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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 April 2, 2005
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 May 11, 2005, 16,826,218 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 April 2, 2005
PART I FINANCIAL INFORMATION
Item 1. Consolidated Balance Sheets 2
Consolidated Statements of Income 3
Consolidated Statements of Comprehensive Income 3
Consolidated Statements of Cash Flows 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and 17
Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 25
PART II OTHER INFORMATION
Item 6. Exhibits 26
Signatures 27
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share information)
April 2, January 1,
2005 2005
----------------------------------
ASSETS (Unaudited) (Audited)
Current assets:
Cash and cash equivalents $ 1,588 $ 4,134
Accounts receivable, less reserves of $1,456 and $2,034 at
April 2, 2005 and January 1, 2005, respectively 39,682 40,708
Inventories 49,591 43,858
Prepaid and deferred income taxes 2,828 2,929
Production supplies 1,887 1,820
Prepaid insurance 1,711 929
Other current assets 6,037 6,215
------------ ------------
Total current assets 103,324 100,593
Property, plant and equipment, net 154,962 158,480
Other assets:
Goodwill 5,432 5,432
Other assets 1,951 2,000
------------ ------------
Total assets $ 265,669 $ 266,505
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt $ 40,000 $ 40,000
Accounts payable 20,527 15,359
Accrued expenses 10,625 11,838
------------ ------------
Total current liabilities 71,152 67,197
Deferred income taxes 29,346 30,541
Other long-term liabilities (Note 9) 1,731 2,275
Commitments and contingencies (Note 7)
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;
16,826,218 shares issued and outstanding as of
April 2, 2005 and January 1, 2005, respectively 168 168
Additional paid-in capital 89,076 89,076
Unearned compensation (437) (488)
Retained earnings 76,582 79,672
Other accumulated comprehensive loss (1,949) (1,936)
------------ ------------
Total stockholders' equity 163,440 166,492
------------ ------------
Total liabilities and stockholders' equity $ 265,669 $ 266,505
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
2
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
Three Months Ended
------------------
Apr. 2, Apr. 3,
2005 2004
------------ ------------
(Unaudited)
Net sales $ 59,215 $ 84,384
Cost of products sold 51,534 65,689
------------ ------------
Gross profit 7,681 18,695
Selling, general and administrative expenses 12,149 14,025
------------ ------------
Operating income (loss) (4,468) 4,670
Other expenses:
Interest expense 748 847
Other expenses (income) 88 (16)
------------ ------------
Income (loss) before provision for income taxes (5,304) 3,839
Provision (benefit) for income taxes (2,214) 1,401
------------ ------------
Net income (loss) $ (3,090) $ 2,438
============ ============
Earnings (loss) per common share - basic $ (0.18) $ 0.15
============ ============
Earnings (loss) per common share - diluted $ (0.18) $ 0.14
============ ============
Dividends per common share $ -- $ 0.030
============ ============
Weighted average shares outstanding - basic 16,826 16,810
============ ============
Weighted average shares outstanding - diluted 16,826 17,307
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
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QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands)
Three Months Ended
------------------
Apr. 2, Apr. 3,
2005 2004
------------ ------------
(Unaudited)
Net income (loss) $ (3,090) $ 2,438
------------ ------------
Other comprehensive loss
Foreign currency translation adjustments (17) (3)
Unrealized gain (loss) on hedging instruments 4 (35)
------------ ------------
Other comprehensive loss (13) (38)
------------ ------------
Comprehensive income (loss) $ (3,103) $ 2,400
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
3
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Three Months Ended
------------------
Apr. 2, Apr. 3,
2005 2004
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net income (loss) $ (3,090) $ 2,438
Adjustments to reconcile net
income to net cash provided
by operating activities:
Depreciation and amortization 4,487 4,870
Amortization of unearned compensation 51 52
Deferred income taxes (1,195) 1,029
Tax benefit related to exercise of common stock options -- 29
Changes in operating assets and liabilities:
Accounts receivable 1,075 (3,515)
Inventories (5,734) (3,305)
Prepaid expenses and other assets (177) 1,318
Accounts payable and accrued expenses 3,955 5,658
Other long-term liabilities (544) 90
------------ ------------
Net cash provided by (used in) operating activities (1,172) 8,664
------------ ------------
Cash flows from investing activities:
Purchase of property, plant and equipment (821) (2,851)
------------ ------------
Cash flows from financing activities:
Proceeds from exercise of common stock options and
issuance of shares under the employee stock purchase plan -- 108
Debt financing costs (492) --
Cash dividends -- (504)
------------ ------------
Net cash used in financing activities (492) (396)
------------ ------------
Effect of exchange rates on cash (61) (53)
------------ ------------
Net increase (decrease) in cash (2,546) 5,364
Cash and cash equivalents, beginning of period 4,134 5,591
------------ ------------
Cash and cash equivalents, end of period $ 1,588 $ 10,955
============ ============
The accompanying notes are an integral part of these consolidated financial
statements
4
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except per share amounts)
Note 1 - OPERATIONS
Quaker Fabric Corporation and subsidiaries (the "Company" or "Quaker")
designs, manufactures and markets woven upholstery fabrics primarily for
residential furniture markets and specialty yarns for use in the production of
its own fabrics and for sale to distributors of craft yarns and manufacturers of
home furnishings and other products.
As discussed in Note 5, on March 11, 2005, the Company entered into
Forbearance Agreements, as hereinafter defined, with respect to the Note
Agreements, as hereinafter defined, and the Credit Agreement, as hereinafter
defined. Pursuant to the Forbearance Agreements, the Company's Lenders, as
hereinafter defined, agreed to waive certain specified covenant defaults as of
January 1, 2005 and to forebear from enforcing their rights under the Note
Agreements and the Credit Agreement until July 15, 2005 subject to certain terms
and conditions. On April 18, 2005, the Company entered into a commitment letter
with Bank of America, N.A. and Banc of America Securities LLC (the "Bank
Commitment Letter") pursuant to which Bank of America, N.A. agreed, subject to
certain conditions, to provide the Company with a five (5) year, $70.0 million
secured senior credit facility ("Senior Credit Facility") including both a
revolving credit facility and a term loan and Banc of America Securities LLC,
agreed to form a syndicate of financial institutions to syndicate the facility.
