Commission File No. 1-12597
CULP, INC.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer, large accelerated filer, and smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one);
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
In September 2011, the FASB issued amended guidance that permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the current two-step goodwill impairment test. If an entity concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, it would not be required to perform the two-step impairment test for that reporting unit. This guidance is effective for interim and annual reporting periods beginning April 30, 2012, with early adoption permitted, and will not have a material impact on our results of operations, cash flows or financial position.
3. Stock-Based Compensation
Common Stock Award
On October 1, 2011, we granted a total of 3,075 shares of common stock to our board of directors. These shares of common stock vested immediately and were measured at $8.45 per share, which represents the closing price of the company’s common stock at the date of grant.
On October 1, 2010, we granted a total of 3,114 shares of common stock to our board of directors. These shares of common stock vested immediately and were measured at $10.02 per share, which represents the closing price of the company’s common stock at the date of grant.
We recorded $26,000 and $31,000 of compensation expense within selling, general, and administrative expense for these common stock awards for the nine-month period ending January 29, 2012 and January 30, 2011, respectively.
Incentive Stock Option Awards
We did not grant any incentive stock option awards during the first nine months of fiscal 2012.
At January 29, 2012, options to purchase 219,375 shares of common stock were outstanding, had a weighted average exercise price of $7.26 per share, and a weighted average contractual term of 5.3 years. At January 29, 2012, the aggregate intrinsic value for options outstanding was $403,000.
At January 29, 2012, outstanding options to purchase 168,175 shares of common stock were exercisable, had a weighted average exercise price of $7.56 per share, and a weighted average contractual term of 5.1 years. At January 29, 2012, the aggregate intrinsic value for options exercisable was $259,000.
The aggregate intrinsic value for options exercised during nine-month periods ended January 29, 2012 and January 30, 2011, were $196,000 and $820,000, respectively.
The remaining unrecognized compensation cost related to incentive stock option awards at January 29, 2012, was $96,000 which is expected to be recognized over a weighted average period of 1.1 years.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We recorded $101,000 and $111,000 of compensation expense on incentive stock option grants within selling, general, and administrative expense for the nine-month periods ended January 29, 2012, and January 30, 2011, respectively.
Time Vested Restricted Stock Awards
We did not grant any time vested restricted stock awards during the first nine months of fiscal 2012.
We recorded $131,000 and $126,000 of compensation expense within selling, general, and administrative expense for time vested restricted stock awards for the nine-month periods ending January 29, 2012 and January 30, 2011, respectively.
At January 29, 2012, there were 185,000 shares of time vested restricted stock outstanding and unvested. Of the 185,000 shares outstanding and unvested, 105,000 shares (granted on January 7, 2009) vest in equal one-third installments on May 1, 2012, 2013, and 2014, respectively. The remaining 80,000 shares (granted on July 1, 2009) vest in equal one-third installments on July 1, 2012, 2013, and 2014, respectively. At January 29, 2012, the weighted average fair value of these outstanding and unvested shares was $3.65 per share.
During the nine-month period ending January 29, 2012, 10,000 shares of time vested restricted stock vested and had a weighted average fair value of $18,800 or $1.88 per share.
At January 29, 2012, the remaining unrecognized compensation cost related to the unvested restricted stock awards was $203,000, which is expected to be recognized over a weighted average vesting period of 1.7 years.
Performance Based Restricted Stock Units
We did not grant any performance based restricted stock units during the first nine months of fiscal 2012.
On January 7, 2009 (fiscal 2009), certain key management employees and a non-employee were granted 120,000 shares of performance based restricted stock units. This award contingently vested in one-third increments, if in any discrete period of two consecutive quarters from February 2, 2009 through April 30, 2012, certain performance goals are met. As of August 1, 2010 (fiscal 2011), the performance goals as defined in the agreement were met and as a result, all of the performance based restricted stock units have vested.
No compensation cost was recorded for performance based restricted stock units for the nine-month period ended January 29, 2012, as all performance based restricted stock units that have been granted by the company were fully vested at the end of fiscal 2011. We recorded $12,000 within selling, general, and administrative expense for performance based restricted stock units for the nine-month period ended January 30, 2011.
Other Share-Based Arrangements
Effective May 2, 2011, we entered into an agreement in which we granted a non-employee a stock appreciation right that is indexed on 70,000 shares of our common stock. This agreement requires us to settle in cash an amount equal to $35,000, plus the excess, if any, over a stock appreciation right value of $700,000 at May 2, 2011. This stock appreciation right value of $700,000 represents the 70,000 indexed shares of common stock noted above measured at the closing price per share of $10 at May 2, 2011. The cash settlement in connection with the stock appreciation right value would represent the difference between a stock appreciation right value that is indexed on the 70,000 shares of common stock noted above and based on the highest closing price per share of our common stock for the period May 2, 2011 through June 30, 2012 (limited to $12 per share) and the $700,000 stock appreciation right value at May 2, 2011. This award will vest over the period May 2, 2011 through June 30, 2012 as this represents the non-employee’s required service period.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Compensation expense associated with this agreement was $44,000 for the nine-months ended January 29, 2012.
4. Accounts Receivable
A summary of accounts receivable follows:
| | | | | | | |
| (dollars in thousands) | | January 29, 2012 | | May 1, 2011 |
| Customers | | $ | 23,113 | | | $ | 21,562 | |
| Allowance for doubtful accounts | | | (561 | ) | | | (776 | ) |
| Reserve for returns and allowances and discounts | | | (540 | ) | | | (577 | ) |
| | | $ | 22,012 | | | $ | 20,209 | |
A summary of the activity in the allowance for doubtful accounts follows:
| | | Nine months ended |
| (dollars in thousands) | | January 29, 2012 | | January 30, 2011 |
| Beginning balance | | $ | (776 | ) | | $ | (1,322 | ) |
| Provision for bad debts | | | 18 | | | | 295 | |
| Net write-offs, net of recoveries | | | 197 | | | | (19 | ) |
| Ending balance | | $ | (561 | ) | | $ | (1,046 | ) |
A summary of the activity in the allowance for returns and allowances and discounts accounts follows:
| | | Nine months ended |
| (dollars in thousands) | | January 29, 2012 | | January 30, 2011 |
| Beginning balance | | $ | (577 | ) | | $ | (534 | ) |
| Provision for returns, allowances and discounts | | | (1,929 | ) | | | (1,606 | ) |
| Credits issued | | | 1,966 | | | | 1,550 | |
| Ending balance | | $ | (540 | ) | | $ | (590 | ) |
Results of Operations
The following analysis of financial condition and results of operations should be read in conjunction with the Financial Statements and Notes and other exhibits included elsewhere in this report.
