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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 4, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-7023
QUAKER FABRIC CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-1933106
(State of incorporation) (I.R.S. Employer Identification No.)
941 Grinnell Street, Fall River, Massachusetts 02721
(Address of principal executive offices)
(508) 678-1951
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
As of November 6, 2003, 16,779,568 shares of Registrant's Common Stock,
$0.01 par value, were outstanding.
- --------------------------------------------------------------------------------
PART I---FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
October 4, January 4,
2003 2003
----------- ----------
(Unaudited) (Audited)
ASSETS
Current assets:
Cash and cash equivalents $ 595 $ 1,098
Accounts receivable, less reserves of $1,900 and $1,826 at
October 4, 2003 and January 4, 2003, respectively 49,417 42,346
Inventories 47,023 50,407
Prepaid and deferred income taxes 3,101 4,080
Production supplies 1,607 1,634
Prepaid insurance 1,322 2,130
Other current assets 6,466 6,250
-------- ---------
Total current assets 109,531 107,945
Property, plant and equipment, net 166,044 173,790
Other assets:
Goodwill 5,432 5,432
Other assets 1,863 1,519
-------- --------
Total assets $282,870 $288,686
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt $ 5,000 $ 5,000
Accounts payable 16,896 15,559
Accrued expenses 14,874 12,578
-------- --------
Total current liabilities 36,770 33,137
Long-term debt 45,000 61,200
Deferred income taxes 32,272 30,643
Other long-term liabilities 2,360 1,901
Redeemable preferred stock:
Series A convertible, $0.01 par value per share, liquidation preference
$1,000 per share, 50,000 shares authorized, none issued --- ---
Stockholders' equity:
Common stock, $0.01 par value per share, 40,000,000 shares authorized;
16,769,619 and 16,146,026 shares issued and outstanding as of
October 4, 2003 and January 4, 2003, respectively 168 161
Additional paid-in capital 88,719 87,668
Unearned compensation (747) (901)
Retained earnings 80,364 76,964
Accumulated other comprehensive loss (2,036) (2,087)
-------- --------
Total stockholders' equity 166,468 161,805
-------- --------
Total liabilities and stockholders' equity $282,870 $288,686
======== ========
The accompanying notes are an integral part of these
consolidated financial statements
1
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATE
(Amounts in thousands, except per share amounts)
Three Months Ended Nine Months Ended
-------------------- ---------------------
Oct. 4, Sep. 28, Oct. 4, Sep. 28,
2003 2002 2003 2002
---- ---- ---- ----
(Unaudited) (Unaudited)
Net sales $80,765 $80,990 $244,876 $282,953
Cost of products sold 62,922 64,945 193,581 221,180
------- ------- -------- --------
Gross profit 17,843 16,045 51,295 61,773
Selling, general and administrative expenses 13,581 12,406 41,130 41,790
------- ------- -------- --------
Operating income 4,262 3,639 10,165 19,983
Other expenses:
Interest expense 968 1,196 3,028 3,404
Other, net (5) 76 84 70
------- ------- -------- --------
Income before provision for income taxes 3,299 2,367 7,053 16,509
Provision for income taxes 1,122 875 2,398 6,108
------- ------- -------- --------
Net income $ 2,177 $ 1,492 $ 4,655 $ 10,401
======= ======= ======== ========
Earnings per common share - basic (Note 1) $ 0.13 $ 0.09 $ 0.28 $ 0.65
======= ======= ======== ========
Earnings per common share - diluted (Note 1) $ 0.13 $ 0.09 $ 0.28 $ 0.62
======= ======= ======== ========
Dividends per common share $ 0.025 $ --- $ 0.075 $ ---
======= ======= ======== ========
Weighted average shares outstanding - basic (Note 1) 16,769 16,112 16,636 15,981
======= ======= ======== ========
Weighted average shares outstanding - diluted (Note 1) 16,986 16,890 16,900 16,899
======= ======= ======== ========
- --------------------------------------------------------------------------------
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
Three Months Ended Nine Months Ended
-------------------- ---------------------
Oct. 4, Sep. 28, Oct. 4, Sep. 28,
2003 2002 2003 2002
---- ---- ---- ----
(Unaudited) (Unaudited)
Net income $2,177 $1,492 $4,655 $10,401
------- ------- -------- -------
Other income (loss)
Foreign currency translation adjustments (131) (644) 51 (885)
Unrealized loss on hedging instruments (8) (8)
------- ------- -------- -------
Other compensation income (loss) (131) (652) 51 (893)
------- ------- -------- -------
Comprehensive income $2,046 $ 840 $4,706 $ 9,508
======= ======= ====== =======
The accompanying notes are an integral part of these