Proceeds from the Senior Credit Facility would be used to liquidate all debt
currently outstanding under the Credit Agreement and the Note Agreements. There
can be no assurance that the financing transaction contemplated by the Bank
Commitment Letter will be consummated on terms acceptable to the Company, or at
all. The Company may be required to seek alternate financing sources, the terms
of which financing, if obtainable, may be disadvantageous to the Company. Based
upon the anticipated performance of the Company for the foreseeable future, and
absent appropriate additional waivers or agreements to forbear from the Lenders,
the failure to obtain new financing would likely result in an Event of Default
under the Note Agreements and the Credit Agreement and the inability to borrow
under the Credit Agreement no later than July 16, 2005. Management, however,
anticipates that the Company will successfully consummate the Senior Credit
Facility prior to the expiry of the Forbearance Agreements.
Note 2 - 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.
In the opinion of management, the accompanying unaudited consolidated financial
statements were prepared following the same policies and procedures used in the
preparation of the audited financial statements and reflect all adjustments
(consisting of normal recurring adjustments) considered necessary to present
fairly the financial position and operations of Quaker Fabric
5
Corporation and Subsidiaries (the "Company"). Operating results for the three
months ended April 2, 2005 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 1, 2005. Certain prior year amounts have been reclassified to conform
with the current year's presentation. These reclassifications had no impact on
the Company's financial position or results of operations.
Earnings (Loss) Per Common Share
Basic earnings (loss) per common share is computed by dividing net
income (loss) 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.
Due to a loss for the three months ended April 2, 2005, no incremental shares
are included in the dilutive weighted average shares outstanding because the
effect would be antidilutive. The dilutive potential common shares for the three
months ended April 2, 2005 would have been 59. The following table reconciles
weighted average common shares outstanding to weighted average common shares
outstanding and dilutive potential common shares.
Three Months Ended
------------------
Apr. 2, Apr. 3,
2005 2004
---- ----
(In thousands)
Weighted average common shares outstanding 16,826 16,810
Dilutive potential common shares -- 497
------------ ------------
Weighted average common shares outstanding
and dilutive potential common shares 16,826 17,307
============ ============
Antidilutive options 2,678 493
============ ============
Goodwill
Goodwill represents the excess of the purchase price over the fair
value of identifiable net assets acquired. In accordance with Financial
Accounting Standards Board Statement of Financial Accounting Standards (SFAS)
No. 142, "Goodwill and Other Intangible Assets," the Company ceased amortization
of goodwill effective December 30, 2001. SFAS No. 142 requires companies to test
all goodwill for impairment at least annually. The Company evaluates goodwill
for impairment annually (at year end) or when changes in events and
circumstances warrant an evaluation. The Company tested goodwill for impairment
at January 1, 2005 and determined that there was no impairment of goodwill.
6
Property, Plant and Equipment
Property, plant and equipment are stated at cost. The Company provides
for depreciation and amortization on property and equipment on a straight-line
basis over their estimated useful lives. The useful life for leasehold
improvements is initially established as the lesser of (i) the useful life of
the asset or (ii) the initial term of the lease excluding renewal option
periods, unless it is reasonably assured that renewal options will be exercised
based on the existence of a bargain renewal option or economic penalties. If the
exercise of renewal options is reasonably assured due to the existence of
bargain renewal options or economic penalties, such as the existence of
significant leasehold improvements, the useful life of the leasehold
improvements includes both the initial term and any renewal periods.
Note 3 - 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.
Inbound freight, purchasing and receiving costs, inspection costs,
internal transfer costs and raw material warehousing costs are all capitalized
into inventory and included in cost of goods sold as related inventory is sold.
Finished goods warehousing costs and the cost of operating the Company's
finished product distribution centers are included in SG&A expenses.
Inventories consisted of the following:
April 2, January 1,
2005 2005
----- ----
Raw materials $ 27,643 $ 22,397
Work-in-process 9,936 8,474
Finished goods 14,257 13,741
------------ ------------
Inventory at FIFO 51,836 44,612
LIFO adjustment (2,245) (754)
------------ ------------
Inventory at LIFO $ 49,591 $ 43,858
============ ============
Note 4 - 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
------------------
Apr. 2, Apr. 3,
2005 2004
---- ----
(In thousands)
United States $ 52,001 $ 75,238
Canada 2,703 3,441
Mexico 1,614 2,338
Middle East 456 689
South America 945 678
Europe 772 1,111
All Other 724 889
----------- -----------
$ 59,215 $ 84,384
=========== ===========
Net sales by product category are as follows:
Three Months Ended
------------------
Apr. 2, Apr. 3,
2005 2004
---- ----
(In thousands)
Fabric $ 53,491 $ 78,372
Yarn 5,724 6,012
----------- -----------
$ 59,215 $ 84,384
=========== ===========
Note 5 - DEBT
Debt consists of the following:
April 2, January 1,
2005 2005
----- ----
7.18% Senior Notes $ 30,000 $ 30,000
7.09% Senior Notes 5,000 5,000
7.56% Series A Notes 5,000 5,000
----------- -----------
$ 40,000 $ 40,000
=========== ===========
Quaker Fabric Corporation of Fall River ("QFR"), a wholly-owned
subsidiary of the Company, two other subsidiaries of the Company (together with
QFR, the "Borrowers") and the Company, as guarantor, are parties to a Second
Amended and Restated Credit Agreement, dated as of February 14, 2002, with a
bank (the "Bank") which expires January 31, 2007 (as amended, the "Credit
Agreement"). The Credit Agreement provides for a revolving credit facility and a
letter of credit facility.
8
Advances made under the Credit Agreement bear interest at either the
prime rate plus 0.25% or the Eurodollar rate plus an "Applicable Margin," as
determined by the Company. The Applicable Margin on advances is adjusted
quarterly based on the Company's Leverage Ratio as defined in the Credit
Agreement. The Applicable Margin for Eurodollar advances may range from 1.0% to
1.875%. The Company is also required to pay certain fees including a commitment
fee which will vary based on the Company's Leverage Ratio. As of April 2, 2005,
the commitment fee is 0.375% of the unused portion of the Credit Agreement which
was $9,804, net of outstanding letters of credit of $5,196. As of April 2, 2005
and January 1, 2005, the Company had $0 outstanding under the Credit Agreement.
QFR issued $45,000 of Senior Notes due October 2005 and 2007 (the
"Senior Notes") during 1997 under a Note Agreement (as amended, the "Senior Note
Agreement") with an insurance company (the "Insurance Company" and together with
the Bank, the "Lenders"). The Senior Notes bear interest at a fixed rate of
7.09% on $15,000 and 7.18% on $30,000. The Senior Notes may be prepaid in whole
or in part prior to maturity, at QFR'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 $5,000 beginning in October 2003 (of which only the October 2005
payment is unpaid as of March 14, 2005), followed by two annual payments of
$15,000 beginning in 2006.
