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HG Holdings, Inc. - Quarter Report: 2006 September (Form 10-Q)

SFC, Inc. Q3-06 Form 10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

Form 10-Q


(Mark One)

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
or
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the transition period from   to  .

Commission file number: 0-14938


STANLEY FURNITURE COMPANY, INC.
(Exact name of registrant as specified in its charter)



 
Delaware
 
54-1272589
 
(State or other jurisdiction of incorporation)
(I.R.S. Employer Identification No.)


1641 Fairystone Park Highway, Stanleytown, Virginia 24168
(Address of principal executive offices, Zip Code)


(276) 627- 2000
(Registrant’s telephone number, including area code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes (x) No ( )

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one);
Large accelerated filer ( ) Accelerated filer (x) Non-accelerated filer ( )

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ( ) No (x)

As of October 13, 2006, 11,131,810 shares of common stock of Stanley Furniture Company, Inc., par value $.02 per share were outstanding.

 
PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

STANLEY FURNITURE COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
   
(unaudited) 
     
   
September 30, 
 
 December 31,
 
   
2006 
 
2005
 
ASSETS
         
Current assets:
             
Cash
 
$
5,400
 
$
12,556
 
Accounts receivable, less allowances of $2,502 and $1,566
   
38,271
   
36,957
 
Inventories:
             
  Finished goods
   
45,491
   
52,609
 
  Work-in-process
   
5,453
   
7,609
 
  Raw materials
   
8,822
   
9,743
 
      Total inventories
   
59,766
   
69,961
 
               
Prepaid expenses and other current assets 
   
1,759
   
1,435
 
Deferred income taxes
   
2,442
   
2,462
 
Total current assets
   
107,638
   
123,371
 
               
Property, plant and equipment, net
   
48,438
   
50,744
 
Goodwill
   
9,072
   
9,072
 
Other assets
   
6,362
   
7,301
 
Total assets
 
$
171,510
 
$
190,488
 
               
LIABILITIES
             
Current liabilities:
             
Current maturities of long-term debt
 
$
2,857
 
$
2,857
 
Accounts payable
   
18,227
   
16,405
 
Accrued salaries, wages and benefits
   
9,636
   
11,144
 
Other accrued expenses
   
2,287
   
1,765
 
        Total current liabilities
   
33,007
   
32,171
 
               
Long-term debt, exclusive of current maturities
   
7,143
   
8,571
 
Deferred income taxes
   
9,386
   
10,164
 
Other long-term liabilities
   
6,559
   
6,833
 
Total liabilities
   
56,095
   
57,739
 
               
STOCKHOLDERS’ EQUITY
             
Common stock, $.02 par value, 25,000,000 shares authorized
11,131,810 and 12,252,000 shares issued and outstanding
   
223
   
245
 
Retained earnings
   
115,370
   
132,682
 
Accumulated other comprehensive loss
   
(178
)
 
(178
)
Total stockholders’ equity
   
115,415
   
132,749
 
    Total liabilities and stockholders’ equity
 
$
171,510
 
$
190,488
 

The accompanying notes are an integral part of the consolidated financial statements.



STANLEY FURNITURE COMPANY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)


   
Three Months
 
Nine Months
 
   
          Ended 
 
           Ended 
 
   
        September
 
         October
 
       September
 
        October
 
   
         30, 2006 
 
          1, 2005  
 
         30, 2006 
 
          1, 2005  
 
                           
Net sales
 
$
75,911
 
$
85,615
 
$
236,911
 
$
252,200
 
                           
Cost of sales
   
60,951
   
65,131
   
184,575
   
190,619
 
                           
Gross profit
   
14,960
   
20,484
   
52,336
   
61,581
 
                           
Selling, general and administrative expenses
   
9,996
   
11,106
   
32,447
   
33,396
 
                           
Operating income
   
4,964
   
9,378
   
19,889
   
28,185
 
                           
Other income, net
   
91
   
71
   
252
   
190
 
Interest income
   
76
   
96
   
332
   
250
 
Interest expense
   
537
   
548
   
1,570
   
1,663
 
                           
Income before income taxes
   
4,594
   
8,997
   
18,903
   
26,962
 
                           
Income taxes
   
1,598
   
3,195
   
6,578
   
9,573
 
                           
Net income
 
$
2,996
 
$
5,802
 
$
12,325
 
$
17,389
 
                           
Earnings per share:
                         