consolidated financial statements
2
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Nine Months Ended
------------------------------
Oct. 4, Sep. 28,
2003 2002
-------- --------
(Unaudited)
Cash flows from operating activities:
Net income $ 4,655 $ 10,401
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 14,410 12,406
Amortization of unearned compensation 154 77
Deferred income taxes 1,629 3,705
Tax benefit related to exercise of common stock options 402 908
Changes in operating assets and liabilities:
Accounts receivable (7,135) (2,558)
Inventories 3,400 (7,604)
Prepaid expenses and other assets 1,213 (1,009)
Accounts payable and accrued expenses 3,633 (4,170)
Other long-term liabilities 459 106
-------- --------
Net cash provided by operating activities 22,820 12,262
-------- --------
Cash flows from investing activities:
Purchase of property, plant and equipment (6,623) (28,015)
-------- --------
Cash flows from financing activities:
Change in revolving credit facility (16,200) 11,000
Repayments of capital lease obligations -- (697)
Proceeds from exercise of common stock options and
issuance of shares under the employee stock purchase plan 656 1,495
Proceeds from issuance of long-term debt -- 5,000
Capitalization of deferred financing costs -- (130)
Cash dividends (1,255) --
-------- --------
Net cash provided by (used in) financing activities (16,799) 16,668
-------- --------
Effect of exchange rates on cash 99 (227)
-------- --------
Net increase (decrease) in cash (503) 688
Cash and cash equivalents, beginning of period 1,098 600
-------- --------
Cash and cash equivalents, end of period $ 595 $ 1,288
======== ========
The accompanying notes are an integral part of these
consolidated financial statements
3
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)
Note 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements reflect
all normal and recurring adjustments that are, in the opinion of management,
necessary to present fairly the financial position, results of operations and
cash flows for the interim periods presented. The unaudited consolidated
financial statements have been prepared pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been omitted pursuant to those rules and regulations, although the Company
believes that the disclosures are adequate to make the information presented not
misleading. Operating results for the nine months ended October 4, 2003 are not
necessarily indicative of the results expected for the full fiscal year or any
future period. These financial statements should be read in conjunction with the
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the year ended January 4, 2003.
Earnings Per Common Share
Basic earnings per common share is computed by dividing net income by
the weighted average number of common shares outstanding during the period. For
diluted earnings per share, the denominator also includes dilutive outstanding
stock options determined using the treasury stock method. The following table
reconciles weighted average common shares outstanding to weighted average common
shares outstanding and dilutive potential common shares.
Three Months Ended Nine Months Ended
------------------------ ------------------------
Oct. 4, Sep. 28, Oct. 4, Sep. 28,
2003 2002 2003 2002
------ ------ ------ ------
(In thousands)
Weighted average common shares outstanding 16,769 16,112 16,636 15,981
Dilutive potential common shares 217 778 264 918
------ ------ ------ ------
Weighted average common shares outstanding
and dilutive potential common shares 16,986 16,890 16,900 16,899
====== ====== ====== ======
Antidilutive options 1,838 541 1,838 403
====== ====== ====== ======
4
Reclassifications
Certain reclassifications have been made to the Fiscal 2002 balances to
conform to the current year presentations.
Note 2 - INVENTORIES
Inventories are stated at the lower of cost or market and include
materials, labor and overhead. A standard cost system is used and approximates
cost on a first in, first out (FIFO) basis. Cost for financial reporting
purposes is determined by the last-in, first-out (LIFO) method.
Inventories at October 4, 2003 and January 4, 2003 consisted of the
following:
October 4, January 4,
2003 2003
------- -------
Raw materials $19,565 $24,984
Work-in-process 9,370 8,930
Finished goods 14,936 13,786
------- -------
Inventory at FIFO 43,871 47,700
LIFO adjustment 3,152 2,707
------- -------
Inventory at LIFO $47,023 $50,407
======= =======
LIFO inventory values are higher than FIFO costs because current
manufacturing costs are lower than the older historical costs used to value
inventory on a LIFO basis.
