| CULP INC ITEM 1A RISK FACTORS Our business is subject to risks and uncertainties |
| In addition to the matters described above under "e Cautionary Statement Concerning Forward-Looking Information, "e set forth below are some of the risks and uncertainties that could cause a material adverse change in our results of operations or financial condition |
| 15 Restructuring initiatives create short-term costs that may not be offset by increased savings or efficiencies |
| Over the past several years, we have undertaken significant restructuring activities, which have involved closing manufacturing plants, realigning manufacturing assets, and changes in product strategy |
| These actions are intended to lower manufacturing costs and increase efficiency, but they involve significant costs, including the write-off or write-down of assets, severance costs for terminated employees, contract termination costs, equipment moving costs, and similar charges |
| In addition, during the time that restructuring activities are underway, manufacturing inefficiencies are caused by moving equipment, realignment of assets, personnel changes, and by the consolidation process for certain functions |
| Unanticipated difficulties in restructuring activities or delays in accomplishing our goals could cause the costs of our restructuring initiatives to be greater than anticipated and the results achieved to be significantly lower, which would negatively impact our results of operations and financial condition |
| We may not be able to restore the upholstery fabrics segment to consistent profitability |
| Our overall sales declined almost 9prca during the past fiscal year, and they have declined by more than 32prca since fiscal 2002 |
| In the upholstery fabrics segment, sales are down significantly, and they have been declining rapidly for US produced fabrics |
| We have undertaken a number of significant restructuring actions in recent years to address our profitability, including (i) consolidating production assets and purchasing more efficient equipment in the mattress fabrics segment, (ii) closing a number of US manufacturing facilities in the upholstery fabrics segment, (iii) establishing upholstery fabrics facilities in China to take advantage of a lower cost environment and greater product diversity, and (iv) outsourcing certain production functions, in the US, including yarn production, and finishing of decorative fabrics |
| Successful completion of our restructuring plans depends on a number of variables, including our ability to consolidate certain functions, manage manufacturing processes with lower direct involvement, managing a longer supply chain, and similar issues |
| Sales continue to decline in both segments |
| There is no assurance that we will be able to manage our restructuring activities successfully to restore the company, especially the upholstery fabrics segment, to profitability |
| Increased reliance on offshore operations and foreign sources of products or raw materials increases the likelihood of disruptions to our supply chain or our ability to deliver products to our customers on a timely basis |
| During recent years, the company has established operations in China, and in addition we have been purchasing an increasing share of our products and raw materials from offshore sources, primarily in China |
| At the same time, our domestic manufacturing capacity for the upholstery fabrics segment has been greatly reduced |
| These changes have caused the company to place greater reliance on a much longer supply chain and on a larger number of suppliers that we do not control, which are inherently subject to greater risks of delay or disruption |
| In addition, operations and sourcing in foreign areas are subject to the risk of changing local governmental rules, taxes, changes in import rules or customs, potential political unrest, or other threats that could disrupt or increase the costs of operating in foreign areas or sourcing products overseas |
| Any of the risks associated with foreign operations and sources could cause unanticipated increases in operating costs or disruptions in business, which could negatively impact the companyapstas ultimate financial results |
| We may have difficulty managing the outsourcing arrangements increasingly being used by the company for products and services |
| The company is relying more on outside sources for various products and services, including raw material, greige (unfinished) fabrics, finished fabrics, and services such as weaving and finishing |
| Increased reliance on outsourcing lowers our capital investment and fixed costs, but it decreases the amount of control that we have over certain elements of our production capacity |
| Interruptions in our ability to obtain raw materials, other required products or services from our outside suppliers on a timely and cost effective basis, especially if alternative suppliers cannot be immediately obtained, could disrupt our production and damage our financial results |
| 16 Further write-offs or write-downs of upholstry fabric segment assets would result in a decrease in our earnings |
| The company has long-lived assets, consisting mainly of property, plant and equipment |
| Accounting rules require that these assets be tested for impairment of their valuation at least annually, as well as upon the occurrence of certain events |
| When assets are taken out of service, which has occurred recently on several occasions in connection with our restructuring activities, they must be tested for impairment, which can result in significant write-downs in the value of those assets |
| Restructuring activities and other tests for impairment have resulted and could in the future result in the write-down of a portion of our long-lived assets and a corresponding reduction in earnings and net worth |
| In fiscal 2006, the company experienced asset write-downs of approximately dlra6dtta0 million, all in the upholstry fabrics segment |