On February 14, 2002, QFR issued $5,000 of 7.56% Series A Notes due
February 2009 (the "Series A Notes" and together with the Senior Notes, the
"Term Notes") under a Note Purchase Agreement (as amended, the "Series A Note
Agreement" and together with the Senior Note Agreement, the "Note Agreements")
with the Insurance Company. The Series A Notes 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 QFR's option, subject to a yield maintenance premium,
as defined.
As of April 2, 2005, required principal payments under the original
terms of the Note Agreements are as follows:
7.18% Note 7.09% Note 7.56% Note
----------- ----------- -----------
October 10, 2005 $ -- $ 5,000 $ --
October 10, 2006 15,000 -- --
October 10, 2007 15,000 -- --
February 14, 2009 -- -- 5,000
----------- ----------- -----------
$ 30,000 $ 5,000 $ 5,000
=========== =========== ===========
The long-term portion of the amounts outstanding under the Note
Agreements was classified as "current" on the Balance Sheet as of April 2, 2005
and January 1, 2005, in accordance with Emerging Issues Task Force Issue 86-30,
"Classification of Obligations When a Violation is Waived by the Creditor" due
to the debt covenant violations existing at April 2, 2005 and January 1, 2005
referred to below.
The Company and/or QFR are required to comply with a number of
affirmative and negative covenants under the Credit Agreement and the Note
Agreements, 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 and QFR; restrictions on the Company's and/or QFR's ability to declare
and pay
9
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. QFR is prohibited under the Credit Agreement and the Note
Agreements from paying dividends or otherwise transferring funds to the Company.
Restricted net assets as of April 2, 2005 equal 100% of the net assets of the
Company. Until March 31, 2005, the Company's obligations under the Credit
Agreement and the Note Agreements were unsecured.
On March 11, 2005, the Borrowers and the Company, as guarantor, entered
into a Forbearance and Amendment to the Second Amended and Restated Credit
Agreement (the "Bank Forbearance Agreement"). Pursuant to the terms of the Bank
Forbearance Agreement, the Borrowers and the Company acknowledged that in the
absence of a waiver from the Bank, they would be in breach of both the debt
service coverage ratio covenant and the profitable operations covenant in the
Credit Agreement for the last quarter of 2004 and possibly in violation of those
covenants and the leverage ratio and senior debt ratio covenants for each of the
first and second quarters of 2005 and that these breaches would constitute
Events of Default, as defined in the Credit Agreement (the "Specified Bank
Defaults"). In the Bank Forbearance Agreement, the Bank agreed to waive the
Specified Bank Defaults through the period ending July 15, 2005 (the "Limited
Bank Waiver Period"), subject to certain conditions including the Bank's receipt
of fully executed copies of a similar waiver from the Insurance Company with
respect to the fixed charge coverage ratio, senior debt ratio and the total debt
ratio set forth in the Note Agreements. The Bank Forbearance Agreement also
provides for, among other things, (i) an increase in the interest rate and fees
payable under the Credit Agreement, (ii) a reduction in the permitted aggregate
amount of capitalized leases and purchase money debt to $5,000, (iii) the
inclusion of a minimum EBITDA covenant, (iv) a change in the definition of EBIT,
(v) monthly financial reporting to the Bank, (vi) the grant, not later than
March 31, 2005, of a perfected, first priority security interest (subject to
certain exceptions, including pari passu liens to be granted to the holders of
the Term Notes) in all personal property assets of the Borrowers and the Company
then owned or thereafter acquired and the contemporaneous execution of an
intercreditor agreement, in form and substance satisfactory to the Bank, among
the Bank, the holders of the Term Notes, the Borrowers and the Company, which is
a condition to any further borrowing under the Credit Agreement, and (vii) the
reduction of the maximum amount of loans and letters of credit the Bank has
agreed to make under the Credit Agreement to $15,000. In the Bank Forbearance
Agreement, the Borrowers and the Company agreed that they will repay all amounts
outstanding, and cash collateralize all letters of credit issued, under the
Credit Agreement on July 16, 2005 and that at such time the Bank will have all
of its rights and remedies under and in respect of the Credit Agreement and
applicable law, including those arising by virtue of the occurrence of the
Specified Bank Defaults. The parties previously had entered into waivers on
December 20, 2004, February 28, 2005 and March 4, 2005 with respect to the debt
service coverage ratio covenant and the profitable operations covenant in the
Credit Agreement and including a reduction in the Bank's Commitment to $20,000.
As of April 2, 2005, there were no loans outstanding under the Credit Agreement,
approximately $5,200 of letters of credit and unused availability (after a
reduction of the Bank's Commitment, as defined in the Credit Agreement) of
$9,800.