                           
Basic
 
$
.26
 
$
.45
 
$
1.04
 
$
1.35
 
Diluted
 
$
.26
 
$
.44
 
$
1.01
 
$
1.31
 
                           
Weighted average shares outstanding:
                         
                           
Basic
   
11,396
   
12,811
   
11,861
   
12,886
 
Diluted
   
11,657
   
13,198
   
12,147
   
13,294
 
                           
Cash dividend declared and paid per common share
 
$
.08
 
$
.06
 
$
.24
 
$
.18
 
                           




The accompanying notes are an integral part of the consolidated financial statements.



STANLEY FURNITURE COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(unaudited)
(in thousands)
 
 
Nine Months Ended 
 
   
September 30,
 
October 1, 
 
   
   2006 
 
              2005 
 
Cash flows from operating activities:
             
Cash received from customers
 
$
234,933
 
$
247,093
 
Cash paid to suppliers and employees
   
(199,742
)
 
(214,001
)
Interest paid, net
   
(1,335
)
 
(1,431
)
Income taxes paid, net
   
(8,612
)
 
(8,447
)
Net cash provided by operating activities
   
25,244
   
23,214
 
               
Cash flows from investing activities:
             
Capital expenditures
   
(2,023
)
 
(3,791
)
Purchase of other assets
   
(17
)
 
(33
)
Net cash used by investing activities
   
(2,040
)
 
(3,824
)
               
Cash flows from financing activities:
             
Repayment of senior notes
   
(1,428
)
 
(2,828
)
Purchase and retirement of common stock
   
(28,282
)
 
(9,996
)
Proceeds from insurance policy loans
   
1,241
   
1,110
 
Dividends paid
   
(2,859
)
 
            (2,330
)
Proceeds from exercised stock options
   
713
   
6,335
 
Tax benefit from exercise of stock options
   
255
       
Net cash used by financing activities
   
(30,360
)
 
(7,709
)
               
Net increase (decrease) in cash
   
(7,156
)
 
11,681
 
Cash at beginning of period
   
12,556
   
7,632
 
Cash at end of period
 
$
5,400
 
$
19,313
 
           
Reconciliation of net income to net cash provided by operating activities:
         
Net income
 
$
12,325
 
$
17,389
 
Depreciation
   
4,368
   
4,228
 
Deferred income taxes
   
(758
)
 
(524
)
Tax benefit from exercise of stock options
   
(255
)
     
Stock-based compensation
   
268
       
Loss on disposal of assets
   
23
       
Changes in assets and liabilities:
             
Accounts receivable
   
(1,314
)
 
(5,062
)
Inventories
   
10,195
   
882
 
Prepaid expenses and other current assets
   
(406
)
 
(1,085
)
Accounts payable
   
1,822
   
2,907
 
Accrued salaries, wages and benefits
   
(1,262
)
 
2,301
 
Other accrued expenses
   
777
   
2,349
 
Other assets
   
(265
)
 
(56
)
Other long-term liabilities 
   
(274
)
 
(115
)
Net cash provided by operating activities
 
$
25,244
 
$
23,214
 
 
The accompanying notes are an integral part of the consolidated financial statements.

 
STANLEY FURNITURE COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except per share data)

1.
Preparation of Interim Unaudited Consolidated Financial Statements

The consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). In our opinion, these statements include all adjustments necessary for a fair presentation of the results of all interim periods reported herein. All such adjustments are of a normal recurring nature. Certain information and footnote disclosures prepared in accordance with generally accepted accounting principles have been either condensed or omitted pursuant to SEC rules and regulations. However, we believe that the disclosures made are adequate for a fair presentation of results of operations and financial position. Operating results for the interim periods reported herein may not be indicative of the results expected for the year. We suggest that these consolidated financial statements be read in conjunction with the consolidated financial statements and accompanying notes included in our latest Annual Report on Form 10-K.

