday closest to April 30. The six months ended October 31, 2010, and November 1, 2009, represent 26 week periods, respectively. Our operations are classified into two business segments: mattress fabrics and upholstery fabrics. The mattress fabrics segment manufacturers, sources and sells fabrics primarily to bedding manufacturers. The upholstery fabrics segment sources, manufactures and sells fabrics primarily to residential and 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.
We evaluate the operating performance of our segments based upon income (loss) from operations before restructuring and related charges or credits, certain unallocated corporate expenses, and other non-recurring items. Cost of sales in both segments include costs to manufacture or source our products, including costs such as raw material and finished goods purchases, direct and indirect labor, overhead and incoming freight charges. 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 non-compete agreements associated with certain acquisitions in its segment assets. The upholstery fabrics segment also includes assets held for sale in its segment assets.
Executive Summary
Net sales were $48.9 million for the second quarter of fiscal 2011, a decrease of 2% compared with $49.7 million for the second quarter of fiscal 2010. Net sales were $104.8 million for the six months ended October 31, 2010, an increase of 10% compared with $95.2 million for the six months ended November 1, 2009. Our increase in net sales on a year-to-date basis was primarily driven by strong consumer demand in the first quarter of fiscal 2011 for both bedding and furniture products. Net sales in the first quarter of fiscal 2011 increased 23% compared with the first quarter of fiscal 2010. However, net sales in the second quarter of fiscal 2011 decreased 13% from $55.9 million in the first quarter of fiscal 2011. This decrease reflects a much weaker U.S. retail environment than the first quarter of fiscal 2011. We believe the weakening U.S. retail environment is a result of the uncertainties surrounding the economic outlook, a continued weak housing market, and high unemployment. This trend is expected to continue into the company’s third quarter of fiscal 2011.
Income before income taxes was $3.2 million for the second quarter of fiscal 2011 compared with $3.5 million for the second quarter of fiscal 2010. Income before income taxes was $7.5 million for the six months ended October 31, 2010 an increase of 36% compared with $5.5 million for the six months ended November 1, 2009. Our increase in income before income taxes on a year-to-date basis was driven by strong consumer demand in the first quarter of fiscal 2011 and the benefits of a leaner and more cost-efficient operating platform. However, the second quarter results reflect a weakening U.S. retail environment, rising raw material costs, and increased competitive customer pricing pressure in both our business segments. These trends are expected to continue into the company’s third quarter of fiscal 2011.
Net income was $4.0 million, or $0.30 per diluted share, in the second quarter of fiscal 2011 compared with $2.9 million, or $0.22 per diluted share, in the second quarter of fiscal 2010. Net income for the second quarter of fiscal 2011 includes an income tax benefit of $801,000 and net income for the second quarter of fiscal 2010 includes income tax expense of $625,000. Net income was $7.7 million, or $0.59 per diluted share, for the six months ended October 31, 2010 compared with $4.8 million, or $0.37 per diluted share for the six months ended November 1, 2009. Net income for the six months ended October 31, 2010 includes an income tax benefit of $270,000 and net income for the six months ended November 1, 2009 includes income tax expense of $740,000. The income tax benefits of $801,000 and $270,000 for the second quarter of fiscal 2011 and the six months ended October 31, 2010, respectively, reflect a $1.3 million non-cash reversal during the second quarter of the company’s valuation allowance associated with its China operations.
Despite the ongoing economic uncertainties, we have maintained a strong financial position. Our cash and cash equivalents and short-term investment balance totaled $19.3 million at October 31, 2010 compared with $21.3 million at May 2, 2010. Our cash and cash equivalents and short-term investment balance of $19.3 million exceeded our total debt (current maturities of long-term debt and long-term debt) of $11.6 million. Our next major scheduled long-term debt principal payment of $2.2 million is not due until August 2011. As of October 31, 2010, our lines of credit totaling $12.5 million had no outstanding balances. All of our long-term debt and line of credit agreements are unsecured.
In the upholstery fabrics segment, we are expanding our global presence with greater emphasis in Europe and other international markets. In the third quarter of fiscal 2011, we formed a subsidiary known as Culp Europe Sp. z.o.o. incorporated in Poland. Culp Europe intends to lease a building by January 2011 and begin sales and distribution activities at that location in early 2011.
The following tables set forth the company’s statement of operations by segment for the three and six months ended October 31, 2010, and November 1, 2009.
|
CULP, INC.
