10-K 1 unifiinc.htm UNIFI, INC. UNIFI INC
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-K
 
     
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended June 25, 2006
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file number 1-10542
 
Unifi, Inc.
(Exact name of registrant as specified in its charter)
 
     
New York   11-2165495
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
P.O. Box 19109 — 7201 West Friendly Avenue
Greensboro, NC
  27419-9109
(Zip Code)
(Address of principal executive offices)    
 
Registrant’s telephone number, including area code:
(336) 294-4410
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock   New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by checkmark if the registrant is a well-know seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ
 
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 þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
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 o     Accelerated filer þ      Non-accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
 
As of December 23, 2005, the aggregate market value of the registrant’s voting common stock held by non-affiliates of the registrant was $145,387,494. The Registrant has no non-voting stock.
 
As of September 5, 2006, the number of shares of the Registrant’s common stock outstanding was 52,208,467.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Definitive Proxy Statement to be filed with the Securities and Exchange Commission (the “SEC”) in connection
with the solicitation of proxies for the Annual Meeting of Shareholders of Unifi, Inc., to be held on October 25, 2006, are incorporated by reference into Part III. (With the exception of those portions which are specifically incorporated by reference in this Form 10-K, the Proxy Statement is not deemed to be filed or incorporated by reference as part of this report.)
 


 

 
UNIFI, INC.
ANNUAL REPORT ON FORM 10-K
 
TABLE OF CONTENTS
 
                 
        Page
 
  Business   3
    Recent Developments   3
    Industry Overview   4
    Products   5
    Sales and Marketing   5
    Customers   6
    Manufacturing   6
    Suppliers   7
    Joint Ventures and Other Equity Investments   7
    Competition   7
    Backlog and Seasonality   8
    Intellectual Property   9
    Employees   9
    Trade Regulation   9
    Environmental Matters   10
    Available Information   11
  Risk Factors   11
  Unresolved Staff Comments   21
  Properties   21
  Legal Proceedings   21
  Submission of Matters to a Vote of Security Holders   21
 
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   23
  Selected Financial Data   25
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   26
  Quantitative and Qualitative Disclosure About Market Risk   50
  Financial Statements and Supplementary Data   52
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   93
  Controls and Procedures   93
  Other Information   95
 
  Directors and Executive Officers of Registrant   96
  Executive Compensation   96
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   96
  Certain Relationships and Related Transactions   96
  Principal Accountant Fees and Services   96
 
  Exhibits and Financial Statement Schedules   97
  101


2


Table of Contents

 
PART I
 
Item 1.   Business
 
Unifi, Inc., a New York corporation formed in 1969 (together with its subsidiaries the “Company” or “Unifi”), is a diversified North American producer and processor of multi-filament polyester and nylon yarns, including specialty yarns with enhanced performance characteristics. The Company manufactures partially oriented, textured, dyed, twisted and beamed polyester yarns as well as textured nylon and nylon covered spandex products. The Company sells its products to other yarn manufacturers, knitters and weavers that produce fabrics for the apparel, hosiery, home furnishings, automotive, industrial and other end-use markets. The Company maintains one of the industry’s most comprehensive product offerings and emphasizes quality, style and performance in all of its products. The Company’s net sales and net loss for fiscal year 2006 were $738.8 million and $14.4 million, respectively.
 
The Company works across the supply chain to develop and commercialize specialty yarns that provide performance, comfort, aesthetic and other advantages that enhance demand for its products. The Company has branded the premium portion of its specialty value-added yarns in order to distinguish its products in the marketplace. The Company currently has more than 20 premium value-added yarns in its portfolio, commercialized under several brand names, including Sorbtek®, A.M.Y.®, Mynx® UV, Reflexx®, MicroVista®, aio® and Repreve®.
 
A significant number of customers, particularly in the apparel market, produce finished goods that they seek to make eligible for duty-free treatment in the regions covered by the North American Free Trade Agreement (“NAFTA”), the U.S. — Dominican Republic — Central American Free Trade Agreement (“CAFTA”), the Caribbean Basin Initiative (“CBI”) and the Andean Trade Preferences Act (“ATPA”) (collectively, the “regional free-trade markets”). When U.S.-origin partially oriented yarn (“POY”) is used to produce finished goods in these regional free-trade markets, and other origin criteria are met, then the finished goods are eligible for duty-free treatment. The Company uses advanced production processes to manufacture its high-quality yarns cost-effectively. The Company believes that its flexibility and experience in producing specialty yarns provides important development and commercialization advantages. The Company has state-of-the-art manufacturing operations in North and South America and participates in joint ventures in China, Israel and the United States.
 
Recent Developments
 
On May 26, 2006, the Company consummated a series of refinancing transactions pursuant to which it issued and sold $190 million in aggregate principal amount of 11.5% senior secured notes due 2014 (the “2014 notes”) and amended its existing senior secured asset-based revolving credit facility (the “old credit facility”) to extend its maturity to 2011, permit the issuance and sale of the 2014 notes, give the Company the ability to request that the borrowing capacity be increased up to $150 million under certain circumstances and revise some of its other terms and covenants (such facility as so amended, the “amended revolving credit facility”). The Company used the proceeds from the 2014 notes offering, cash on hand of $55.7 million and borrowings of $3.0 million under its amended revolving credit facility to fund the purchase price of $248.7 million in aggregate principal amount of its 6.5% senior unsecured notes due 2008 (the “2008 notes”) that had been tendered into a tender offer for all such notes launched by the Company on April 28, 2006. 99.5% of the then outstanding principal amount of the 2008 notes was tendered in the tender offer and substantially all of the restrictive covenants and certain events of default were removed from the indenture governing the 2008 notes. The Company paid a total consideration of $253.9 million for the tendered 2008 notes. The 2008 notes that were not tendered and purchased in the tender offer remain outstanding in accordance with their amended terms. The offering of the 2014 notes, the tender offer for the 2008 notes, the execution of the amended revolving credit facility and the use of proceeds from the 2014 notes offering, cash on hand and borrowings under the amended revolving credit facility to pay the consideration of the tender offer and all associated fees and expenses are collectively referred to throughout this Annual Report on Form 10-K as the “refinancing transactions.”


3


Table of Contents

 
Industry Overview
 
The textile and apparel market consists of natural and synthetic fibers used for apparel and non-apparel applications. The industry is characterized by dependence upon a wide variety of end-markets which primarily include apparel, home textiles, industrial and consumer products, floor coverings, fiber fill and tires. The apparel and hosiery markets account for 25% of total production, the floor covering market accounts for 32%, the industrial and consumer markets account for 20%, the home textiles market accounts for 13% and other end-uses account for 10%.
 
According to the National Council of Textile Organizations, the U.S. textile market’s total shipments were $75.1 billion for the twelve month period ended November 2005. Approximately $30 billion of capital expenditures has been invested in the textile industry over the past ten years. In calendar year 2005, the U.S. textile and apparel market employed more than 650,000 workers.
 
Textiles and apparel goods are made from natural fiber, such as cotton and wool, or synthetic fiber, such as polyester and nylon. Since 1980, global demand for polyester has grown steadily, and in calendar year 2003, polyester replaced cotton as the fiber with the largest percentage of sales worldwide. In calendar year 2005, global polyester accounted for an estimated 40% of global fiber consumption and demand is projected to increase by 6% to 7% annually through 2009. In the U.S., the synthetic fiber sector accounts for approximately 55% of the textile and apparel market.
 
The synthetic filament industry includes petrochemical and raw material producers, fiber and yarn manufacturers (like Unifi), fabric and product producers, retailers and consumers. Among synthetic filament yarn producers, pricing is highly competitive, with innovation, product quality and customer service being essential for differentiating the competitors within the industry. Both product innovation and product quality are particularly important, as product innovation gives customers competitive advantages and product quality provides for improved manufacturing efficiencies.
 
The North American synthetic yarn market has contracted since 1999, primarily as a result of intense foreign competition in finished goods on the basis of price. In addition, due to consumer preferences, demand for sheer hosiery products has declined in recent years, which negatively impacts nylon manufacturers. Despite this decline, U.S. retailers and other end-users have consistently expressed their need for a balanced procurement strategy with both global and regional production to satisfy their need for readily available production capacity, quick response times, specialized products, product changes based on customer feedback and more customized orders. As a result, the contraction in the U.S. synthetic yarn market continues; however, the Company expects a lesser rate of decline in the future as regional manufacturers continue to demand U.S. manufactured synthetic yarn. There has also been growing emphasis domestically towards premium value-added yarns as consumers, retailers and manufacturers demand products with enhanced performance characteristics. This emphasis on incorporating specialty synthetic yarn in finished goods has greatly increased domestic demand for value-added synthetic fibers. The U.S. government has attempted to regulate the growth of certain textile and apparel imports by establishing quotas and duties on imports from countries that historically account for significant shares of U.S. imports. Under the January 1995 Agreement on Textiles and Clothing, the World Trade Organization (“WTO”) began implementing a phased-in elimination of import quotas and a reduction of duties among its members, which culminated with the elimination of all remaining quotas for all members of WTO on January 1, 2005. After extensive negotiations, the United States and China entered into a bilateral agreement in November 2005, reinstating quotas on a number of categories of Chinese textile and apparel products. These quotas under this agreement will end on December 31, 2008. Nevertheless, duties on imported textile and apparel products, including textile and apparel products from China, remain in effect. The Company believes that duties are a more effective method than quotas in providing protection for the U.S. textile and apparel industry.
 
In the Americas region, regional free-trade agreements, such as NAFTA and CAFTA, and U.S. unilateral duties preference programs, such as ATPA and CBI, have a significant impact on the flow of goods among the region and the relative costs of production. The cost advantages offered by these regional free-trade agreements and duties preference programs on finished goods which incorporate U.S.-origin synthetic fiber and the desire for quick inventory turns have enabled regional synthetic yarn producers to effectively compete with imported finished goods from lower wage-based countries. The Company estimates that the duty-free benefit of processing synthetic textiles


4


Table of Contents

and apparel finished goods under the terms of these regional free-trade agreements and duties preference programs typically represents a wholesale cost advantage up to 30% on these finished goods. As a result of such cost advantages, it is expected that these regions will continue to grow in their supply of textiles to the United States.
 
Products
 
The Company manufactures polyester POY and synthetic polyester and nylon yarns for a wide range of end-uses. The Company processes and sells POY, as well as high-volume commodity yarns and specialty yarns, domestically and internationally.
 
Polyester POY is used to make polyester yarn. Polyester yarn products include textured, dyed, twisted and beamed yarns. The Company sells its polyester yarns to other yarn manufacturers, knitters and weavers that produce fabrics for the apparel, automotive and furniture upholstery, home furnishings, industrial, military, medical and other end-use markets. Nylon products include textured nylon and covered spandex products, which the Company sells to other yarn manufacturers, knitters and weavers that produce fabrics for the apparel, hosiery, sock and other end-use markets.
 
In addition to producing high-volume yarns, the Company develops, manufactures and commercializes specialty yarns that provide performance, comfort, aesthetic and other advantages. For example, it has developed a line of products that are made from recycled materials in order to appeal to environmentally conscious consumers. The Company has branded the premium portion of its specialty value-added yarns in order to distinguish its products in the marketplace and it currently has more than 20 premium value-added yarn products in its portfolio. Such branded yarn products include:
 
  •  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;
 
  •  A.M.Y. ®, a yarn with permanent antimicrobial and odor control;
 
  •  Mynx® UV, an ultraviolet protective yarn;
 
  •  Reflexx®, a family of stretch yarns, that can be found in a wide array of end-use applications from home furnishings to performance wear and from hosiery and socks to workwear and denim;
 
  •  MicroVista®, a family of microfiber yarns;
 
  •  aio®, all-in-one performance yarns, which combine multiple performance properties into a single yarn; and
 
  •  Repreve®, an eco-friendly yarn made from 100% recycled materials.
 
The Company’s net sales of polyester and nylon accounted for 77% and 23% of total net sales, respectively, for fiscal year 2006.
 
Sales and Marketing
 
The Company employs a sales force of approximately 30 persons operating out of sales offices in the United States, Brazil 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, Unifi 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 assisting in the development of fabrics for those brands and retailers utilizing these value-added products. Based on many commercial and branded programs, this strategy has proven to be successful for Unifi. Examples include:
 
  •  Sorbtek®, which is used in many well-known apparel brands and retailers, including Wal-Mart, Reebok, the U.S. military, Dick’s Sporting Goods, Duofold, Hind and Icy Hot. Today Sorbtek® can be found in over 2,500 Wal-Mart stores under the Athletic Works brand;


5


Table of Contents

 
  •  A.M.Y.®, which can be found in many apparel brands, including Reebok, Eastern Mountain Sports, the U.S. military, Everlast, Duofold, Jerzees Socks and Russell Athletics;
 
  •  Mynx® UV, which can be found in Asics Running Apparel and Terry Cycling; and
 
  •  Reflexx®, which can be found in major brands, including VF Corporation’s Wrangler and Red Kap, Dockers and Majestic Athletic (a maker of uniforms for several major league baseball teams, including the New York Yankees).
 
Customers
 
The Company sells its polyester yarns to approximately 900 customers and its nylon yarns to approximately 200 customers in a variety of geographic markets. In fiscal year 2006, the Company’s nylon segment had sales to Sara Lee Branded Apparel of $76.4 million which is in excess of 10% of its consolidated revenues. The loss of this customer would have a material adverse effect on the Company’s nylon segment.
 
Products are generally sold on an order-by-order basis for both the polyester and nylon segments, even for premium value-added yarn with enhanced performance characteristics. For substantially all customer orders, including those involving more customized yarns, the manufacture and shipment of yarn is in accordance with firm orders received from customers specifying yarn type and delivery dates. The Company does not currently provide raw yarn consignment arrangements to any customers.
 
Customer payment terms are generally consistent for both the polyester and nylon reporting segments and are usually based on prevailing industry practices for the sale of yarn domestically or internationally. In certain cases, payment terms are subject to further negotiation between the Company and individual customers based on specific circumstances impacting the customer and may include the extension of payment terms or negotiation of situation specific payment plans. The Company does not believe that any such deviations from normal payment terms are significant to either of its reporting segments or the Company taken as a whole. See “Item 1A — Risk Factors — The Company’s business could be negatively impacted by the financial condition of its customers.”
 
Manufacturing
 
Polyester POY is made from petroleum-based chemicals such as terephthalic acid (“TPA’) and monoethylene glycol (“MEG”). The production of polyester POY consists of two primary processes, polymerization (performed at the Company’s Kinston facility) and spinning (performed at the Company’s Yadkinville and Kinston facilities). The polymerization process is the production of polymer by a chemical reaction involving TPA and MEG, which are combined to form chip. The spinning process involves the extrusion of molten polymer, directly from polymerization or using polyester polymer beads (“chip”) into polyester POY. The molten polymer is extruded through spinnerettes to form continuous multi-filament raw yarn.
 
The Company’s polyester and nylon 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 processing of polyester POY, which is either natural or solution-dyed raw polyester or natural nylon filament fiber. Texturing polyester POY involves the use of high-speed machines to draw, heat and twist the polyester POY to produce yarn having various physical characteristics, depending on its ultimate end-use. This process gives the yarn greater bulk, strength, stretch, consistent dyeability and a softer feel, thereby making it suitable for use in knitting and weaving of fabrics.
 
Package dyeing allows for matching of customer specific color requirements for yarns sold into the automotive, home furnishings and apparel markets. Twisting incorporates real twist into the filament yarns, which can be sold for such uses as sewing thread, home furnishings and apparel. Beaming places both textured and covered yarns on beams to be used by customers in knitting and weaving applications. Warp drawing converts polyester POY into flat yarn, also packaged on beams.
 
Additional processing of nylon products mostly 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.


6


Table of Contents

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, premium value-added yarns reflecting current consumer preferences.
 
Suppliers
 
The primary raw material suppliers for the polyester segment are Nanya Plastics Corp. of America (“Nanya”) for chip, DAK Americas LLC (“DAK”) for TPA and E.I. DuPont de Nemours (“DuPont”) for MEG. The primary suppliers of nylon POY to the nylon segment are U.N.F. Industries Ltd. (“UNF”), Invista S.a.r.l., Sara Lee Nilit Fibers, Ltd and Universal Premier Fibers, LLC (formerly Cookson Fibers, Inc.). UNF is a 50/50 joint venture with Nilit Ltd. (“Nilit”), located in Israel. The joint venture produces nylon POY at Nilit’s manufacturing facility in Migdal Ha — Emek, Israel. The nylon POY production is being utilized in the domestic nylon texturing operations. The Company has entered into long-term supply agreements with each of Nanya, DAK, DuPont and UNF. The agreement with Nanya will expire in October 2007 and may otherwise be terminated earlier upon six months prior notice. The agreements with DAK can be terminated upon two years prior notice. The agreement with DuPont will terminate on December 31, 2006 and the agreement with UNF will terminate in April 2008. The supply agreements typically provide for formula-driven pricing. Although the Company does not generally expect having any significant difficulty in obtaining raw nylon POY or chemical and other raw materials used to manufacture polyester POY, the Company has in the past and may in the future experience interruptions or limitations in supply which could materially and adversely affect its operations. See “Item 1A — Risk Factors — The Company depends upon limited sources for raw materials, and interruptions in supply could increase its costs of production and cause its operations to suffer.”
 
Joint Ventures and Other Equity Investments
 
The Company participates in joint ventures in China, Israel and the United States. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation — Joint Ventures and Other Equity Investments” for a more detailed description of its joint ventures.
 
Competition
 
The industry in which the Company currently operates is highly competitive. The Company processes and sells both high-volume commodity products and more specialized yarns both domestically and internationally into many end-use markets, including the apparel, automotive upholstery and home furnishing markets. The Company competes with a number of other foreign and domestic producers of polyester and nylon yarns as well as with imports of textile and apparel products.
 
The polyester segment’s major regional competitors are Nanya, Dillon Yarn Corporation (“Dillon”), O’Mara, Inc., Spectrum Yarns, Inc. (“Spectrum”), KOSA and AKRA, S.A. de C.V. The nylon segments major regional competitors are Sapona Manufacturing Company, Inc., McMichael Mills, Inc. and Worldtex, Inc.
 
The Company also competes against a number of foreign competitors that not only sell polyester and nylon yarns in the United States but also import foreign sourced fabric and apparel into the United States and other countries in which it does business, which adversely impacts the sale of its polyester and nylon yarns.
 
The Company’s foreign competitors include yarn manufacturers located in the regional free-trade markets who also benefit from the NAFTA, CAFTA, CBI and ATPA trade agreements which provide for duty-free treatment of most apparel and textiles between the signatory (and qualifying) countries. The cost advantages offered by these trade agreements and the desire for quick inventory turns have enabled commodity yarn producers from these regions to effectively compete. As a result of such cost advantages, the Company expects that the CAFTA and ATPA regions will continue to grow in their supply to the United States. The Company is the largest of only a few significant producers of eligible 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 fabric producers and domestic producers who ship their products into the region for further processing.


7


Table of Contents

On a global basis, the Company competes not only as a yarn producer but also as part of a supply chain. As one of the many participants in the textile industry supply chain, its business and competitive position are directly impacted by the business, financial condition and competitive position of the several other participants in the supply chain in which it operates.
 
In the apparel market, a significant source of overseas competition comes from textile and apparel manufacturers that operate in lower labor and lower raw materials cost countries such as China. The primary competitive factors in the textile industry include price, quality, product styling and differentiation, flexibility of production and finishing, delivery time and customer service. The needs of particular customers and the characteristics of particular products determine the relative importance of these various factors. Several of the Company’s foreign competitors have significant competitive advantages, including lower wages, lower raw materials and energy costs and favorable currency exchange rates against the U.S. dollar, which could make the Company’s products less competitive and may cause its sales and profits to decrease. In addition, while traditionally these foreign competitors have focused on commodity production, they are now increasingly focused on premium value-added products where the Company continues to generate higher margins. In recent years, international imports of fabric and finished goods in the United States have significantly increased, resulting in a significant reduction in the Company’s customer base. The primary drivers for that growth are the reduction in equipment costs which have reduced barriers to entry in the market, the currency devaluation of Asian currencies following the Asian financial crisis, the entry of China into the free-trade markets and the staged elimination of all textile and apparel quotas. In May 2005, the U.S. government imposed safeguard quotas on various categories of Chinese-made products, citing “market disruption.” Following extensive negotiations, the United States and China entered into a bilateral agreement in November 2005 resulting in the imposition of annually decreasing quotas on a number of categories of Chinese textile and apparel products until December 31, 2008. The Company expects competitive pressures to intensify as a result of the gradual elimination of trade protections. See “— Trade Regulation.”
 
The U.S. automotive upholstery market has been less susceptible to import penetration because of the exacting specifications and quality requirements often imposed on manufacturers of automotive upholstery and the often short time frame for deliveries. Effective customer service and prompt response to customer feedback are logistically more difficult for an importer to provide. Nevertheless, to the extent the U.S. automotive industry itself faces competition from imports, the U.S. automotive upholstery industry is also affected by imports.
 
The nylon hosiery market has been experiencing a decline in recent years due to changing consumer preferences, but is expected to decline at a much lower rate compared to previous years. The Company supplies the largest domestic ladies hosiery producer, Sara Lee Branded Apparel.
 
General economic conditions, such as raw material prices, interest rates, currency exchange rates and inflation rates that exist in different countries have a significant impact on competitiveness, as do various country-to-country trade agreements and restrictions.
 
The Company believes that the continuing development and marketing of new and improved products, the growing need for quick response, speed to market, quick inventory turns and cost of capital will continue to require a sizable portion of the textile industry to remain based in North America. The Company’s success will continue to be primarily based on its ability to improve the mix of product offerings to more premium value-added products, to implement cost saving strategies and to pass along raw material price increases, which will improve its financial results, and to strategically penetrate growth markets such as China.
 
See “Item 1A — Risk Factors — The Company faces intense competition from a number of domestic and foreign yarn producers and importers of textile and apparel products.”
 
Backlog and Seasonality
 
The Company generally sells products on an order-by-order basis for both the polyester and nylon reporting segments, even for premium value-added yarns. Changes in economic indicators and consumer confidence levels can have a significant impact on retail sales. Deviations between expected sales and actual consumer demand result in significant adjustments to desired inventory levels and, in turn, replenishment orders placed with suppliers. This changing demand ultimately works its way through the supply chain and impacts the Company. As a result, the


8


Table of Contents

Company does not track unfilled orders for purposes of determining backlog but will routinely reconfirm or update the status of potential orders. Consequently, backlog is generally not applicable to the Company and it does not consider its products to be seasonal.
 
Intellectual Property
 
The Company has a limited number of patents and approximately 26 U.S. registered trademarks, 4 trademark applications and several foreign trademark registrations, none of which is material to any of the Company’s reporting segments or its business taken as a whole. The Company does license certain trademarks, including Dacron® and Softectm from INVISTA S.a.r.l. (“INVISTA”).
 
Employees
 
The Company employs approximately 3,300 employees of which approximately 3,275 are full-time and approximately 25 are part-time employees. Approximately 2,500 employees are employed in the polyester segment, approximately 700 employees are employed in the nylon segment and approximately 100 employees are employed in corporate offices. While employees of the Company’s foreign operations are generally unionized, none of the domestic employees are currently covered by collective bargaining agreements. The Company believes that its relations with its employees are good.
 
Trade Regulation
 
Increases in capacity and imports of foreign-made textile and apparel products are a significant source of competition for the Company. The U.S. government attempts to regulate the growth of certain textile and apparel imports by establishing quotas and duties on imports from countries that historically account for significant shares of U.S. imports. Although imported apparel represents a significant portion of the U.S. apparel market, in recent years, a significant portion of import growth has been attributable to imports of apparel products manufactured outside the United States of (or using) domestic textile components. In addition, imports of certain textile products into the United States have increased in recent years as a result of significant depreciation of the currencies of other textile producing countries, particularly within Asia, against the U.S. dollar, and perhaps as a result of unfair trade practices.
 
The extent of import protection afforded by the U.S. government to domestic textile producers has been, and is likely to remain, subject to considerable domestic political deliberation and foreign considerations. In January 1995, a multilateral trade organization, the WTO, was formed by the members of the General Agreement on Tariffs and Trade (“GATT”), to replace GATT. The WTO has set forth the mechanisms by which world trade in textiles and clothing will be progressively liberalized through the elimination of quotas and the reduction of duties. The implementation began in January 1995 with the phasing-out of quotas and the gradual reduction of duties to take place over a 10-year period. All textile and apparel quotas expired on January 1, 2005. In May 2005, however, the U.S. government imposed safeguard quotas on various categories of Chinese-made products, citing “market disruption.” Following extensive negotiations, the United States and China entered into a bilateral agreement in November 2005 resulting in the imposition of annually increasing quotas on a number of categories of Chinese textile and apparel products that will remain in effect until December 31, 2008.
 
NAFTA, which is a free trade agreement between the United States, Canada and Mexico that became effective on January 1, 1994, has created the world’s largest free-trade area. The agreement contains safeguards sought by the U.S. textile industry, including certain rules of origin for textile and apparel products that must be met for these products to receive benefits under NAFTA. Under these rules of origin, to receive NAFTA benefits, the textile and apparel products must be produced from yarn or fabric made in the NAFTA region, and all subsequent processing must occur in the NAFTA region. Thus, in general, not only must eligible apparel be made from North American fabric, but the fabric must be woven from North American spun yarn. Based on experience to date, NAFTA has had a favorable impact on the Company’s business.
 
In 2000, the United States passed the United States-Caribbean Basin Trade Partnership Act, which was amended by the Trade Act of 2002, and allows apparel products manufactured in the Caribbean region using yarns or fabrics produced in the United States to be imported into the United States duty and quota free. Also in 2000, the


9


Table of Contents

United States passed the African Growth and Opportunity Act (“AGOA”), which was amended by the Trade Act of 2002, and allows apparel products manufactured in the sub-Saharan African region using yarns or fabrics produced in the United States to be imported to the United States duty and quota free.
 
On August 2, 2005, the United States passed CAFTA, which is a free trade agreement between seven signatory countries: the United States, the Dominican Republic, Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua. Qualifying textile and apparel products that are produced in any of the seven signatory countries from fabric, yarn or fibers that are also produced in any of the seven signatory countries may be imported into the United States duty-free.
 