On March 11, 2005, QFR and the Company, as guarantor, entered into a
Forbearance to Note Agreements with respect to the Note Agreements with the
Insurance Company (the "Insurance Company Forbearance Agreement") and together
with the Bank Forbearance Agreement, the "Forbearance Agreements"). Pursuant to
the terms of the Insurance Company Forbearance Agreement, QFR and the Company
acknowledged that in the absence of a waiver
10
from the Insurance Company, QFR and the Company would be in breach of the fixed
charge coverage ratio set forth in the Note Agreements for the last quarter of
2004 and possibly for each of the first and second quarters of 2005 and possibly
in breach of the senior debt ratio and total debt ratio set forth in the Note
Agreements for each of the first and second quarters of 2005 and that this
breach would constitute an Event of Default, as defined in the Note Agreements
(the "Specified Insurance Company Defaults"). In the Insurance Company
Forbearance Agreement, the Insurance Company agreed to waive the Specified
Insurance Company Defaults through the period ending July 15, 2005 (the "Limited
Insurance Company Waiver Period"), subject to certain conditions including, but
not limited to, the Insurance Company's receipt of fully executed copies of a
similar waiver from the Bank with respect to the debt service coverage ratio
covenant, the profitable operations covenant, the senior debt ratio covenant and
the leverage ratio covenant set forth in the Credit Agreement. The Insurance
Company Forbearance Agreement also provides, among other things, (i) that the
Company will not permit any Priority Debt (as defined in the Note Agreements) to
be outstanding at anytime other than as permitted under the Note Agreements,
(ii) the Company will not, and will not permit any subsidiary to, directly or
indirectly create, incur, assume or permit to exist any Lien (as defined in the
Note Agreements) for securing Recourse Obligations (as defined in the Note
Agreements), (iii) for the inclusion of a consolidated minimum EBITDA covenant,
(iv) for monthly financial reporting to the Insurance Company, (v) for the
grant, not later than March 31, 2005, of a perfected, first priority security
interest (subject to certain exceptions, including pari passu liens to be
granted to the Bank) in all personal property assets of the Borrowers and the
Company then owned or thereafter acquired and the contemporaneous execution of
an intercreditor agreement, in form and substance satisfactory to the Insurance
Company, among the Bank, the Insurance Company, Borrowers and the Company and
(vi) that on or prior to July 10, 2005, the Company shall enter into a
refinancing credit facility and using the proceeds thereof shall repay in full
all of the Obligations (as defined in the Insurance Company Forbearance
Agreement). Pursuant to the Insurance Company Forbearance Agreement, on July 15,
2005, the Company has agreed to immediately repay to the Insurance Company all
of the outstanding Obligations, and the Company has acknowledged that the
Insurance Company shall be free in its sole and absolute discretion to proceed
to enforce any or all of its rights and remedies under or in respect of the Note
Agreements and applicable law, including without limitation, those of
termination, acceleration, enforcement and other rights and remedies arising by
virtue of the maturity of the Obligations and of the occurrence of the Specified
Defaults. The parties previously had entered into waivers on December 22, 2004,
February 28, 2005 and March 4, 2005 with respect to the fixed charge coverage
covenant in the Note Agreements. As of April 2, 2005, QFR owed $40,000 principal
plus accrued interest under the Note Agreements.
On March 31, 2005, the Borrowers and the Company (i) consented to an
Intercreditor and Collateral Agency Agreement by and among the Bank, as
Collateral Agent, and the Bank and the Insurance Company, as Lenders, (the
"Intercreditor Agreement," (ii) executed a security agreement pursuant to which
the Borrowers and the Company granted to the Lenders a perfected, first priority
security interest in all personal property assets of the Borrowers and the
Company then owned or thereafter acquired, (the "Security Agreement,") and (iii)
entered into various other agreements with the Lenders which provide, among
other things, that the Bank has no obligation to make further Advances or to
issue, extend or renew Letters of Credit for the Company's accounts to the
extent that any such Advances or Letter of Credit Obligations would increase the
Company's obligations to the Bank by more than $10.0 million (the "Other
Agreements.") As a result, all of the conditions to the continued effectiveness
of the Bank Forbearance Agreement and the Insurance Company Forbearance
Agreement were satisfied, and the Borrowers' right to borrow under the Credit
Agreement, as amended, was reinstated.
11
On April 18, 2005, the Company and QFR entered into a commitment letter
with Bank of America, N.A. ("BofA") and Banc of America Securities LLC ("BAS")
pursuant to which BofA agreed, subject to certain conditions, to provide QFR
with a five (5) year, $70.0 million secured Senior Credit Facility (the "Senior
Credit Facility") including both a revolving credit facility of up to $50.0
million (the "Revolving Credit Facility") and a term loan of up to $20.0 million
(the "Term Loan") and BAS agreed to form a syndicate of financial institutions
to syndicate the facility (the "Bank Commitment Letter"). Proceeds from the
Senior Credit Facility will be used to replace and repay borrowings under the
Note Agreements and the Credit Agreement. Prepayment of the Note Agreements may
result in the Company incurring prepayment penalties which may be as much as
$2,300.
The commitments of the BofA and BAS under the Bank Commitment Letter
are subject to a number of conditions including, but not limited to, completion
of BofA's due diligence effort, negotiation and execution of satisfactory
definitive documentation, no material adverse change in the banking or financial
markets and no material adverse change in QFR's financial condition or prospects
for the future.
The Bank Commitment Letter also provides that advances to QFR under the
Revolving Credit Facility would be limited to a formula based on QFR's accounts
receivable and inventory minus an "Availability Reserve" (and such other
reserves as the BofA may establish.) In addition, all obligations to the Bank
and any other Lenders would be secured by first priority liens upon all of QFR's
and the Company's assets and on the assets of any Guarantor, and amortization of
the Term Loan would be over a five year period beginning six months after the
closing date of the Senior Credit Facility with principal payments made on a
quarterly basis.
In addition, the financing agreements contemplated by the Bank
Commitment Letter are expected to include customary financial covenants,
reporting obligations, and certain affirmative and negative covenants including,
but not limited to, restrictions on dividend payments, capital expenditures,
indebtedness, liens and acquisitions and investments.
There can be no assurance that the financing transaction contemplated
by the Bank Commitment Letter will be consummated on terms acceptable to the
Company, or at all. The Company may be required to seek alternate financing
sources, the terms of which financing, if obtainable, may be disadvantageous to
the Company. Based upon the anticipated performance of the Company for the
foreseeable future, and absent appropriate additional waivers or agreements to
forbear from the Company's existing lenders, the failure to obtain new financing
would likely result in an Event of Default under the Company's existing debt
agreements and the inability to borrow under the Company's existing revolving
credit facility no later than July 16, 2005. Management, however, anticipates
that the Company will successfully consummate the Senior Credit Facility prior
to the expiry of the Forbearance Agreements.
Note 6 - ACCOUNTING FOR STOCK-BASED COMPENSATION
Accounting for Stock-Based Compensation. The Company discloses
stock-based compensation information in accordance with SFAS 148 and SFAS 123.
SFAS 148 provides additional transition guidance for companies that elect to
voluntarily adopt the provisions of SFAS 123. SFAS 148 does not change the
provisions of SFAS 123 that permit entities to continue to apply the intrinsic
value method of APB 25. The Company has elected to continue to account for its
stock option plans under APB 25 as well as to provide disclosure of stock based
12
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. SFAS 123 does not apply to awards made
prior to June 24, 1995, and so all pro forma disclosures include only the
effects of all options granted after June 24, 1995. Additional awards in
future years are anticipated. The effects of applying SFAS 123 in this pro
forma disclosure are not indicative of future expectations.
