Description
Filed with the SEC from Oct 18 to Oct 24:
Unifi (UFI)
Kenneth Langone, a director of the company and a private investor, disclosed he now owns 1,012,161 shares (5%) after buying 95,000 on Oct. 12 at $11.88 in a privately negotiated transaction. Langone did not disclose any plans or proposals.
BUSINESS OVERVIEW
Recent Developments and Strategy
Deleveraging Strategy: During the June 2012 quarter, the Company successfully completed its comprehensive debt refinancing. The refinancing allowed the Company to extend the maturity profile of its indebtedness to May 2017 and will generate approximately $9,000 of annual interest expense savings. In addition, the Company believes that this new financing will provide the availability and flexibility needed to execute its strategic objectives.
Raw Materials: Polyester raw material costs for fiscal year 2012 averaged 8 to 9 cents per pound higher than fiscal year 2011. Throughout most of fiscal year 2012, and for the latter half of fiscal year 2011, polyester raw material costs remained at their highest levels in over thirty years. In addition, Asian imported yarns have become more competitive and continued to place pressure on the Company’s commodity business as the U.S.-Asia gap in polymer pricing averaged 11 to 12 cents per pound in fiscal year 2012 versus the 4 to 5 cents average per pound for the prior fiscal year period.
Inventory Destocking: The Company believes inventory in the U.S. apparel supply chain reached elevated levels during the first quarter of the Company’s recently completed fiscal year, and producers and wholesalers reacted to the elevated inventory levels by curtailing purchases from August to December 2011. The Company reacted by adjusting its production below its sales levels in order to reduce its on-hand inventory units. As a result of the Company’s actions, the production volume and per unit manufacturing costs in the Company’s Polyester and Nylon segments were negatively impacted during the first half of fiscal 2012.
Inflation: For the most recently completed fiscal year and for the foreseeable future, the Company expects rising costs to continue in areas such as employee costs and benefits, consumables and utility costs. The Company attempts to mitigate the impacts of these rising costs through its operational efficiencies and increased selling prices. Inflation may become a factor that begins to negatively impact the Company’s profitability.
Operational Excellence: Over the past year, the Company expanded its efforts in LEAN manufacturing and statistical process control in all of its operations. These efforts have resulted in demonstrated savings as well as greatly improved operational flexibility and are expected to result in continued improvement over the next several years.
PVA: The Company remains committed to growing the business for its value-added products and believes its research and development work with brands and retailers continues to create new, world-wide sales opportunities as the Company raises the visibility of REPREVE® as a consumer brand. The Company’s PVA products represent approximately 18% of its consolidated sales volume and REPREVE® continues to grow at a faster pace than other PVA products. Throughout fiscal year 2012, domestic PVA sales volume increased versus the prior year and held stronger than the remainder of the business. Internationally, PVA sales volume was negatively impacted by weakened demand in Brazil and a temporary delay of orders from a large volume customer for the Company’s Chinese sales office. In comparison to the levels at the end of fiscal year 2010, the Company is on pace to double its domestic PVA sales volumes within three years and its consolidated PVA sales volumes within four years.
Investment in Central America: The Central American Free Trade Agreement (“CAFTA”) region, which continues to be a competitive alternative to Asian supply chains, has in recent years maintained its share of synthetic apparel supply to U.S. retailers and continues to see ongoing investments being made. During the past quarter, the Company has completed the installation of additional texturing capacity at its plant in El Salvador in order to take advantage of the long-term volume opportunities in this region.
Repreve Recycling Center: The recycling facility which opened in May 2011 allows the Company to expand the REPREVE® brand by increasing the amount and types of recyclable material that can be used in the manufacturing process and to develop and commercialize PVA products that meet the sustainability demands for brands and retailers.
Repreve Renewables, LLC: During the December 2011 quarter, the Company acquired an additional 20% membership interest in Repreve Renewables, LLC (“Renewables”) bringing the Company’s current ownership to 60%. The Company’s investment in Renewables, a development stage company that focuses on cultivating and selling bio-mass crops for the bio-fuel and bio-power industries, is anticipated to provide the Company with a unique revenue stream and supports its strategy to grow the REPREVE® brand and other sustainability initiatives.
Industry Overview
Since 1980, global demand for polyester yarns, which includes both filament and staple yarns, has grown steadily, and in calendar year 2003, polyester replaced cotton as the fiber with the largest percentage of worldwide sales. In calendar year 2011, global polyester consumption accounted for an estimated 51% of global fiber consumption and demand is projected to increase by approximately 3% to 4% annually through 2020. In calendar year 2011, global nylon consumption accounted for an estimated 5% of global fiber consumption and demand is projected to increase by approximately 1% annually through 2020. The polyester and nylon fiber sectors together accounted for approximately 56% of U.S. textile consumption during calendar year 2011.
According to the National Council of Textile Organizations, the U.S. textile market’s total shipments were $53.3 billion for calendar year 2011. The industrial and consumer, floor covering, apparel and hosiery, and furnishing markets account for 43%, 34%, 15% and 8% of total production, respectively. During calendar year 2011, the U.S. textile sector exported more than $17 billion of textile products, an increase of 13.4% versus the prior year period, and employed approximately 390,000 people making it one of the largest manufacturing employers in the U.S.
Rules of Origin
A significant number of the Company’s customers, particularly in the apparel market, produce finished goods that meet the eligibility requirements for duty-free treatment in the regions covered by the North American Free Trade Agreement (“NAFTA”), CAFTA, and the Colombia and Peru Free Trade Agreements. The Company is the largest filament yarn manufacturer and one of the few producers of such qualifying yarns in the three regions covered by these agreements (collectively the “Regional FTAs”) which contain rules of origin requirements. In order to be eligible for duty-free treatment, the garment, fabric, yarn (such as POY) and fibers (filament and staple) are generally required to be fully formed within the respective regions, each of which include production from the U.S.
Government legislation referred to as the Berry Amendment stipulates that certain purchases of textile and apparel articles made by the U.S. Department of Defense must be manufactured in the U.S. and consist of yarns and fibers produced in the U.S. Efforts are currently underway to expand this legislation to require other government programs such as the Department of Homeland Security to purchase U.S. origin textile products when available. The Company is the largest producer of such yarns for Berry Amendment compliant programs.
Collectively, the Company refers to fibers sold with specific rules of origin requirements under the Regional FTAs and fibers sold with rule of origin requirements under the Berry Amendment as "Compliant Yarns".
Trade Regulation
Over the last decade, imports of fabric and finished goods into the U.S. have increased significantly from countries who do not participate in free trade agreements or trade preference programs despite duties charged on those imports. The duty rate on finished apparel categories that utilize polyester and nylon filament yarns are generally 16% to 32%. The primary drivers for that growth were lower overseas operating costs, foreign government subsidizing of textile industries, increased overseas sourcing by U.S. retailers, the entry of China into the World Trade Organization and the staged elimination of all textile and apparel quotas. Although global apparel imports represent a significant percentage of the U.S. market, Regional FTAs, which allow duty free advantages for apparel made from regional fibers, yarns and fabrics, allow the Company opportunities to participate in this growing market.