|
|
|
STATEMENTS OF OPERATIONS BY SEGMENT
|
|
|
FOR THE THREE MONTHS ENDED OCTOBER 31, 2010 AND NOVEMBER 1, 2009
|
|
|
(Unaudited)
|
|
|
(Amounts in thousands)
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
THREE MONTHS ENDED
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Amounts
|
|
|
|
|
|
Percent of Total Sales
|
|
| |
|
October 31,
|
|
|
November 1,
|
|
|
% Over
|
|
|
October 31,
|
|
|
November 1,
|
|
|
Net Sales by Segment
|
|
2010
|
|
|
2009
|
|
|
(Under)
|
|
|
2010
|
|
|
2009
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
28,335 |
|
|
|
28,202 |
|
|
|
0.5 |
% |
|
|
58.0 |
% |
|
|
56.7 |
% |
|
Upholstery Fabrics
|
|
|
20,544 |
|
|
|
21,514 |
|
|
|
(4.5 |
)% |
|
|
42.0 |
% |
|
|
43.3 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$ |
48,879 |
|
|
|
49,716 |
|
|
|
(1.7 |
)% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
Gross Profit by Segment
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit Margin
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
5,030 |
|
|
|
5,896 |
|
|
|
|
(14.7 |
)% |
|
|
17.8 |
% |
|
|
20.9 |
% |
|
Upholstery Fabrics
|
|
|
2,579 |
|
|
|
3,281 |
|
|
|
|
(21.4 |
)% |
|
|
12.6 |
% |
|
|
15.3 |
% |
|
Subtotal
|
|
|
7,609 |
|
|
|
9,177 |
|
|
|
|
(17.1 |
)% |
|
|
15.6 |
% |
|
|
18.5 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring related charges
|
|
|
- |
|
|
|
(43 |
) |
(1) |
|
|
(100.0 |
)% |
|
|
0.0 |
% |
|
|
(0.1 |
)% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
$ |
7,609 |
|
|
|
9,134 |
|
|
|
|
(16.7 |
)% |
|
|
15.6 |
% |
|
|
18.4 |
% |
|
Selling, General and Administrative expenses by Segment
|
|
|
|
|
|
|
|
Percent of Sales
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
1,704 |
|
|
|
1,856 |
|
|
|
(8.2 |
)% |
|
|
6.0 |
% |
|
|
6.6 |
% |
|
Upholstery Fabrics
|
|
|
1,777 |
|
|
|
2,183 |
|
|
|
(18.6 |
)% |
|
|
8.6 |
% |
|
|
10.1 |
% |
|
Unallocated Corporate expenses
|
|
|
721 |
|
|
|
1,346 |
|
|
|
(46.4 |
)% |
|
|
1.5 |
% |
|
|
2.7 |
% |
|
Selling, General and Administrative expenses
|
|
|
4,202 |
|
|
|
5,385 |
|
|
|
(22.0 |
)% |
|
|
8.6 |
% |
|
|
10.8 |
% |
|
Operating Income (loss) by Segment
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income (Loss) Margin
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
3,326 |
|
|
|
4,041 |
|
|
|
|
(17.7 |
)% |
|
|
11.7 |
% |
|
|
14.3 |
% |
|
Upholstery Fabrics
|
|
|
802 |
|
|
|
1,097 |
|
|
|
|
(26.9 |
)% |
|
|
3.9 |
% |
|
|
5.1 |
% |
|
Unallocated corporate expenses
|
|
|
(721 |
) |
|
|
(1,346 |
) |
|
|
|
(46.4 |
)% |
|
|
(1.5 |
)% |
|
|
(2.7 |
)% |
|
Subtotal
|
|
|
3,407 |
|
|
|
3,792 |
|
|
|
|
(10.2 |
)% |
|
|
7.0 |
% |
|
|
7.6 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring and related credit
|
|
|
- |
|
|
|
141 |
|
(2) |
|
|
(100.0 |
)% |
|
|
0.0 |
% |
|
|
0.3 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$ |
3,407 |
|
|
|
3,933 |
|
|
|
|
(13.4 |
)% |
|
|
7.0 |
% |
|
|
7.9 |
% |
|
Depreciation by Segment
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
944 |
|
|
|
880 |
|
|
|
7.3 |
% |
|
|
Upholstery Fabrics
|
|
|
139 |
|
|
|
240 |
|
|
|
(42.1 |
)% |
|
|
Subtotal
|
|
|
1,083 |
|
|
|
1,120 |
|
|
|
(3.3 |
)% |
|
|
Notes:
|
| |
|
|
(1)
|
The $43 restructuring related charge represents other operating costs associated with a closed plant facility.
|
| |
|
|
(2)
|
The $141 restructuring and related credit represents a credit of $200 for employee termination benefits, offset by a charge of $43 for other operating costs associated with a closed plant facility, and a charge of $16 for lease termination and other exit costs. Of this total credit, a credit of $184 was recorded in restructuring credit and a charge of $43 was recorded in cost of sales.
|
|
CULP, INC.
|
|
STATEMENTS OF OPERATIONS BY SEGMENT
|
|
FOR THE SIX MONTHS ENDED OCTOBER 31, 2010 AND NOVEMBER 1, 2009
|
|
(Unaudited)
|
|
(Amounts in thousands)
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
SIX MONTHS ENDED
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Amounts
|
|
|
|
|
|
|
|
Percent of Total Sales
|
| |
|
October 31,
|
|
|
|
|
November 1,
|
|
|
|
|
% Over
|
|
|
October 31,
|
|
|
November 1,
|
|
|
Net Sales by Segment
|
|
2010
|
|
|
|
|
2009
|
|
|
|
|
(Under)
|
|
|
2010
|
|
|
2009
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
59,253 |
|
|
|
|
|
54,476 |
|
|
|
|
|
8.8 |
% |
|
|
56.5 |
% |
|
|
57.2 |
% |
|
Upholstery Fabrics
|
|
|
45,538 |
|
|
|
|
|
40,717 |
|
|
|
|
|
11.8 |
% |
|
|
43.5 |
% |
|
|
42.8 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$ |
104,791 |
|
|
|
|
|
95,193 |
|
|
|
|
|
10.1 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit by Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit Margin
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
11,020 |
|
|
|
|
|
10,658 |
|
|
|
|
|
3.4 |
% |
|
|
18.6 |
% |
|
|
19.6 |
% |
|
Upholstery Fabrics
|
|
|
6,298 |
|
|
|
|
|
6,076 |
|
|
|
|
|
3.7 |
% |
|
|
13.8 |
% |
|
|
14.9 |
% |
|
Subtotal
|
|
|
17,318 |
|
|
|
|
|
16,734 |
|
|
|
|
|
3.5 |
% |
|
|
16.5 |
% |
|
|
17.6 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring related charges
|
|
|
- |
|
|
|
|
|
(14 |
) |
|
(2) |
|
|
(100.0 |
