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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 July 3, 2004
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 August 11, 2004, 16,820,818 shares of Registrant's Common Stock,
$0.01 par value, were outstanding.
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Table of Contents
QUAKER FABRIC CORPORATON
Quarterly Report on Form 10-Q
Quarter ending July 3, 2004
PART I FINANCIAL INFORMATION
Item 1. Consolidated Balance Sheets 2
Consolidated Statements of Income 3
Consolidated Statements of Comprehensive Income 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 17
Item 4. Controls and Procedures 19
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
July 3, January 3,
2004 2004
---------- ----------
ASSETS (Unaudited) (Audited)
Current assets:
Cash and cash equivalents $ 8,101 $ 5,591
Accounts receivable, less reserves of $1,927 and $2,089 at
July 3, 2004 and January 3, 2004, respectively 42,686 44,374
Inventories 46,890 43,987
Prepaid and deferred income taxes 1,136 1,038
Production supplies 1,934 1,727
Prepaid insurance 1,337 2,132
Other current assets 8,481 7,842
-------- --------
Total current assets 110,565 106,691
Property, plant and equipment, net 160,455 162,293
Other assets:
Goodwill 5,432 5,432
Other assets 1,820 1,862
-------- --------
Total assets $278,272 $276,278
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt $ 5,000 $ 5,000
Accounts payable 15,765 14,386
Accrued expenses 11,953 13,137
-------- --------
Total current liabilities 32,718 32,523
Long-term debt 40,000 40,000
Deferred income taxes 32,313 31,634
Other long-term liabilities 2,763 2,616
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;
16,820,818 and 16,795,818 shares issued and outstanding as of
July 3, 2004 and January 3, 2004, respectively 168 168
Additional paid-in capital 89,047 88,870
Unearned compensation (592) (695)
Retained earnings 84,175 83,228
Other accumulated comprehensive loss (2,320) (2,066)
-------- --------
Total stockholders' equity 170,478 169,505
-------- --------
Total liabilities and stockholders' equity $278,272 $276,278
======== ========
The accompanying notes are an integral part of these consolidated financial
statements
2
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share amounts)
Three Months Ended Six Months Ended
------------------ ----------------
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
--------- ---------- ---------- -----------
(Unaudited) (Unaudited)
Net sales $73,132 $73,886 $157,516 $164,111
Cost of products sold 59,733 59,401 125,422 130,659
------- ------- -------- --------
Gross profit 13,399 14,485 32,094 33,452
Selling, general and administrative expenses 13,381 13,298 27,406 27,549
------- ------- -------- --------
Operating income 18 1,187 4,688 5,903
Other expenses:
Interest expense 860 991 1,707 2,060
Other, net (36) 113 (52) 89
------- ------- -------- --------
Income (loss) before provision for income taxes (806) 83 3,033 3,754
Provision (benefit) for income taxes (324) (82) 1,077 1,276
------- ------- -------- --------
Net income (loss) $ (482) $ 165 $ 1,956 $ 2,478
======= ======= ======== ========
Earnings (loss) per common share - basic (Note 1) $ (0.03) $ 0.01 $ 0.12 $ 0.15
======= ======= ======== ========
Earnings (loss) per common share - diluted (Note 1) $ (0.03) $ 0.01 $ 0.11 $ 0.15
======= ======= ======== ========
Dividends per common share $ 0.030 $ 0.025 $ 0.060 $ 0.050
======= ======= ======== ========
Weighted average shares outstanding - basic (Note 1) 16,820 16,724 16,815 16,570
======= ======= ======== ========
Weighted average shares outstanding - diluted (Note 1) 17,141 16,950 17,224 16,857
======= ======= ======== ========
The accompanying notes are an integral part of these consolidated financial
statements
3
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
Three Months Ended Six Months Ended
------------------ ----------------
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
--------- ---------- ---------- -----------
(Unaudited) (Unaudited)
Net income (loss) $(482) $165 $1,956 $2,478
----- ---- ------ ------
Other comprehensive income (loss)
Foreign currency translation adjustments (243) 217 (246) 182
Unrealized gain (loss) on hedging instruments 27 18 (8) --
----- ---- ------ ------
Other comprehensive income (loss) (216) 235 (254) 182
----- ---- ------ ------
Comprehensive income (loss) $(698) $400 $1,702 $2,660
===== ==== ====== ======
The accompanying notes are an integral part of these consolidated financial
statements
4