Note 3 - SEGMENT REPORTING
The Company operates as a single business segment consisting of sales
of two products, upholstery fabric and specialty yarns. Management evaluates the
Company's financial performance in the aggregate and allocates the Company's
resources without distinguishing between yarn and fabric products.
5
Gross foreign and export sales from the United States to unaffiliated
customers by major geographical area were as follows:
Three Months Ended Nine Months Ended
----------------------- -----------------------
Oct. 4, Sep. 28, Oct. 4, Sep. 28,
2003 2002 2003 2002
------ ------- ------- -------
(In thousands)
North America (excluding USA) $5,717 $7,235 $18,055 $22,760
Middle East 1,441 2,022 2,573 4,855
South America 578 775 1,774 2,284
Europe 1,022 1,051 3,014 3,651
All Other 1,162 877 2,988 2,643
------ ------- ------- -------
$9,920 $11,960 $28,404 $36,193
====== ======= ======= =======
Gross sales by product category are as follows:
Three Months Ended Nine Months Ended
----------------------- -----------------------
Oct. 4, Sep. 28, Oct. 4, Sep. 28,
2003 2002 2003 2002
------ ------- ------- -------
(In thousands)
Fabric $79,083 $78,476 $239,540 $273,934
Yarn 2,465 3,970 7,712 13,149
Other 319 262 908 679
------- ------- -------- --------
$81,867 $82,708 $248,160 $287,762
======= ======= ======== ========
Note 4 - ACCOUNTING FOR STOCK-BASED COMPENSATION
Accounting for Stock-Based Compensation. The Company has elected to
continue to account for its stock option plans under APB 25 and related
interpretations as well as to provide disclosure of stock based compensation as
outlined in SFAS 123 as amended by SFAS 148. SFAS 123 requires disclosure of pro
forma net income, EPS and other information as if the fair value method of
accounting for stock options and other equity instruments described in SFAS 123
had been adopted. The following table illustrates the effect on net income and
earnings per share as if the Black-Scholes fair value method described in SFAS
No. 123, "Accounting for Stock-Based Compensation," as amended, had been applied
to the Company's stock option plans.
6
Three Months Ended Nine Months Ended
------------------ -----------------
Oct. 4, Sep. 28, Oct. 4, Sep. 28,
2003 2002 2003 2002
---- ---- ---- ----
(In thousands) (In thousands)
-------------- --------------
(Unaudited) (Unaudited)
Net income, as reported $2,177 $1,492 $4,655 $10,401
Add: Stock-based employee compensation
expense included in net income, net of
related tax effects 37 33 102 49
Less: Stock-based employee compensation
expense determined under Black-Scholes
option pricing model, net of related tax effects 265 255 793 716
------ ------ ------ ------
Pro forma net income (loss): $1,949 $1,270 $3,964 $9,734
====== ====== ====== ======
Earnings per common share - basic
As reported $0.13 $0.09 $0.28 $0.65
Pro forma $0.12 $0.08 $0.24 $0.61
Earnings per common share - diluted
As reported $0.13 $0.09 $0.28 $0.62
Pro forma $0.11 $0.08 $0.23 $0.58
Note 5 - INCOME TAXES
The Company is currently challenging tax assessments from the Internal
Revenue Service for the years 1997-1999 and from the Massachusetts Department of
Revenue for the years 1993-1998. The ultimate resolution of these actions is not
expected to have a material impact on the results of operations or financial
position of the Company. In addition, during the third quarter, the Company
filed amended tax returns for these and subsequent years to claim approximately
$3.5 million of federal and state research and development credits. Audits of
these amended returns commenced during October 2003. There is significant
uncertainty surrounding the amount and timing of the benefit that will be
ultimately realized. The Company believes that it has a supportable basis for
claiming these credits, but the amounts are subject to ongoing audits by federal
and state authorities. Accordingly, the Company has not reflected the potential
benefits of these credits in its financial statements for these or subsequent
years. No benefit will be recognized in the financial statements until these
gain contingencies are resolved through the eventual disposition with the
respective tax authorities.