) % |
|
|
0.0 |
% |
|
|
(0.0 |
) % |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit
|
|
$ |
17,318 |
|
|
|
|
|
16,720 |
|
|
|
|
|
3.6 |
% |
|
|
16.5 |
% |
|
|
17.6 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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| |
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|
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|
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|
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|
|
|
|
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|
|
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|
Selling, General and Administrative expenses by Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent of Sales
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
3,701 |
|
|
|
|
|
3,665 |
|
|
|
|
|
1.0 |
% |
|
|
6.2 |
% |
|
|
6.7 |
% |
|
Upholstery Fabrics
|
|
|
3,878 |
|
|
|
|
|
4,216 |
|
|
|
|
|
(8.0 |
) % |
|
|
8.5 |
% |
|
|
10.4 |
% |
|
Unallocated Corporate expenses
|
|
|
1,837 |
|
|
|
|
|
2,399 |
|
|
|
|
|
(23.4 |
) % |
|
|
1.8 |
% |
|
|
2.5 |
% |
|
Subtotal
|
|
|
9,416 |
|
|
|
|
|
10,280 |
|
|
|
|
|
(8.4 |
) % |
|
|
9.0 |
% |
|
|
10.8 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income (loss) by Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income (Loss) Margin
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
7,319 |
|
|
|
|
|
6,993 |
|
|
|
|
|
4.7 |
% |
|
|
12.4 |
% |
|
|
12.8 |
% |
|
Upholstery Fabrics
|
|
|
2,420 |
|
|
|
|
|
1,860 |
|
|
|
|
|
30.1 |
% |
|
|
5.3 |
% |
|
|
4.6 |
% |
|
Unallocated corporate expenses
|
|
|
(1,837 |
) |
|
|
|
|
(2,399 |
) |
|
|
|
|
(23.4 |
) % |
|
|
(1.8 |
) % |
|
|
(2.5 |
) % |
|
Subtotal
|
|
|
7,902 |
|
|
|
|
|
6,454 |
|
|
|
|
|
22.4 |
% |
|
|
7.5 |
% |
|
|
6.8 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructuring and related credit
|
|
|
8 |
|
|
(1) |
|
|
329 |
|
|
(3) |
|
|
97.6 |
% |
|
|
0.0 |
% |
|
|
0.3 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
$ |
7,910 |
|
|
|
|
|
6,783 |
|
|
|
|
|
16.6 |
% |
|
|
7.5 |
% |
|
|
7.1 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation by Segment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mattress Fabrics
|
|
$ |
1,822 |
|
|
|
|
|
1,779 |
|
|
|
|
|
2.4 |
% |
|
|
|
|
|
|
|
|
|
Upholstery Fabrics
|
|
|
275 |
|
|
|
|
|
273 |
|
|
|
|
|
0.7 |
% |
|
|
|
|
|
|
|
|
|
Subtotal
|
|
|
2,097 |
|
|
|
|
|
2,052 |
|
|
|
|
|
2.2 |
% |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes:
|
| |
|
| (1) |
The $8 restructuring credit primarily represents a credit of $15 for employee termination benefits and a charge of $7 for lease termination and other exit costs.
|
| |
|
| (2) |
The $14 restructuring related charge represents a charge of $64 for other operating costs associated with a closed plant facility offset by a credit of $50 for the sale of inventory previously reserved for.
|
| |
|
| (3) |
The $329 restructuring and related credit represents a credit of $169 for employee termination benefits, a credit of $113 for sales proceeds received on equipment with no carrying value, a credit of $61 for lease termination and other exit costs, a credit of $50 for the sale of inventory previously reserved for, offset by a charge of $64 for other operating costs associated with a closed plant facility.
|
Three and Six months ended October 31, 2010 compared with the Three and Six Months ended November 1, 2009
Mattress Fabrics Segment
Net Sales
Net sales were $28.3 million for the second quarter of fiscal 2011 compared with $28.2 million for the second quarter of fiscal 2010. Although net sales were relatively flat compared with the prior period, these results were achieved in spite of weakening consumer demand in the bedding industry and the planned discontinuance of a product line. Continuing product lines increased 7% in the second quarter of fiscal 2011 compared with the second quarter of fiscal 2010.
Net sales were $59.3 million for the six months ended October 31, 2010, an increase of 9% compared with $54.5 million for the six months ended November 1, 2009. This increase in net sales reflects the strong consumer demand in the bedding industry in the first two months of this fiscal year and the closure of a key competitor in late calendar 2009. Although net sales increased 9% on a year-to-date basis, the second quarter results reflect weakening consumer demand in the bedding industry. This trend is expected to continue into the company’s third quarter of fiscal 2011.
Gross Profit and Operating Income
Gross profit was $5.0 million for the second quarter of fiscal 2011, or 18% of net sales, compared with $5.9 million, or 21% of net sales for the second quarter of fiscal 2010. Selling, general, and administrative expenses (SG&A) for the second quarter of fiscal 2011 was $1.7 million compared with $1.9 million for the second quarter of fiscal 2010. Operating income was $3.3 million for the second quarter of fiscal 2011 compared with $4.0 million for the first quarter of fiscal 2010. Operating margins were 12% and 14% of net sales in the second quarter of fiscal 2011 and 2010, respectively.