General
Our fiscal year is the 52 or 53 week period ending on the Sunday closest to April 30. The nine months ended January 29, 2012, and January 30, 2011, represent 39 week periods, respectively. Our operations are classified into two business segments: mattress fabrics and upholstery fabrics. The mattress fabrics segment manufactures, sources and sells fabrics to bedding manufacturers. The upholstery fabrics segment sources, manufactures and sells fabrics primarily to residential and commercial (contract) furniture manufacturers.
We evaluate the operating performance of our segments based upon income (loss) from operations before restructuring and related charges or credits, certain unallocated corporate expenses, and other non-recurring items. Cost of sales in both segments include costs to manufacture or source our products, including costs such as raw material and finished goods purchases, direct and indirect labor, overhead and incoming freight charges. Unallocated corporate expenses represent primarily compensation and benefits for certain executive officers and all costs related to being a public company.
Executive Summary
Net sales were $60.5 million for the third quarter of fiscal 2012, an increase of 17% compared with $51.7 million for the third quarter of fiscal 2011. Net sales were $178.7 million for the nine months ended January 29, 2012, an increase of 14% compared with $156.4 million for the nine months ended January 30, 2011. Both of our business segments had sales gains, in spite of an uncertain global economic environment. In addition, our third quarter is typically a slower quarterly period due to the scheduled holiday plant shutdowns. We believe these trends reflect the success of our various sales and marketing initiatives along with the benefits of our design capabilities and global manufacturing platform.
Income before income taxes was $2.9 million in the third quarter of fiscal 2012 and the third quarter of fiscal 2011. Income before income taxes was $8.7 million for the nine months ended January 29, 2012, a decrease of 16% compared with $10.4 million for the nine months ended January 30, 2011. Despite the increase in net sales, income before income taxes declined primarily because of significant increases in our raw material costs in both business segments and higher selling, general, and administrative expenses (SG&A) primarily in the upholstery fabrics segment. To help offset the increased raw material costs, we have implemented customer price increases in both business segments. These price increases, however, are not expected to fully restore our reduced operating profit margins. While the increased raw material costs affected our operating margins for year to date fiscal 2012, we are encouraged that raw material prices have recently stabilized for both of our business segments.
We reported net income of $1.8 million, or $0.14 per diluted share in the third quarter of fiscal 2012 compared with net income of $2.4 million, or $0.18 per diluted share in the third quarter of fiscal 2011. Net income for the third quarter of fiscal 2012 includes income tax expense of $1.1 million and net income for the third quarter of fiscal 2011 includes income tax expense of $483,000. Net income was $9.9 million, or $0.76 per diluted share, for the nine months ended January 29, 2012, compared with $10.2 million, or $0.77 per diluted share, for the nine months ended January 30, 2011. Net income for the nine months ended January 29, 2012 includes an income tax benefit of $1.2 million and net income for the nine months ended January 30, 2011 includes income tax expense of $213,000. The income tax benefit of $1.2 million for the nine months ended January 29, 2012, includes a $4.4 million non-cash reversal during the second quarter of fiscal 2012 for a portion of the valuation allowance associated with our U.S. operations. The income tax expense of $213,000 for the nine months ended January 30, 2011 includes a $1.3 million non-cash reversal during the second quarter of fiscal 2011 for the entire valuation allowance associated with our China operations.
At January 29, 2012, our cash and cash equivalents and short-term investments totaled $23.6 million, exceeding our total debt (current maturities of long-term debt, long-term debt, and line of credit) of $10.1 million. We made our first $2.2 million scheduled principal payment on our long-term debt during the second quarter of fiscal 2012. Our next scheduled principal payment of $2.2 million is due in August 2012.
On January 17, 2012, we entered into an unsecured credit agreement associated with our operations in Poland that provides for a line of credit up to 6.8 million Polish Zloty (approximately $2.1 million USD at January 29, 2012). This agreement expires on January 15, 2013 and bears interest at the Warsaw Interbank Offered Rate (“WIBOR”) plus 2% (applicable interest rate of 6.89% at January 29, 2012). At January 29, 2012, $875,000 (2.8 million Polish Zloty) was outstanding under this agreement. In connection with the unsecured credit agreement associated with our operations in Poland, we entered into an eighteenth amendment of our U.S. unsecured credit agreement to decrease our revolving loan commitment from $10.0 million to $7.6 million.
Our board of directors has authorized the expenditure of up to $7.0 million for the repurchase of shares of our common stock. Under the common stock repurchase program, shares may be purchased from time to time in open market transactions, block trades, and through plans established under the Securities Exchange Act Rule 10b5-1. The amount of shares purchased and the timing of such purchases will be based on working capital requirements, market and general business conditions and other factors including alternative investment opportunities. Since the initial authorization of this program on June 16, 2011, we have repurchased 624,459 shares of our common stock at a cost of $5.4 million, through the third quarter of fiscal 2012.
Segment Analysis
The following tables set forth the company’s statement of operations by segment for the three and nine months ended January 29, 2012, and January 30, 2011.