The Andean Trade Promotion and Drug Eradication Act was passed on August 6, 2002 to renew and enhance the ATPA. Under the enhanced ATPA, apparel manufactured in Bolivia, Colombia, Ecuador and Peru using yarns and fabrics produced in the United States, or in these four Andean countries, may be imported into the United States duty and quota free through December 31, 2006. This legislation effectively granted these four countries the favorable trade terms afforded Mexico and the Caribbean region. A free trade agreement was recently completed with Peru and Colombia which follows, for the most part, the same yarn forward rules of origin as the ATPA. These agreements require congressional action which is expected by early 2007.
 
The Deficit Reduction Act of 2005, which was signed into law on February 8, 2006, contains statutory changes to the Step 2 cotton program and export credit guarantee programs to comply with parts of a WTO ruling against U.S. cotton subsidies. The legislative changes eliminate the Step 2 program, which provides for payments to U.S. cotton and textile producers. The measure, part of an agriculture budget reconciliation process, does away with the subsidy program as of August 1, 2006. Parkdale America, LLC (“PAL”), the Company’s joint venture with Parkdale Mills, Inc., will no longer receive payments under the Step 2 program after August 1, 2006. Measures such as additional quotas for foreign cotton are under discussion to help ease the transition.
 
Environmental Matters
 
The Company is subject to various federal, state and local environmental laws and regulations limiting the use, storage, handling, release, discharge and disposal of a variety of hazardous substances and wastes used in or resulting from its operations and potential remediation obligations thereunder, particularly the Federal Water Pollution Control Act, the Clean Air Act, the Resource Conservation and Recovery Act (including provisions relating to underground storage tanks) and the Comprehensive Environmental Response, Compensation, and Liability Act, commonly referred to as “Superfund” or “CERCLA” and various state counterparts. The Company has obtained, and is in compliance in all material respects with, all significant permits required to be issued by federal, state or local law in connection with the operation of its business as described in this Annual Report on Form 10-K.
 
The Company’s operations are also governed by laws and regulations relating to workplace safety and worker health, principally the Occupational Safety and Health Act and regulations thereunder which, among other things, establish exposure standards regarding hazardous materials and noise standards, and regulate the use of hazardous chemicals in the workplace.
 
The Company believes that the operation of its production facilities and the disposal of waste materials are substantially in compliance with applicable federal, state and local laws and regulations and that there are no material ongoing or anticipated capital expenditures associated with environmental control facilities necessary to remain in compliance with such provisions. However, the Company is evaluating several options with respect to the upgrade of its industrial boilers at the Kinston site. The estimated investment ranges from $0 to $2.0 million. No determination has been made with respect to which alternative to pursue, if any. The Company incurs normal operating costs associated with the discharge of materials into the environment but does not believe that these costs are material or inconsistent with other domestic competitors.
 
The land associated with the Company’s Kinston facility in North Carolina (the “Kinston Site”) is leased pursuant to a 99 year ground lease (the “Ground Lease”) with DuPont. Since 1993, DuPont has been investigating and cleaning up the Kinston Site under the supervision of the U.S. Environmental Protection Agency (the “EPA”) and the North Carolina Department of Environment and Natural Resources pursuant to the Resource Conservation


10


Table of Contents

and Recovery Act Corrective Action Program. The Corrective Action Program requires DuPont to identify all potential areas of environmental concern, known as solid waste management units or areas of concern, assess the extent of contamination at the identified areas and clean them up to applicable regulatory standards. Under the terms of the Ground Lease, upon completion by DuPont of required remedial action, ownership of the Kinston Site will pass to the Company. Thereafter, the Company will have responsibility for future remediation requirements, if any, at the solid waste management units and areas of concern previously addressed by DuPont and at any other areas at the plant. At this time the Company has no basis to determine if and when it will have any responsibility or obligation with respect to the solid waste management units and areas of concern or the extent of any potential liability for the same. Accordingly, the possibility that the Company could face material clean-up costs in the future relating to the Kinston Site cannot be eliminated.
 
Available Information
 
The Company’s Internet address is: www.unifi.com. Copies of the Company’s reports, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, that the Company files with or furnishes to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and beneficial ownership reports on Forms 3, 4, and 5, are available as soon as practicable after such material is electronically filed with or furnished to the SEC and maybe obtained without charge by accessing the Company’s web site or by writing Mr. William M. Lowe, Jr. at Unifi, Inc. P.O. Box 19109, Greensboro, North Carolina 27419-9109.
 
Item 1A.   Risk Factors
 
The Company’s substantial level of indebtedness could adversely affect its financial condition.
 
The Company has substantial indebtedness. As of June 25, 2006, the Company had a total of $204.0 million of debt outstanding, including $190.0 million outstanding in aggregate principal amount of 2014 notes, $1.3 million outstanding in aggregate principal amount of 2008 notes, $10.5 million outstanding in loans relating to a Brazilian government tax program and $2.2 million outstanding on a sales leaseback obligation. There were no amounts outstanding under the Company’s amended revolving credit facility.
 
The Company’s outstanding indebtedness could have important consequences to investors, including the following:
 
  •  high level of indebtedness could make it more difficult for the Company to satisfy its obligations with respect to its outstanding notes, including its repurchase obligations;
 
  •  the restrictions imposed on the operation of its business may hinder its ability to take advantage of strategic opportunities to grow its business;
 
  •  its ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes may be impaired;
 
  •  the Company must use a substantial portion of its cash flow from operations to pay interest on its indebtedness, which will reduce the funds available to the Company for operations and other purposes;
 
  •  its high level of indebtedness could place the Company at a competitive disadvantage compared to its competitors that may have proportionately less debt;
 
  •  its flexibility in planning for, or reacting to, changes in its business and the industry in which it operates may be limited; and
 
  •  its high level of indebtedness makes the Company more vulnerable to economic downturns and adverse developments in its business.
 
Any of the foregoing could have a material adverse effect on the Company’s business, financial condition, results of operations, prospects and ability to satisfy its obligations under its indebtedness.


11


Table of Contents

Despite its current indebtedness levels, the Company may still be able to incur substantially more debt. This could exacerbate further the risks associated with its substantial leverage.
 
The Company and its subsidiaries may be able to incur substantial additional indebtedness, including additional secured indebtedness, in the future. The terms of its current debt restrict, but do not completely prohibit, the Company from doing so. The Company’s amended revolving credit facility permits up to $100 million of borrowings, which the Company can request be increased to $150 million under certain circumstances, with a borrowing base specified in the credit facility as equal to specified percentages of eligible accounts receivable and inventory. In addition, the indenture for its 2014 notes allows the Company to issue additional notes under certain circumstances and to incur certain other additional secured debt, and allows its foreign subsidiaries to incur additional debt. The indenture for its 2014 notes does not prevent the Company from incurring other liabilities that do not constitute indebtedness. If new debt or other liabilities are added to its current debt levels, the related risks that the Company now faces could intensify
 
The Company will require a significant amount of cash to service its indebtedness and its ability to generate cash depends on many factors beyond its control.
 
For fiscal year 2006, after giving effect to the refinancing transactions, interest expense, net, would have been approximately $24.2 million. The Company’s principal sources of liquidity are cash flow generated from operations and borrowings under its amended revolving credit facility. The Company’s ability to make payments on and to refinance its indebtedness and to fund planned capital expenditures will depend on its ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond its control.
 
The business may not generate cash flow from operations, and future borrowings may not be available to the Company under its amended revolving credit facility in an amount sufficient to enable the Company to pay its indebtedness and to fund its other liquidity needs. If the Company is not able to generate sufficient cash flow or borrow under its amended revolving credit facility for these purposes, the Company may need to refinance or restructure all or a portion of its indebtedness, on or before maturity, reduce or delay capital investments or seek to raise additional capital. The Company may not be able to implement one or more of these alternatives on terms that are acceptable or at all. The terms of its existing or future debt agreements may restrict the Company from adopting any of these alternatives. The failure to generate sufficient cash flow or to achieve any of these alternatives could materially adversely affect the Company’s financial condition.
 
In addition, without such refinancing, the Company could be forced to sell assets to make up for any shortfall in its payment obligations under unfavorable circumstances. The Company’s amended revolving credit facility and the indenture for its 2014 notes limit its ability to sell assets and also restrict the use of proceeds from any such sale. Furthermore, the 2014 notes and its amended revolving credit facility are secured by substantially all of its assets. Therefore, the Company may not be able to sell its assets quickly enough or for sufficient amounts to enable the Company to meet its debt service obligations.
 
The terms of the Company’s outstanding indebtedness impose significant operating and financial restrictions, which may prevent the Company from pursuing certain business opportunities and taking certain actions.
 
The terms of the Company’s outstanding indebtedness impose significant operating and financial restrictions on its business. These restrictions will limit or prohibit, among other things, its ability to:
 
  •  incur and guarantee indebtedness or issue preferred stock;
 
  •  repay subordinated indebtedness prior to its stated maturity;
 
  •  pay dividends or make other distributions on or redeem or repurchase the Company’s stock;
 
  •  issue capital stock;
 
  •  make certain investments or acquisitions;


12


Table of Contents

 
  •  create liens;
 
  •  sell certain assets or merge with or into other companies;
 
  •  enter into certain transactions with stockholders and affiliates;
 
  •  make capital expenditures; and
 
  •  restrict dividends, distributions or other payments from its subsidiaries.
 
In addition, the Company’s amended revolving credit facility also requires the Company to meet a minimum fixed charge ratio test if borrowing capacity is less than $25 million at any time during the quarter and restricts its ability to make capital expenditures or prepay certain other debt. The Company may not be able to maintain this ratio. These restrictions could limit its ability to plan for or react to market conditions or meet its capital needs. The Company may not be granted waivers or amendments to its amended revolving credit facility if for any reason the Company is unable to meet its requirements or the Company may not be able to refinance its debt on terms that are acceptable, or at all.
 
The breach of any of these covenants or restrictions could result in a default under the indenture for its 2014 notes or its amended revolving credit facility. An event of default under its debt agreements would permit some of its lenders to declare all amounts borrowed from them to be due and payable.
 
The Company faces intense competition from a number of domestic and foreign yarn producers and importers of textile and apparel products.
 
The Company’s industry is highly competitive. The Company competes not only against domestic and foreign yarn producers, but also against importers of foreign sourced fabric and apparel into the United States and other countries in which the Company does business. The Company’s major regional competitors are Nanya, Dillon, O’Mara, Inc., Spectrum, KOSA and AKRA, S.A. de C.V. in the polyester yarn segment and Sapona Manufacturing Company, Inc., McMichael Mills, Inc. and Worldtex, Inc. in the nylon yarn segment. The importation of garments and fabrics from lower wage-based countries and overcapacity throughout the world has resulted in lower net sales, gross profits and net income for both its polyester and nylon segments. The primary competitive factors in the textile industry include price, quality, product styling and differentiation, flexibility of production and finishing, delivery time and customer service. The needs of particular customers and the characteristics of particular products determine the relative importance of these various factors. Because the Company, and the supply chain in which the Company operates, do not typically operate on the basis of long-term contracts with textile and apparel customers, these competitive factors could cause the Company’s customers to rapidly shift to other producers. A large number of the Company’s foreign competitors have significant competitive advantages, including lower labor costs, lower raw materials and energy costs and favorable currency exchange rates against the U.S. dollar. If any of these advantages increase, the Company’s products could become less competitive, and its sales and profits may decrease as a result. In addition, while traditionally these foreign competitors have focused on commodity production, they are now increasingly focused on value-added products, where the Company continues to generate higher margins. Competitive pressures may also intensify as a result of the gradual elimination of quotas and the potential elimination of duties. See “— Changes in the trade regulatory environment could weaken the Company’s competitive position dramatically and have a material adverse effect on its business, net sales and profitability.” The Company, and the supply chain in which the Company operates, may therefore not be able to continue to compete effectively with imported foreign-made textile and apparel products, which would materially adversely affect its business, financial condition, results of operations or cash flows.
 
Changes in the trade regulatory environment could weaken the Company’s competitive position dramatically and have a material adverse effect on its business, net sales and profitability.
 
A number of sectors of the textile industry in which the Company sells its products, particularly apparel and home furnishings, are subject to intense foreign competition. Other sectors of the textile industry in which the Company sells its products may in the future become subject to more intense foreign competition. There are currently a number of trade regulations, quotas and duties in place to protect the U.S. textile industry against competition from low-priced foreign producers, such as China. Changes in such trade regulations, quotas and duties


13


Table of Contents

may make its products less attractive from a price standpoint than the goods of its competitors or the finished apparel products of a competitor in the supply chain, which could have a material adverse effect on the Company’s business, net sales and profitability. In addition, increased foreign capacity and imports that compete directly with its products could have a similar effect. Furthermore, one of the Company’s key business strategies is to expand its business within countries that are parties to free-trade agreements with the United States. Any relaxation of duties or other trade protections with respect to countries that are not parties to those free-trade agreements could therefore decrease the importance of the trade agreements and have a material adverse effect on its business, net sales and profitability. See “Item 1 — Business — Trade Regulation.”
 
The significant price volatility of many of the Company’s raw materials and rising energy costs may result in increased production costs, which the Company may not be able to pass on to its customers, which could have a material adverse effect on its business, financial condition, results of operations or cash flows.
 
A significant portion of the Company’s raw materials are petroleum-based chemicals and a significant portion of its costs are energy costs. The prices for petroleum and petroleum-related products and energy costs are volatile and have recently increased significantly. While the Company frequently enters into raw material supply agreements, as is the general practice in its industry, these agreements typically provide for formula-based pricing. Therefore, its supply agreements provide only limited protection against price volatility. As a result, its production costs have increased significantly in recent times. While the Company has in the past matched cost increases with corresponding product price increases, the Company may not always be able to immediately raise product prices, and, ultimately, pass on underlying cost increases to its customers. The Company has in the past lost and expects that it will continue to lose, customers to its competitors as a result of these price increases. In addition, its competitors may be able to obtain raw materials at a lower cost due to market regulations. Additional raw material and energy cost increases that the Company is not able to fully pass on to customers or the loss of a large number of customers to competitors as a result of price increases could have a material adverse effect on its business, financial condition, results of operations or cash flows.
 
The Company depends upon limited sources for raw materials, and interruptions in supply could increase its costs of production and cause its operations to suffer.
 
The Company depends on a limited number of third parties for certain raw material supplies, such as chip, TPA and MEG. Although alternative sources of raw materials exist, the Company may not continue to be able to obtain adequate supplies of such materials on acceptable terms, or at all, from other sources when its existing supply agreements expire. In addition, the Company has in the past and may in the future experience interruptions or limitations in the supply of its raw materials, which would increase its product costs and could have a material adverse effect on its business, financial condition, results of operations or cash flows. For example, in the Louisiana area in 2005, Hurricane Katrina created shortages in the supply of paraxlyene, a feedstock used in polymer production, because refineries diverted production to mixed xylene to increase the supply of gasoline. As a result, supplies of paraxlyene were reduced, and prices increased. Additionally, five of the six refineries in Texas that produce MEG shut down, including the supplier to the Company’s Kinston operation due to Hurricane Rita. The supply of MEG was reduced, and prices increased as well. These disruptions had an adverse effect on the Company’s net sales and product costs. Any future disruption or curtailment in the supply of any of its raw materials could cause the Company to reduce or cease its production in general or require the Company to increase its pricing, which could have a material adverse effect on its business, financial condition, results of operations or cash flows. See “— The significant price volatility of many of the Company’s raw materials and rising energy costs may result in increased production costs, which the Company may not be able to pass on to its customers, which could have a material adverse effect on its business, financial condition, results of operations or cash flows.”
 
A decline in general economic or political conditions and changes in consumer spending could cause the Company’s sales and profits to decline.
 
The Company’s products are used in the production of fabrics primarily for the apparel, hosiery, home furnishing, automotive, industrial and other similar end-use markets. Demand for furniture and durable goods, such as automobiles, is often affected significantly by economic conditions. Demand for a number of categories of


14


Table of Contents

apparel also tends to be tied to economic cycles. Domestic demand for textile products therefore tends to vary with the business cycles of the U.S. economy as well as changes in global economic and political conditions. Future armed conflicts, terrorist activities or natural disasters in the United States or abroad and any consequent actions on the part of the U.S. government and others may cause general economic conditions in the United States to deteriorate or otherwise reduce U.S. consumer spending. A decline in general economic conditions or consumer confidence may also lead to significant changes to inventory levels and, in turn, replenishment orders placed with suppliers. These changing demands ultimately work their way through the supply chain and could adversely affect demand for the Company’s products and have a material adverse effect on its business, net sales and profitability.
 
Failure to successfully reduce the Company’s production costs may adversely affect its financial results.
 
A significant portion of the Company’s strategy relies upon its ability to successfully rationalize and improve the efficiency of its operations. In particular, the Company’s strategy relies on its ability to reduce its production costs in order to remain competitive. Over the past three years, the Company has consolidated multiple unprofitable businesses and production lines in an effort to match operating rates to the market; reduced overhead and supply costs; focused on optimizing the product mix amongst its reorganized assets; and made significant capital expenditures to more completely automate its production facilities, lessen the dependence on labor and decrease waste. If the Company is not able to continue to successfully implement cost reduction measures, or if these efforts do not generate the level of cost savings that it expects going forward or result in higher than expected costs, there could be a material adverse effect on its business, financial condition, results of operations or cash flows.
 
Changes in customer preferences, fashion trends and end-uses could have a material adverse effect on the Company’s business, net sales and profitability and cause inventory build-up if the Company is not able to adapt to such changes.
 
The demand for many of the Company’s products depends upon timely identification of consumer preferences for fabric designs, colors and styles. In the apparel sector, a failure by the Company or its customers to identify fashion trends in time to introduce products and fabrics consistent with those trends could reduce its sales and the acceptance of its products by its customers and decrease its profitability as a result of costs associated with failed product introductions and reduced sales. The Company’s nylon segment has been adversely affected by changing customer preferences that have reduced demand for sheer hosiery products. In all sectors, changes in customer preferences or specifications may cause shifts away from the products which the Company provides, which can also have an adverse effect on its business, net sales and profitability.
 
The Company has significant foreign operations and its results of operations may be adversely affected by currency fluctuations.
 
The Company has a significant operation in Brazil, operations in Colombia and joint ventures in China and Israel. The Company serves customers in Canada, Mexico, Israel and various countries in Europe, Central America, South America and South Africa. Foreign operations are subject to certain political, economic and other uncertainties not encountered by its domestic operations that can materially affect sales, profits, cash flows and financial position. The risks of international operations include trade barriers, duties, exchange controls, national and regional labor strikes, social and political risks, general economic risks, required compliance with a variety of foreign laws, including tax laws, the difficulty of enforcing agreements and collecting receivables through foreign legal systems, taxes on distributions or deemed distributions to the Company or any of its U.S. subsidiaries, maintenance of minimum capital requirements and import and export controls. Through its foreign operations, the Company is also exposed to currency fluctuations and exchange rate risks. Because a significant amount of its costs incurred to generate the revenues of its foreign operations are denominated in local currencies, while the majority of its sales are in U.S. dollars, the Company has in the past been adversely impacted by the appreciation of the local currencies relative to the U.S. dollar, and currency exchange rate fluctuations could have a material adverse effect on its business, financial condition, results of operations or cash flows. The Company has translated its revenues and expenses denominated in local currencies into U.S. dollars at the average exchange rate during the relevant period and its assets and liabilities denominated in local currencies into U.S. dollars at the exchange rate at the end of the relevant period. Fluctuations in the foreign exchange rates will affect period-to-period comparisons of its reported


15


Table of Contents

results. Additionally, the Company operates in countries with foreign exchange controls. These controls may limit its ability to repatriate funds from its international operations and joint ventures or otherwise convert local currencies into U.S. dollars. These limitations could adversely affect the Company’s ability to access cash from these operations.
 
The Company may be exposed to liabilities under the Foreign Corrupt Practices Act and any determination that the Company violated the Foreign Corrupt Practices Act could have a material adverse effect on its business.
 
To the extent that the Company operates outside the United States, it is subject to the Foreign Corrupt Practices Act (the “FCPA”) which generally prohibits U.S. companies and their intermediaries from bribing foreign officials for the purpose of obtaining or keeping business or otherwise obtaining favorable treatment. In particular, the Company may be held liable for actions taken by its strategic or local partners even though such partners are foreign companies that are not subject to the FCPA. Any determination that the Company violated the FCPA could result in sanctions that could have a material adverse effect on its business.
 
The Company’s business could be negatively impacted by the financial condition of its customers.
 
The U.S. textile and apparel industry faces many challenges. Overcapacity, volatility in raw material pricing, and intense pricing pressures has led to the closure of many domestic textile and apparel plants. Continued negative industry trends may result in the deteriorating financial condition of its customers. Certain of the Company’s customers are experiencing financial difficulties. The loss of any significant portion of its sales to any of these customers could have a material adverse impact on its business, results of operations, financial condition or cash flows. In addition, any receivable balances related to its customers would be at risk in the event of their bankruptcy.
 
As one of the many participants in the U.S. and regional textile and apparel supply chain, the Company’s business and competitive position are directly impacted by the business and financial condition of the other participants across the supply chain in which it operates, including other regional yarn manufacturers, knitters and weavers. If other supply chain participants are unable to access capital, fund their operations and make required technological and other investments in their businesses or experience diminished demand for their products, there could be a material adverse impact on the Company’s business, financial condition, results of operations or cash flows.
 
Failure to implement future technological advances in the textile industry or fund capital expenditure requirements could have a material adverse effect on the Company’s competitive position and net sales.
 
The Company’s operating results depend to a significant extent on its ability to continue to introduce innovative products and applications and to continue to develop its production processes to be a competitive producer. Accordingly, to maintain its competitive position and its revenue base, the Company must continually modernize its manufacturing processes, plants and equipment. To this end, the Company has made significant investments in its manufacturing infrastructure over the past fifteen years and does not currently anticipate any significant additional capital expenditures to replace or expand its production facilities over the next five years. Accordingly, the Company expects its capital requirements in the near term will be used primarily to maintain its manufacturing operations, but the Company may nevertheless require significant capital expenditures for expansion purposes. Future technological advances in the textile industry may result in the availability of new products or increase the efficiency of existing manufacturing and distribution systems, and the Company may not be able to adapt to such technological changes or offer such products on a timely basis or establish or maintain competitive positions. Existing, proposed or yet undeveloped technologies may render its technology less profitable or less viable, and the Company may not have available the financial and other resources to compete effectively against companies possessing such technologies. To the extent sources of funds are insufficient to meet its ongoing capital improvement requirements, the Company would need to seek alternative sources of financing or curtail or delay capital spending plans. The Company may not be able to obtain the necessary financing when needed or on terms acceptable to us. The Company is unable to predict which of the many possible future products and services will meet the evolving industry standards and consumer demands. If the Company fails to make the capital


16


Table of Contents

improvements necessary to continue the modernization of its manufacturing operations and reduction of its costs, its competitive position may suffer, and its net sales may decline.
 
Unforeseen or recurring operational problems at any of the Company’s facilities may cause significant lost production, which could have a material adverse effect on its business, financial condition, results of operations and cash flows.
 
The Company’s manufacturing process could be affected by operational problems that could impair its production capability. Each of its facilities contains complex and sophisticated machines that are used in its manufacturing process. Disruptions at any of its facilities could be caused by maintenance outages; prolonged power failures or reductions; a breakdown, failure or substandard performance of any of its machines; the effect of noncompliance with material environmental requirements or permits; disruptions in the transportation infrastructure, including railroad tracks, bridges, tunnels or roads; fires, floods, earthquakes or other catastrophic disasters; labor difficulties; or other operational problems. Any prolonged disruption in operations at any of its facilities could cause significant lost production, which would have a material adverse effect on its business, financial condition, results of operations and cash flows.
 
The Company has made and may continue to make investments in entities that it does not control.
 
The Company has established joint ventures and made minority interest investments designed to increase its vertical integration, increase efficiencies in its procurement, manufacturing processes, marketing and distribution in the United States and other markets. The Company’s principal joint ventures and minority investments include UNF, Unifi-SANS Technical Fibers, LLC (“USTF”), PAL and Yihua Unifi Fibre Industry Company Limited (“YUFI”). See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Joint Ventures and Other Equity Investments.” The Company’s inability to control entities in which it invests may affect its ability to receive distributions from those entities or to fully implement its business plan. The incurrence of debt or entry into other agreements by an entity not under its control may result in restrictions or prohibitions on that entity’s ability to pay dividends or make other distributions. Even where these entities are not restricted by contract or by law from making distributions, the Company may not be able to influence the occurrence or timing of such distributions. In addition, if any of the other investors in these entities fails to observe its commitments, that entity may not be able to operate according to its business plan or the Company may be required to increase its level of commitment. If any of these events were to occur, its business, results of operations, financial condition or cash flows could be adversely affected. Because the Company does not own a majority or maintain voting control of these entities, the Company does not have the ability to control their policies, management or affairs. The interests of persons who control these entities or partners may differ from the Company’s, and they may cause such entities to take actions which are not in its best interest. If the Company is unable to maintain its relationships with its partners in these entities, the Company could lose its ability to operate in these areas which could have a material adverse effect on its business, financial condition, results of operations or cash flows.
 
The Company’s acquisition strategy may not be successful, which could adversely affect its business.
 
The Company has expanded its business partly through acquisitions and anticipates that it will continue to make selective acquisitions. The Company’s acquisition strategy is dependent upon the availability of suitable acquisition candidates, obtaining financing on acceptable terms, and its ability to comply with the restrictions contained in its debt agreements. Acquisitions may divert a significant amount of management’s time away from the operation of its business. Future acquisitions may also have an adverse effect on its operating results, particularly in the fiscal quarters immediately following their completion while the Company integrates the operations of the acquired business. Growth by acquisition involves risks that could have a material adverse effect on business and financial results, including difficulties in integrating the operations and personnel of acquired companies and the potential loss of key employees and customers of acquired companies. Once integrated, acquired operations may not achieve the levels of revenues, profitability or productivity comparable with those achieved by its existing operations, or otherwise perform as expected. While the Company has experience in identifying and integrating acquisitions, the Company may not be able to identify suitable acquisition candidates, obtain the capital necessary


17


Table of Contents

to pursue its acquisition strategy or complete acquisitions on satisfactory terms or at all. Even if the Company successfully completes an acquisition, it may not be able to integrate it into its business satisfactorily or at all.
 