Gross profit was $11.0 million for the six months ended October 31, 2010, or 18.6% of net sales, compared with $10.7 million, or 19.6% of net sales for the six months ended November 1, 2009. Selling, general, and administrative expenses (SG&A) was $3.7 million for the six month periods ended October 31, 2010 and November 1, 2009, respectively. Operating income was $7.3 million for the six months ended October 31, 2010, compared with $7.0 million for the six months ended November 1, 2009. Operating margins were 12.4% and 12.8% of net sales for the six month periods ending October 31, 2010 and November 1, 2009, respectively.
Although net sales remained flat in the second quarter of fiscal 2011 compared with the second quarter of fiscal 2010, gross profit and operating margins decreased when comparing the two quarters. In addition, gross profit and operating margins decreased slightly for the six month period ending October 31, 2010 compared with the six month period ending November 1, 2009, despite net sales increasing 9% for the same year over year period. This trend in decreased profitability was due to increased competitive customer pricing pressure and higher raw material costs experienced primarily in the second quarter of fiscal 2011. These trends are expected to continue into the company’s third quarter of fiscal 2011.
During fiscal 2011, we completed a multi-year expansion of our mattress fabrics business which included the expansion of internal production capacity for our knitted fabrics product line, our fastest growing product category, and the completion of an energy initiative in our Canadian operation that will have an environmental benefit and reduce future operating costs. The total investment for this multi-year expansion totaled $45 million, which included $25 million in capital expenditures and $20 million spent for two successful acquisitions. As a result of these investments, we are well positioned with a large and modern vertically integrated manufacturing platform in the two major product categories of the mattress fabrics industry and have been able to substantially improve our supply logistics from pattern inception to fabric delivery.
Segment assets
Segment assets consist of accounts receivable, inventory, assets held for sale, non-compete agreements associated with the certain acquisitions, goodwill, and property, plant, and equipment.
As of October 31, 2010, accounts receivable and inventory totaled $23.5 million compared with $22.3 million at May 2, 2010.
As of October 31, 2010, property, plant and equipment totaled $29.6 million compared with $26.7 million at May 2, 2010. The $29.6 million at October 31, 2010, represents property, plant, and equipment of $20.8 million and $8.8 million located in the U.S. and Canada, respectively. The $26.7 million at May 2, 2010, represents property, plant, and equipment of $18.8 million and $7.9 million located in the U.S. and Canada, respectively. The increase in property, plant, and equipment during fiscal 2011 represents capital expenditures of $4.7 million for the capital investment programs noted above, offset by depreciation of $1.8 million.
As of October 31, 2010 and May 2, 2010, the carrying value of the segment’s goodwill was $11.5 million. As of October 31, 2010, and May 2, 2010, the carrying values of the non-compete agreements were $626,000 and $843,000, respectively. At October 31, 2010 and May 2, 2010, assets held for sale totaled $34,000.
Upholstery Fabrics Segment
Net Sales
Upholstery fabric net sales for the second quarter of fiscal 2011 were $20.5 million, a 5% decrease compared with $21.5 million in the second quarter of fiscal 2010. Net sales of upholstery fabrics produced outside our U.S. manufacturing operations were $17.2 million in the second quarter of fiscal 2011, a 4% decrease compared with $17.9 million in the second quarter of fiscal 2010. Net sales of U.S. produced upholstery fabrics were $3.4 million in the second quarter of fiscal 2011, a decrease of 7% from $3.6 million in the second quarter of fiscal 2010. These decreases in net sales reflect weakening U.S. consumer demand for furniture.
Upholstery fabric net sales for the six months ended October 31, 2010 were $45.5 million, a 12% increase compared with $40.7 million for the six months ended November 1, 2009. Net sales of upholstery fabrics produced outside our U.S. manufacturing operations were $39.3 million for the six months ended October 31, 2010 a 15% increase compared with $34.0 million for the six months ended November 1, 2009. Net sales of U.S. produced upholstery fabrics were $6.3 million for the six months ended October 31, 2010, a decrease of 6% from $6.7 million for the six months ended November 1, 2009.
Our increase of 12% in net sales on a year-to-date basis was primarily driven by a stronger consumer demand in the first quarter of fiscal 2011, in which the company experienced an increase of 30% in net sales compared with the first quarter of fiscal 2010, a planned discontinuation of certain U.S. products in fiscal 2010, and a significant increase in the provision for returns, allowances, and discounts in fiscal 2010 that did not recur in fiscal 2011. Although net sales increased 12% on a year-to-date basis, these results reflect a weakening U.S. consumer demand for furniture in comparison to the first quarter of fiscal 2011. Net sales in the second quarter of fiscal 2011 decreased 18% from $25.0 million in the first quarter of fiscal 2011. This trend is expected to continue into the company’s third quarter of fiscal 2011.
Our upholstery fabric net sales continue to be driven by our operations located in China, accounting for 84% and 86% of upholstery fabric net sales in the second quarter of fiscal 2011 and for the six months ended October 31, 2010, respectively. Although most of our China produced products have been traditionally been sold to our U.S. customers, we have expanded our sales to the local China market. The net sales in the local China market have been small, but we are encouraged with the favorable customer response and the ability to leverage these opportunities from our China platform.
In addition, we are expanding our global presence with greater emphasis on sales to customers in Europe and other international markets. In the third quarter of fiscal 2011, we formed a subsidiary known as Culp Europe Sp. z o.o., incorporated in Poland. Culp Europe intends to lease a building by January 2011 near Poznan, Poland. We plan to begin sales and distribution activities at that location in early 2011 for upholstery fabrics sourced primarily from our China platform, but also from the company’s U.S. operations and possibly directly from outside suppliers. Our sales and marketing efforts in Europe also include a program for shipping containers of fabric and cut and sewn kits directly from our operations in China to customers in Europe. The investment required for this initiative will be principally working capital, estimated at 15 to 20% of sales generated, and only a minimal amount of fixed assets (under $100,000) for warehouse equipment and leasehold improvements. There will also be a relatively small amount of SG&A expenses involved in the start up phase of Culp Europe. We expect sales for Culp Europe to begin by the end of the fourth quarter of fiscal 2011.
