##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2005 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  000-26667
 CRAFTMADE INTERNATIONAL, INC.
  Delaware
    
    75-2057054(State or other jurisdiction
of incorporation or organization)
    
    (I.R.S. Employer
Identification No.)650 South Royal Lane, Suite 100, Coppell, Texas
    
    75019(Address of principal executive offices)
    
    (Zip Code)
  þ o
 þ o
 o þ




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Part I. Financial Information (Unaudited)Item 1. Financial Statements.Condensed Consolidated Statements of IncomeCondensed Consolidated Balance SheetsCondensed Consolidated Statements of Cash FlowsNotes to Condensed Consolidated Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.Item 3. Quantitative and Qualitative Disclosures About Market Risk.Item 4. Controls and Procedures.Part II. Other InformationItem 1. Legal Proceedings.Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.Item 3. Defaults Upon Senior Securities.Item 4. Submission of Matters to a Vote of Security Holders.Item 5. Other Information.Item 6. Exhibits.Modification, Renewal and Extension AgreementAmended and Restated Loan AgreementArbitration and Notice of Final AgreementCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
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PART I
FINANCIAL INFORMATION
 
   
    Gross profit
    
    
    8,746
    
    
    
    8,520Selling, general and administrative expenses
    
    
    4,898
    
    
    
    5,409Interest expense, net
    
    
    304
    
    
    
    230Depreciation and amortization
    
    
    158
    
    
    
    147Total expenses
    
    
    5,360
    
    
    
    5,786Income before income taxes and minority interests
    
    
    3,386
    
    
    
    2,734Minority interests
    
    
    734
    
    
    
    566Income before income taxes
    
    
    2,652
    
    
    
    2,168Income taxes
    
    
    920
    
    
    
    770Net income
    
    $
    1,732
    
    
    $
    1,398Basic earnings per common share
    
    $
    0.33
    
    
    $
    0.27Diluted earnings per common share
    
    $
    0.33
    
    
    $
    0.27Cash dividends declared per common share
    
    $
    0.12
    
    
    $
    0.10
 
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September 30,
    
    
    June 30,2005
    
    
    2005(Unaudited)Current assetsCash
    
    $
    3,454
    
    
    $
    9,145Accounts receivable  net of allowance
of $232 and $300, respectively
    
    
    20,792
    
    
    
    21,810Inventories  net of allowance of $761
and $717, respectively
    
    
    18,755
    
    
    
    18,042Deferred income taxes
    
    
    1,637
    
    
    
    1,224Prepaid expenses and other current assets
    
    
    468
    
    
    
    374Total current assets
    
    
    45,106
    
    
    
    50,595Property and equipmentLand
    
    
    1,535
    
    
    
    1,535Building
    
    
    7,796
    
    
    
    7,796Office furniture and equipment
    
    
    9,184
    
    
    
    9,148Leasehold improvements
    
    
    279
    
    
    
    27918,794
    
    
    
    18,758Less: accumulated depreciation
    
    
    (10,416
    )
    
    
    (10,266
    )Total property and equipment, net
    
    
    8,378
    
    
    
    8,492Other assetsGoodwill
    
    
    11,480
    
    
    
    11,480Other intangibles  net of accumulated amortization
of $17 and $10, respectively
    
    
    183
    
    
    
    190Other assets
    
    
    51
    
    
    
    58Total other assets
    
    
    11,714
    
    
    
    11,728Total assets
    
    $
    65,198
    
    
    $
    70,815
 
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September 30,
    
    
    June 30,2005
    
    
    2005(Unaudited)Current liabilitiesNote payable  current
    
    $
    1,050
    
    
    $
    1,319Revolving line of credit
    
    
    1,548
    
    
    
    24,548Accounts payable
    
    
    9,422
    
    
    
    9,299Commissions payable
    
    
    223
    
    
    
    248Income taxes payable
    
    
    1,298
    
    
    
    (33
    )Accrued customer allowances
    
    
    4,731
    
    
    
    4,164Other accrued expenses
    
    
    1,086
    
    
    
    1,055Total current liabilities
    
    
    19,358
    
    
    
    40,600Other non-current liabilitiesNote payable  long term
    
    
    16,271
    
    
    
    1,551Other long-term expenses
    
    
    860
    
    
    
    860Deferred income taxes
    
    
    202
    
    
    
    226Total other non-current liabilities
    
    
    17,333
    
    
    
    2,637Total liabilities
    
    
    36,691
    
    
    
    43,237Minority interests
    
    
    3,016
    
    
    
    3,205Commitments and contingencies (Note 5)Stockholders equitySeries A cumulative, convertible callable
preferred stock, $1.00 par value, 2,000,000
shares authorized; 32,000 shares issued
    
    
    32
    
    
    
    32Common stock, $0.01 par value, 15,000,000
shares authorized and 9,699,920 shares issued
    
    
    97
    
    
    
    97Additional paid-in capital
    
    
    18,662
    
    
    
    18,653Retained earnings
    
    
    46,707
    
    
    
    45,598Less: treasury stock, 4,499,920 common shares
at cost, and 32,000 preferred shares at cost
    
    
    (40,007
    )
    
    
    (40,007
    )Total stockholders equity
    
    
    25,491
    
    
    
    24,373Total liabilities and stockholders equity
    
    $
    65,198
    
    
    $
    70,815
 
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##### Table of Contents



FOR THE THREE MONTHS ENDEDSeptember 30,
    
    
    September 30,2005
    
    
    2004Net cash provided by operating activities
    
    $
    3,426
    
    
    $
    5,057Cash flows from investing activitiesAdditions to property and equipment
    
    
    (36
    )
    
    
    (17
    )Cash used in investing activities
    
    
    (36
    )
    
    
    (17
    )Cash flows from financing activitiesNet payments on lines of credit
    
    
    (8,010
    )
    
    
    (316
    )Principal payments on notes payable
    
    
    (540
    )
    
    
    (789
    )Treasury stock repurchases
    
    
    
    
    
    
    (993
    )Stock options exercised
    
    
    
    
    
    
    10Cash dividends
    
    
    (531
    )
    
    
    (502
    )Distributions to minority interest members
    
    
    
    
    
    
    (293
    )Net cash used in financing activities
    
    
    (9,081
    )
    
    
    (2,883
    )Net increase/(decrease) in cash
    
    
    (5,691
    )
    
    
    2,157Cash at beginning of period
    
    
    9,145
    
    
    
    5,838Cash at end of period
    
    $
    3,454
    
    
    $
    7,995Supplemental disclosure of non-cash financing activities:Minority interest earned but not paid
    
    $
    922
    
    
    $
    
 
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The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America and
with the rules and regulations of the Securities and Exchange Commission (SEC) for interim
financial reporting, and include all adjustments which are, in the opinion of management,
necessary for a fair presentation. The condensed consolidated financial statements include
the accounts of Craftmade International, Inc. (Craftmade), and its wholly-owned
subsidiaries, including Trade Source International, Inc. (TSI), and two 50% owned limited
liability companies, Prime/Home Impressions, LLC (PHI) and Design Trends, LLC (Design
Trends). Craftmade and its subsidiaries including TSI, PHI and Design Trends are sometimes
collectively referred to as the Company. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and regulations.
The Company believes that the disclosures are adequate to make the information presented
not misleading; however, it is suggested that these financial statements be read in
conjunction with the financial statements and the notes thereto, in the Companys Annual
Report on Form 10-K for the fiscal year ended June 30, 2005 filed with the SEC on September
20, 2005. The financial data for the interim periods may not necessarily be indicative of
results to be expected for the year.
  The following is a reconciliation of the numerator and denominator used in the basic and
diluted EPS calculations:
 FOR THE THREE MONTHS ENDEDSeptember 30,
    
    
    September 30,2005
    
    
    2004(In thousands,except per share data)Basic and diluted earnings per share:NumeratorNet income
    
    $
    1,732
    
    
    $
    1,398Denominator for basic EPSCommon shares outstanding
    
    
    5,200
    
    
    
    5,084Denominator for diluted EPSCommon shares outstanding
    
    
    5,200
    
    
    
    5,084Incremental shares for stock options
    
    
    10
    
    
    
    40Potentially dilutive common shares
    
    
    5,210
    
    
    
    5,124Basic earnings per share
    
    $
    0.33
    
    
    $
    0.27Diluted earnings per share
    
    $
    0.33
    
    
    $
    0.27
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Effective July 1, 2005, the Company adopted SFAS 123 (revised 2004), Share-Based Payment
(SFAS 123R), which revises SFAS 123 and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. SFAS 123R requires all share-based payments to employees to be
recognized in the financial statements based on their fair values using an option-pricing
model, such as the Black-Scholes model, at the date of grant. The cost will be recognized
over the period during which an employee is required to provide services in exchange for the
award, known as the requisite service period (usually the vesting period). The Company
elected to use the modified prospective method for adoption, which requires compensation
expense to be recorded for all unvested stock options and restricted shares beginning in the
first quarter of adoption. Compensation cost for awards granted prior to, but not vested as
of, the date the Company adopted SFAS 123R were based on the grant date fair value and
attributes originally used to value those awards.
 For three months ended September 30, 2005, compensation expense from unvested options
outstanding as of July 1, 2005 totaled $9,000. There were no options granted in the quarter
ended September 30, 2005.
 The following table shows pro forma net income for the three months ended September 30, 2004
had compensation expense for the Companys stock option plans been determined based upon the
fair value at the grant date for awards consistent with the methodology prescribed by SFAS
123. The pro forma results for the three months ended September 30, 2004 are compared to
actual results for the three months ended September 30, 2005 where stock option expense is
included in reported net income. The pro forma effects may not be representative of expense
in future periods since the estimated fair value of stock options on the date of grant is
amortized to expense over the vesting period and additional options may be granted or
options may be cancelled in future years.
 FOR THE THREE MONTHS ENDEDSeptember 30,
    
    
    September 30,2005
    
    
    2004(In thousands,except per share data)Actual
    
    
    Pro FormaNet income, as reported
    
    $
    1,732
    
    
    $
    1,398Compensation expense, net of related taxes
    
    
    
    
    
    
    (31
    )Net income, proforma
    
    $
    1,732
    
    
    $
    1,367Basic earnings per share, as reported
    
    $
    0.33
    
    
    $
    0.27Basic earnings per share, proforma
    
    
    0.33
    
    
    
    0.27Diluted earnings per share, as reported
    
    $
    0.33
    
    
    $
    0.27Diluted earnings per share, proforma
    
    
    0.33
    
    
    
    0.27
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The Company operates in two reportable segments, Craftmade and TSI. The accounting policies
of the segments are the same as those described in Note 2  Summary of Significant
Accounting Policies to the Companys Annual Report on Form 10-K for the fiscal year ended
June 30, 2005 as filed with the SEC on September 20, 2005. The Company evaluates the
performance of its segments and allocates resources to them based on their net sales, income
before minority interests and income taxes, and cash flows.
 The Company is organized on a combination of product type and customer base. The Craftmade
segment primarily derives its revenue from home furnishings including ceiling fans, light
kits, bathstrip lighting, lamps, light bulbs, door chimes, ventilation systems and other
lighting accessories offered primarily through lighting showrooms, certain major retail
chains and catalog houses. The TSI segment derives its revenue from outdoor lighting,
portable lamps, indoor lighting and fan accessories marketed solely to mass merchandisers.
 The following table presents sales and income for the reportable segments:
 FOR THE THREE MONTHS ENDEDSeptember 30,
    
    
    September 30,2005
    
    
    2004(In thousands)Net salesCraftmade
    
    $
    16,511
    
    
    $
    14,600TSI
    
    
    13,958
    
    
    
    14,425Total
    
    $
    30,469
    
    
    $
    29,025Income before minority
interests and
income taxesCraftmade
    
    $
    2,104
    
    
    $
    1,515TSI
    
    
    1,282
    
    
    
    1,219Total
    
    $
    3,386
    
    
    $
    2,734Net incomeCraftmade
    
    $
    1,345
    
    
    $
    982TSI
    
    
    387
    
    
    
    416Total
    
    $
    1,732
    
    
    $
    1,398
 Total assets for the TSI segment were $5,375,000 lower on September 30, 2005 than as
reported on June 30, 2005. This is primarily due to a decrease of cash in the amount of
$5,692,000. See the discussion in Item 2: Liquidity and Capital Resourcesfor the uses of
cash. The following table presents the total assets for the reportable segments:
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Total
Assets by Segment
 
 September 30,
    
    
    June 30,2005
    
    
    2005
    
    
    ChangeTSI
    
    $
    14,605
    
    
    $
    19,980
    
    
    $
    (5,375
    )Craftmade
    
    
    50,593
    
    
    
    50,835
    
    
    
    (242
    )Total
    
    $
    65,198
    
    
    $
    70,815
    
    
    $
    (5,617
    )
  As more fully described in the Companys Form 10-K for the fiscal year ended June 30, 2005
as filed with the SEC on September 20, 2005, the Company is a party to a lawsuit alleging
patent infringement related to a patent held by Lamps Plus, Inc. In November 2003, a jury
verdict held that the Company willfully infringed on the patent. The jury awarded damages of
$143,385, and Lamps Plus filed a motion to seek treble damages plus reasonable attorneys
fees and court costs. On September 14, 2004, the Court entered a Judgment and Permanent
Injunction and issued an Order Awarding Attorneys Fees. The Judgment awards Lamps Plus
$143,385 in actual damages plus costs of court. The Order awards $600,000 in attorneys
fees to Lamps Plus. The Company and other defendants in the lawsuit have appealed the
Judgment and Order, and the outcome of the appeal is uncertain. This appeal is pending in
the United States Court of Appeals for the Federal Circuit.
 Craftmade has an agreement with Dolan Northwest, LLC (the owner of the other 50% of Design
Trends) pursuant to which Dolan Northwest is responsible for the judgment rendered in the
lawsuit, plus all costs and expenses, including legal fees and court costs, associated with
the judgment. Dolan Northwest has also agreed to indemnify and hold harmless the Company
from and against any and all liabilities, losses, damages, costs or other expenses
associated with said judgment. Patrick Dolan has unconditionally guaranteed the obligations
of Dolan Northwest under this agreement.
 If the defendants appeal is unsuccessful, according to the above mentioned agreement, any
damages would be the responsibility of Dolan Northwest, LLC. Pursuant to this agreement,
Dolan Northwest filed a deposit in lieu of supersedeas bond with the court. Accordingly,
given the agreement and deposit in lieu of supersedeas bond, management believes that there
is no contingent liability for the Company.
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On October 31, 2005, the Company entered into a loan agreement (the Agreement) with Frost
National Bank (Frost) that renews the Companys promissory note in the amount of
$20,000,000 at the interest rate of the LIBOR index plus the following amounts based on
Debt to Net Worth. The Agreement is scheduled to mature on October 31, 2007.
Additionally, the Agreement does not have a provision where the outstanding balance of this
note can be due upon demand. Financial covenants of the Agreement are amended to remove the
Interest Coverage Ratio and modify the Fixed Charge Coverage ratio from 1.5:1 to
1.25:1. Other covenants and restrictions that apply to this Agreement limit the
Companys debt to tangible net worth ratio to be less than 3.0 to 1.0 after December 31,
2005. The Company has agreed not to purchase its stock if its debt to tangible net worth
exceeds 3.0 to 1.0. The Companys debt to tangible net worth ratio totaled 2.8 to 1.0 at
September 30, 2005.
 Percentage
    
    Debt to Net Worth Ratio2.75%
    
    >3.00 to 1.002.25%
    
    >=2.50 to 1.00 or <=3.00 to 1.001.75%
    
    >2.00 to 1.00 or <2.50 to 1.001.50%
    
    <=2.00 to 1.00
 In accordance with the terms of the SFAS 6, Classification of Short-Term Obligations
Expected to be Refinanced, the Company reclassified $14,990,000 of its existing promissory
note from short-term to long-term obligations at September 30, 2005.
  At September 30, 2005, the Company owed Home Impressions, LLP, the Companys 50% partner in
PHI, a payable totaling $1,289,000, primarily consisting of undistributed earnings.
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Cautionary StatementWith the exception of historical information, the matters discussed in this document contain
forward-looking statements. There are certain important factors which could cause actual
results to differ materially from those anticipated by these forward-looking statements.
Some of the important factors which would cause actual results to differ materially from
those in the forward-looking statements include, among other things, the dependency of TSI,
PHI and Design Trends on sales to select mass merchandiser customers and changes in those
relationships, changes in anticipated levels of sales, whether due to future national or
regional economic and competitive conditions, changes in relationships with Craftmade
customers, customer acceptance of existing and new products, pricing pressures due to excess
capacity, cost increases, changes in tax or interest rates, unfavorable economic and
political developments in Asia (the location of the Companys primary vendors) and changes
in the foreign currency exchange rate between the U.S. and Taiwan dollar or Chinese yuan,
declining conditions in the home construction industry, inability to realize deferred tax
assets, labor strikes, lockouts, and other labor slow downs, the ability of the Company to
import merchandise from foreign countries without significantly restrictive tariffs, duties
or quotas and the ability of the Company to source, ship and deliver items from foreign
countries to its U.S. distribution centers at reasonable prices and rates and in a timely
fashion, disruption or failure of management information systems, fluctuation of the results
of operations from quarter to quarter, restrictions of the Companys credit facility could
restrict operational flexibility, retention of key personnel, as well as other
uncertainties, all of which are difficult to predict and many of which are beyond the
control of the Company. When used in this document, the words believes, plans,
estimates, expects, anticipates, intends, continue, may, will, should,
projects, forecast, might, could or the negative of such terms and similar
expressions as they relate to Craftmade or its management are intended to identify
forward-looking statements.Critical Accounting Policies and EstimatesManagements discussion and analysis of the Companys financial condition and results of
operations following are based upon the Companys consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires the Companys management to
make estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and liabilities. The
Companys estimates are based on historical experience and various other factors that are
believed to be reasonable under the circumstances, the results of which form the basis for
the Companys conclusions. The Company continually evaluates the information used to make
these estimates as its business and the economic environment changes. The Companys
management believes that the estimates, assumptions and judgments involved in the accounting
policies described below have the greatest potential impact on its financial statements, so
the Company considers these to be its critical accounting policies. As the financial
statements contained herein are condensed, one should also read the Companys Form 10-K for
the year ended June 30, 2005 as filed with the SEC on September 20, 2005 regarding
expanded information about our critical accounting policies and estimates.Stock-Based CompensationEffective July 1, 2005, the Company adopted SFAS 123 (revised 2004), Share-Based Payment
(SFAS 123R), which revises SFAS 123 and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees. SFAS 123R requires all share-based payments to employees to be
recognized in the financial statements based on their fair values using an option-pricing
model, such as the Black-Scholes model, at the date of grant. The cost will be recognized
over the period during which an employee is required to provide services in exchange for the
award, known as the requisite service period (usually the vesting period). The Company
elected to use the modified prospective method for adoption, which requires compensation
expense to be recorded for all unvested stock options and restricted shares beginning in the
first quarter of adoption. Compensation cost for awards granted prior to, but not vested as
of, the date the
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Company adopted SFAS 123R were based on the grant date fair value and attributes originally
used to value those awards.OverviewManagement reviews a number of key indicators to evaluate the Companys financial
performance, including net sales, gross profit and selling, general and administrative
expenses by segment. A condensed overview of results for the three months ended September
30, 2005 and the corresponding prior year period can be summarized as follows (in
thousands):
 Three Months Ended
    
    
    Three Months EndedSeptember 30, 2005
    
    
    September 30, 2004Craftmade
    
    
    TSI
    
    
    Total
    
    
    Craftmade
    
    
    TSI
    
    
    TotalNet sales
    
    $
    16,511
    
    
    $
    13,958
    
    
    $
    30,469
    
    
    $
    14,600
    
    
    $
    14,425
    
    
    $
    29,025Cost of goods sold
    
    
    10,650
    
    
    
    11,073
    
    
    
    21,723
    
    
    
    8,970
    
    
    
    11,535
    
    
    
    20,505Gross profit
    
    
    5,861
    
    
    
    2,885
    
    
    
    8,746
    
    
    
    5,630
    
    
    
    2,890
    
    
    
    8,520Gross margin
    
    
    35.5
    %
    
    
    20.7
    %
    
    
    28.7
    %
    
    
    38.6
    %
    
    
    20.0
    %
    
    
    29.4
    %SG&A
    
    
    3,331
    
    
    
    1,567
    
    
    
    4,898
    
    
    
    3,787
    
    
    
    1,622
    
    
    
    5,409As a % of net sales
    
    
    20.2
    %
    
    
    11.2
    %
    
    
    16.1
    %
    
    
    25.9
    %
    
    
    11.2
    %
    
    
    18.6
    %Interest
    
    
    278
    
    
    
    26
    
    
    
    304
    
    
    
    197
    
    
    
    33
    
    
    
    230Depreciation
    
    
    148
    
    
    
    10
    
    
    
    158
    
    
    
    131
    
    
    
    16
    
    
    
    147Income before minority
interests and income taxes
    
    $
    2,104
    
    
    $
    1,282
    
    
    $
    3,386
    
    
    $
    1,515
    
    
    $
    1,219
    
    
    $
    2,734Minority interests
    
    
    
    
    
    
    734
    
    
    
    734
    
    
    
    
    
    
    
    566
    
    
    
    566Provision for income taxes
    
    
    759
    
    
    
    161
    
    
    
    920
    
    
    
    533
    
    
    
    237
    
    
    
    770Net income
    
    $
    1,345
    
    
    $
    387
    
    
    $
    1,732
    
    
    $
    982
    
    
    $
    416
    
    
    $
    1,398
 Results of OperationsThree Months Ended September 30, 2005 Compared to Three Months Ended September 30,
2004Net Sales.Net sales for the Company increased $1,444,000 or 5.0% to $30,469,000 for the
quarter ended September 30, 2005, compared to $29,025,000 for the same period last year. The
increase in sales was due to increased sales in the Craftmade segment partially offset by a
decline in sales in the TSI segment.Net sales from the Craftmade segment increased $1,911,000 or 13.1% to $16,511,000 for the
quarter ended September 30, 2005, from $14,600,000 for the same period last year. The
increase resulted from $2,014,000 of incremental net sales from the acquisition of Bill
Teiber Co., Inc. (Teiber). The remaining $103,000 decrease in sales of the Craftmade
segment resulted from a general decline across product lines.Based on sales results from fiscal year 2005, management anticipates that net sales from the
Craftmade segment, excluding results from the Teiber acquisition, will improve in fiscal
year 2006 as newly introduced products become available, assuming continued strength in the
housing sector and the overall U.S. economy. Management believes that the Teiber acquisition
will continue to provide incremental growth opportunities throughout fiscal year 2006.Net sales of the TSI segment declined $467,000 or 3.2% to $13,958,000 for the quarter ended
September 30, 2005, from $14,425,000 for the same period last year, as summarized in the
following table (in thousands except percentage data):
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##### Table of Contents



Change in Net Sales of TSI Segment
 Prime/
    
    
    TSITrade
    
    
    Design
    
    
    Home
    
    
    SegmentQuarter Ended
    
    Source
    
    
    Trends
    
    
    Impressions
    
    
    TotalSeptember 30, 2005
    
    $
    5,114
    
    
    $
    5,429
    
    
    $
    3,415
    
    
    $
    13,958September 30, 2004
    
    
    5,795
    
    
    
    6,145
    
    
    
    2,485
    
    
    
    14,425Dollar change
    
    
    (681
    )
    
    
    (716
    )
    
    
    930
    
    
    
    (467
    )Percent change
    
    
    -11.8
    %
    
    
    -11.7
    %
    
    
    37.4
    %
    
    
    -3.2
    %
 The TSI segment includes the Trade Source entity which is wholly owned by the Company
and the Prime/Home Impressions (PHI) and Design Trends entities which are 50% owned
companies. Hereafter, TSI refers to the segment and Trade Source to the entity. The net
decrease in sales of Trade Source primarily resulted from a decrease in sales of the mix and
match fan program to Wal-Mart and promotional indoor lighting products.The decline in Design Trends net sales was primarily due the previously disclosed loss of
four regional distribution centers which serve approximately 383 stores. More detail of
this event is provided in the Companys Form 10-K for the year ended June 30, 2005 as filed
with the SEC on September 20, 2005, and the Companys Form 8-K filing dated April 25, 2005.
Design Trends is the primary vendor to Lowes for its mix and match portable lamp program,
and such program is currently available in approximately 722 Lowes stores.The increase in net sales of PHI primarily resulted from the annual reset of the fan
accessory and lamp replacement parts business to Lowes.Future growth of the TSI segment, exclusive of Design Trends, is contingent upon the success
of the Companys ongoing efforts to introduce new products to existing customers and to
expand the business to new customers.Gross Profit.Gross profit of the Company as a percentage of net sales decreased to 28.7%
for the quarter ended September 30, 2005, compared to 29.4% for the same period last year.
Gross profit as a percentage of net sales of the Craftmade segment decreased 3.1% to 35.5%
for the quarter ended September 30, 2005, compared to 38.6% in the same period last year.
The decline in the gross margin of the Craftmade segment was primarily the result of
increased product costs due to a weaker U.S. dollar compared to the Taiwan dollar. The
Company anticipates that margins for the Craftmade division will stabilize in the second
quarter of fiscal 2006 due to a decrease in cost from a strengthening of the U.S. dollar
compared to the Taiwan dollar and from establishing relationships with manufacturers that
are located in other countries with a more favorable exchange rate.The gross profit of the TSI segment increased to 20.7% of sales for the quarter ended
September 30, 2005, compared to 20.0% of sales in the same prior year period, as summarized
in the following table:
 Change in Gross Margins of TSI Segment
 Prime/
    
    TSITrade
    
    Design
    
    Home
    
    SegmentQuarter Ended
    
    Source
    
    Trends
    
    Impressions
    
    TotalSeptember 30, 2005
    
    
    10.2
    %
    
    
    21.9
    %
    
    
    34.4
    %
    
    
    20.7
    %September 30, 2004
    
    
    15.9
    %
    
    
    19.5
    %
    
    
    31.0
    %
    
    
    20.0
    %Percent Change
    
    
    -5.7
    %
    
    
    2.4
    %
    
    
    3.4
    %
    
    
    0.7
    %
 The net increase in gross margin as a percentage of sales for the TSI segment resulted
from changes in mix of (i) vendor program accruals as a percentage of gross sales, (ii)
sales mix, and (iii) changes in composition of shipments origin. Orders shipped directly
from the Companys vendors to its customers are typically at lower margins. Orders shipped
domestically from the Companys warehouse are typically at higher margins to offset the
costs associated with storage and handling of products.
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Specifically, margins decreased at the Trade Source entity from (i) a 1.2% increase in
vendor programs as a percentage of gross sales primarily related to annual product resets at
Lowes and (ii) a increased product costs from changes in mix as described above. The
improvement in gross margins at Design Trends resulted from lower sales discounts in the
current year quarter from the sale of slow moving inventory and a 1.8% reduction in vendor
programs as a percentage of gross sales, primarily from lower amounts set aside
for product markdowns. The increase in margins at PHI resulted from the increased sale of
higher margin products as a result of the annual reset which occurred in September 2005.For fiscal year 2006, gross profit as a percentage of sales of the TSI segment is expected
to remain consistent with the quarter ended September 30, 2005 provided that a similar sales
mix, customer concentration and level of vendor program commitment continues for this
segment in fiscal year 2006.Selling, General and Administrative Expenses.Total selling, general and administrative
(SG&A) expenses of the Company decreased $511,000 to $4,898,000 or 16.1% of net sales for
the quarter ended September 30, 2005 from $5,409,000 or 18.6% of net sales for the prior
year.Total SG&A expense of the Craftmade segment decreased $456,000 to $3,331,000 or 20.2% of
sales compared to $3,787,000 or 25.9% of sales for the same period in the previous year. The
decrease in SG&A of the Craftmade segment is summarized as follows (in thousands):
 ChangeQuarter Ended
    
    
    FromSeptember 30,
    
    
    Prior Year2005
    
    
    2004
    
    
    PeriodAccounting, legal and consulting
    
    $
    572
    
    
    $
    966
    
    
    
    ($394
    )Salaries and wages
    
    
    1,116
    
    
    
    905
    
    
    
    211Other
    
    
    1,643
    
    
    
    1,916
    
    
    
    (273
    )$
    3,331
    
    
    $
    3,787
    
    
    
    ($456
    )
 Lower accounting, legal and consulting fees in the quarter ended September 30, 2005
were primarily due to higher costs incurred in the same period in the prior year to (i)
address internal controls issues, (ii) evaluate the proper interpretation of FIN 46 with
respect to the Companys 50% owned subsidiaries and (iii) an increase in cost to comply with
Section 404 of the Sarbanes-Oxley Act of 2002.The increase in salaries and wages was impacted by higher salaries due to adjustments of
current employees to remain competitive with market conditions as well as the addition of
seven Teiber employees, and additional accounting and IT staff.The decrease in other costs primarily resulted from lower advertising and health insurance
costs.Total SG&A expenses of the TSI segment decreased $55,000 to $1,567,000 or 11.2% of sales for
the quarter ended September 30, 2005 from $1,622,000 or 11.2% of sales for the same period
in the previous year.Management anticipates that based on current market conditions, future SG&A expenses as a
percentage of sales, excluding accounting, legal and consulting fees related to compliance
with Section 404, will be relatively consistent with results generated in fiscal year 2005.
Management anticipates that accounting, legal and consulting costs, including costs to
comply with Section 404, will be reduced by approximately 35% to 50% of such costs in fiscal
year 2005.Interest Expense.Net interest expense of the Company increased $74,000 to $304,000 for the
quarter ended September 30, 2005 from $230,000 for the same period in the previous year.
This increase was primarily the result of higher outstanding balances from the Companys
revolving lines of credit, combined with higher interest rates in effect during the period.
The balance on the Companys revolving lines of credit increased primarily as a result of
Craftmades borrowings to finance its acquisition of Teiber. In
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addition, the outstanding
balance on the Companys facility note was lower than in the same period during fiscal 2005,
and the interest rate on the facility note remained unchanged compared to the same period in
the prior year. Management anticipates that in the future, lower outstanding balances on its
lines of credit may offset expected increases in interest rates, resulting in total interest
expense that is not significantly different from the expense generated in fiscal year 2005.Minority Interests.Minority interests generated by the Companys 50% owned subsidiaries
increased $168,000 to $734,000 for the quarter ended September 30, 2005, compared to
$566,000 for the same period in the previous year. The increase was primarily due to a
$217,000 increase as a result of the increased sales and gross profit of PHI, partially
offset by a decline of $49,000 as a result of the in sales and gross profit of Design
Trends, as discussed above.Provision for Income Taxes.The provision for income tax was $920,000 or 34.7% of income
before income taxes for the quarter ended September 30, 2005, compared to $770,000 or 35.5%
of income before taxes for the same quarter of the prior year. The decrease in percentage
resulted from the tax benefit obtained from receiving an 85% dividends received deduction
for the repatriation of undistributed 2005 foreign earnings under the American Jobs Creation
Act of 2004. The Company expects to receive a similar benefit throughout calendar year
2006.Liquidity and Capital ResourcesThe Companys cash decreased $5,691,000 from $9,145,000 at June 30, 2005 to $3,454,000 at
September 30, 2005. The Companys operating activities provided cash of $3,426,000.The $36,000 of cash used in investing activities related to additions to property and
equipment, which consisted primarily of purchases of computer equipment and office
furniture.Cash used in financing activities of $9,081,000 was primarily the result (i) net payments on
the Companys revolving lines of credit of $8,010,000, (ii) principal payments on the
Companys notes payable of $540,000 and (iii) cash dividends of $531,000.The Companys management believes that its current lines of credit, combined with cash flows
from operations, are adequate to fund the Companys current operating needs, debt service
payments and any future dividend payments, as well as its projected growth over the next
twelve months.Management anticipates that future cash flows will be used primarily to retire existing
debt, pay dividends, fund potential acquisitions and distribute earnings to minority
interest members. The Company remains committed to its business strategy of creating
long-term earnings growth, maximizing stockholder value through internal improvements,
making selective acquisitions and dispositions of assets, focusing on cash flow and
retaining quality personnel.At September 30, 2005, subject to continued compliance with certain covenants and
restrictions, the Company had a $20,000,000 line of credit with The Frost National Bank
(Frost) at an interest rate of prime (6.75% at September 30, 2005) less 0.5% or LIBOR
(4.4067% at September 30, 2005) plus 1.50% to 2.25% depending on the debt to worth ratio.
The line of credit is scheduled to mature on October 31, 2005.On October 31, 2005, the Company entered into a loan agreement with Frost that renews the
Companys promissory note in the amount of $20,000,000. This loan agreement is scheduled to
mature on October 31, 2007. Information regarding the promissory note is set forth in Note
6  Subsequent Events to the consolidated financial statements in Item 1 of Part I of this
Form 10-Q.On February 25, 2005, the line of credit was amended to provide, among other things, a
$3,000,000 increase in the commitment initially through March 31, 2005 and subsequently
through December 31, 2005. Accordingly, there was $14,990,000 outstanding under the
$20,000,000 line of credit at September 30, 2005 and no outstanding balance on the
$3,000,000 amendment.Under this line of credit, for each one-percentage point (1%) incremental increase in
LIBOR, the
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Companys annualized interest expense would increase by approximately $150,000.
Consequently, an increase in LIBOR of five percentage points (5%) would result in an
estimated annualized increase in interest expense for the Company of approximately $750,000.At September 30, 2005, Design Trends had a $2,000,000 loan agreement with Frost, of which
none had been utilized. The loan matured on October 31, 2005 and was not extended.One of the Companys 50%-owned subsidiaries, PHI, has a $3,000,000 promissory note (the $3
Million Line of Credit) with Wachovia Bank, N.A. (Wachovia), at an interest rate equal to
the monthly LIBOR index (3.8584% at September 30, 2005) plus 2%, which expired on October
15, 2005 and was subsequently renewed through December 15, 2006. The terms of the renewal
remained substantially unchanged from the original $3 Million Line of Credit. There was an
outstanding balance of $1,548,000 at September 30, 2005. The PHI members, which include TSI,
agreed to be guarantors of the $3 Million Line of Credit in order to induce the lender to
provide these loans to PHI.Based on the amounts outstanding at September 30, 2005 under the $3 Million Line of Credit,
for each one-percentage point (1%) incremental increase in LIBOR, the Companys annualized
interest expense would increase by approximately $15,000. Consequently, an increase in
LIBOR of five percentage points (5%) would result in an estimated annualized increase in
interest expense for the Company of approximately $77,000.At September 30, 2005, $2,331,000 remained outstanding under the note payable for the
Companys 378,000 square foot operating facility. The loan is payable in equal monthly
installments of $100,378 of principal and interest at 8.302%. The Companys management
believes that this facility will be sufficient for its purposes for the foreseeable future.
The facility note payable matures on January 1, 2008.Fanthing Electrical Corp. (Fanthing), Craftmades ceiling fan vendor, has provided
Craftmade with a $1,000,000 credit limit, pursuant to which it will manufacture and ship
ceiling fans prior to receipt of payment from Craftmade. Accordingly, payment can be
deferred until delivery of such products. At present levels, such credit facility is
equivalent to approximately three weeks supply of ceiling fans and represents a supplier
commitment, which, in the opinion of the Companys management, is unusual for the industry
and favorable to the Company. This manufacturer is not required to provide this credit
facility under its agreement with Craftmade, and it may discontinue this arrangement at any
time.Management does not anticipate that the covenants and restrictions of its lines of credit
and loan agreements will limit the Companys growth potential.TSI maintained inventory levels of $5,097,000 at September 30, 2005. TSIs sales are highly
concentrated with Lowes. Should the revenues generated by TSI from its programs with this
customer be at levels significantly lower than originally anticipated, the Company would be
required to find other customers for this inventory. There can be no assurances that the
Company would be able to obtain additional customers for this inventory or that any
alternative sources would generate similar sales levels and profit margins as anticipated
with the current mass merchandiser customer.
 
  The information set forth below constitutes a forward looking statement. See Managements
Discussion and Analysis of Financial Condition and Results of Operations  Cautionary
Statement.The Company currently purchases a substantial amount of ceiling fans and other products of
its Craftmade segment from Fanthing, a Taiwanese company. The Companys verbal understanding
with Fanthing provides that all transactions are to be denominated in U.S. dollars; however,
the understanding further provides that, in the event that the value of the U.S. dollar
appreciates or depreciates against the Taiwan dollar by one Taiwan dollar or more,
Fanthings prices will be accordingly adjusted by 2.5%.The Company also purchases a substantial amount of other products of its Craftmade and TSI
segments from numerous manufacturing companies located in the Peoples Republic of China
(China). On July
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21, 2005, Chinas central bank adjusted the exchange rate of the Chinese
yuan to the U.S. dollar and continuing fluctuations in the Chinese yuan against the U.S.
dollar are expected. All transactions with Chinese manufacturers are denominated in U.S.
dollars, but fluctuations in the exchange rate between the U.S. dollar and Chinese yuan
could affect the pricing of items manufactured in China.The following table summarizes the exchange rate of the United States dollar (USD) to the
Taiwan dollar
(TWD) and Chinese yuan (YUAN):
 USD:TWD
    
    
    USD:YUANJune 30, 2004
    
    $
    33.75
    
    
    $
    8.287September 30, 2004
    
    
    33.99
    
    
    
    8.287December 31, 2004
    
    
    31.98
    
    
    
    8.287March 31, 2005
    
    
    31.88
    
    
    
    8.287June 30, 2005
    
    
    31.67
    
    
    
    8.287September 30, 2005
    
    
    33.27
    
    
    
    8.110
 A sharp appreciation of the Taiwan dollar or the Chinese yuan relative to the U.S. dollar
could materially adversely affect the financial condition and results of operations of the
Company. The Company has not entered into any instruments to minimize this market risk of
adverse changes in currency rates because the Company believes (i) the cost associated with
such instruments would outweigh the benefits that would be obtained from utilizing such
instruments and (ii) this risk is not unique to Craftmade as other competitors also purchase
a majority of their product from Asian manufacturers.During the fiscal quarter ended September 30, 2005, the Company purchased approximately
$4,583,000 of products from Fanthing and $11,548,000 of products from Chinese manufacturing
companies. The Company estimates that an appreciation of the Chinese yuan and the Taiwan
dollar to the U.S. dollar of 1% would result in an estimated annual increase in cost of
goods sold of approximately $920,000 and a decrease in net income of $527,000, based on the
Companys purchases during the quarter ended September 30, 2005 on an annualized basis. A
10% incremental appreciation of the Chinese yuan and the Taiwan dollar to the U.S. Dollar
would result in an estimated annualized increase in cost of goods sold of approximately
$5,994,000 and a decrease in net income of $3,204,000, based on the Companys purchases
during the quarter ended September 30, 2005 on an annualized basis. A 20% incremental
appreciation of the Chinese yuan and the Taiwan dollar to the U.S. Dollar would result in an
increase of approximately $12,447,000 and a decrease in net income of $6,702,000, on an
annualized basis, based on the Companys purchases during the quarter ended September 30,
2005 on an annualized basis. The amounts are estimates of the financial impact of an
appreciation of the Chinese yuan and the Taiwan dollar relative to the U.S. dollar and are
based on annualizations of the Companys purchases from Chinese manufacturing companies and
Fanthing for the quarter ended September 30, 2005. Consequently, these amounts are not
necessarily indicative of the effect of such changes with respect to an entire year.Other market risks at September 30, 2005 have not changed significantly from those discussed
in Item 7A of the Companys Annual Report on Form 10-K for the year ended June 30, 2005 as
filed with the SEC on September 20, 2005.For a discussion of the effects of hypothetical changes in interest rates, see Item 2.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 
Liquidity and Capital Resources.
 
  Disclosure Controls and ProceduresAs of the end of the period covered by this report, the Company conducted an
evaluation, under the supervision and with the participation of the principal executive
officer and principal financial officer, of the Companys disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this
evaluation, the principal executive officer and principal financial officer concluded that
the Companys disclosure controls and procedures are effective. Notwithstanding the
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##### Table of Contents



foregoing, a control system, no matter how well designed and operated, can provide only
reasonable, not absolute, assurance that it will detect or uncover failures within the
Company to disclose material information otherwise required to be set forth in the Companys
periodic reports.Changes in Internal Controls
There was no change in the Companys internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the Companys
most recently completed fiscal quarter that has materially affected, or is reasonably likely
to materially affect, the Companys internal control over financial reporting.
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##### Table of Contents



PART II
OTHER INFORMATION
 
  Information regarding our legal proceedings is set forth in
Note 5  Commitments and
Contingencies to the consolidated financial statements in Item 1 of Part I of this Form
10-Q, which is incorporated herein by reference.
 
   
   
   
   
   10.1*
    
    Modification, Renewal and Extension Agreement dated October 31, 2005 by and
between Craftmade International, Inc. and The Frost National Bank.10.2*
    
    Amended and Restated Loan Agreement dated October 31, 2005 by and between
Craftmade International, Inc. and The Frost National Bank.10.3*
    
    Arbitration and Notice of Final Agreement dated October 31, 2005 by and
between Craftmade International, Inc. and The Frost National Bank.31.1*
    
    Certification of James R. Ridings, Chief Executive Officer of the Company,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of J. Marcus Scrudder, Chief Financial Officer of the Company,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of James R. Ridings, Chief Executive Officer of the Company,
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of J. Marcus Scrudder, Chief Financial Officer of the Company,
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 *
    
    Each document marked with an asterisk is filed or furnished herewith. 20




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##### Table of Contents



CRAFTMADE INTERNATIONAL, INC.(Registrant)Date: November 8, 2005
    
    /s/ James R. RidingsJAMES R. RIDINGSPresident and ChiefExecutive OfficerDate: November 8, 2005
    
    /s/ J. Marcus ScrudderJ. MARCUS SCRUDDERChief Financial Officer
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##### Table of Contents



Index to Exhibits
 ExhibitNumber
    
    Description10.1*
    
    Modification, Renewal and Extension Agreement dated October 31, 2005 by and
between Craftmade International, Inc. and The Frost National Bank.10.2*
    
    Amended and Restated Loan Agreement dated October 31, 2005 by and between
Craftmade International, Inc. and The Frost National Bank.10.3*
    
    Arbitration and Notice of Final Agreement dated October 31, 2005 by and
between Craftmade International, Inc. and The Frost National Bank.31.1*
    
    Certification of James R. Ridings, Chief Executive Officer of the Company,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of J. Marcus Scrudder, Chief Financial Officer of the Company,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of James R. Ridings, Chief Executive Officer of the Company,
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of J. Marcus Scrudder, Chief Financial Officer of the Company,
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 *
    
    Each document marked with an asterisk is filed or furnished herewith. 22