Increases of illegal transshipment of textile and apparel goods into the United States could have a material adverse effect on the Company’s business.
 
There has been a significant increase recently in illegal transshipments of apparel products into the United States. Illegal transshipment involves circumventing quotas by falsely claiming that textiles and apparel are a product of a particular country of origin or include yarn of a particular country of origin to avoid paying higher duties or to receive benefits from regional free-trade agreements, such as NAFTA and CAFTA. If illegal transshipment is not monitored and enforcement is not effective, these shipments could have a material adverse effect on its business.
 
The Company is subject to many environmental and safety regulations that may result in significant unanticipated costs or liabilities or cause interruptions in its operations.
 
The Company is subject to extensive federal, state, local and foreign laws, regulations, rules and ordinances relating to pollution, the protection of the environment and the use or cleanup of hazardous substances and wastes. The Company may incur substantial costs, including fines, damages and criminal or civil sanctions, or experience interruptions in its operations for actual or alleged violations of or compliance requirements arising under environmental laws, any of which could have a material adverse effect on its business, financial condition, results of operations or cash flows. The Company’s operations could result in violations of environmental laws, including spills or other releases of hazardous substances to the environment. In the event of a catastrophic incident, the Company could incur material costs.
 
In addition, the Company could incur significant expenditures in order to comply with existing or future environmental or safety laws. For example, the land associated with the Kinston acquisition is leased pursuant to a 99 year Ground Lease with DuPont. Since 1993, DuPont has been investigating and cleaning up the Kinston Site under the supervision of the EPA and the North Carolina Department of Environment and Natural Resources 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, known as solid waste management units or areas of concern, assess the extent of contamination at the identified areas and clean them up to applicable regulatory standards. Under the terms of the Ground Lease, upon completion by DuPont of required remedial action, ownership of the Kinston Site will pass to the Company. Thereafter, the Company will have responsibility for future remediation requirements, if any, at the solid waste management units and areas of concern previously addressed by DuPont and at any other areas at the plant. At this time, the Company has no basis to determine if and when it will have any responsibility or obligation with respect to contaminated solid waste management units and areas of concern or the extent of any potential liability for the same. Accordingly, the possibility that the Company could face material clean-up costs in the future relating to the Kinston facility cannot be eliminated. Capital expenditures and, to a lesser extent, costs and operating expenses relating to environmental or safety matters will be subject to evolving regulatory requirements and will depend on the timing of the promulgation and enforcement of specific standards which impose requirements on its operations. Therefore, capital expenditures beyond those currently anticipated may be required under existing or future environmental or safety laws. See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Environmental Liabilities.”
 
Furthermore, the Company may be liable for the costs of investigating and cleaning up environmental contamination on or from its properties or at off-site locations where the Company disposed of or arranged for the disposal or treatment of hazardous materials or from disposal activities that pre-dated the purchase of its businesses. If significant previously unknown contamination is discovered, existing laws or their enforcement change or its indemnities do not cover the costs of investigation and remediation, then such expenditures could have a material adverse effect on the Company’s business, financial condition, results of operations or cash flows.
 
Health and safety regulation costs could increase.
 
The Company’s operations are also subject to regulation of health and safety matters by the United States Occupational Safety and Health Administration and comparable statutes in foreign jurisdictions where the


18


Table of Contents

Company operates. The Company believes that it employs appropriate precautions to protect its employees and others from workplace injuries and harmful exposure to materials handled and managed at its facilities. However, claims that may be asserted against the Company for work-related illnesses or injury, and changes in occupational health and safety laws and regulations in the United States or in foreign jurisdictions in which the Company operates could increase its operating costs. The Company is unable to predict the ultimate cost of compliance with these health and safety laws and regulations. Accordingly, the Company may become involved in future litigation or other proceedings or be found to be responsible or liable in any litigation or proceedings, and such costs may be material to us.
 
The Company’s business may be adversely affected by adverse employee relations.
 
The Company employs approximately 3,300 employees, approximately 2,900 of which are domestic employees and approximately 400 of which are foreign employees. While employees of its foreign operations are generally unionized, none of its domestic employees are currently covered by collective bargaining agreements. The failure to renew collective bargaining agreements with employees of the Company’s foreign operations and other labor relations issues, including union organizing activities, could result in an increase in costs or lead to a strike, work stoppage or slow down. Such labor issues and unrest by its employees could have a material adverse effect on the Company’s business.
 
The Company depends on the continued services of key managers and employees.
 
The Company’s ability to maintain its competitive position is dependent to a large degree on the services of its senior management team, including its Chief Executive Officer, Mr. Parke, and its Chief Operating Officer and Chief Financial Officer, Mr. Lowe. The Company currently does not have any employment agreements with its senior management team other than Mr. Parke and Mr. Lowe, and cannot assure investors that any of these individuals will remain with it. The Company currently does not have a life insurance policy on any of the members of the senior management team. The death or loss of the services of any of its senior managers or the inability to attract and retain additional senior management personnel could have a material adverse effect on its business.
 
The Company’s future financial results could be adversely impacted by asset impairments or other charges.
 
Under Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company is required to assess the impairment of the Company’s long-lived assets, such as plant and equipment, whenever events or changes in circumstances indicate that the carrying value may not be recoverable as measured by the sum of the expected future undiscounted cash flows. When the Company determines that the carrying value of certain long-lived assets may not be recoverable based upon the existence of one or more impairment indicators, the Company then measures any impairment based on a projected discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in its current business model. In accordance with SFAS No. 144, any such impairment charges will be recorded as operating losses. See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Impairment of Long-Lived Assets.”
 
In addition, the Company evaluates the net values assigned to various equity investments it holds, such as its investment in YUFI, PAL, USTF and UNF, in accordance with the provisions of Accounting Principles Board Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” APB No. 18 requires that a loss in value of an investment, which is other than a temporary decline, should be recognized as an impairment loss. Any such impairment losses will be recorded as operating losses. See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Joint Ventures and Other Equity Investments” for more information regarding the Company’s equity investments.
 
Any operating losses resulting from impairment charges under SFAS No. 144 or APB No. 18 could have an adverse effect on its net income and therefore the market price of its securities, including its common stock.
 
The Company’s business could be adversely affected if the Company fails to protect its intellectual property rights.
 
The Company’s success depends in part on its ability to protect its intellectual property rights. The Company relies on a combination of patent, trademark, and trade secret laws, licenses, confidentiality and other agreements to


19


Table of Contents

protect its intellectual property rights. However, this protection may not be fully adequate: its intellectual property rights may be challenged or invalidated, an infringement suit by the Company against a third party may not be successful and/or third parties could design around its technology or adopt trademarks similar to its own. In addition, the laws of some foreign countries in which its products are manufactured and sold do not protect intellectual property rights to the same extent as the laws of the United States. Although the Company routinely enters into confidentiality agreements with its employees, independent contractors and current and potential strategic and joint venture partners, among others, such agreements may be breached, and the Company could be harmed by unauthorized use or disclosure of its confidential information. Further, the Company licenses trademarks from third parties, and these agreements may terminate or become subject to litigation. Its failure to protect its intellectual property could materially and adversely affect its competitive position, reduce revenue or otherwise harm its business. The Company may also be accused of infringing or violating the intellectual property rights of third parties. Any such claims, whether or not meritorious, could result in costly litigation and divert the efforts of its personnel. Should the Company be found liable for infringement, the Company may be required to enter into licensing arrangements (if available on acceptable terms or at all) or pay damages and cease selling certain products or using certain product names or technology. The Company’s failure to prevail in any intellectual property litigation could materially adversely affect its competitive position, reduce revenue or otherwise harm its business.
 
Forward-Looking Statements
 
Forward-looking statements are those that do not relate solely to historical fact. They include, but are not limited to, any statement that may predict, forecast, indicate or imply future results, performance, achievements or events. They may contain words such as “believe,” “anticipate,” “expect,” “estimate,” “intend,” “project,” “plan,” “will,” or words or phrases of similar meaning. They may relate to, among other things, the risks described under the caption “Item 1A — Risk Factors” above and:
 
  •  the competitive nature of the textile industry and the impact of worldwide competition;
 
  •  changes in the trade regulatory environment and governmental policies and legislation;
 
  •  the availability, sourcing and pricing of raw materials;
 
  •  general domestic and international economic and industry conditions in markets where the Company competes, such as recession and other economic and political factors over which the Company has no control;
 
  •  changes in consumer spending, customer preferences, fashion trends and end-uses;
 
  •  its ability to reduce production costs;
 
  •  changes in currency exchange rates, interest and inflation rates;
 
  •  the financial condition of its customers;
 
  •  technological advancements and the continued availability of financial resources to fund capital expenditures;
 
  •  the operating performance of joint ventures, alliances and other equity investments;
 
  •  the impact of environmental, health and safety regulations; and
 
  •  employee relations.
 
These forward-looking statements reflect the Company’s current views with respect to future events and are based on assumptions and subject to risks and uncertainties that may cause actual results to differ materially from trends, plans or expectations set forth in the forward-looking statements. These risks and uncertainties may include those discussed above or in “Item 1A — Risk Factors.” New risks can emerge from time to time. It is not possible for the Company to predict all of these risks, nor can it assess the extent to which any factor, or combination of factors, may cause actual results to differ from those contained in forward-looking statements. The Company will not update these forward-looking statements, even if its situation changes in the future, except as required by federal securities laws.


20


Table of Contents

 
Item 1B.   Unresolved Staff Comments
 
None.
 
Item 2.   Properties
 
Following is a summary of principal properties owned or leased by the Company as of June 25, 2006:
 
     
Location
 
Description
 
Polyester Segment Properties:
   
     
Domestic:
   
Yadkinville, NC
  Five plants and three warehouses
Kinston, NC
  One plant and one warehouse
Reidsville, NC
  One plant
Mayodan, NC
  One plant
Staunton, VA
  One plant and one warehouse
     
Foreign:
   
Alfenas, Brazil
  One plant and one warehouse
Sao Paulo, Brazil
  One corporate office
     
Nylon Segment Properties:  
   
     
Domestic
   
Madison, NC
  One plant
Fort Payne, AL
  One central distribution center
     
Foreign:
   
Bogota, Colombia
  One plant
 
In addition to the above properties, the corporate administrative office for each of its segments is located at 7201 West Friendly Ave. in Greensboro, North Carolina. Such property consists of a building containing approximately 100,000 square feet located on a tract of land containing approximately 9 acres.
 
All of the above facilities are owned in fee simple, with the exception of a plant in Mayodan, North Carolina which is leased from a financial institution pursuant to a sale-leaseback agreement entered into on May 20, 1997, as amended; one warehouse in Staunton, Virginia, one warehouse in Kinston, North Carolina and one office in Sao Paulo, Brazil. Management believes all the properties are well maintained and in good condition. In fiscal year 2006, the Company’s manufacturing plants in the U.S. and Brazil operated below capacity. Accordingly, management does not perceive any capacity constraints in the foreseeable future.
 
In March 2006 the Company classified several properties as assets held for sale. During the fourth quarter of fiscal year 2006, the Company sold an idle manufacturing facility in Staunton, Virginia and a central distribution center in Madison, North Carolina. The remaining assets held for sale are not included in the property listing table above.
 
The Company also leases two manufacturing facilities to other manufacturers, one of which is leased to USTF, a joint venture in which the Company is a 50% owner.
 
Item 3.   Legal Proceedings
 
There are no pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company is a party or of which any of its property is the subject.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of security holders during the fourth quarter for the fiscal year ended June 25, 2006.


21


Table of Contents

EXECUTIVE OFFICERS OF THE COMPANY
 
The following is a description of the name, age, position and offices held, and the period served in such position or offices for each of the executive officers of the Company.
 
Chairman of the Board and Chief Executive Officer
 
BRIAN R. PARKE — Age: 58 — Mr. Parke has been the Chief Executive Officer of the Company since January 2000 and the President of the Company since 1999. Mr. Parke has also been the Chairman of the Board of Directors since 2004. Prior to that, Mr. Parke had been the President and Chief Operating Officer of the Company since January 1999 and the Manager or President of its former Irish subsidiary (Unifi Textured Yarns Europe Limited) since its acquisition by the Company in 1984. Additionally, Mr. Parke had been a Vice President of the Company since October 1993. Mr. Parke was elected to the Company’s Board of Directors in July 1999.
 
Vice Presidents
 
WILLIAM M. LOWE, JR. — Age: 53 — Mr. Lowe has been Vice President and Chief Financial Officer of the Company since January 2004 and Chief Operating Officer of the Company since April 2004. Prior to being employed by the Company, Mr. Lowe was Executive Vice President and Chief Financial Officer of Metaldyne Corporation, an automotive component and systems manufacturer from 2001 to 2003. From 1991 to 2001 Mr. Lowe held various financial positions at Arvinmeritor, Inc. a diversified manufacturer of automotive components and systems.
 
R. ROGER BERRIER — Age: 37 — Mr. Berrier has been the Vice President of Commercial Operations of the Company since April 2006. Prior to that, Mr. Berrier had been the Commercial Operations Manager responsible for Corporate Product Development, Marketing and Brand Sales Management since April 2004. 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.
 
THOMAS H. CAUDLE, JR. — Age: 54 — Mr. Caudle has been the Vice President of Global Operations of the Company since April 2003. Prior to that, Mr. Caudle had been Senior Vice President in charge of manufacturing for the Company since July 2000 and Vice President of Manufacturing Services of the Company since January 1999. Mr. Caudle has been an employee of the Company since 1982.
 
BENNY L. HOLDER — Age: 44 — Mr. Holder has been the Vice President and Chief Information Officer of the Company since January 2001, and has been an employee of the Company since January 1995. Mr. Holder has held various management positions within the Company’s information technology group since joining the Company, overseeing all of the Company’s information technology operations as Managing Director from June 1999 until January 2001. Prior to joining the Company, Mr. Holder held various management positions in the information technology departments of Memorex Telex from 1990 until 1994 and Revlon, Inc. from 1994 until 1995.
 
WILLIAM L. JASPER — Age: 53 — Mr. Jasper has been the Vice President of Sales since April 2006. Prior to that, Mr. Jasper was the General Manager of the Polyester segment, having responsibility for all natural polyester businesses. He joined the Company with the purchase of the Kinston polyester POY assets from INVISTA in September 2004. Prior to joining the Company, he was the Director of INVISTA’s Dacron® polyester filament business. Prior to that, Mr. Jasper held various management positions in Operations, Technology, Sales and Business for DuPont since 1980.
 
CHARLES F. MCCOY — Age: 42 — Mr. McCoy has been the Vice President, Secretary and General Counsel of the Company since October 2000, the Corporate Compliance Officer of the Company since 2002 and the Corporate Governance Officer of the Company since 2004. Mr. McCoy became an employee of the Company in January 2000, when he joined the Company as its Assistant Secretary and General Counsel. Prior to that, Mr. McCoy was a partner with the law firm of Frazier, Frazier & Mahler, LLP, the firm serving as outside counsel to the Company.
 
These executive officers, unless otherwise noted, were elected by the Board of Directors of the Registrant at the Annual Meeting of the Board of Directors held on October 19, 2005. Each executive officer was elected to serve until the next Annual Meeting of the Board of Directors or until his successor was elected and qualified. No executive officer has a family relationship as close as first cousin with any other executive officer or director.


22


Table of Contents

 
PART II
 
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
The Company’s common stock is listed for trading on the New York Stock Exchange (“NYSE”) under the symbol “UFI.” The following table sets forth the high and low sales prices of the Company’s common stock as reported on the NYSE Composite Tape for the Company’s two most recent fiscal years.
 
                 
    High     Low  
 
Fiscal year 2005:
               
First quarter ended September 26, 2004
  $ 3.24     $ 1.80  
Second quarter ended December 26, 2004
    4.05       2.00  
Third quarter ended March 27, 2005
    4.55       3.02  
Fourth quarter ended June 26, 2005
    4.12       2.75  
Fiscal year 2006:
               
First quarter ended September 25, 2005
  $ 4.49     $ 3.33  
Second quarter ended December 25, 2005
    3.49       2.33  
Third quarter ended March 26, 2006
    3.37       2.82  
Fourth quarter ended June 25, 2006
    3.76       2.84  
 
As of September 5, 2006 there were approximately 515 record holders of the Company’s common stock. A significant number of the outstanding shares of common stock which are beneficially owned by individuals and entities are registered in the name of Cede & Co. Cede & Co. is a nominee of The Depository Trust Company, a securities depository for banks and brokerage firms. The Company estimates that there are approximately 4,200 beneficial owners of its common stock.
 
No dividends were paid in the past two fiscal years and none are expected to be paid in the foreseeable future. The indenture governing the 2014 notes and the Company’s amended revolving credit facility restrict its ability to pay dividends or make distributions on its capital stock. See “Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Long-Term Debt — Senior Secured Notes” and “— Amended Revolving Credit Facility.”
 
The following table summarizes information as of June 25, 2006 regarding the number of shares of common stock that may be issued under the Company’s equity compensation plans:
 
                         
    (a)     (b)     (c)  
                Number of Securities Remaining
 
    Number of Shares to be
    Weighted-Average
    Available for Future Issuance
 
    Issued Upon Exercise of
    Exercise Price of
    Under Equity Compensation
 
    Outstanding Options,
    Outstanding Options,
    Plans (Excluding Securities
 
Plan Category
  Warrants and Rights     Warrants and Rights     Reflected in Column (a))  
 
Equity compensation plans approved by shareholders
    3,946,341     $ 6.85       2,218,460  
Equity compensation plans not approved by shareholders
                 
                         
Total
    3,946,341     $ 6.85       2,218,460  
                         
 
Under the terms of the 1999 Unifi Inc. Long-Term Incentive Plan (“1999 Long-Term Incentive Plan”), the maximum number of shares to be issued was approved at 6,000,000. Of the 6,000,000 shares approved for issuance, no more than 3,000,000 may be issued as restricted stock. To date, 258,466 shares have been issued as restricted stock and are deemed to be outstanding. Any option or restricted stock that is forfeited may be reissued under the terms of the plan. The amount forfeited or canceled is included in the number of securities remaining available for future issuance in column (c) in the above table.


23


Table of Contents

During the fiscal quarter ended June 25, 2006, the maximum number of shares available for purchase under Company plans or programs were 6,807,241. The Company did not make any repurchases under such plans or programs during this time.
 
On April 25, 2003, the Company announced that its Board of Directors had reinstituted the Company’s previously authorized stock repurchase plan at its meeting on April 24, 2003. The plan was originally announced by the Company on July 26, 2000 and authorized the Company to repurchase of up to 10.0 million shares of its common stock. During fiscal years 2004 and 2003, the Company repurchased approximately 1.3 million and 0.5 million shares, respectively. The repurchase program was suspended in November 2003 and the Company has no immediate plans to reinstitute the program. There is remaining authority for the Company to repurchase approximately 6.8 million shares of its common stock under the repurchase plan. The repurchase plan has no stated expiration or termination date.
 
For information regarding the Company’s equity compensation plans, see “Item 12 — Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”


24


Table of Contents

 
Item 6.   Selected Financial Data
 
                                         
    June 25, 2006
    June 26, 2005
    June 27, 2004
    June 29, 2003
    June 30, 2002
 
    (52 Weeks)     (52 Weeks)     (52 Weeks)     (52 Weeks)     (53 Weeks)  
    (Amounts in thousands, except per share data)  
 
Summary of Operations:  
                                       
Net sales
  $ 738,825     $ 793,796     $ 666,383     $ 747,681     $ 813,635  
Cost of sales
    696,055       762,717       625,983       675,829       739,623  
Selling, general and administrative expenses
    41,534       42,211       45,963       48,182       44,707  
Provision for bad debts
    1,256       13,172       2,389       3,812       6,285  
Interest expense
    19,247       20,575       18,698       19,736       22,948  
Interest income
    (4,489 )     (2,152 )     (2,152 )     (1,420 )     (2,260 )
Other (income) expense, net
    (3,118 )     (2,300 )     (2,590 )     (115 )     4,129  
Equity in (earnings) losses of unconsolidated affiliates
    (825 )     (6,938 )     6,877       (10,728 )     1,659  
Minority interest (income) expense
          (530 )     (6,430 )     4,769        
Restructuring charges (recovery)(1)
    (254 )     (341 )     8,229       10,597        
Arbitration costs and expenses(2)
                182       19,185       1,129  
Alliance plant closure costs (recovery)(3)
                (206 )     (3,486 )      
Write down of long-lived assets(4)
    2,366       603       25,241              
Goodwill impairment(5)
                13,461              
Loss on early extinguishment of debt(6)
    2,949                          
                                         
Loss from continuing operations before income taxes and extraordinary item
    (15,896 )     (33,221 )     (69,262 )     (18,680 )     (4,585 )
Benefit for income taxes
    (1,170 )     (13,483 )     (25,113 )     (2,590 )     (2,132 )
                                         
Loss from continuing operations before extraordinary Item
    (14,726 )     (19,738 )     (44,149 )     (16,090 )     (2,453 )
Income (loss) from discontinued operations, net of tax
    360       (22,644 )     (25,644 )     (11,087 )     (3,621 )
                                         
Loss before extraordinary item and cumulative effect of accounting change
    (14,366 )     (42,382 )     (69,793 )     (27,177 )     (6,074 )
Extraordinary gain — net of taxes of $0(7)
          1,157                    
Cumulative effect of accounting change, net of tax(8)
                            (37,851 )
                                         
Net loss
  $ (14,366 )   $ (41,225 )   $ (69,793 )   $ (27,177 )   $ (43,925 )
                                         
Per Share of Common Stock: (basic and diluted)
                                       
Loss from continuing operations
  $ (.28 )   $ (.38 )   $ (.85 )   $ (.30 )   $ (.05 )
Income (loss) from discontinued operations, net of tax
          (.43 )     (.49 )     (.21 )     (.06 )
Extraordinary gain — net of taxes of $0
          .02                    
Cumulative effect of accounting change, net of tax
                            (.71 )
                                         
Net loss
  $ (.28 )   $ (.79 )   $ (1.34 )   $ (.51 )   $ (.82 )
                                         


25


Table of Contents

                                         
    June 25, 2006
    June 26, 2005
    June 27, 2004
    June 29, 2003
    June 30, 2002
 
    (52 Weeks)     (52 Weeks)     (52 Weeks)     (52 Weeks)     (53 Weeks)  
    (Amounts in thousands, except per share data)  
 
Balance Sheet Data:  
                                       
Working capital
  $ 179,540     $ 242,440     $ 236,881     $ 183,973     $ 167,469  
Gross property, plant and equipment
    916,337       955,459       943,555       978,200       961,327  
Total assets
    732,637       845,375       872,535       1,002,201       1,019,555  
Long-term debt and other obligations
    202,110       259,790       263,779       259,395       280,267  
Shareholders’ equity
    382,953       383,575       401,901       479,748       498,040  
 
 
(1) During fiscal year 2003, the Company developed a plan of reorganization that resulted in the termination of management and production level employees. In fiscal year 2004, the Company recorded a restructuring charge which consisted of severance and related employee termination costs and facility closure costs.
 
(2) The arbitration costs and expenses include the award owed by the Company to DuPont as a result of an arbitration panel ruling in June 2003 and professional fees incurred.
 
(3) In fiscal year 2001, the Company recorded its share of the anticipated costs of closing DuPont’s Cape Fear, North Carolina facility which was in accordance with the Company’s manufacturing alliance with DuPont. During fiscal year 2003, the project was substantially complete; and as a result, the Company obtained updated cost estimates which resulted in reductions to the reserve.
 
(4) In fiscal year 2004, management performed impairment testing for the domestic textured polyester business due to the continued challenging business conditions and reduction in volume and gross profit. As a result, management determined that the assets were in fact impaired, resulting in a charge of $25.2 million.
 
(5) In fiscal year 2004, management performed an impairment test for the entire domestic polyester segment. As a result of the testing, the Company recorded a goodwill impairment charge of $13.5 million to reduce the segment’s goodwill to $0.
 
(6) In April 2006, the Company commenced a tender offer for all of its outstanding 2008 notes. In May 2006, the Company issued $190 million of notes due in 2014. The $2.9 million charge related to the fees associated with the tender offer as well as the unamortized bond issuance costs on the 2008 notes.
 
(7) In fiscal year 2005, the Company completed its acquisition of the INVISTA polyester POY manufacturing assets located in Kinston, North Carolina, including inventories, valued at $24.4 million. As part of the acquisition, the Company announced its plans to curtail two production lines and downsize the workforce at its newly acquired manufacturing facility. At that time, the Company recorded a reserve of $10.7 million in related severance costs and $0.4 million in restructuring costs which were recorded as assumed liabilities in purchase accounting; and therefore, had no impact on the Consolidated Statements of Operations. As of March 27, 2005, both lines were successfully shut down and a reduction in the original restructuring estimate for severance was recorded. As a result of the reduction to the restructuring reserve, a $1.2 million extraordinary gain, net of tax, was recorded.
 
(8) The 2002 fiscal year cumulative effect of accounting change represents the write-off of goodwill associated with the nylon reporting segment. Upon adoption of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), the Company wrote off $46.3 million ($37.9 million after tax) or $.71 per diluted share of the unamortized balance of the goodwill associated with the nylon business segment as of June 25, 2001, as a cumulative effect of an accounting change.
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of management’s views on the financial condition and results of operations of the Company should be read in conjunction with the Consolidated Financial Statements and Notes included elsewhere in this Annual Report on Form 10-K. The discussion contains forward-looking statements that reflect management’s current expectations, estimates and projections. Actual results for the Company could differ materially from those discussed in the forward-looking statements. Factors that could cause such differences are discussed in “Forward-Looking Statements” above in “Item 1A — Risk Factors” and elsewhere in this Annual Report on Form 10-K.

26


Table of Contents

Business Overview
 
The Company is a diversified producer and processor of multi-filament polyester and nylon yarns, including specialty yarns with enhanced performance characteristics. Unifi adds value to the supply chain and enhances consumer demand for its products through the development and introduction of branded yarns that provide unique performance, comfort and aesthetic advantages. The Company manufactures partially oriented, textured, dyed, twisted and beamed polyester yarns as well as textured nylon and nylon covered spandex products. Unifi sells its products to other yarn manufacturers, knitters and weavers that produce fabrics for the apparel, hosiery, home furnishings, automotive, industrial and other end-use markets. The Company maintains one of the industry’s most comprehensive product offerings and emphasizes quality, style and performance in all of its products.
 