Gross Profit and Operating Income
The upholstery fabrics segment reported a gross profit of $2.6 million, or 13% of net sales, in the second quarter of fiscal 2011 compared with $3.3 million, or 15% of net sales, in the second quarter of fiscal 2010. Selling, general, and administrative expenses (SG&A) for the second quarter of fiscal 2011 were $1.8 million compared with $2.2 million in the second quarter of fiscal 2010. Operating income was $802,000 in the second quarter of fiscal 2011 compared with operating income of $1.1 million in the second quarter of fiscal 2010. Operating margins were 3.9% and 5.1% of net sales in the second quarter of fiscal 2011 and 2010, respectively.
The upholstery fabrics segment reported a gross profit of $6.3 million, or 13.8% of net sales, for the six months ended October 31, 2010 compared with $6.1 million, or 14.9% of net sales, for the six months ended November 1, 2009. SG&A expenses for the six months ended October 31, 2010 were $3.9 million compared with $4.2 million for the six months ended November 1, 2009. Operating income was $2.4 million for the six months ended October 31, 2010 compared with operating income of $1.9 million for the six months ended November 1, 2009. Operating margins were 5.3% and 4.6% of net sales for the six month periods ending October 31, 2010 and November 1, 2009, respectively.
Although net sales increased 12% for the six months ended October 31, 2010 compared with the six months ended November 1, 2009, gross profit margins decreased and operating margins slightly increased for the same year over year period. In addition, operating income and margins decreased in the second quarter of fiscal 2011 compared with the first quarter of fiscal 2011. Operating income and margins were $1.6 million and 6.5% for the first quarter of fiscal 2011 compared with $802,000 and 3.9% for the second quarter of fiscal 2011. This reduction in profitability is the result of rising raw material costs in addition to the lower sales volume experienced in the second quarter of fiscal 2011. These trends are expected to continue into the company’s third quarter of fiscal 2011. In order to offset some of the raw material price increases, we have implemented customer price increases on certain products.
Segment Assets
Segment assets consist of accounts receivable, inventory, assets held for sale, and property, plant, and equipment. As of October 31, 2010, accounts receivable and inventory totaled $20.8 million compared to $23.5 million at May 2, 2010. At October 31, 2010 and May 2, 2010, assets held for sale totaled $89,000.
As of October 31, 2010, property, plant, and equipment totaled $959,000 compared with $989,000 at May 2, 2010. The $959,000 at October 31, 2010, represents property, plant, and equipment of $767,000 and $192,000 located in the U.S. and China, respectively. The $989,000 at May 2, 2010, represents property, plant, and equipment of $887,000 and $102,000 located in the U.S. and China, respectively.
Other Income Statement Categories
Selling, General and Administrative Expenses
Selling, general, and administrative expenses (SG&A) for the company as a whole were $4.2 million for the second quarter of fiscal 2011 compared with $5.4 million for the second quarter of fiscal 2010. SG&A expenses were 8.6% of net sales in the second quarter of fiscal 2011 compared with 10.8% of net sales in the second quarter of fiscal 2010. SG&A expenses for the company as whole were $9.4 million for the six months ended October 31, 2010 compared with $10.3 million for the six months ended November 1, 2009. SG&A expenses were 9% of net sales for the six months ended October 31, 2010 compared with 10.8% for the six months ended November 1, 2009. This decrease in SG&A expenses primarily pertains to (i) a decrease in stock-based compensation expense which reflects a decrease in stock-based awards and the company’s stock price, (ii) a decrease in incentive bonus accruals reflecting weaker financial results in relation to pre-established performance targets and (iii) a decrease in bad debt expense reflecting the decrease in our consolidated accounts receivable balance, as well as management's assessment of estimated credit exposures within its accounts receivable portfolio.
Interest Expense (Income)
Interest expense for the second quarter of fiscal 2011 was $225,000 compared to $342,000 for the second quarter of fiscal 2010. Interest expense for the six months ended October 31, 2010 was $435,000 compared to $699,000 for the six months ended November 1, 2009. This trend reflects lower outstanding balances in the company’s long-term debt.
Interest income was $49,000 for the second quarter of fiscal 2011 compared to $16,000 for the second quarter of fiscal 2010. Interest income was $87,000 for the six months ended October 31, 2010 compared to $28,000 for the six months ended November 1, 2009. Our increase in interest income is primarily due to higher cash and cash equivalent and short-term investment balances during fiscal 2011 compared with fiscal 2010 and a higher rate of return on short-term investments that were not acquired until the third quarter of fiscal 2010.
Other Expense
Other expense for the second quarter of fiscal 2011 was $30,000 compared with $103,000 for the second quarter of fiscal 2010. Other expense for the six months ended October 31, 2010 was $83,000 compared with $617,000 for the six months ended November 1, 2009. This change primarily reflects fluctuations in the foreign currency exchange rate for our subsidiary domiciled in Canada and our ability to maintain a natural hedge by keeping a balance of our assets and liabilities denominated in Canadian dollars during fiscal 2011.
Income Taxes
Effective Income Tax Rate
We recorded an income tax benefit of $270,000, or (3.6)% of income before income tax expense, for the six-month period ended October 31, 2010, compared to income tax expense of $740,000 or 13.5% of income before income tax expense, for the six-month period ended November 1, 2009. Our effective income tax rates for the six-month periods ended October 31, 2010, and November 1, 2009, 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 affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and foreign sources versus annual projections, as well as changes in foreign currencies in relation to the U.S. dollar.