Note 6 - POTENTIAL ASSET IMPAIRMENT
Due primarily to a continued trend of declining yarn sales, the Company
has temporarily idled certain yarn manufacturing equipment for an estimated
period through the fourth quarter of 2004. This equipment has a net book value
of approximately $1.3 million and continues to be depreciated. Management
believes this equipment will be needed to support the Company's future fabric
business. In conjunction with this action, management performed an impairment
analysis in accordance with SFAS No.144. Based on management's estimates, the
expected
7
future cash flows generated by this equipment are not less than the carrying
value of the equipment as of October 4, 2003 and, therefore, no impairment was
recognized.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's fiscal year is a 52 or 53 week period ending on the
Saturday closest to January 1. "Fiscal 2002" was a 53 week period ended January
4, 2003 and "Fiscal 2003" will be a 52 week period ending January 3, 2004. The
first nine months of Fiscal 2002 and Fiscal 2003 ended September 28, 2002 and
October 4, 2003, respectively.
The Company typically shuts down operations for vacation and annual
maintenance during the first two weeks in July. As a result of the shut down and
the Company's fiscal calendar, the third quarter of 2003 contained 12 operating
weeks versus 11 weeks in the prior year period. The first nine months of 2003
and 2002 contained 37 operating weeks.
Critical Accounting Policies
- ----------------------------
The Company considered the disclosure requirements of Financial
Reporting Release No. 60 regarding critical accounting policies and Financial
Reporting Release No. 61 regarding liquidity and capital resources, certain
trading activities and related party/certain other disclosures, and concluded
that there were no material changes during the first nine months of 2003 that
would warrant further disclosure beyond those matters previously disclosed in
the Company's Annual Report on Form 10-K for the year ended January 4, 2003.
Results of Operations - Quarterly Comparison
- ---------------------
Net sales for the third quarter of 2003 decreased $0.2 million or 0.3%,
to $80.8 million from $81.0 million for the third quarter of 2002. The overall
weighted average gross sales price per yard decreased 0.4%, to $5.70 for the
third quarter of 2003 from $5.72 for the third quarter of 2002. The average
gross sales price per yard of middle to better-end fabrics increased by 1.2%, to
$6.67 in the third quarter of 2003 as compared to $6.59 in the third quarter of
2002. The average gross sales price per yard of promotional-end fabric was $4.13
in the third quarter of 2003 as compared to $4.03 in the third quarter of 2002.
The gross volume of fabric sold increased 1.2%, to 13.9 million yards for the
third quarter of 2003 from 13.7 million yards for the third quarter of 2002.
Middle to better-end fabrics represented 72.3% of fabric sales during the third
quarter of 2003 compared to 76.2% in the third quarter of 2002. The Company sold
5.5% fewer yards of middle to better-end fabrics and 14.3% more yards of
promotional-end fabrics in the third quarter of 2003 than in the third quarter
of 2002. The decline in middle to better-end fabrics is primarily attributable
to the 17% decline in foreign and export sales which primarily consist of middle
to better-end fabrics as well as the success of fabrics targeted to the
promotional category.
The Company's new order rate increased approximately 39% during the
third quarter of 2003 as compared to the third quarter of 2002, and the
Company's backlog increased by approximately 5%, to $30.2 million at the end of
the third quarter of 2003 as compared to $28.8 million at the end of the third
quarter of 2002.
8
Gross fabric sales within the United States increased 4.0%, to $69.2
million in the third quarter of 2003 from $66.5 million in the third quarter of
2002. Foreign and Export sales decreased 17.1%, to $9.9 million in the third
quarter of 2003 from $12.0 million in the third quarter of 2002. Gross yarn
sales decreased 37.9%, to $2.5 million in the third quarter of 2003 from $4.0
million in the same period of 2002.
The gross profit margin for the third quarter of 2003 increased to
22.1%, as compared to 19.8% for the third quarter of 2002. The increase in the
gross margin percentage resulted primarily from lower fixed costs per unit
attributable to higher production volumes and improved manufacturing operations,
which resulted in lower costs.
Selling, general and administrative expenses increased to $13.6 million
for the third quarter of 2003 from $12.4 million for the third quarter of 2002.