In calendar year 2000, 56% of the garments purchased in the U.S. were produced in the North and Central American regions. By calendar year 2009, approximately 18% of the garments purchased at U.S. retail were produced in these regions. In the last four years, the garment market share has stabilized in these regions and has begun to grow on a unit basis based on synthetic apparel consumption. This recent trend supports the Company’s view that the remaining synthetic apparel production in the regions is more specialized and defensible, and, in some cases, apparel producers are bringing programs back to the region as a part of a balanced sourcing strategy of some retailers and brands.
NAFTA is a permanent FTA between the U.S., Canada and Mexico that became effective on January 1, 1994. The agreement contains certain rules of origin for textile and apparel products that must be met for these products to receive duty-free benefits under NAFTA. In general, textile and apparel products must be produced from yarns and fabrics made in the NAFTA region, and all subsequent processing must occur in the NAFTA region to receive duty-free treatment.
Implementation of CAFTA began in 2006, between the U.S., the Dominican Republic, Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua. CAFTA supersedes the Caribbean Basin Trade Preference Agreement (“CBTPA”) for the CAFTA signatory countries and provides permanent benefits not only for apparel produced in the region, but for all textile products that meet the rules of origin. Qualifying textile and apparel products that are produced in any of the seven signatory countries from fabric, yarn and fibers that are also produced in any of the seven signatory countries may be imported into the U.S. duty free.
In August 2012, legislation was passed to correct a number of technical errors in CAFTA, including a requirement that single ply synthetic sewing thread must originate from one of the signatory countries. This measure, expected to be fully implemented in the fall of 2012, is expected to have a favorable impact on the Company’s twisted yarn business, as the Company will be one of the largest suppliers of twisted yarns eligible to be used in these sewing thread applications.
The U.S.-Peru Trade Promotion Agreement became effective in February 2009, and the U.S.-Colombia Trade Promotion Agreement was implemented on May 15, 2012. These free trade pacts replaced the Andean Trade Promotion and Drug Eradication Act (“ATPDEA”) in these markets and established, primarily, the same yarn forward rules of origin for textile and apparel products as NAFTA.
Additionally, the Company operates under FTA’s with Australia, Bahrain, Chile, Israel, Jordan, Morocco, Oman, Singapore and South Korea. The U.S.-South Korean FTA became effective on March 15, 2012. The Company anticipates limited impact on its business as South Korea is not a low cost provider of textiles in comparison to other Asian countries and South Korea provides little or no export opportunities for the Company or for U.S. textile manufacturers. The Company believes that a potential threat exists due to the agreement’s failure to address the potential damage from the lack of strong customs enforcement language and the exposure of illegal transshipments from China through South Korea.
Although quotas on textiles and apparel imports were eliminated after December 31, 2008, tariffs on certain imported products remain in effect. The Doha Development Round is the current trade-negotiation round of the World Trade Organization which commenced in November 2001 with the objective to further lower trade barriers around the world. Over recent years, negotiations have stalled over a divide on major issues, such as agriculture, industrial tariffs and non-tariff barriers, services, and other trade remedies with the most significant differences between developed nations and emerging countries. There is also considerable contention regarding the maintenance of agricultural subsidies—which can be seen to operate effectively as a trade barrier. No significant progress has been made from the negotiations held in recent years and the future of the Doha Development Round remains uncertain.
During 2012, numerous rounds of negotiations have been held to forge a new TransPacific Partnership Agreement (“TPP”). Countries currently participating in the TPP negotiations include Australia, Brunei, Chile, Malaysia, New Zealand, Peru, Singapore, and Vietnam, with Mexico and Canada recently announcing their intentions to join. The U.S. government has presented a yarn forward rule of origin; however, negotiations for market access and rules of origin for textiles and apparel have not been completed.
The Company believes the requirements of the rules of origin and the associated duty-free cost advantages in the regional free trade agreements, such as NAFTA and CAFTA, together with the Berry Amendment and the growing need for quick response and inventory turns, ensures that a portion of the existing textile industry will remain based in the America regions. The Company expects that the NAFTA and CAFTA regions will continue to increase their percentage of the U.S. market. The Company is the largest of only a few significant producers of Compliant Yarn under these trade agreements. As a result, one of the Company’s business strategies is to leverage its eligibility status to increase its share of business with regional and domestic fabric producers who ship their products into these regions for further duty free processing.
Approximately 62% of the Company’s sales are sold as Compliant Yarn under the terms of FTA’s or the Berry Amendment.
Markets
The Company serves diverse market segments. The apparel market, which includes hosiery, represents approximately 65% of the Company’s sales. Apparel retail sales, supply chain inventory levels and strength of the regional supply base are vital to this market segment. Generally, synthetic apparel consumed in the U.S. grows 4% per year and, over the last four years, the Regional FTA share of supply of U.S. synthetic apparel has remained constant at 18%.
The industrial market represents approximately 17% of the Company’s sales. This market includes medical, belting, tapes, filtration, ropes, protective fabrics, awnings, etc.
The furnishing market, which includes both contract and home furnishing, represents approximately 12% of the Company’s sales. Furnishing sales are dependent upon the housing market, which in turn is influenced by consumer confidence and credit availability.
The automotive upholstery market represents approximately 6% of the Company’s sales and has been less susceptible to import penetration because of the exacting specifications and quality requirements often imposed on manufacturers of automotive upholstery and the just-in-time delivery requirements. Effective customer service and prompt response to customer feedback are logistically more difficult for an importer to provide. North American automotive production during calendar year 2011 grew 11% over calendar year 2010 and an additional 22% during the first half of calendar year 2012 compared to the prior year comparable period.
Competition
The industry in which the Company currently operates is global and highly competitive. On a global basis, the Company competes not only as a yarn producer but also as part of a regional supply chain. For Compliant Yarns, the Company competes with a limited number of foreign and domestic producers of polyester and nylon yarns. For non-Compliant Yarns, the Company competes with a certain number of foreign and domestic producers of polyester and nylon yarns, who can meet the required customer specifications of quality, reliability and timeliness. While competitors have traditionally focused on commodity production, they are now increasingly focused on specialty and value-added products where the Company generates higher margins. The Company is affected by the importation of textile, apparel and hosiery products which adversely impacts demand for polyester and nylon yarns in the Company’s markets. Several foreign competitors in the Company’s supply chain have significant competitive advantages, including lower wages, raw material costs, capital costs, and favorable currency exchange rates against the U.S. dollar which could make the Company’s products, or the related supply chains, less competitive.
The major regional competitors for polyester yarns are O’Mara, Inc., and NanYa Plastics Corp. of America (“NanYa”) in the U.S., AKRA, S.A. de C.V. in the NAFTA region, and C S Central America S.A. de C.V. (“CS Central America”) in the CAFTA region. The Company’s major competitors in Brazil are Avanti Industria Comercio Importacao e Exportacao Ltda., Polyenka Ltda., and other imported yarns and fibers. The major regional competitors for nylon yarns are Sapona Manufacturing Company, Inc., and McMichael Mills, Inc. in the U.S. and Worldtex, Inc. in the ATPDEA region.
