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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 September 30, 2006
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one:)
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes |_| No |X|
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
As of November 8, 2006, 16,876,918 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 ended September 30, 2006
PART I FINANCIAL INFORMATION
Item 1. Consolidated Balance Sheets......................................... 2
Consolidated Statements of Operations............................... 3
Consolidated Statements of Comprehensive Loss....................... 3
Consolidated Statements of Cash Flows............................... 4
Notes to Consolidated Financial Statements.......................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................... 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......... 28
Item 4. Controls and Procedures............................................. 29
PART II OTHER INFORMATION
Item 1. Legal Proceedings................................................... 30
Item 1A. Risk Factors........................................................ 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds......... 30
Item 3. Defaults upon Senior Securities..................................... 30
Item 4. Submission of Matters to a Vote of Security Holders................. 30
Item 5. Other Information................................................... 30
Item 6. Exhibits............................................................ 30
Signatures.......................................................... 31
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share information)
September 30, December 31,
2006 2005
---------------- ----------------
Current assets:
Cash and cash equivalents $ 446 $ 725
Accounts receivable, less reserves of $2,188 and $1,463 at
September 30, 2006 and December 31, 2005, respectively 24,229 31,822
Inventories 29,680 37,827
Prepaid and deferred income taxes - 106
Production supplies 1,743 1,904
Prepaid insurance 153 1,212
Other current assets 3,199 4,848
---------------- ----------------
Total current assets 59,450 78,444
Property, plant and equipment, net 89,838 131,177
Assets held for sale 17,669 6,483
Other assets 4,054 3,758
---------------- ----------------
Total assets $ 171,011 $ 219,862
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of debt $ 28,467 $ 37,880
Current portion of capital lease obligations 150 143
Accounts payable 12,285 13,423
Accrued expenses 7,656 8,337
---------------- ----------------
Total current liabilities 48,558 59,783
Capital lease obligations, less current portion 516 629
Deferred income taxes 3,559 16,501
Other long-term liabilities 1,711 1,785
Commitments and contingencies (Note 8)
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;
16,876,918 and 16,826,218 shares issued and outstanding as of September
30, 2006 and December 31, 2005, respectively 169 168
Additional paid-in capital 89,168 89,076
Retained earnings 28,713 53,416
Other accumulated comprehensive loss (1,383) (1,496)
---------------- ----------------
Total stockholders' equity 116,667 141,164
---------------- ----------------
Total liabilities and stockholders' equity $ 171,011 $ 219,862
================ ================
The accompanying notes are an integral part of these consolidated financial statements
2
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
(Amounts in thousands, except per share amounts)
Three Months Ended Nine Months Ended
------------------------ ------------------------
Sept. 30, Oct. 1, Sept. 30, Oct. 1,
2006 2005 2006 2005
------------ ----------- ----------- -----------
Net sales $ 30,311 $ 46,457 $ 119,471 $ 174,557
Cost of products sold 28,314 40,382 106,808 150,667
------------ ----------- ----------- -----------
Gross profit 1,997 6,075 12,663 23,890
Selling, general and administrative expenses 9,161 10,533 28,340 35,248
Goodwill impairment - - - 5,433
Restructuring and asset impairment charges 4,920 5,990 18,788 9,651
Gain on sale of fixed assets, net (439) - (377) -
------------ ----------- ----------- -----------
Operating loss (11,645) (10,448) (34,088) (26,442)
Other:
Interest expense 1,079 754 2,761 2,197
Early extinguishment of debt - - - 2,232
Other, net 110 13 723 145
------------ ----------- ----------- -----------
Loss before provision for income taxes (12,834) (11,215) (37,572) (31,016)
Benefit from income taxes (4,396) (4,060) (12,869) (10,429)
------------ ----------- ----------- -----------
Net loss $ (8,438) $ (7,155) $ (24,703) $ (20,587)
============ =========== =========== ===========
Loss per common share - basic $ (0.50) $ (0.43) $ (1.46) $ (1.22)
============ =========== =========== ===========
Loss per common share - diluted $ (0.50) $ (0.43) $ (1.46) $ (1.22)
============ =========== =========== ===========
Weighted average shares outstanding - basic 16,877 16,826 16,866 16,826
============ =========== =========== ===========
Weighted average shares outstanding - diluted 16,877 16,826 16,866 16,826
============ =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS - UNAUDITED
(Amounts in thousands)
Three Months Ended Nine Months Ended
------------------------- -------------------------
Sept. 30, Oct. 1, Sept. 30, Oct. 1,
2006 2005 2006 2005
------------ ------------ ------------ -----------
Net loss $ (8,438) $ (7,155) $ (24,703) $ (20,587)
Other comprehensive income (loss)
Foreign currency translation adjustments, net of tax
provision of $30 and $50; $39 and $184 for the quarters
and year to date September 30, 2006 and October 1, 2005,
respectively 58 137 74 546
Unrealized loss on hedging instruments - (4) - (23)
------------ ------------ ------------ -----------
Other comprehensive income (loss) 58 133 74 523
------------ ------------ ------------ -----------
Comprehensive loss $ (8,380) $ (7,022) $ (24,629) $ (20,064)
============ ============ ============ ===========
The accompanying notes are an integral part of these consolidated financial statements
3
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(Dollars in thousands)
Nine Months Ended
-------------------------
Sept. 30, Oct. 1,
2006 2005
----------- ------------
Cash flows from operating activities:
Net loss $ (24,703) $ (20,587)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 11,283 12,978
Amortization of unearned compensation - 155
Provision for bad debts 1,191 245
Deferred income taxes (12,942) (8,539)
Goodwill write-off - 5,432
Asset impairments 16,264 9,408
(Gain) on sale of assets (377) -
Early extinguishment of debt - 2,232
Write-off of deferred financing costs 456 -
Prepayment penalty on extinguishment of long-term debt - (1,990)
Changes in operating assets and liabilities:
Accounts receivable 6,445 7,097
Inventories 8,181 2,126
Prepaid expenses and other assets 2,584 419
Accounts payable, accrued expenses and other current liabilities (2,370) (6,785)
Other long-term liabilities (74) (354)
----------- ------------
Net cash provided by (used in) operating activities 5,938 1,837
----------- ------------
Cash flows from investing activities:
Purchase of property, plant and equipment (639) (4,496)
Proceeds from asset dispositions 4,385 -
----------- ------------
Net cash used in investing activities 3,746 (4,496)
----------- ------------
Cash flows from financing activities:
Borrowings from revolving credit facility 78,036 34,900
Repayments of revolving credit facility (81,606) (13,878)
Repayment of term loan (5,843) (40,000)
Proceeds from issuance of term loan - 20,000
Repayment of capital leases (106) -
Change in overdraft 551 139
Capitalization of deferred financing costs (1,124) (1,978)
Proceeds from exercise of common stock options, including tax benefits 93 -
----------- ------------
Net cash provided by (used in) financing activities (9,999) (817)
----------- ------------
Effect of exchange rates on cash 36 81
----------- ------------
Net increase (decrease) in cash (279) (3,395)
Cash and cash equivalents, beginning of period 725 4,134
----------- ------------
Cash and cash equivalents, end of period $ 446 $ 739
=========== ============
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)
1. Operations
Quaker Fabric Corporation and subsidiaries (the Company or Quaker)
pdesigns, 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.
On a comparative basis, the Company's sales have declined
quarter-to-quarter in each of the nine consecutive fiscal quarters ending
September 30, 2006. Primarily as a result of this decline in the Company's
sales, Quaker also reported operating losses in each of those fiscal quarters.
As discussed in Note 6, in anticipation of not achieving certain financial
covenants in the Company's 2005 Credit Agreement, as hereinafter defined, the
Company entered into Amendment No. 3 to the 2005 Credit Agreement in February
2006. Subsequently, while Quaker has made all payments under the 2005 Credit
Agreement as they fell due, the Company failed to comply with the amended
financial covenants in the 2005 Credit Agreement as of the end of fiscal
February 2006. As a result of the Company's recurring losses, these debt
covenant defaults and the possibility that the Company will be unable to achieve
the improvements in its operating performance necessary to meet future debt
covenants, the Company's independent registered public accounting firm notified
the Company that its report on the Company's Fiscal 2005 financial statements
would include an explanatory paragraph expressing substantial doubt about the
Company's ability to continue as a going concern. The failure to deliver audited
financial statements to the lenders without qualification or expression of
concern as to uncertainty of the Company to continue as a going concern
constituted a separate event of default under the 2005 Credit Agreement.
As a result of these events of default, all of the Company's obligations,
liabilities and indebtedness to the lenders under the 2005 Credit Agreement
could have been declared due and payable in full at any time. The Company then
engaged in discussions with its lenders to obtain a forbearance agreement or a
waiver with respect to these defaults. On March 22, 2006, the Company entered
into Amendment No. 4, as hereinafter defined, with respect to the 2005 Credit
Agreement. Pursuant to Amendment No. 4, the Company's lenders agreed to waive
certain specified covenant defaults as of the end of fiscal February 2006 and to
make certain other amendments to the 2005 Credit Agreement, subject to certain
terms and conditions. Among the covenant defaults waived was the requirement
that the Company deliver its Fiscal 2005 audited financial statements to the
lenders without qualification or expression of concern, by the Company's
independent registered public accounting firm, as to uncertainty of the Company
to continue as a going concern, and it should be noted that the report issued by
the Company's independent registered public accounting firm on the Company's
Fiscal 2005 financial statements includes an explanatory paragraph raising
substantial doubt about the ability of the Company to continue as a going
concern.
On June 5, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 5, effective as of May 6, 2006, to the 2005
Credit Agreement ("Amendment No. 5") to (i) waive compliance with certain
financial covenants through the end of fiscal 2006, (ii) reset the performance
levels in the two (2) consecutive month minimum consolidated EBITDA covenant
through February of 2007, (iii) require the Company to continue to engage the
services of the Additional Financial Consultant (as defined in Amendment No. 4)
to perform the services set forth in Amendment No. 4, (iv) adjust the
Availability Reserve requirements to levels consistent with the Company's
forecasted cash flows (advances under the Revolving Credit Facility are limited
to a formula based on Quaker's accounts receivable and inventory minus the
Availability Reserve), (v) add a new "Minimum Net Cash Flow" covenant, (vi)
provide that a portion of the net proceeds from the sale of certain identified
real estate and all of the net proceeds of any other asset sales be applied to
the remaining scheduled installments of principal under the Term Loan in the
inverse order of their maturity, (vii) reinstate the Company's ability to
request, convert and continue LIBOR rate loans, and (viii) increase the interest
rates payable by the Company on all outstanding balances by 200 basis points. In
addition, the Company also agreed to an amendment fee of $470, payable in
monthly installments of $25 each, beginning on June 1, 2006, with the balance of
$294 due in mid-December 2006.