The income tax expense for the six-month period ended October 31, 2010, is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
●
|
The income tax rate was reduced by 37% for a reduction in our valuation allowance recorded against our net deferred tax assets. Of this 37% reduction in our income tax rate, 20% and 17% pertain to the company’s operations located in the U.S. and China, respectively. The 20% reduction in our income tax rate from our U.S. operations is due to the realization of our U.S. net deferred tax assets from ordinary taxable income projected for fiscal 2011. Since the realization of our U.S. net deferred tax assets are from ordinary taxable income in the current fiscal year, its tax effects are included in the computation of the annual effective rate for fiscal 2011. The 17% reduction in our income tax rate from our China operations is due to a change in judgment about the realization of our China net deferred tax assets in future years. Since the realization of our China net deferred tax assets is a result of a change in judgment about future years, we recorded an adjustment of $1.3 million that represents a discrete event in which the full tax effects were recorded for three-month and six-month periods ended October 31, 2010.
|
|
●
|
The income tax rate was reduced by 6% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
●
|
The income tax rate was reduced by 4% for adjustments made to our Canadian deferred tax liabilities and associated with our election to file our Canadian income tax returns in U.S. dollars commencing with our fiscal 2011 tax year. Our Canadian income tax returns were filed in Canadian dollars for fiscal years prior to fiscal 2011. This adjustment totaled $315,000 and represents a discrete event in which the full tax effects were recorded during the six-month period ended October 31, 2010.
|
|
●
|
The income tax rate increased 9% for an increase in unrecognized tax benefits. This 9% increase in the income tax rate also includes an income tax benefit of $58,000 or a reduction in the income tax rate of 0.8% for the subsequent recognition of unrecognized tax benefits that were effectively settled during the second quarter of fiscal 2011. This adjustment of $58,000 represents a discrete event in which the full tax effects were recorded during the three-month and six-month periods ended October 31, 2010.
|
|
●
|
The income tax rate was increased by 0.4% for stock-based compensation and other miscellaneous items.
|
The income tax expense for the six-month period ending November 1, 2009, is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
●
|
The income tax rate was reduced by 34% for a reduction in the valuation allowance recorded against substantially all of the company’s net deferred tax assets. This reduction in the valuation allowance is primarily due to the U.S. taxable income generated by the repatriation of undistributed earnings from our subsidiaries located in China and the resulting utilization of the U.S. net operating loss carryforwards.
|
|
●
|
The income tax rate was reduced by 10% for the tax effects of foreign exchange losses on U.S. denominated account balances in which income taxes are paid in Canadian dollars. The Canadian foreign exchange rate in relation to the U.S. dollar has been very volatile due to global economic conditions.
|
|
●
|
The income tax rate was reduced by 6% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
●
|
The income tax rate increased 17% for the recording of a deferred tax liability for estimated U.S. income taxes that will be payable upon anticipated future repatriation of undistributed earnings from our subsidiaries located in China. During the first quarter of fiscal 2010, we received authorization from the Chinese government to repatriate additional funds that would not be subject to withholding taxes payable in China.
|
|
●
|
The income tax rate increased 11% for an increase in income tax reserves for unrecognized tax benefits.
|
|
●
|
The income tax rate increased 1.5% for stock-based compensation and other miscellaneous items.
|
Deferred Income Taxes
In accordance with ASC Topic 740, we evaluate our deferred income taxes each reporting period to determine if a valuation allowance is required. ASC Topic 740 requires that companies assess whether a valuation allowance is necessary based on the consideration of all available positive and negative evidence using a “more likely than not” standard, with significant weight being given to evidence that can be objectively verified compared with evidence that represents future events and therefore, is more subjective. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, taking into account the effects of local tax law.
United States
Our net deferred tax asset regarding our U.S. operations primarily pertains to incurring significant U.S. pre-tax losses over the last several years, with U.S. loss carryforwards totaling $64.0 million at May 2, 2010. Due to the favorable results of our multi-year restructuring process in our upholstery fabric operations and key acquisitions and capital investments made for our mattress fabrics segment, on a cumulative three-year basis ending October 31, 2010, our U.S. operations have earned a marginal pre-tax income (achieved in the second quarter of fiscal 2011). Although our U.S. operations have earned a marginal pre-tax income on a cumulative three-year basis ending October 31, 2010, this did not represent sufficient positive evidence to demonstrate future pre-tax income, due to the significance of the cumulative pre-tax losses that have been incurred over a much longer time period. In addition, the significant uncertainty in the current and expected demand for furniture and mattresses, increasing raw material prices in both our upholstery and mattress businesses, and the prevailing uncertainty in the overall economic climate, has made it very difficult to forecast our financial results associated with our U.S. operations. Based on the significant negative evidence noted above, we maintained our position that it is more-likely-than-not that our U.S. net deferred tax assets will not be fully recovered. As a result, we recorded a full valuation allowance totaling $20.6 million against our U.S. net deferred tax assets as of October 31, 2010.