Polyester Segment.  The polyester segment manufactures partially oriented, textured, dyed, twisted and beamed yarns with sales to other yarn manufacturers, knitters and weavers that produce fabrics for the apparel, automotive and furniture upholstery, hosiery, home furnishings, automotive, industrial and other end-use markets. The polyester segment primarily manufactures its products in Brazil, Colombia and the United States, which has the largest operations and number of locations. For fiscal years 2006, 2005, and 2004 polyester segment net sales were $566.4 million, $587.0 million, and $481.9 million, respectively.
 
Nylon Segment.  The nylon segment manufactures textured nylon and covered spandex products with sales to other yarn manufacturers, knitters and weavers that produce fabrics for the apparel, hosiery, sock and other end-use markets. The nylon segment consists of operations in the United States and Colombia. For fiscal years 2006, 2005, and 2004 nylon segment net sales were $172.5 million, $206.8 million, and $184.5 million, respectively.
 
Sourcing Segment.  In July 2005, the Company announced its decision to exit the sourcing business, and as of the end of fiscal year 2006 the Company had fully liquidated the business. All periods have been presented as discontinued operations in accordance with generally accepted accounting principles in the United States (“GAAP”).
 
The Company’s fiscal year is the 52 or 53 weeks ending in the last Sunday in June. Fiscal years 2006, 2005 and 2004 had 52 weeks.
 
Line Items Presented
 
Net sales.  Net sales include amounts billed by the Company to customers for products, shipping and handling, net of allowances for rebates. Rebates may be offered to specific large volume customers for purchasing certain quantities of yarn over a prescribed time period. The Company provides for allowances associated with rebates in the same accounting period the sales are recognized in income. Allowances for rebates are calculated based on sales to customers with negotiated rebate agreements with the Company. Non-defective returns are deducted from revenues in the period during which the return occurs. The Company records allowances for customer claims based upon its estimate of known claims and its past experience for unknown claims.
 
Cost of sales.  The Company’s cost of sales consists of direct material, delivery and other manufacturing costs, including labor and overhead, depreciation and amortization expense with respect to manufacturing assets, fixed asset depreciation, amortization of intangible assets and reserves for obsolete and slow-moving inventory. Cost of sales also includes amounts directly related to providing technological support to the Company’s Chinese joint venture discussed below.
 
Selling, general and administrative expenses.  The Company’s selling, general and administrative expenses consist of selling expense (which includes sales staff salaries and bonuses), advertising and promotion (which includes direct marketing expenses) and administrative expense (which includes corporate expenses and bonuses). In addition, selling, general and administrative expenses also include depreciation and amortization with respect to certain corporate administrative assets.
 
Recent Developments and Outlook
 
Although the global textile and apparel industry continues to grow, the U.S. textile and apparel industry has contracted since 1999, caused primarily by intense foreign competition in finished goods on the basis of price,


27


Table of Contents

resulting in ongoing U.S. domestic overcapacity, many producers moving their operations offshore and the closure of many domestic textile and apparel plants. More recently, the U.S. textile and apparel industry has continued to decline although it has been experiencing low negative growth rates. In addition, due to consumer preferences, demand for sheer hosiery products has declined significantly in recent years, which negatively impacts nylon manufacturers. Because of these general industry trends, the Company’s net sales, gross profits and net income have been trending downward for the past several years. These challenges continue to impact the U.S. textile and apparel industry, and the Company expects that they will continue to impact the U.S. textile and apparel industry for the foreseeable future. The Company believes that its success going forward is primarily based on its ability to improve the mix of its product offerings to shift to more premium value-added products, to exploit the free-trade agreements to which the United States is a party and to implement cost saving strategies which will improve its operating efficiencies. The continued viability of the U.S. domestic textile and apparel industry is dependent, to a large extent, on the international trade regulatory environment. For the most part, because of protective duties currently in place and NAFTA, CAFTA, CBI, ATPA and other free-trade agreements or duties preference programs, the Company has not experienced significant declines in its market share due to the importation of Asian products.
 
The Company is also highly committed and dedicated to identifying strategic opportunities to participate in the Asian textile market, specifically China, where the growth rate is estimated to be within a range of 7% to 9%. As further discussed below in “— Joint Ventures and Other Equity Investments,” the Company has invested $30.0 million in a joint venture in China to manufacture, process and market polyester filament yarn.
 
During fiscal year 2006, the Company continued its focus away from selling large volumes of products in order to focus on making each product line profitable. The Company has identified unprofitable product lines and raised sales prices accordingly. In some cases, this strategy has resulted in reduced sales of these products or even the elimination of the unprofitable product lines. The Company expects that the reduction of these unprofitable businesses will improve its future operating results. This program has resulted in significant restructuring charges in recent periods, and additional losses of volume associated with these actions may require additional plant consolidations in the future, which may result in further restructuring charges.
 
The Company entered into a manufacturing alliance with DuPont in June 2000 to produce polyester POY at DuPont’s facility in Kinston and at the Company’s facility in Yadkinville, North Carolina. DuPont later transferred its interest in this alliance to Invista, Inc. This alliance resulted in significant annual benefits to the Company of approximately $30 million, consisting of reductions in fixed costs, variable costs savings and product development enrichment. On September 30, 2004, the Company acquired the Kinston facility, including inventories, for approximately $24.4 million, in the form of a note payable to Invista (the “Kinston acquisition’’). The Company closed two of the Kinston facility’s four production lines, increased efficiency and automation and reduced the workforce. See “— Corporate Restructurings.” The acquisition resulted in the termination of the Company’s alliance with DuPont. As a result of the Kinston acquisition, the Company’s results for periods subsequent to the Kinston acquisition will not be fully comparable to its results for the prior periods, which include the annual benefit of the alliance.
 
The impact of Hurricane Katrina on the oil refineries in the Louisiana area in August 2005 created shortages of supply of gasoline and as a result a shortage of paraxlyene, a feedstock used in polymer production in its polyester segment, because producers diverted production to mixed xlyene to increase the supply of gasoline. As a result, while supplies were tight, paraxlyene continued to be available at a much higher price. During September 2005, the Company received notices from several raw material suppliers declaring force majeure under its contracts and increasing the price the Company paid under those contracts effective September 1, 2005. As a result of this increase, and other energy-related cost increases, the Company imposed a 14 cents per pound surcharge on its polyester products in an effort to maintain its margins. Throughout the second quarter of fiscal year 2006, the surcharge stayed in effect at different levels as raw material prices declined. In other operations that have a high usage of natural gas, the Company also increased sales prices effective November 1, 2005 to compensate for the increase in utility costs.
 
Though polyester raw material prices declined during the end of the second quarter of fiscal year 2006, a different set of paraxylene industry dynamics emerged during the third quarter of fiscal year 2006 that led to further increases of raw material prices. Polyester raw material prices once again increased during the last two quarters of


28


Table of Contents

fiscal year 2006 and continue to be steady. The belief is that the pressure from strong gasoline demand coupled with the phase out of Methyl Tert-butyl Ether (“MTBE”) from gasoline has had an impact on paraxylene pricing as it has raised the value of mixed xylenes (feedstock to paraxylene) as a blend component for gasoline, as xylenes are diverted into gasoline as a replacement for MTBE.
 
Hurricane Rita shut down five of the six refineries in Texas that produce MEG in September 2005, including the supplier to the Company’s Kinston polyester filament manufacturing operation. In addition, an unrelated accident closed one of the supplier’s facilities in early October 2005. With five of the six facilities closed, the supply of MEG in the marketplace became temporarily tight, and MEG became unavailable at historical prices. At the time of Hurricane Rita, the Company had approximately 22 days of inventory of MEG. The Company started purchasing MEG on the spot market and trucking the MEG to Kinston, which increased its costs compared to its more economical method of transportation by railroad.
 
The Company successfully managed through these transportation and access issues to meet its delivery commitments. As of the close of the second quarter of fiscal year 2006, the availability of raw materials had returned to normal levels, but pricing had not returned to pre-hurricane levels. Effective January 1, 2006, the Company removed the surcharge on its products and instituted a price increase to maintain its margins.
 
In spite of the Company’s ability to pass to its customers nearly all of the cost increases resulting from the 2005 hurricanes and the associated supply shortages, revenues in the polyester segment for the second and third quarters of fiscal year 2006 were lower than for the comparable period in fiscal year 2005 due to lower overall purchases by its customers because of the increased prices. The polyester segment revenues lost during the second and third quarters of fiscal year 2006 have not been fully offset by increased orders in subsequent periods. In addition to the decrease in overall polyester segment revenues, increased prices also resulted in smaller order size for the polyester segment products during the second quarter of fiscal year 2006, as customers sought to purchase only their minimum requirements during the supply disruption period. Smaller order sizes affected margins negatively during that period, as repeated changes in production lines increased per-unit costs for smaller orders. As a result, in February 2006, the Company instituted small order pricing surcharges to offset this effect on margins.
 
On April 28, 2006, the Company commenced a tender offer for all of its then outstanding $250 million in aggregate principal amount of 2008 notes simultaneously with a consent solicitation from the holders of the 2008 notes to remove substantially all of the restrictive covenants and certain events of default under the indenture governing the 2008 notes. The tender offer expired on May 25, 2006, and $248.7 million in aggregate principal amount of 2008 notes were tendered in the tender offer, representing 99.5% of the then outstanding aggregate principal amount of 2008 notes. The tender consideration was 100% of the principal amount of 2008 notes validly tendered plus accrued but unpaid interest to, but not including, May 26, 2006. The Company paid a total consideration of $253.9 million for the tendered 2008 notes and accrued interest. The proceeds from the sale of the 2014 notes were used to fund, in part, the purchase price for the tendered 2008 notes. The $1.3 million in aggregate principal amount of 2008 notes that were not tendered and purchased in the tender offer remain outstanding in accordance with their amended terms.
 
On May 26, 2006 the Company issued $190 million in aggregate principal amount of 2014 notes. Interest is payable on the notes on May 15 and November 15 of each year, beginning on November 15, 2006. The 2014 notes are unconditionally guaranteed on a senior, secured basis by each of the Company’s existing and future restricted domestic subsidiaries. The 2014 notes and guarantees are secured by first-priority liens, subject to permitted liens, on substantially all of the Company’s and the Company’s subsidiary guarantors’ assets (other than the assets securing the Company’s obligations under its amended revolving credit facility on a first-priority basis, which consist primarily of accounts receivable and inventory), including, but not limited to, property, plant and equipment, the capital stock of the Company’s domestic subsidiaries and certain of the Company’s joint ventures and up to 65% of the voting stock of the Company’s first-tier foreign subsidiaries, whether now owned or hereafter acquired, except for certain excluded assets. The 2014 notes and guarantees are secured by second-priority liens, subject to permitted liens, on the Company and its subsidiary guarantors’ assets that secure the Company’s amended revolving credit facility on a first-priority basis. In connection with the issuance, the Company incurred $6.8 million in professional fees and other expenses which will be amortized to expense over the life of the 2014 notes. The estimated fair value of the 2014 notes, based on quoted market prices, at June 25, 2006 was approximately $182.4 million.


29


Table of Contents

Concurrently with the closing of the offering of the 2014 notes, the Company amended its existing senior secured asset-based revolving credit facility to extend its maturity to 2011, permit the 2014 notes offering, give the Company the ability to request that the borrowing capacity be increased up to $150 million under certain circumstances and revise some of its other terms and covenants. The Company drew $3.0 million under its amended revolving credit facility to fund, in part, the purchase price of the tendered 2008 notes. The remainder of the purchase price of the tender 2008 notes was funded with cash on hand of $55.7 million.
 
Key Performance Indicators
 
The Company continuously reviews performance indicators to measure its success. The following are the indicators management uses to assess performance of the Company’s business:
 
  •  sales volume, which are an indicator of demand;
 
  •  margins, which are an indicator of product mix and profitability;
 
  •  net loss before interest, taxes, depreciation and amortization and loss or income from discontinued operations (“EBITDA”), which is an indicator of its ability to pay debt; and
 
  •  working capital of each business unit as a percentage of sales, which is an indicator of its production efficiency and ability to manage its inventory and receivables.
 
Corporate Restructurings
 
Over the last three fiscal years, the Company has focused on reducing costs throughout its operations and continuing to improve working capital. The Company closed one of its air-jet texture operations in Altamahaw, North Carolina in mid-2004. The Company closed its dyed facility in Manchester, England, in June 2004. On July 28, 2004, the Company announced the closing of its European manufacturing operations and associated sales offices. The Company ceased its manufacturing operations in Ireland on October 31, 2004. The Company ceased all other European operations by June 2005 and sold the real property, plant and equipment of its European division in fiscal year 2005 and 2006 for total proceeds of $38.0 million that resulted in a net gain of approximately $4.6 million. In connection with these closings and consolidations, the Company significantly reduced its workforce. As a result, the Company incurred a restructuring charge of $27.7 million in fiscal year 2004 for employee severance costs, fixed asset write-offs associated with the closure of the dyed facility in Manchester and lease related costs associated with the closure of the air-jet texture operation in North Carolina. All payments, excluding lease related payments which continue until May 2008, have been paid and the Company reclassified the financial results of its UK and Ireland facilities as “discontinued operations” for all periods prescribed in its financial statements.
 
On October 19, 2004, the Company announced plans to close two production lines and downsize its facility in Kinston, North Carolina, which had been acquired in September 2004. During the second quarter of fiscal year 2005, the Company recorded a severance reserve of $10.7 million for approximately 500 production level employees and a restructuring reserve of $0.4 million for the cancellation of certain warehouse leases. The entire restructuring reserve was recorded as assumed liabilities in purchase accounting; and accordingly, was not recorded as a restructuring expense in the Company’s consolidated statements of operations. During the third quarter of fiscal year 2005, the Company completed the closure of both production lines as scheduled, which resulted in an actual reduction of 388 production level employees and a reduction to the initial restructuring reserve. Since no long-term assets or intangible assets were recorded in purchase accounting, the net reduction of $1.2 million was recorded as an extraordinary gain in fiscal year 2005. During the first quarter of fiscal year 2006, the Company determined that there were additional costs relating to the termination of two warehouse leases which resulted in a $0.2 million extraordinary loss. During the second quarter of fiscal year 2006, the Company negotiated a favorable settlement on the two warehouse leases that resulted in a reduction to the reserve and the recognition of an extraordinary gain of $0.2 million.
 
In fiscal year 2005, the Company closed its central distribution center in Mayodan, North Carolina, and moved the operations to its warehouse and logistics facilities in Yadkinville, North Carolina, and relocated one of its plants from Mayodan to Madison, North Carolina. In connection with this initiative, the Company determined to offer for


30


Table of Contents

sale a plant, a warehouse and a central distribution center (“CDC”) located in Mayodan. Based on appraisals received in September 2005, the Company determined that the warehouse was impaired and recorded an impairment charge of $1.5 million, which included $0.2 million in estimated selling costs that will be paid from the proceeds of the sale when it occurs. On March 13, 2006, the Company entered into a contract to sell the CDC and related land located in Mayodan, North Carolina. The terms of the contract call for a sale price of $2.7 million, which was approximately $0.7 million below the property’s carrying value. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” (“SFAS No. 144”) the Company recorded an impairment charge of approximately $0.8 million during the third quarter of fiscal year 2006 which included selling costs of $0.1 million. The sale of the CDC closed in the fourth quarter of fiscal 2006 with no further expense to the Company.
 
On July 28, 2005, the Company announced its decision to discontinue the operations of its external sourcing business, Unimatrix Americas, and as of the end of the third quarter fiscal year 2006, the Company had substantially liquidated the business resulting in the reclassification of the sourcing segment’s losses for the current and prior periods as discontinued operations. The sourcing segment was completely liquidated as of June 25, 2006.
 
On April 20, 2006, the Company re-organized its domestic business operations, and as a result, recorded a restructuring charge for severance of approximately $0.8 million in the fourth quarter of fiscal 2006. Approximately 45 management level salaried employees were affected by the plan of reorganization.
 
The table below summarizes changes to the accrued severance and accrued restructuring accounts for fiscal years 2006, 2005 and 2004 (in thousands):
 
                                         
    Balance at
    Additional
          Amounts
    Balance at
 
    June 26, 2005     Charges     Adjustments     Used     June 25, 2006  
 
Accrued severance
  $ 5,252     $ 812     $ 44     $ (5,532 )   $ 576  
Accrued restructuring
    5,053             (195 )     (1,308 )     3,550  
 
                                         
    Balance at
    Additional
          Amounts
    Balance at
 
    June 27, 2004     Charges     Adjustments     Used     June 26, 2005  
 
Accrued severance
  $ 2,949     $ 10,701     $ (834 )   $ (7,564 )   $ 5,252  
Accrued restructuring
    6,654       391       (695 )     (1,297 )     5,053  
 
                                         
    Balance at
    Additional
          Amounts
    Balance at
 
    June 29, 2003     Charges     Adjustments     Used     June 27, 2004  
 
Accrued severance
  $ 13,893     $ 7,847     $ (10 )   $ (18,781 )   $ 2,949  
Accrued restructuring
          6,739             (85 )     6,654  
 
Joint Ventures and Other Equity Investments
 
YUFI.  In August 2005, the Company formed YUFI, a 50/50 joint venture with Sinopec Yizheng Chemical Fiber Co., Ltd., or (“YCFC”), to manufacture, process and market polyester filament yarn in YCFC’s facilities in Yizheng, Jiangsu Province, China. YCFC is a publicly traded (listed in Shanghai and Hong Kong) enterprise with approximately $1.3 billion in annual sales. The Company believes that the addition of a high-quality, globally cost competitive operation in China allows the Company to pursue long-term, profitable revenue growth in Asia. By forming a joint venture with a long-established and highly respected fiber industry leader like YCFC, the Company also has an immediately accessible customer base in Asia at lower start-up costs and with fewer execution risks. The principal goal of YUFI is to supply premium value-added products to the Chinese market, which is currently an importer of such products. On August 4, 2005, the Company contributed to YUFI its initial capital contribution of $15.0 million in cash. On October 12, 2005, the Company transferred an additional $15.0 million in the form of shareholder loan with a thirteen month term to complete the capitalization of the joint venture. Effective July 25, 2006, the shareholder loan was converted to registered capital of the joint venture. During fiscal year 2006, the Company recognized equity losses relating to YUFI of $3.2 million which is reported net of elimination of intercompany support provided . The Company expects that YUFI will continue to incur losses for at least the next six months as it continues to transition the business from the sale of commodity products to value-added products which have a higher gross margin. In addition, the Company recognized $2.7 million in operating expenses for


31


Table of Contents

fiscal year 2006, which were primarily reflected on the “Cost of sales” line item in the consolidated statements of operations, directly related to providing technological support in accordance with the Company’s joint venture contract. The Company has granted YUFI an exclusive, non-transferable license to certain of its branded product technology (including Mynx®, Sorbtek®, Reflexx®, dye springs and other products) in China for a license fee of $6.0 million that is payable over four years.
 
PAL.  In June 1997, the Company contributed all of the assets of its spun cotton yarn operations, utilizing open-end and air jet spinning technologies, into PAL, a joint venture with Parkdale Mills, Inc. in exchange for a 34% ownership interest in the joint venture. PAL is a producer of cotton and synthetic yarns for sale to the textile and apparel industries primarily within North America. PAL has 14 manufacturing facilities primarily located in central and western North Carolina. The Company’s investment in PAL at June 25, 2006 was $140.9 million. For the fiscal years 2006, 2005, and 2004, the Company reported equity income (loss) of $3.8 million, $6.4 million, and $(6.9) million, respectively, from PAL. The Company is currently exploring ways to monetize its interest in PAL.
 
USTF.  On September 13, 2000, the Company formed USTF a 50/50 joint venture with SANS Fibres of South Africa (“SANS Fibres”), to produce low-shrinkage high tenacity nylon 6.6 light denier industrial, or “LDI” yarns in North Carolina. The business is operated in its plant in Stoneville, North Carolina. The Company manages the day-to-day production and shipping of the LDI produced in North Carolina and SANS Fibres handles technical support and sales. Sales from this entity are primarily to customers in the Americas. For the fiscal years 2006, 2005, and 2004, the Company reported equity income (loss) of $0.8 million, $(0.1) million and $(1.3) million, respectively, from USTF. The Company has a put right under this agreement to sell its entire interest in the joint venture at fair market value and the related Stoneville, North Carolina manufacturing facility for $3.0 million (or fair market value if the sale is consummated after March 2011) in cash to SANS Fibres. This right can be exercised beginning on December 31, 2006 upon one year’s prior written notice. SANS Fibres has a call option upon the same terms as the Company’s put right.
 
UNF.  On September 27, 2000, The Company formed UNF a 50/50 joint venture with Nilit, which produces nylon POY at Nilit’s manufacturing facility in Migdal Ha-Emek, Israel, that is its primary source of nylon POY for its texturing and covering operations. The Company has entered into a supply agreement, on customary terms, with UNF which expires in April 2008 pursuant to which the Company has agreed to purchase from UNF all of the nylon POY produced from three dedicated production lines at a rate determined by index prices, subject to certain adjustments for market downturns. This vertical integration allows the Company to realize advantageous raw material pricing in its domestic nylon operations. The Company’s investment in UNF at June 25, 2006 was $6.3 million. For the fiscal years 2006, 2005, and 2004, the Company reported income (losses) in equity investees of $(0.8) million, $0.7 million, and $1.1 million, respectively, from UNF.
 
Condensed balance sheet information as of June 25, 2006 and June 26, 2005, and income statement information for fiscal years 2006, 2005 and 2004, of combined unconsolidated equity affiliates were as follows (in thousands):
 
                 
    June 25, 2006     June 26, 2005  
 
Current assets
  $ 149,278     $ 127,188  
Noncurrent assets
    217,955       176,265  
Current liabilities
    48,334       28,235  
Noncurrent liabilities
    44,460       18,840  
Shareholders’ equity and capital accounts
    274,439       256,378  
 
                         
    Fiscal Years Ended  
    June 25, 2006     June 26, 2005     June 27, 2004  
 
Net sales
  $ 567,223     $ 471,786     $ 469,512  
Gross profit
    31,853       40,312       7,880  
Income (loss) from continuing operations
    8,435       16,991       (15,928 )
Net income (loss)
    6,279       14,003       (20,183 )


32


Table of Contents

UTP.  Minority interest (income) expense was $0.0 million, $(0.5) million and $(6.4) million, respectively, for fiscal year 2006, 2005 and 2004. The minority interest (income) expense recorded in the consolidated statements of operations for the fiscal year 2006, 2005 and 2004 primarily relates to the minority owner’s share of the earnings of UTP. The Company had an 85.4% ownership interest in UTP and Burlington Industries, LLC had a 14.6% interest in UTP. In April 2005, the Company acquired ITG’s ownership interest in UTP for $0.9 million in cash.
 
Review of Fiscal Year 2006 Results of Operations (52 Weeks) Compared to Fiscal Year 2005 (52 Weeks)
 
The following table sets forth the loss from continuing operations components for each of the Company’s business segments for fiscal year 2006 and fiscal year 2005. The table also sets forth each of the segments’ net sales as a percent to total net sales, the net income components as a percent to total net sales and the percentage increase or decrease of such components over the prior year:
 
                                         
    Fiscal Year 2006     Fiscal Year 2005        
          % to
          % to
       
          Total           Total     % Inc. (Dec.)  
    (Amounts in thousands, except percentages)  
Consolidated
                                       
Net sales
                                       
Polyester
  $ 566,367       76.7     $ 587,008       73.9       (3.5 )
Nylon
    172,458       23.3       206,788       26.1       (16.6 )
                                         
Total
  $ 738,825       100.0     $ 793,796       100.0       (6.9 )
                                         
 
                                         
          % to
          % to
       
          Net Sales           Net Sales        
Cost of sales
                                       
Polyester
  $ 527,354       71.4     $ 558,498       70.4       (5.6 )
Nylon
    168,701       22.8       204,219       25.7       (17.4 )
                                         
Total
    696,055       94.2       762,717       96.1       (8.7 )
Selling, general and administrative
                                       
Polyester
    32,771       4.4       30,291       3.8       8.2  
Nylon
    8,763       1.2       11,920       1.5       (26.5 )
                                         
Total
    41,534       5.6       42,211       5.3       (1.6 )
Restructuring charges (recovery)
                                       
Polyester
    533       0.1       (212 )           (351.4 )
Nylon
    (787 )     (0.1 )     (129 )           510.1  
                                         
Total
    (254 )     0.0       (341 )           (25.5 )
Write down of long-lived assets
                                       
Polyester
    51                         100.0  
Nylon
    2,315       0.3       603       0.1       283.9  
                                         
Total
    2,366       0.3       603       0.1       292.4  
Other (income) expenses
    15,020       2.0       21,827       2.7       (31.2 )
                                         
Loss from continuing operations before income taxes
    (15,896 )     (2.1 )     (33,221 )     (4.2 )     (52.2 )
Benefit for income taxes
    (1,170 )     (0.2 )     (13,483 )     (1.7 )     (91.3 )
                                         
Loss from continuing operations
    (14,726 )     (1.9 )     (19,738 )     (2.5 )     (25.4 )
Income (loss) from discontinued operations, net of tax
    360             (22,644 )     (2.9 )     (101.6 )
Extraordinary gain — net of taxes of $0
                1,157       0.1       (100.0 )
                                         
Net loss
  $ (14,366 )     (1.9 )   $ (41,225 )     (5.2 )     (65.2 )
                                         


33


Table of Contents

For the fiscal year 2006, the Company recognized a $15.9 million loss from continuing operations before income taxes which was a $17.3 million improvement from the prior year. The improvement in continuing operations was primarily attributable to increased polyester conversion margins, decreased selling, general and administrative expenses, reduced charges of $11.9 million for bad debt expenses offset by asset impairment charges and debt extinguishment expenses. The last-in, first-out (“LIFO”) reserve increased $3.9 million for fiscal year 2006 compared to $2.4 million for the prior fiscal year. During fiscal year 2006 raw material prices increased for polyester ingredients in POY whereas in fiscal year 2005 the primary drivers to the LIFO reserve were increases in nylon raw material prices and higher values in the nylon inventories due to the product mix.
 
Consolidated net sales from continuing operations decreased from $793.8 million to $738.8 million, or 6.9%, for the current fiscal year. For the fiscal year 2006, the weighted average price per pound for the Company’s products on a consolidated basis increased 6.1% compared to the prior year. Unit volume from continuing operations decreased 13.0% for the fiscal year primarily due to management’s decision to focus on profitable business as well as market conditions.
 