On November 3, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 6, dated as of September 29, 2006, to the
2005 Credit Agreement ("Amendment No. 6") to eliminate the two consecutive month
minimum consolidated EBITDA covenants for the months of April through and
including September 2006.
5
Management has put a restructuring plan in place that is intended to
restore the Company to profitability. The key elements of this restructuring
plan include: (i) stabilizing revenues from Quaker's U.S.-based residential
fabric business by concentrating the Company's marketing efforts on those
markets least sensitive to imported products; (ii) reducing operating costs
enough to compensate for the drop the Company has experienced in its revenues
over the past few years; (iii) consolidating its manufacturing facilities and
selling excess assets, including idled buildings and equipment; (iv) developing
strategically important commercial relationships with a limited number of
carefully chosen offshore fabric mills to recapture the share of the domestic
residential market lost to foreign imports over the past few years; and (v)
generating additional profitable sales by penetrating the outdoor and contract
fabric markets and expanding the Company's specialty yarns business.
Successfully executing this restructuring plan will require considerable
operational, management, financial, sales and marketing, supply chain,
information systems and design expertise involving the need to continually
recruit, train and retain qualified personnel. There can be no assurance that
the Company will have the resources, including the human resources, needed to
manage execution of its restructuring plan effectively, or maintain its current
sales levels.
The Company is exploring various alternatives to improve its financing
situation. Such possibilities include a replacement of the 2005 Credit Agreement
and the sale of excess real estate and idled machinery and equipment. To reduce
the Company's working capital requirements and further conserve cash, the
Company may also further reduce its cost structure by taking actions such as
further personnel reductions and/or the suspension of certain new product/new
market development projects. These actions may or may not prove to be consistent
with Quaker's long-term strategic objectives. There can be no assurance that
such actions will generate sufficient resources to fully address the
uncertainties of the Company's financial position.
The Company, as it announced on October 17, 2006, has reached a preliminary
agreement on the terms of a refinancing transaction with Bank of America, N.A.
and GB Merchant Partners, LLC that would provide the Company with approximately
$50,000 of senior secured financing, subject to various conditions. The Company
is negotiating with these lenders to reach definitive agreements with respect to
the proposed financing. There can be no assurance that the proposed financing
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 a
further event of default under the 2005 Credit Agreement and the inability to
borrow under the Revolving Credit Facility.
As of September 30, 2006, there were $28,500 of loans outstanding under the
2005 Credit Agreement, including the remaining $13,200 Term Loan component, and
approximately $4,500 of letters of credit. Unused availability under the 2005
Credit Agreement fluctuates daily and on September 30, 2006, unused availability
was $2,100, net of the $4,000 Availability Reserve.
In addition, the Company has substantial tangible assets, including
significant investments in special-purpose machinery and equipment useful only
in the production of certain types of yarns or fabrics. A reduction in demand
for the Company's products, changes in the Company's product mix or changes in
the various internally-produced components used in the production of the
Company's novelty yarns or fabrics could result in the idling of some or all of
this equipment, requiring the Company to test for impairment of these assets.
Depending upon the outcome of these tests, the Company could be required to
write-down all or a portion of these assets, resulting in a corresponding
reduction in Quaker's earnings and net worth. During 2005, this testing process
resulted in the need for Quaker to write down by $10,200, buildings, machinery
and equipment determined to be impaired. The Company also wrote down by $3,900
and $16,264 assets determined to be impaired during the third quarter and first
nine months of 2006, respectively.
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
6
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 for the year ended December 31,
2005 and reflect all adjustments (consisting of normal recurring adjustments)
considered necessary to present fairly the financial position and results of
operations of Quaker Fabric Corporation and Subsidiaries (the "Company").
Operating results for the nine months ended September 30, 2006 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 December 31, 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.
Loss Per Common Share
Basic loss per common share is computed by dividing net loss by the
weighted average number of common shares outstanding during the period. For
diluted loss per share, the denominator also includes dilutive outstanding stock
options determined using the treasury stock method. Due to losses for the nine
months ended September 30, 2006 and October 1, 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 September 30, 2006 and October 1, 2005 would have been 0 and 21,
respectively. The following table reconciles weighted average common shares
outstanding to weighted average common shares outstanding and dilutive potential
common shares.
Three Months Ended Nine Months Ended
----------------------- -----------------------
Sept. 30, Oct. 1, Sept. 30, Oct. 1,
2006 2005 2006 2005
----------- ----------- ---------- -----------
(In thousands)
Weighted average common shares outstanding 16,877 16,826 16,866 16,826
Dilutive potential common shares - - - -
----------- ----------- ---------- -----------
Weighted average common shares outstanding and
dilutive potential common share 16,877 16,826 16,866 16,826
=========== =========== ========== ===========
Antidilutive options 2,612 2,996 2,650 2,898
=========== =========== ========== ===========
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 also requires companies to
test goodwill for impairment at least annually, or when changes in events and
circumstances warrant an evaluation. Due to lower than anticipated orders and a
related reduction in the Company's backlog position, the Company determined that
goodwill should be tested for impairment at July 2, 2005 in accordance with the
provisions of SFAS No. 142. The Company tested for impairment using a discounted
cash flow approach. As a result of this testing, the Company determined that
goodwill had been impaired and should be written down to $0. Accordingly, a
goodwill impairment charge of $5,432, or $0.32 per share, was recorded in the
three month period ended July 2, 2005.
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.
7
Note 3 - RESTRUCTURING CHARGES AND ASSET IMPAIRMENTS
The Company initiated a restructuring plan during 2005 and has previously
reported restructuring charges and asset impairment charges. Implementation of
this plan continues during 2006, with further consolidation of domestic
manufacturing operations and reductions in workforce as necessary.
A summary of the Company's restructuring and asset impairments charges by
period is below:
Three Months Ended October 1, 2005
----------------------------------
Balance Cost Cash Non-Cash Balance
July 2, 2005 Incurred Payments Adjustments Oct. 1, 2005
------------ -------- -------- ----------- ------------
Employee severance costs $ 243 $ - $ (167) $ - $ 76
Asset impairments - 5,990 - (5,990) -
Restructuring professional fees - - - - -
Plant consolidation costs - - - - -
------------ -------- -------- ----------- ------------
$ 243 $ 5,990 $ (167) $ (5,990) $ 76
============ ======== ======== =========== ============
Three Months Ended September 30, 2006
-------------------------------------
Balance Cost Cash Non-Cash Balance
July 1, 2006 Incurred Payments Adjustments Sept. 30, 2006
------------ -------- -------- ----------- ------------
Employee severance costs $ 47 $ 247 $ (101) $ - $ 193
Asset impairments - 3,931 - (3,931) -
Restructuring professional fees 89 543 (502) - 130
Plant consolidation costs - 199 (199) -
------------ -------- -------- ----------- ------------
$ 136 $ 4,920 $ (802) $ (3,931) $ 323
============ ======== ======== =========== ============
Nine Months Ended October 1, 2005
---------------------------------
Balance Cost Cash Non-Cash Balance
Jan. 2, 2005 Incurred Payments Adjustments Oct. 1, 2005
------------ -------- -------- ----------- ------------
Employee severance costs $ - $ 243 $ (167) $ - $ 76
Asset impairments - 9,408 - (9,408) -
Restructuring professional fees - - - - -
Plant consolidation costs - - - - -
------------ -------- -------- ----------- ------------
$ - $ 9,651 $ (167) $ (9,408) $ 76
============ ======== ======== =========== ============
Nine Months Ended September 30, 2006
------------------------------------
Balance Cost Cash Non-Cash Balance
Jan. 1, 2006 Incurred Payments Adjustments Sept. 30, 2006
------------ -------- -------- ----------- ------------
Employee severance costs $ 25 $ 639 $ (471) $ - $ 193
Asset impairments - 16,264 - (16,264) -
Restructuring professional fees - 1,425 (1,295) 130
Plant consolidation costs - 460 (460) - -
------------ -------- -------- ----------- ------------
$ 25 $18,788 $ (2,226) $ (16,264) $ 323
============ ======== ======== =========== ============
8
2005 Restructuring
During the third quarter of 2005, the Company reduced its production
capacity by idling certain manufacturing equipment. As a result of this change,
the Company evaluated this idled equipment for impairment, in accordance with
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
Based upon the projected gross cash flows expected from this equipment, the
Company determined that these assets were impaired and recorded an impairment
charge of $3,419. The Company also reduced its workforce during the third
quarter of 2005 and recorded $243 of employee termination costs, which included
severance costs with respect to sixteen affected employees.
During the third quarter of 2005, the Company decided to close its
manufacturing facility located at 763 Quequechan Street in Fall River,
Massachusetts and offer the building for sale. As a result of this decision, the
building and certain of the equipment in it were evaluated for impairment in
accordance with SFAS No. 144. Based on projected gross cash flows expected from
this equipment and facility, the Company determined that these assets were
impaired and recorded a charge of $5,283, representing the difference between
management's estimate of their fair value and their book value. In accordance
with SFAS No. 144, the building and certain equipment was classified in the
balance sheet as "Assets held for sale." In addition, due to weakness in
upholstery fabric orders, the Company evaluated its prepaid marketing materials
for impairment. As a result of this analysis, the Company determined that a
portion of this asset had been impaired and recorded a charge of $707 during the
third quarter of 2005.
During the fourth quarter of 2005, the Company idled all of the
manufacturing equipment at its Somerset, Massachusetts facility and decided to
offer the building for sale and to move the machinery and equipment into another
facility at such time as the facility was sold. This facility manufactured
chenille yarns. The net book value of the machinery and equipment idled was
approximately $4,300. This equipment was evaluated for impairment as of December
31, 2005 and it was determined that an impairment charge of $1,385 was required.
The building was also evaluated for impairment as of December 31, 2005 and the
Company determined that no impairment charge was required. During the fourth
quarter 2005, the Company also recorded an additional $154 asset impairment
charge related to its manufacturing facility at 763 Quequechan Street in Fall
River, Massachusetts.
2006 Restructuring
During the third quarter of 2006, the Company continued to consolidate its
operations as a result of continued weakness in its domestic sales. The
principal objective of these efforts is to reduce the Company's manufacturing
and operating costs by consolidating operations at its six existing
manufacturing facilities into two facilities. As a result, a significant amount
of equipment will be idled and offered for sale. Also, the Company has offered
for sale three owned manufacturing facilities and its corporate headquarters and
research and development facility. The Company evaluated these facilities and
equipment for impairment, in accordance with SFAS No. 144. Based upon the
projected gross cash flows expected from these assets, the Company determined
that these assets were impaired and recorded an impairment charge of $3,424.
Also, the Company recorded an additional impairment charge of $507 during the
third quarter related to the 60 acres of land currently held for sale. This land
previously had a book value of $4,007, which was approximately the fair market
value based upon independent appraisals. This land has been offered for sale for
over one year and recently the Company entered into a letter of intent to sell
the majority of the property for $3,200. The Company is also negotiating with a
second purchaser for the remaining property and anticipates realizing an
additional $300. The land was therefore written down in the third quarter of
2006 to its estimated sales value of $3,500.