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Six Months Ended
----------------------------------
July 3, July 5,
2004 2003
------------- ------------
(Unaudited)
Cash flows from operating activities:
Net income $ 1,956 $ 2,478
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 9,797 9,599
Amortization of unearned compensation 103 99
Deferred income taxes 679 853
Tax benefit related to exercise of common stock options 40 402
Changes in operating assets and liabilities:
Accounts receivable 1,581 1,885
Inventories (2,995) 6,624
Prepaid expenses and other assets (134) 1,491
Accounts payable and accrued expenses 195 (6,007)
Other long-term liabilities 147 287
-------- --------
Net cash provided by operating activities 11,369 17,711
-------- --------
Cash flows from investing activities:
Purchase of property, plant and equipment (7,932) (3,844)
-------- --------
Cash flows from financing activities:
Change in revolving credit facility - - (13,700)
Proceeds from exercise of common stock options and
issuance of shares under the employee stock purchase plan 137 603
Cash dividends (1,009) (836)
-------- --------
Net cash used in financing activities (872) (13,933)
-------- --------
Effect of exchange rates on cash (55) (10)
-------- --------
Net increase (decrease) in cash 2,510 (76)
Cash and cash equivalents, beginning of period 5,591 1,098
-------- --------
Cash and cash equivalents, end of period $ 8,101 $ 1,022
======== ========
The accompanying notes are an integral part of these consolidated financial
statements
5
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 instructions to Form
10-Q and Rule 10-01 of regulation S-X 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 six
months ended July 3, 2004 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 3, 2004.
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 Six Months Ended
-------------------- ----------------
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
---- ---- ---- ----
(In thousands)
Weighted average common shares outstanding 16,820 16,724 16,815 16,570
Dilutive potential common shares 321 226 409 287
------ ------ ------ ------
Weighted average common shares outstanding
and dilutive potential common shares 17,141 16,950 17,224 16,857
====== ====== ====== ======
Antidilutive options 1,572 1,838 1,032 1,838
====== ====== ====== ======
6
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 using the last-in, first-out (LIFO) method.
Inventories at July 3, 2004 and January 3, 2004 consisted of the
following:
July 3, January 3,
2004 2004
---- ----
Raw materials $21,628 $19,714
Work-in-process 6,506 7,709
Finished goods 17,032 12,484
------- -------
Inventory at FIFO 45,166 39,907
LIFO adjustment 1,724 4,080
------- -------
Inventory at LIFO $46,890 $43,987
======= =======
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.
7
Net sales to unaffiliated customers by major geographical area were as
follows:
Three Months Ended Six Months Ended
------------------ -------------------
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
---- ---- ---- ----
(In thousands)
United States $64,235 $64,787 $139,473 $145,796
Canada 3,444 3,455 6,885 7,175
Mexico 1,689 2,386 4,027 4,808
Middle East 1,169 668 1,858 1,121
South America 615 569 1,293 1,165
Europe 936 931 2,047 1,973
All Other 1,044 1,090 1,933 2,073
------- ------- -------- --------
$73,132 $73,886 $157,516 $164,111
======= ======= ======== ========
Net sales by product category are as follows:
Three Months Ended Six Months Ended
------------------ ----------------
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
---- ---- ---- ----
(In thousands)
Fabric $66,599 $71,463 $144,559 $158,335
Yarn 6,196 2,199 12,208 5,187
Other 337 224 749 589
------- ------- -------- --------
$73,132 $73,886 $157,516 $164,111
======= ======= ======== ========
Note 4 - ACCOUNTING FOR STOCK BASED COMPENSATION
Accounting for Stock-Based Compensation. The Company follows Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB No. 25"), in accounting for its employee stock option and employee stock
purchase plans, rather than the fair value method of accounting provided under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123"). Under APB No. 25, the Company accounts for its
employee stock options using the intrinsic value method. Under this method the
Company does not recognize compensation expense on stock options granted to
employees when the exercise price of each option is greater than or equal to the
market price of the underlying stock on the date of the grant.
