Culp, Inc. — Form 10-Q Summary
Business context and reporting period
Culp, Inc. operates two segments: mattress fabrics, sold primarily to bedding manufacturers, and upholstery fabrics, sold primarily to residential and commercial furniture manufacturers. This unaudited report covers the quarter and six-month period ended October 28, 2012, representing the second quarter and first half of fiscal 2013. Comparable periods ended October 30, 2011.
Financial performance and key metrics
| Metric | Three months ended Oct. 28, 2012 | Three months ended Oct. 30, 2011 | Six months ended Oct. 28, 2012 | Six months ended Oct. 30, 2011 |
|---|---|---|---|---|
| Net sales | $65.6 million | $58.0 million | $134.7 million | $118.3 million |
| Gross profit | $11.9 million | $8.6 million | $25.0 million | $17.5 million |
| Gross margin | 18.1% | 14.9% | 18.6% | 14.8% |
| Operating income | $4.7 million | $2.9 million | $10.1 million | $6.0 million |
| Operating margin | 7.1% | 5.0% | 7.5% | 5.1% |
| Income before taxes | $4.5 million | $2.9 million | $9.9 million | $5.8 million |
| Net income | $8.3 million | $6.3 million | $11.8 million | $8.1 million |
| Diluted EPS | $0.67 | $0.49 | $0.94 | $0.62 |
Six-month net cash provided by operating activities was $7.7 million, compared with $2.6 million in the prior-year period. Cash used in investing activities was $1.2 million, including $1.9 million of capital expenditures. Cash used in financing activities was $7.9 million, primarily reflecting $2.3 million of debt payments, $5.0 million of share repurchases, and $747,000 of dividends.
At October 28, 2012, cash and cash equivalents were $23.5 million and short-term investments were $5.2 million, for total cash and short-term investments of $28.7 million. Total debt, including the line of credit, was approximately $7.7 million. Total current assets were $93.8 million versus current liabilities of $37.6 million.
Debt consisted primarily of $6.6 million of unsecured senior term notes and a $217,000 Canadian government loan. The company had $875,000 outstanding under its Polish revolving credit agreement and no borrowings under its U.S. or China revolving credit facilities. The company was in compliance with its financial covenants.
Material changes versus the prior comparable period
- Second-quarter sales increased 13%; six-month sales increased 14%, driven by improved demand, new product introductions, innovative designs, and broader product offerings.
- Mattress fabrics sales increased 13% in the quarter and 15% year to date. Six-month segment operating income increased 49% to $10.3 million, and operating margin improved to 13.3% from 10.3%.
- Upholstery fabrics sales increased 14% in the quarter and 12% year to date. Six-month segment operating income increased to $3.3 million from $991,000, with operating margin improving to approximately 5.8% from 1.9%.
- Gross margins improved primarily because of higher sales volume, favorable product mix, operating efficiencies, and stabilized or lower raw-material costs.
- Consolidated SG&A increased to $14.9 million from $11.5 million for the first six months, primarily because of higher incentive compensation accruals. SG&A represented 11.0% of sales versus 9.7% in the prior-year period.
- Interest expense declined to $346,000 from $409,000 for the first six months, reflecting lower debt balances.
- Shares outstanding declined to 12.2 million at October 28, 2012 from 12.7 million at April 29, 2012, following $5.0 million of fiscal 2013 repurchases.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected fiscal 2013 cash capital expenditures of approximately $5.0 million and depreciation expense of approximately $5.1 million. Planned capital expenditures primarily relate to mattress fabrics.
- Culp-Lava Applied Sewn Solutions, a wholly owned sewn-mattress-cover business formed with A. Lava & Son Co., began production in November 2012. Management projected approximately $1.0 million of capital investment over four years and planned to develop the operation gradually over the next two quarters.
- Net income included significant discrete tax items: a $12.2 million benefit from reversing most of the valuation allowance on U.S. deferred tax assets, partly offset by a $6.6 million charge for taxes associated with expected repatriation of $55.6 million of undistributed foreign earnings. The six-month effective tax rate was a 19.1% benefit rate, compared with a 38.5% benefit rate in the prior-year period.
- The company had $12.8 million of gross unrecognized tax benefits at October 28, 2012 and estimated an increase of approximately $833,000 during fiscal 2013.
- Management cited risks from housing and furniture demand, consumer confidence, disposable income, interest rates, inflation, raw-material and energy costs, foreign currency movements, international economic or political conditions, and changing consumer preferences.
- The company faces an environmental-related lawsuit concerning a former Pennsylvania manufacturing site. Management believes liability is not probable, expects to defend the matter vigorously, and recorded no reserve because the loss was not probable or estimable. An indemnification agreement exists, although the financial capacity of the indemnitors is unclear.
- Open equipment purchase commitments totaled $1.4 million at October 28, 2012. Culp Europe in Poland had cumulative pretax losses of approximately $1.1 million and a full valuation allowance of $209,000 against related deferred tax assets.
- The board authorized a new $2.0 million share-repurchase program. It also approved a $0.50 per-share special dividend and an accelerated $0.03 quarterly dividend, both scheduled for payment on December 28, 2012.
Most important facts for investors to verify
- Whether sales momentum and improved raw-material costs are sustainable, particularly in mattress fabrics.
- The recurring earnings impact of the discrete tax benefits and charges, including the recoverability of remaining U.S. deferred tax assets.
- Cash requirements for debt maturities, repurchases, dividends, capital expenditures, and the Culp-Lava startup.
- Progress and profitability of Culp Europe and the broader effect of European economic conditions.
- Status, potential exposure, and indemnification coverage related to the Chromatex environmental litigation.
- Whether working-capital trends, including higher receivables, inventories, days sales outstanding, and lower inventory turns, normalize or require additional cash funding.