China
Our net deferred tax asset regarding our China operations primarily pertains to the book versus tax basis difference associated with our China operations’ fixed assets. This book versus tax basis difference resulted from our impairment losses and fixed asset write-downs associated with our September 2008 upholstery fabrics restructuring plan. In order for this net deferred tax asset to be realized, our China operations must have sufficient pre-tax income levels to utilize tax depreciation expense each of the next four fiscal years. Due to the favorable results from our restructuring activities and profit improvement plan initiated in the second quarter of fiscal 2009, our China operations have been profitable, reporting pre-tax income of $3.6 million for the first two quarters of fiscal 2011 and $7.9 million in fiscal 2010. In addition, our China operations have earned a pre-tax income of $6.8 million over a cumulative three-year period ending October 31, 2010. As a result of the improvement of our China operations’ pre-tax income levels that have been demonstrated over a cumulative period of three-years, there is sufficient positive evidence that our China operations can provide sufficient pre-tax income levels to utilize tax depreciation expense each of the next four fiscal years. Based on this significant positive evidence, we did not record a valuation allowance against our China net deferred tax assets at October 31, 2010, and recognized an income tax benefit of $1.3 million in the second quarter of fiscal 2011 to reduce the valuation allowance of $1.3 million recorded at May 2, 2010 (the beginning of our fiscal year). The $1.3 million income tax benefit was treated as a discrete event in which the full tax effects of this adjustment were recorded in the three-month and six-month periods ended October 31, 2010 as it pertained to a change in judgment about future years.
Overall
The recorded valuation allowance of $20.6 million has no effect on our operations, loan covenant compliance, or the possible realization of the U.S. income tax loss carryforwards in the future. If it is determined that it is more-likely-than-not that we will realize any of these U.S. income tax loss carryforwards, an income tax benefit would be recognized at that time.
At October 31, 2010, the current deferred tax asset of $176,000 represents $78,000 and $98,000 from our operations located in Canada and China, respectively. At May 2, 2010, the current deferred tax asset of $150,000 represents $84,000 and $66,000 from our operations located in Canada and China, respectively. At October 31, 2010, the non-current deferred tax asset of $1.4 million pertains to our operations located in China. At May 2, 2010, the non-current deferred tax asset of $324,000 pertains to our operations located in China. At October 31, 2010, the non-current deferred tax liability of $622,000 pertains to our operations located in Canada. May 2, 2010, the non-current deferred tax liability of $982,000 pertains to our operations located in Canada.
Uncertainty In Income Taxes
At October 31, 2010, we had $10.8 million of total gross unrecognized tax benefits, of which $3.9 million represents the amount of gross unrecognized tax benefits that, if recognized would favorably affect the income tax rate in future periods. Of the $10.8 million in gross unrecognized tax benefits as of October 31, 2010, $6.9 million were classified as net non-current deferred income taxes and $3.9 million were classified as income taxes payable –long-term in the accompanying consolidated balance sheets.
We estimate that the amount of gross unrecognized tax benefits will increase by approximately $1.5 million for fiscal 2011. This increase primarily relates to double taxation under applicable tax treaties with foreign tax jurisdictions.
Liquidity and Capital Resources
Liquidity
Our sources of liquidity include cash and cash equivalents, short-term investments, cash flow from operations, and amounts available under our unsecured revolving credit lines. We believe these will be sufficient to fund our foreseeable business needs, capital expenditures and other contractual obligations.
Our cash and cash equivalents and short-term investment balance totaled $19.3 million at October 31, 2010, compared with $21.3 million at May 2, 2010. This decrease reflects planned cash capital expenditures of $5.1 million mostly related to our mattress fabrics segment, offset by cash flow provided by operating activities of $2.6 million, and cash proceeds from the issuance of common stock totaling $511,000.
Despite the ongoing economic uncertainties, we have maintained a strong financial position. Our cash and cash equivalents and short-term investment balance of $19.3 million exceeded our total debt (current maturities of long-term debt and long-term debt) of $11.6 million. Our next major scheduled long-term debt principal payment of $2.2 million is not due until August 2011. As of October 31, 2010, our lines of credit totaling $12.5 million had no outstanding balances. All of our long-term debt and line of credit agreements are unsecured.
Our cash and cash equivalents and short-term investment balance may be adversely affected by factors beyond our control, such as weakening industry demand and delays in receipt of payment on accounts receivable.
Working Capital
Accounts receivable at October 31, 2010, were $14.8 million, a decrease of $2.0 million, or 12%, compared with $16.8 million at November 1, 2009. This decrease primarily reflects a decline in business volume in both our business segments in the second quarter of fiscal 2011 compared with the second quarter of fiscal 2010 and customers associated with the mattress fabrics segment continuing to take advantage of cash discounts for early payments. Days’ sales outstanding totaled 28 and 31 days during the quarter ended October 31, 2010, and November 1, 2009, respectively.
Inventories as of October 31, 2010, were $29.4 million, an increase of $7.6 million, or 35%, in comparison with $21.8 million at November 1, 2009. This increase primarily reflects inventory purchases that were made based on expected demand trends at the beginning of the second quarter that have been slower to materialize as a result of the weakening consumer demand that was much more severe than anticipated in both our business segments. Inventory is expected to decrease by the end of the company’s third quarter of fiscal 2011 as we will utilize inventory on hand to meet future consumer demand. Inventory turns for the second quarter of fiscal 2011 were 5.5 compared with 7.5 for the second quarter of fiscal 2010.
Accounts payable-trade as of October 31, 2010, were $18.0 million, an increase of $1.6 million, or 10% in comparison with $16.4 million at November 1, 2009. This increase primarily reflects increased inventory purchases in both our business segments in the second quarter of fiscal 2011 compared with the second quarter of fiscal 2010.
Operating working capital (comprised of accounts receivable and inventories, less accounts payable-trade and capital expenditures) was $26.0 million at October 31, 2010 compared with $21.6 million at November 1, 2009. Working capital turnover was 8.9 and 7.4 during the quarters ended October 31, 2010, and November 1, 2009, respectively.