The following pro forma information presents the Company's net income
and basic and diluted net income per share for the three months and six months
ended July 3, 2004 and July 5, 2003 as if compensation cost had been measured
under the fair value method of SFAS No. 123, "Accounting for Stock Based
Employee Compensation," for stock option grants and shares
8
issued under the employee stock option and employee stock purchase plans,
respectively. The Company utilizes the Black-Scholes option pricing model to
estimate the fair value of options.
Three Months Ended Six Months Ended
------------------ ----------------
July 3, July 5, July 3, July 5,
2004 2003 2004 2003
---- ---- ---- ----
(In thousands) (In thousands)
------------- -------------
(Unaudited) (Unaudited)
Net income (loss), as reported $ (482) $165 $1,956 $2,478
Add: Stock-based employee compensation
expense included in net income, net of
related tax effects 33 34 66 65
Less: Stock-based employee compensation
expense determined under Black-Scholes
option pricing model, net of related tax effects (306) (264) (601) (528)
----- ---- ------ ------
Pro forma net income (loss): $(755) $(65) $1,421 $2,015
===== ==== ====== ======
Earnings (loss) per common share - basic
As reported $(0.03) $0.01 $0.12 $0.15
Pro forma $(0.04) $0.00 $0.08 $0.12
Earnings (loss) per common share - diluted
As reported $(0.03) $0.01 $0.11 $0.15
Pro forma $(0.04) $0.00 $0.08 $0.12
Note 5 - COMMITMENTS AND CONTINGENCIES
(a) 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.
In addition, during the third quarter of 2003, the Company filed
amended tax returns for these and subsequent years to claim
approximately $3,500 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.
(b) Litigation. In the ordinary course of business, the Company is
party to various types of litigation. The Company believes it has
meritorious defenses to all claims and in its opinion, all
litigation currently pending or threatened will not have a
material effect on the Company's financial position, results of
operations or liquidity.
(c) Environmental Cleanup Matters. The Company accrues for estimated
costs associated with known environmental matters when such costs
are probable and can be
9
reasonably estimated. The actual costs to be incurred for
environmental remediation may vary from estimates, given the
inherent uncertainties in evaluating and estimating environmental
liabilities, including the possible effects of changing laws and
regulations, the stage of the remediation process and the
magnitude of contamination found as the remediation progresses.
During 2003, the Company entered into agreements with the
Massachusetts Department of Environmental Protection to install
air pollution control equipment at one of its manufacturing
plants in Fall River, Massachusetts. Management anticipates that
the costs associated with the acquisition and installation of the
equipment will total approximately $900 over a three-year period,
which began in 2003. These costs will be capitalized and
depreciated over the estimated useful life. Management believes
the ultimate disposition of known environmental matters will not
have a material adverse effect on the liquidity, capital
resources, business or consolidated financial position of the
Company.
Note 6 - INCOME TAXES
The Company determines its periodic income tax expense based upon the
current period income and the estimated annual effective tax rate for the
Company. The rate is revised, if necessary, as of the end of each successive
interim period during the fiscal year to the Company's best current estimate of
its annual effective tax rate.
Note 7 - NEW FACILITY ACQUISITION
On July 2, 2004, the Company entered into a purchase and sale agreement
to acquire for $21.0 million a single story industrial building located on 33.6
acres of land in Fall River, Massachusetts. The Company anticipates that it may
utilize borrowings under the Credit Agreement (as hereafter defined) as the
initial source of the funds to complete the transaction, but that it will also
review alternative financing strategies, which may include the designation of an
unrelated third party to take title to the property which would then be leased
to Quaker. Completion of the purchase or long-term lease of this facility is
anticipated during the fourth quarter of 2004. By the end of 2005, the Company
plans to have moved four of the manufacturing and warehousing operations
currently being conducted in leased facilities into this new facility. The
Company anticipates that it will incur a short-term increase in operating
expenses of approximately $2.1 million during the transition to this new
facility. Approximately $1.6 million will be moving and lease termination costs
and another $0.5 million attributable to the duplication of certain
facilities-related expenses.