| CULP, INC. |
| STATEMENTS OF OPERATIONS BY SEGMENT |
| FOR THE THREE MONTHS ENDED JANUARY 29, 2012 AND JANUARY 30, 2011 |
| (Unaudited) |
| | |
| (Amounts in thousands) |
| | | THREE MONTHS ENDED |
| | | | | | | | | | | | | | | | | | | | |
| | | Amounts | | | | | | | | Percent of Total Sales |
| | | January 29, | | | | January 30, | | | | | % Over | | January 29, | | January 30, |
| Net Sales by Segment | | 2012 | | | | 2011 | | | | | (Under) | | 2012 | | 2011 |
| | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 34,719 | | | | | 27,991 | | | | | | 24.0 | % | | | 57.4 | | % | | | 54.2 | % |
| Upholstery Fabrics | | | 25,731 | | | | | 23,661 | | | | | | 8.7 | % | | | 42.6 | | % | | | 45.8 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Sales | | $ | 60,450 | | | | | 51,652 | | | | | | 17.0 | % | | | 100.0 | | % | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
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| Gross Profit by Segment | | | | | | | | | | | | | | | | | Gross Profit Margin |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 5,104 | | | | | 4,596 | | | | | | 11.1 | % | | | 14.7 | | % | | | 16.4 | % |
| Upholstery Fabrics | | | 3,407 | | | | | 3,643 | | | | | | (6.5 | ) % | | | 13.2 | | % | | | 15.4 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross Profit | | | 8,511 | | | | | 8,239 | | | | | | 3.3 | % | | | 14.1 | | % | | | 16.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
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| Selling, General and Administrative expenses by Segment | | | | | | | | | | | | | | | | | Percent of Sales |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 1,970 | | | | | 1,780 | | | | | | 10.7 | % | | | 5.7 | | % | | | 6.4 | % |
| Upholstery Fabrics | | | 2,653 | | | | | 2,517 | | | | | | 5.4 | % | | | 10.3 | | % | | | 10.6 | % |
| Unallocated Corporate expenses | | | 895 | | | | | 832 | | | | | | 7.6 | % | | | 1.5 | | % | | | 1.6 | % |
| Selling, General and Administrative expenses | | | 5,518 | | | | | 5,129 | | | | | | 7.6 | % | | | 9.1 | | % | | | 9.9 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
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| | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating Income (loss) by Segment | | | | | | | | | | | | | | | | | Operating Income (Loss) Margin |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 3,134 | | | | | 2,816 | | | | | | 11.3 | % | | | 9.0 | | % | | | 10.1 | % |
| Upholstery Fabrics | | | 754 | | | | | 1,126 | | | | | | (33.0 | ) % | | | 2.9 | | % | | | 4.8 | % |
| Unallocated corporate expenses | | | (895 | ) | | | | (832 | ) | | | | | 7.6 | % | | | (1.5 | ) | % | | | (1.6 | ) % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Subtotal | | | 2,993 | | | | | 3,110 | | | | | | (3.8 | ) % | | | 5.0 | | % | | | 6.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Restructuring and related charges | | | - | | | | | (7 | ) | | (1) | | | (100.0 | ) % | | | 0.0 | | % | | | (0.0 | ) % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income | | | 2,993 | | | | | 3,103 | | | | | | (3.5 | ) % | | | 5.0 | | % | | | 6.0 | % |
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| Depreciation by Segment | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 1,081 | | | | | 974 | | | | | | 11.0 | % | | | | | | | | | |
| Upholstery Fabrics | | | 133 | | | | | 134 | | | | | | (0.7 | ) % | | | | | | | | | |
| Subtotal | | $ | 1,214 | | | | | 1,108 | | | | | | 9.6 | % | | | | | | | | | |
Notes:
(1) The $7 restructuring charge represents $17 for lease termination and other exit costs offset by a credit of $10 for sales proceeds received on equipment with no carrying value.
| CULP, INC. |
| STATEMENTS OF OPERATIONS BY SEGMENT |
| FOR THE NINE MONTHS ENDED JANUARY 29, 2012 AND JANUARY 30, 2011 |
| (Unaudited) |
| | |
| (Amounts in thousands) |
| | | NINE MONTHS ENDED | |
| | | | | | | | | | | | | | | | | | |
| | | Amounts | | | | | | Percent of Total Sales |
| | | January 29, | | | | | January 30, | | | % Over | | January 29, | | January 30, |
| Net Sales by Segment | | 2012 | | | | | 2011 | | | (Under) | | 2012 | | 2011 |
| | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 102,130 | | | | | | 87,244 | | | | 17.1 | % | | | 57.1 | % | | | 55.8 | % |
| Upholstery Fabrics | | | 76,603 | | | | | | 69,199 | | | | 10.7 | % | | | 42.9 | % | | | 44.2 | % |
| | | | | | | | | | | | | | | | | | | | | | | |
| Net Sales | | $ | 178,733 | | | | | | 156,443 | | | | 14.2 | % | | | 100.0 | % | | | 100.0 | % |
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| Gross Profit by Segment | | | | | | | | | | | | | | | | Gross Profit Margin |
| | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 16,180 | | | | | | 15,616 | | | | 3.6 | % | | | 15.8 | % | | | 17.9 | % |
| Upholstery Fabrics | | | 9,932 | | | | | | 9,941 | | | | (0.1 | ) % | | | 13.0 | % | | | 14.4 | % |
| Subtotal | | | 26,112 | | | | | | 25,557 | | | | 2.2 | % | | | 14.6 | % | | | 16.3 | % |
| | | | | | | | | | | | | | | | | | | | | | | |
| Other non-recurring charges | | | (77 | ) | | (1) | | | - | | | | 100.0 | % | | | (0.0 | ) % | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | |
| Gross Profit | | | 26,035 | | | | | | 25,557 | | | | 1.9 | % | | | 14.6 | % | | | 16.3 | % |
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| Selling, General and Administrative expenses by Segment | | | | | | | | | | | | | | | | Percent of Sales |
| | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 6,094 | | | | | | 5,480 | | | | 11.2 | % | | | 6.0 | % | | | 6.3 | % |
| Upholstery Fabrics | | | 8,186 | | | | | | 6,394 | | | | 28.0 | % | | | 10.7 | % | | | 9.2 | % |
| Unallocated Corporate expenses | | | 2,715 | | | | | | 2,670 | | | | 1.7 | % | | | 1.5 | % | | | 1.7 | % |
| Selling, General, and Administrative expenses | | | 16,995 | | | | | | 14,544 | | | | 16.9 | % | | | 9.5 | % | | | 9.3 | % |
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| Operating Income (loss) by Segment | | | | | | | | | | | | | | | | Operating Income (Loss) Margin |
| | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 10,087 | | | | | | 10,136 | | | | (0.5 | ) % | | | 9.9 | % | | | 11.6 | % |
| Upholstery Fabrics | | | 1,745 | | | | | | 3,547 | | | | (50.8 | ) % | | | 2.3 | % | | | 5.1 | % |
| Unallocated corporate expenses | | | (2,715 | ) | | | | | (2,670 | ) | | | 1.7 | % | | | (1.5 | ) % | | | (1.7 | ) % |
| Subtotal | | | 9,117 | | | | | | 11,013 | | | | (17.2 | ) % | | | 5.1 | % | | | 7.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | |
| Other non-recurring charges | | | (77 | ) | | (1) | | | - | | | | 100.0 | % | | | (0.0 | ) % | | | 0.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | |
| Operating income | | | 9,040 | | | | | | 11,013 | | | | (17.9 | ) % | | | 5.1 | % | | | 7.0 | % |
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| Depreciation by Segment | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Mattress Fabrics | | $ | 3,163 | | | | | | 2,795 | | | | 13.2 | % | | | | | | | | |
| Upholstery Fabrics | | | 437 | | | | | | 410 | | | | 6.6 | % | | | | | | | | |
| Subtotal | | | 3,600 | | | | | | 3,205 | | | | 12.3 | % | | | | | | | | |
Notes:
(1) Our other non-recurring charges represent employee termination benefits associated with our Anderson, SC plant facility.