Products
The Company manufactures polyester related products in the U.S., El Salvador and Brazil and nylon yarns in the U.S. and Colombia for a wide range of end-uses. In addition, the Company purchases certain yarns for resale to its customers. The Company processes and sells POY, as well as high-volume commodity, specialty, and PVA yarns, domestically and internationally, with PVA yarns making up approximately 18%, 17%, and 15% of consolidated sales for fiscal years 2012, 2011 and 2010, respectively.
The Company works closely with its customers to develop yarns using a research and development staff that evaluates trends and uses the latest technology to create innovative specialty and PVA yarns reflecting current consumer preferences. The Company also adds value to the supply chain and increases consumer demand for its products through the development and introduction of branded yarns that provide unique sustainability, performance, comfort and aesthetic advantages. The Company’s branded portion of its yarn portfolio continues to provide product differentiation to brands, retailers and consumers and includes products such as:
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REPREVE ® , a family of eco-friendly yarns made from recycled materials. Since its introduction in 2006, REPREVE ® has been the Company ’ s most successful branded product. The Company ’ s recycled performance fibers are manufactured to provide certain performance and/or functional properties to various types of fabrics and end products. REPREVE ® can be found in many well-known brands and retailers including Ford, Haggar, Life Khaki, Polartec, The North Face, Patagonia, REI, Perry Ellis, Home Depot, Sears, Macy ’ s, Kohl ’ s, Greg Norman and Belk department stores. Recent REPREVE ® press mentions include USA Today, the Wall Street Journal and People Style Watch.
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aio® all-in-one performance yarns combine multiple performance properties into a single yarn. aio® is being used by brands MJ Soffe and New Balance for several U.S. military apparel products.
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Sorbtek®, a permanent moisture management yarn primarily used in performance base layer applications, compression apparel, athletic bras, sports apparel, socks and other non-apparel related items. Sorbtek® can be found in many well-known apparel brands, including Adidas and Asics, and is also used by MJ Soffe and New Balance for the U.S. military.
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A.M.Y. ®, a yarn with permanent antimicrobial properties for odor control. A.M.Y.® is being used by MJ Soffe and New Balance for the U.S. military.
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Reflexx®, a family of stretch yarns that can be found in a wide array of end-use applications from home furnishing to performance wear and from hosiery and socks to work wear and denim. Reflexx® can be found in many products including those used by the U.S. military.
For fiscal years 2012, 2011 and 2010, the Company incurred $4,764, $4,145, and $3,591 for research and development costs, respectively.
Customers
The Company’s Polyester segment has approximately 420 customers, its Nylon segment has approximately 170 customers, and its International segment has approximately 600 customers in a variety of geographic markets. Yarn is manufactured based upon product specifications and shipped based upon customer order requirements. Customer payment terms are generally consistent across the segments and are based on prevailing industry practices for the sale of yarn domestically or internationally.
The Company’s sales are not materially dependent on a single customer or a small group of customers with no single customer comprising greater than ten percent of consolidated net sales. The Company’s top ten customers accounted for approximately 32% of sales for fiscal year 2012 and 36% of receivables as of June 24, 2012.
Sales and Marketing
The Company employs a sales force of approximately forty persons operating out of sales offices in the U.S., Brazil, China, El Salvador and Colombia. The Company relies on independent sales agents for sales in several other countries. The Company seeks to create strong customer relationships and continually seeks ways to build and strengthen those relationships throughout the supply chain. Through frequent communications with customers, partnering with customers in product development and engaging key downstream brands and retailers, the Company has created significant pull-through sales and brand recognition for its products. For example, the Company works with brands and retailers to educate and create demand for its value-added products. The Company then works with key fabric mill partners to develop specific fabric for those brands and retailers utilizing its PVA products. Based on the results of many commercial and branded programs, this strategy has been successful for the Company.
Suppliers and Sourcing
The primary raw material supplier for the Polyester segment is NanYa for Chip and POY. For the International segment, Reliance Industries, Ltd (“Reliance”) is the main supplier for POY. The primary suppliers of POY to the Nylon segment are HN Fibers, Ltd., U.N.F. Industries Ltd. (“UNF”), UNF America, LLC (“UNF America”), Invista S.a.r.l. (“INVISTA”), Universal Premier Fibers, LLC, and Nilit US (“Nilit”). Currently, there are numerous domestic suppliers available to fulfill the Company’s sourcing requirements for its recycled products. UNF and UNF America are 50/50 joint ventures between the Company and Nilit. The Company produces and buys certain of its compliant raw material fibers from both the U.S. and Israel. The Company produces a portion of its Chip requirements in its recycling center and purchases the remainder of its requirements from external suppliers for use in its spinning facility. In the U.S., Brazil and China, the Company purchases nylon and polyester resale products from various suppliers. Although the Company does not generally have difficulty in obtaining raw nylon POY or raw polyester POY, the Company has in the past experienced interruptions or limitations in the supply of polyester Chip and other raw materials used to manufacture polyester POY.
Manufacturing Processes
The Company uses advanced production processes to manufacture its high quality yarns cost effectively. The Company believes that its flexibility and know-how in producing specialty yarns provides important development and commercialization advantages. The Company produces polyester POY for its commodity, specialty and PVA yarns in its polyester spinning facility located in Yadkinville, North Carolina. The POY yarns can be sold externally or further processed internally. Additional processing of polyester products includes texturing, package dyeing, twisting and beaming. The texturing process, which is common to both polyester and nylon, involves the use of high-speed machines to draw, heat and false-twist the POY to produce yarn having various physical characteristics, depending on its ultimate end-use. Texturing gives the yarn greater bulk, strength, stretch, consistent dye-ability and a softer feel, thereby making it suitable for use in the knitting and weaving of fabric. Package dyeing allows for matching of customer specific color requirements for yarns sold into the automotive, home furnishing and apparel markets. Twisting incorporates real twist into the filament yarns which can be sold for such uses as sewing thread, home furnishing and apparel. Beaming places both textured and covered yarns onto beams to be used by customers in warp knitting and weaving applications. Additional processing of nylon products primarily includes covering which involves the wrapping or air entangling of filament or spun yarn around a core yarn. This process enhances a fabric’s ability to stretch, recover its original shape and resist wrinkles while maintaining a softer feel.
CEO BACKGROUND
WILLIAM J. ARMFIELD, IV (77) — Mr. Armfield has been the President of Spotswood Capital, LLC, Greensboro, North Carolina, a private investment company, since 1995 . Mr. Armfield was a director and President of Macfield, Inc., a textile company in North Carolina, from 1970 until August 1991, when Macfield, Inc. merged with and into Unifi, Inc. Mr. Armfield was the Vice Chairman and a director of the Company from 1991 to December 1995. Mr. Armfield again became a director of the Company in 2001, and is a member of the Board’s Audit Committee and Compensation Committee. Mr. Armfield serves as an Audit Committee financial expert. Mr. Armfield brings operating and management experience, expertise in finance, and business development experience to the Company as a result of his professional experiences. In addition, through his experience at Macfield, he brings direct textile experience to the Board. These experiences provide the Board with, among other things, expertise and context important to the oversight of the Company’s financial reporting and business strategy implementation.