At the segment level, polyester dollar net sales accounted for 76.7% in fiscal year 2006 compared to 73.9% in fiscal year 2005. Nylon accounted for 23.3% of dollar net sales for fiscal year 2006 compared to 26.1% for the prior fiscal year.
 
Gross profit from continuing operations increased $11.7 million to $42.8 million for fiscal year 2006. This increase is primarily attributable to higher average selling prices for both the polyester and nylon segments.
 
Selling, general, and administrative expenses decreased by 1.6% or $0.7 million for the fiscal year. The decrease in selling, general, and administrative expenses is due to the downsizing of the Company’s corporate departments and their related costs. During the fiscal year 2005, the Company incurred approximately $1.1 million in professional fees associated with its efforts in becoming compliant with the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). During the fiscal year 2006, the Company incurred $0.3 million in professional fees associated with Sarbanes-Oxley 404.
 
For the fiscal year 2006, the Company recorded a $1.3 million provision for bad debts. This compares to $13.1 million recorded in the prior fiscal year. The decrease relates to the Company’s domestic operations and is primarily due to the write off of one customer who filed bankruptcy in May 2005 resulting in $8.2 million in additional bad debt expense. Although the Company experienced significant improvements in its collections during fiscal year 2006, the financial viability of certain customers continue to require close management scrutiny. Management believes that its reserve for uncollectible accounts receivable is adequate.
 
Interest expense decreased from $20.6 million in fiscal year 2005 to $19.2 million in fiscal year 2006. The decrease in interest expense is primarily due to the payment by the Company of a notes payable relating to the Kinston acquisition. The Company had no outstanding borrowings under its amended revolving credit facility as of June 25, 2006 or its old credit facility as of June 26, 2005. The weighted average interest rate of Company debt outstanding at June 25, 2006 and June 26, 2005 was 6.9% and 6.7%, respectively. Interest income increased from $2.1 million in fiscal year 2005 to $4.5 million in fiscal year 2006 which was due to the increased cash position that the Company maintained throughout most of fiscal year 2006.
 
Other (income) expense increased from $2.3 million of income in fiscal year 2005 to $3.1 million of income in fiscal year 2006. Fiscal year 2006 other income includes net gains from the sale of property and equipment of $1.8 million, offset by charges relating to currency translations and other expenses of $0.7 million. Fiscal year 2005 other income includes net gains from the sale of property and equipment of $1.8 million and net unrealized gains on hedging contracts of $1.7 million; offset by charges relating to currency translations and other expenses of $0.9 million.
 
Equity in the net income of its equity affiliates, PAL, USTF, UNF, and YUFI was $0.8 million in fiscal year 2006 compared to equity in net income of $6.9 million in fiscal year 2005. The decrease in earnings is primarily attributable to the $3.2 million loss that the Company incurred on its newly acquired investment in YUFI as discussed above. The Company’s share of PAL’s earnings decreased from a $6.4 million income in fiscal year 2005 to $3.8 million of income in fiscal year 2006. PAL realized net losses on cotton futures contracts of $1.4 million for


34


Table of Contents

fiscal year 2006 compared to $1.4 million in realized net gains for fiscal year 2005. The Company expects to continue to receive cash distributions from PAL.
 
The Company recorded no minority interest income for fiscal year 2006 compared to minority interest income of $0.5 million in the fiscal year 2005. Minority interest recorded in the Company’s Consolidated Statements of Operations primarily relates to the minority owner’s share of the earnings of UTP. The Company had an 85.4% ownership interest and ITG, had a 14.6% interest in UTP. In April 2005, the Company acquired ITG’s ownership interest for $0.9 million in cash.
 
In fiscal year 2006, the Company’s nylon segment recorded charges of $2.3 million to write down to fair value less cost to sell a nylon manufacturing plant and a nylon warehouse. In the fourth quarter of fiscal year 2005, the Company’s nylon segment recorded a $0.6 million charge to write down to fair value less cost to sell 166 textile machines that are held for sale.
 
The Company has established a valuation allowance against its deferred tax assets relating primarily to North Carolina income tax credits. The valuation allowance decreased $1.7 million in fiscal year 2006 compared to a decrease of $2.2 million in fiscal year 2005. The gross decrease of $3.6 million in fiscal year 2006 consisted of the expiration of unused North Carolina income tax credits. The gross decrease of $3.0 million in fiscal year 2005 consisted of the expiration of unused North Carolina income tax credits of $2.2 million and the expiration of a long-term capital loss carryforward of $0.8 million. Due to lower estimates of future state taxable income, the portion of the valuation allowance that relates to North Carolina income tax credits increased $1.9 million and $0.8 million in fiscal years 2006 and 2005, respectively. The net impact of changes in the valuation allowance to the effective tax rate reconciliation for fiscal years 2006 and 2005 were 11.9% and 2.5%, respectively. The percentage increase from fiscal year 2006 to fiscal year 2005 was primarily attributable to lower forecasted state taxable income.
 
The Company recognized an income tax benefit in fiscal year 2006, at a 7.4% effective tax rate, compared to an income tax benefit, at a 40.6% effective tax rate, in fiscal year 2005. The fiscal year 2006 effective rate was negatively impacted by foreign losses for which no tax benefit was recognized, the change in the deferred tax valuation allowance and tax expense not previously accrued for repatriation of foreign earnings. In fiscal year 2006, the Company recognized a state income tax benefit net of federal income tax of 10.4% as compared to 4.2% in fiscal year 2005. The increase in fiscal year 2006 was primarily attributable to the pass through of $1.2 million of state income tax credits from an equity affiliate.
 
With respect to repatriation of foreign earnings, the American Jobs Creation Act of 2004 (the “AJCA”) created a temporary incentive for U.S. multinational corporations to repatriate accumulated income earned outside the U.S. by providing an 85% dividend received deduction for certain dividends from controlled foreign corporations. According to the AJCA, the amount of eligible repatriation was limited to $500 million or the amount described as permanently reinvested earnings outside the U.S. in the most recent audited financial statements filed with the SEC on or before June 30, 2003. Dividends received must be reinvested in the U.S. in certain permitted uses. The Company repatriated $31 million in fiscal year 2006 resulting from approximately $45 million of proceeds from the liquidation of its European manufacturing operations less approximately $30 million re-invested in YUFI as well as $16 million of accumulated income earned by its Brazilian manufacturing operation. The Company has not made any changes to its position on the reinvestment of other foreign earnings.


35


Table of Contents

The following summarizes the results of the above and the prior year after restatements:
 
                 
    Fiscal Year 2006     Fiscal Year 2005  
 
Loss from continuing operations before extraordinary item
  $ (14,726 )   $ (19,738 )
Income (loss) from discontinued operations, net of tax
    360       (22,644 )
                 
Loss before extraordinary item
    (14,366 )     (42,382 )
Extraordinary gain — net of taxes of $0
          1,157  
                 
Net loss
  $ (14,366 )   $ (41,225 )
                 
Income (losses) per common share (basic and diluted):
               
Loss from continuing operations before extraordinary item
  $ (.28 )   $ (.38 )
Loss from discontinued operations, net of tax
          (.43 )
Extraordinary gain — net of taxes of $0
          .02  
                 
Net loss per common share
  $ (.28 )   $ (.79 )
                 
 
Polyester Operations
 
The following table sets forth the segment operating gain (loss) components for the polyester segment for fiscal year 2006 and fiscal year 2005. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:
 
                                         
    Fiscal Year 2006     Fiscal Year 2005        
          % to
          % to
       
          Net Sales           Net Sales     % Inc. (Dec.)  
    (Amounts in thousands, except percentages)  
 
Net sales
  $ 566,367       100.0     $ 587,008       100.0       (3.5 )
Cost of sales
    527,354       93.1       558,498       95.1       (5.6 )
Selling, general and administrative expenses
    32,771       5.8       30,291       5.2       8.2  
Restructuring charges (recovery)
    533       0.1       (212 )           (351.4 )
Write down of long-lived assets
    51                          
                                         
Segment operating income (loss)
  $ 5,658       1.0     $ (1,569 )     (0.3 )     (460.6 )
                                         
 
Fiscal year 2006 polyester net sales decreased $20.6 million, or 3.5% compared to fiscal year 2005. The Company’s polyester segment sales volumes decreased approximately 11.8% while the weighted-average unit prices increased approximately 8.3%.
 
Domestically, polyester sales volumes decreased 15.2% while average unit prices increased approximately 8.7%. Sales from the Company’s Brazilian texturing operation, on a local currency basis, decreased 11.2% over fiscal year 2005 due primarily to the devaluation of the U.S. dollar against the Brazilian Real. The Brazilian texturing operation predominately purchased all of its fiber in U.S. dollars. The impact on net sales from this operation on a U.S. dollar basis as a result of the change in currency exchange rate was an increase of $17.2 million in fiscal year 2006.
 
Gross profit on sales for the polyester operations increased $10.5 million, or 36.8%, over fiscal year 2005, and gross margin (gross profit as a percentage of net sales) increased from 4.9% in fiscal year 2005 to 6.9% in fiscal year 2006. The increase from the prior year is primarily attributable to an increase in higher average selling prices as well as costs savings realized from the consolidation of warehousing and transportation services, and the curtailment of two POY production lines at the Kinston facility. In addition, fiber cost decreased as a percent of net sales from 54.8% in fiscal year 2005 to 52.4% in fiscal year 2006.
 
Selling, general and administrative expenses for the polyester segment increased $2.5 million from fiscal years 2005 to 2006. While the methodology to allocate domestic selling, general and administrative costs remained consistent between fiscal year 2005 and fiscal year 2006, the percentage of such costs allocated to each segment are determined at the beginning of every year based on specific cost drivers. The polyester segment had a higher percentage in fiscal year 2006 compared to fiscal year 2005 due to the addition of the Kinston manufacturing operations to the polyester segment.


36


Table of Contents

The polyester segment net sales, gross profit and selling, general and administrative expenses as a percentage of total consolidated amounts were 73.9%, 91.7% and 71.8% for fiscal year 2005 compared to 76.7%, 91.2% and 78.9% for fiscal year 2006, respectively.
 
Restructuring charges of $0.5 million in fiscal year 2006 were related to adjustments for severance, retiree reserves and charges related to the polyester segment of Unifi Latin America.
 
The Company’s international polyester pre-tax results of operations for the polyester segment’s Brazilian location increased $0.2 million in fiscal year 2006 over fiscal year 2005. This increase is primarily due to a $0.9 million increase in interest income, a $0.2 million reduction in bad debt expense, a $1.1 million increase in Other (income) expense, net offset by a $0.9 million reduction in gross margin and a $1.1 million increase in selling, general and administrative costs.
 
Nylon Operations
 
The following table sets forth the segment operating loss components for the nylon segment for fiscal year 2006 and fiscal year 2005. The table also sets forth the percent to net sales and the percentage increase or decrease over fiscal year 2005:
 
                                         
    Fiscal Year 2006     Fiscal Year 2005        
          % to
          % to
       
          Net Sales           Net Sales     % Inc. (Dec.)  
    (Amounts in thousands, except percentages)  
 
Net sales
  $ 172,458       100.0     $ 206,788       100.0       (16.6 )
Cost of sales
    168,701       97.8       204,219       98.8       (17.4 )
Selling, general and administrative expenses
    8,763       5.1       11,920       5.8       (26.5 )
Restructuring charges (recovery)
    (787 )     (0.4 )     (129 )     (0.1 )     510.1  
Write down of long-lived assets
    2,315       1.3       603       0.3       283.9  
                                         
Segment operating loss
  $ (6,534 )     (3.8 )   $ (9,825 )     (4.8 )     (33.5 )
                                         
 
Fiscal year 2006 nylon net sales decreased $34.3 million, or 16.6% compared to fiscal year 2005. Unit volumes for fiscal year 2006 decreased 23.4% while the average selling price increased 6.9%. Weighted-average selling prices increased in fiscal year 2006 due to a greater percentage of higher priced products being sold and to sales price increases instituted during the third quarter.
 
Gross profit increased $1.2 million, or 46.2% in fiscal year 2006 and gross margin increased from 1.2% in fiscal year 2005 to 2.2% in fiscal year 2006. This was primarily attributable to higher per unit sales prices, cost savings associated with closing a central distribution center, and closing two nylon manufacturing facilities. Fiber costs decreased from 64.5% of net sales in fiscal year 2005 to 60.1% of net sales in fiscal year 2006 due to the incremental change in product mix driven by the Company’s supply agreement with Sara Lee Branded Apparel and the continued price increases. Fixed and variable manufacturing costs increased as a percentage of sales from 30.6% in fiscal year 2005 to 35.5% in fiscal year 2006.
 
Selling, general and administrative expenses for the nylon segment decreased $3.1 million in fiscal year 2006. This decrease as a percentage of net sales is primarily due to a reduced allocation percentage of selling, general and administrative expenses to the nylon segment due to additional business from the polyester Kinston manufacturing operation.
 
The nylon segment net sales, gross profit and selling, general and administrative expenses as a percentage of total consolidated amounts were 26.1%, 8.3% and 28.2% for fiscal year 2005 compared to 23.3%, 8.8% and 21.1% for fiscal year 2006, respectively.
 
Restructuring recoveries of $0.8 million in fiscal year 2006 were related to adjustments for severance, retiree reserves and recoveries of 2001 reserves related to the nylon segment of Unifi Latin America.
 
See “— Corporate Restructurings” above for a discussion of the Company’s restructurings of its nylon facilities in North Carolina.


37


Table of Contents

Review of Fiscal Year 2005 Results of Operations (52 Weeks) Compared to Fiscal Year 2004 (52 Weeks)
 
The following table sets forth the loss from continuing operations components for each of the Company’s business segments for fiscal year 2005 and fiscal year 2004. The table also sets forth each of the segments’ net sales as a percent to total net sales, the net income components as a percent to total net sales and the percentage increase or decrease of such components over the prior year:
 
                                         
    Fiscal Year 2005     Fiscal Year 2004        
          % to
          %
       
          Total           to Total     % Inc. (Dec.)  
    (Amounts in thousands, except percentages)  
 
Consolidated
                                       
Net sales
                                       
Polyester
  $ 587,008       73.9     $ 481,847       72.3       21.8  
Nylon
    206,788       26.1       184,536       27.7       12.1  
                                         
Total
  $ 793,796       100.0     $ 666,383       100.0       19.1  
                                         
 
                                         
          % to
          % to
       
          Net Sales           Net Sales        
 
Cost of sales
                                       
Polyester
  $ 558,498       70.4     $ 449,121       67.4       24.4  
Nylon
    204,219       25.7       176,862       26.5       15.5  
                                         
Total
    762,717       96.1       625,983       93.9       21.8  
Selling, general and administrative
                                       
Polyester
    30,291       3.8       34,835       5.2       (13.0 )
Nylon
    11,920       1.5       11,128       1.7       7.1  
                                         
Total
    42,211       5.3       45,963       6.9       (8.2 )
Restructuring charges (recovery)
                                       
Polyester
    (212 )           7,591       1.1        
Nylon
    (129 )           638       0.1        
                                         
Total
    (341 )           8,229       1.2        
Arbitration costs and expense
                                       
Polyester
                182              
Alliance plant closure costs (recovery)
                                       
Polyester
                (206 )            
Write down of long-lived assets
                                       
Polyester
                25,241       3.8        
Nylon
    603       0.1                    
                                         
Total
    603       0.1       25,241       3.8       (97.6 )
Goodwill impairment
                                       
Polyester
                13,461       2.0        
Other (income) expenses
    21,827       2.7       16,792       2.5       30.0  
                                         
Loss from continuing operations before income taxes
    (33,221 )     (4.2 )     (69,292 )     (10.4 )     (52.0 )
Benefit for income taxes
    (13,483 )     (1.7 )     (25,113 )     (3.8 )     (46.3 )
                                         
Loss from continuing operations
    (19,738 )     (2.5 )     (44,149 )     (6.6 )     (55.3 )
Loss from discontinued operations, net of tax
    (22,644 )     (2.9 )     (25,644 )     (3.8 )     (11.7 )
Extraordinary gain — net of taxes of $0
    1,157       0.1                    
                                         
Net loss
  $ (41,225 )     (5.2 )   $ (69,793 )     (10.5 )     (40.9 )
                                         


38


Table of Contents

For fiscal year 2005, the Company recognized a $33.2 million loss from continuing operations before income taxes, which was a $36.0 million improvement from fiscal year 2004. The improvement in continuing operations was primarily attributable to $38.7 million in charges for asset write downs and goodwill impairment included in fiscal year 2004 that did not occur in 2005, consisted of a $25.2 million impairment of fixed assets in its domestic polyester segment and the writedown of $13.5 million of goodwill related to UTP. During fiscal year 2005, raw material prices declined slightly and selling prices increased slightly due in part to efforts to improve gross margin.
 
Consolidated net sales from continuing operations increased from $666.4 million to $793.8 million, or 19.1%, for fiscal year 2005. Included in fiscal year 2005 net sales amounts are $117.7 million related to revenue generated from the Kinston acquisition. Unit volume from continuing operations increased 19.6% for the year, while average net selling prices decreased by 0.4%. The primary driver of the increase in unit volumes is the Kinston acquisition. The increase in net selling price was reduced by 10.5% due to the Kinston operation which sold lower priced commodity products. See the polyester segment discussion below for further analysis on the effects of the Kinston acquisition on fiscal year 2005.
 
At the segment level, polyester dollar net sales accounted for 73.9% of consolidated net sales in fiscal year 2005 compared to 72.3% in fiscal year 2004. Nylon accounted for 26.1% of consolidated net sales for fiscal year 2005 compared to 27.7% for fiscal year 2004.
 
Gross profit from continuing operations decreased $9.3 million to $31.1 million for fiscal year 2005. This decrease is primarily attributable to higher volumes and lower average selling prices for the nylon segment resulting from a change in product mix from high-volume to premium value-added products and the polyester segment resulting from the Kinston acquisition and a delay in passing increased fiber prices to customers during the first half of fiscal year 2005. The Company also recognized, as a reduction of cost of sales, cost savings and other benefits from its alliance with DuPont at the Kinston facility of $8.4 million in fiscal year 2005 compared to $38.2 million in fiscal year 2004. In addition, the Company sold off inventory during the fourth quarter of fiscal year 2005 that was slow moving at below cost in order to reduce its inventories and improve its working capital position, which resulted in a $3.1 million loss in fiscal year 2005.
 
Selling, general, and administrative expenses decreased by 8.2% or $3.8 million for fiscal year 2005. The decrease in selling, general, and administrative expenses was due to the downsizing of the Company’s corporate departments and reducing its related costs. During fiscal year 2005, the Company incurred approximately $1.1 million in professional fees associated with its efforts in becoming compliant with the Sarbanes-Oxley.
 
For fiscal year 2005, the Company recorded a $13.2 million provision for bad debts, compared to $2.4 million recorded in fiscal year 2004. The increase relates to its domestic operations and is primarily due to the write off of debts of one customer who filed for bankruptcy in May 2005, resulting in $8.2 million in additional bad debt expense. Fiscal year 2005 continued to be a challenging year for the U.S. textile industry, particularly in the apparel sector. The financial viability of certain customers continued to require close management scrutiny. Management believes that the reserve for uncollectible accounts receivable is adequate.
 
Interest expense increased from $18.7 million in fiscal year 2004 to $20.6 million in fiscal year 2005. The increase in interest expense was primarily due to the interest payable on the notes the Company issued to the seller in the Kinston acquisition. The Company had no outstanding borrowings on its old credit facility at June 26, 2005 and June 27, 2004, and had no borrowings on this facility since October 3, 2002. The weighted average interest rate of its debt outstanding at June 26, 2005 and June 27, 2004 was 6.7% and 6.4%, respectively. Interest income remained at $2.2 million in fiscal year 2004 and $2.2 million in fiscal year 2005.
 
Other (income) expense decreased from $2.6 million of income in fiscal year 2004 to $2.3 million of income in fiscal year 2005. Fiscal year 2004 income included net gains from the sale of property and equipment of $3.2 million, offset by other expenses of $0.7 million. Fiscal year 2005 income includes net gains from the sale of property and equipment of $1.8 million and net unrealized gains on hedging contracts of $1.7 million, offset by charges relating to currency translations and other expenses of $0.9 million.
 
Equity in the net income of the Company’s equity affiliates, PAL, USTF and UNF, totaled $6.9 million in fiscal year 2005 compared to equity in net loss of $6.9 million in fiscal year 2004. The Company’s share of PAL’s earnings improved from a $6.9 million loss in fiscal year 2004 to $6.4 million of income in fiscal year 2005. The increase in


39


Table of Contents

earnings is primarily attributable to PAL’s higher operating profit due primarily to lower cotton prices and realized net gains on cotton futures contracts. PAL realized gains on future contracts of $1.4 million in fiscal year 2005 compared to net losses of $4.7 million on future contracts for cotton purchases in fiscal year 2004. PAL reported net income of $8.2 million in calendar year 2005 as compared to a net loss of $9.8 million in calendar year 2004. As a result of this financial improvement, the Company expects to continue to receive cash distributions from PAL.
 
The Company recorded minority interest income of $0.5 million for fiscal year 2005 compared to minority interest income of $6.4 million in fiscal year 2004. Minority interest recorded in its consolidated statements of operations primarily relates to the minority owner’s share of the earnings of UTP. See “— Joint Ventures and Other Equity Investments.”
 
In the fourth quarter of fiscal year 2005, the nylon segment recorded a $0.6 million charge to write down to fair value less cost to sell 166 textile machines that are held for sale.
 
The Company has established a valuation allowance against its deferred tax assets relating primarily to North Carolina income tax credits. The valuation allowance decreased $2.2 million in fiscal year 2005 compared to an increase of $2.6 million in fiscal year 2004. The gross decrease of $3.0 million in fiscal year 2005 consisted of the expiration of unused North Carolina income tax credits of $2.2 million and the expiration of a long-term capital loss carry forward of $0.8 million. Due to lower estimates of future state taxable income, the portion of the valuation allowance that relates to North Carolina income tax credits increased $0.8 million and $2.6 million in fiscal years 2005 and 2004, respectively. In fiscal year 2004, the increase to the reserve also included $0.8 million that related to a long-term capital loss carry forward that the Company did not expect to utilize before it was scheduled to expire in fiscal year 2005. The net impact of changes in the valuation allowance to the effective tax rate reconciliation for fiscal years 2005 and 2004 were 2.5% and 5.7%, respectively. The percentage decrease from fiscal year 2005 to fiscal year 2004 is primarily attributable to the stabilization of forecasted state taxable income.
 
The Company recognized an income tax benefit in fiscal year 2005 at a 40.6% effective tax rate compared to an income tax benefit at a 36.3% effective tax rate in fiscal year 2004. Fiscal year 2005 effective rate was positively impacted by a reduction in the change to the valuation allowance, an increase in the utilization of state tax losses and a change in the tax status of a subsidiary. Fiscal year 2005 effective rate was also positively impacted by the recording of a deferred tax asset for a foreign subsidiary that should have been previously recognized. The Company recorded this deferred tax asset of $1.2 million in the fourth quarter of fiscal year 2005. The Company evaluated the effect of the adjustment and determined that the differences were not material for any of the periods presented in its consolidated financial statements. Fiscal year 2005 effective tax rate was negatively impacted by the accrual required by management’s decision to repatriate approximately $15.0 million from controlled foreign corporations under the provisions of the AJCA.
 
The following summarizes the results of the above and the prior year after restatements:
 
                 
    Fiscal Year 2005     Fiscal Year 2004  
 
Loss from continuing operations before extraordinary item
  $ (19,738 )   $ (44,149 )
Loss from discontinued operations, net of tax
    (22,644 )     (25,644 )
                 
Loss before extraordinary item
    (42,382 )     (69,793 )
Extraordinary gain — net of taxes of $0
    1,157        
                 
Net loss
  $ (41,225 )   $ (69,793 )
                 
Income (losses) per common share (basic and diluted):
               
Loss from continuing operations before extraordinary item
  $ (.38 )   $ (.85 )
Loss from discontinued operations, net of tax
    (.43 )     (.49 )
Extraordinary gain — net of taxes of $0
    .02        
                 
Net loss per common share
  $ (.79 )   $ (1.34 )
                 


40


Table of Contents

Polyester Operations
 
The following table sets forth the segment operating loss components for the polyester segment for fiscal year 2005 and fiscal year 2004. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:
 
                                         
    Fiscal Year 2005     Fiscal Year 2004        
          % to
          % to
       
          Net Sales           Net Sales     % Inc. (Dec.)  
    (Amounts in thousands, except percentages)  
 
Net sales
  $ 587,008       100.0     $ 481,847       100.0       21.8  
Cost of sales
    558,498       95.1       449,121       93.2       24.4  
Selling, general and administrative
    30,291       5.2       34,835       7.2       (13.0 )
Restructuring charges (recovery)
    (212 )           7,591       1.6       (102.8 )
Arbitration costs and expenses
                182              
Alliance plant closure costs (recovery)
                (206 )            
Write down of long-lived assets
                25,241       5.2        
Goodwill impairment
                13,461       2.8        
                                         
Segment operating loss
  $ (1,569 )     (0.3 )   $ (48,378 )     (10.0 )     (96.8 )
                                         
 
Fiscal year 2005 polyester net sales increased $105.2 million, or 21.8%, compared to fiscal year 2004. The polyester segment sales volumes and average unit prices increased approximately 21.3% and 0.5%, respectively. The increase was due mainly to the Kinston acquisition on September 30, 2004, which contributed $77.9 million of net sales that were realized in the second half of fiscal year 2005.
 
Domestically, polyester sales volumes increased 28.3% while average unit prices declined approximately 4.5%. Sales from the Company’s Brazilian texturing operation, on a local currency basis, increased 3.7% over fiscal year 2004 due primarily to sales price adjustments for changes in the inflation index which were significant during fiscal year 2005. The impact on net sales from this operation on a U.S. dollar basis as a result of the change in currency exchange rate was an increase of $6.1 million.
 