Three and Nine months ended January 29, 2012 compared with the Three and Nine Months ended January 30, 2011
Mattress Fabrics Segment
Net Sales
Net sales were $34.7 million for the third quarter of fiscal 2012, an increase of 24% compared with $28.0 million for the third quarter of fiscal 2011. Net sales were $102.1 million for the nine months ended January 29, 2012, an increase of 17% compared with $87.2 million for the nine months ended January 30, 2011.This increase in net sales was primarily due to improved industry demand and our sales and marketing initiatives. We have been able to respond to this increased demand as we are benefitting from our recent investments in production facilities that have expanded our internal capacity. The bedding industry is evolving into a more decorative business with increased product diversity and growing consumer demand for better bedding and a higher quality mattress fabric. Our expanded manufacturing platform has allowed us to better serve our customers by providing them with a diverse product line in all major product categories. This product diversity, along with our design capabilities and product innovation, has created additional sales opportunities with customers who are leading suppliers in the bedding industry. The increase in net sales also reflects price increases we implemented starting in the fourth quarter of fiscal 2011 to partially offset the increased raw material costs noted below.
Gross Profit and Operating Income
For the third quarter of fiscal 2012, the mattress fabrics segment reported a gross profit of $5.1 million compared with $4.6 million for the third quarter of fiscal 2011. Gross profit margins were 14.7% and 16.4% of net sales for the third quarter of fiscal 2012 and 2011, respectively. Selling, general, and administrative expenses (SG&A) for the third quarter of fiscal 2012 were $2.0 million, or 6% of net sales, compared with $1.8 million, or 6% of net sales, for the third quarter of fiscal 2011. Operating income for the third quarter of fiscal 2012 was $3.1 million compared with $2.8 million for the third quarter of fiscal 2011. Operating margins were 9% and 10% of net sales in the third quarter of fiscal 2012 and 2011, respectively.
For the nine months ended January 29, 2012, gross profit was $16.2 million, compared with $15.6 million for the nine months ended January 30, 2011. Gross profit margins were 16% and 18% of net sales for the nine months ended January 29, 2012, and January 30, 2011, respectively. SG&A for the nine months ended January 29, 2012 were $6.1 million, or 6% of net sales, compared with $5.5 million, or 6% of net sales, for the nine months ended January 30, 2011. Operating income was $10.1 million for the nine months ended January 29, 2012 and January 30, 2011, respectively. Operating margins were 10% and 12% of net sales for the nine months ended January 29, 2012 and January 30, 2011, respectively.
Although we are pleased with the increase in net sales noted above, our gross profit and operating margins were affected by higher raw material costs, and customer pricing pressure, and scheduled holiday plant shutdowns. We are encouraged that raw material costs have decreased from their peak levels and seem to have stabilized. However, we are still experiencing higher raw material costs as compared to prior year periods. As a result, we implemented customer price increases starting in the fourth quarter of fiscal 2011. These customer price increases, however, are not expected to fully restore our reduced operating profit margins. In addition, we have worked diligently to manage our production costs and identify alternative sources of yarns and raw materials without comprising quality or production efficiency.
Segment assets
Segment assets consist of accounts receivable, inventory, assets held for sale, non-compete agreements associated with the certain acquisitions, goodwill, and property, plant, and equipment.
As of January 29, 2012, accounts receivable and inventory totaled $28.6 million compared with $25.5 million at May 1, 2011. This increase is primarily due to increased net sales from increased customer demand. As noted above, net sales for our mattress fabrics segment increased 17% for the nine months ended January 29, 2012 compared with the nine months ended January 30, 2011.
As of January 29, 2012, property, plant and equipment totaled $28.2 million compared with $28.6 million at May 1, 2011. The $28.2 million at January 29, 2012, represents property, plant, and equipment of $19.8 million and $8.4 million located in the U.S. and Canada, respectively. The $28.6 million at May 1, 2011, represents property, plant, and equipment of $20.0 million and $8.6 million located in the U.S. and Canada, respectively. The decrease of this segment’s property, plant, and equipment reflects capital spending of $2.8 million offset by depreciation expense of $3.2 million.
As of January 29, 2012 and May 1, 2011, the carrying value of the segment’s goodwill was $11.5 million. As of January 29, 2012, and May 1, 2011, the carrying value of the non-compete agreements were $369,000 and $480,000, respectively. The decrease in the carrying value of the non-compete agreements is primarily due to amortization expense for the nine months ended January 29, 2012. At January 29, 2012 and May 1, 2011, assets held for sale totaled $14,000.
Upholstery Fabrics Segment
Net Sales
Upholstery fabric net sales for the third quarter of fiscal 2012 were $25.7 million, a 9% increase compared with $23.7 million in the third quarter of fiscal 2011. Net sales of upholstery fabrics produced outside our U.S. manufacturing operations were $22.6 million in the third quarter of fiscal 2012, a 9% increase compared with $20.7 million in the third quarter of fiscal 2011. Net sales of upholstery fabrics produced by our U.S. manufacturing operations were $3.1 million in the third quarter of fiscal 2012, a 6% increase compared with $2.9 million in the third quarter of fiscal 2011.
Upholstery fabric net sales for the nine months ended January 29, 2012, were $76.6 million, an 11% increase compared with $69.2 million for the nine months ended January 30, 2011. Net sales for upholstery fabrics produced outside our U.S. manufacturing operations were $67.3 million for the nine months ended January 29, 2012, a 12% increase compared with $60.0 million for the nine months ended January 30, 2011. Net sales of upholstery fabrics produced by our U.S. manufacturing operations were $9.3 million for the nine months ended January 29, 2012, a 1% increase compared with $9.2 million for the nine months ended January 30, 2011.
We are encouraged by the favorable sales trends in our upholstery fabrics business in spite of the continued weakness in the U.S. housing market and the uncertain global economic environment. Our increase in net sales was primarily driven by the growth of our China produced fabrics, with increased sales to key customers located in the U.S., the local China market, and other international customers. This increase in net sales also reflects price increases we implemented starting in the fourth quarter of fiscal 2011 to partially offset increased raw material costs. In addition, the increase reflects the third full quarter of sales from our European operation located in Poland. This operation was established in the fourth quarter of fiscal 2011 and is still in the early stages of development. We are encouraged by the initial sales trends and the interest level from several of the largest furniture manufacturers and retailers in Europe.
Gross Profit and Operating Income
For the third quarter of fiscal 2012, the upholstery fabrics segment reported a gross profit of $3.4 million, compared with $3.6 million for the third quarter of fiscal 2011. Gross profit margins were 13% and 15% for the third quarters of fiscal 2012 and 2011, respectively. SG&A for the third quarter of fiscal 2012 were $2.7 million compared with $2.5 million for the third quarter of fiscal 2011. Operating income for the third quarter of fiscal 2012 was $754,000 compared with operating income of $1.1 million in the third quarter of fiscal 2011. Operating margins were 3% and 5% for the third quarters of fiscal 2012 and 2011, respectively.