Selling, general and administrative expenses as a percentage of net sales
increased to 16.8% in the third quarter of 2003 from 15.3% in the third quarter
of 2002. The increase in selling, general and administrative expenses both as a
percentage of sales and in absolute dollars, when compared to the third quarter
of 2002 was due to the elimination in the third quarter of 2002 of a $1.1
million reserve established with respect to the Company's Fiscal 2002
performance-based variable compensation program. No provision has been made with
respect to this compensation program for the nine months of Fiscal 2003.
Interest expense was $1.0 million for the third quarter of 2003 and
$1.2 million for the third quarter of 2002. Lower levels of variable rate debt
and lower variable interest rates in the third quarter of 2003 resulted in the
decline in interest expense.
The Company provides for income taxes on an interim basis, using an
estimated annual effective income tax rate. The Company's estimated tax rate was
37% for 2002 and the first quarter of 2003. In the second quarter of 2003, the
Company adjusted the estimated annual effective tax rate for 2003 downward to
34%. This reduction in the tax rate is due to lower levels of projected income
for 2003 reducing the effective statutory federal tax rate from 35% to
approximately 34% and an increased estimated benefit to the tax rate from the
Extraterritorial Income Exclusion. The effective income tax rate is lower than
the combined federal and state statutory rates, due primarily to certain tax
benefits related to extraterritorial income at the federal level and investment
tax credits at the state level.
The Company is currently challenging tax assessments from the Internal
Revenue Service for the years 1997-1999 and from the Massachusetts Department of
Revenue for the years 1993-1998. The ultimate resolution of these actions is not
expected to have a material impact on the results of operations or financial
position of the Company. In addition, during the third quarter, the Company
filed amended tax returns for these and subsequent years to claim approximately
$3.5 million of federal and state research and development credits. Audits of
these amended returns commenced during October 2003. There is significant
uncertainty surrounding the amount and timing of the benefit that will be
ultimately realized. The Company believes that it has a supportable basis for
claiming these credits, but the amounts are subject to ongoing audits by federal
and state authorities. Accordingly, the Company has not reflected the potential
benefits of these credits in its financial statements for these or subsequent
years. No benefit will be recognized in the financial statements until these
gain contingencies are resolved through the eventual disposition with the
respective tax authorities.
9
Net income for the third quarter of 2003 increased to $2.2 million or
$0.13 per common share-diluted, from $1.5 million or $0.09 per common
share-diluted for the third quarter of 2002.
Results of Operations - Nine-month Comparison
- ---------------------
Net sales for the first nine months of 2003 decreased $38.1 million or
13.5%, to $244.9 million from $283.0 million for the first nine months of 2002.
The overall weighted average gross sales price per yard increased 0.9%, to $5.62
for the first nine months of 2003 from $5.57 for the first nine months of 2002.
The average gross sales price per yard of middle to better-end fabrics increased
by 2.8%, to $6.59 in the first nine months of 2003 as compared to $6.41 in the
first nine months of 2002. The average gross sales price per yard of
promotional-end fabric was $4.07 in the first nine months of 2003 as compared to
$4.01 in the first nine months of 2002. The gross volume of fabric sold
decreased 13.3%, to 42.6 million yards for the first nine months of 2003 from
49.2 million yards for the first nine months of 2002. Middle to better-end
fabrics represented 72.0% of fabric sales during the first nine months of 2003
compared to 74.7% in the first nine months of 2002. The Company sold 18.0% fewer
yards of middle to better-end fabrics and 4.6% fewer yards of promotional-end
fabrics in the first nine months of 2003 than in the first nine months of 2002.
The decline in middle to better-end fabrics is primarily attributable to the 22%
decline in foreign and export sales which primarily consist of middle to
better-end fabrics as well as the success of fabrics targeted to the promotional
category.
The Company's new order rate declined approximately 3% during the first
nine months of 2003 as compared to the first nine months of 2002, and the
Company's backlog increased by approximately 5%, to $30.2 million at the end of
the first nine months of 2003 as compared to $28.8 million at the end of the
first nine months half of 2002. The decline in the new order rate occurred in
the first half of 2003 as compared to 2002. The Company's new order rate
increased approximately 39% during the third quarter of 2003 as compared to the
third quarter of 2002.