R. ROGER BERRIER, JR. (43) — Mr. Berrier has been the President and Chief Operating Officer of the Company since February 2011. He had been the Executive Vice President of Sales, Marketing and Asian Operations of the Company from September 2007 to February 2011. Prior to September 2007, he had been the Vice President of Commercial Operations from April 2006 to September 2007 and the Commercial Operations Manager responsible for corporate product development, marketing and brand sales management from April 2004 to April 2006. Mr. Berrier joined the Company in 1991 and has held various management positions within operations, including international operations, machinery technology, research & development and quality control. He has been a director since September 2007 and is a member of the Board’s Executive Committee. Mr. Berrier brings executive decision making skills, operating and management experience, expertise in sales, marketing and branding, business development and direct textile industry business acumen to the Company as a result of his professional experiences. These experiences and Mr. Berrier’s on-going interaction with the Company’s customers and suppliers provide the Board with, among other things, industry expertise important to the Company’s businesses, as well as a detailed understanding of the Company’s business and operations and the economic environment in which it operates.
ARCHIBALD COX, JR. (72) — Mr. Cox has been the Chairman of Sextant Group, Inc., a financial advisory and private equity firm, since 1993. Mr. Cox is the former Chairman of Barclays Americas, a position he held from May 2008 until June 2011. Mr. Cox was a director of Hutchinson Technology Incorporated from May 1996 to September 2009, was the Chairman of Magnequench, Inc., a manufacturer of magnetic material, from September 2005 to September 2006 and was the President and Chief Executive Officer of Magnequench, Inc., from October 1995 to August 2005. He was Chairman of Neo Material Technologies Inc., a manufacturer of rare earth, zirconium and magnetic materials, from September 2005 to September 2006. Mr. Cox has been a director of the Company since February 2008 and is a member of the Board’s Compensation Committee. Mr. Cox brings executive decision making skills, operating and management experience, expertise in finance, investment and business development experience to the Company as a result of his professional experiences. In addition, through his experience as Chairman of Barclays Americas in particular, Mr. Cox brings to the Board considerable experience with financial and strategic planning matters critical to the oversight of the Company’s financial reporting, compensation practices and business strategy implementation.
WILLIAM L. JASPER (59) — Mr. Jasper has been the Company’s Chairman of the Board since February 2011 and Chief Executive Officer since September 2007 . Mr. Jasper joined the Company in September 2004, was later appointed as the General Manager of the Polyester Division, and in April 2006 was promoted to Vice President of Sales. From September 2007 to February 2011, he was also the President of the Company. Prior to joining the Company, he was the Director of INVISTA’s Dacron® polyester filament business. Before working at INVISTA, Mr. Jasper had held various management positions in operations, technology, sales and business for E.I. du Pont de Nemours and Co. since 1980. He has been a director since September 2007 and is a member of the Board’s Executive Committee (Chair). Mr. Jasper brings executive decision making skills, operating and management experience, expertise in manufacturing operations, sales, business development and direct textile industry business acumen to the Company as a result of his professional experiences. These experiences and Mr. Jasper’s on-going leadership of the Company and interaction with the Company’s customers and suppliers provide the Board with, among other things, a detailed understanding of the Company’s businesses and the competitive environment in which it operates.
KENNETH G. LANGONE (76) — Mr. Langone has been the President and Chief Executive Officer of Invemed Associates, LLC, an investment banking firm, New York, New York, since 1974, and a director and Executive Chairman and Chief Executive Officer of Geeknet, Inc. since 2011 . Mr. Langone was a co-founder of The Home Depot, Inc. and served as a director from 1978 to 2008. He also served as a director of ChoicePoint, Inc. from 2002 to 2008 and of General Electric Co. from 1999 to 2005. Mr. Langone has been a director of the Company since 1969, and is a member of the Board’s Corporate Governance and Nominating Committee. Mr. Langone brings operating and management experience, including as chief executive officer of a financial services business, expertise in finance, and public company directorship and committee experience to the Company as a result of his professional experiences. In addition, Mr. Langone’s service on the Company’s Board since 1969 provides the Board with a valuable historical perspective through which it can contextualize and direct the Company’s performance and strategic planning.
GEORGE R. PERKINS, JR. (72) — Mr. Perkins is the retired Chairman of the Board and the former Chief Executive Officer of Frontier Spinning Mills, Inc., a company that he founded in 1996 and in which he served in these roles until 2009. Prior to founding Frontier, Mr. Perkins served from 1993 to 1996 as President of the spun yarns division of the Company and was a member of the Board. Mr. Perkins has served as a director of First BanCorp since 2006. He has been a director of the Company since August 2007, and is a member of the Board’s Corporate Governance and Nominating Committee. Mr. Perkins brings executive decision making skills, operating and management experience, and business development acumen to the Company as a result of his professional experiences. In addition, his deep understanding of the cotton business assists the Board in analyzing the Company’s businesses. These experiences provide the Board with, among other things, specific industry expertise important for an understanding of the Company’s businesses and operations.
SUZANNE M. PRESENT (53) – Ms. Present is a co-founder and has been a principal of Gladwyne Partners, LLC, a private partnership fund manager, since June 1998. Ms. Present currently serves on the boards of directors of The Electric Sheep Company, Inc., a privately-held developer of content and technologies for virtual worlds, and Anshe Chung Studios, Limited, a privately-held Chinese-based developer of content for virtual worlds. She served on the board of directors of Geeknet, Inc. from September 2008 to July 2010. She has been a director of the Company since February 2011 and is a member of the Board’s Audit Committee (Chair). Ms. Present serves as an Audit Committee financial expert. Through her experiences at Gladwyne Partners and service on various boards of directors, Ms. Present brings financial expertise important to the oversight of the Company’s audit functions and business strategies.
WILLIAM M. SAMS (74) — Mr. Sams was the President and Chief Investment Officer of FPA Paramount Fund, Inc., as well as the Executive Vice President of both First Pacific Advisors, Inc. and FPA Perennial Fund, Inc. from 1981 until he retired in 2000 . Mr. Sams has been a General Partner of Marlin Sams Fund since April 2008 and has served as a director of America’s Car-Mart, Inc. and a member of its audit committee since March 2005. He has been a director of the Company since April 2007, is a member of the Board’s Audit Committee and previously served as independent “Lead Director” of the Board from April 2007 until April 2011. Mr. Sams brings expertise in finance, public company directorship and committee experience to the Company as a result of his professional experiences. In addition, his tenure at First Pacific Advisors, Inc. and FPA Perennial Fund, Inc. in particular bring the Board a valuable perspective regarding executive decision making and business development important to the oversight of the Company’s implementation of its business and financial goals.