For the nine months ended January 29, 2012 and January 30, 2011, the upholstery fabrics segment reported a gross profit of $9.9 million. Gross profit margins were 13.0% and 14.4% for the nine months ended January 29, 2012 and January 30, 2011, respectively. SG&A for the nine months ended January 29, 2012 were $8.2 million, a 28% increase compared with $6.4 million for the nine months ended January 30, 2011. Operating income for the nine months ended January 29, 2012 was $1.7 million, a decrease of 51% compared with $3.5 million for the nine months ended January 30, 2011. Operating margins were 2% and 5% for the nine months ended January 29, 2012 and January 30, 2011, respectively.
Although we are pleased with the increase in net sales noted above, our upholstery fabric results were affected by higher raw material costs and unfavorable foreign currency fluctuations in relation to the U.S. dollar associated with our operations located in China. As a result, we implemented customer price increases starting in the fourth quarter of fiscal 2011 and in addition are expected to implement a price increase late in the fourth quarter of fiscal 2012. These customer price increases, however, are not expected to fully restore our reduced operating profit margins. While we are encouraged that raw material costs have stabilized, our production costs are still higher in comparison to the same time a year ago. In order to reduce our production costs, we have utilized our design capabilities and manufacturing platform to introduce new products that offer excellent quality and value at better margins.
The adverse trends in gross profit and operating income margins were also affected by lower profitability in our U.S. velvet products line in the first half of fiscal 2012. The lower profitability in our U.S. velvet products line was due to both higher raw material costs and lower demand in this product category. Because of these trends, we implemented customer price increases and took steps to align our velvet capacity with expected demand. As a result of these initiatives, our U.S. upholstery operation returned to profitability during the third quarter of fiscal 2012. Going forward, we are encouraged about the opportunity to increase our net sales of woven textured products, which we started manufacturing at this U.S. facility just over two years ago. Our costs to produce this product category in the U.S. are now comparable to our production costs in China.
The decline in operating income was also due to a significant increase in SG&A in fiscal 2012. This increase was primarily due to start-up expenses associated with our Culp Europe operations that did not occur in the nine month period ending January 30, 2011. In addition, SG&A were lower for the nine month period ending January 30, 2011 due to (i) a decrease in incentive compensation accruals reflecting weaker financial results in relation to pre-established performance targets and (ii) a decrease in bad debt expense reflecting a decrease in our consolidated accounts receivable balance, as well as management's assessment of estimated credit exposures within our accounts receivable portfolio. These decreases in SG&A in the nine months ending January 30, 2011 did not occur for the nine months ending January 29, 2012.
Segment Assets
Segment assets consist of accounts receivable, inventory, assets held for sale, and property, plant, and equipment. As of January 29, 2012, accounts receivable and inventory totaled $26.3 million compared to $23.5 million at May 1, 2011. This increase is primarily due to increased net sales from increased customer demand. As noted above, net sales for our upholstery fabrics segment increased 11% for the nine months ended January 29, 2012 compared with the nine months ended January 30, 2011.
Assets held for sale totaled $31,000 and $61,000 at January 29, 2012 and May 1, 2011, respectively.
As of January 29, 2012, property, plant, and equipment totaled $1.2 million compared with $967,000 at May 1, 2011. The $1.2 million at January 29, 2012, represents property, plant, and equipment located in the U.S. of $957,000, located in China of $179,000, and located in Poland of $110,000. The $967,000 at May 1, 2011, represents property, plant, and equipment located in the U.S. of $727,000, located in China of $184,000, and located in Poland of $56,000.
Other Income Statement Categories
Selling, General and Administrative Expenses (SG&A)
For the third quarter of fiscal 2012, SG&A for the company as a whole was $5.5 million compared with $5.1 million for the third quarter of fiscal 2011. For the nine months ended January 29, 2012, SG&A for the company as a whole was $17.0 million, an increase of 17% compared with $14.5 million for the nine months ended January 30, 2011. These increases in SG&A were primarily due to start-up expenses associated with our Culp Europe operations that did not occur in the nine months ended January 30, 2011. In addition, SG&A were lower in the nine months ended January 30, 2011, due to (i) a decrease in stock based compensation which reflects a decrease in stock-based awards and the company's stock price, (ii) a decrease in incentive compensation accruals reflecting weaker financial results in relation to pre-established performance targets, and (iii) a decrease in bad debt expense reflecting a decrease in our consolidated accounts receivable balance, as well as management's assessment of estimated credit exposures within our accounts receivable portfolio. These decreases in SG&A in the nine months ended January 30, 2011, did not occur in the nine months ended January 29, 2012.
Interest Expense (Income)
Interest expense for the third quarter of fiscal 2012 was $181,000 compared with $224,000 for the third quarter of fiscal 2011. Interest expense for the nine months ended January 29, 2012 was $590,000 compared with $659,000 for the nine months ended January 30, 2011. This trend reflects lower outstanding balances on our long-term debt.
Interest income was $148,000 for the third quarter of fiscal 2012 compared with $57,000 for the third quarter of fiscal 2011. Interest income for the nine months ended January 29, 2012 was $387,000 compared with $144,000 for the nine months ended January 30, 2011. Our increase in interest income is primarily due to a higher rate of return on increased short-term investment balances in fiscal 2012 compared with the fiscal 2011.
Other Expense
Other expense for the third quarter of fiscal 2012 was $83,000 compared with $28,000 for the third quarter of fiscal 2011. Other expense was $132,000 for the nine months ended January 29, 2012 compared with $111,000 for the nine months ended January 30, 2011.This change primarily reflects fluctuations in the foreign currency exchange rates for our subsidiaries domiciled in Canada, China, and Poland and our ability to maintain a natural hedge by keeping a balance of our assets and liabilities denominated in Canadian dollars, the Polish Zloty, and EUROs during fiscal 2012.
Income Taxes
Effective Income Tax Rate
We recorded an income tax benefit of $1.2 million, or (13.4)% of income before income tax expense, for the nine month period ended January 29, 2012, compared to income tax expense of $213,000, or 2.1% of income before income tax expense, for the nine month period ended January 30, 2011. Our effective income tax rates for the nine month periods ended January 29, 2012, and January 30, 2011, were based upon the estimated effective income tax rate applicable for the full year after giving effect to any significant items related specifically to interim periods. The effective income tax rate can be affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and foreign sources versus annual projections and changes in foreign currencies in relation to the U.S. dollar.