Had compensation cost for awards granted under the Company's
stock-based compensation plans been determined based on the fair value at the
grant dates consistent with the method set forth in SFAS No. 123, the effect on
the Company's net income (loss) and earnings (loss) per common share would have
been as follows:
Three Months Ended
------------------
Apr. 2, Apr. 3,
2005 2004
---- ----
(In thousands)
(Unaudited)
Net income (loss), as reported $ (3,090) $ 2,438
Add: Stock-based employee compensation
expense included in net income, net of
related tax effects 30 33
Less: Stock-based employee compensation
expense determined under the fair value
method, net of related tax effects (229) (295)
------------ ------------
Pro forma net income (loss): $ (3,289) $ 2,176
============ ============
Earnings (loss) per common share - basic
As reported $ (0.18) $ 0.15
Pro forma $ (0.20) $ 0.13
Earnings (loss) per common share - diluted
As reported $ (0.18) $ 0.14
Pro forma $ (0.20) $ 0.13
Pro forma compensation expense for options is reflected over the
vesting period; therefore, future pro forma compensation expense may be greater
as additional options are granted.
13
The Black-Scholes option-pricing model is used to estimate the fair
value on the date of grant of each option granted after December 15, 1994. The
assumptions used for stock option grants and employee stock purchase right
grants were as follows:
Three Months Ended
------------------
Apr. 2, Apr. 3,
2005 2004
---- ----
Expected volatility 60.0% 60.0%
Risk-free interest rate 3.8% 3.8%
Expected life of options 7 years 7 years
Expected dividends 0.0% 1.2%
The Black-Scholes option pricing model was developed for use in
estimating the fair value of traded options with no vesting or transferability
restrictions. In addition, option pricing models require the input of highly
subjective assumptions, including expected stock price volatility. Because the
Company's stock options have characteristics significantly different from those
of traded options and because changes in the subjective input assumptions used
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.
Note 7 - COMMITMENTS AND CONTINGENCIES
(a) 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.
(b) Environmental Cleanup Matters. The Company accrues for estimated
costs associated with known environmental matters when such costs are probable
and can be 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 changes in 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, to
be spent ratably over a three-year period, which began in 2003. 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.
14
Note 8 - INCOME TAXES
The Company accounts for income taxes under SFAS No. 109, "Accounting
for Income Taxes." This statement requires that the Company recognize a current
tax liability or asset for current taxes payable or refundable and a deferred
tax liability or asset for the estimated future tax effects of temporary
differences and carryforwards to the extent they are realizable. A valuation
allowance is recorded to reduce the Company's deferred tax assets to the amount
that is more likely than not to be realized. While management has considered
future taxable income and ongoing prudent and feasible tax planning strategies
in assessing the need for the valuation allowance, in the event management were
to determine that the Company would be able to realize deferred tax assets in
the future in excess of the net recorded amount, an adjustment to the deferred
tax asset would increase income in the period such determination was made.
Likewise, should management determine that the Company would not be able to
realize all or part of its net deferred tax asset in the future, an adjustment
to the deferred tax asset would be charged to income in the period such
determination was made. The Company does not provide for United States income
taxes on earnings of subsidiaries outside of the United States. The Company's
intention is to reinvest these earnings permanently. Management believes that
United States foreign tax credits would largely eliminate any United States
taxes or offset any foreign withholding 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 9 - DEFERRED COMPENSATION PLAN
The Company maintains a deferred compensation plan for certain senior
executives of the Company. Benefits payable upon retirement are grossed up by
the Company's marginal tax rate. During the first quarter of 2005, the Company
reduced Other Long-term Liabilities and Selling, General, and Administrative
expenses by approximately $575, primarily due to four executives contractually
waiving their rights to have their benefit grossed up by the marginal tax rate.
Note 10 - NEW ACCOUNTING PRONOUNCEMENTS
Recently Issued Statements of Financial Accounting Standards, Accounting
Guidance and Disclosure Requirements
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations." FIN 47 clarifies that the term
"conditional asset retirement obligation" as used in SFAS No. 143, "Accounting
for Asset Retirement Obligations," refers to a legal obligation to perform an
asset retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of the
entity. FIN 47 is effective no later than the end of fiscal years ending after
December 15, 2005. The Company does not expect there to be any material effect
on the consolidated financial ftatements upon adoption of the new standard.
In December 2004, the FASB issued SFAS No. 123 (revised), "Share-Based
Payment." Statement 123 (revised) replaces SFAS No. 123, "Accounting for
Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees." Statement
15
123 (revised) covers a wide range of share-based compensation arrangements and
requires that the compensation cost related to these types of payment
transactions be recognized in financial statements. Cost will be measured based
on the fair value of the equity or liability instruments issued. Statement 123
(revised) becomes effective for years beginning after June 15, 2005. The Company
is currently assessing the impact of SFAS 123 (revised) on its consolidated
financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs,"
which amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing." This
amendment clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material (spoilage). SFAS No. 151
requires that those items be recognized as current-period charges regardless of
whether they meet the criteria specified in ARB 43 of "so abnormal." In
addition, SFAS No. 151 requires that allocation of fixed production overheads to
the costs of conversion be based on normal capacity of the production
facilities. SFAS No. 151 is effective for financial statements for fiscal years
beginning after June 15, 2005. The Company is currently assessing the impact of
SFAS No. 151 on its consolidated financial statements.
In December 2004, the FASB issued FASB Staff Position No. FAS 109-1,
"Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004," indicating that this deduction should be accounted for
as a special deduction in accordance with the provisions of SFAS No. 109.
Beginning in 2005 as qualifying activity occurs, the Company will recognize
the allowable deductions through its effective tax rate at that time.
In December 2004, the FASB issued Staff Position No. FAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004," which provides a
practical exception to the SFAS No. 109 requirement to reflect the effect of a
new tax law in the period of enactment by allowing additional time beyond the
financial reporting period to evaluate the effects on plans for reinvestment
or repatriation of unremitted foreign earnings. The adoption of FAS 109-2
does not have any material effect on the Company's consolidated financial
statements.
In December 2004 the FASB issued Statement of Financial Accounting
Standards No. 153 (SFAS 153), "Exchanges of Non-Monetary Assets" as an amendment
to Accounting Principles Board Opinion No. 29 (APB 29), "Accounting for
Non-Monetary Transactions." APB 29 prescribes that exchanges of non-monetary
transactions should be measured based on the fair value of the assets exchanged,
while providing an exception for non-monetary exchanges of similar productive
assets. SFAS 153 eliminates the exception provided in APB 29 and replaces it
with a general exception for exchanges of non-monetary assets that do not have
commercial substance. SFAS 153 is to be applied prospectively and is effective
for all non-monetary asset exchanges occurring in fiscal periods beginning after
June 15, 2005. The Company does not expect there to be any material effect on
the Company's consolidated financial statements upon adoption of the new
standard.