Gross profit on sales for the polyester operations decreased $4.2 million, or 12.9%, over fiscal year 2004, while gross margin (gross profit as a percentage of net sales) declined from 6.8% in fiscal year 2004 to 4.9% in fiscal year 2005. These decreases were primarily attributable to an increase in fixed and variable manufacturing costs which were 38.4% of net sales in fiscal year 2005 compared to 37.5% of net sales in fiscal year 2004. In addition, fiber cost increased as a percent of net sales from 52.6% in fiscal year 2004 to 54.8% in fiscal year 2005. The Company also recognized, as a reduction of cost of sales, cost savings and other benefits from the alliance with DuPont of $8.4 million and $38.2 million for fiscal years 2005 and 2004, respectively. Following the Kinston acquisition, the benefits to the Company from its alliance with DuPont ended.
 
Selling, general and administrative expenses for this segment decreased $4.5 million from fiscal year 2004 to fiscal year 2005. While the methodology to allocate domestic selling, general and administrative costs remains consistent between fiscal year 2004 and fiscal year 2005, the percentage of such costs allocated to each segment is determined at the beginning of every year based on specific cost drivers. The polyester segment’s share of these costs for fiscal year 2005 was lower compared to fiscal year 2004 due to increases in the nylon segment’s share of these cost drivers.
 
The polyester segment net sales, gross profit and selling, general and administrative expenses for fiscal year 2005 were 73.9%, 91.7% and 71.8%, respectively, of consolidated amounts compared to 72.3%, 81.0% and 75.8%, respectively, for fiscal year 2004.
 
Restructuring charges of $7.6 million in fiscal year 2004 were primarily caused by relocation of the air jet texturing business from Altamahaw, North Carolina, to Yadkinville, North Carolina, which resulted in an accrual for future lease obligations. During the third quarter of fiscal year 2004, management performed impairment testing for the domestic textured polyester business due to the continued challenging business conditions and reduction in


41


Table of Contents

volume and gross profit in the preceding quarter. As a result, management determined that its plant, property and equipment were impaired, and the Company recorded a $25.2 million write down of the assets. As a result of the testing, the Company also recorded a goodwill impairment charge of $13.5 million in the third quarter of fiscal year 2004 to eliminate the polyester segment’s goodwill.
 
The Company’s international polyester pre-tax results of operations for the polyester segment’s Brazilian location declined $4.6 million in fiscal year 2005 over fiscal year 2004. This decline is primarily due to a 4.8% increase in the cost of fiber, a 4.5% decrease in volume and a $0.5 million increase in selling, general and administrative costs.
 
Nylon Operations
 
The following table sets forth the segment operating loss components for the nylon segment for fiscal year 2005 and fiscal year 2004. The table also sets forth the percent to net sales and the percentage increase or decrease over the prior year:
 
                                         
    Fiscal Year 2005     Fiscal Year 2004        
          % to
          % to
       
          Net sales           Net sales     % Inc. (Dec.)  
    (Amounts in thousands, except percentages)  
 
Net sales
  $ 206,788       100.0     $ 184,536       100.0       12.1  
Cost of sales
    204,219       98.8       176,862       95.8       15.5  
Selling, general and administrative
    11,920       5.8       11,128       6.0       7.1  
Restructuring charges (recovery)
    (129 )     (0.1 )     638       0.4       (120.2 )
Write down of long-lived assets
    603       0.3                    
                                         
Segment operating loss
  $ (9,825 )     (4.8 )   $ (4,092 )     (2.2 )     140.1  
                                         
 
Fiscal year 2005 nylon net sales increased $22.3 million, or 12.1%, compared to fiscal year 2004. Unit volumes for fiscal year 2005 increased 5.9% while the average selling price increased 6.2%. The Company acquired the Sara Lee hosiery yarn business for $2.6 million and completed the integration of its operations and sales volume during 2004. The Company entered in to a five-year branded apparel supply agreement with Sara Lee in April 2004. The increase in sales volume and price is primarily attributable to higher sales at retail resulting from the Sara Lee agreement. These incremental sales were offset by erosion in its U.S. customer base due primarily to an increase in the importation of socks into the domestic market and a decline in domestic demand for sheer hosiery products.
 
Gross profit for the nylon operations decreased $5.1 million, or 66.5%, over fiscal year 2004 while gross margin decreased from 4.2% in fiscal year 2004 to 1.2% in fiscal year 2005. These decreases are primarily attributable to reductions in per unit sales prices in excess of reduced unit costs for raw materials. Fiber costs increased from 62.0% of net sales in fiscal year 2004 to 64.5% of net sales in fiscal year 2005 due to the incremental change in product mix driven by the Sara Lee agreement. Fixed and variable manufacturing costs decreased as a percentage of sales from 30.9% in fiscal year 2004 to 30.6% in fiscal year 2005.
 
Selling, general and administrative expense for the nylon segment increased $0.8 million in fiscal year 2005. This increase is due to a significantly larger allocation of selling, general and administrative expenses based on cost drivers which were affected by increased sales volumes directly related to the Sara Lee agreement. The increase in volumes attributable to the Sara Lee agreement more than offset the overall reduction of selling, general and administrative expense that the Company realized.
 
The nylon segment net sales, gross profit and selling, general and administrative expenses for fiscal year 2005 were 26.1%, 8.3% and 28.2%, respectively, of consolidated amounts compared to 27.7%, 19.0% and 24.2%, respectively, for fiscal year 2004.
 
Restructuring expenses of $0.6 million in fiscal year 2004 were related to severance. In June 2005, the Company entered into a contract to sell 166 machines held by the nylon segment. As a result, a $0.6 million impairment of long-lived assets was recorded to write the assets down to their fair value less cost to sell.


42


Table of Contents

Liquidity and Capital Resources
 
Cash Provided by Continuing Operations
 
While the Company had a net loss in fiscal year 2006, the Company generated $30.1 million of cash from continuing operations in fiscal year 2006 primarily due to depreciation and amortization of $49.9 million, a decrease in accounts receivables of $10.6 million, an impairment charge of $2.4 million, loss from unconsolidated equity affiliates of $1.9 million, non-cash charges for the early extinguishment of debt of $1.8 million, a provision for bad debt of $1.3 million, other amounts of $1.8 million, and income taxes of $0.6 million, as compared to $28.8 million for fiscal year 2005. Cash uses from continuing operations included net loss from continuing operations of $14.4 million, reductions in accounts payable and accrued expenses of $8.5 million, decreases in deferred taxes of $7.7 million, higher inventories of $5.8 million, gains from the sale of capital assets of $1.8 million, increases in other current assets of $1.3 million, income from discontinued operations of $0.4 million and recoveries of restructuring charges of $0.3 million. The primary items affecting deferred taxes were depreciation in excess of federal tax depreciation, decreases in investments in equity affiliates, decreases in reserves for accounts receivable and severance, and increases in net operating losses which reduced the deferred tax obligation by $10.8 million, $3.6 million, $4.0 million and $2.7 million, respectively.
 
While the Company had a net loss in fiscal year 2005, it generated $28.8 million of cash from continuing operations in fiscal year 2005 primarily due to depreciation and amortization of $52.9 million, lower inventories of $20.6 million, a provision for bad debt of $13.2 million that was increased by the write-off of Collins & Aikman receivables, asset impairment charges of $0.6 million and income taxes of $0.2 million, as compared to $11.4 million for fiscal year 2004. Cash uses from continuing operations included net loss from continuing operations of $41.2 million, decreases in deferred taxes of $19.1 million, reductions in accounts payable and accrued expenses of $10.9 million, income from unconsolidated equity affiliates of $2.3 million, other amounts of $2.1 million, gains from the sale of capital assets of $1.8 million, increases in accounts receivable of $1.5 million and recoveries of restructuring charges of $0.3 million. The primary items affecting deferred taxes were depreciation in excess of federal tax depreciation, increases in reserves for accounts receivable and severance and increases in net operating losses which reduced the deferred tax obligation by $10.0 million, $3.6 million and $4.1 million, respectively. The decrease in inventories was primarily the result of our inventory reduction program in the fourth quarter of fiscal year 2005.
 
Cash provided by continuing operations was $11.4 million for fiscal year 2004 based on a net loss of $69.8 million. Non-cash components of the net loss were depreciation and amortization of $57.6 million, write-downs of long-lived assets of $25.2 million, goodwill impairment charges of $13.5 million, losses of unconsolidated equity affiliates of $8.7 million, non-cash restructuring charges of $7.2 million and the provision for bad debt of $2.4 million. Cash uses from continuing operations included a reduction of deferred taxes of $28.2 million, decreases in accounts payable and accrued expenses of $13.5 million, increases in accounts receivable of $9.0 million, other items of $3.8 million, gain on sales of assets $3.2 million, decreased inventories of $0.8 million and decreases in other current assets of $0.7 million. The accounts payable decrease includes $25.0 million representing a delayed billing payment resulting from a vendor’s inability to invoice us for an extended period of time due to technical issues associated with the vendor’s software system. The decrease in deferred taxes primarily relates to a goodwill impairment write-down of $13.5 million, long-lived asset write-downs totaling $25.2 million and book depreciation in excess of federal tax depreciation of $30.5 million.
 
Working capital changes have been adjusted to exclude the effects of acquisitions and currency translation for all years presented, where applicable. Net working capital at June 25, 2006 was $179.5 million.
 
Cash Used in Investing Activities
 
The Company utilized $29.2 million for net investing activities and $90.2 million in net financing activities during fiscal year 2006. For fiscal year 2005, the Company utilized $4.7 million for net investing activities and provided $0.1 million for net financing activities. The primary cash expenditures during fiscal year 2006 included $248.7 million for payment of the 2008 notes, $30.6 million for its investment in YUFI, $24.4 million for early payment of notes payable, $12.0 million for capital expenditures and $8.0 million for issuance and debt refinancing costs, offset by $190.0 million in proceeds from the issuance of the 2014 notes, proceeds from the sale of capital


43


Table of Contents

assets of $10.1 million, decreased restricted cash of $2.7 million, other financing activities of $1.0 million, and other investing activities of $0.5 million.
 
The Company utilized net cash of $4.7 million for investing activities in fiscal year 2005, which included $9.4 million for capital expenditures, $2.7 million for a deposit of restricted cash, and $1.4 million for acquisition related costs. These amounts were offset by $6.1 million for return of capital on investments from equity affiliates, $2.3 million of proceeds from sales of capital assets and $0.4 million, net of other investing activities. Net cash provided by financing activities increased by $0.1 million in fiscal year 2005 due to the issuance of common stock pursuant to the exercise of stock options.
 
The Company utilized $5.8 million for net investing activities and $8.5 million for net financing activities during fiscal year 2004. Significant expenditures during this period included $11.1 million for capital expenditures which included the $2.6 million purchase of the Sara Lee assets, and $3.6 million in capitalized software costs. Additionally, $8.4 million was expended for repurchasing the Company’s stock.
 
Long-Term Debt
 
On May 26, 2006, the Company issued $190.0 million in aggregate principal amount of its 2014 notes and entered into the amended revolving credit facility. The Company used the net proceeds of the issuance of the 2014 notes, borrowings under its amended revolving credit facility and cash on hand to pay the consideration for the 2008 notes tendered in its tender offer for the 2008 notes.
 
Tender Offer for the 2008 Notes.  On April 28, 2006, the Company commenced a tender offer for all of its then outstanding $250 million in aggregate principal amount of 2008 notes, simultaneously with a consent solicitation from the holders of the 2008 notes to remove substantially all of the restrictive covenants and certain events of default under the indenture governing the 2008 notes. The tender offer expired on May 25, 2006, and $248.7 million in aggregate principal amount of 2008 notes were tendered in the tender offer, representing 99.5% of the then outstanding aggregate principal amount of 2008 notes. The $1.3 million in aggregate principal amount of 2008 notes that were not tendered and purchased in the tender offer remain outstanding in accordance with their amended terms. The Company funded the purchase price in the tender offer with available cash, borrowings under its amended revolving credit facility and proceeds from the initial notes offering. As a result of the tender offer and the 2014 notes offering, the Company expects that its interest expense will increase approximately $5.6 million.
 
2014 Notes.  On May 26, 2006 the Company issued $190 million in aggregate principal amount of 2014 notes. Interest is payable on the notes on May 15 and November 15 of each year, beginning on November 15, 2006. The 2014 notes are unconditionally guaranteed on a senior, secured basis by each of the Company’s existing and future restricted domestic subsidiaries. The 2014 notes and guarantees are secured by first-priority liens, subject to permitted liens, on substantially all of the Company’s and the Company’s subsidiary guarantors’ assets (other than the assets securing the Company’s obligations under its amended revolving credit facility on a first-priority basis, which consist primarily of accounts receivable and inventory), including, but not limited to, property, plant and equipment, the capital stock of the Company’s domestic subsidiaries and certain of the Company’s joint ventures and up to 65% of the voting stock of the Company’s first-tier foreign subsidiaries, whether now owned or hereafter acquired, except for certain excluded assets. The 2014 notes and guarantees are secured by second-priority liens, subject to permitted liens, on the Company and its subsidiary guarantors’ assets that secure amended revolving credit facility on a first-priority basis. The Company may redeem some or all of the 2014 notes on or after May 15, 2010. In addition, prior to May 15, 2009, the Company may redeem up to 35% of the principal amount of the 2014 notes with the proceeds of certain equity offerings. In connection with the issuance, the Company incurred $6.8 million in professional fees and other expenses which will be amortized to expense over the life of the 2014 notes. The estimated fair value of the 2014 notes, based on quoted market prices, at June 25, 2006 was approximately $182.4 million.
 
The indenture for the 2014 notes, among other things, restricts the Company’s ability and the ability of its restricted subsidiaries to make investments, incur additional indebtedness and issue disqualified stock, pay dividends or make distributions on capital stock or redeem or repurchase capital stock, create liens, incur dividend or other payment restrictions affecting subsidiaries, sell assets, merge or consolidated with other entities and enter into transactions with affiliates.


44


Table of Contents

Amended Revolving Credit Facility.  Concurrently with the closing of issuance of the 2014 notes, the Company amended its old credit facility to extend its maturity to 2011, permit the initial notes, give it the ability to request that the borrowing capacity be increased up to $150 million under certain circumstances and revise some of its other terms and covenants. The amended revolving credit facility matures in 2011. The borrowings under the amended revolving credit facility are collateralized by first-priority liens, subject to permitted liens, in among other things, the Company’s inventory, accounts receivable, general intangibles (other than uncertified capital stock of subsidiaries and other persons), investment property (other than capital stock of subsidiaries and other persons), chattel paper, documents, instruments, letter of credit rights, deposit accounts and other related personal property and all proceeds relating to any of the above and by second-priority liens, subject to permitted liens, on the Company’s and its subsidiary guarantors’ assets that secure the 2014 notes and guarantees on a first-priority basis, in each case, other than certain excluded assets. The Company’s ability to borrow under its amended revolving credit facility is limited to a borrowing base equal to specified percentages of eligible accounts receivable and inventory and is subject to other conditions and limitations. As of June 25, 2006, no amounts were outstanding under that facility.
 
The amended revolving credit facility contains affirmative and negative customary covenants for asset-based loans that restrict future borrowings and capital spending. The covenants under the amended revolving credit facility are more restrictive than those in the indenture for the 2014 notes. Such covenants include, without limitation, restrictions and limitations on (i) sales of assets, consolidation, merger, dissolution and the issuance of the Company’s capital stock, each subsidiary guarantor and any domestic subsidiary thereof, (ii) permitted encumbrances on the Company’s property, each subsidiary guarantor and any domestic subsidiary thereof, (iii) the incurrence of indebtedness by the Company, any subsidiary guarantor or any domestic subsidiary thereof, (iv) the making of loans or investments by the Company, any subsidiary guarantor or any domestic subsidiary thereof, (v) the declaration of dividends and redemptions by the Company or any subsidiary guarantor, (vi) transactions with affiliates by the Company or any subsidiary guarantor and (vii) the repurchase by the Company of the 2014 notes.
 
Under the amended revolving credit facility, if borrowing capacity is less than $25 million at any time during the quarter, covenants also include a required minimum fixed charge coverage ratio of 1.1 to 1.0. In addition, maximum capital expenditures are limited to $30 million per fiscal year (subject to pro forma availability greater than $25 million) with a 75% one-year unused carry forward. The amended revolving credit facility also permits the Company to make distributions, subject to standard criteria, as long as pro forma excess availability is greater than $25 million both before and after giving effect to such distributions, subject to certain exceptions. Under the amended revolving credit facility, acquisitions by the Company are subject to pro forma covenant compliance. In addition, under the amended revolving credit facility, receivables are subject to cash dominion if excess availability is below $25 million.
 
Liquidity Assessment
 
In addition to its normal operating cash and working capital requirements and service of its indebtedness, the Company will also require cash to fund capital expenditures and enable cost reductions through restructuring projects as follows:
 
  •  Capital Expenditures.  The Company has no current commitment to make any significant capital expenditures which relate to fiscal year 2006, but the Company estimates its fiscal year 2007 capital expenditures will be within a range of $12.0 million to $15.0 million. Its capital expenditures primarily relate to maintenance of existing assets and equipment and technology upgrades. Management continuously evaluates opportunities to further reduce production costs, and the Company may incur additional capital expenditures from time to time as it pursues new opportunities for further cost reductions.
 
  •  Restructuring/Cost Reductions.  On April 20, 2006, the Company reorganized its domestic business operations, and as a result, recorded a restructuring charge for severance of approximately $0.8 million in the fourth quarter of fiscal year 2006. Approximately 45 management level salaried employees were affected by the plan of reorganization. In connection with its acquisition strategy, the Company may incur additional restructuring charges, including severance payments and other related expenses.


45


Table of Contents

 
  •  Joint Venture Investments.  The Company may from time to time increase its interest in its joint ventures, sell its interest in its joint ventures, invest in new joint ventures or transfer idle equipment to its joint ventures.
 
The Company believes that, based on current levels of operations and anticipated growth, cash flow from operations, together with other available sources of funds, including borrowings under its amended revolving credit facility, will be adequate to fund anticipated capital and other expenditures and to satisfy its working capital requirements for at least the next 12 months.
 
The Company’s ability to meet its debt service obligations and reduce its total debt will depend upon its ability to generate cash in the future which, in turn, will be subject to general economic, financial, business, competitive, legislative, regulatory and other conditions, many of which are beyond its control. The Company may not be able to generate sufficient cash flow from operations and future borrowings may not be available to the Company under its amended revolving credit facility in an amount sufficient to enable it to repay its debt or to fund its other liquidity needs. If its future cash flow from operations and other capital resources are insufficient to pay its obligations as they mature or to fund its liquidity needs, the Company may be forced to reduce or delay its business activities and capital expenditures, sell assets, obtain additional debt or equity capital or restructure or refinance all or a portion of its debt on or before maturity. The Company may not be able to accomplish any of these alternatives on a timely basis or on satisfactory terms, if at all. In addition, the terms of its existing and future indebtedness, including the 2014 notes and its amended revolving credit facility, may limit its ability to pursue any of these alternatives. See “Item 1A — Risk Factors — The Company will require a significant amount of cash to service its indebtedness, and its ability to generate cash depends on many factors beyond its control.” Some risks that could adversely affect its ability to meet its debt service obligations include, but are not limited to, intense domestic and foreign competition in its industry, general domestic and international economic conditions, changes in currency exchange rates, interest and inflation rates, the financial condition or its customers and the operating performance of joint ventures, alliances and other equity investments.
 
Other Factors Affecting Liquidity
 
Stock Repurchase Program.  Effective July 26, 2000, the Board of Directors increased the remaining authorization to repurchase up to 10.0 million shares of its common stock. The Company purchased 1.4 million shares in fiscal year 2001 for a total of $16.6 million. There were no significant stock repurchases in fiscal year 2002. Effective April 24, 2003, the Board of Directors re-instituted the stock repurchase program. Accordingly, the Company purchased 0.5 million shares in fiscal year 2003 and 1.3 million shares in fiscal year 2004. At June 25, 2006, the Company had remaining authority to repurchase approximately 6.8 million shares of its common stock under the repurchase plan. The repurchase program was suspended in November 2003, and the Company has no immediate plans to reinstitute the program.
 
Acquisitions.  On September 30, 2004, the Company completed the Kinston acquisition, including inventories, for a purchase price of approximately $24.4 million which was financed with a seller note. The acquisition resulted in the termination of the Company’s alliance agreement with INVISTA. As part of the Kinston acquisition and upon finalizing the quantities and value of the acquired inventory, Unifi Kinston, LLC, a subsidiary of the Company, entered into a $24.4 million five-year loan agreement. The loan, which calls for interest only payments for the first two years, bore interest at 10% per annum and was payable in arrears each quarter commencing December 31, 2004 until paid in full. Quarterly principal payments of approximately $2.0 million were due beginning December 31, 2006 with the final payment due September 30, 2009. The loan agreement contained customary covenants for asset based loans including a required minimum collateral value ratio of 1.0 to 1.0 and a pre-defined maximum leverage ratio. The loan was secured by all of the business assets held by Unifi Kinston, LLC. On July 25, 2005, the Company made a $24.4 million pre-payment, plus accrued interest, paying off the loan in full.
 
Environmental Liabilities.  The land associated with the Kinston acquisition is leased pursuant to a 99 year Ground Lease with DuPont. Since 1993, DuPont has been investigating and cleaning up the Kinston Site under the supervision of the EPA and the North Carolina Department of Environment and Natural Resources pursuant to the Resource Conservation and Recovery Act Corrective Action Program. The Corrective Action Program requires DuPont to identify all solid waste management units or areas of concern, assess the extent of contamination at the


46


Table of Contents

identified areas and clean them up to applicable regulatory standards. Under the terms of the Ground Lease, upon completion by DuPont of required remedial action, ownership of the Kinston Site will pass to the Company. Thereafter, the Company will have responsibility for future remediation requirements, if any, at the solid waste management units and areas of concern previously addressed by DuPont and at any other areas at the plant. At this time, the Company has no basis to determine if and when it will have any responsibility or obligation with respect to the solid waste management units and areas of concern or the extent of any potential liability for the same. Accordingly, the possibility that the Company could face material clean-up costs in the future relating to the Kinston facility cannot be eliminated. In addition, the Company is evaluating several options with respect to the upgrade of its industrial boilers at the Kinston Site. The estimated investment ranges from $0 to $2.0 million. No determination has been made with respect to which alternative to pursue, if any.
 
Joint Ventures.  The Company has invested $30.6 million in cash in its Chinese joint venture, YUFI, for its 50% equity interest which the Company paid using the proceeds of capital asset sales relating to the closure of its European manufacturing operations.
 
Contractual Obligations
 
The Company’s significant long-term obligations as of June 25, 2006 are as follows:
 
                                         
    Cash Payments Due by Period  
          Less Than
                More Than
 
Description of Commitment
  Total     1 Year     1-3 years     3-5 Years     5 Years  
    (Amounts in thousands)  
 
2014 notes(1)
  $ 190,000     $     $     $     $ 190,000  
2008 notes(2)
    1,273             1,273              
Interest on long-term debt(3)
    175,704       22,554       44,795       44,598       63,757  
Other long-term debt
    19,028       10,766       7,148       785       329  
Purchase obligations Nylon yarn procurement — U.S. (4)
    41,070       20,535       20,535              
Operating leases
    9,795       3,460       6,019       316        
                                         
    $ 436,870     $ 57,315     $ 79,770     $ 45,699     $ 254,086  
                                         
 
 
(1) The notes will mature in 2014.
 
(2) On April 28, 2006, the Company commenced a tender offer for all of its then outstanding $250 million in aggregate principal amount of 2008 notes, simultaneously with a consent solicitation from the holders of the 2008 notes to remove substantially all of the restrictive covenants and certain events of default under the indenture governing the 2008 notes. The tender offer expired on May 25, 2006, and $248.7 million in aggregate principal amount of 2008 notes were tendered in the tender offer, representing 99.5% of the then outstanding aggregate principal amount of 2008 notes. The $1.3 million in aggregate principal amount of 2008 notes that were not tendered and purchased in the tender offer remain outstanding in accordance with their amended terms.
 
(3) Consists of interest on the 2014 notes, the 2008 notes and the amended revolving credit facility and interest on other long-term debt.
 
(4) The nylon segment has a supply agreement with UNF which expires in April 2008. The Company is obligated to purchase certain to be agreed upon quantities of yarn production from UNF. The agreement does not provide for a fixed or minimum amount of yarn purchases, therefore there is a degree of uncertainty associated with the obligation. Accordingly, the Company has estimated its obligation under the agreement based on past history and internal projections.
 
Recent Accounting Pronouncements
 
In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). This is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations”


47


Table of Contents

(“SFAS No. 143”) which applies to all entities and addresses the legal obligations with the retirement of tangible long-lived assets that result from the acquisition, construction, development or normal operation of a long-lived asset. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. FIN 47 further clarifies that “conditional asset retirement obligation,” means with respect to recording the asset retirement obligation discussed in SFAS No. 143. The effective date is for fiscal years ending after December 15, 2005. During the fourth quarter of fiscal 2006, the Company performed a formal review of its asset retirement obligations in accordance with FIN 47. With respect to assets in which the retirement was measurable the impact on the Company’s financial position and results of operations was immaterial. The fair value of the assets retirement obligations relating to the Company’s Kinston facility (see Note 19, “Contingencies”) could not be reasonable estimated.
 
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) which is an interpretation of SFAS No. 109. The pronouncement creates a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 as of the first day of fiscal year 2008 and it does not expect that the adoption of this interpretation will have a significant impact on its financial position and results of operations.
 
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, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources.
 
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 Note 1, “Significant Accounting Policies and Financial Statement Information” of its audited historical consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
 
Allowance for Doubtful Accounts.  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 receivable, historical write-off experience, present economic conditions such as chapter 11 bankruptcy filings within the industry 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 doubtful accounts. Accounts are written off when they are no longer deemed to be collectible. The reserve for bad debts is established based on certain percentages applied to accounts receivable aged for certain periods of time and are supplemented by specific reserves for certain customer accounts where collection is no longer certain. The Company’s exposure to losses as of June 25, 2006 on accounts receivable was $98.4 million against which an allowance for losses of $5.1 million was provided. Establishing reserves for yarn claims and bad debts requires management judgment and estimates, which may impact the ending accounts receivable valuation, gross margins (for yarn claims) and the provision for bad debts.
 