The effective income tax rate of (13.4)% for the nine month period ended January 29, 2012 is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
| · | The effective income tax rate was reduced by 50% for a reduction in our valuation allowance associated with our U.S. net deferred income tax assets. This 50% reduction in our effective income tax rate is due to a change in judgment about the realization of our U.S. net deferred income tax assets in future years. Since the realization of our U.S. net deferred income tax assets is a result of a change in judgment about future years, we recorded an income tax benefit of $4.4 million that represents a discrete event in which the full tax effects were recorded for the nine month period ending January 29, 2012. |
| · | The effective income tax rate was reduced by 7% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States. |
| · | The effective income tax rate was increased 7% for an increase in unrecognized tax benefits. |
| · | The effective income tax rate was increased by 2.6% for stock-based compensation and other miscellaneous items. |
The effective income tax rate of 2.1% for the nine month period ended January 30, 2011 is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
| · | The effective income tax rate was reduced by 31% for a reduction in our valuation allowance recorded against our net deferred income tax assets. Of this 31% reduction in our effective income tax rate, 19% and 12% pertain to our operations located in the U.S. and China, respectively. The 19% reduction in our effective income tax rate from our U.S. operations is due to the realization of our U.S. net deferred income tax assets from ordinary taxable income projected for fiscal 2011. Since the realization of our U.S. net deferred income tax assets were from ordinary taxable income in the current fiscal year, its tax effects are included in the computation of the annual effective tax rate for fiscal 2011. The 12% reduction in our effective income tax rate from our China operations is due to a change in judgment about the realization of our China net deferred income tax assets in future years. Since the realization of our China net deferred income tax assets is a result of a change in judgment about future years, we recorded an income tax benefit of $1.3 million that represents a discrete event in which the full tax effects were recorded for the nine month period ended January 30, 2011. |
| · | The income tax rate was reduced by 7% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States. |
| · | The income tax rate was reduced by 3% for adjustments made to our Canadian deferred income tax liabilities and associated with our election to file our Canadian income tax returns in U.S. dollars commencing with our fiscal 2011 tax year. Our Canadian income tax returns were filed in Canadian dollars for fiscal years prior to fiscal 2011. This adjustment totaled $315,000 and represented a discrete event in which the full tax effects were recorded during the nine-month period ended January 30, 2011. |
| · | The income tax rate increased 9% for an increase in unrecognized tax benefits. This 9% increase in the income tax rate also includes an income tax benefit of $107,000 or a reduction in the income tax rate of 1% for the subsequent recognition of unrecognized tax benefits. This adjustment of $107,000 represents a discrete event in which the full tax effects were recorded during the nine month period ended January 30, 2011. |
| · | The income tax rate was increased by 0.1% for stock-based compensation and other miscellaneous items. |
Deferred Income Taxes
Summary
In accordance with ASC Topic 740, we evaluate our deferred income taxes to determine if a valuation allowance is required. ASC Topic 740 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard, with significant weight being given to evidence that can be objectively verified. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, taking into account the effects of local tax law. Based on our assessments, we recorded a partial valuation allowance of $12.1 million and $16.4 million against our net deferred income tax assets associated with our U.S. operations at January 29, 2012, and May 1, 2011, respectively. No valuation allowance has been recorded against our net deferred income tax assets associated with our operations located in China, Canada, and Europe.
United States
Our net deferred income tax asset regarding our U.S. operations primarily pertains to incurring significant U.S. pre-tax losses over prior fiscal years, with U.S. loss carryforwards totaling $60.0 million at May 1, 2011. Due to the favorable results of our multi-year restructuring process in our upholstery fabric operations and key acquisitions and capital investments made for our mattress fabric segment, on a cumulative three-year basis ending May 1, 2011 (the end of our fiscal 2011), our U.S. operations earned a pre-tax income of $4.2 million. In addition, our U.S. operations reported a pre-tax income over fiscal years 2011 and 2010 totaling $8.2 million. We believe that fiscal years 2011 and 2010 are a more indicative measure of future pre-tax income as these fiscal years reflect operating performance after the cost savings of recent profit-improvement and restructuring plans were realized, as well as the full operational effects of the acquisitions associated with the company’s mattress fabric operations located in the U.S.
This improvement continued through the second quarter of fiscal 2012, as our U.S. operations earned a cumulative pretax income through the second quarter of fiscal 2012 and fiscal years 2011 and 2010 totaling $10.0 million. This continued earnings improvement from our U.S. operations was driven by our mattress fabric operations (which primarily resides in the U.S.). During the second quarter of fiscal 2012, our mattress fabric operations had net sales totaling $35.2 million compared with $28.3 million in the second quarter of fiscal 2011. In addition, our mattress fabric operations had operating income totaling $3.8 million in the second quarter of fiscal 2012 compared with $3.3 million in the second quarter of fiscal 2011. These improved results in the second quarter of fiscal 2012, which were better than expected, can be attributed to increased sales from our sales and marketing initiatives and new programs with customers who are leading suppliers in the bedding industry. Collectively, these developments increased our confidence in forecasting U.S. taxable income through fiscal 2014 in the second quarter of fiscal 2012. Based on the continuation of these trends in the third quarter of fiscal 2012, we maintain our position that we can forecast U.S. taxable income through 2014. During the third quarter of fiscal 2012, our mattress fabric operations had net sales totaling $34.7 million compared with $28.0 million in the third quarter of fiscal 2011. In addition, our mattress fabric operations had operating income totaling $3.1 million in the third quarter of fiscal 2012 compared with $2.8 million in the third quarter of fiscal 2011.
Although our U.S. operations have reported pre-tax income on a cumulative three-year basis, the significant uncertainty in the overall economic climate, has made it very difficult to forecast medium and long-term financial results associated with our U.S. operations. Since it will take a significant period of time for our U.S. operations to realize its U.S. net deferred income tax assets based on earned and forecasted U.S. pre-tax income levels, we believe it is too uncertain to project U.S. pre-tax income levels associated with our U.S. operations after fiscal 2014 that support a “more likely than not” assertion at the end of our third quarter of fiscal 2012.
Based on the positive and negative evidence noted above, we recorded a partial valuation allowance of $12.1 million at January 29, 2012, against the net deferred income tax assets associated with our U.S. operations that are expected to reverse beyond fiscal 2014 and we recognized an income tax benefit of $4.4 million in the second quarter of fiscal 2012 for the reduction in this valuation allowance for projected U.S. taxable income in fiscal years 2013 and 2014 to reduce our U.S. loss carryforwards.
Overall
The recorded valuation allowance of $12.1 million has no effect on our operations, loan covenant compliance, or the possible realization of the U.S. income tax loss carryforwards in the future. If it is determined that it is “more likely than not” that we will realize any of these U.S. income tax loss carryforwards, an income tax benefit would be recognized at that time.
