Culp, Inc. Form 10-Q Summary
Business context and reporting period
Culp, Inc. designs, manufactures, sources, and sells mattress fabrics and upholstery fabrics. The filing covers the second quarter and first six months of fiscal 2014, ended October 27, 2013; comparable periods ended October 28, 2012. The financial statements are unaudited and the six-month periods each comprise 26 weeks.
- Mattress fabrics are sold to bedding manufacturers and include mattress covers produced through the CLASS venture.
- Upholstery fabrics are sold primarily to residential furniture manufacturers; products sourced or manufactured outside the United States account for most upholstery sales.
Key financial metrics
| Metric | Three months ended October 27, 2013 | Three months ended October 28, 2012 | Six months ended October 27, 2013 | Six months ended October 28, 2012 |
|---|---|---|---|---|
| Net sales | $70.6 million | $65.6 million | $140.7 million | $134.7 million |
| Gross profit | $12.2 million | $11.9 million | $25.3 million | $25.0 million |
| Gross margin | 17.3% | 18.1% | 18.0% | 18.6% |
| Income from operations | $5.0 million | $4.7 million | $11.0 million | $10.1 million |
| Operating margin | 7.1% | 7.1% | 7.8% | 7.5% |
| Net income | $3.1 million | $8.3 million | $6.3 million | $11.8 million |
| Diluted earnings per share | $0.25 | $0.67 | $0.51 | $0.94 |
| Net cash from operating activities | Not separately provided | Not separately provided | $9.4 million | $7.7 million |
Amounts are presented in millions except per-share data. Net income was substantially affected by unusual tax items in the prior-year period.
Material changes versus the prior comparable period
- Second-quarter sales increased 8%; six-month sales increased 4%. Upholstery sales increased 17% in the quarter and 9% year to date, while mattress-fabric sales increased 2% and 1%, respectively.
- Upholstery operating income increased to $1.7 million in the quarter from $1.2 million and to $4.2 million for six months from $3.3 million. Mattress operating income declined to $4.7 million in the quarter from $5.1 million and to $9.7 million for six months from $10.3 million.
- Consolidated gross margin declined because of lower mattress-fabric margins and weaker profitability in the U.S. upholstery operation. Consolidated operating margin improved for the six-month period primarily because SG&A declined 4%.
- Net income declined because fiscal 2013 included a $12.2 million tax benefit from reversing most of a U.S. deferred-tax valuation allowance, partly offset by a $6.6 million deferred-tax charge related to foreign earnings. Fiscal 2014 included normal tax expense, including a $273,000 discrete adjustment related to North Carolina tax rates.
- Accounts receivable increased 21% year over year to $24.9 million, inventories increased 17% to $44.9 million, and trade payables increased 23% to $28.5 million. Days sales outstanding increased to 32 days from 29 days.
Cash flow, liquidity, debt, and capital allocation
- Cash and cash equivalents were $24.3 million and short-term investments were $6.2 million at October 27, 2013, for total cash and investments of $30.5 million.
- Total debt was approximately $5.0 million, consisting primarily of $4.4 million of unsecured term notes and $585,000 drawn under the European facility. The company had no U.S. or China revolving-credit borrowings and was in compliance with its debt covenants.
- The U.S. revolving facility was renewed in August 2013, increased to a $10.0 million commitment, and extended through August 31, 2015. A $195,000 workers-compensation letter of credit reduced availability.
- Six-month investing cash outflows were $5.5 million, including $1.9 million of capital expenditures and $2.6 million paid for the Bodet & Horst asset acquisition. Financing cash outflows were $2.9 million, including $2.2 million of debt repayment and $979,000 of dividends.
- Management stated that available cash, operating cash flow, and revolving-credit capacity should fund fiscal 2014 operating needs and contractual obligations. Two remaining annual term-note principal payments of $2.2 million were due in August 2014 and August 2015.
- Quarterly dividends increased from $0.03 to $0.04 per share beginning in the first quarter of fiscal 2014. After quarter-end, the company announced an increase to $0.05 per share beginning in the third quarter of fiscal 2014. No shares were repurchased under the $2.0 million authorization during the quarter.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected fiscal 2014 cash capital expenditures of approximately $5.1 million, including $890,000 of equipment acquired from Bodet & Horst, and projected depreciation of approximately $5.5 million.
- Management reported progress in CLASS, with improving productivity and plans to add capacity gradually to address mattress-industry seasonality. Transition costs continued to weigh on mattress-fabric results.
- On May 8, 2013, Culp paid $2.6 million for equipment and other assets from Bodet & Horst and restructured related consulting and non-compete arrangements. The transaction added equipment, a non-compete agreement, and customer relationships, and permits sales to a previously restricted leading manufacturer.
- Other expense included a $206,000 charge for a tentative settlement of environmental litigation relating to a closed facility. The settlement remained subject to final agreement, governmental review, and court approval; related indemnification may be difficult to collect because the indemnitors’ assets were uncertain.
- The company held $13.5 million of gross unrecognized tax benefits at October 27, 2013 and estimated an additional approximately $848,000 increase during fiscal 2014. It also recorded a $7.1 million deferred-tax liability for undistributed foreign earnings.
- Key risks include housing and furniture demand, consumer confidence, raw-material and energy costs, limited ability to pass cost increases to customers, foreign-currency volatility, international operating conditions, customer preferences, and potential working-capital pressure from higher inventories and receivables.
- The filing reported no material changes to previously disclosed risk factors, no material changes to other litigation beyond the environmental matter, and effective disclosure controls with no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether CLASS transition costs decline as productivity and capacity improve, and whether mattress-fabric margins recover.
- Whether upholstery growth, particularly from China-produced fabrics, offsets continued weakness in the U.S. upholstery operation.
- Inventory levels, receivable collections, days sales outstanding, and operating cash conversion as sales expand.
- Final approval and cash cost of the environmental litigation settlement, including the practical value of related indemnification.
- Future effective tax rates, realization of deferred tax assets, unrecognized tax benefits, and potential cash taxes on foreign earnings.
- Compliance with debt covenants and repayment capacity for the $2.2 million annual term-note maturities in fiscal 2015 and 2016.
- Whether the announced dividend increases remain consistent with capital-expenditure, working-capital, and debt-service requirements.