G. ALFRED WEBSTER (64) — Mr. Webster was an Executive Vice President of the Company, and had been an officer of the Company from 1979 through his retirement in 2003, and a director from 1986 until October 2004 . Mr. Webster is a director and Chairman of the Compensation Committee of New Bridge Bank Corporation (formerly Lexington State Bank). Mr. Webster again became a director of the Company in August 2007, has served as the independent “Lead Director” of the Board since April 2011, and is a member of the Board’s Compensation Committee (Chair), Corporate Governance and Nominating Committee (Chair), and Executive Committee. Mr. Webster brings executive decision making skills, operating and management experience, and experience in public company directorship and committee experience, as well as direct textile industry business acumen to the Company as a result of his professional experiences. In addition, Mr. Webster’s long tenure with the Company provides the Board with a valuable historical perspective on the Company. These experiences provide the Board with, among other things, industry expertise relevant to the oversight of the Company’s businesses.
MITCHEL WEINBERGER (43) — Mr. Weinberger has served as the President and Chief Operating Officer of Dillon Yarn Corporation since March 2011 . He was the Executive Vice President of Dillon from January 2007 to March 2011 and its Strategic Marketing Manager from 1992 to November 2007. The polyester and nylon texturing operations of Dillon were purchased by the Company on January 1, 2007, as discussed in more detail below under “Transactions with Related Parties, Promoters and Certain Control Persons—Transactions with Dillon Yarn Corporation”. He has been a director of the Company since March 2011 and is a member of the Board’s Executive Committee. Through his executive leadership experience at Dillon, Mr. Weinberger brings to the Board a solid understanding of the textile industry in which the Company operates as well as operating and management experience. These experiences provide the Board with, among other things, industry expertise important to the oversight of the Company’s management and execution of its business plans.
MANAGEMENT DISCUSSION FROM LATEST 10K
Business Overview
The Company sells its polyester and nylon products to other yarn manufacturers, knitters and weavers that produce fabric for the apparel, hosiery, sock, home furnishing, automotive upholstery, industrial and other end-use markets. The Company maintains one of the industry’s most comprehensive product offerings and has ten manufacturing operations in four countries and participates in joint ventures in Israel and the United States (“U.S.”). The Company’s principal markets are located in the U.S., Canada, Mexico, Central America, and South America. In addition, the Company has a wholly-owned subsidiary in the People’s Republic of China (“China”) focused on the sale and promotion of the Company’s specialty and PVA products in the Asian textile market, primarily in China as well as into Europe. The Company has three operating segments which are also its reportable segments: the Polyester segment, the Nylon segment and the International segment. For further information regarding our business, see “Item 1. Business” included in this Annual Report on 10-K and for further information regarding segments, see “Footnote 28. Business Segment Information” to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Deleveraging Strategy: During the June 2012 quarter, the Company successfully completed its comprehensive debt refinancing. The refinancing allowed the Company to extend the maturity profile of its indebtedness to May 2017 and will generate approximately $9,000 of annual interest expense savings. In addition, the Company believes that this new financing will provide the availability and flexibility needed to execute its strategic objectives.
Raw Materials: Polyester raw material costs for fiscal year 2012 averaged 8 to 9 cents per pound higher than fiscal year 2011. Throughout most of fiscal year 2012, and for the latter half of fiscal year 2011, polyester raw material costs remained at their highest levels in over thirty years. In addition, Asian imported yarns have become more competitive and continued to place pressure on the Company’s commodity business as the U.S.-Asia gap in polymer pricing averaged 11 to 12 cents per pound in fiscal year 2012 versus the 4 to 5 cents average per pound for the prior fiscal year period.
Inventory Destocking: The Company believes inventory in the U.S. apparel supply chain reached elevated levels during the first quarter of the Company’s recently completed fiscal year, and producers and wholesalers reacted to the elevated inventory levels by curtailing purchases from August to December 2011. The Company reacted by adjusting its production below its sales levels in order to reduce its on-hand inventory units. As a result of the Company’s actions, the production volume and per unit manufacturing costs in the Company’s Polyester and Nylon segments were negatively impacted during the first half of fiscal 2012.
Brazil : The strengthening of the Brazilian Real during the first half of fiscal year 2012 began to negatively impact the competitiveness of the local apparel supply chain by making imports of competing fibers, garments and apparel more competitively priced. The return of the Real to more normalized levels during the second half of the fiscal year and the initiatives taken by the Brazilian government to help support the domestic manufacturers have helped shift demand back to the domestic Brazilian textile producers. Due to the long supply chain for the procurement of its raw materials, the Company’s Brazilian business was negatively impacted by the cost of higher priced inventory flowing through the operation in the current fiscal year. Lower sales and production volume also caused unfavorable increases in production costs due to lower utilization rates as well as higher spending due to inflationary increases for employee costs and power.
Strategy: While the Company continues to face a challenging operating environment caused by global competition across the supply chain, inflation in input costs and raw materials, and potential decreased demand caused by continuing weakness of the U.S. and global economies, the Company believes it has the appropriate strategies to succeed in such an environment. The Company continues to focus on its key strategies: striving for continuous improvement across all operational and business processes; enriching its product mix by growing its higher margin PVA product portfolio; increasing sales of yarns with regional rules of origin requirements; and continuing its strategic penetration in global growth markets, such as China, Central America and Brazil. Going forward, the Company expects to continue its support of these strategies through investments in product and geographic growth opportunities and utilizing excess liquidity to continue its deleveraging strategy, with the goal of reducing leverage, prepaying its Term B Loan, and developing other strategies to enhance shareholder value.
Company Outlook: The Company expects operating profit improvements for fiscal year 2013 when compared to fiscal year 2012 due to anticipated higher sales volume (from the lessening effect of the inventory destocking and signs of improvement in the Company’s key markets) and gross margin improvement.
Cash Used in Investing Activities and Financing Activities
The Company utilized $6,858 for net investing activities and utilized $49,834 in net financing activities during fiscal year 2012. The Company spent $6,354 on capital expenditures and reduced its overall long-term debt by $47,112. In addition, the Company refinanced its debt at a cost of $3,127.
The Company utilized $17,396 for net investing activities and utilized $14,029 in net financing activities during fiscal year 2011. In addition to the $20,539 cash spent to fund capital expenditures the Company reduced its total long-term debt by $10,726 at a premium cost of $2,587. The Company also refinanced its prior revolving credit facility at a cost of $825. The primary offset to these expenditures was proceeds of $3,241 from the return of split dollar life insurance premiums.
Contingencies
Environmental
On September 30, 2004, the Company completed its acquisition of the polyester filament manufacturing assets located in Kinston, North Carolina from INVISTA. The land for the Kinston site was leased pursuant to a 99 year ground lease (“Ground Lease”) with E.I. DuPont de Nemours (“DuPont”). Since 1993, DuPont has been investigating and cleaning up the Kinston site under the supervision of the U.S. Environmental Protection Agency and the North Carolina Department of Environment and Natural Resources (“DENR”) pursuant to the Resource Conservation and Recovery Act Corrective Action program. The Corrective Action program requires DuPont to identify all potential areas of environmental concern (“AOCs”), assess the extent of containment at the identified AOCs and clean it up to comply with applicable regulatory standards. Effective March 20, 2008, the Company entered into a Lease Termination Agreement associated with conveyance of certain assets at Kinston to DuPont. This agreement terminated the Ground Lease and relieved the Company of any future responsibility for environmental remediation, other than participation with DuPont, if so called upon, with regard to the Company’s period of operation of the Kinston site. However, the Company continues to own a satellite service facility acquired in the INVISTA transaction that has contamination from DuPont’s operations and is monitored by DENR. This site has been remediated by DuPont and DuPont has received authority from DENR to discontinue remediation, other than natural attenuation. DuPont’s duty to monitor and report to DENR will be transferred to the Company in the future, at which time DuPont must pay the Company for seven years of monitoring and reporting costs and the Company will assume responsibility for any future remediation and monitoring of the site. At this time, the Company has no basis to determine if and when it will have any responsibility or obligation with respect to the AOCs or the extent of any potential liability for the same.