Gross fabric sales within the United States decreased 11.2%, to $211.1
million in the first nine months of 2003 from $237.8 million in the first nine
months of 2002. Foreign and Export sales decreased 21.5%, to $28.4 million in
the first nine months of 2003 from $36.2 million in the first nine months of
2002. Gross yarn sales decreased 41.3%, to $7.7 million in the first nine months
of 2003 from $13.1 million in the same period of 2002. The decline in domestic
and international sales is primarily attributable to political and economic
issues that adversely affected the demand for furniture and upholstery fabric.
The gross profit margin for the first nine months of 2003 decreased to
20.9%, as compared to 21.8% for the first nine months of 2002. Due to a decline
in orders during the first nine months of 2003, the Company adjusted its
production rates to levels consistent with the lower order rates and during the
second quarter of 2003 reduced inventory positions. The decrease in the gross
margin percentage resulted primarily from higher fixed costs per unit
attributable to lower production volumes, as well as fairly significant period
over period increases in energy, insurance and depreciation costs, partially
offset by improved manufacturing operations.
Selling, general and administrative expenses decreased to $41.1 million
for the first nine months of 2003 from $41.8 million for the first nine months
of 2002. Selling, general and administrative expenses as a percentage of net
sales increased to 16.8% in the first nine months of 2003 from 14.8% in the
first nine months of 2002. The net increase in selling, general and
10
administrative expenses as a percentage of sales was due to lower sales volume
in combination with higher sampling expenses and higher professional fees.
Interest expense decreased to $3.0 million for the first nine months of
2003 from $3.4 million in the same period of 2002. Lower levels of variable rate
debt in the first nine months of 2003 and lower interest rates resulted in the
decline.
The Company provides for income taxes on an interim basis, using an
estimated annual effective income tax rate. The Company's estimated tax rate was
37% for 2002 and the first quarter of 2003. In the second quarter of 2003, the
Company adjusted the estimated annual effective tax rate for 2003 downward to
34%. This reduction in the tax rate is due to lower levels of projected income
for 2003 reducing the effective statutory federal tax rate from 35% to
approximately 34% and an increased estimated benefit to the tax rate from the
Extraterritorial Income Exclusion. The effective income tax rate is lower than
the combined federal and state statutory rates, due primarily to certain tax
benefits related to extraterritorial income at the federal level and investment
tax credits at the state level.
The Company is currently challenging tax assessments from the Internal
Revenue Service for the years 1997-1999 and from the Massachusetts Department of
Revenue for the years 1993-1998. The ultimate resolution of these actions is not
expected to have a material impact on the results of operations or financial
position of the Company. In addition, during the third quarter, the Company
filed amended tax returns for these and subsequent years to claim approximately
$3.5 million of federal and state research and development credits. Audits of
these amended returns commenced during October 2003. There is significant
uncertainty surrounding the amount and timing of the benefit that will be
ultimately realized. The Company believes that it has a supportable basis for
claiming these credits, but the amounts are subject to ongoing audits by federal
and state authorities. Accordingly, the Company has not reflected the potential
benefits of these credits in its financial statements for these or subsequent
years. No benefit will be recognized in the financial statements until these
gain contingencies are resolved through the eventual disposition with the
respective tax authorities.
Net income for the first nine months of 2003 decreased to $4.7 million,
or $0.28 per common share-diluted, from $10.4 million or $0.62 per common
share-diluted, for the first nine months of 2002.
Liquidity and Capital Resources
- -------------------------------
The Company historically has financed its operations and capital
requirements through a combination of internally generated funds, borrowings
under the Credit Agreement (as hereinafter defined), and debt and equity
offerings. The Company's capital requirements have arisen principally in
connection with (i) the purchase of equipment to expand production capacity,
introduce new technologies to broaden and differentiate the Company's products,
and improve the Company's quality and productivity performance, (ii) increases
in the Company's working capital needs related to its sales growth, and (iii)
investments in the Company's information technology systems.
The primary source of the Company's liquidity and capital resources has
been operating cash flow. The Company's net cash provided by operating
activities was $22.8 million and $12.3 million in the first nine months of 2003
and 2002, respectively. As necessary, the Company
11
supplements its operating cash flow with borrowings. Net borrowings (repayments)
were ($16.2) million in the first nine months of 2003 and $15.3 million in the
first nine months of 2002.