During the third quarter of 2006, the Company also incurred $199 of plant
consolidation expenses as a result of moving equipment and preparing facilities
and equipment for sale. The Company anticipates that the consolidation of
facilities will be completed by the third quarter of 2007 and that cash payments
for these expenses will be approximately $1,700 during the balance of 2006.
Management estimates that upon completion of this consolidation plan, fixed
manufacturing and overhead costs will be reduced by $2,100 on an annualized
basis.
In accordance with Amendment No. 5 to the 2005 Credit Agreement, the
Company engaged Alvarez & Marsal to assist the Company in implementing its
restructuring and consolidation plan. Expenses incurred during the third quarter
of 2006 for these services were $543. The Company expects to continue working
with Alvarez & Marsal at least through year-end 2006.
9
The Company also reduced its workforce during the third quarter of 2006 and
recorded $247 of employee termination costs, consisting of severance costs with
respect to twenty-four affected employees.
Note 4 - 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:
Sept. 30, Dec. 31,
2006 2005
--------------- --------------
$ 16,780 $ 22,504
Raw materials
Work-in-process 5,414 6,120
Finished goods 10,577 12,169
--------------- --------------
Inventory at FIFO 32,771 40,793
LIFO adjustment (3,091) (2,966)
--------------- --------------
Inventory at LIFO $ 29,680 $ 37,827
=============== ==============
Note 5 - 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.
Net sales to unaffiliated customers by major geographical area were as
follows:
Three Months Ended Nine Months Ended
----------------------- ------------------------
Sept. 30, Oct. 1, Sept. 30, Oct. 1,
2006 2005 2006 2005
---------- ----------- ----------- -----------
(In thousands)
United States $ 24,951 $ 40,150 $ 101,044 $ 152,670
Canada 1,468 2,222 5,630 7,867
Mexico 1,370 1,401 4,297 4,435
Middle East 210 344 1,205 1,744
South America 1,075 938 3,503 2,971
Europe 418 565 1,703 2,197
All Other 819 837 2,089 2,673
---------- ----------- ----------- -----------
$ 30,311 $ 46,457 $ 119,471 $ 174,557
========== =========== =========== ===========
10
Net sales by product category are as follows:
Three Months Ended Nine Months Ended
----------------------- ------------------------
Sept. 30, Oct. 1, Sept. 30, Oct. 1,
2006 2005 2006 2005
---------- ----------- ----------- -----------
(In thousands)
Fabric $ 29,805 $ 42,100 $ 115,795 $ 154,312
Yarn 506 4,357 3,676 20,245
---------- ----------- ----------- -----------
$ 30,311 $ 46,457 $ 119,471 $ 174,557
========== =========== =========== ===========
Note 6 - DEBT
Debt consists of the following:
Sept. 30, Dec. 31,
2006 2005
---------------- ---------------
Senior Secured Revolving Credit Facility $ 15,310 $ 18,880
Term Loan payable in quarterly principal installments
through May 1, 2006 and monthly installments
thereafter, plus interest, over a 5 year period
beginning November 1, 2005 13,157 19,000
---------------- ---------------
Total Debt $ 28,467 $ 37,880
Less: Current Portion of Term Loan 13,157 19,000
Current Portion of Senior Secured
Revolving Credit Facility 15,310 18,880
---------------- ---------------
Total Long-Term Debt $ - $ -
================ ===============
On May 18, 2005, Quaker Fabric Corporation of Fall River (QFR), a
wholly-owned subsidiary of the Company, entered into a five-year, $70,000 senior
secured revolving credit and term loan agreement with Bank of America, N.A. and
two other lenders (the 2005 Credit Agreement). The 2005 Credit Agreement
provides for a $20,000 term loan (the Term Loan) and a $50,000 revolving credit
and letter of credit facility (the Revolving Credit Facility), reduced by
Amendment Nos. 3 and 4 (as hereinafter defined) to $30,000. QFR's obligations
under the 2005 Credit Agreement are guaranteed by the Company and two QFR
subsidiaries (the Guaranty). Pursuant to a Security Agreement (also dated as of
May 18, 2005) executed by QFR, the Company, and two subsidiaries of QFR, all of
QFR's obligations under the 2005 Credit Agreement are secured by first priority
liens upon all of QFR's and the Company's assets and on the assets of the two
QFR subsidiaries acting as guarantors (the Security Agreement).
Advances to QFR under the Revolving Credit Facility are limited by a
formula based on Quaker's accounts receivable and inventory, minus an
Availability Reserve (and such other reserves as the Bank may establish from
time to time in its reasonable credit judgment.) Advances made under the
Revolving Credit Facility bear interest at the prime rate plus Applicable Margin
and until October 21, 2005 the Applicable Margin was 0.75% for prime rate
advances. Thereafter, the Applicable Margin is adjusted quarterly based upon the
Company's ratio of Consolidated Total Funded Debt to EBITDA, as defined in the
2005 Credit Agreement, with the Applicable Margin ranging from 0.25% to 1.0% for
prime rate advances. When the 2005 Credit Agreement was initially put in place
in May of 2005, LIBOR (London Interbank Offered Rate) rate loans were also
permissible with respect to the Term Loan at an Applicable Margin of 2.25% until
11
October 21, 2005, with quarterly adjustments ranging from 1.75% to 2.5%
thereafter, based upon the Company's ratio of Consolidated Total Funded Debt to
EBITDA. Amendment No. 4 (as hereinafter defined) eliminated QFR's ability to
request, convert or continue LIBOR rate loans. Amendment No. 5 (as hereinafter
defined) reinstated the Company's ability to request, convert and continue LIBOR
rate loans, and increased the interest rates payable by the Company on all
outstanding balances by 200 basis points. As of September 30, 2006, the weighted
average interest rates of the advances outstanding was 11.25%.
The Revolving Credit Facility has a term of five years which expires on
May 18, 2010. Effective March 22, 2006, the 2005 Credit Agreement requires that
all funds in the Company's cash operating account be applied daily to the
payment of outstanding advances under the Revolving Credit Facility.
The Term Loan bears interest at the prime rate plus Applicable Margin and
until October 21, 2005, the Applicable Margin was 1.50% for prime rate advances.
Thereafter, the Applicable Margin is adjusted quarterly based upon the Company's
ratio of Consolidated Total Funded Debt to EBITDA, as defined, in the 2005
Credit Agreement with the Applicable Margin for prime rate advances ranging from
1.00% to 1.75%. When the 2005 Credit Agreement was initially put in place in May
of 2005, LIBOR (London Interbank Offered Rate) rate loans were also permissible
with respect to the Term Loan at an Applicable Margin of 3.0% until October 21,
2005, with quarterly adjustments ranging from 2.5% to 3.25% thereafter, based
upon the Company's ratio of Consolidated Total Funded Debt to EBITDA. Amendment
No. 4 (as hereinafter defined) eliminated QFR's ability to request, convert or
continue LIBOR rate loans. Amendment No. 5 (as hereinafter defined) reinstated
the Company's ability to request, convert and continue LIBOR rate loans, and
increased the interest rates payable by the Company on all outstanding balances
by 200 basis points. As of September 30, 2006, the weighted average interest
rates of the advances outstanding was 11.25%. As of September 30, 2006, the
weighted average interest rate of the Term Loan was 12.0%. Amortization of the
Term Loan is over a five-year period beginning November 1, 2005, with payments
of principal to be made on a quarterly basis until May 1, 2006 and monthly
thereafter. In certain events, such as the sale of assets, proceeds must be used
to prepay the Term Loan. During the third quarter of 2006, the Company sold
certain equipment and applied the proceeds of $1,392 to reduce the Term Loan.
Also, on July 18, 2006, The Company sold its facility located at 3129 County
Street, Somerset, Massachusetts for $1,132, net of expenses. In accordance with
Amendment No. 5, 50% of the proceeds or $566 was applied to the Term Loan. As of
September 30, 2006, remaining principal payments under the Term Loan are as
follows:
Fiscal Year
----------------------------------
2006 $ 1,000
2007 4,000
2008 4,290
2009 3,867
2010 -
------------
$ 13,157
============
The 2005 Credit Agreement includes customary financial covenants, reporting
obligations, and affirmative and negative covenants including, but not limited
to, limitations on certain business activities of the Company and QFR and
restrictions on the Company's and/or QFR's ability to declare and pay dividends,
incur additional indebtedness, create certain liens, make capital expenditures,
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 2005
Credit Agreement from paying dividends or otherwise transferring funds to the
Company. Restricted net assets as of July 1, 2006 equal 100% of the net assets
of the Company.
QFR's initial borrowing under the 2005 Credit Agreement was $46,500, of
which $42,300 was used to repay, in full, all of QFR's outstanding obligations
under Senior Notes due October 2005 and 2007 that QFR issued to an insurance
company during 1997 and Series A Notes due February 2009 that QFR issued to the
same insurance company during 2002, with such repayment including a yield
maintenance premium of $1,990. The balance of the initial borrowing was used to
cover approximately $1,000 of closing costs and to repay, in full, all of QFR's
outstanding obligations to Fleet National Bank (Fleet) under the Second Amended
and Restated Credit Agreement dated February 14, 2002 by and between Fleet and
QFR (the 2002 Credit Agreement). The Company recorded a charge in the second
quarter of 2005 of $2,232 for Early Extinguishment of Debt which includes the
$1,990 yield maintenance premium plus the write off of existing debt issuance
costs.
12
On July 26, 2005, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 1, effective as of July 1, 2005, to the
2005 Credit Agreement to: (i) increase the Availability Reserve from $5,000 to
$7,500 effective August 20, 2005 and from $7,500 to $10,000 effective September
24, 2005, (ii) reduce the minimum consolidated EBITDA and fixed charge coverage
ratio requirements in the financial covenants, (iii) reduce the limits on the
Company's annual capital expenditure programs, and (iv) under certain
circumstances, require the Company to retain a consultant. The Company paid an
amendment fee of $87.5 which was capitalized and will be amortized over the
remaining term of the 2005 Credit Agreement.