16
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 2004" was a 52 week period ended January
1, 2005 and "Fiscal 2005" will be a 52 week period ending December 31, 2005. The
first three months of Fiscal 2004 and Fiscal 2005 ended April 3, 2004 and April
2, 2005, 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 during the first three months of 2005 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 1, 2005.
Recently Issued Statements of Financial Accounting Standards, Accounting
Guidance and Disclosure Requirements
In March 2005, the FASB issued Interpretation No. 47, "Accounting for
Conditional Asset Retirement Obligations." FIN 47 clarifies that the term
"conditional asset retirement obligation" as used in SFAS No. 143, "Accounting
for Asset Retirement Obligations," refers to a legal obligation to perform an
asset retirement activity in which the timing and (or) method of settlement are
conditional on a future event that may or may not be within the control of the
entity. FIN 47 is effective no later than the end of fiscal years ending after
December 15, 2005. The Company does not expect there to be any material effect
on the Company's consolidated financial statements upon adoption of the new
standard.
In December 2004, the FASB issued SFAS No. 123 (revised), "Share-Based
Payment." Statement 123 (revised) replaces SFAS No. 123, "Accounting for
Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees." Statement 123 (revised) covers a wide range of
share-based compensation arrangements and requires that the compensation cost
related to these types of payment transactions be recognized in financial
statements. Cost will be measured based on the fair value of the equity or
liability instruments issued. Statement 123 (revised) becomes effective for
years beginning after June 15, 2005. The Company is currently assessing the
impact of SFAS 123 (revised) on its consolidated financial statements.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs,"
which amends the guidance in ARB No. 43, Chapter 4, "Inventory Pricing." This
amendment clarifies the accounting for abnormal amounts of idle facility
expense, freight, handling costs and wasted material (spoilage). SFAS No. 151
requires that those items be recognized as current-period charges regardless of
whether they meet the criteria specified in ARB 43 of "so abnormal." In
addition, SFAS No. 151 requires that allocation of fixed production overheads to
the costs of conversion be based on normal capacity of the production
facilities. SFAS No. 151 is effective for financial statements for fiscal years
beginning after June 15, 2005. The Company is currently assessing the impact of
SFAS No. 151 on its consolidated financial statements.
17
In December 2004, the FASB issued FASB Staff Position No. FAS 109-1,
"Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax
Deduction on Qualified Production Activities Provided by the American Jobs
Creation Act of 2004," indicating that this deduction should be accounted for as
a special deduction in accordance with the provisions of SFAS No. 109. Beginning
in 2005 as qualifying activity occurs, the Company will recognize the allowable
deductions through its effective tax rate at that time.
In December 2004, the FASB issued Staff Position No. FAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004," which provides a
practical exception to the SFAS No. 109 requirement to reflect the effect of a
new tax law in the period of enactment by allowing additional time beyond the
financial reporting period to evaluate the effects on plans for reinvestment or
repatriation of unremitted foreign earnings. The adoption of FAS 109-2 does not
have any material effect on the Company's consolidated financial statements.
In December 2004 the FASB issued Statement of Financial Accounting
Standards No. 153 (SFAS 153), "Exchanges of Non-Monetary Assets" as an amendment
to Accounting Principles Board Opinion No. 29 (APB 29), "Accounting for
Non-Monetary Transactions." APB 29 prescribes that exchanges of non-monetary
transactions should be measured based on the fair value of the assets exchanged,
while providing an exception for non-monetary exchanges of similar productive
assets. SFAS 153 eliminates the exception provided in APB 29 and replaces it
with a general exception for exchanges of non-monetary assets that do not have
commercial substance. SFAS 153 is to be applied prospectively and is effective
for all non-monetary asset exchanges occurring in fiscal periods beginning after
June 15, 2005. The Company does not expect there to be any material effect on
the Company's consolidated financial statements upon adoption of the new
standard.
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 13.5% of
the Company's net revenues during the first quarter of 2005 were attributable to
fabrics sold outside the United States and approximately 60.0% 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. In addition, there has been a recent and significant increase
in imports of both furniture coverings and fully upholstered furniture into the
U.S. market, with industry data indicating that sales of imported fabrics in
both roll and "kit" form represented approximately 42% of total U.S. fabric
sales during 2004, up from 29% in 2003 and 11% in 2002. Competition in the U.S.
domestic market may further intensify as a result of 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, microdenier "faux 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
18
trends and the amount of retail floor space allocated to various upholstered
furniture product categories at any given time. For example, leather furniture
and furniture covered with microdenier faux suede products, primarily imported
in roll and "kit" form from low labor cost countries, particularly China, have
enjoyed growing popularity over the past few years, primarily at the expense of
woven fabrics, such as the Jacquards and other woven fabrics Quaker
manufactures, and in some retail furniture stores, these products may occupy as
much as 50% of the floor space allocated to upholstered furniture products.
Competitive factors in the industry include product design, product
pricing, customer service and quality. Recent improvements in service levels and
product design have enhanced the competitive position of lower cost imported
products, particularly those products coming into the United States from China.
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
orders during the first quarter of 2005 were down approximately 15.2% compared
to the first quarter of 2004. The total backlog of fabric and yarn products at
the end of the first quarter of 2005 was up $2.1 million compared to that of a
year ago, the dollar value of the yarn backlog was up $2.9 million or 60.7%,
while the dollar value of the fabric backlog was down $0.8 million or 3.7%. The
Company does not anticipate further sequential declines in net sales in the near
future in either the domestic or foreign markets.
Results of Operations - Quarterly Comparison
- ---------------------
Net Sales. Net sales for the first quarter of 2005 decreased $25.2
million, or 29.8%, to $59.2 million from $84.4 million in first quarter of 2004.
Net fabric sales within the United States decreased 33.2%, to $46.3 million in
the first quarter of 2005 from $69.2 million in the first quarter of 2004, as a
result of weak overall furniture demand and increased competition from leather,
microdenier faux suede and other furniture coverings being imported into the
U.S. in roll and "kit" form, primarily from low labor cost countries in Asia.
Net foreign sales decreased 21.1%, to $7.2 million in the first quarter of 2005
from $9.1 million in the first quarter of 2004. This decrease in foreign sales
was due primarily to lower sales in Mexico, Canada, Europe and the Middle East.