Note 8 - New Accounting Pronouncements
Consolidation of Variable Interest Entities
In January 2003, FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," which clarifies the application
of Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial
Statements," relating to consolidation of certain entities. First, FIN 46 will
require identification of the Company's participation in variable interest
entities (VIE), which are defined as entities with a level of invested equity
that is not sufficient to fund future activities to permit them to operate on a
stand alone basis, or whose equity holders lack certain characteristics of a
controlling financial interest. Then, for entities identified as VIE, FIN 46
sets
10
forth a model to evaluate potential consolidation based on an assessment of
which party to the VIE, if any, bears a majority of the exposure to its expected
losses, or stands to gain from a majority of its expected returns. In December
2003, the FASB issued a revised FIN 46 ("FIN 46R") to defer the effective date
and provide further clarification on the interpretation. FIN 46R is effective
for public companies in the first fiscal period after December 15, 2003. The
Company does not have any interests that would qualify as a variable interest
entity and therefore the adoption of FIN 46 does not have an effect on the
Company's results of operations and financial condition.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
In May 2003, the FASB issued SFAS 150, Accounting For Certain Financial
Instruments with Characteristics of Both Liabilities and Equity (SFAS 150),
which establishes standards for how an issuer of financial instruments
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances) if, at inception, the monetary value of the obligation is based
solely or predominantly on a fixed monetary amount known at inception,
variations in something other than the fair value of the issuer's equity shares
or variations inversely related to changes in the fair value of the issuer's
equity shares. In November 2003, the FASB deferred the effective date for
applying the provisions of SFAS 150 for mandatorily redeemable financial
instruments that have a fixed redemption period to be effective for fiscal
periods beginning after December 15, 2003. For all other mandatorily redeemable
financial instruments, the disclosure provisions of SFAS 150 have been deferred
for an indefinite period. The adoption of this standard did not have any impact
on the Company's financial position or results of operations.
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 2003" was a 52 week period ended January
3, 2004 and "Fiscal 2004" will be a 52 week period ending January 1, 2005. The
first six months of Fiscal 2003 and Fiscal 2004 ended July 5, 2003 and July 3,
2004, respectively.
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 in these areas during the first six months
of 2004 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
3, 2004.
11
General
Quaker is a leading designer, manufacturer and worldwide marketer of a
broad range of woven upholstery fabrics, which it sells at various price points
primarily to manufacturers of residential furniture. The Company is also a
leading developer and manufacturer of specialty yarns. Approximately 11.5% of
the Company's revenues during the first six months of 2004 were attributable to
fabrics sold outside the United States and approximately 65.0% of Quaker's
fabrics are manufactured to customer order.
Competition in the industry is intense, from both domestic fabric mills
and fabric mills located outside the U.S. manufacturing products for sale into
the U.S. market. Management believes that competition in the U.S. domestic
market may intensify following the January 1, 2005 expiration of the quotas
imposed under the Uruguay Round Agreement on Textiles and Clothing on textile
and apparel products coming into the U.S. The Company's fabric products compete
with other furniture coverings, including leather, suede, prints, tufts, flocks
and velvets, for consumer acceptance. Consumer tastes in upholstered furniture
coverings are somewhat cyclical and do change over time, with various coverings
gaining or losing share depending on changes in home furnishing trends. For
example, leather and suede furniture has enjoyed growing popularity over the
past few years, to some extent at the expense of woven fabrics, such as the
Jacquards and other woven fabrics Quaker manufactures. As a result, overall
domestic demand for furniture covered with woven upholstery products is
currently somewhat weaker than demand for other types of furniture, including
furniture covered with leather and suede products. In addition, company sales
into some foreign markets have been hurt by market-specific geopolitical and
macroeconomic factors reducing aggregate demand in these locations.