On October 25, 2005, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 2, effective as of October 21, 2005, to the
2005 Credit Agreement (Amendment No. 2) to: (i) reduce the Availability Reserve,
(ii) reduce the minimum consolidated EBITDA requirement for the fourth quarter
of fiscal 2005 in the financial covenants, (iii) eliminate the minimum
consolidated EBITDA requirement in its entirety for all periods after the fourth
quarter of fiscal 2005, (iv) add a new Two Quarter Fixed Charge Coverage Ratio
requirement to the financial covenants applicable to the five fiscal quarters
beginning with the first quarter of fiscal 2006 and ending with the first
quarter of fiscal 2007, (v) reduce the Minimum Fixed Charge Coverage Ratio in
the financial covenants for the first fiscal quarter of 2006, (vi) increase the
Applicable Margin by 0.25% with respect to the Term Loan and all Revolving
Credit Facility advances until March 1, 2006, when all subsequent changes in
Applicable Margins will be determined solely based upon the Company's ratio of
Consolidated Total Funded Debt to EBITDA. The Company paid an amendment fee of
$175, which was capitalized and will be amortized over the remaining term of the
2005 Credit Agreement.
On February 3, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 3, effective as of December 30, 2005, to
the 2005 Credit Agreement (Amendment No. 3) to (i) make certain amendments to
the definitions of Consolidated EBITDA and Consolidated Interest Expense, (ii)
add a new provision with respect to the Company's retention of a Financial
Consultant (as defined in Amendment No. 3), (iii) eliminate the minimum
consolidated EBITDA requirement for the fourth quarter of fiscal 2005, (iv) add
a new two consecutive month minimum consolidated EBITDA covenant through May
2006, (v) eliminate the Minimum Fixed Charge Coverage Ratio for the first two
fiscal quarters of 2006 and reduce the Minimum Fixed Charge Coverage Ratio for
the third quarter of 2006, and (vi) eliminate the Two Quarter Fixed Charge
Coverage Ratio requirement for the first quarter of 2006. In addition, the
Company also agreed to pay a fee of $175 in exchange for a $17,500 reduction in
the Revolving Credit Facility to $32,500, effective February 2, 2006. In
accordance with EITF 98-14, Debtor's Accounting for Changes in Line-of-Credit or
Revolving Debt Arrangements, the Company expensed $401 of previously capitalized
debt issuance costs associated with this reduction in the Revolving Credit
Facility, which is included in "Other Expenses."
On March 22, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Waiver and Amendment No. 4, effective as of March 22,
2006, to the 2005 Credit Agreement (Amendment No. 4) to (i) waive certain
Specified Defaults arising out of the Company's failure to comply with the two
(2) consecutive month minimum consolidated EBITDA covenant for the two month
period ending at the end of Fiscal February and the Company's anticipated
failure to deliver audited financial statements without qualification or
expression of concern as to the uncertainty of the Parent to continue as a going
concern within ninety (90) days of the end of Fiscal 2005, (ii) add a new
provision with respect to the Company's retention of an Additional Financial
Consultant (as defined in Amendment No. 4) to perform certain specific services
set forth in Amendment No. 4, (iii) increase the Availability Reserve from
$7,500 to $8,500 during the period commencing on March 22, 2006 and ending on
May 1, 2006 (advances under the Revolving Credit Facility are limited to a
formula based on Quaker's accounts receivable and inventory minus the
Availability Reserve), (iv) eliminate the two (2) consecutive month minimum
consolidated EBITDA covenant for the two month period ending at the end of
Fiscal March, (v) change the amortization schedule on the Term Loan from
quarterly to monthly, effective June 1, 2006, (vi) require that the net proceeds
of any asset sales be applied to the remaining scheduled installments of
principal under the Term Loan in the inverse order of their maturity, rather
than pro rata, (vii) by no later than May 12, 2006, provide the lenders with
weekly 13-week cash flow forecasts and a revised 2006 business plan, (viii)
require that all cash received by the Company be applied daily to the reduction
of the Company's obligations under the Revolving Credit Facility, requiring the
13
Company to re-borrow funds more frequently to meet its liquidity requirements,
(ix) end the Company's ability to request, convert or continue any LIBOR rate
loans, and (x) require the Company to reimburse not only the Administrative
Agent but also the other lenders for all out-of-pocket expenses incurred in
connection with the preparation of Amendment No. 4 and the on-going
administration of the Loan Documents. In addition, the Company also agreed to
pay an amendment fee of $125 in exchange for the amendment and a $2,500
reduction in the Total Commitment (as defined in the 2005 Credit Agreement),
bringing the Total Commitment down to $30,000, effective March 22, 2006. In
accordance with EITF 98-14, Debtor's Accounting for Changes in Line-of-Credit or
Revolving Debt Arrangements, the Company expensed $55 of debt issuance costs
associated with this reduction in the Revolving Credit Facility, which is
included in "Other Expenses."
On June 5, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 5, effective as of May 6, 2006, to the 2005
Credit Agreement ("Amendment No. 5") to (i) waive compliance with certain
financial covenants through the end of fiscal 2006, (ii) reset the performance
levels in the two (2) consecutive month minimum consolidated EBITDA covenant
through February of 2007, (iii) require the Company to continue to engage the
services of the Additional Financial Consultant (as defined in Amendment No. 4)
to perform the services set forth in Amendment No. 4, (iv) adjust the
Availability Reserve requirements to levels consistent with the Company's
forecasted cash flows (advances under the Revolving Credit Facility are limited
to a formula based on Quaker's accounts receivable and inventory minus the
Availability Reserve), (v) add a new "Minimum Net Cash Flow" covenant, (vi)
provide that a portion of the net proceeds from the sale of certain identified
real estate and all of the net proceeds of any other asset sales be applied to
the remaining scheduled installments of principal under the Term Loan in the
inverse order of their maturity, (vii) reinstate the Company's ability to
request, convert and continue LIBOR rate loans, and (viii) increase the interest
rates payable by the Company on all outstanding balances by 200 basis points. In
addition, the Company also agreed to an amendment fee of $470, payable in
monthly installments of $25 each, beginning on June 1, 2006, with the balance of
$294 due in mid-December 2006.
On November 3, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 6, dated as of September 29, 2006, to the
2005 Credit Agreement ("Amendment No. 6") to eliminate the two consecutive month
minimum consolidated EBITDA covenants for the months of April through and
including September 2006.
As of September 30, 2006, there were $28,467 of loans outstanding under the
2005 Credit Agreement, including the $13,157 term loan component, approximately
$4,500 of letters of credit and unused availability of approximately $2,100, net
of the Availability Reserve, which includes the $4,000 Availability Reserve
required by Amendment No. 5. In accordance with EITF 86-30, Classification of
Obligations When a Violation is Waived by the Creditor, all of the Company's
outstanding debt under the 2005 Credit Agreement is classified as current.
The Company's ability to meet its current obligations is dependent on: (i)
its access to trade credit, (ii) its operating cash flow and (iii) its
Availability under the 2005 Credit Agreement, which is a function of Eligible
Accounts Receivable, Eligible Inventory, and the Availability Reserve as those
terms are defined in the 2005 Credit Agreement. Availability is typically lowest
during the third quarter of each fiscal year principally due to: (i) the
seasonality of the Company's business and (ii) the negative effects of the
Company's annual two-week July shutdown period on sales and cash. Increases in
the Availability Reserve, such as those reflected in Amendment Nos. 1 and 4 to
the 2005 Credit Agreement, discussed above, reduce Availability and thus the
Company's ability to borrow. In like manner, decreases in the Availability
Reserve, such as those reflected in Amendment No. 2 to the 2005 Credit
Agreement, discussed above, increase Availability and thus the Company's ability
to borrow. The Company manages its inventory levels, accounts payable and
capital expenditures to provide adequate resources to meet its operating needs,
maximize its cash flow and reduce the need to borrow under the 2005 Credit
Agreement. However, its cash position may be adversely affected by factors it
cannot completely control, including but not limited to, a reduction in incoming
order rates, production rates, sales, and accounts receivable, as well as delays
in receipt of payment of accounts receivable and limitations of trade credit.
The Company has implemented a plan to reduce its investment in inventory and is
seeking to dispose of certain production equipment and manufacturing and
warehousing facilities as part of its ongoing restructuring program. In
addition, management adjusts the Company's cost structure on a continuing basis
to reflect changes in demand.
The Company, as it announced on October 17, 2006, has reached a preliminary
agreement on the terms of a refinancing transaction with Bank of America, N.A.
and GB Merchant Partners, LLC that would provide the Company with approximately
$50,000 of senior secured financing, subject to various conditions. The Company
is negotiating with these lenders to reach definitive agreements with respect to
the proposed financing. There can be no assurance that the proposed financing
will be consummated on terms acceptable to the Company, or at all. The Company
14
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 a
further event of default under the 2005 Credit Agreement and the inability to
borrow under the Revolving Credit Facility.
Note 7 - ACCOUNTING FOR STOCK-BASED COMPENSATION
Accounting for Stock-Based Compensation. Prior to January 1, 2006 the
Company accounted for its stock option plans under APB 25 as well as provided
disclosure of stock based compensation as outlined in Financial Accounting
Standards Board Statement No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123") as amended by Financial Accounting Standards Board Statement No.
148, "Accounting for Stock-Based Compensation Transition and Disclosure" ("SFAS
148"). SFAS 123 required disclosure of pro forma net income, EPS and other
information as if the fair value method of accounting for stock options and
other equity instruments described in SFAS 123 had been adopted. The Company
adopted Financial Accounting Standards Board Statement No. 123R "Share Based
Payment" ("SFAS 123R") effective January 1, 2006 using the modified prospective
method. No unvested stock options were outstanding as of December 31, 2005. No
stock options were granted and no modifications to outstanding options were made
during the nine months ended September 30, 2006.
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 loss and loss per common share would have been as follows:
Three Months Nine Months
Ended Ended
Oct. 1, 2005 Oct. 1, 2005
------------ ------------
In thousands) (In thousands)
------------ ------------
(Unaudited) (Unaudited)
Loss, as reported $ (7,155) $ (20,587)
Add: Stock-based employee compensation expense included in net
income, net of related tax effects 33 98
Less: Stock-based employee compensation expense determined under
Black-Scholes option pricing model, net of related tax effects (225) (689)
------------ ------------
Pro forma loss: $ (7,347) $ (21,178)
============ ============
Loss per common share - basic
As reported $ (0.43) $ (1.22)
Pro forma $ (0.44) $ (1.26)
Loss per common share - diluted
As reported $ (0.43) $ (1.22)
Pro forma $ (0.44) $ (1.26)
The Company has several stock option plans (the "Plans") in effect that
provide for the granting of non-qualified stock options and other equity-based
incentives to directors, officers, and employees of the Company. Options under
the Plans are generally granted at fair market value and vesting is determined
by the Board of Directors.