In Mexico, the Company competes primarily with Mexican weavers which typically
offer their products at prices lower than the Company's. The Company has lost
some additional market share to these lower cost local mills. Sales in Europe
declined primarily due to general economic weakness. In Canada, where furniture
manufacturers sell furniture into both the United States and Canadian markets,
competition from faux suede fabrics and leather increased during the first
quarter of 2005 and contributed to a more difficult competitive environment. The
political climate in the Middle East continued to have a negative impact on
sales into that region during the first quarter of 2005. Net yarn sales
decreased to $5.7 million in the first quarter of 2005 from $6.0 million in the
first quarter of 2004. Yarn sales decreased in the third and fourth quarters of
2004 to approximately $4.5 million and $3.7 million, respectively. Yarn sales in
the first quarter of 2005 increased compared to the prior quarter principally
due to strong sales of craft yarns to a single customer. The Company anticipates
that yarn sales will remain stable for the near future.
The gross volume of fabric sold decreased 33.3%, to 9.4 million yards
in the first quarter of 2005 from 14.0 million yards in the first quarter of
2004. The weighted average gross sales price per yard increased 1.8%, to $5.74
in the first quarter of 2005 from $5.64 in the first quarter of 2004 as a result
of product mix changes. The Company sold 35.9% fewer yards of middle to
19
better-end fabrics and 29.1% fewer yards of promotional-end fabrics in the first
quarter of 2005 than in the first quarter of 2004. The average gross sales price
per yard of middle to better-end fabrics increased by 4.8%, to $6.94 in the
first quarter of 2005 from $6.62 in the first quarter of 2004. The average gross
sales price per yard of promotional-end fabrics decreased by 1.5%, to $4.02 in
first quarter of 2005 from $4.08 in the first quarter of 2004.
Gross Margin. The gross margin percentage for the first quarter of 2005
decreased to 13.0% as compared to 22.2% for the first quarter of 2004. The 29.8%
drop in net sales in the first quarter of 2005 compared to the first quarter of
2004 caused fixed manufacturing costs as a percentage of net sales to increase,
leading to a decline in the gross margin of approximately 5.6%. Non-recurring
and unusual costs of approximately $1.7 million during the quarter reduced the
gross margin performance in the first quarter of 2005 by an additional 2.9%.
These costs include temporary pricing increases of raw materials, and overtime
charges and inventory carrying costs related to Solutia's decision to exit the
acrylic fiber business and the liquidation of Du-Re, both of which have been
important suppliers for the Company. Solutia and Du-Re related supply
interruptions during the first quarter of 2005 caused the Company to incur
additional costs, including overtime, in order to fill customer orders. The
Company had put alternative suppliers in place by the end of the first quarter.
and these new suppliers had begun furnishing raw materials to the Company at
lower costs by the beginning of the second quarter of 2005.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $12.1 million in the first quarter of 2005
as compared to $14.0 for the first quarter of 2004. Selling, general and
administrative expenses as a percentage of net sales were 20.5% and 16.6% in the
first quarter of 2005 and 2004, respectively. Reducing costs in the first
quarter of 2005, such as sales commissions related to lower sales, payroll costs
attributable to staffing reductions and an adjustment in certain assumptions
used to value benefits due to the Company's executives under the terms of its
non-qualified deferred compensation plan were partially offset by approximately
$0.6 million of severance costs associated with the reduction in force completed
during the quarter and various increases in professional fees. Selling, general
and administrative expenses were higher as a percentage of net sales due to
lower sales.
Interest Expense. Interest expense decreased to $0.7 million in the
first quarter of 2005 from $0.8 million in the first quarter of 2004, primarily
due tolower average levels of senior debt.
Effective Tax Rate. The Company's effective tax rate was a benefit of
41.75% in the first quarter of 2005 compared to a provision of 36.5% in the
first quarter of 2004. The change in the effective tax rate is due to an
expected loss for 2005 plus the additional benefit of federal research and
development tax credits.
The Company is currently challenging tax assessments from the
Massachusetts Department of Revenue (MDOR) for the years 1993-1998. During the
third quarter of 2003, the Company filed amended tax returns with the MDOR
claiming approximately $1.4 million of research and development tax credits for
the years 1993-2001. Also, additional credits of $0.7 million were claimed on
the originally filed tax returns for 2002 and 2003. The MDOR is currently
reviewing the amended tax returns. There is significant uncertainty surrounding
the amount, if any, and timing of the benefit that will be ultimately realized.
The Company believes that it has a supportable basis for claiming these research
and development tax credits, but the amounts are subject to an ongoing audit.
Accordingly, the Company has not reflected the potential benefits of these
credits in its financial statements for these or subsequent years. No
20
benefit will be recognized in the financial statements until these gain
contingencies are resolved through the eventual disposition with the tax
authorities.
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, add
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
(used in) operating activities was ($1.2) million, and $8.7 million in the first
quarter of 2005, and 2004, respectively. Cash provided by operating activities
decreased during the first quarter of 2005 due principally to a $5.5 million
reduction in net income, a $2.2 million reduction in the deferred tax provision,
and an increase in the Company's raw material inventory position primarily to
build a "safety stock" of fiber from Solutia, Inc. ("Solutia").
In January 2005, Solutia, the Company's supplier of acrylic fiber,
announced that it would be exiting the acrylic business, with operations at
Solutia's acrylic manufacturing facilities expected to cease in April 2005.
Approximately 36% of the Company's filling yarns are acrylic and are purchased
from spinners that have historically used acrylic fiber purchased from Solutia.
As a result of this, the Company took steps to build a safety stock of fiber
during the first quarter of 2005, resulting in an overall increase in inventory.
This safety stock is meant to facilitate the Company's transition from Solutia
to other sources of acrylic fiber and the Company expects to use all of it
before the end of the third quarter.
Capital expenditures for the first three months of 2005 and 2004 were
$0.8 million, and $2.9 million, respectively. Capital expenditures during 2005
were funded by operating cash flow. Management anticipates that capital
expenditures for new projects will total approximately $7.6 million in 2005
consisting principally of facilities maintenance expenditures, modifications
needed at the 540,000 square foot manufacturing and warehousing facility leased
by the Company in December 2004 and a modest amount of new equipment needed to
support the expansion of the Company's craft yarn sales. As of April 2, 2005 and
January 1, 2005, the Company had no loans outstanding under the Credit Agreement
and $5.2 million and $5.3 million of letters of credit outstanding,
respectively. As of May 11, 2005, the Company had $4.0 million outstanding under
the Credit Agreement and availability of $6.2 million. Management believes that
cash on hand, operating income and borrowings under the Credit Agreement, will
provide sufficient funding for the Company's capital expenditures, working
capital and debt service needs for the foreseeable future, subject to the
favorable resolution of discussions with its Lenders (as hereinafter defined)
described below.