Competitive factors in the industry include product design, product
pricing, customer service and quality. Competition from lower cost imported
products has increased, particularly those products coming into the United
States from China and other parts of Asia. Management considers such factors as
incoming customer order rates, size of production backlog, manufacturing
efficiencies, product mix and price points in evaluating the Company's financial
condition and operating performance. Incoming fabric orders during the first six
months of 2004 were down approximately 10.4% compared to the first six months of
2003. The total backlog of fabric and yarn products at the end of the first six
months of 2004 was down 11.9% compared to that of a year ago. The dollar value
of the yarn backlog was up $2.0 million or 143.3%, while the dollar value of the
fabric backlog was down $4.9 million or 21.3%. Management will continue to
aggressively pursue its core strategy of building profitable volume by providing
the market with the best products and service.
Results of Operations - Quarterly Comparison
Net sales for the second quarter of 2004 decreased $0.8 million or
1.0%, to $73.1 million from $73.9 million for the second quarter of 2003. Net
fabric sales within the United States decreased 7.3%, to $58.0 million in the
second quarter of 2004 from $62.6 million in the second quarter of 2003,
primarily due to increased competition from leather and lower priced imported
suede products. In addition, overall domestic furniture demand appears to be
lagging the U.S. economic recovery as a whole, with the upholstered furniture
category trailing aggregate demand for furniture. The overall weighted average
sales price per yard increased 1.9%, to $5.77 for the second quarter of 2004
from $5.66 for the second quarter of 2003 due to a slight shift in product mix
to middle to better-end fabrics and an increase of 3.0% in the average price
point of middle to better-end fabrics. Foreign and Export sales were essentially
the same at approximately $9.0 million for both quarters. Net yarn sales
increased 181.8%, to $6.2 million in the second quarter
12
of 2004 from $2.2 million in the same period of 2003. This improvement in the
yarn sales segment is due to the penetration of new markets, particularly the
craft yarn category.
The Company's dollar value of incoming orders during the second quarter
of 2004 decreased approximately 6.2% compared to the second quarter of 2003. The
dollar value of the backlog decreased by approximately 11.9%, to $21.6 million
at the end of the second quarter of 2004 as compared to $24.5 million at the end
of the same period in 2003, with the dollar value of the fabric backlog down
21.3% and the dollar value of the yarn backlog up 143.3%.
The gross profit margin for the second quarter of 2004 decreased to
18.3% from 19.6% in the second quarter of 2003. The decrease in the gross margin
percentage resulted primarily from lower weekly production and shipping rates
and higher payroll-related unemployment taxes.
Selling, general and administrative expenses increased slightly to
$13.4 million in the second quarter of 2004 from $13.3 million in the second
quarter of 2003. Higher costs were incurred in the second quarter of 2004 as
compared to the second quarter of 2003 in several semi-variable expense
categories, such as expenditures for professional fees and certain wage and
fringe benefit expenses. Selling, general and administrative expenses as a
percentage of net sales increased to 18.3% in the second quarter of 2004 from
18.0% in the second quarter of 2003. This increase as a percentage of net sales
was due to lower net sales in combination with the above mentioned higher
expenses in the second quarter of 2004 compared to the same period in 2003.
Interest expense was $0.9 million for the second quarter of 2004 and
$1.0 million for the second quarter of 2003. Lower levels of both variable and
fixed rate debt in the second quarter of 2004 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
35.4% for 2003 and 36.5% for the first quarter of 2004. The Company has adjusted
the estimated annual effective tax rate for 2004 downward to 35.5%. This
reduction in the tax rate is due to lower levels of projected income for 2004
reducing the effective statutory federal income 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. In addition, during the third quarter of Fiscal
2003 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.
13
The Company incurred a net loss in the second quarter of 2004 of ($0.5)
million or ($0.03) per common share-diluted, compared to net income of $0.2
million or $0.01 per common share-diluted for the second quarter of 2003.