15
A summary of the Company's stock option activity is as follows:
Nine Months Ended Fiscal Year Ended
----------------- -----------------
Sept. 30, 2006 Dec. 31, 2005 Jan. 1, 2005
-------------- -------------- ------------
Weighted Weighted Weighted
Number Avg. Number Avg. Number Avg.
of Exercise of Exercise of Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Options outstanding, beginning of year
3,007 $7.57 3,147 $7.58 3,218 $7.57
Granted - - - - 10 $9.12
Exercised 51 $1.37 - - (30) $5.31
Forfeited 344 $7.25 (140) $7.79 (51) $8.52
------ -------- ------ -------- ------ --------
Options outstanding, end of year 2,612 $7.73 3,007 $7.57 3,147 $7.58
Options exercisable 2,612 $7.73 3,007 - 2,125 $7.50
Options available for grant 2,118 - 1,766 - 1,633 -
Weighted average fair value per share
of options granted - - - - - $4.25
The following table summarizes information for options outstanding and
exercisable at September 30, 2006:
Weighted Weighted Weighted
Average Average Average
Options Exercise Remaining Life Options Exercise
Outstanding Price (in years) Exercisable Price
----------- --------- -------------- ----------- ----------
$1.78 - 3.53 2 $ 2.75 0.0 2 $ 2.75
$3.54 - 5.30 447 4.23 3.9 447 4.23
$5.31 - 7.07 667 6.42 5.1 667 6.42
$7.08 - 8.84 607 8.02 4.1 607 8.02
$8.85 - 10.60 798 9.62 4.1 798 9.62
$12.37 - 14.14 30 13.00 1.8 30 13.00
$15.90 - 17.67 61 17.67 1.7 66 17.67
----------- --------- -------------- ----------- ----------
2,612 $ 7.73 4.2 2,612 $ 7.73
=========== ========= ============== =========== ==========
Note 8 - 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 (MADEP) to install air pollution control equipment on
three exhaust stacks 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. The
16
required pollution control equipment is installed on two of the three exhaust
stacks, and the Company reached an agreement with MADEP extending the date by
which the equipment required on the third stack must be installed to October
2007. Management believes the ultimate disposition of known environmental
matters will not have a material adverse effect on the liquidity, capital
resources, business or consolidated financial position of the Company.
Note 9 - 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. 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 reflect the Company's best current
estimate of its annual effective tax rate.
Note 10 - DEFERRED COMPENSATION PLAN
The Company maintains a deferred compensation plan for certain senior
executives of the Company. Prior to 2005, benefits payable upon retirement were
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. During the fourth quarter of 2005, the remaining executives
waived their right to have their benefit grossed up, resulting in an additional
reduction in Other Long-Term Liabilities and Selling, General and Administrative
expenses of $215.
Note 11 - RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
(SFAS No. 123R). SFAS No. 123R replaces SFAS No. 123, and supersedes APB Opinion
No. 25. Statement 123R 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 123R became effective for years beginning after June 15, 2005 and is
effective for the Company beginning in the first quarter of 2006. The Company
has adopted the modified prospective method and therefore will not restate
prior-period results. No unvested options were outstanding as of December 31,
2005.
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 adoption of SFAS No. 151 did not have a material effect on the
Company's Consolidated Financial Statements.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the accounting and
reporting for income taxes recognized in accordance with SFAS No. 109,
"Accounting for Income Taxes." This Interpretation prescribes a comprehensive
model for the financial statement recognition, measurement, presentation and
disclosure of uncertain tax positions taken, or expected to be taken, in income
tax returns. The Company is currently evaluating the impact of FIN 48. The
Company will adopt this Interpretation in the first quarter of 2007.
17
In September 2006, the FASB issued SFAS 157, "Fair Value Measurements,"
which provides enhanced guidance for using fair value to measure assets and
liabilities. SFAS 157 establishes a common definition of fair value, provides a
framework for measuring fair value under accounting principles generally
accepted in the United States and expands disclosure requirements about fair
value measurements. SFAS 157 is effective for us as of January 1, 2008. The
Company is currently evaluating the impact, if any, the adoption of SFAS 157
will have on its financial position and results of operations.
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB) No.
108, "Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements." SAB No. 108 was issued in
order to eliminate the diversity of practice surrounding how public companies
quantify financial statement misstatements. This SAB establishes a "dual
approach" methodology that requires quantification of financial statement
misstatements based on the effects of the misstatements on each of the company's
financial statements (both the statement of operations and statement of
financial position). The SEC has stated that SAB No. 108 should be applied no
later than the annual financial statements for the first fiscal year ending
after November 15, 2006, with earlier application encouraged. SAB No. 108
permits a company to elect either retrospective or prospective application.
Prospective application requires recording a cumulative effect adjustment in the
period of adoption, as well as detailed disclosure of the nature and amount of
each individual error being corrected through the cumulative adjustment and how
and when it arose. The Company is currently evaluating the impact, if any, the
application of SAB No. 108 will have on the consolidated financial statements.
Note 12 - ASSETS HELD FOR SALE
During the second half of 2005, the Company idled certain manufacturing
equipment and decided to offer two owned facilities for sale. The land,
buildings and improvements were written down to management's estimate of fair
market value and placed with a real estate broker. Subsequently, the Company
entered into agreements during the first quarter of 2006 to sell its Quequechan
Street facility in Fall River and its County Street facility in Somerset,
Massachusetts for $1,400 and $1,700, respectively. The Quequechan Street
facility sold in June 2006 for $1,400 less expenses of $118 and the County
Street facility sold in July 2006 for $1,625. The Company sold the County Street
facility for a gain of $367. In addition, the Company has 60 acres of unimproved
land purchased in 1998, which has been placed with a real estate broker for
sale. This land is stated at estimated fair market value based upon management's
estimate of the expected proceeds to be received upon sale of the property. The
Company wrote down the book value of this land to $3,500 during the third
quarter of 2006. During the third quarter of 2006, the Company decided to offer
three manufacturing facilities and its administrative office and R&D facility
for sale. A real estate broker is currently actively marketing these four
properties which have an aggregate book value of $14,169. The book value of
three of the properties is less than the estimated fair market value of these
properties based upon an independent appraisal. The book value of the fourth
property was written down to fair market value based on an independent appraisal
during the third quarter of 2006.
Assets held for sale consist of the following:
Sept. 30, Dec. 31,
2006 2005
--------------- ---------------
60 Acres of Unimproved Land in Fall River, Massachusetts $ 3,500 $ 4,008
Land, Buildings and Improvements 14,169 2,398
Equipment - 77
--------------- ---------------
$17,669 $ 6,483
=============== ===============
18
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 2005" was a 52 week period ended December 31, 2005
and "Fiscal 2006" will be a 52 week period ending December 30, 2006. The first
nine months of Fiscal 2005 and Fiscal 2006 ended October 1, 2005 and September
30, 2006, respectively.
Critical Accounting Policies
- ----------------------------
The Company has concluded that there were no material changes during the
first nine months of 2006 that would warrant further disclosure beyond those
matters previously disclosed in the Company's Annual Report on Form 10-K for the
year ended December 31, 2005.
Recent Accounting Pronouncements
- --------------------------------
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment,"
(SFAS No. 123R). SFAS No. 123R replaces SFAS No. 123, and supersedes APB Opinion
No. 25. Statement 123R 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 123R became effective for years beginning after June 15, 2005 and is
effective for the Company beginning in the first quarter of 2006. The Company
has adopted the modified prospective method and therefore will not restate
prior-period results. No unvested options were outstanding as of December 31,
2005.
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 adoption of SFAS No. 151 did not have a material effect on the
Company's Consolidated Financial Statements.
In July 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" (FIN 48). FIN 48 clarifies the accounting and
reporting for income taxes recognized in accordance with SFAS No. 109,
"Accounting for Income Taxes." This Interpretation prescribes a comprehensive
model for the financial statement recognition, measurement, presentation and
disclosure of uncertain tax positions taken, or expected to be taken, in income
tax returns. The Company is currently evaluating the impact of FIN 48. The
Company will adopt this Interpretation in the first quarter of 2007.
In September 2006, the FASB issued SFAS 157, "Fair Value Measurements,"
which provides enhanced guidance for using fair value to measure assets and
liabilities. SFAS 157 establishes a common definition of fair value, provides a
framework for measuring fair value under accounting principles generally
accepted in the United States and expands disclosure requirements about fair
value measurements. SFAS 157 is effective for us as of January 1, 2008. The
Company is currently evaluating the impact, if any, the adoption of SFAS 157
will have on its financial position and results of operations.
In September 2006, the SEC staff issued Staff Accounting Bulletin (SAB) No.
108, "Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements." SAB No. 108 was issued in
order to eliminate the diversity of practice surrounding how public companies
quantify financial statement misstatements. This SAB establishes a "dual
approach" methodology that requires quantification of financial statement
misstatements based on the effects of the misstatements on each of the company's
19
financial statements (both the statement of operations and statement of
financial position). The SEC has stated that SAB No. 108 should be applied no
later than the annual financial statements for the first fiscal year ending
after November 15, 2006, with earlier application encouraged. SAB No. 108
permits a company to elect either retrospective or prospective application.
Prospective application requires recording a cumulative effect adjustment in the
period of adoption, as well as detailed disclosure of the nature and amount of
each individual error being corrected through the cumulative adjustment and how
and when it arose. The Company is currently evaluating the impact, if any, the
application of SAB No. 108 will have on the consolidated financial statements.
General
-------
Overview. Quaker is a leading designer, manufacturer and worldwide marketer
of woven upholstery fabrics and one of the largest producers of Jacquard
upholstery fabrics in the world. To complement the Company's U.S. production
capability and to generate incremental sales, Quaker has recently begun to build
a global fabric sourcing capability. This global fabric sourcing capability
primarily involves the development of commercial relationships with a limited
number of carefully chosen offshore fabric mills and is intended to allow the
Company to recapture the share of the domestic residential market it has lost to
foreign imports over the past few years. The Company also manufactures specialty
yarns, most of which are used in the production of the Company's fabric
products. The balance is sold to manufacturers of craft yarns, home furnishings
and other products.
Overall demand levels in the upholstery fabric sector are a function of
overall demand for household furniture, which is, in turn, affected by general
economic conditions, population demographics, new household formations, consumer
confidence and disposable income levels, sales of new and existing homes and
interest rates.
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, i.e., cut and sewn, form represented approximately 42% of
total U.S. fabric sales during 2004, up from 29% in 2003 and 11% in 2002.
Management believes that this trend continued throughout 2005 and into 2006.
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 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
(i.e., cut and sewn) 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. 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. Competition from lower cost imported
products has increased, particularly from 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 nine months of 2006 were down
approximately 26.3% compared to the first nine months of 2005. The total backlog
of fabric and yarn products at the end of the first nine months of 2006 was
$10.0 million, down $5.8 million or 36.8% compared to that of a year ago, with
the dollar value of the yarn backlog down $0.9 million or 67.0% and the dollar
value of the fabric backlog down $4.9 million or 33.9%.