At January 29, 2012, the current deferred income tax asset of $2.8 million represents $2.5 million and $256,000 from our operations located in the U.S. and China, respectively. At May 1, 2011, the current deferred income tax asset of $293,000 pertains to our operations located in China. At May 1, 2011, the current deferred income tax liability of $82,000 pertains to our operations located in Canada. At January 29, 2012, the non-current deferred income tax asset of $3.9 million represents $2.8 million and $1.1 million from our operations located in the U.S. and China, respectively. At May 1, 2011, the non-current deferred income tax asset of $3.6 million represents $2.3 million and $1.3 million from our operations located in the U.S. and China, respectively. At January 29, 2012 and May 1, 2011, the non-current deferred income tax liability of $659,000 and $596,000 pertains to our operations located in Canada.
Uncertainty In Income Taxes
At January 29, 2012, we had $12.3 million of total gross unrecognized tax benefits, of which $4.0 million represents the amount of gross unrecognized tax benefits that, if recognized would favorably affect the income tax rate in future periods. Of the $12.3 million in gross unrecognized tax benefits as of January 29, 2012, $8.3 million were classified as net non-current deferred income taxes and $4.0 million were classified as income taxes payable –long-term in the accompanying consolidated balance sheets.
At May 1, 2011, we had $11.7 million of total gross unrecognized tax benefits, of which $4.2 million would favorably affect the income tax rate in future periods. Of the $11.7 million in total gross unrecognized tax benefits as of May 1, 2011, $7.5 million were classified as net non-current deferred income taxes and $4.2 million were classified as income taxes payable – long-term in the accompanying consolidated balance sheets.
We estimate that the amount of gross unrecognized tax benefits will increase by approximately $1.0 million for fiscal 2012. This increase primarily relates to double taxation under applicable tax treaties with foreign tax jurisdictions.
Although we reported an income tax benefit of $1.2 million and income tax expense of $213,000 for the nine months ending January 29, 2012 and January 30, 2011, respectively, we pay income taxes associated with our subsidiaries located in Canada, China, and Poland. We had income tax payments of $1.9 million and $1.1 million for the nine months ending January 29, 2012 and January 30, 2011, respectively.
Liquidity and Capital Resources
Liquidity
Our sources of liquidity include cash and cash equivalents, short-term investments, cash flow from operations, and amounts available under our unsecured revolving credit lines. These sources have been adequate for day-to-day operations and capital expenditures. We believe our present cash and cash equivalents and short-term investment balance of $23.6 million at January 29, 2012, cash flow from operations, and current availability under our unsecured revolving credit lines will be sufficient to fund our business needs and fiscal 2012 contractual obligations.
Our board of directors has authorized the expenditure of up to $7.0 million for the repurchase of shares of our common stock. Under the common stock repurchase program, shares may be purchased from time to time in open market transactions, block trades, and through plans established under Securities Exchange Act Rule 10b5-1. The amount of shares purchased and the timing of such purchases will be based on working capital requirements, market and general business conditions and other factors including alternative investment opportunities. Since the initial authorization of this program on June 16, 2011, we have repurchased 624,459 shares of our common stock at a cost of $5.4 million, through the third quarter of fiscal 2012.
At January 29, 2012, our cash and cash equivalents and short-term investments totaled $23.6 million, exceeding our total debt (current maturities of long-term debt, long-term debt, and line of credit) of $10.1 million. Our cash and cash equivalents and short-term investments of $23.6 million at January 29, 2012, decreased from $30.9 million at May 1, 2011. This decrease reflects higher than normal working capital levels to facilitate our sales growth, capital expenditures of $3.7 million, long-term debt principal payments of $2.4 million and common stock repurchases of $5.4 million, offset by net income during the nine months ended January 29, 2012.
Looking ahead to the rest of fiscal 2012, we continue to be encouraged by the opportunities for generating free cash flow, principally from net income plus depreciation and other non-cash expenses. With respect to uses of our cash for the remainder for fiscal 2012, we expect cash capital expenditures to be approximately $5.3 million, of which $3.7 million has been spent through the third quarter of fiscal 2012. Additionally, we expect a modest working capital investment to support higher sales. We have already made our first scheduled principal payment of $2.2 million during the second quarter of fiscal 2012 and our next scheduled $2.2 million principal payment is not due until August 2012. Lastly, we have spent $5.4 million of the approved $7.0 million for our common stock repurchase program.
Our cash and cash equivalents and short-term investment balance may be adversely affected by factors beyond our control, such as weakening industry demand and delays in receipt of payment on accounts receivable.
Working Capital
Accounts receivable at January 29, 2012, were $22.0 million, an increase of 30% compared with $16.9 million at January 30, 2011. This increase primarily reflects increased business volume in both our business segments for fiscal 2012 compared with fiscal 2011. Days’ sales outstanding totaled 31 and 28 days during the third quarters of fiscal 2012 and 2011, respectively.
Inventories as of January 29, 2012 were $32.9 million, an increase of 25%, compared with $28.7 million at January 30, 2011. This increase also reflects increased business volume in both our business segments for fiscal 2012 compared with fiscal 2011. Inventory turns were 6.2 for the third quarters of fiscal 2012 and 2011, respectively.
Accounts payable-trade as of January 29, 2012, was $23.5 million, an increase of 37% compared with $17.1 million at January 30, 2011. This increase reflects increased business volume and inventory purchases in both our business segments in fiscal 2012 compared with fiscal 2011.
Operating working capital (comprised of accounts receivable and inventories, less accounts payable-trade and capital expenditures) was $31.4 million at January 29, 2012 compared with $26.0 million at January 30, 2011. Working capital turnover was 8.7 and 8.5 during the quarters ended January 29, 2012, and January 30, 2011 respectively.
Financing Arrangements
Unsecured Term Notes
In connection with the Bodet & Horst acquisition in 2008, we entered into a note agreement dated August 11, 2008. This agreement provided for the issuance of $11.0 million of unsecured term notes with a fixed interest rate of 8.01% and a term of seven years. Principal payments of $2.2 million per year are due on the notes beginning August 11, 2011. The principal payments are payable over an average term of 3.5 years through August 11, 2015. Any principal prepayments will be assessed a penalty as defined in the agreement. This agreement contains customary financial and other covenants as defined in the agreement.
We made our first principal payment of $2.2 million associated with this note agreement on August 11, 2011.
Government of Quebec Loan
We have an agreement with the Government of Quebec for a term loan that is non-interest bearing and is payable in 48 equal monthly installments (denominated in Canadian dollars) commencing December 1, 2009. The proceeds were used to partially finance capital expenditures at our Rayonese facility located in Quebec, Canada.