Results of Operations - Six-month Comparison
Net sales for the first half of 2004 decreased $6.6 million or 4.0%, to
$157.5 million from $164.1 million for the first half of 2003. Net fabric sales
within the United States decreased 9.5%, to $127.3 million in the first half of
2004 from $140.6 million in the first half of 2003, primarily due to increased
competition from leather and lower priced imported suede products. In addition,
overall domestic furniture demand appears to be lagging the U.S. economic
recovery as a whole, with the upholstered furniture category trailing aggregate
demand for furniture. The overall weighted average sales price per yard
increased 2.2%, to $5.70 for the first half of 2004 from $5.58 for the first
half of 2003 due to a slight shift in product mix to middle to better-end
fabrics and an increase of 3.0% in the average price point of middle to
better-end fabrics. Foreign and Export sales were essentially the same at
approximately $18.0 million for both six month periods. Net yarn sales increased
134.6%, to $12.2 million in the first half of 2004 from $5.2 million in the same
period of 2003. This improvement in the yarn sales segment is due to the
penetration of new markets, particularly the craft yarn category.
The Company's dollar value of incoming orders during the first half of
2004 decreased approximately 10.4% compared to the first half of 2003. The
dollar value of the backlog decreased by approximately 11.9%, to $21.6 million
at the end of the first half of 2004 as compared to $24.5 million at the end of
the same period in 2003, with the dollar value of the fabric backlog down 21.3%
and the dollar value of the yarn backlog up 143.3%.
The gross profit margin for the first half of both 2003 and 2004 was
20.4%. The improvement in the gross margin in the first quarter of 2004 was
offset primarily by higher fixed unit costs in the second quarter of 2004.
Selling, general and administrative expenses decreased to $27.4 million
in the first half of 2004 from $27.5 million in the first half of 2003. Lower
costs were incurred in the first half of 2004 as compared to the first half of
2003 in several semi-variable expense categories, such as expenditures for
research and development and advertising expenses. Selling, general and
administrative expenses as a percentage of net sales increased to 17.4% in the
first half of 2004 from 16.8% in the first half of 2003. This increase as a
percentage of net sales was due to lower net sales in the first half of 2004
compared to the same period in 2003.
Interest expense was $1.7 million for the first half of 2004 and $2.1
million for the first half of 2003. Lower levels of both variable and fixed rate
debt in the first half of 2004 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
35.4% for 2003 and 36.5% for the first quarter of 2004. The Company has adjusted
the estimated annual effective tax rate for 2004 downward to 35.5%. This
reduction in the tax rate is due to lower levels of projected income for 2004
reducing the effective statutory federal income 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.
14
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. In addition, during the third quarter of Fiscal
2003 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 half of 2004 decreased to $2.0 million or
$0.11 per common share-diluted, from $2.5 million or $0.15 per common
share-diluted for the first half of 2003.
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 in
recent years has been operating cash flow. The Company's net cash provided by
operating activities was $11.4 million and $17.7 million in the first six months
of 2004 and 2003, respectively. Cash provided by operating activities decreased
during 2004 primarily due to changes in working capital. As necessary, the
Company supplements its operating cash flow with borrowings. Net debt repayments
were $0.0 million in the first six months of 2004 and $13.7 million in the first
six months of 2003.
Capital expenditures in the first six months of 2004 and 2003 were $7.9
million and $3.8 million, respectively. Capital expenditures during the first
six months of 2004 were funded by operating cash flow. Management anticipates
that capital expenditures for new projects will total approximately $15.7
million in 2004, consisting of approximately $11.5 million for various
manufacturing equipment, $2.1 million for IT projects, and $2.1 million for
various other capital projects. Management believes that cash on hand, 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.
On July 2, 2004, the Company entered into a purchase and sale agreement
to acquire for $21.0 million a single story industrial building located on 33.6
acres of land in Fall River, Massachusetts. The Company anticipates that it may
utilize borrowings under the Credit Agreetment as the initial source of the
funds to complete the transaction, but that it will also review alternative
financing strategies, which may include the designation of an unrelated third
party to take title to the property which would then be leased to Quaker.
Completion of the
15
purchase or long-term lease of this facility is anticipated during the fourth
quarter of 2004. By the end of 2005, the Company plans to have moved four of the
manufacturing and warehousing operations currently being conducted in leased
facilities into this new facility. The Company anticipates that it will incur a
short-term increase in operating expenses of approximately $2.1 million during
the transition to this new facility. Approximately $1.6 million will be moving
and lease termination costs and another $0.5 million attributable to the
duplication of certain facilities-related expenses.
