Culp, Inc. Fiscal 2018 Third-Quarter 10-Q Summary
Business context and reporting period
Culp, Inc. manufactures, sources, develops, and sells mattress fabrics and upholstery fabrics. The report covers the three and nine months ended January 28, 2018, compared with January 29, 2017; each nine-month period comprised 39 weeks. The financial statements are unaudited.
- Mattress fabrics: sales to bedding manufacturers, including mattress covers.
- Upholstery fabrics: products primarily for residential and commercial furniture manufacturers.
- Common shares outstanding at January 28, 2018: 12.45 million.
Key financial metrics
| Metric | Three months ended Jan. 28, 2018 | Three months ended Jan. 29, 2017 | Nine months ended Jan. 28, 2018 | Nine months ended Jan. 29, 2017 |
|---|---|---|---|---|
| Net sales | $85.3 million | $76.2 million | $245.5 million | $232.2 million |
| Gross profit | $17.6 million | $16.8 million | $49.9 million | $52.1 million |
| Gross margin | 20.6% | 22.0% | 20.3% | 22.4% |
| Income from operations | $7.6 million | $6.9 million | $21.0 million | $22.9 million |
| Operating margin | 9.0% | 9.1% | 8.6% | 9.9% |
| Income before taxes | $7.5 million | $7.0 million | $20.4 million | $22.7 million |
| Net income | $(0.7) million | $6.3 million | $8.2 million | $16.1 million |
| Diluted earnings per share | $(0.06) | $0.51 | $0.65 | $1.29 |
Amounts are rounded from the filing and presented in millions except per-share data.
- Third-quarter sales increased 12.0%; nine-month sales increased 5.7%.
- Third-quarter SG&A increased 1.4% to $10.0 million; nine-month SG&A decreased 1.0% to $28.9 million.
- Nine-month operating cash flow was $21.5 million, down from $24.7 million. Cash flow reflected lower operating income and higher inventory requirements.
- Nine-month capital expenditures on a cash basis were $10.4 million, including $3.8 million vendor-financed, compared with $10.3 million in the prior year.
- Cash and investments totaled $55.7 million at January 28, 2018, compared with $54.2 million at April 30, 2017. Cash and cash equivalents were $22.4 million.
- There were no borrowings under the U.S. or China revolving credit facilities. The U.S. facility provided a $30 million commitment, and the company reported $36.4 million of total revolving-credit availability.
- Total liabilities were $64.7 million and shareholders' equity was $152.2 million at January 28, 2018.
Material changes versus the prior comparable period
- Revenue growth occurred in both segments. Third-quarter mattress fabrics sales rose 6.8% and upholstery fabrics sales rose 19.9%; nine-month increases were 2.9% and 10.3%, respectively.
- Despite higher sales, nine-month gross profit declined 4.2% and operating income declined 8.3%. Gross margin contracted 210 basis points, primarily reflecting operating disruptions, higher costs in China, and the prior-year comparison.
- Mattress-fabrics nine-month operating income declined 11.0%, while upholstery-fabrics operating income increased 2.3%.
- Third-quarter upholstery sales benefited from customers advancing purchases ahead of the Chinese New Year shutdown. Management expects this benefit to reverse in the fourth quarter because February production in China was disrupted.
- Higher Chinese operating costs reflected unfavorable foreign-exchange rates. A government shutdown of certain Chinese textile mills for environmental controls also caused additional freight costs during the second quarter.
- The mattress-fabrics business completed a major North American manufacturing transformation involving facility consolidation, capital projects, equipment relocations, and supply-chain enhancements. Management reported sequential operating-margin improvement to 13.9% in the third quarter, versus 13.1% and 13.5% in the first and second quarters.
- The company began production and shipments from its 50%-owned Haiti mattress-cover joint venture. The venture generated a $498,000 net loss for the nine months, of which Culp recognized $249,000.
Guidance, outlook, risks, contingencies, and unusual items
- Management projected fiscal 2018 capital expenditures, including vendor-financed amounts, to be comparable to fiscal 2017 spending of $12.9 million and fiscal 2018 depreciation of approximately $8.0 million. Fiscal 2019 capital expenditures were expected to range from $7.0 million to $8.0 million.
- The company expects current cash, available-for-sale short-term investments, operating cash flow, and revolving-credit availability to fund foreseeable business needs, contractual obligations, and potential acquisitions.
- The Tax Cuts and Jobs Act produced a provisional $5.9 million tax charge, or $0.48 per diluted share, consisting primarily of a $4.8 million transition-tax charge and a $1.1 million deferred-tax remeasurement charge. The estimates may change during the permitted measurement period.
- The effective tax rate for the nine months increased to 58.6% from 28.9%. The prior-year period included a $2.1 million discrete tax benefit from the reversal of an uncertain foreign tax position.
- The IRS proposed an approximately $12.5 million adjustment related to transfer pricing for fiscal years 2014 through 2016. Management disagrees with the proposed adjustment and intends to defend its position. The ultimate outcome and potential cash settlement cannot currently be determined.
- At January 28, 2018, gross unrecognized income tax benefits totaled $12.4 million, including $9.9 million that could favorably affect future tax rates if recognized.
- On March 8, 2018, after the reporting period, Culp agreed to acquire Read Window Products, a hospitality and commercial window-treatment provider with approximately $11.0 million of 2017 revenue. Closing was expected by the end of March, subject to customary conditions, and was expected to be funded with cash and investments without additional debt.
- On February 28, 2018, the board approved a quarterly dividend of $0.09 per share, a 12.5% increase from $0.08. Future dividends remain subject to board approval.
- Principal business risks include housing and furniture demand, consumer confidence, raw-material and petrochemical costs, foreign-exchange movements, international operations, supply-chain disruptions, inflation, and the ability to pass cost increases to customers.
- The company reported effective disclosure controls and procedures and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the provisional Tax Act accounting will be revised and the timing and cash cost of transition-tax payments.
- The outcome of the IRS transfer-pricing examination and any resulting tax liability or use of tax attributes.
- Whether the expected fourth-quarter slowdown after the Chinese New Year timing benefit affects upholstery-fabrics revenue and margins.
- Progress, profitability, and capacity additions at the Haiti joint venture.
- Completion terms, purchase price, financing, and post-closing results of the Read Window Products acquisition.
- Execution of the North American mattress-fabrics transformation and whether margins sustain the reported sequential improvement.
- Inventory growth, foreign-exchange exposure, Chinese supply-chain conditions, and the company’s ability to meet its capital, dividend, and contractual commitments.