Inventory Reserves.  The Company maintains reserves for inventories valued utilizing the first-in, first-out (“FIFO”) method and may provide for additional reserves over and above the LIFO reserve for inventories valued at


48


Table of Contents

LIFO. Such reserves for both FIFO and LIFO valued inventories can be specific to certain inventory or general based on judgments about the overall condition of the inventory. Reserves are established based on percentage markdowns applied to inventories 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; and, for inventory subject to LIFO (raw materials only), the amount of existing LIFO reserves. The LIFO reserve has increased $3.8 million for fiscal year 2006 primarily due to increases in raw material prices and higher inventory levels. The balance of the LIFO reserve was $7.6 million as of June 25, 2006. 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.
 
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 and used, an 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 by the difference between the carrying amount of the asset and the 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. During the third quarter of fiscal year 2004, the Company performed impairment testing on its domestic polyester texturing segment’s long-lived assets and determined that a write down was required. Based on the historical financial performance of the segment and the uncertainty of the moderate forecasted cash flows, the Company estimated the fair value of assets using a market value of $73.7 million. Management determined that the assets were impaired because the carrying value was $98.9 million. This resulted in the segment recording an impairment charge of $25.2 million. The Company also tested for impairment the entire domestic polyester segment and domestic nylon segment, both of which passed the tests. Future events impacting cash flows for existing assets could render a write down necessary that previously required no such write down.
 
For assets held for disposal, an impairment charge is recognized if the carrying value of the assets exceeds the fair value less costs to sell. Estimates are required of fair value, 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. Actual cash flows received or paid could differ from those used in estimating the impairment loss, which would impact the impairment charge ultimately recognized and the Company’s cash flows.
 
Accruals for Costs Related to Severance of Employees and Related Health Care Costs.  From time to time, the Company establishes accruals associated with employee severance or other cost reduction initiatives. Such accruals require that estimates be made about the future payout of various costs, including, for example, health care claims. The Company uses historical claims data and other available information about expected future health care costs to estimate its projected liability. Such costs are subject to change due to a number of factors, including the incidence rate for health care claims, prevailing health care costs and the nature of the claims submitted, among others. Consequently, actual expenses could differ from those expected at the time the provision was estimated, which may impact the valuation of accrued liabilities and results of operations. The Company’s estimates have been materially accurate in the past; and accordingly, at this time management expects to continue to utilize the present estimation processes.
 
Valuation Allowance for Deferred Tax Assets.  The Company established a valuation allowance against its deferred tax assets in accordance with SFAS No. 109, “Accounting for Income Taxes.” The specifically identified deferred tax assets which may not be recoverable are primarily state income tax credits. The Company’s realization of some of its deferred tax assets is based on future taxable income within a certain time period and is therefore uncertain. On a quarterly basis, the Company reviews its estimates for future taxable income over a period of years to assess if the need for a valuation allowance exists. To forecast future taxable income, the Company uses historical profit before tax amounts which may be adjusted upward or downward depending on various factors, including perceived trends, and then applies the expected change in rates to deferred tax assets and liabilities based on when they reverse in the future. At June 25, 2006, the Company had a gross deferred tax liability of approximately


49


Table of Contents

$10.8 million relating specifically to depreciation. The reversal of this deferred tax liability is the primary item generating future taxable income. Actual future taxable income may vary significantly from management’s projections due to the many complex judgments and significant estimations involved, which may result in adjustments to the valuation allowance which may impact the net deferred tax liability and provision for income taxes.
 
Management and the Company’s audit committee discussed the development, selection and disclosure of all of the critical accounting estimates described above.
 
Item 7A.   Quantitative and Qualitative Disclosure About Market Risk
 
The Company is exposed to market risks associated with changes in interest rates and currency fluctuation rates, which may adversely affect its financial position, results of operations and cash flows. In addition, the Company is also exposed to other risks in the operation of its business.
 
Interest Rate Risk:  The Company is exposed to interest rate risk through its borrowing activities, which are further described in Note 2, “Long Term Debt and Other Liabilities.” The majority of the Company’s borrowings are in long-term fixed rate bonds. Therefore, the market rate risk associated with a 100 basis point change in interest rates would not be material to the Company’s results of operation at the present time.
 
Currency Exchange Rate Risk:  The Company conducts its business in various foreign currencies. As a result, it is subject to the transaction exposure that arises from foreign exchange rate movements between the dates that foreign currency transactions are recorded (export sales and purchases commitments) and the dates they are consummated (cash receipts and cash disbursements in foreign currencies). The Company utilizes some natural hedging to mitigate these transaction exposures. The Company also enters into foreign currency forward contracts for the purchase and sale of European and North American currencies to hedge balance sheet and income statement currency exposures. These contracts are principally entered into for the purchase of inventory and equipment and the sale of Company products into export markets. Counter parties for these instruments are major financial institutions. If the derivative is a hedge, changes in the fair value of derivatives are either offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings. The Company does not enter into derivative financial instruments for trading purposes nor is it a party to any leveraged financial instruments.
 
Currency forward contracts are used to hedge exposure for sales in foreign currencies based on specific sales orders with customers or for anticipated sales activity for a future time period. Generally, 60-80% of the sales value of these orders is covered by forward contracts. Maturity dates of the forward contracts are intended to match anticipated receivable collections. The Company marks the outstanding accounts receivable and forward contracts to market at month end and any realized and unrealized gains or losses are recorded as other income and expense. The Company also enters currency forward contracts for committed or anticipated equipment and inventory purchases. Generally 50-75% of the asset cost is covered by forward contracts, although 100% of the asset cost may be covered by contracts in certain instances. Effective February 14, 2005, the Company entered into a contract to sell the European facility in Ireland and received a $2.8 million non-refundable deposit from the purchaser. In addition to the deposit, the contract called for a partial payment of 16.0 million Euros on June 30, 2005 and a final payment of 2.1 million Euros on September 30, 2005. On February 22, 2005, the Company entered into a forward exchange contract for 15.0 million Euros. The Company was required by the financial institution to deposit $2.8 million in an interest bearing collateral account to secure the financial institution’s maximum exposure on the hedge contract. This cash deposit has been reclassified as “Restricted cash” and is included on the Company’s balance sheet under current assets. On July 15, 2005, the Company settled the forward exchange contract for 15.0 million Euros. Forward contracts are matched with the anticipated date of delivery of the assets and gains and losses are recorded as a component of the asset cost for purchase transactions for which the Company is firmly committed. The latest maturity for all outstanding purchase and sales foreign currency forward contracts is July 2006 and October 2006, respectively.


50


Table of Contents

The dollar equivalent of these forward currency contracts and their related fair values are detailed below:
 
                         
    June 25,
    June 26,
    June 27,
 
    2006     2005     2004  
    (Amounts in thousands)  
 
Foreign currency purchase contracts:
                       
Notional amount
  $ 526     $ 168     $ 3,660  
Fair value
    535       159       3,642  
                         
Net (gain) loss
  $ (9 )   $ 9     $ 18  
                         
Foreign currency sales contracts:
                       
Notional amount
  $ 832     $ 24,414     $ 18,833  
Fair value
    878       22,687       19,389  
                         
Net (gain) loss
  $ 45     $ (1,727 )   $ 556  
                         
 
The fair values of the foreign exchange forward contracts at the respective year-end dates are based on discounted year-end forward currency rates. The total impact of foreign currency related items that are reported on the line item “Other (income) expense, net” in the Consolidated Statements of Operations, including transactions that were hedged and those that were not hedged, was a pre-tax loss of $0.7 million for the fiscal year ended June 25, 2006, a pre-tax gain of $1.1 million for the fiscal year ended June 26, 2005, and a pre-tax loss of $0.5 million for the fiscal year ended June 27, 2004.
 
Inflation and Other Risks:  The inflation rate in most countries the Company conducts business has been low in recent years and the impact on the Company’s cost structure has not been significant. The Company is also exposed to political risk, including changing laws and regulations governing international trade such as quotas and tariffs and tax laws. The degree of impact and the frequency of these events cannot be predicted.


51


Table of Contents

 
Item 8.   Financial Statements and Supplementary Data
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Shareholders of Unifi, Inc.
 
We have audited the accompanying consolidated balance sheets of Unifi, Inc. as of June 25, 2006, and June 26, 2005, and the related consolidated statements of operations, changes in shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended June 25, 2006. Our audits also include the Valuation and Qualifying Accounts financial statement schedule in the index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Unifi, Inc. at June 25, 2006 and June 26, 2005 and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 25, 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Unifi, Inc.’s internal control over financial reporting as of June 25, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated August 30, 2006, expressed an unqualified opinion thereon.
 
/s/  Ernst & Young LLP
 
Greensboro, North Carolina
August 30, 2006


52


Table of Contents

CONSOLIDATED BALANCE SHEETS
 
                 
    June 25,
    June 26,
 
    2006     2005  
    (Amounts in thousands,
 
    except per share data)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 35,317     $ 105,621  
Receivables, net
    93,236       106,437  
Inventories
    116,018       110,827  
Deferred income taxes
    11,739       14,578  
Assets held for sale
    15,419       32,536  
Restricted cash
          2,766  
Other current assets
    9,229       15,590  
                 
Total current assets
    280,958       388,355  
                 
Property, plant and equipment:
               
Land
    3,628       3,979  
Buildings and improvements
    170,377       166,504  
Machinery and equipment
    642,192       664,228  
Other
    100,140       120,748  
                 
      916,337       955,459  
Less accumulated depreciation
    (676,641 )     (675,727 )
                 
      239,696       279,732  
Investments in unconsolidated affiliates
    190,217       160,675  
Other noncurrent assets
    21,766       16,613  
                 
    $ 732,637     $ 845,375  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 68,593     $ 62,666  
Accrued expenses
    23,869       45,618  
Deferred gain
    323        
Income taxes payable
    2,303       2,292  
Current maturities of long-term debt and other current liabilities
    6,330       35,339  
                 
Total current liabilities
    101,418       145,915  
                 
Long-term debt and other liabilities
    202,110       259,790  
Deferred gain
    295        
Deferred income taxes
    45,861       55,913  
Minority interests
          182  
Commitments and contingencies
               
Shareholders’ equity:
               
Common stock, $0.10 par (500,000 shares authorized, 52,208 and 52,145 shares outstanding)
    5,220       5,215  
Capital in excess of par value
    929       208  
Retained earnings
    382,082       396,448  
Unearned compensation
          (128 )
Accumulated other comprehensive loss
    (5,278 )     (18,168 )
                 
      382,953       383,575  
                 
    $ 732,637     $ 845,375  
                 
 
The accompanying notes are an integral part of the financial statements.


53


Table of Contents

CONSOLIDATED STATEMENTS OF OPERATIONS
 
                         
    Fiscal Years Ended  
    June 25,
    June 26,
    June 27,
 
    2006     2005     2004  
    (Amounts in thousands,
 
    except per share data)  
 
Summary of Operations:
                       
Net sales
  $ 738,825     $ 793,796     $ 666,383  
Cost of sales
    696,055       762,717       625,983  
Selling, general and administrative expenses
    41,534       42,211       45,963  
Provision for bad debts
    1,256       13,172       2,389  
Interest expense
    19,247       20,575       18,698  
Interest income
    (4,489 )     (2,152 )     (2,152 )
Other (income) expense, net
    (3,118 )     (2,300 )     (2,590 )
Equity in (earnings) losses of unconsolidated affiliates
    (825 )     (6,938 )     6,877  
Minority interest income
          (530 )     (6,430 )
Restructuring charges (recovery)
    (254 )     (341 )     8,229  
Arbitration costs and expenses
                182  
Alliance plant closure recovery
                (206 )
Write down of long-lived assets
    2,366       603       25,241  
Goodwill impairment
                13,461  
Loss from early extinguishment of debt
    2,949              
                         
Loss from continuing operations before income taxes and extraordinary item
    (15,896 )     (33,221 )     (69,262 )
Benefit for income taxes
    (1,170 )     (13,483 )     (25,113 )
                         
Loss from continuing operations before extraordinary item
    (14,726 )     (19,738 )     (44,149 )
Income (loss) from discontinued operations, net of tax
    360       (22,644 )     (25,644 )
                         
Loss before extraordinary item
    (14,366 )     (42,382 )     (69,793 )
Extraordinary gain — net of taxes of $0
          1,157        
                         
Net loss
  $ (14,366 )   $ (41,225 )   $ (69,793 )
                         
Income (losses) per common share (basic and diluted):
                       
Loss from continuing operations before extraordinary item
  $ (.28 )   $ (.38 )   $ (.85 )
Income (loss) from discontinued operations, net of tax
          (.43 )     (.49 )
Extraordinary gain — net of taxes of $0
          .02        
                         
Net loss per common share
  $ (.28 )   $ (.79 )   $ (1.34 )
                         
 
The accompanying notes are an integral part of the financial statements.


54


Table of Contents

CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
 
                                                                 
                Capital in
                Other
    Total
    Comprehensive
 
    Shares
    Common
    Excess of
    Retained
    Unearned
    Comprehensive
    Shareholders’
    Income (Loss)
 
    Outstanding     Stock     Par Value     Earnings     Compensation     Income (Loss)     Equity     Note 1  
    (Amounts in thousands)  
 
Balance June 29, 2003
    53,399     $ 5,340     $     $ 515,572     $ (302 )   $ (40,862 )   $ 479,748        
Purchase of stock
    (1,304 )     (131 )     (7 )     (8,242 )                 (8,380 )      
Cancellation of unvested restricted stock
    (2 )                 (18 )     18                    
Issuance of restricted stock
    22       2       134             (136 )                  
Amortization of restricted stock
                            192             192        
Currency translation adjustments
                                  134       134     $ 134  
Net loss
                      (69,793 )                 (69,793 )     (69,793 )
                                                                 
Balance June 27, 2004
    52,115       5,211       127       437,519       (228 )     (40,728 )     401,901     $ (69,659 )
                                                                 
Purchase of stock
    (1 )           (2 )                       (2 )      
Options exercised
    33       4       101                         105        
Cancellation of unvested restricted stock
    (2 )           (18 )           15             (3 )      
Amortization of restricted stock
                            85             85        
Currency translation adjustments
                                  19,580       19,580     $ 19,580  
Liquidation of foreign subsidiaries
                      154             2,980       3,134       2,980  
Net loss
                      (41,225 )                 (41,225 )     (41,225 )
                                                                 
Balance June 26, 2005
    52,145       5,215       208       396,448       (128 )     (18,168 )     383,575     $ (18,665 )
                                                                 
Reclassification upon adoption of SFAS 123R
          (1 )     27             128             154        
Options exercised
    63       6       168                         174        
Stock option tax benefit
                1                         1        
Stock option expense
                394                         394        
Cancellation of unvested restricted stock
                131                         131        
Currency translation adjustments
                                  5,550       5,550     $ 5,550  
Liquidation of foreign subsidiaries
                                  7,340       7,340       7,340  
Net loss
                      (14,366 )                 (14,366 )     (14,366 )
                                                                 
Balance June 25, 2006
    52,208     $ 5,220     $ 929     $ 382,082     $     $ (5,278 )   $ 382,953     $ (1,476 )
                                                                 
 
The accompanying notes are an integral part of the financial statements.


55


Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                         
    Fiscal Years Ended  
    June 25,
    June 26,
    June 27,
 
    2006     2005     2004  
    (Amounts in thousands)  
 
Cash and cash equivalents at beginning of year
  $ 105,621     $ 65,221     $ 76,801  
Operating activities:
                       
Net loss
    (14,366 )     (41,225 )     (69,793 )
Adjustments to reconcile net loss to net cash provided by continuing operating activities:
                       
Extraordinary gain
          (1,157 )      
(Income) loss from discontinued operations
    (360 )     22,644       25,644  
Net (income) loss of unconsolidated equity affiliates, net of distributions
    1,945       (2,302 )     8,695  
Depreciation
    48,669       51,542       56,226  
Amortization
    1,276       1,350       1,377  
Net (gain) loss on asset sales
    (1,755 )     (1,770 )     (3,227 )
Non-cash portion of loss on extinguishment of debt
    1,793              
Non-cash portion of restructuring charges (recovery)
    (254 )     (341 )     7,155  
Non-cash write down of long-lived assets
    2,366       603       25,241  
Non-cash effect of goodwill impairment
                13,461  
Deferred income taxes
    (7,776 )     (19,057 )     (28,201 )
Provision for bad debts
    1,256       13,172       2,389  
Change in cash surrender value of life insurance
    1,643       (1,077 )     3,107  
Minority interest
          (551 )     (6,148 )
Other
    148       (461 )     (731 )
Changes in assets and liabilities, excluding effects of acquisitions and foreign currency adjustments:
                       
Receivables
    10,592       (1,504 )     (8,954 )
Inventories
    (5,844 )     20,574       (813 )
Other current assets
    (1,278 )     (901 )     (668 )
Accounts payable and accrued expenses
    (8,504 )     (10,933 )     (13,539 )
Income taxes
    542       179       159  
                         
Net cash provided by continuing operating activities
    30,093       28,785       11,380  
                         
Investing activities:
                       
Capital expenditures
    (11,988 )     (9,422 )     (11,124 )
Acquisition
    (30,634 )     (1,358 )     (83 )
Return of capital from equity affiliates
          6,138       1,665  
Investment of foreign restricted assets
    171       388       (323 )
Collection of notes receivable
    404       520       581  
Increase in notes receivable
          (139 )     (711 )
Proceeds from sale of capital assets
    10,093       2,290       4,242  
Restricted cash
    2,766       (2,766 )      
Other
    (42 )     (342 )     (24 )
                         
Net cash used in investing activities
    (29,230 )     (4,691 )     (5,777 )
                         
Financing activities:
                       
Payment of long term debt
    (273,134 )            
Borrowing of long term debt
    190,000              
Debt issuance costs
    (8,041 )            
Issuance of Company stock
    176       104        
Purchase and retirement of Company stock
          (2 )     (8,390 )
Other
    825       (20 )     (77 )
                         
Net cash provided by (used in) financing activities
    (90,174 )     82       (8,467 )
                         
Cash flows of discontinued operations (Revised — See Note 18)
                       
Operating cash flow
    (3,342 )     (6,273 )     (8,358 )
Investing cash flow
    22,028       13,902       (427 )
Financing cash flow
                10  
                         
Net cash provided by (used in) discontinued operations
    18,686       7,629       (8,775 )
Effect of exchange rate changes on cash and cash equivalents
    321       8,595       59  
                         
Net increase (decrease) in cash and cash equivalents
    (70,304 )     40,400       (11,580 )
                         
Cash and cash equivalents at end of year
  $ 35,317     $ 105,621     $ 65,221  
                         
 
The accompanying notes are an integral part of the financial statements.


56


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.   Significant Accounting Policies and Financial Statement Information
 
Principles of Consolidation.  The Consolidated Financial Statements include the accounts of the Company and all majority-owned subsidiaries. The portion of the income applicable to non-controlling interests in the majority-owned operations is reflected as minority interests in the Consolidated Statements of Operations. The accounts of all foreign subsidiaries have been included on the basis of fiscal periods ended three months or less prior to the dates of the Consolidated Balance Sheets. All significant intercompany accounts and transactions have been eliminated. Investments in 20% to 50% owned companies and partnerships where the Company is able to exercise significant influence, but not control, are accounted for by the equity method and, accordingly, consolidated income includes the Company’s share of the investees’ income or losses.
 
Fiscal Year.  The Company’s fiscal year is the 52 or 53 weeks ending in the last Sunday in June. Fiscal years 2006, 2005 and 2004 were comprised of 52 weeks.
 
Reclassification.  The Company has reclassified the presentation of certain prior year information to conform with the current year presentation.
 
Restatements.  In July 2004, the Company announced the closing of its European manufacturing operations and associated sales offices. Unifi ceased operating its dyed facility in Manchester, England, in June 2004 and ceased its manufacturing operations in Ireland in October 2004. The Company ceased all other European operations by June 2005 and sold the real property, plant and equipment of its European division in fiscal years 2005 and 2006. In July 2005, the Company announced that it had decided to exit the sourcing business and, as of the end of the third quarter of fiscal year 2006, it had substantially liquidated the business. Accordingly, the consolidated financial statements have been restated to present these results as discontinued operations for all periods presented.
 
Revenue Recognition.  Revenues from sales are recognized at the time shipments are made and include amounts billed to customers for shipping and handling. Costs associated with shipping and handling are included in cost of sales in the Consolidated Statements of Operations. Freight paid by customers is included in net sales in the Consolidated Statements of Operations.
 
Foreign Currency Translation.  Assets and liabilities of foreign subsidiaries are translated at year-end rates of exchange and revenues and expenses are translated at the average rates of exchange for the year. Gains and losses resulting from translation are accumulated in a separate component of shareholders’ equity and included in comprehensive income (loss). Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiary’s functional currency) are included in other income or expense in the Consolidated Statements of Operations.
 
Cash and Cash Equivalents.  Cash equivalents are defined as short-term investments having an original maturity of three months or less.
 
Restricted Cash.  Cash deposits held for a specific purpose or held as security for contractual obligations are classified as restricted cash.
 
Receivables.  The Company extends unsecured credit to its customers as part of its normal business practices. 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 experience and known pending claims. The ability to collect accounts receivable is based on a combination of factors including the aging of accounts receivable, write-off experience and the financial condition of specific customers. Accounts are written off when they are no longer deemed to be collectible. General reserves are established based on the percentages applied to accounts receivables aged for certain periods of time and are supplemented by specific reserves for certain customer accounts where collection is no longer certain. Establishing reserves for yarn claims and bad debts requires management judgment and estimates, which may impact the ending accounts receivable valuation, gross margins (for yarn claims) and the provision for bad debts. The reserve for such losses was $5.1 million at June 25, 2006 and $14.0 million at June 26, 2005.


57


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Inventories.  The Company utilizes the last-in, first-out (“LIFO”) method for valuing certain inventories representing 38.2% and 40.2% of all inventories at June 25, 2006, and June 26, 2005, respectively, and the first-in, first-out (“FIFO”) method for all other inventories. Inventories are valued at lower of cost or market including a provision for slow moving and obsolete items. Market is considered net realizable value. Inventories valued at current or replacement cost would have been approximately $7.3 million and $3.5 million in excess of the LIFO valuation at June 25, 2006, and June 26, 2005, respectively. The Company did not have LIFO liquidations during fiscal year 2006 but experienced LIFO liquidations of $0.3 million pre-tax loss during fiscal year 2005. The Company maintains reserves for inventories valued utilizing the FIFO method and may provide for additional reserves over and above the LIFO reserve for inventories valued at LIFO. Such reserves for both FIFO and LIFO valued inventories can be specific to certain inventory or general based on judgments about the overall condition of the inventory. General reserves are established based on percentage markdowns applied to inventories 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; and, for inventory subject to LIFO, the amount of existing LIFO reserves. 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 total inventory reserves on the Company’s books, including LIFO reserves, at June 25, 2006 and June 26, 2005 were $10.7 million and $7.9 million, respectively. The following table reflects the composition of the Company’s inventory as of June 25, 2006 and June 26, 2005:
 
                 
    June 25,
    June 26,
 
    2006     2005  
    (Amounts in thousands)  
 
Raw materials and supplies
  $ 48,594     $ 47,441  
Work in process
    10,144       8,497  
Finished goods
    57,280       54,889  
                 
    $ 116,018     $ 110,827  
                 
 
Other Current Assets.  Other current assets consist of government tax deposits ($4.3 million and $8.9 million), prepaid insurance ($2.5 million and $2.8 million), unrealized gains on hedging contracts ($0.0 million and $1.6 million), prepaid VAT taxes ($1.4 million and $1.0 million), deposits of ($0.7 million and $0.7 million) and other assets ($0.3 million and $0.6 million) as of June 25, 2006 and June 26, 2005, respectively.
 
Property, Plant and Equipment.  Property, plant and equipment are stated at cost. Depreciation is computed for asset groups primarily utilizing the straight-line method for financial reporting and accelerated methods for tax reporting. For financial reporting purposes, asset lives have been assigned to asset categories over periods ranging between three and forty years. Amortization of assets recorded under capital leases is included with depreciation expense.
 
Goodwill and Other Intangible Assets.  The Company accounts for goodwill and other intangibles under the provisions of Statements of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 142 requires that these assets be reviewed for impairment annually, unless specific circumstances indicate that a more timely review is warranted. This impairment test involves estimates and judgments that 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. In addition, future events impacting cash flows for existing assets could render a writedown necessary that previously required no such writedown.
 
Other Noncurrent Assets.  Other noncurrent assets at June 25, 2006, and June 26, 2005, consist primarily of the cash surrender value of key executive life insurance policies ($4.6 million and $6.1 million), unamortized bond issue costs and debt origination fees ($7.9 million and $2.5 million), restricted cash investments in Brazil ($6.2 million and $4.1 million), strategic investment assets ($1.0 million and $1.4 million), other miscellaneous assets ($1.8 million and $0.7 million), and various notes receivable due from both affiliated and non-affiliated parties ($0.3 million and $1.8 million), respectively. On April 28, 2006 the Company commenced a tender offer to purchase the outstanding $250 million of 2008 senior, unsecured debt securities (the “2008 notes”). The offer


58


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

expired on May 25, 2006. On May 26, 2006, the Company issued $190 million in senior, secured notes (the “2014 notes”) that expire in 2014, incurring $6.8 million in related issuance costs. As a result, $1.3 million of the remaining 2008 note issue costs were expensed. The Company simultaneously on May 26, 2006 amended its Revolving Credit Facility (“amended revolving credit facility”) to extend its maturity from 2006 to 2011 and increase its borrowing capacity. The Company incurred $1.2 million in origination fees related to the new facility. The debt origination fees relating to the old facility of $0.2 million were expensed in the fourth quarter fiscal 2006. All debt related origination costs have been amortized on the straight-line method over the life of the corresponding debt, which approximates the effective interest method. Accumulated amortization at June 25, 2006 for unamortized debt origination costs attributable to the 2014 notes and 2011 amended credit facility was $0.1 million. Accumulated amortization at June 26, 2005 attributable to the 2008 notes and 2006 Revolving Credit Facility was $7.3 million.
 
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 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 by the difference between the carrying amount of the asset and the 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. In addition, future events impacting cash flows for existing assets could render a writedown necessary that previously required no such writedown.
 
For assets held for disposal, an impairment charge is recognized if the carrying value of the assets exceeds the fair value less costs to sell. Estimates are required of fair value, 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. Actual cash flows received or paid could differ from those used in estimating the impairment loss, which would impact the impairment charge ultimately recognized and the Company’s cash flows.
 