Financing Arrangements
Unsecured Term Notes
In connection with the Bodet & Horst acquisition, we entered into a note agreement dated August 11, 2008. This agreement provided 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 August 11, 2011. The principal payments are payable over an average term of 4.8 years through August 11, 2015. This agreement contains customary financial and other covenants as defined in the agreement.
Government of Quebec Loan
We have an agreement with the Government of Quebec for a term loan that is non-interest bearing and is payable in 48 equal monthly installments (denominated in Canadian dollars) commencing December 1, 2009. The proceeds were used to partially finance capital expenditures at our Rayonese facility located in Quebec, Canada.
Revolving Credit Agreement – United States
On August 13, 2010, we entered into a sixteenth amendment to our revolving credit agreement. This agreement currently provides for a loan commitment of $6.5 million, including letters of credit of $3.0 million. This agreement expires August 15, 2012 and provides for a pricing matrix to determine the interest rate payable on loans made under this agreement (applicable interest rate of 2.26% at October 31, 2010). As of October 31, 2010, there were $425,000 in outstanding letters of credit (all of which related to workers compensation). At October 31, 2010 and May 2, 2010, there were no borrowings outstanding under the agreement.
The sixteenth amendment to this revolving credit agreement also increased the annual capital expenditure limit from $4.0 million to $10.0 million.
Revolving Credit Agreement – China
We have an unsecured credit agreement that provides for a line of credit of up to approximately $6.0 million and expires on March 2, 2011. This agreement bears interest at a rate determined by the Chinese government. There were no borrowings outstanding under the agreement as of October 31, 2010 and May 2, 2010.
Overall
Our loan agreements require, among other things, that we maintain compliance with certain financial covenants. At October 31, 2010, the company was in compliance with these financial covenants.
At October 31, 2010, the principal payment requirements of long-term debt during the next five years are: Year 1 – $2.4 million; Year 2 - $2.4 million; Year 3 - $2.4 million; Year 4 - $2.2 million; and Year 5 - $2.2 million.
Capital Expenditures and Depreciation
Capital expenditures on an accrual and cash basis for the six months ended October 31, 2010, were $5.0 million and $5.1 million, respectively. Capital expenditures for the six months ended October 31, 2010, mostly relate to the mattress fabrics segment. Depreciation expense for the six months ended October 31, 2010 was $2.1 million, and primarily relates to the mattress fabrics segment.
For all of fiscal 2011, we currently expect capital expenditures to be approximately $6.5 million. Planned capital expenditures for fiscal 2011 primarily relate to the mattress fabrics segment. With the substantial completion of our capital spending in our mattress fabrics segment, we expect capital spending for the company as a whole to be substantially lower in the foreseeable future. For fiscal 2011, depreciation expense is projected to be $4.4 million, which primarily relates to the mattress fabrics segment.
At October 31, 2010, we had amounts due regarding capital expenditures totaling $253,000, of which $188,000 was vendor-financed and $65,000 was non-vendor financed. Our vendor-financed arrangement bears interest at a fixed interest rate of 7.14%. The total outstanding amount of $253,000 is required to be paid in full during fiscal 2011.
Critical Accounting Policies and Recent Accounting Developments
As of October 31, 2010, there were no changes in the nature of our significant accounting policies or the application of those policies from those reported in our annual report on Form 10-K for the year ended May 2, 2010.
Refer to Note 2 located in the notes to the consolidated financial statements for recently adopted and issued accounting pronouncements since the filing of our Form 10-K for the year ended May 2, 2010.
Contractual Obligations
As of October 31, 2010, there were no significant changes to or new contractual obligations from those reported in our annual report on Form 10-K for the year ended May 2, 2010, with the exception of open purchase commitments to acquire equipment with regard to the mattress fabrics segment totaling $258,000 at October 31, 2010 compared with $3.8 million at May 2, 2010.
Inflation
Any significant increase in our raw material costs, utility/energy costs and general economic inflation could have a material adverse effect on the company, because competitive conditions have limited our ability to pass significant operating increases on to customers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk from changes in interest rates on our revolving credit lines. At October 31, 2010, the company’s U.S. revolving credit agreement provides for a pricing matrix to determine the interest rate payable on loans made under this agreement. The company’s revolving credit line associated with its China subsidiaries bears interest at a rate determined by the Chinese government. At October 31, 2010, there were no borrowings outstanding under these revolving credit lines.
We are not exposed to market risk from changes in interest rates on our long-term debt. The company’s unsecured term notes have a fixed interest rate of 8.01%, and the loan associated with the Government of Quebec is non-interest bearing.
We are exposed to market risk from changes in the value of foreign currencies for our subsidiaries domiciled in China and Canada. On January 21, 2009, we entered into a Canadian dollar foreign exchange contract associated with its loan from the Government of Quebec. The agreement effectively converted the Canadian dollar principal debt payments at a fixed Canadian dollar foreign exchange rate versus the United States dollar of 1.21812 and was due to expire on November 1, 2013. During the first quarter of fiscal 2011, we elected to terminate this contract due to the current favorable Canadian dollar foreign exchange rates in comparison to the fixed contractual rate noted above. Additionally, we try to maintain a natural hedge by keeping a balance of our assets and liabilities denominated in the local currency of our subsidiaries domiciled in China and Canada, although there is no assurance that we will be able to continually maintain this natural hedge. Our 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 October 31, 2010, would not have had a significant impact on our results of operations or financial position.
ITEM 4. CONTROLS AND PROCEDURES
We have conducted an evaluation of the effectiveness of our disclosure controls and procedures as of October 31, 2010, 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 October 31, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.