The Company issued $45.0 million of Senior Notes due October 2005 and
2007 (the Senior Notes) during 1997. The Senior Notes are unsecured and bear
interest at a fixed rate of 7.09% on $15.0 million and 7.18% on $30.0 million.
The Senior 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. 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 October 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 July 3, 2004, the Company
had no loans outstanding under the Credit Agreement and unused availability of
$59.7 million. See Note 5 of Notes to Consolidated Financial Statements included
in the Company's 2003 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.
No dividends were paid on the Company's common stock prior to Fiscal
2003. During the first quarter of 2003, the Board of Directors adoped a new
dividend policy. This policy provides for future dividends to be declared at the
discretion of the Board of Directors, based on the Board's quarterly evaluation
of the Company's results of operations, cash requirements, financial conditions
and other factors deemed relevant by the Board. In the first half of 2004 and
2003, the Company paid cash dividends of $1.0 million or $0.06 per common share
and $0.8 million or $0.05 per common share, respectively. On July 22, 2004, the
Board of Directors
16
declared a cash dividend of $0.03 per common share payable on August 18, 2004 to
shareholders of record on August 4, 2004.
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 Company's
ability to comply in a timely manner with the rules and regulations set forth in
the Sarbanes-Oxley Act, 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.
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.
17
Foreign currency risk
Approximately 2.5% 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 July 3, 2004, 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 Amount Weighted Fair Value
Type of in Local Average Notional Amount Gain
Instrument Currency Currency Contract Rate in U.S. Dollars (Losses) Maturity
---------- -------- -------- ------------- --------------- -------- --------
Type of
Instrument
Forward Contracts Mexican Peso 28.0 million 11.46 $2.4 million $ 42,000 Jan. 2005
Capped Forward Options Mexican Peso 44.0 million 11.52 $3.8 million $103,000 Dec. 2005
Forward Contracts Brazilian Real 0.6 million 3.20 $0.2 million $ (5,000) Oct. 2004
The Capped Forward Options are agreements to sell Mexican pesos at the
fixed rate of 11.52, as long as the spot rate at the maturity of each contract
is 12.70 or less.
The Company occasionally purchases manufacturing equipment at prices
which are denominated in foreign currencies. The Company hedges these purchases
by purchasing forward contracts at the time the purchase commitment is made. As
of July 3, 2004, the Company had entered into forward contracts to purchase 1.5
million Euros (USD $1.2 million) at an average rate of 1.22. The fair value of
these contracts was $8,000 as of July 3, 2004.
Interest Rate Risk
All of the Company's outstanding long-term debt is at fixed rates.
Accordingly, a change in prevailing 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 July 3, 2004
and has determined that such a rate change would not have a material impact on
the Company.
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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(e) 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.
19
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
On May 21, 2004, an annual meeting of the shareholders of the Company
was held at which directors were elected to serve until their successors shall
have been elected and shall have qualified and the Quaker Fabric Corporation
2004 Stock Incentive Plan was approved. The number of votes cast for, against,
or withheld/abstained and the number of broker non-votes with regard to each
nominee or matter are set forth below:
Withheld Broker
For Against Abstained Non-Votes
--- ------- --------- ---------
Election of directors:
Sangwoo Ahn 14,797,904 N/A 1,033,897 N/A
Larry A. Liebenow 14,941,016 N/A 890,785 N/A
Jerry I. Porras 14,995,706 N/A 836,095 N/A
Eriberto R. Scocimara 14,888,704 N/A 943,097 N/A
Approval of the Quaker Fabric
Corporation 2004
Stock Incentive Plan 11,842,281 1,393,095 113,831 2,482,603
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 April 19, 2004, in which
the Company furnished a press release announcing its first quarter
results for the period ending April 3, 2004.
20
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: August 11, 2004 By: /s/ Paul J. Kelly
------------------ ------------------------------
Paul J. Kelly
Vice President - Finance
and Treasurer (Principal Financial Officer)
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