Recent Accounting Pronouncements
There have been no newly issued or newly applicable accounting pronouncements that have, or are expected to have, a significant impact on the Company's financial statements.
Off Balance Sheet Arrangements
The Company is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, results of operations, liquidity or capital expenditures.
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The SEC has defined a company’s most critical accounting policies as those involving accounting estimates that require management to make assumptions about matters that are highly uncertain at the time and where different reasonable estimates or changes in the accounting estimate from quarter to quarter could materially impact the presentation of the financial statements. The following discussion provides further information about accounting policies critical to the Company and should be read in conjunction with “Footnote 2. Summary of Significant Accounting Policies” to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Receivables Reserves . An allowance for losses is provided for known and potential losses arising from yarn quality claims and for amounts owed by customers. Reserves for yarn quality claims are based on historical claim experience and known pending claims. The collectability of accounts receivable is based on a combination of factors including the aging of accounts, historical write off experience, present economic conditions such as customer bankruptcy filings and the financial health of specific customers and market sectors. Since losses depend to a large degree on future economic conditions, and the health of the textile industry, a significant level of judgment is required to arrive at the allowance for uncollectible accounts which is established based on percentages applied to accounts aged for certain periods of time, supplemented by specific reserves for certain customer accounts where collection is no longer certain. Establishing reserves for yarn claims and uncollectible accounts requires management judgment and estimates. The Company does not believe there is a reasonable likelihood that there will be a material change in the estimates and assumptions it uses to assess allowance for losses. Certain unexpected events such as a customer bankruptcy filing could have a material impact on the Company’s results of operations. The Company has not made any material changes to the methodology used in establishing its accounts receivable loss reserves during the past three fiscal years. A plus or minus 10% change in its aged accounts receivable reserve percentages would not have been material to the Company’s financial statements for the past three years.
Inventory Reserves. Inventory reserves are established based on percentage markdowns applied to items aged for certain time periods. Specific reserves are established based on a determination of the obsolescence of the inventory and whether the inventory value exceeds amounts to be recovered through expected sales prices, less selling costs. Estimating sales prices, establishing markdown percentages and evaluating the condition of the inventories require judgments and estimates, which may impact the ending inventory valuation and gross margins. The Company uses current and historical knowledge to record reasonable estimates of its markdown percentages and expected sales prices. The Company believes it is unlikely that differences in actual demand or selling prices from those projected by management would have a material impact on the Company’s financial condition or results of operations. The Company has not made any material changes to the methodology used in establishing its inventory loss reserves during the past three fiscal years. A plus or minus 10% change in its aged inventory markdown percentages would not have been material to the Company’s financial statements for the past three years.
Impairment of Long-Lived Assets . Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. For assets held for sale, an impairment charge is recognized if the carrying value of the assets exceeds the fair value less costs to sell. Estimates are required to determine the fair value, the disposal costs and the time period to dispose of the assets. Such estimates are critical in determining whether any impairment charge should be recorded and the amount of such charge if an impairment loss is deemed to be necessary. For assets held and used, impairment may occur if projected undiscounted cash flows are not adequate to cover the carrying value of the assets. In such cases, additional analysis is conducted to determine the amount of loss to be recognized. The impairment loss is determined as the amount the carrying value of the asset or asset group exceeds the estimated fair value, measured by future discounted cash flows. The analysis requires estimates of the amount and timing of projected cash flows and, where applicable, judgments associated with, among other factors, the appropriate discount rate. Such estimates are critical in determining whether any impairment charge should be recorded and the amount of such charge if an impairment loss is deemed to be necessary. The Company’s judgment regarding the existence of circumstances that indicate the potential impairment of an asset’s carrying value is based on several factors including, but not limited to, changes in business environment, a decline in operating cash flows or a decision to close a manufacturing facility. The variability of these factors depends on a number of conditions, including uncertainty about future events and general economic conditions.
Impairment of Investment in Unconsolidated Affiliates. The Company evaluates its investments in unconsolidated affiliates whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company evaluates the ability of an affiliate to sustain sufficient earnings and cash flows to justify its carrying value. Reductions in an affiliate’s cash flows that are other than temporary and indicative of a loss of investment value are assessed for impairment purposes. For the fiscal year ended June 24, 2012, the Company determined there were no “other-than-temporary” impairments related to the carrying value of its investments.
Valuation Allowance for Deferred Tax Assets. The Company currently has a valuation allowance against certain of its net deferred tax assets in the U.S. and foreign subsidiaries due to negative evidence concerning the realization of those deferred tax assets. In assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences reverse. Management considers the scheduled reversal of taxable temporary differences, taxable income in carryback periods, projected future taxable income and tax planning strategies in making this assessment. The Company reviews its estimates of future taxable income on a quarterly basis to assess if the need for a valuation allowance exists. The Company continually evaluates both positive and negative evidence to determine whether and when the valuation allowance, or a portion thereof, should be released. A release of the valuation allowance could have a material effect on earnings in the period of release. The valuation allowance as of June 24, 2012 was $13,911.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Business Overview
The Company processes and sells high-volume commodity yarns, specialized yarns designed to meet certain customer specifications, and premier value-added (“PVA”) yarns with enhanced performance characteristics and higher expected gross margin percentages. The Company sells its polyester and nylon products primarily to other yarn manufacturers and knitters and weavers that produce fabric for the apparel, hosiery, sock, home furnishings, automotive upholstery, industrial and other end-use markets. The Company maintains one of the industry’s most comprehensive product offerings and has ten manufacturing operations in four countries and participates in joint ventures in Israel and the U.S. In addition, the Company has a wholly-owned subsidiary in China focused on the sale and promotion of the Company’s specialty and PVA products in the Asian textile market, primarily in China.
The Company’s operations are managed in three operating segments, each of which is a reportable segment for financial reporting purposes:
Polyester Segment. The Polyester segment manufactures recycled Chip, partially oriented yarn (“POY”), textured, dyed, twisted and beamed yarns with sales primarily to other yarn manufacturers, knitters and weavers that produce yarn and/or fabric for the apparel, automotive upholstery, hosiery, home furnishings, industrial and other end-use markets. The Polyester segment consists of manufacturing operations in the U.S. and El Salvador.