As discussed in Note 5 to the financial statements, on March 11, 2005,
the Company entered into Forbearance Agreements, as hereinafter defined, with
respect to the Note Agreements, and the Credit Agreement. Pursuant to the
Forbearance Agreements, the Company's Lenders, agreed to waive certain specified
covenant defaults as of January 1, 2005
21
and to forebear from enforcing their rights under the Note Agreements and the
Credit Agreement until July 15, 2005, subject to certain terms and conditions,
including but not limited to the grant by the Company to the Lenders of a first
priority security interest in all personal property assets of the Company.
On April 18, 2005, the Company entered into a commitment letter with
Bank of America, N.A. and Banc of America Securities LLC pursuant to which Bank
of America, N.A. agreed, subject to certain conditions, to provide the Company
with a five (5) year, $70.0 million secured senior credit facility ("Senior
Credit Facility") including both a revolving credit facility and a term loan and
Banc of America Securities LLC agreed to form a syndicate of financial
institutions to syndicate the facility. Proceeds from the Senior Credit Facility
would be used to liquidate all debt and satisfy all obligations currently
outstanding under the Credit Agreement and the Note Agreements. There can be no
assurance that the financing transaction contemplated by the Bank of America,
N.A. Commitment Letter will be consummated on terms acceptable to the Company,
or at all. The Company may be required to seek alternate financing sources, the
terms of which financing, if obtainable, may be disadvantageous to the Company.
Based upon the anticipated performance of the Company for the foreseeable
future, and absent appropriate additional waivers or agreements to forbear from
the Lenders, the failure to obtain new financing would likely result in an Event
of Default under the Note Agreements and the Credit Agreement and the inability
to borrow under the Credit Agreement no later than July 16, 2005. Management,
however, anticipates that the Company will successfully conclude the Senior
Credit Facility prior to the expiry of the Forbearance Agreements.
No dividends were paid on the Company's common stock prior to 2003.
During the first quarter of 2003, the Board of Directors adopted 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 2004 and 2003, the Company
paid cash dividends of $1.5 million or $0.09 per common share and $1.7 million
or $0.10 per common share, respectively. As noted above, the Company has agreed
with its Lenders not to declare or pay any dividends or distributions, and in
accordance with those agreements, the Company suspended dividend payments during
the third quarter of 2004 and no dividends have been declared or paid since that
time. It is anticipated that any further amendments to the Note Agreements or
the Credit Agreement, or any agreements for alternate financing, may prohibit
the declaration or payment of dividends. Furthermore, QFR is prohibited under
the Credit Agreement and Note Agreements from paying dividends or otherwise
transferring funds to the Company. Restricted net assets of the Company as of
April 2, 2005 equal 100% of the net assets of the Company. All operations of the
Company are conducted by QFR. This restriction has no impact on the Company's
operations, except for the prohibition on the payment of dividends.
22
Purchase Obligations
The following table sets forth purchase obligations as of April 2,
2005. These purchase obligations consist primarily of normal recurring purchases
of inventory and expense items.
Payments Due by Period (In Thousands)
Less than
Total 1 year 2-3 years 4-5 years 5 years
Purchase Obligations $ 15,600 $ 15,600 $ -- $ -- $ --
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 with 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 the Company's ability to
obtain new financing in an amount and on terms acceptable to it, product demand
and market acceptance of the Company's products, regulatory uncertainties, the
effect of economic conditions, the impact of competitive products and pricing,
including, but not limited to, imported furniture and furniture coverings sold
into the U.S. domestic market, foreign currency exchange rates, changes in
customers' 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 3.4% 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 Mexico and Brazil 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.
The Company also enters into forward exchange contracts to hedge the
purchase of fixed assets denominated in foreign currencies. These hedges are
designated as cash flow hedges intended to reduce the risk of currency
fluctuations from the time of order through delivery of the equipment. Gains or
losses on these derivative instruments are reported as a component of "other
comprehensive income."
At April 2, 2005, the Company had the following derivative financial
instruments outstanding:
Notional Weighted
Amount in Average Notional Fair Value
Type of Local Contract Amount in U.S. Gain
Instrument Currency Currency Rate Dollars (Losses) Maturity
---------- -------- -------- ---- ------- -------- --------
Forward Contracts Mexican Peso 36.0 million 11.52 $3.1 million $ (21,000) Dec. 2005
Forward Contracts Brazilian Real 1.0 million 2.94 $0.3 million $ (26,000) Aug. 2005
Forward Contracts Euro 0.4 million .77 $0.5 million $ (4,000) May 2005
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The Company estimated the change in the fair value of all derivative
financial instruments assuming both a 10% strengthening and weakening of the
U.S. dollar relative to all other major currencies. In the event of a 10%
strengthening of the U.S. dollar, the change in fair value of all derivative
financial instruments would result in an unrealized loss of approximately $0.4
million; whereas a 10% weakening of the U.S. dollar would result in an
unrealized gain of approximately $0.4 million.
Interest Rate Risk
All of the Company's long-term debt is at fixed rates, and has been
classified as current in accordance with Emerging Issues Task Force Issue 86-30,
"Classification of Obligations When a Violation is Waived by the Creditor," due
to the debt covenant violations existing at January 1, 2005. Because of the
debt's fixed rate nature, a change in interest rates has an insignificant effect
on the Company's interest expense, but the fair value of the Company's long-term
debt, would change in response to interest rate movements. Using a scenario
analysis, the Company has evaluated the impact on all long-term maturities of
changing the interest rate 10% from the rate levels that existed at January 1,
2005 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(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
and in ensuring that the information required to be disclosed by the Company in
the reports it files or submits under the Exchange Act is recorded, processed,
summarized, and reported within the time periods specified in the rules of the
Securities and Exchange Commission. 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
--------
(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.
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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: May 11, 2005 By: /s/ Paul J. Kelly
----------------------- ----------------------
Paul J. Kelly
Vice President - Finance
and Treasurer (Principal Financial Officer)
27