Results of Operations - Quarterly Comparison
- ---------------------
Net Sales. Net sales for the third quarter of 2006 decreased $16.2 million,
or 34.8%, to $30.3 million from $46.5 million in the third quarter of 2005. Net
fabric sales within the United States decreased 31.6%, to $24.5 million in the
third quarter of 2006 from $35.8 million in the third quarter of 2005, as a
result of continued 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 of fabric
decreased 15.6%, to $5.3 million in the third quarter of 2006 from $6.3 million
in the third quarter of 2005. This decrease in foreign sales was due primarily
20
to lower sales in Canada. Canadian furniture manufacturers sell furniture into
both the United States and Canadian markets where strong competition from
imported faux suede fabrics and leather continued during the third quarter of
2006 and contributed to a more difficult competitive environment. Sales to the
Middle East were also down due to unrest in the area. Net yarn sales decreased
to $0.5 million in the third quarter of 2006 from $4.4 million in the third
quarter of 2005, with the decrease in the third quarter of 2006 principally due
to lower craft yarn sales to a single customer. Sales to this customer accounted
for 0.0% of third quarter 2006 and 70.2% of third quarter 2005 yarn sales.
The gross volume of fabric sold decreased 32.8%, to 4.7 million yards in
the third quarter of 2006 from 7.1 million yards in the third quarter of 2005.
The weighted average gross sales price per yard increased 4.8%, to $6.33 in the
third quarter of 2006 from $6.04 in the third quarter of 2005, as a result of
product mix changes. The Company sold 17.4% fewer yards of middle to better-end
fabrics and 56.5% fewer yards of promotional-end fabrics in the third quarter of
2006 than in the third quarter of 2005. The average gross sales price per yard
of middle to better-end fabrics decreased by 1.8%, to $7.16 in the third quarter
of 2006 from $7.29 in the third quarter of 2005. The average gross sales price
per yard of promotional-end fabrics decreased by 4.9%, to $3.92 in the third
quarter of 2006 from $4.12 in the third quarter of 2005.
Gross Margin. The gross margin percentage for the third quarter of 2006
decreased to 6.6%, from 13.1% for the third quarter of 2005. Sales declined by
approximately 35% and fixed costs decreased by 16% resulting in higher fixed
costs per unit and a decline of 520 basis points. Higher variable manufacturing
costs contributed approximately 40 basis points to the margin decline and higher
return and allowance charges contributed 90 basis points.
Restructuring and Impairment Charges. During the three month period ended
September 30, 2006, the Company reported a restructuring charge of $4.9 million
consisting of: $3.9 million of asset impairments, $0.5 million for professional
fees required by Amendment Nos. 4 and 5 to the 2005 Credit Agreement, $0.2
million of plant consolidation expenses and $0.2 million for employee
termination costs consisting of severance costs payable to twenty-four affected
employees.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $9.2 million in the third quarter of 2006
as compared to $10.5 million in the third quarter of 2005, primarily due to
lower sales commissions as a result of lower sales and a decrease in payroll
costs attributable to staffing reductions. Third quarter 2006 selling, general
and administrative expenses reflect a $0.8 million decrease in payroll and
fringe benefits, a $0.3 million decrease in commissions related to lower sales,
and a $0.2 million decrease in fabric sampling expenses. Selling, general and
administrative expenses as a percentage of net sales were 30.2% and 22.7% in the
third quarters of 2006 and 2005, respectively.
Interest Expense. Interest expense was approximately $1.1 million in the
third quarter of 2006 and $0.8 million in the third quarter of 2005
respectively. The increase was due to higher interest rates.
Effective Tax Rate. The Company's effective tax rate was a benefit of
34.25% in the third quarter of 2006 compared to a benefit of 36.2% in the third
quarter of 2005. The effective tax rate in the third quarter of 2006 was lower
due to lower levels of estimated federal and state tax credits for 2006.
Results of Operations - Nine-Month Comparison
- ---------------------
Net Sales. Net sales for the first nine months of 2006 decreased $55.1
million, or 31.6%, to $119.5 million from $174.6 million in the first nine
months of 2005. Net fabric sales within the United States decreased 26.4%, to
$97.5 million in the first nine months of 2006 from $132.4 million in the first
nine months of 2005, as a result of continued 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 of fabric decreased 16.3%, to $18.3 million in the first nine
months of 2006 from $21.9 million in the first nine months of 2005. This
decrease in foreign sales was due primarily to lower sales in Canada. Canadian
furniture manufacturers sell furniture into both the United States and Canadian
markets where strong competition from imported faux suede fabrics and leather
continued during the first nine months of 2006 and contributed to a more
difficult competitive environment. Sales to the Middle East were also down due
to unrest in the area. Net yarn sales decreased to $3.7 million in the first
nine months of 2006 from $20.2 million in the first nine months of 2005, with
the decrease in the first nine months of 2006 principally due to lower craft
yarn sales to a single customer. Sales to this customer accounted for 0.0% of
first nine months 2006 yarn sales and 81.1% of first nine months 2005 yarn
sales.
21
The gross volume of fabric sold decreased 30.0%, to 18.5 million yards in
the first nine months of 2006 from 26.4 million yards in the first nine months
of 2005. The weighted average gross sales price per yard increased 5.6%, to
$6.20 in the first nine months of 2006 from $5.87 in the first nine months of
2005, as a result of both a general price increase effective April 2005 and
product mix changes. The Company sold 17.1% fewer yards of middle to better-end
fabrics and 48.5% fewer yards of promotional-end fabrics in the first nine
months of 2006 than in the first nine months of 2005. The average gross sales
price per yard of middle to better-end fabrics increased by 0.6%, to $7.16 in
the first nine months of 2006 from $7.12 in the first nine months of 2005. The
average gross sales price per yard of promotional-end fabrics decreased by 1.7%,
to $3.99 in the first nine months of 2006 from $4.06 in the first nine months of
2005.
Gross Margin. The gross margin percentage for the first nine months of 2006
decreased to 10.6%, from 13.7% for the first nine months of 2005. Sales declined
by approximately 32% and fixed costs decreased by 20%, resulting in higher fixed
costs per unit and a decline of 310 basis points.
Restructuring and Impairment Charges. During the nine month period ended
September 30, 2006, the Company reported a restructuring charge of $18.8 million
consisting of: $16.3 million of asset impairments, $1.4 million for professional
fees required by Amendment Nos. 4 and 5 to the 2005 Credit Agreement, $0.5
million of plant consolidation expenses and $0.6 million for employee
termination costs consisting of severance costs payable to forty-nine affected
employees.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased to $28.3 million in the first nine months of
2006 as compared to $35.2 million in the first nine months of 2005, primarily
due to lower sales commissions as a result of lower sales and a decrease in
payroll costs attributable to staffing reductions. The first nine months of 2005
benefited by a reduction in deferred compensation liability of $575 as discussed
in Note 10 to the Consolidated Financial Statements. Excluding the effect of
this adjustment, selling, general and administrative expenses declined $7.5
million, from $35.8 million to 28.3 million. The reduction in selling, general
and administrative expenses reflects a $3.0 million decrease in payroll and
fringe benefits, a $1.1 million decrease in commissions related to lower sales,
a $0.9 million decrease in fabric sampling expenses, and a $2.5 million
reduction in "all other expenses" as part of the Company's overall cost
reduction program. Selling, general and administrative expenses as a percentage
of net sales were 23.7% and 20.2% in the first nine months of 2006 and 2005,
respectively.
Interest Expense. Interest expense was approximately $2.8 million in the
first nine months of 2006 and $2.2 million in the first nine months of 2005,
respectively. The increase was due to higher interest rates.
Effective Tax Rate. The Company's effective tax rate was a benefit of
34.25% in the first nine months of 2006 compared to a benefit of 33.62% in the
first nine months of 2005. The effective tax rate in the first nine months of
2006 was lower due to lower levels of estimated federal and state tax credits
for 2006.
Liquidity and Capital Resources
- -------------------------------
The Company historically has financed its operations and capital
requirements through a combination of internally generated funds, debt and
equity offerings and borrowings under the 2002 Credit Agreement (as hereinafter
defined) and the 2005 Credit Agreement (as hereinafter defined). 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,
(iii) investments in the Company's information technology systems, and (iv)
expenditures necessary to maintain the Company's facilities and equipment. The
Company's current capital requirements are related to the execution of Quaker's
restructuring plan and maintenance of facilities and equipment. The Company has
experienced recurring losses from operations, has failed to achieve certain debt
covenants in its senior secured revolving credit and term loan agreement and
must achieve significant improvements in its operating performance in order to
meet certain future debt covenants. As a result, the report issued by the
Company's independent registered public accounting firm on the Company's Fiscal
2005 financial statements includes an explanatory paragraph raising substantial
doubt about the ability of the Company to continue as a going concern.
A key objective of the restructuring plan the Company has in place is to
stabilize revenues from Quaker's core domestic residential business while
22
simultaneously working to generate incremental sales from the new product and
new market initiatives the Company has been pursuing. These initiatives include
the launch of an initial collection of fabrics designed and developed by Quaker
but manufactured outside the U.S. through the new strategic relationship put in
place in January 2006 as well as the roll-out of an offshore sourcing program
intended to allow Quaker to supplement the woven fabrics in its product line
with other upholstery products, such as velvets and faux suedes, that the
Company does not have the equipment to make itself. These complementary offshore
sourcing programs are intended to allow the Company to recapture at least a
portion of the domestic residential business it has lost to imported products
over the past several years.
Simultaneously, Quaker intends to generate revenues based on its U.S.
production by continuing to aggressively develop other products that for both
strategic and economic reasons are best produced in the Company's Fall
River-based manufacturing facilities. These include Quaker's new outdoor fabric
and contract furniture programs, which are intended to build revenues by
leveraging the Company's technological expertise to expand the markets it
serves, as well as fabrics for those domestic and international residential
customers in need of a strong U.S.-based fabric mill to meet their requirements
for high quality, innovative products with relatively short delivery lead times.
The Company also intends to expand its presence in the novelty yarn market. On
the cost reduction front, Quaker intends to continue to consolidate its Fall
River manufacturing operations into fewer facilities, actively market its excess
real estate and other excess assets, improve its quality performance and
productivity levels and be increasingly innovative and flexible while at the
same time keep operating costs as low as possible and generate positive
operating cash flows through careful inventory control.
To complete the restructuring of the Company's business, Quaker will need
to make significant investments in the development of new commercial
relationships and in the development, production, marketing and sale of new
products. This investment is critical in order to maintain and grow our
business. However, we cannot guarantee that the capital needed to achieve this
will be available or that we will be successful in our strategic initiatives. If
we are not successful, management is prepared to take various actions which may
include, but not be limited to, a reduction in our expenditures for internal and
external new product development and further reductions in overhead expenses.
These actions, should they become necessary, may result in a significant
reduction in the size of our operations.
The primary source of the Company's liquidity and capital resources in
recent years has been operating cash flow supplemented at times by borrowings
under the Company's revolving credit facilities. The Company's net cash provided
by (used in) operating activities was $5.9 million, and $1.8 million in the
first nine months of 2006 and 2005, respectively. Cash provided by operating
activities increased during 2006 due principally to a net increase in operating
assets and liabilities of $12.3 million, $6.9 million of asset impairments and
$0.9 million in the provision for bad debts offset by a $4.1 million reduction
in net income, a $4.4 million reduction in deferred income taxes, a $5.4 million
reduction in goodwill write off, a $1.7 million reduction in depreciation and
amortization, and a $0.4 million gain on sale of assets.