Nylon Segment. The Nylon segment manufactures textured nylon and covered spandex yarns with sales to knitters and weavers that produce fabric for the apparel, hosiery, sock and other end-use markets. The Nylon segment consists of manufacturing operations in the U.S. and Colombia.
International Segment. The International segment’s products primarily include textured polyester and various types of resale yarns. The International segment sells its yarns to knitters and weavers that produce fabric for the apparel, automotive upholstery, home furnishings, industrial and other end-use markets primarily in the South American and Asian regions. This segment includes manufacturing and sales offices in Brazil and a sales office in China.
Recent Developments
Company Outlook: The Company expects operating profit improvements in the fourth quarter of fiscal year 2012 as a result of higher sales volume (due to the lessening effect of the inventory destocking and signs of improvement in the Brazilian textile market) and improving gross margins (due to easing raw material costs and lower converting costs).
Deleveraging Strategy: The planned refinancing will allow the Company to extend the maturity profile of its indebtedness out to May 2017 and will generate approximately $9,000 of annual interest expense savings. The Company believes that this new financing will accelerate its deleveraging strategy as well as to provide the flexibility to explore strategic initiatives designed to leverage its core competencies and grow its business within key market segments.
Raw Materials: Raw material costs for polyester for the March 2012 quarter declined approximately 1 cent per pound on average compared to the December 2011 quarter. However, the average polyester raw material costs for the first three quarters of fiscal year 2012 continue to remain at the highest levels in over thirty years. In addition, Asian imported yarns have become more competitive as the U.S.-Asia gap in polymer pricing has grown to between 7 to 14 cents per pound on average for this fiscal year to date period versus 2 to 5 cents per pound for the prior fiscal year to date period and continues to place pressure on the Company’s commodity business.
Inventory Destocking: The Company believes that inventory in the apparel supply chain reached elevated levels during the first quarter of the Company’s current fiscal year, and producers and wholesalers reacted to the elevated inventory levels by curtailing purchases from August to December 2011. The Company reacted by adjusting its production below its sales levels in order to reduce its on-hand inventory units. As a result of the Company’s actions, the production volume and per unit manufacturing costs of the Company’s Polyester and Nylon segments have been negatively impacted for the year to date period. Despite continued declines of inventories throughout the supply chain and at retail, current indications suggest improvement in the Company’s key market segments and allowed the Company to increase its production levels during the third quarter.
Brazil : The strengthening of the Brazilian Real during previous quarters began to negatively impact the competitiveness of the local apparel supply chain by making imports of competing fibers, garments and apparel more competitively priced. The return of the Real to more normalized levels during the most recent fiscal quarter and the initiatives taken by the Brazilian government to help support the domestic manufacturers have helped shift demand back to the domestic Brazilian textile producers and increased demand throughout the current quarter. For the fiscal year to date period versus the prior year period, the Brazil operation, due to the long supply chain for the procurement of its raw materials, has also been negatively impacted by the cost of higher priced inventory flowing through the operation. Lower sales and production volume have also caused unfavorable increases in production costs due to lower utilization percentages as well as higher spending due to inflationary increases for employee costs and power.
PVA: Domestically, PVA sales volume held stronger than the remainder of the business and increased versus the prior year quarter. Internationally, PVA sales volume was negatively impacted by the results in Brazil and the temporary delay of orders from a large volume customer for the Chinese sales office. The Company’s PVA products represent approximately 18% of its consolidated sales volume and REPREVE® continues to grow at a faster pace than other PVA products.
Inflation: The Company continues to be impacted by inflationary increases in areas such as employee costs and benefits, consumables and utility costs. The Company attempts to mitigate the impacts of these rising costs through its operational efficiencies and increased selling prices. Inflation may become a factor that begins to significantly impact the Company’s profitability.
Investment in Central America: The CAFTA region which continues to be a competitive alternative to Asian supply chains, has in recent years maintained its share of synthetic apparel supply to U.S. retailers and continues to see ongoing investments being made in the region. The Company expects to complete the installation of additional texturing capacity at its plant in El Salvador by the end of this fiscal year to take advantage of the long-term volume opportunities in this region.
Repreve Recycling Center: The new recycling facility which opened in May 2011 allows the Company to expand the REPREVE® brand by increasing the amount and types of recyclable material that can be processed through its facilities and to develop and commercialize value-added products that meet the sustainability demands for brands and retailers.
Repreve Renewables, LLC: During the December 2011 quarter, the Company acquired an additional 20% ownership interest in Repreve Renewables, LLC (“Renewables”) bringing the Company’s current ownership to 60%. The Company’s investment in Renewables, which is a development stage company that focuses on cultivating and selling bio-mass crops for the bio-fuel and bio-power industries, is anticipated to provide the Company with a unique revenue stream and support its strategy to grow the REPREVE® brand and its sustainability initiatives.
U.S.-South Korean Free Trade Agreement: Even though the agreement was passed, the Company anticipates limited impact on its business as South Korea is not a low cost provider of textiles in comparison to other Asian countries and South Korea provides little or no export opportunities for the Company or for U.S. textile manufacturers. The Company believes that the largest potential threats are caused by the failure of the agreement to address the potential damage from the lack of customs enforcement language and the exposure of illegal transshipments from China through South Korea.
Consolidated Net Sales
Net sales for the March 2012 quarter decreased by $353, or 0.2%, as compared to the prior year March quarter primarily due to a decline in sales volume for each of the Company’s reportable segments offset by an increase in the overall weighted average selling price. On a consolidated basis, sales volume decreased by 3.4% due to volume declines of 2.4%, 10.8% and 2.8% in the Polyester, Nylon, and International reportable segments, respectively. The Company believes that the inventory destocking across the apparel supply chain, which had softened demand and negatively impacted its sales volumes throughout most of the current fiscal year including the first month of the current quarter, has ended and expects volume improvements in the fourth quarter of fiscal year 2012. Overall, the weighted average selling price increased by 3.2% as a result of raw material inflation and mix enrichment.
Consolidated Gross Profit
Gross profit for the March 2012 quarter decreased by $2,011, or 12.9%, as compared to the prior year March quarter. Gross profit declines were experienced in the Company’s Nylon and International segments primarily due to lower sales volumes in both segments and lower unit conversion margin in the International segment offset by an increase in gross profit in the Polyester segment. In addition, the Company’s operation in Brazil was negatively impacted by less expensive imports which created a challenging competitive environment for local production, higher manufacturing costs due to lower utilization rates and inflationary cost increases.
Interest Expense, Net
Net interest expense decreased from $4,432 in the March 2011 quarter to $3,618 in the March 2012 quarter. The favorable decline in interest expense was primarily due to the lower average outstanding debt balance as a result of the Company’s redemptions of its 2014 notes. These redemptions were financed through a mix of cash generated from operations and borrowings under the Company’s revolving credit facility which carries a lower average interest rate. The weighted average interest rate of Company debt for the March 2012 quarter and the March 2011 quarter was 10.4% and 11.3%, respectively.
Outlook:
As a result of the continued implementation of the Company’s Deleveraging Strategy, the Company expects to incur approximately $3.6 million less interest expense, net for fiscal year 2012 versus fiscal year 2011. As the Company continues to execute on its Deleveraging Strategy, the trend for declining interest expense is expected to continue.