Capital expenditures in the first nine months of 2003 and 2002 were
$6.6 million and $28.0 million, respectively. Capital expenditures during the
first nine months of 2003 were funded by operating cash flow. Management
anticipates that capital expenditures for new projects will total approximately
$10.0 million in 2003, consisting principally of $5.0 million for various
manufacturing equipment, $2.0 million for IT projects, $1.1 million to acquire a
previously leased manufacturing facility and $1.9 million for various other
capital projects. Additionally, the Company is analyzing several financing
alternatives in connection with the possible development of additional
manufacturing and warehousing facilities in the Fall River area. Management
believes that operating income and borrowings under the Credit Agreement (as
hereinafter defined) will provide sufficient funding for the Company's capital
expenditures and working capital needs for the foreseeable future.
The Company issued $45.0 million of Senior Notes due October 2005 and
2007 (the Senior Notes) during 1997. The Senior Notes bear interest at a fixed
rate of 7.09% on $15.0 million and 7.18% on $30.0 million. Annual principal
payments began on October 10, 2003 with a final payment due October 10, 2007.
Annual principal payment amounts are three payments of $5.0 million beginning
in 2003, followed by two payments of $15.0 million beginning in 2006.
On February 14, 2002, the Company issued $5.0 million of 7.56% Series A
Notes due February 2009 (the "Series A Notes"). The Series A Notes are unsecured
and bear interest at a fixed rate of 7.56%, payable semiannually. The Series A
Notes may be prepaid in whole or in part prior to maturity, at the Company's
option, subject to a yield maintenance premium, as defined. In addition and also
on February 14, 2002, the Company entered into a $45.0 million non-committed
shelf note agreement with an insurance company pursuant to which the Company may
issue additional senior notes prior to February 14, 2005 with maturity dates of
up to ten years.
The Company also has a $60.0 million Credit Agreement with a bank which
expires January 31, 2007 (the Credit Agreement). As of October 4, 2003, the
Company had no loan outstanding under the Credit Agreement and unused
availability of $59.9 million. See Note 5 of Notes to Consolidated Financial
Statements included in the Company's 2002 Annual Report on Form 10-K.
The Company is required to comply with a number of affirmative and
negative convenants under the Credit Agreement, the Senior Notes, and the Series
A Notes, including, but not limited to, maintenance of certain financial tests
and ratios (including interest coverage ratios, net worth related ratios, and
net worth requirements); limitations on certain business activities of the
Company; restrictions on the Company's ability to declare and pay dividends,
incur additional indebtedness, create certain liens, incur capital lease
obligations, make certain investments, engage in certain transactions with
stockholders and affiliates, and purchase, merge, or consolidate with or into
any other corporation. The Company is currently in compliance with all the
affirmative and negative convenants in the Credit Agreement, the Series A Notes,
and the Senior Notes and management believes the Company's continued compliance
will not prevent the Company from operating in the normal course of business.
12
The Company has historically not paid dividends, instead using earnings
to fuel growth and capital equipment requirements. On March 3, 2003, the
Company's Board of Directors adopted a new dividend policy reflecting Quaker's
intention to pay quarterly dividends going forward, with the level of each
dividend payment, if any, to be determined by Quaker's Board of Directors based
on a number of factors, including the Company's financial performance, cash
flows and cash requirements.
Inflation
- ---------
The Company does not believe that inflation has had a significant
impact on the Company's results of operations for the periods presented.
Historically, the Company believes it has been able to minimize the effects of
inflation by improving its manufacturing and purchasing efficiency, by
increasing employee productivity, and by reflecting the effects of inflation in
the selling prices of the new products it introduces each year.
Cautionary Statement Regarding Forward-Looking Information
- ----------------------------------------------------------
Statements contained in this report, as well as oral statements made by
the Company that are prefaced by the words "may," "will," "expect,"
"anticipate," "continue," "estimate," "project," "intend," "designed" and
similar expressions, are intended to identify forward-looking statements
regarding events, conditions and financial trends that may affect the Company's
future plans of operations, business strategy, results of operations and
financial position. These statements are based on the Company's current
expectations and estimates as to prospective events and circumstances about
which the Company can give no firm assurance. Further, any forward-looking
statement speaks only as of the date on which such statement is made, and the
Company undertakes no obligation to update any forward-looking statement to
reflect events or circumstances after the date on which such statement is made.