Revolving Credit Agreement – United States
At May 1, 2011, we had an unsecured Amended and Restated Credit Agreement that provided for a revolving loan commitment of $6.5 million, including letters of credit up to $3.0 million. This agreement was set to expire August 15, 2012. On August 25, 2011, we entered into a seventeenth amendment to the Amended and Restated Credit Agreement, amending the agreement effective May 1, 2011 (the end of our fiscal 2011). This amendment extends the expiration date of the line of credit through August 25, 2013, increases the revolving loan commitment from $6.5 million to $10.0 million, and decreases the capital expenditure limit for fiscal years 2012 and 2013 from $10.0 million to $6.0 million. On January 17, 2012, and in connection with the Culp Europe Credit Agreement discussed below, we entered into an eighteenth amendment to decrease our revolving loan commitment from $10.0 million to $7.6 million.
The amended agreement provides for a pricing matrix to determine the interest rate payable on loans made under the agreement (applicable interest rate of 1.88% at January 29, 2012). As of January 29, 2012, there were $50,000 in outstanding letters of credit (all of which related to workers compensation). At January 29, 2012 and May 1, 2011, there were no borrowings outstanding under the agreement.
Revolving Credit Agreement – China
At January 29, 2012, we had an unsecured credit agreement associated with our operations in China that provides for a line of credit of up to 40 million RMB (approximately $6.3 million USD at January 29, 2012). This agreement expires on September 2, 2012 and has an interest rate determined by the Chinese government. There were no borrowings outstanding under the agreement as of January 29, 2012 and May 1, 2011.
Revolving Credit Agreement - Europe
On January 17, 2012, we entered into an unsecured credit agreement associated with our operations in Poland that provides for a line of credit up to 6.8 million Polish Zloty (approximately $2.1 million USD at January 29, 2012). This agreement expires on January 15, 2013 and bears interest at WIBOR plus 2% (applicable interest rate of 6.89% at January 29, 2012). At January 29, 2012, $875,000 (2.8 million Polish Zloty) was outstanding under this agreement.
Overall
Our loan agreements require, among other things, that we maintain compliance with certain financial covenants. At January 29, 2012, the company was in compliance with these financial covenants.
At January 29, 2012, the principal payment requirements of long-term debt during the next four years are: Year 1 – $2.4 million; Year 2 - $2.4 million; Year 3 - $2.2 million; and Year 4 - $2.2 million.
Capital Expenditures and Depreciation
Capital expenditures on a cash basis for the nine months ended January 29, 2012 and January 30, 2011 were $3.7 million and $5.6 million, respectively. Capital expenditures for the nine months ended January 29, 2012 and January 30, 2011 primarily relate to the mattress fabrics segment. Depreciation expense for the nine months ended January 29, 2012 and January 30, 2011 was $3.6 million $3.2 million, respectively. Depreciation expense for the nine months ended January 29, 2012 and January 30, 2011, primarily relate to the mattress fabrics segment.
For the full fiscal 2012, we expect cash capital expenditures to be approximately $5.3 million compared with capital expenditures of $6.4 million in fiscal 2011 and $7.4 million in fiscal 2010. Planned capital expenditures for fiscal 2012 primarily relate to the mattress fabrics segment. For fiscal 2012, depreciation expense is projected to be $5 million, which primarily relates to the mattress fabrics segment. For fiscal 2013, we are estimating cash capital expenditures and depreciation expense for the company as a whole to be approximately $5.0 million. The estimated capital spending and depreciation expense for fiscal 2013 primarily relates to our mattress fabrics segment. These are management’s current expectations only, and changes in our business needs could cause changes in plans for capital expenditures and expectations for related depreciation expense.
At January 29, 2012, we had amounts due regarding capital expenditures totaling $15,000, which pertain to outstanding vendor invoices, none of which are financed. The total outstanding amount of $15,000 is expected to be paid in full in fiscal 2012.
Critical Accounting Policies and Recent Accounting Developments
As of January 29, 2012, there were no changes in the nature of our significant accounting policies or the application of those policies from those reported in our annual report on Form 10-K for the year ended May 1, 2011.
Refer to Note 1 located in the notes to the consolidated financial statements for recently adopted and issued accounting pronouncements since the filing of our Form 10-K for the year ended May 1, 2011.
Contractual Obligations
As of January 29, 2012, there were no significant or new contractual obligations from those reported in our annual report on Form 10-K for the year ended May 1, 2011, with the exception of open purchase commitments to acquire equipment with regards to our mattress fabrics segment totaling $1.4 million at January 29, 2012, compared with $980,000 at May 1, 2011.
Inflation
Any significant increase in our raw material costs, utility/energy costs and general economic inflation could have a material adverse impact on the company, because competitive conditions have limited our ability to pass significant operating cost increases on to customers. As discussed elsewhere in this report (see “Segment Analysis”), significant increases in raw material costs led to lower profit margins for both of our business segments for the nine months ended January 29, 2012.
We are exposed to market risk from changes in interest rates on our revolving credit lines. At January 29, 2012, our U.S. revolving credit agreement provides for a pricing matrix to determine the interest rate payable on loans made under this agreement. Our revolving credit line associated with our China subsidiaries bears interest at a rate determined by the Chinese government. At January 29, 2012, there were no borrowings outstanding under our U.S. and China revolving credit lines. On January 17, 2012, we entered into an unsecured credit agreement associated with our operations in Poland that bears interest at WIBOR plus 2%. At January 29, 2012, $875,000 was outstanding under this agreement and this amount is required to be paid in full by January 15, 2013, when this agreement expires.
We are not exposed to market risk from changes in interest rates on our long-term debt. Our unsecured term notes have a fixed interest rate of 8.01%, and the loan associated with the Government of Quebec is non-interest bearing.
We are exposed to market risk from changes in the value of foreign currencies for our subsidiaries domiciled in China, Canada, and Europe. We try to maintain a natural hedge by keeping a balance of our assets and liabilities denominated in the local currencies of our subsidiaries domiciled in Canada and Europe, although there is no assurance that we will be able to continually maintain this natural hedge. Our foreign subsidiaries use the U.S. dollar as their functional currency. A substantial portion of the company’s imports purchased outside the United States are denominated in U.S. dollars. A 10% change in the above exchange rates at January 29, 2012, would not have had a significant impact on our results of operations or financial position.
During the fourth quarter of fiscal 2012, we entered into an agreement to enter foreign exchange contracts that mitigate the risk of foreign exchange rate fluctuations for inventory purchases associated with our operations located in Poland. These contracts effectively convert USD inventory payments at a fixed USD foreign exchange rate compared with the Polish Zloty.
We have conducted an evaluation of the effectiveness of our disclosure controls and procedures as of January 29, 2012, the end of the period covered by this report. This evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, we have concluded that these disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports filed by us and submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized, and reported as and when required. Further, we concluded that our disclosure controls and procedures have been designed to ensure that information required to be disclosed in reports filed by us under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, in a manner to allow timely decisions regarding the required disclosures.
There has been no change in our internal control over financial reporting that occurred during the quarter ended January 29, 2012, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