Other Non-Operating (Income) Expenses
For the three months ended March 25, 2012, Other non-operating (income) expense consists of a $9 gain from the Company’s Brazilian operation related to a refund of non-income related taxes plus interest. For the three months ended March 27, 2011, Other non-operating (income) expense consists of $2,193 for debt extinguishment charges and $78 for costs associated with an unsuccessful debt refinancing.
Equity in (Earnings) Losses of Unconsolidated Affiliates
The Company participates in joint ventures in the U.S. and in Israel. As of March 25, 2012, the Company had $97,883 invested in these unconsolidated affiliates. For the three months ended March 25, 2012, the Company’s $8,171 income before income taxes included $9,863 of income generated from its investments in these unconsolidated affiliates. See “Footnote 25. Investments in Unconsolidated Affiliates and Variable Interest Entities” to the Condensed Consolidated Financial Statements included in this Form 10-Q for a detailed discussion of the Company’s investments in these joint ventures.
For the three months ended March 25, 2012, earnings from the Company’s unconsolidated affiliates were $9,863 compared to losses of $2,103 for the three months ended March 27, 2011. During these periods, the Company’s 34% share of PAL’s earnings increased from a loss of $2,450 to earnings of $9,720 due to PAL’s gross margins temporarily benefitting from the significant drop in the raw material portion of cost of goods sold, as recent declines in cotton costs were not immediately offset by a corresponding drop in selling prices primarily due to the lag in various of PAL’s index-based selling arrangements and contractual terms with customers. PAL’s results for the three months ended March 27, 2011 included unfavorable derivative losses and its gross margins were similarly affected, inversely, by rapidly rising cotton costs and the related sales price lag. The remaining decrease in the earnings of unconsolidated affiliates relates primarily to lower operating results of UNF and UNF America which was primarily driven by decreased sales volume and lower capacity utilization.
Outlook:
The Company expects its unconsolidated affiliates to continue to be impacted by lower expected sales volume with a return to expected sales volume and profitability by the end of the calendar year 2012 .
Income Taxes
The Company’s income tax provision for the quarter ended March 25, 2012 resulted in tax expense at an effective rate of 10.5% compared to the quarter ended March 27, 2011, which resulted in a tax benefit at an effective rate of 3.9%. The difference between the Company’s income tax expense and the U.S. statutory rate for the quarter ended March 25, 2012 was primarily due to losses in tax jurisdictions for which no tax benefit could be recognized, foreign dividends taxed in the U.S. and abroad, and earnings attributable to foreign operations which are taxed at rates lower than the U.S. statutory rate.
The Company currently has a full valuation allowance against its net deferred tax assets in the U.S. and certain foreign subsidiaries due to negative evidence concerning the realization of those deferred tax assets in recent years. The Company continues to evaluate both positive and negative evidence to determine whether and when the valuation allowance, or a portion thereof, should be released. A release of the valuation allowance could have a material effect on net earnings in the period of release.
The Company is subject to income tax examinations for U.S. federal income taxes for fiscal years 2005 through 2011, for non-U.S. income taxes for tax years 2002 through 2011, and for state and local income taxes for fiscal years 2001 through 2011.
Interest Expense, Net
Net interest expense decreased from $13,352 for the March 2011 year-to-date period to $11,078 in the March 2012 year-to-date period. The favorable decline in interest expense was primarily due to the lower average outstanding debt balance as a result of the Company’s redemptions of its 2014 notes. These redemptions were financed through a mix of cash generated from operations and borrowings under the Company’s revolving credit facility which carries a lower average interest rate. The weighted average interest rate of Company debt for the March 2011 year-to-date period and the March 2012 year-to-date period was 11.6% and 10.2%, respectively.
Other Non-Operating (Income) Expenses
For the nine months ended March 25, 2012, Other non-operating (income) expense consists of a gain of $1,488 from the Company’s Brazilian operation related to a refund of non-income related taxes plus interest partially offset by a loss on extinguishment of debt of $462. For the nine months ended March 27, 2011, Other non-operating (income) expense consists of $3,337 in losses from extinguishment of debt and $528 for costs associated with an unsuccessful debt refinancing.
Equity in Earnings of Unconsolidated Affiliates
For the nine months ended March 25, 2012, the Company’s $2,719 income before income taxes included $14,166 of income generated from its investments in its unconsolidated affiliates.
For the nine months ended March 25, 2012, earnings from the Company’s unconsolidated equity affiliates were $14,166 compared to $11,887 for the nine months ended March 27, 2011. During these periods, the Company’s 34% share of PAL’s earnings increased from $10,607 to $14,213 primarily due to PAL’s gross margins temporarily benefitting from the significant drop in the raw material portion of cost of goods sold, as recent declines in cotton costs were not immediately offset by a corresponding drop in selling prices primarily due to the lag in various of PAL’s index-based selling arrangements and contractual terms with customers. The remaining decrease in the earnings of unconsolidated affiliates relates primarily to lower operating results of UNF and UNF America which was primarily driven by decreased sales volume and lower capacity utilization.
Income Taxes
The Company’s income tax provision for the year-to-date period ended March 25, 2012 resulted in tax expense at an effective rate of 108.1% compared to the year-to-date period ended March 27, 2011, which resulted in tax expense at an effective rate of 26.6%. The difference between the Company’s income tax expense and the U.S. statutory rate for the year-to-date period ended March 25, 2012 was primarily due to losses in tax jurisdictions for which no tax benefit could be recognized, foreign dividends taxed in the U.S. and abroad, and earnings attributable to foreign operations which are taxed at rates lower than the U.S. statutory rate. The differences between the Company’s income tax expense and the U.S. statutory rate for the year-to-date period ended March 27, 2011 was primarily due to losses from one of its equity affiliates, increases in uncertain tax positions, and foreign operations taxed at rates lower than in the U.S., which was partially offset by foreign dividends taxed in the U.S.
Net Income Attributable to Unifi, Inc.
Net income attributable to Unifi, Inc. for the March 2012 year-to-date period was $213 or $0.01 per basic share compared to net income attributable to Unifi, Inc. of $11,575, or $0.58 per basic share, for the prior year-to-date period. The Company’s decreased profitability was primarily due to lower gross profits and the loss on the previously held equity interest in Renewables partially offset by an increase in earnings from unconsolidated affiliates and lower SG&A expenses.
Adjusted EBITDA
Adjusted EBITDA for the March 2012 year-to-date period decreased $20,672 versus the prior year-to-date period. As discussed above, the $20,335 reduction in consolidated gross profit is the primary driver for the decline in Adjusted EBITDA.
Liquidity and Capital Resources
The Company’s primary capital requirements are for working capital, capital expenditures, debt repayment and service of indebtedness. The Company’s primary sources of capital are cash generated from operations and amounts available under its revolving credit facility. For the nine months ended March 25, 2012, cash generated from operations was $27,254 and as of March 25, 2012, excess availability under the Company’s revolving credit facility was $52,955.
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Fund Letters