2.
Stock-based Compensation 

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“FAS 123(R)”) using the modified-prospective-transition method. Under this transition method, compensation cost in 2006 includes options granted prior to but not vested as of December 31, 2005, and options granted in 2006. Therefore, results for prior periods have not been restated.

The adoption of SFAS No. 123(R) lowered net income by approximately $175 for the nine months ended September 30, 2006, and had an insignificant impact on the third quarter of 2006, compared to if we had continued to account for share-based compensation under APB No. 25, Accounting For Stock Issued to Employees.

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 during the periods presented. For the purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes option-pricing model and amortized to expense over the vesting periods.

   
   Three Months
Ended
 
Nine Months
Ended
 
   
October
 
October
 
   
1, 2005 
 
1, 2005 
 
Net income as reported
 
$
5,802
 
$
17,389
 
Deduct: Total stock-based compensation expense determined
             
under fair value based method for all awards, net of related
             
   tax effects
   
18
   
495
 
Pro forma net income
 
$
5,784
 
$
16,894
 
               
Earnings per share:
             
Basic - as reported
 
$
0.45
 
$
1.35
 
Basic - pro forma
 
$
0.45
 
$
1.31
 
               
Diluted - as reported
 
$
0.44
 
$
1.31
 
Diluted - pro forma
 
$
0.44
 
$
1.27
 

As of September 30, 2006, there was approximately $574 of unrecognized compensation cost related to unvested share-based compensation awards granted. That cost is expected to be recognized over the next four years.



In November 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3 (“FSP 123(R)”), Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. FSP 123(R)-3 provides an elective alternative transition method for calculating the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to the adoption of FAS 123(R). Companies may take up to one year from the effective date of FSP 123(R)-3 to evaluate the available transition alternatives and make a one-time election as to which method to adopt. We are currently in the process of evaluating the alternative methods.

Options are granted to certain employees and directors at prices equal to the market value of the stock on the dates the options were granted. The options granted have a term of 10 years from the grant date and granted options for employees vest ratably over a four to five year period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. We have estimated the fair value of all stock option awards as of the date of the grant by applying the Black-Scholes pricing valuation model. The application of this valuation model involves assumptions that are judgmental and sensitive in the determination of compensation expense. The weighted average for key assumptions used in determining the fair value of options granted during the nine months ended September 30, 2006 follows:
 
Expected price volatility
 36.1
%  
Risk-free interest rate
 4.7
%  
Weighted average expected life in years
 5.2
 
Dividend yield
 1.2
%  
 
Historical information was the primary basis for the selection of the expected volatility, expected dividend yield and the expected lives of the options. The risk-free interest rate was selected based upon yields of U. S. Treasury issues with a term equal to the expected life of the option being valued.

Stock option activity during the nine months ended September 30, 2006 is as follows:

           
Weighted
     
           
Average
     
       
Weighted
 
Remaining
 
Aggregate
 
   
Number of
 
Average
 
Contractual
 
Intrinsic
 
   
Shares 
 
Exercise price
 
Term (in yrs)
 
Value
 
                           
Outstanding at January 1, 2006
   
855
 
$
14.71
   
5.7
       
Lapsed
   
  (23)
 
$
17.49
             
Exercised
   
  (54)
 
$
13.21
             
Granted
   
  25
 
$
27.59
             
                           
Outstanding at September 30, 2006
   
          803
 
$
15.14
   
5.2
 
$
4,960
 
                           
Exercisable at September 30, 2006
   
 729
 
$
14.14
   
4.8
 
$
5,223
 

The average fair market value of options granted in the first nine months of 2006 was $9.92. Cash proceeds, tax benefits and intrinsic value related to total stock options exercised during the three and nine month periods of 2006 and 2005 are as follows:

   
Three Months
 
Nine Months
 
   
Ended 
 
Ended 
 
   
September
 
October
 
September
 
October
 
   
30, 2006 
 
1, 2005 
 
30, 2006 
 
1, 2005 
 
Proceeds from stock options exercised
 
$
0
 
$
1,225
 
$
713
 
$
6,335
 
Tax benefits related to stock options exercised
 
$
0
 
$
   503
 
$
255
 
$
1,743
 
Intrinsic value of stock options exercised 
 
$
0
 
$
1,361
 
$
689
 
$
4,718
 





3. Property, Plant and Equipment

   
 
 
   
September 
 
December  
 
 
   
30, 2006   
   
31, 2005
 
Land and buildings
 
$
40,800
 
$
39,894
 
Machinery and equipment
   
78,435
   
77,693
 
Office furniture and equipment
   
2,053
   
1,916
 
Property, plant and equipment, at cost
   
121,288
   
119,503
 
Less accumulated depreciation
   
72,850
   
68,759
 
Property, plant and equipment, net
 
$
48,438
 
$
50,744
 

4. Debt
   
 
 
   
September 
 
December  
 
 
   
30, 2006  
   
31, 2005
 
7.43% senior notes due through November 18, 2007
 
$
2,857
 
$
2,857
 
6.94% senior notes due through May 3, 2011
   
7,143
   
8,571
 
Total
   
10,000
   
11,428
 
Less current maturities
   
2,857
   
2,857
 
Long-term debt, exclusive of current maturities
 
$
7,143
 
$
8,571
 

The above loan agreements were amended effective July 14, 2006, to eliminate the covenant restricting our ability to pay dividends with respect to our common stock and to repurchase our common stock.

5. Employee Benefits Plans

Components of pension cost:
 
   
Three Months
 
Nine Months
 
   
Ended 
 
Ended 
 
   
   September
 
October
 
    September
 
October
 
   
30, 2006 
 
1, 2005 
 
30, 2006 
 
1, 2005 
 
Interest Cost
 
$
$232
 
$
230
 
$
696
 
$
715
 
Expected return on plan assets
   
(245
)   
(248
 
(736
 
(761
Net amortization and deferral
   
125
   
106
   
375
   
328
 
    Net Cost
   
112
   
88
   
335
   
282
 
 Settlement Expense     341    
                   286 
     652      859  
    Total expense
 
$
453
 
$
374
 
$
987
 
$
1,141
 
 
The Plan is fully funded as an ongoing plan; therefore, no contributions are required to be deposited in 2006.

On July 17, 2006, we announced our decision to terminate our defined benefit pension plan (“the Plan”). No benefits have accrued under the Plan since it was frozen in December 1995, at which time our contributions to a 401k savings plan became the primary retirement benefit. The Plan’s termination must be approved by the Internal Revenue Service and the Pension Benefit Guaranty Corporation. We expect to receive these approvals within twelve to fifteen months. As a result of the termination, we expect to make cash contributions to the Plan in the range of $1 million to $3 million between now and the final termination. In addition, we expect to record a charge to earnings in the range of $6 million and $8 million pre-tax, or $3.9 million to $5.2 million net of taxes, upon final termination. Pension expense related to this Plan for 2005 was approximately $1.2 million and is expected to be about the same for 2006.

Components of other postretirement benefit cost:

   
Three Months
 
Nine Months
 
   
Ended 
 
Ended 
 
   
September
 
October
 
September
 
October
 
   
30, 2006 
 
1, 2005 
 
30, 2006 
 
1, 2005 
 
Service cost
 
$
25
 
$
22
 
$
73
 
$
66
 
Interest cost
   
43
   
46
   
130
   
138
 
Amortization of transitions obligation
   
33
   
33
   
98
   
99
 
Amortization of net actuarial loss 
   
10
   
17
   
31
   
51
 
Net periodic postretirement benefit cost
 
$
111
 
$
118
 
$
332
 
$
354
 

6.
Stockholders’ Equity

Basic earnings per common share are based upon the weighted average shares outstanding. Outstanding stock options are treated as potential common stock for purposes of computing diluted earnings per share. Basic and diluted earnings per share are calculated using the following share data:

   
Three Months
 
Nine Months
 
   
Ended 
 
Ended 
 
   
September
 
October
 
September
 
       October
 
   
30, 2006 
 
1, 2005 
 
30, 2006 
 
1, 2005 
 
Weighted average shares outstanding
for basic calculation
   
11,396
   
12,811
   
11,861
   
12,886
 
Add: Effect of dilutive stock options
   
261
   
387
   
286
   
408
 
Weighted average shares outstanding
Adjusted for diluted calculation
   
11,657
   
13,198
   
12,147
   
13,294
 

A reconciliation of the activity in Stockholders’ Equity accounts for the quarter ended September 30, 2006 is as follows:
               
Accumulated
 
       
      Capital in
     
Other
 
   
Common
 
      Excess of
 
Retained
 
Comprehensive
 
   
Stock 
 
Par Value
 
Earnings
 
Loss
 
Balance, December 31, 2005
 
$
245
       
$
132,682
 
$
(178
)
                           
Net income
               
12,325
   
 
Exercise of stock options
   
1
 
$
712
             
Tax benefit on exercise of stock options
         
255
             
Stock repurchases
   
(23
)
 
(1,511
)
 
(26,748
)
     
Stock awards
         
246
             
Stock-based compensation
         
298
   
(30
)
     
Cash dividends paid, $.24 per share                            (2,859  )       
Balance, September 30, 2006
 
$
223
       
$
115,370
 
$
(178
)

7. New Accounting Standards

In June 2006, the Financial Standards Accounting Board (FASB) issued FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes (“FIN 48”) an interpretation of FASB Statement No. 109 (“SFAS 109”). This interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. FIN 48 details how companies should recognize, measure, present, and disclose uncertain tax positions that have been or expect to be taken. As such, financial statements will reflect expected future tax consequences of uncertain tax positions presuming the taxing authorities’ full knowledge of the position and all relevant facts. We are currently analyzing the effect of FIN 48 on our financial statements.

FIN 48 is effective for public companies for annual periods that begin after December 15, 2006.

In September 2006, the U.S. Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 108 (“SAB 108”), "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." SAB 108 eliminates the diversity of practice surrounding how public companies quantify financial statement misstatements. It establishes an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company's financial statements and the related financial statement disclosures. We do not expect SAB 108 to have a material impact on our financial condition or results of operations. SAB 108 must be applied to annual financial statements for their first fiscal year ending after November 15, 2006.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). This standard clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. Additionally, it establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. We have not yet determined the impact that the implementation of SFAS No. 157 will have on our results of operations or financial condition. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007.
 
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R)” ( “SFAS No. 158” ). This standard requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. Additionally, SFAS No. 158 requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position. We are currently evaluating the impact that the implementation of SFAS No. 158 will have on our financial statements.  The new reporting requirements and related new footnote disclosure rules of SFAS No. 158 are effective for fiscal years ending after December 15, 2006.  The new measurement date requirement applies for fiscal years ending after December 15, 2008.
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

Over the past few years the residential wood furniture industry has experienced a surge in low cost imported products, primarily from China. Imports have grown dramatically in the past few years and according to industry sources it is estimated that imports now account for over half of all residential wood furniture sold in the United States.

In response to this trend, we developed a blended strategy of combining our domestic manufacturing capabilities with an offshore sourcing program and realigned our manufacturing capacity. We incorporate selected imported component parts and finished items in our product line to lower cost, provide design flexibility and offer a better value to our customers. Sourced product represented approximately 34% of sales during the first nine months of 2006 compared to 32% in 2005. We anticipate this percentage will be about 35% for the remainder of 2006.

Recently, we began reinvigorating our continuous improvement efforts using lean business principles to improve processes and efficiencies. These efforts have allowed us to reduce inventories, which have lowered production levels and operating margins in the first nine months of 2006. We expect this trend may continue in the near term. While these renewed efforts have shown positive results, it is difficult to project the speed and the extent to which we are able to lower costs, improve quality and reduce inventories.

The following table sets forth the percentage relationship to net sales of certain items included in the Consolidated Statements of Income:

   
Three Months
 
Nine Months
 
   
Ended 
 
Ended 
 
   
September
 
October
 
September
 
October
 
   
30, 2006 
 
1, 2005 
 
30, 2006 
 
1, 2005 
 
Net sales
   
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
Cost of sales
   
80.3
   
76.1
   
77.9
   
75.6
 
Gross profit
   
19.7
   
23.9
   
22.1
   
24.4
 
Selling, general and administrative expenses
   
13.2
   
13.0
   
13.7
   
13.2
 
Operating income
   
6.5
   
11.0
   
8.4
   
11.2
 
Other income, net
   
.1
   
.1
   
.1
   
.1
 
Interest income
   
.1
   
.1
   
.1
   
.1
 
Interest expense
   
.7
   
.6
   
.6
   
.7
 
Income before income taxes
   
6.0
   
10.5
   
8.0
   
10.7
 
Income taxes
   
2.1
   
3.7
   
2.8
   
3.8
 
Net income
   
3.9
%
 
6.8
%
 
5.2
%
 
6.9
%

Net sales decreased $9.7 million, or 11.3%, for the three month period ended September 30, 2006, from the comparable 2005 period. For the nine month period, net sales decreased $15.3 million, or 6.1% from the 2005 nine month period. This was primarily due to lower unit volume resulting from continued weakness in demand, which we believe is due to current industry conditions, partially offset by higher average selling prices.

Gross profit margins for the three and nine month periods of 2006 were 19.7% and 22.1%, respectively compared to 23.9% and 24.4% for the comparable 2005 periods. Lower margins resulted from lower sales, decreased production levels, and higher raw material, compensation and energy costs. As a result of improving processes and reducing lead times, production levels decreased more sharply than the sales decline particularly in the second and third quarters of 2006 and led to lower margins due to the under absorption of factory overhead costs.

Selling, general and administrative expenses for the three and nine month periods as a percentage of net sales were 13.2% and 13.7%, respectively compared to 13.0% and 13.2% for the comparable 2005 periods. The higher percentage for the current year periods is primarily due to lower sales. Selling, general and administrative expenses decreased during the three and nine month periods, compared to the 2005 periods, due to lower selling expenses resulting from decreased sales and lower performance based compensation expense due to lower earnings. These lower costs were partially offset by increased bad debt expense and consulting fees related to our continuous improvement efforts.

As a result of the above, operating income as a percentage of net sales was 6.5% and 8.4%, respectively, for the three and nine month periods of 2006 compared to 11.0% and 11.2% for the comparable 2005 periods.

Interest expense for the nine month period of 2006 decreased primarily due to lower average debt levels. Interest income increased during the 2006 period due to higher interest income rates.




The effective tax rate for 2006 is expected to be 34.8%, compared to 35.3% for the total year 2005. The decrease in the effective tax rate is primarily a result of lower taxable income and an increase in tax-exempt interest income.

Financial Condition, Liquidity and Capital Resources

Our sources of liquidity include cash on hand, cash from operations and amounts available under a $25.0 million credit facility. These sources have been adequate for day-to-day expenditures, debt payments, purchases of our stock, capital expenditures and payment of cash dividends to stockholders. We expect these sources of liquidity to continue to be adequate for the future.

Working capital, excluding cash and current maturities of long-term debt, decreased $9.4 million during the first nine months of 2006 from $81.5 million at year end. The decrease was primarily due to a $10.2 million decrease in inventories, resulting from lower production levels due to lower sales and a reduction in manufacturing lead times.

Cash generated from operations was $25.2 million in the first nine months of 2006 compared to $23.2 million in the 2005 period. The increase was primarily due to lower payments to suppliers and employees due to lower production levels.

Net cash used by investing activities was approximately $2.0 million in the 2006 period compared to $3.8 million in 2005 and consisted primarily of normal capital expenditures. Capital expenditures for 2006 are anticipated to be in the range of $4.0 million to $4.5 million.

Net cash used by financing activities was $30.4 million in the 2006 period compared to $7.7 million in the 2005 period. In the 2006 period, cash from operations and proceeds from the exercise of stock options provided funds for the purchase and retirement of our common stock, cash dividends and the payment of our senior notes. During the first nine months of 2006, $28.3 million was used to purchase 1,184,190 shares of our common stock in the open market at an average price of $23.88. We currently have $37.9 million authorized by our Board of Directors to repurchase shares of our common stock. In the 2005 period, cash from operations provided funds for the purchase and retirement of our common stock, to pay cash dividends, and the payment of our senior notes. The Board of Directors increased the annual dividend policy to $0.32 per share on January 30, 2006. Our loan agreements were amended effective July 14, 2006, to eliminate the covenant restricting our ability to pay dividends with respect to our common stock and to repurchase our common stock.

At September 30, 2006, long-term debt including current maturities was $10.0 million. Debt service requirements are $1.4 million remaining in 2006, $2.9 million in 2007 and $1.4 million in 2008, 2009 and 2010. As of September 30, 2006, approximately $25.0 million of additional borrowings were available under the revolving credit facility and cash on hand was $5.4 million.

Pension Plan Termination

On July 17, 2006, we announced our decision to terminate our defined benefit pension plan (“the Plan”). No benefits have accrued under the Plan since it was frozen in December 1995, at which time contributions to a 401k savings plan became the primary retirement benefit. The Plan’s termination must be approved by the Internal Revenue Service and the Pension Benefit Guaranty Corporation. We expect to receive these approvals within twelve to fifteen months. As a result of the termination, we expect to make cash contributions to the Plan in the range of $1 million to $3 million between now and the final termination. In addition, we expect to record a charge to earnings in the range of $6 million and $8 million pre-tax, or $3.9 million to $5.2 million net of taxes upon final termination. Pension expense related to this Plan for 2005 was approximately $1.2 million and is expected to be about the same for 2006.




Critical Accounting Policies

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in our 10-K for the fiscal year ended December 31, 2005, except as follows:

Stock-Based Compensation - The Company accounts for stock-based compensation in accordance with the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R. The Company uses the Black-Scholes option - pricing model, which requires the input of subjective assumptions. These assumptions include estimating the length of time employees will retain their vested stock options before exercising them (“expected term”), the estimated volatility of the Company’s common stock price over the expected term and the number of options that ultimately will not vest (“forfeitures”). Changes in the subjective assumptions can materially affect the estimate of fair value stock-based compensation and consequently, the related amount recognized on the consolidated statements of income.

See note 2 to the consolidated financial statements, “Stock Based Compensation”, for a more detailed discussion of the effects of SFAS 123(R) on our results of operations and financial condition.

Recently Issued Accounting Standards

The Financial Standards Accounting Board (FASB) issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109” in June 2006. In September 2006, the FASB issued both Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements” and SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R)”. In September 2006, the U.S. Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements".

See note 7 to the consolidated financial statements, “New Accounting Standards”, for a more detailed discussion of the requirements and effective dates of these new standards.

Forward-Looking Statements

Certain statements made in this report are not based on historical facts, but are forward-looking statements. These statements can be identified by the use of forward-looking terminology such as “believes,” “estimates,” “expects,” “may,” “will,” “should,” or “anticipates,” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. These statements reflect our reasonable judgment with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include the cyclical nature of the furniture industry, competition in the furniture industry including competition from lower-cost foreign manufacturers, disruptions in offshore sourcing including those arising from supply or distribution disruptions or those arising from changes in political, economic and social conditions, as well as laws and regulations, in China or countries from which we source products, international trade policies of the United States and countries from which we source products, manufacturing realignment, the inability to obtain sufficient quantities of quality raw materials in a timely manner, business failures or loss of large customers, the inability to raise prices in response to inflation and increasing costs, failure to anticipate or respond to changes in consumer tastes and fashions in a timely manner, environmental compliance costs, extended business interruption at manufacturing facilities, and the impact of interest rate changes on the cost of terminating our defined benefit pension plan.



Any forward-looking statement speaks only as of the date of this filing, and we undertake no obligation to update or revise any forward-looking statements, whether as a result of new developments or otherwise.

ITEM 3.
 Quantitative and Qualitative Disclosures about Market Risk

Our revolving credit facility bears interest at a variable rate; therefore, changes in prevailing interest rates impact our borrowing costs. A one-percentage point fluctuation in market interest rates would not have a material impact on earnings during the first nine months of 2006.

None of our foreign sales or purchases are denominated in foreign currency and we do not have any foreign currency hedging transactions. While our foreign purchases are denominated in U.S. dollars, a relative decline in the value of the U.S. dollar could result in an increase in the cost of our component parts and finished items obtained from offshore sourcing and reduce our earnings, unless we are able to increase our prices for these items to reflect any such increased cost.

ITEM 4.
Controls and Procedures

(a)
Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation, our principal executive officer and our principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

(b)
Changes in internal controls over financial reporting. There were no changes in our internal control over financial reporting that occurred during the third quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities:

       
Maximum number (or
     
Total number of
approximate dollar
 
Total
 
Shares purchased
value) of shares that
 
number of
Average
as part of publicly
may yet be purchased
 
Shares
price paid
announced plans
under the plans or
Period
Purchased
per share
or programs
programs (a)
         
July 2 to August 5, 2006
218,500
$22.27
218,500
$45,133,367
August 6 to September 2, 2006
151,845
$22.51
151,845
$41,715,033
September 3 to September 30, 2006
178,000
$21.47
178,000
$37,893,302
         
Total
548,345
 $22.08
548,345
 

(a)
On July 17, 2006, we announced that our Board of Directors increased our stock repurchase authorization to $50 million. Consequently, we may purchase our common stock, from time to time, either directly or through agents, in the open market, through negotiated purchases or otherwise, at prices and on terms satisfactory to us.




Item 6. Exhibits

3.1
Restated Certificate of Incorporation of the Registrant as amended (incorporated by reference to Exhibit 3.1 to the Registrant’s Form 10-Q (Commission File No. 0-14938) for the quarter ended July 2, 2005).
 
     
3.2
By-laws of the Registrant as amended (incorporated by reference to Exhibit 3 to the Registrant’s Form 10-Q (Commission File No. 0-14938) for the quarter ended September 27, 2003).
 
     
10.1
Third amendment, dated June 14, 2006, to the revolving credit facility dated August 29, 2003, between the Registrant and Wachovia Bank (incorporated by reference to Exhibit 10.1 to the Registrant’s Form 8-K (Commission File No. 0-14938) filed on July 18, 2006).
 
     
31.1
Certification by Jeffrey R. Scheffer, our Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.(1)
 
     
31.2
Certification by Douglas I. Payne, our Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (1)
 
     
32.1
Certification of Jeffrey R. Scheffer, our Chief Executive Officer, pursuant to 18 U. S. C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. (1)
 
     
32.2
Certification of Douglas I. Payne, our Chief Financial Officer, pursuant to 18 U. S. C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002. (1)
 



 
(1) Filed herewith



SIGNATURE



Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Date: October 17, 2006
 
STANLEY FURNITURE COMPANY, INC.
   
By: /s/ Douglas I. Payne
   
Douglas I. Payne
   
Executive V.P. - Finance & Administration
And Secretary
   
(Principal Financial and Accounting Officer)