As it is not possible to predict every new factor that may emerge,
forward-looking statements should not be relied upon as a prediction of the
Company's actual future financial condition or results. These forward-looking
statements, like any forward-looking statements, involve risks and uncertainties
that could cause actual results to differ materially from those projected or
anticipated. Such risks and uncertainties include product demand and market
acceptance of the Company's products, regulatory uncertainties, the effect of
economic conditions, the impact of competitive products and pricing, foreign
currency exchange rates, changes in customer ordering patterns, and the effect
of uncertainties in markets outside the U.S. (including Mexico and South
America) in which the Company operates.
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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Derivative Financial Instruments, Other Financial Instruments, and Derivative
Commodity Instruments
Quantitative and Qualitative Disclosures About Market Risk
The Company's exposures relative to market risk are due to foreign
exchange risk and interest rate risk.
Foreign currency risk
Approximately 2.8% of the Company's revenues are generated outside the
U.S. from sales which are not denominated in U.S. dollars. Foreign currency risk
arises because the Company engages in business in certain foreign countries in
local currency. Accordingly, in the absence of hedging activities whenever the
U.S. dollar strengthens relative to the other major currencies, there is an
adverse affect on the Company's results of operations, and alternatively,
whenever the U.S. dollar weakens relative to the other major currencies, there
is a positive affect on the Company's results of operations.
It is the Company's policy to minimize, for a period of time, the
unforeseen impact on its results of operations of fluctuations in foreign
exchange rates by using derivative financial instruments to hedge the fair value
of foreign currency denominated intercompany payables. The Company's primary
foreign currency exposures in relation to the U.S. dollar are the Mexican peso
and the Brazilian real.
At October 4, 2003, the Company had the following derivative financial
instruments to hedge the anticipated cash flows from the repayment of foreign
currency denominated intercompany payables outstanding:
Notional Weighted Notional
Amount in Average Amount in
Type of Local Contract U.S. Fair
Instrument Currency Currency Rate Dollars Value Maturity
---------- -------- -------- ---- ------- ----- --------
Forward Contract Mexican Peso 60.0 million 11.09 $5.4 million $ 242,000 Dec. 2004
Forward Contract Brazilian Real 1.4 million 3.18 $0.5 million $ (36,000) Nov. 2003
14
Interest Rate Risk
All of the Company's long-term debt is at fixed rates. Accordingly, a
change in interest rates has an insignificant effect on the Company's interest
expense. The fair value of the Company's long-term debt, however, would change
in response to interest rate movements due to its fixed rate nature.
The Company has evaluated the impact on all long-term maturities of
changing the interest rate 10% from the rate levels that existed at October 4,
2003 and has determined that such a rate change would not have a material impact
on the Company.
Item 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision and with the
participation of the Chief Executive Officer and Chief Financial Officer, has
evaluated the effectiveness of the Company's disclosure controls and procedures
(as such term is defined in Rule 13a-15(c) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")) as of the end of the period covered by
this report. Based on such evaluation, management has concluded that, as of the
end of the period covered by this report, the Company's disclosure controls and
procedures are effective in alerting them on a timely basis to material
information relating to the Company (including its consolidated subsidiaries)
required to be included in the Company's periodic filings under the Exchange
Act. In addition, management has evaluated and concluded that during the most
recent fiscal quarter covered by this report, there has not been any change in
the Company's internal control over financial reporting that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
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QUAKER FABRIC CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(A) Exhibits
31.1 Certification by the Chief Executive Officer pursuant to section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by the Chief Financial Officer pursuant to section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by the Chief Executive Officer pursuant to section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification by the Chief Financial Officer pursuant to section
906 of the Sarbanes-Oxley Act of 2002.
(B) The Company filed a report on Form 8-K on July 24, 2003, in which the
Company furnished a press release announcing its second quarter
results for the period ending July 5, 2003.
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QUAKER FABRIC CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
QUAKER FABRIC CORPORATION
Date: November 4, 2003 By: /s/ Paul J. Kelly
---------------- ---------------------
Paul J. Kelly
Vice President - Finance
and Treasurer (Principal Financial Officer)
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