Capital expenditures for the first nine months of 2006 and 2005 were $0.6
million and $4.5 million, respectively. Capital expenditures were funded by
operating cash flow and borrowings under the Company's 2005 Credit Agreement
during 2006 and 2005. Management anticipates that capital expenditures for new
projects will not exceed $1.0 million in 2006, consisting principally of
facilities-related expenditures. Capital expenditures are restricted under the
2005 Credit Agreement and may not exceed $10.0 million in Fiscal 2006.
As of September 30, 2006, the Company had $28.5 million outstanding under
the 2005 Credit Agreement, $4.5 million of letters of credit and unused
availability of approximately $2.1 million, net of the Availability Reserve. As
of October 1, 2005, the Company had $51.9 million outstanding under the 2005
Credit Agreement, $4.7 million of letters of credit and unused availability of
approximately $6.0 million, net of the Availability Reserve. In accordance with
EITF 86-30, Classification of Obligations When a Violation is Waived by the
Creditor, all of the Company's outstanding debt under the 2005 Credit Agreement
is classified as current.
23
Debt consists of the following:
Sept. 30, Dec. 31,
2006 2005
--------------- ----------------
(In thousands)
Senior Secured Revolving Credit Facility $ 15,310 $ 18,880
Term Loan payable in quarterly principal installments
through May 1, 2006 and monthly installments
thereafter, plus interest, over a 5 year period
beginning November 1, 2005 13,157 19,000
--------------- ----------------
Total Debt $ 28,467 $ 37,880
Less: Current Portion of Term Loan 13,157 19,000
Current Portion of Senior Secured Revolving
Credit Facility 15,310 18,880
--------------- ----------------
Total Long-Term Debt $ - $ -
=============== ================
On May 18, 2005, Quaker Fabric Corporation of Fall River (QFR), a
wholly-owned subsidiary of the Company, entered into a five-year, $70.0 million
senior secured revolving credit and term loan agreement with Bank of America,
N.A. and two other lenders (the 2005 Credit Agreement). The 2005 Credit
Agreement provides for a $20.0 million term loan (the Term Loan) and a $50.0
million revolving credit and letter of credit facility (the Revolving Credit
Facility), reduced by Amendment Nos. 3 and 4 (as hereinafter defined) to $30.0
million. QFR's obligations under the 2005 Credit Agreement are guaranteed by the
Company and two QFR subsidiaries (the Guaranty). Pursuant to a Security
Agreement (also dated as of May 18, 2005) executed by QFR, the Company, and two
subsidiaries of QFR, all of QFR's obligations under the 2005 Credit Agreement
are secured by first priority liens upon all of QFR's and the Company's assets
and on the assets of the two QFR subsidiaries acting as guarantors (the Security
Agreement).
Advances to QFR under the Revolving Credit Facility are limited by a
formula based on Quaker's accounts receivable and inventory, minus an
Availability Reserve (and such other reserves as the Bank may establish from
time to time in its reasonable credit judgment.) Advances made under the
Revolving Credit Facility bear interest at the prime rate plus Applicable Margin
and until October 21, 2005 the Applicable Margin was 0.75% for prime rate
advances. Thereafter, the Applicable Margin is adjusted quarterly based upon the
Company's ratio of Consolidated Total Funded Debt to EBITDA, as defined in the
2005 Credit Agreement, with the Applicable Margin ranging from 0.25% to 1.0% for
prime rate advances. When the 2005 Credit Agreement was initially put in place
in May of 2005, LIBOR (London Interbank Offered Rate) rate loans were also
permissible with respect to the Term Loan at an Applicable Margin of 2.25% until
October 21, 2005, with quarterly adjustments ranging from 1.75% to 2.5%
thereafter, based upon the Company's ratio of Consolidated Total Funded Debt to
EBITDA. Amendment No. 4 (as hereinafter defined) eliminated QFR's ability to
request, convert or continue LIBOR rate loans. Amendment No. 5 (as hereinafter
defined) reinstated the Company's ability to request, convert and continue LIBOR
rate loans, and increased the interest rates payable by the Company on all
outstanding balances by 200 basis points. As of September 30, 2006, the weighted
average interest rates of the advances outstanding was 11.25%.
The Revolving Credit Facility has a term of five years which expires on May
18, 2010. Effective March 22, 2006, the 2005 Credit Agreement requires that all
funds in the Company's cash operating account be applied daily to the payment of
outstanding advances under the Revolving Credit Facility.
The Term Loan bears interest at the prime rate plus Applicable Margin and
until October 21, 2005, the Applicable Margin was 1.50% for prime rate advances.
Thereafter, the Applicable Margin is adjusted quarterly based upon the Company's
ratio of Consolidated Total Funded Debt to EBITDA, as defined, in the 2005
Credit Agreement with the Applicable Margin for prime rate advances ranging from
1.00% to 1.75%. When the 2005 Credit Agreement was initially put in place in May
24
of 2005, LIBOR (London Interbank Offered Rate) rate loans were also permissible
with respect to the Term Loan at an Applicable Margin of 3.0% until October 21,
2005, with quarterly adjustments ranging from 2.5% to 3.25% thereafter, based
upon the Company's ratio of Consolidated Total Funded Debt to EBITDA. Amendment
No. 4 (as hereinafter defined) eliminated QFR's ability to request, convert or
continue LIBOR rate loans. Amendment No. 5 (as hereinafter defined) reinstated
the Company's ability to request, convert and continue LIBOR rate loans, and
increased the interest rates payable by the Company on all outstanding balances
by 200 basis points. As of September 30, 2006, the weighted average interest
rates of the advances outstanding was 11.25%. As of September 30, 2006, the
weighted average interest rate of the Term Loan was 12.0%. Amortization of the
Term Loan is over a five-year period beginning November 1, 2005, with payments
of principal to be made on a quarterly basis until May 1, 2006 and monthly
thereafter. In certain events, such as the sale of assets, proceeds must be used
to prepay the Term Loan. During the third quarter of 2006, the Company sold
certain equipment and applied the proceeds of $1,392 to reduce the Term Loan.
Also, on July 18, 2007, The Company sold its facility located at 3129 County
Street, Somerset, Massachusetts for $1,132, net of expenses. In accordance with
Amendment No. 5, 50% of the proceeds or $566 was applied to the Term Loan. As of
September 30, 2006, remaining principal payments under the Term Loan are as
follows:
Fiscal Year (In thousands)
------------------- --------------
2006 $ 1,000
2007 4,000
2008 4,290
2009 3,867
2010 -
-------------
$13,157
=============
The 2005 Credit Agreement includes customary financial covenants, reporting
obligations, and affirmative and negative covenants including, but not limited
to, limitations on certain business activities of the Company and QFR and
restrictions on the Company's and/or QFR's ability to declare and pay dividends,
incur additional indebtedness, create certain liens, make capital expenditures,
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 2005
Credit Agreement from paying dividends or otherwise transferring funds to the
Company. Restricted net assets as of September 30, 2006 equal 100% of the net
assets of the Company.
QFR's initial borrowing under the 2005 Credit Agreement was $46.5 million,
of which $42.3 million, was used to repay, in full, all of QFR's outstanding
obligations under Senior Notes due October 2005 and 2007 that QFR issued to an
insurance company during 1997 and Series A Notes due February 2009 that QFR
issued to the same insurance company during 2002, with such repayment including
a yield maintenance premium of $2.0 million. The balance of the initial
borrowing was used to cover approximately $1.0 million of closing costs and to
repay, in full, all of QFR's outstanding obligations to Fleet National Bank
(Fleet) under the Second Amended and Restated Credit Agreement dated February
14, 2002 by and between Fleet and QFR (the 2002 Credit Agreement). The Company
recorded a charge in the second quarter of 2005 of $2.2 million for Early
Extinguishment of Debt which includes the $2.0 million yield maintenance premium
plus the write off of existing debt issuance costs.
On July 26, 2005, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 1, effective as of July 1, 2005, to the
2005 Credit Agreement to: (i) increase the Availability Reserve from $5.0
million to $7.5 million effective August 20, 2005 and from $7.5 million to $10.0
million effective September 24, 2005, (ii) reduce the minimum consolidated
EBITDA and fixed charge coverage ratio requirements in the financial covenants,
(iii) reduce the limits on the Company's annual capital expenditure programs,
and (iv) under certain circumstances, require the Company to retain a
consultant. The Company paid an amendment fee of $87,500 which was capitalized
and will be amortized over the remaining term of the 2005 Credit Agreement.
On October 25, 2005, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 2, effective as of October 21, 2005, to the
2005 Credit Agreement (Amendment No. 2) to: (i) reduce the Availability Reserve,
(ii) reduce the minimum consolidated EBITDA requirement for the fourth quarter
of fiscal 2005 in the financial covenants, (iii) eliminate the minimum
consolidated EBITDA requirement in its entirety for all periods after the fourth
quarter of fiscal 2005, (iv) add a new Two Quarter Fixed Charge Coverage Ratio
requirement to the financial covenants applicable to the five fiscal quarters
25
beginning with the first quarter of fiscal 2006 and ending with the first
quarter of fiscal 2007, (v) reduce the Minimum Fixed Charge Coverage Ratio in
the financial covenants for the first fiscal quarter of 2006, (vi) increase the
Applicable Margin by 0.25% with respect to the Term Loan and all Revolving
Credit Facility advances until March 1, 2006, when all subsequent changes in
Applicable Margins will be determined solely based upon the Company's ratio of
Consolidated Total Funded Debt to EBITDA. The Company paid an amendment fee of
$175,000 which was capitalized and will be amortized over the remaining term of
the 2005 Credit Agreement.
On February 3, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 3, effective as of December 30, 2005, to
the 2005 Credit Agreement (Amendment No. 3) to (i) make certain amendments to
the definitions of Consolidated EBITDA and Consolidated Interest Expense, (ii)
add a new provision with respect to the Company's retention of a Financial
Consultant (as defined in Amendment No. 3), (iii) eliminate the minimum
consolidated EBITDA requirement for the fourth quarter of fiscal 2005, (iv) add
a new two consecutive month minimum consolidated EBITDA covenant through May
2006 (v) eliminate the Minimum Fixed Charge Coverage Ratio for the first two
fiscal quarters of 2006 and reduce the Minimum Fixed Charge Coverage Ratio for
the third quarter of 2006, and (vi) eliminate the Two Quarter Fixed Charge
Coverage Ratio requirement for the first quarter of 2006. In addition, the
Company also paid a fee of $175,000 in exchange for a $17.5 million reduction in
the Revolving Credit Facility to $32.5 million, effective February 2, 2006. In
accordance with EITF 98-14, Debtor's Accounting for Changes in Line-of-Credit or
Revolving Debt Arrangements, the Company expensed $401 of debt issuance costs
associated with this reduction in the Revolving Credit Facility, which is
included in "Other Expenses."
On March 22, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Waiver and Amendment No. 4, effective as of March 22,
2006, to the 2005 Credit Agreement (Amendment No. 4) to (i) waive certain
Specified Defaults arising out of the Company's failure to comply with the two
(2) consecutive month minimum consolidated EBITDA covenant for the two month
period ending at the end of Fiscal February and the Company's anticipated
failure to deliver audited financial statements without qualification or
expression of concern as to the uncertainty of the Parent to continue as a going
concern within ninety (90) days of the end of Fiscal 2005, (ii) add a new
provision with respect to the Company's retention of an Additional Financial
Consultant (as defined in Amendment No. 4) to perform certain specific services
set forth in Amendment No. 4, (iii) increase the Availability Reserve from $7.5
million to $8.5 million during the period commencing on March 22, 2006 and
ending on May 1, 2006 (advances under the Revolving Credit Facility are limited
to a formula based on Quaker's accounts receivable and inventory minus the
Availability Reserve), (iv) eliminate the two (2) consecutive month minimum
consolidated EBITDA covenant for the two month period ending at the end of
Fiscal March, (v) change the amortization schedule on the Term Loan from
quarterly to monthly, effective June 1, 2006, (vi) require that the net proceeds
of any asset sales be applied to the remaining scheduled installments of
principal under the Term Loan in the inverse order of their maturity, rather
than pro rata, (vii) by no later than May 12, 2006, provide the lenders with
weekly 13-week cash flow forecasts and a revised 2006 business plan, (viii)
require that all cash received by the Company be applied daily to the reduction
of the Company's obligations under the Revolving Credit Facility, requiring the
Company to re-borrow funds more frequently to meet its liquidity requirements,
(ix) end the Company's ability to request, convert or continue any LIBOR rate
loans, and (x) require the Company to reimburse not only the Administrative
Agent but also the other lenders for all out-of-pocket expenses incurred in
connection with the preparation of Amendment No. 4 and the on-going
administration of the Loan Documents. In addition, the Company also agreed to
pay an amendment fee of $125 in exchange for the amendment and a $2.5 million
reduction in the Total Commitment (as defined in the 2005 Credit Agreement),
bringing the Total Commitment down to $30.0 million, effective March 22, 2006.
In accordance with EITF 98-14, Debtor's Accounting for Changes in Line-of-Credit
or Revolving Debt Arrangements, the Company expensed $55 of debt issuance costs
associated with this reduction in the Revolving Credit Facility, which is
included in "Other Expenses."
On May 6, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 5, effective as of May 6, 2006, to the 2005
Credit Agreement ("Amendment No. 5") to (i) waive compliance with the certain
financial covenants through the end of fiscal 2006, (ii) reset the performance
levels in the two (2) consecutive month minimum consolidated EBITDA covenant
through February of 2007, (ii) require the Company to continue to engage the
services of the Additional Financial Consultant (as defined in Amendment No. 4)
to perform the services set forth in Amendment No. 4, (iii) adjust the
Availability Reserve requirements to levels consistent with the Company's
forecasted cash flows (advances under the Revolving Credit Facility are limited
to a formula based on Quaker's accounts receivable and inventory minus the
Availability Reserve), (iv) add a new "Minimum Net Cash Flow" covenant, (v)
provide that a portion of the net proceeds of certain identified real estate
sales and all of the net proceeds of any other asset sales be applied to the
26
remaining scheduled installments of principal under the Term Loan in the inverse
order of their maturity, (vi) reinstate the Company's ability to request,
convert and continue LIBOR rate loans, and (vii) increase the interest rates
payable by the Company on all outstanding balances by 200 basis points. In
addition, the Company also agreed to an amendment fee of $469,900, payable in
monthly installments of $25,000 each, beginning on June 1, 2006, with the
balance of $294,000 due in mid-December 2006.
On November 3, 2006, the Company and the other parties to the 2005 Credit
Agreement entered into Amendment No. 6, dated as of September 29, 2006, to the
2005 Credit Agreement ("Amendment No. 6") to eliminate the two consecutive month
minimum consolidated EBITDA covenants for the months of April through and
including September 2006.
As of September 30, 2006, there were $28.5 million of loans outstanding
under the 2005 Credit Agreement, including the $13.2 million term loan
component, approximately $4.5 million of letters of credit and unused
availability of approximately $2.1 million, net of the Availability Reserve, as
defined in the 2005 Credit Agreement. In accordance with EITF 86-30,
Classification of Obligations When a Violation is Waived by the Creditor, all of
the Company's outstanding debt under the 2005 Credit Agreement is classified as
current.
The Company's ability to meet its current obligations is dependent on: (i)
its access to trade credit, (ii) its operating cash flow and (iii) its
Availability under the 2005 Credit Agreement, which is a function of Eligible
Accounts Receivable, Eligible Inventory, and the Availability Reserve as those
terms are defined in the 2005 Credit Agreement. Availability is typically lowest
during the third quarter of each fiscal year principally due to: (i) the
seasonality of the Company's business and (ii) the negative effects of the
Company's annual two-week July shutdown period on sales and cash. Increases in
the Availability Reserve such as those reflected in Amendment Nos. 1 and 4 to
the 2005 Credit Agreement, discussed above, reduce Availability and thus the
Company's ability to borrow. In like manner, decreases in the Availability
Reserve such as those reflected in Amendment Nos. 2 and 5 to the 2005 Credit
Agreement discussed above, increase Availability and thus the Company's ability
to borrow. The Company manages its inventory levels, accounts payable and
capital expenditures to provide adequate resources to meet its operating needs,
maximize its cash flow and reduce the need to borrow under the 2005 Credit
Agreement. However, its cash position may be adversely affected by factors it
cannot completely control, including but not limited to, a reduction in incoming
order rates, production rates, sales, and accounts receivable, as well as delays
in receipt of payment of accounts receivable and limitations of trade credit.
The Company has implemented a plan to reduce its investment in inventory and is
seeking to dispose of certain production equipment and manufacturing and
warehousing facilities no longer needed as a result of the consolidation of some
of its facilities. In addition, management adjusts the Company's cost structure
on a continuing basis to reflect changes in demand. In the event the Company's
efforts to improve its liquidity are not successful, the Company may not have
sufficient liquidity to continue its business.
The Company, as it announced on October 17, 2006, has reached a preliminary
agreement on the terms of a refinancing transaction with Bank of America, N.A.
and GB Merchant Partners, LLC that would provide the Company with approximately
$50,000 of senior secured financing, subject to various conditions. The Company
is negotiating with these lenders to reach definitive agreements with respect to
the proposed financing. There can be no assurance that the proposed financing
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 a
further event of default under the 2005 Credit Agreement and the inability to
borrow under the Revolving Credit Facility.
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. However, recent increases in oil
prices have resulted in significant increases in the Company's energy and raw
material costs, primarily as a result of the substantial number of raw materials
used by the Company that are derived from petroleum, and despite an across the
board price increase effected by the Company during the first half of 2005, and
27
a $0.15 per yard temporary surcharge effected in October, 2005, intense
competition in the industry has impaired the Company's ability to pass all of
these cost increases along to its customers.
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 comply with the terms of the financing documents to which
it is a party, the Company's ability to generate sufficient Eligible Accounts
Receivable and Eligible Inventory, net of the Availability Reserve (all as
defined in the 2005 Credit Agreement) to maintain adequate Availability to meet
its liquidity needs, 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.
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 4.9% 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."
28
At September 30, 2006, the Company had the following derivative financial
instruments outstanding:
Notional Weighted Notional
Amount in Average Amount in Fair Value
Type of Local Contract U.S. Gain
Instrument Currency Currency Rate Dollars (Losses) Maturity
---------- -------- -------- ---- ------- -------- --------
Forward Contracts Mexican Peso 10.4 million 11.16 $0.9 million $ (8,400) Nov. 2006
Forward Contracts Brazilian Real 0.4 million 2.28 $0.2 million $ (8,600) Oct. 2006
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 $0.1
million; whereas a 10% weakening of the U.S. dollar would result in an
unrealized gain of approximately $0.1 million.
Interest Rate Risk
The Company is exposed to market risk from changes in interest rates on
debt. The Company's exposure to interest rate risk consists of floating rate
debt based on the Prime rate plus an Applicable Margin under the Company's 2005
Credit Agreement. As of September 30, 2006, there were $28.5 million of
borrowings outstanding under the 2005 Credit Agreement at floating rates,
including some London Interbank Offered Rate (LIBOR) loans. Increases in
short-term interest rates will increase the Company's interest expense. Prior to
March 22, 2006, the effective date of Amendment No. 4 (as previously defined),
the Company mitigated this risk in the short term by locking in a portion of its
outstanding borrowings at LIBOR rates for up to six months. Amendment No. 5
restored the Company's ability to borrow at LIBOR rates. Based upon the balances
outstanding as of September 30, 2006, an increase of 100 basis points in
interest rates would increase annual interest expense by approximately $285,000.
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 Rules 13a-15(e) and 15d-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.
29
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
There has been no material change to the matters discussed in Part I, Item
3 - Legal Proceedings in the Company's Annual Report on Form 10-K as filed with
the Securities and Exchange Commission as of March 31, 2006.
Item 1A. Risk Factors
------------
The Company has concluded that there were no material changes during the
first nine months of 2006 that would warrant further disclosure beyond those
matters discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 2005, in Notes 1 and 6 to the Consolidated Financial Statements of
the Company included in Item 1 of Part I of this Form 10-Q, and in Part I, Item
2 - Management's Discussion and Analysis of Financial Condition and Results of
Operations of this Form 10-Q.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
None
Item 3. Defaults upon Senior Securities
-------------------------------
None
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 5. Other Information
-----------------
None
Item 6. Exhibits
--------
(A) Exhibits
10.36 Amendment No. 6 dated as of September 29, 2006 to
Revolving Credit and Term Loan Agreement (dated as
of May 18, 2005) by and among Quaker Fabric
Corporation of Fall River, as Borrower; Bank of
America, N.A. and the Other Lending Institutions
which are or may become parties thereto; Bank of
America, N.A., as Administrative Agent and Issuing
Bank; Fleet National Bank, as Cash Management Bank;
and Banc of America Securities LLC, as Sole Lead
Arranger and Book Manager.
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.
30
QUAKER FABRIC CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
QUAKER FABRIC CORPORATION
Date: November 9, 2006 By: /s/ Paul J. Kelly
---------------- ----------------------------
Paul J. Kelly
Vice President - Finance
and Treasurer (Principal Financial Officer)
31