Accrued Expenses.  The following table reflects the composition of the Company’s accrued expenses as of June 25, 2006 and June 26, 2005:
 
                 
    June 25,
    June 26,
 
    2006     2005  
    (Amounts in thousands)  
 
Payroll and fringe benefits
  $ 11,112     $ 14,309  
Severance
    576       5,252  
Interest
    1,984       7,325  
Pension
          6,141  
Other
    10,197       12,591  
                 
    $ 23,869     $ 45,618  
                 
 
Income Taxes.  The Company and its domestic subsidiaries file a consolidated federal income tax return. Income tax expense is computed on the basis of transactions entering into pre-tax operating results. Deferred income taxes have been provided for the tax effect of temporary differences between financial statement carrying amounts and the tax basis of existing assets and liabilities. Otherwise, income taxes have not been provided for the undistributed earnings of certain foreign subsidiaries as such earnings are deemed to be permanently invested.


59


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Losses Per Share.  The following table details the computation of basic and diluted losses per share:
 
                         
    Fiscal Year Ended  
    June 25,
    June 26,
    June 27,
 
    2006     2005     2004  
    (Amounts in thousands)  
 
Numerator:
                       
Loss from continuing operations before discontinued operations
  $ (14,726 )   $ (19,738 )   $ (44,149 )
Income (loss) from discontinued operations, net of tax
    360       (22,644 )     (25,644 )
Extraordinary gain, net of taxes of $0
          1,157        
                         
Net loss
  $ (14,366 )   $ (41,225 )   $ (69,793 )
                         
Denominator:
                       
Denominator for basic losses per share — weighted average shares
    52,155       52,106       52,249  
Effect of dilutive securities:
                       
Stock options
                 
Restricted stock awards
                 
                         
Diluted potential common shares denominator for diluted losses per share — adjusted weighted average shares and assumed conversions
    52,155       52,106       52,249  
                         
 
In fiscal years 2006, 2005, and 2004, options and unvested restricted stock awards had the potential effect of diluting basic earnings per share, and if the Company had net earnings in these years, diluted weighted average shares would have been higher than basic weighted average shares by 232,986 shares, 199,207 shares, and 1,507 shares, respectively.
 
Stock-Based Compensation.  With the adoption of SFAS 123, the Company elected for fiscal years 2005 and 2004 to continue to measure compensation expense for its stock-based employee compensation plans using the intrinsic value method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Had the fair value-based method under SFAS 148 been applied, compensation expense would have been recorded for the options outstanding in fiscal years 2005 and 2004 based on their respective vesting schedules.
 
Net loss in fiscal years 2005 and 2004 on a pro forma basis assuming SFAS 123 had been applied would have been as follows:
 
                 
    June 26,
    June 27,
 
    2005     2004  
    (Amounts in thousands, except per share amounts)  
 
Net loss as reported
  $ (41,225 )   $ (69,793 )
Adjustment: Impact of stock options, net of tax
    (3,321 )     (1,656 )
                 
Adjusted net loss
  $ (44,546 )   $ (71,449 )
                 
Basic and diluted net loss per share:
               
As reported
  $ (.79 )   $ (1.34 )
Adjusted for stock option expense
    (.85 )     (1.37 )


60


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Stock options were granted during fiscal years 2006, 2005, and 2004. The fair value and related compensation expense of fiscal years 2006, 2005, and 2004 options were calculated as of the issuance date using the Black-Scholes model with the following assumptions:
 
                         
Options Granted
  2006     2005     2004  
 
Expected term (years)
    6.1       7.0       7.0  
Interest rate
    4.9 %     4.4 %     2.5 %
Volatility
    57.2 %     57.0 %     51.0 %
Dividend yield
                 
 
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) finalized Statement of Financial Accounting Standards (“SFAS”) No. 123(R) “Shared-Based Payment” (“SFAS No. 123R”) which, after the Securities and Exchange Commission (“SEC”) amended the compliance dates on April 15, 2005, was effective for the Company’s fiscal year beginning June 27, 2005. The new standard required the Company to record compensation expense for stock options using a fair value method. On March 29, 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), which provides the Staff’s views regarding interactions between SFAS No. 123R and certain SEC rules and regulations and provides interpretation of the valuation of share-based payments for public companies.
 
Effective June 27, 2005, the Company adopted SFAS 123R and elected the Modified — Prospective Transition Method whereby compensation cost is recognized for share-based payments based on the grant date fair value from the beginning of the fiscal period in which the recognition provisions are first applied (see Note 4, “Common Stock, Stock Option Plan and Restricted Stock Plan”).
 
Comprehensive Income.  Comprehensive income includes net income and other changes in net assets of a business during a period from non-owner sources, which are not included in net income. Such non-owner changes may include, for example, available-for-sale securities and foreign currency translation adjustments. Other than net income, foreign currency translation adjustments presently represent the only component of comprehensive income for the Company. The Company does not provide income taxes on the impact of currency translations as earnings from foreign subsidiaries are deemed to be permanently invested.
 
Recent Accounting Pronouncements.  In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”). This is an interpretation of SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”) which applies to all entities and addresses accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development or normal operation of a long-lived asset. The SFAS requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. FIN 47 further clarifies what “conditional asset retirement obligation” means with respect to recording the asset retirement obligation discussed in SFAS No. 143. The effective date is for fiscal years ending after December 15, 2005. During fiscal year 2006, the Company performed a formal review of its asset retirement obligations in accordance with FIN 47. With respect to assets for which the retirement obligation was measurable, the impact on the Company’s financial position and results of operations was immaterial.
 
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) which is an interpretation of SFAS No. 109. The pronouncement creates a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company will adopt FIN 48 as of the first day of fiscal year 2008 and it does not expect that the adoption of this interpretation will have a significant impact on its financial position and results of operations.


61


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Use of Estimates.  The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
 
2.   Long-Term Debt and Other Liabilities
 
A summary of long-term debt and other liabilities follows:
 
                 
    June 25,
    June 26,
 
    2006     2005  
    (Amounts in thousands)  
 
Senior secured notes — due 2014
  $ 190,000     $  
Senior unsecured notes — due 2008
    1,273       249,473  
Note payable
          24,407  
Brazilian government loans
    10,499       12,912  
Other obligations
    6,668       8,337  
                 
Total debt and other obligations
    208,440       295,129  
Current maturities
    (6,330 )     (35,339 )
                 
Total long-term debt and other liabilities
  $ 202,110     $ 259,790  
                 
 
Long-Term Debt
 
On February 5, 1998, the Company issued $250 million of senior, unsecured debt securities which bore a coupon rate of 6.5% and were scheduled to mature in February 2008. On April 28, 2006, the Company commenced a tender offer for all of its outstanding 2008 notes. As of June 25, 2006 $1.3 million in aggregate principal amount of 2008 notes had not been tendered and remain outstanding in accordance with their amended terms. As a result of the tender offer, the Company incurred $1.1 million in related fees and wrote off the remaining $1.3 million of unamortized issuance costs and $0.3 million of unamortized bond discounts as expense. The estimated fair value of the 2008 notes, based on quoted market prices as of June 25, 2006, and June 26, 2005, was approximately $1.3 million and $210.0 million, respectively.
 
On May 26, 2006 the Company issued $190 million of 11.5% senior secured notes due May 15, 2014. Interest is payable on the notes on May 15 and November 15 of each year, beginning on November 15, 2006. The 2014 notes and guarantees are secured by first-priority liens, subject to permitted liens, on substantially all of the Company’s and the Company’s subsidiary guarantors’ assets (other than the assets securing the Company’s obligations under the Company’s amended revolving credit facility on a first-priority basis, which consist primarily of accounts receivable and inventory), including, but not limited to, property, plant and equipment, the capital stock of the Company’s domestic subsidiaries and certain of the Company’s joint ventures and up to 65% of the voting stock of the Company’s first-tier foreign subsidiaries, whether now owned or hereafter acquired, except for certain excluded assets. The 2014 notes are unconditionally guaranteed on a senior, secured basis by each of the Company’s existing and future restricted domestic subsidiaries. The 2014 notes and guarantees are secured by second-priority liens, subject to permitted liens, on the Company and its subsidiary guarantors’ assets that will secure the notes and guarantees on a first-priority basis. The Company may redeem some or all of the 2014 notes on or after May 15, 2010. In addition, prior to May 15, 2009, the Company may redeem up to 35% of the principal amount of the 2014 notes with the proceeds of certain equity offerings. In connection with the issuance, the Company incurred $6.8 million in professional fees and other expenses which will be amortized to expense over the life of the 2014 notes. The estimated fair value of the 2014 notes, based on quoted market prices, at June 25, 2006 was approximately $182.4 million.
 
Concurrently with the closing of this offering, the Company amended its senior secured asset-based revolving credit facility to provide a $100 million revolving borrowing base (with an option to increase borrowing capacity up to $150 million), to extend its maturity to 2011, and revise some of its other terms and covenants. The amended


62


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

revolving credit facility is secured by first-priority liens on the Company’s and it’s subsidiary guarantors’ inventory, accounts receivable, general intangibles (other than uncertificated capital stock of subsidiaries and other persons), investment property (other than capital stock of subsidiaries and other persons), chattel paper, documents, instruments, supporting obligations, letter of credit rights, deposit accounts and other related personal property and all proceeds relating to any of the above, and by second-priority liens, subject to permitted liens, on the Company’s and its subsidiary guarantors’ assets securing the notes and guarantees on a first-priority basis, in each case other than certain excluded assets. The Company’s ability to borrow under the Company’s amended revolving credit facility is limited to a borrowing base equal to specified percentages of eligible accounts receivable and inventory and is subject to other conditions and limitations.
 
Borrowings under the amended revolving credit facility bear interest at rates of LIBOR plus 1.50% to 2.25% and/or prime plus 0.00% to 0.50%. The interest rate matrix is based on the Company’s excess availability under the amended revolving credit facility. The amended revolving credit facility also includes a 0.25% LIBOR margin pricing reduction if the Company’s fixed charge coverage ratio is greater than 1.5 to 1.0. The unused line fee under the amended revolving credit facility is 0.25% to 0.35% of the borrowing base. In connection with the refinancing, the Company incurred fees and expenses aggregating $1.2 million, which are being amortized over the term of the amended revolving credit facility. As of June 25, 2006, the Company had no outstanding borrowings and availability of $94.2 million under the terms of the amended credit facility.
 
The amended credit facility replaces the December 7, 2001 $100 million revolving bank credit facility (the “Credit Agreement”), as amended, which would have terminated on December 7, 2006. The Credit Agreement was secured by substantially all U.S. assets excluding manufacturing facilities and manufacturing equipment. Borrowing availability was based on eligible domestic accounts receivable and inventory. Borrowings under the Credit Agreement bore interest at rates selected periodically by the Company of LIBOR plus 1.75% to 3.00% and/or prime plus 0.25% to 1.50%. The interest rate matrix was based on the Company’s leverage ratio of funded debt to EBITDA, as defined by the Credit Agreement. Under the Credit Agreement, the Company paid unused line fees ranging from 0.25% to 0.50% per annum on the unused portion of the commitment which is included in interest expense. In connection with the refinancing, the Company incurred fees and expenses aggregating $2.0 million, which were being amortized over the term of the Credit Agreement with the balance of $0.2 million expensed upon the May 26, 2006 refinancing.
 
The amended revolving credit facility contains affirmative and negative customary covenants for asset based loans that restrict future borrowings and capital spending. The covenants under the amended revolving credit facility are more restrictive than those in the indenture. Such covenants include, without limitation, restrictions and limitations on (i) sales of assets, consolidation, merger, dissolution and the issuance of our capital stock, each subsidiary guarantor and any domestic subsidiary thereof, (ii) permitted encumbrances on our property, each subsidiary guarantor and any domestic subsidiary thereof, (iii) the incurrence of indebtedness by the Company, any subsidiary guarantor or any domestic subsidiary thereof, (iv) the making of loans or investments by the Company, any subsidiary guarantor or any domestic subsidiary thereof, (v) the declaration of dividends and redemptions by the Company or any subsidiary guarantor and (vi) transactions with affiliates by the Company or any subsidiary guarantor.
 
Under the amended revolving credit facility, if borrowing capacity is less than $25 million at any time during the quarter, covenants will include a required minimum fixed charge coverage ratio of 1.1 to 1.0. In addition, the maximum capital expenditures are limited to $30 million per fiscal year (subject to pro forma availability greater than $25 million) with a 75% one-year unused carry forward. The amended revolving credit facility permits the Company to make distributions, subject to standard criteria, as long as pro forma excess availability is greater than $25 million both before and after giving effect to such distributions, subject to certain exceptions. Under the amended revolving credit facility, acquisitions by the Company are subject to pro forma covenant compliance. In addition, the amended revolving credit facility receivables are subject to cash dominion if excess availability is below $25 million.


63


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
On September 30, 2004, the Company completed its acquisition of the polyester filament manufacturing assets located in Kinston, North Carolina from INVISTA S.a.r.l. (“INVISTA”), a subsidiary of Koch Industries, Inc. (“Koch”). As part of the acquisition of the Kinston facility from INVISTA and upon finalizing the quantities and value of the acquired inventory, the Company entered into a $24.4 million five-year Loan Agreement. The note, which called for interest only payments for the first two years, bore interest at 10% per annum. The note was secured by all of the business assets held by Unifi Kinston, LLC. On July 25, 2005 the Company paid off the $24.4 million note payable and the related accrued interest.
 
Unifi do Brasil, receives loans from the government of the State of Minas Gerais to finance 70% of the value added taxes due by Unifi do Brasil to the State of Minas Gerais. These loans were granted as part of a 24 month tax incentive to build a manufacturing facility in the State of Minas Gerais. The loans have a 2.5% origination fee and bear an effective interest rate equal to 50% of the Brazilian inflation rate, which currently is significantly lower than the Brazilian prime interest rate. The loans are collateralized by a performance bond letter issued by a Brazilian bank, which secures the performance by Unifi do Brasil of its obligations under the loans. In return for this performance bond letter, Unifi do Brasil makes certain cash deposits with the Brazilian bank. The deposits made by Unifi do Brasil earn interest at a rate equal to approximately 100% of the Brazilian prime interest rate. These tax incentives will end in September 2008.
 
The following summarizes the maturities of the Company’s long-term debt on a fiscal year basis:
 
                                         
    Aggregate Debt Maturities
Description of Commitment
  Total   2007   2008   2009-2011   Thereafter
    (Amounts in thousands)
 
Long-term debt
  $ 201,772     $ 4,335     $ 7,437     $     $ 190,000  
 
Other Obligations
 
On May 20, 1997, the Company entered into a sale-leaseback agreement with a financial institution whereby land, buildings and associated real and personal property improvements of certain manufacturing facilities were sold to the financial institution and will be leased by the Company over a sixteen-year period. This transaction has been recorded as a direct financing arrangement. As of June 25, 2006 the balance of the note was $2.3 million and the net book value of the related assets was $6.6 million. Payments for the remaining balance of the sale-leaseback agreement are due semi-annually and are in varying amounts, in accordance with the agreement. Average annual principal payments over the next six years are approximately $0.3 million. The interest rate implicit in the agreement is 7.84%.
 
Other obligations also includes operating lease accruals associated with the Altamahaw, North Carolina plant closure in the amount of $2.7 million and $1.7 million of liquidation accruals associated with the closure of a dye operation in England in June 2004.
 
3.   Income Taxes
 
Income from continuing operations before income taxes is as follows:
 
                         
    June 25,
    June 26,
    June 27,
 
    2006     2005     2004  
    (Amounts in thousands)  
 
Income (loss) from continuing operations before income taxes:
                       
United States
  $ (15,256 )   $ (40,838 )   $ (80,399 )
Foreign
    (640 )     7,617       11,137  
                         
    $ (15,896 )   $ (33,221 )   $ (69,262 )
                         


64


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The provision for (benefit from) income taxes applicable to continuing operations for fiscal years 2006, 2005, and 2004 consists of the following:
 
                         
    June 25,
    June 26,
    June 27,
 
    2006     2005     2004  
    (Amounts in thousands)  
 
Currently payable (recoverable):
                       
Federal
  $ (29 )   $ 2,729     $ 669  
Repatriation of foreign earnings
    2,125              
State
    21       203       (675 )
Foreign
    2,221       2,073       2,734  
                         
Total current
    4,338       5,005       2,728  
                         
Deferred:
                       
Federal
    (4,956 )     (18,096 )     (28,637 )
Repatriation of foreign earnings
    (1,122 )     1,122        
State
    290       (908 )     433  
Foreign
    280       (606 )     363  
                         
Total deferred
    (5,508 )     (18,488 )     (27,841 )
                         
Income tax benefits
  $ (1,170 )   $ (13,483 )   $ (25,113 )
                         
 
Income tax benefits were 7.4%, 40.6%, and 36.3% of pre-tax losses in fiscal 2006, 2005, and 2004, respectively. A reconciliation of the provision for income tax benefits with the amounts obtained by applying the federal statutory tax rate is as follows:
 
                         
    June 25,
    June 26,
    June 27,
 
    2006     2005     2004  
 
Federal statutory tax rate
    (35.0 )%     (35.0 )%     (35.0 )%
State income taxes net of federal tax benefit
    (10.4 )     (4.2 )     (4.4 )
Foreign taxes less than domestic rate
    17.3       (0.7 )     (1.1 )
Foreign tax adjustment
          (3.0 )      
Repatriation of foreign earnings
    6.3       3.4        
Change in valuation allowance
    11.9       2.5       5.7  
Change in tax status of subsidiary
          (3.9 )      
Nondeductible expenses and other
    2.5       0.3       (1.5 )
                         
Effective tax rate
    (7.4 )%     (40.6 )%     (36.3 )%
                         
 
During fiscal year 2006, the Company repatriated approximately $31.0 million of dividends from foreign subsidiaries which qualified for the temporary dividends-received-deduction available under the American Jobs Creation Act. The associated net tax cost of approximately $1.1 million was not fully provided for in fiscal year 2005 due to management’s decision during fiscal year 2006 to increase the original repatriation plan from $15.0 million to $40.0 million.
 
During fiscal year 2005, the Company determined that it had not properly recorded deferred tax assets of a foreign subsidiary that should have been previously recognized. The Company recorded a deferred tax asset of $1.2 million in the fourth quarter of fiscal year 2005. The Company evaluated the effect of the adjustment and determined that the differences were not material for any of the periods presented in the Consolidated Financial Statements.


65


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The deferred income taxes reflect the net tax effects of temporary differences between the basis of assets and liabilities for financial reporting purposes and their basis for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets as of June 25, 2006 and June 26, 2005 were as follows:
 
                 
    June 25,
    June 26,
 
    2006     2005  
    (Amounts in thousands)  
 
Deferred tax liabilities:
               
Property, plant and equipment
  $ 50,044     $ 60,859  
Investments in equity affiliates
    11,251       14,821  
Unremitted foreign earnings
          1,122  
Other
    42       2  
                 
Total deferred tax liabilities
    61,337       76,804  
                 
Deferred tax assets:
               
State tax credits
    10,597       13,085  
Accrued liabilities and valuation reserves
    11,783       15,748  
Net operating loss carryforwards
    7,799       10,529  
Intangible assets
    4,278       4,914  
Charitable contributions
    876       1,022  
Other items
    1,114       1,101  
                 
Total gross deferred tax assets
    36,447       46,399  
Valuation allowance
    (9,232 )     (10,930 )
                 
Net deferred tax assets
    27,215       35,469  
                 
Net deferred tax liability
  $ 34,122     $ 41,335  
                 
 
As of June 25, 2006, the Company has available for income tax purposes approximately $21.0 million in federal net operating loss carryforwards that may be used to offset future taxable income. The carryforwards expire as set forth in the table below:
 
                         
    2023   2024   2025
    (Amounts in thousands)
 
Expiration amount
  $ 1,373     $ 11,989     $ 7,618  
 
The Company also has available for state income tax purposes approximately $16.3 million in North Carolina investment tax credits, for which the Company has established a valuation allowance in the amount of $9.2 million. The credits expire as set forth in the table below:
 
                                                 
    2007   2008   2009   2010   2011   Thereafter
    (Amounts in thousands)
 
Expiration amount
  $ 3,861     $ 3,760     $ 3,689     $ 3,204     $ 1,229     $ 562  
 
The Company also has charitable contribution carryforwards of $2.5 million expiring in fiscal year 2007 through fiscal year 2010 that also may be used to offset future taxable income.
 
For the years ended June 25, 2006 and June 26, 2005, the valuation allowance decreased $1.7 million and $2.2 million, respectively. 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 become deductible. Management considers the scheduled reversal of deferred tax liabilities, available taxes in the carryback periods, projected future taxable income and tax planning strategies in making this assessment.


66


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
4. Common Stock, Stock Option Plans and Restricted Stock Plan
 
Common shares authorized were 500 million in 2006 and 2005. Common shares outstanding at June 25, 2006 and June 26, 2005 were 52,208,467 and 52,145,434, respectively.
 
At its meeting on April 24, 2003, the Company’s Board of Directors reinstituted the Company’s previously authorized stock repurchase plan. During fiscal year 2004, the Company repurchased approximately 1.3 million shares. At June 25, 2006, there was remaining authority for the Company to repurchase approximately 6.8 million shares of its common stock under the repurchase plan. The repurchase program was suspended in November 2003 and the Company has no immediate plans to reinstitute the program.
 
In December 2004, the FASB issued SFAS No. 123R as a replacement to SFAS No. 123 “Accounting for Stock-Based Compensation”. SFAS No. 123R supersedes APB No. 25 which allowed companies to use the intrinsic method of valuing share-based payment transactions. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on the fair-value method as defined in SFAS No. 123. On March 29, 2005, the SEC issued SAB No. 107 to provide guidance regarding the adoption of SFAS No. 123R and disclosures in Management’s Discussion and Analysis. The effective date of SFAS No. 123R was modified by SAB No. 107 to begin with the first annual reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. Accordingly, the Company implemented SFAS No. 123R effective June 27, 2005.
 
Previously the Company measured compensation expense for its stock-based employee compensation plans using the intrinsic value method prescribed by APB Opinion No. 25, “Accounting for Stock Issued to Employees” as permitted by SFAS No. 123 and SFAS No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure”. Had the fair value-based method under SFAS No. 123 been applied, compensation expense would have been recorded for the options outstanding based on their respective vesting schedules.
 
The Company currently has only one share-based compensation plan which had unvested stock options as of June 25, 2006. The compensation cost that was charged against income for this plan was $0.7 million and $0 for the fiscal years ended June 25, 2006 and June 26, 2005, respectively. The total income tax benefit recognized for share-based compensation in the Consolidated Statements of Operations was not material for the fiscal years 2006, 2005 and 2004.
 
During the fourth quarter of fiscal year 2006, the Board authorized the issuance of 150 thousand options from the 1999 Long-Term Incentive Plan to two newly promoted officers of the Company. During the first half of fiscal year 2005, the Board authorized the issuance of approximately 2.1 million stock options from the 1999 Long-Term Incentive Plan to certain key employees. The stock options granted in fiscal years 2006 and 2005 vest in three equal installments: the first one-third at the time of grant, the next one-third on the first anniversary of the grant and the final one-third on the second anniversary of the grant.
 
On April 20, 2005, the Board of Director’s approved a resolution to vest all stock options, in which the exercise price exceeded the closing price of the Company’s common stock on April 20, 2005, granted prior to June 26, 2005. The Board decided to fully vest these specific underwater options, as there was no perceived value in these options to the employee, little retention ramifications, and to minimize the expense to the Company’s consolidated financial statements upon adoption of SFAS No. 123R. No other modifications were made to the stock option plan except for the accelerated vesting. This acceleration of the original vesting schedules affected 0.3 million unvested stock options.
 
SFAS No. 123R requires the Company to record compensation expense for stock options using the fair value method. The Company decided to adopt SFAS No. 123R using the Modified — Prospective Transition Method in which compensation cost is recognized for share-based payments based on the grant date fair value from the beginning of the fiscal period in which the recognition provisions are first applied. The effect of the change from applying the intrinsic method of accounting for stock options under APB 25, previously permitted by SFAS No. 123 as an alternative to the fair value recognition method, to the fair value recognition provisions of SFAS No. 123 on income from continuing operations before income taxes, income from continuing operations and net income for the


67


Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

fiscal year 2006 was $0.7 million, $0.7 million and $0.7 million, respectively. There was no material change from applying the original provisions of SFAS No. 123 on cash flow from continuing operations, cash flow from financing activities, and basic and diluted earnings per share.
 
The fair value of each option award is estimated on the date of grant using the Black-Scholes model. The Company uses historical data to estimate the expected life, volatility, and estimated forfeitures of an option. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.
 
On October 21, 1999, the shareholders of the Company approved the 1999 Unifi, Inc. Long-Term Incentive Plan (“1999 Long-Term Incentive Plan”). The plan authorized the issuance of up to 6,000,000 shares of Common Stock pursuant to the grant or exercise of stock options, including Incentive Stock Options (“ISO”), Non-Qualified Stock Options (“NQSO”) and restricted stock, but not more than 3,000,000 shares may be issued as restricted stock. Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant.
 
Stock options granted under the plan have vesting periods of three to five years based on continuous service by the employee. All stock options have a 10 year contractual term. In addition to the 3,672,174 common shares reserved for the options that remain outstanding under grants from the 1999 Long-Term Incentive Plan, the Company has previous ISO plans with 57,500 common shares reserved and previous NQSO plans with 216,667 common shares reserved at June 25, 2006. No additional options will be issued under any previous ISO or NQSO plan. The stock option activity for fiscal years 2006, 2005 and 2004 of all three plans was as follows:
 
                                 
    ISO     NQSO  
    Options
    Weighted
    Options
    Weighted
 
    Outstanding     Avg. $/Share     Outstanding     Avg. $/Share  
 
Fiscal year 2004:
                               
Shares under option — beginning of year
    3,880,772     $ 10.81       583,175     $ 24.67  
Granted
    20,000       6.85              
Expired
    (294,252 )     12.89       (50,000 )     26.66  
Forfeited
    (71,693 )     8.79              
                                 
Shares under option — end of year
    3,534,827       10.66       533,175       24.48  
Fiscal year 2005:
                               
Granted
    2,101,788       2.84              
Exercised
    (33,330 )     2.76              
Expired
    (1,227,591 )     12.76       (191,508 )     25.82  
Forfeited
    (102,691 )     4.91              
                                 
Shares under option — end of year
    4,273,003       6.41       341,667       23.72  
Fiscal year 2006: