Culp, Inc. 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended January 26, 2014; comparable periods ended January 27, 2013. The nine-month periods each comprised 39 weeks. Culp operates mattress fabrics and upholstery fabrics businesses. Financial statements are unaudited.
Financial Performance and Position
| Metric | Q3 FY2014 | Q3 FY2013 | 9M FY2014 | 9M FY2013 |
|---|---|---|---|---|
| Net sales | $72.4 million | $63.7 million | $213.1 million | $198.4 million |
| Gross profit | $11.8 million | $11.7 million | $37.1 million | $36.7 million |
| Gross margin | 16.4% | 18.3% | 17.4% | 18.5% |
| Income from operations | $4.8 million | $4.9 million | $15.8 million | $15.0 million |
| Operating margin | 6.6% | 7.6% | 7.4% | 7.6% |
| Net income | $8.4 million | $2.8 million | $14.7 million | $14.6 million |
| Diluted EPS | $0.68 | $0.23 | $1.19 | $1.17 |
All dollar amounts are approximate unless otherwise indicated. The third-quarter tax benefit included a $5.4 million discrete benefit related to U.S. foreign tax credits and undistributed earnings of Chinese subsidiaries, materially increasing reported net income.
- Segment sales: Q3 mattress fabrics sales were $38.5 million, up 8.5%; upholstery fabrics sales were $33.8 million, up 20.1%. For nine months, mattress fabrics sales increased 3.4% to $117.0 million and upholstery fabrics sales increased 12.7% to $96.1 million.
- Segment profitability: Q3 mattress fabrics operating income declined 20.5% to $3.3 million, while upholstery fabrics operating income increased 50.0% to $2.7 million. Nine-month mattress fabrics operating income declined 10.2% to $13.0 million; upholstery fabrics increased 33.4% to $6.8 million.
- Cash flow: Nine-month net cash provided by operating activities was $11.0 million versus $10.8 million in the prior year. Investing activities used $7.1 million, including $2.6 million for the Bodet & Horst asset purchase and $2.7 million of capital expenditures. Financing activities used $3.5 million, including $2.2 million of debt repayment and $1.6 million of dividends.
- Liquidity: Cash and cash equivalents were $23.3 million and short-term investments were $7.1 million at January 26, 2014. Combined liquidity of $30.4 million exceeded total debt of approximately $5.0 million.
- Balance sheet: Total assets were $156.7 million and shareholders’ equity was $109.4 million. Accounts receivable were $26.4 million and inventories were $43.7 million.
- Debt: Long-term debt was $4.4 million, consisting primarily of unsecured fixed-rate term notes; a $573,000 Polish line-of-credit borrowing was also outstanding. The company had no U.S. or China revolving-loan borrowings and was in compliance with its financial covenants.
Material Changes Versus Prior Comparable Period
- Sales increased 13.6% in the quarter and 7.4% for nine months, driven by favorable customer response to new designs and products in both segments, particularly China-sourced upholstery fabrics.
- Gross and operating margins contracted despite higher sales. Mattress fabrics margins were pressured by higher-than-expected transition costs for the Culp Lava mattress-cover operation, production of covers acquired from a prior supplier, and sampling and development costs.
- Management estimated that the acquired-cover production temporarily reduced third-quarter gross profit by approximately $600,000 and expected improvement as those products were phased out and new products were introduced.
- Reported Q3 net income increased 196.9%, primarily because of the $5.4 million discrete tax benefit. Nine-month net income increased only 0.6% because the prior-year period included significant tax benefits and charges that do not recur comparably.
- Interest expense declined due to lower debt balances. Other expense increased for nine months to $895,000 from $421,000, principally due to foreign-exchange effects and a $206,000 charge for a tentative environmental-litigation settlement.
- The May 2013 Bodet & Horst transaction added equipment, a non-compete agreement, and customer relationships for $2.6 million in cash and expanded Culp’s mattress-fabric selling rights and competitive protections.
Guidance, Outlook, Risks, and Unusual Items
- Management expected operating efficiencies and margins in mattress fabrics to improve in the fourth quarter as transition issues subsided. It planned capacity-expansion spending for mattress fabrics, including additional knitting machines, a second finishing line, and facility expansion in North Carolina.
- Fiscal 2014 cash capital expenditures were expected to be approximately $5.2 million, with depreciation of approximately $5.4 million. Fiscal 2015 capital spending and depreciation were each expected to be approximately $6.0 million.
- Adverse U.S. weather, the timing of the Chinese New Year holiday, housing and furniture demand, consumer confidence, raw-material and energy costs, foreign exchange, interest rates, and changing consumer preferences could affect fourth-quarter and future results.
- The company had $3.8 million of open equipment purchase commitments at January 26, 2014, compared with $170,000 at April 28, 2013.
- A tentative settlement of environmental litigation related to a closed Pennsylvania facility resulted in a recorded $206,000 charge. Settlement remained subject to government review and court approval; the company also had an indemnification agreement whose collectability was uncertain.
- The company reported $13.6 million of gross unrecognized tax benefits and estimated that these benefits could increase by approximately $808,000 during fiscal 2014.
- The board increased the common-stock repurchase authorization to $5.0 million on February 25, 2014; no shares had been repurchased under the prior authorization as of January 26, 2014. The quarterly dividend had been increased to $0.05 per share.
- Management stated that disclosure controls and procedures were effective and that no material change occurred in internal control over financial reporting during the quarter.
Important Facts for Investors to Verify
- Separate recurring operating performance from the $5.4 million discrete tax benefit and compare with prior-year tax adjustments.
- Assess whether mattress-fabric margins recover after Culp Lava transition costs and the approximately $600,000 temporary gross-profit impact.
- Monitor execution of planned capacity expansion, the $3.8 million equipment commitments, and future capital-spending requirements.
- Review debt maturities of $2.2 million in each of the next two years and the terms and availability of revolving credit facilities.
- Track the environmental settlement approval, indemnification collectability, and any additional litigation exposure.
- Evaluate foreign-exchange exposure, Chinese and Polish operations, undistributed foreign earnings, and the $13.6 million unrecognized-tax-benefit balance.
- Consider the sustainability of dividends and any future share repurchases relative to operating cash flow, working-capital needs, and expansion spending.