| Write-offs of assets or weak financial performance could cause us to breach financial covenants in our debt agreements |
| At the end of fiscal 2006, the company had dlra47dtta7 million of long-term debt, of which approximately dlra42dtta4 million was owed on unsecured senior notes issued in 1998 |
| Under the debt agreements that govern our long-term debt, we are required to maintain compliance with certain financial covenants, including minimum tangible net worth, debt to tangible capitalization, debt to capital, and interest and lease payment coverage |
| The company has been able to maintain compliance with these financial covenants |
| For example, our tangible net worth has decreased significantly in recent years due to asset write-offs and operating losses |
| Additional write-offs of assets or continued operating losses would decrease the companyapstas tangible net worth further, which could lead to a breach of financial covenants and a default under our loan agreements |
| In particular, we reported a deferred income tax asset of dlra27dtta3 million as of April 30, 2006 |
| Our continued ability to carry this deferred tax asset on our balance sheet at its full value depends upon our ability to generate taxable income in the future attributable to US operations |
| A write-off of a portion or all of this asset would cause a breach of the minimum tangible net worth covenant that applies to our unsecured senior notes |
| A breach of our debt covenants would give the lenders under our long term debt agreements the right to declare all of the debt immediately due and payable and to terminate our right to obtain further borrowings |
| If such an event occurred, it is unlikely that we would be able to repay all of our debt from current resources, and there is no assurance that we would be able to find alternative sources of financing |
| Changes in the price, availability and quality of raw materials could increase our costs or cause production delays and sales interruptions, which would result in decreased earnings |
| The company depends upon outside suppliers for most of its raw material needs, and increasingly we rely upon outside suppliers for component materials such as yarn and unfinished fabrics, as well as for certain services such as finishing and weaving |
| Fluctuations in the price, availability and quality of these goods and services could have a negative effect on our production costs and ability to meet the demands of our customers, which would affect our ability to generate sales and earnings |
| In many cases, we are not able to pass through increased costs of raw materials or increased production costs to our customers through price increases |
| In particular, many of our basic raw materials are petrochemical products or are produced from such products |
| For this reason, our material costs are especially sensitive to changes in prices for petrochemicals and the underlying price of oil |
| Increases in prices for oil, petrochemical products or other raw materials and services provided by outside suppliers could significantly increase our costs and negatively affect earnings |
| Increases in energy costs would increase our operating costs and could adversely affect earnings |
| Higher prices for electricity, natural gas and fuel increase our production and shipping costs |
| A significant shortage, increased prices, or interruptions in the availability of these energy sources would increase the costs of producing and delivering products to our customers, and would be likely to adversely affect our earnings |
| During fiscal 2006, energy prices increased significantly, in part due to supply disruptions caused by hurricanes |
| Although some price increases were implemented to offset the effect of these increased costs, we were not able to fully recoup these costs, and operating margins were negatively affected |
| Further increases in energy costs could have a negative effect on our earnings |
| 17 Business difficulties or failures of large customers could result in a decrease in our sales and earnings |
| In the mattress fabric segment, several large bedding manufacturers have large market shares and comprise a significant portion of our mattress fabric sales |
| In the upholstery fabrics segment, La-Z-Boy Inc |
| accounted for 13prca of consolidated net sales during fiscal 2006, and several other large furniture manufacturers comprised a significant portion of sales |
| A business failure or other significant financial difficulty by one or more of our major customers could cause a significant loss in sales, an adverse effect on our earnings, and collection of our trade accounts receivable |
| If we are unable to manage our cash effectively, we will not have funds available to repay debt and to maintain the flexibility necessary for successful operation of our business |
| Our ability to meet our cash obligations depends on our operating cash flow, access to trade credit, and our ability to borrow under our debt agreements |
| In addition to the cash needs of operating our business, we have substantial debt repayments that are due over the next several years on our unsecured senior notes (see note 10 to the consolidated financial statements) |
| During the past fiscal year, in spite of incurring losses, we were able to generate substantial cash flow through reductions of working capital |
| Our ability to generate cash flow going forward will rely to a heavier degree on our ability to generate profits from our business, and we have not been able to generate earnings on a consistent basis in recent quarters |
| If we are not able to generate cash during the coming year, we may not be able to provide the funds needed to operate and maintain our business or to make payments on our debt as they become due |
| Further loss of market share due to competition would result in further declines in sales and could result in additional losses or decreases in earnings |
| Our business is highly competitive, and in particular the upholstery fabric industry is fragmented and is experiencing an increase in the number of competitors |
| As a result, we face significant competition from a large number of competitors, both foreign and domestic |
| We compete with many other manufacturers of fabric, as well as converters who source fabrics from various producers and market them to manufacturers of furniture and bedding |
| In many cases, these fabrics are sourced from foreign suppliers who have a lower cost structure than the company |
| The highly competitive nature of our business means we are constantly subject to the risk of losing market share |
| Our sales have decreased significantly over the past five years due in part to the increased number of competitors in the marketplace, especially foreign sources of fabric |
| As a result of increased competition, there have been deflationary pressures on the prices for many of our products, which makes it more difficult to pass along increased operating costs such as raw materials, energy or labor in the form of price increases and puts downward pressure on our profit margins |
| Also, the large number of competitors and wide range of product offerings in our business can make it more difficult to differentiate our products through design, styling, finish and other techniques |
| Demand for various types of upholstery fabrics and mattress coverings change over time due to fashion trends and changing consumer tastes for furniture and bedding |
| Our success in marketing our fabrics depends upon our ability to anticipate and respond in a timely manner to fashion trends in home furnishings |
| In addition, incorrect projections about the demand for certain products could cause the accumulation of excess raw material or finished goods inventory, which could lead to inventory write-downs and further decreases in earnings |
| Overall demand for our products depends upon consumer demand for furniture and bedding, which is subject to variations in the general economy |
| Because purchases of furniture or bedding are discretionary purchases for most individuals and businesses, demand for these products is sometimes more easily influenced by economic trends than demand for other products |
| Economic downturns can affect consumer spending habits and demand for home furnishings, which reduces the demand for our products and therefore could cause a decrease in our sales and earnings |
| We are subject to litigation and environmental regulations that could adversely impact our sales and earnings |
| We are, and in the future may be, a party to legal proceedings and claims, including environmental matters, product liability and employment disputes, some of which claim significant damages |
| We face the continual business risk of exposure to claims that our business operations have caused personal injury or property damage |
| We maintain insurance against product liability claims and in some cases have indemnification agreements with regard to environmental claims, but there can be no assurance that these arrangements will continue to be available on acceptable terms or that such arrangements will be adequate for liabilities actually incurred |
| Given the inherent uncertainty of litigation, there can be no assurance that claims against the company will not have a material adverse impact on our earnings or financial condition |
| We are also subject to various laws and regulations in our business, including those relating to environmental protection and the discharge of materials into the environment |
| We could incur substantial costs as a result of noncompliance with or liability for cleanup or other costs or damages under environmental laws or other regulations |
| The company must comply with a number of governmental regulations applicable to our business, and changes in those regulations could adversely affect our business |
| Our products and raw materials are and will continue to be subject to regulation in the United States by various federal, state and local regulatory authorities |
| In addition, other governments and agencies in other jurisdictions regulate the manufacture, sale and distribution of our products and raw materials |
| For example, standards for flame resistance of fabrics have been recently introduced in the state of California, and additional standards are scheduled to apply on a nationwide basis beginning July 1, 2007 |
| Also, rules and restrictions regarding the importation of fabrics and other materials, including custom duties, quotas and other regulations, are continually changing |
| Environmental laws, labor laws, tax regulations and other regulations also continually affect our business |
| All of these rules and regulations can and do change from time to time, which can increase our costs or require us to make changes in our manufacturing processes, product mix, sources of products and raw materials, or distribution |
| Changes in the rules and regulations applicable to our business may negatively impact our sales and earnings |
| The companyapstas market capitalization and shareholders equity have fallen below the level required for continued listing on the New York Stock Exchange |
| Under the NYSEapstas current listing standards, we are required to have market capitalization or shareholders equity of more than dlra75 million to maintain compliance with continued listing standards |
| The companyapstas market capitalization is now below dlra75 million, and as of the end of fiscal 2006 our shareholders &apos equity was dlra74dtta5 million |
| As a result, the company will be listed as "e below compliance "e with NYSE listing standards, and we must submit a plan regarding our ability to return to compliance with these standards |
| If the company is not able to return to compliance with the NYSE standards, our stock will be delisted from trading on the NYSE, resulting in the need to find another market on which our stock can be listed or causing our stock to cease to be traded on an active market, which could result in a reduction in the liquidity for our stock and a reduction in demand for our stock |