Culp, Inc. Form 10-Q Summary
Reporting period: Three months ended August 4, 2019, representing the first quarter of fiscal 2020. The comparable period ended July 29, 2018, contained 13 weeks, versus 14 weeks in the current quarter. Culp operates through mattress fabrics, upholstery fabrics, and home accessories segments.
Financial Performance and Liquidity
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $74.8 million | $71.5 million | 4.7% |
| Gross profit | $13.4 million | $10.6 million | 26.6% |
| Gross margin | 17.9% | 14.8% | Up 310 bps |
| Income from operations | $2.7 million | $2.1 million | 29.6% |
| Operating margin | 3.6% | 2.9% | Up 70 bps |
| Net income | $1.2 million | $1.0 million | 21.7% |
| Net income attributable to Culp shareholders | $1.3 million | $1.0 million | 39.8% |
| Diluted EPS | $0.11 | $0.08 | Increase |
| Operating cash flow | $2.0 million | $(1.9) million | Improved |
Income before taxes increased to $2.8 million from $1.9 million. The effective tax rate rose to 59.1% from 46.5%, primarily due to the mix of earnings in higher-tax foreign jurisdictions and higher GILTI tax. Management expects U.S. cash taxes to remain minimal in fiscal 2020 because of federal net operating loss carryforwards.
Cash and cash equivalents totaled $44.2 million at August 4, 2019, compared with $40.0 million at April 28, 2019. Cash and investments totaled approximately $44.2 million, compared with $45.0 million at fiscal year-end, because short-term held-to-maturity investments matured and proceeds were converted to cash. The company reported $30.8 million of availability under its revolving credit lines and stated that liquidity is sufficient for foreseeable business needs, contractual obligations, and potential acquisitions.
Total borrowings were $925,000 under eLuxury’s subordinated loan payable. There were no borrowings under the U.S. or China revolving credit facilities, and the company was in compliance with its financial covenants. Total liabilities were $60.1 million and total equity was $164.3 million at quarter-end.
Segment Results and Material Changes
- Mattress fabrics: Sales increased 12.5% to $38.7 million, supported by sewn mattress covers, woven fabrics, an additional week, and demand related to roll-packed bedding. Operating income declined 6.1% to $2.6 million, and operating margin decreased to 6.8% from 8.1% because of lower demand for higher-margin knitted products and higher employee-related costs.
- Upholstery fabrics: Sales declined 7.6% to $31.9 million amid soft retail furniture demand, tariffs, trade uncertainty, and the closure of the Anderson, South Carolina facility. Operating income increased 13.8% to $2.9 million, while operating margin improved to 9.0% from 7.3% due to product mix and favorable foreign exchange. The prior-year quarter included $2.0 million of restructuring and related charges; the current quarter included a $35,000 restructuring credit.
- Home accessories: Sales increased to $4.3 million from $2.6 million, although the prior-year comparison included only six weeks of eLuxury operations. The segment reported a $535,000 operating loss versus $33,000 of operating income, reflecting reduced demand for legacy bedding products and increased marketing and promotional expenses.
SG&A increased 33.3% to $10.7 million, driven by the absence of the prior-year stock-based compensation credit, higher incentive compensation, a full period of eLuxury operations, and higher selling expenses. Inventory declined 7.9% year over year to $50.7 million, primarily due to lower mattress-fabrics inventory. Accounts receivable increased 3.7% to $24.1 million.
Outlook, Risks, and Unusual Items
- Management expected mattress-fabrics conditions to stabilize and anticipated improved second-quarter performance as production was rationalized and demand for mattress covers continued to develop.
- Management expected soft furniture demand and tariff uncertainty to continue at least through the second quarter of fiscal 2020. The impact of additional proposed tariffs and geopolitical developments remained difficult to forecast.
- The company was refining the home-accessories business model with greater emphasis on business-to-business sales, customer diversification, online marketplaces, and new products. Management reported no goodwill impairment indicators at August 4, 2019, but stated that unsuccessful execution could lead to future impairment charges.
- Fiscal 2020 cash capital expenditures were projected at $7.0 million to $8.0 million, with depreciation projected at approximately $8.0 million. Open equipment purchase commitments totaled $1.5 million.
- The company adopted ASC Topic 842 on April 29, 2019, recognizing $6.5 million of right-of-use assets and $6.4 million of operating lease liabilities at quarter-end. The adoption did not materially affect net income or cash flow.
- eLuxury included a contingent earn-out obligation of $5.9 million at quarter-end, based on an adjusted EBITDA formula for the twelve months ending August 31, 2021.
- Key disclosed risks include housing and furniture demand, consumer confidence, changes in consumer preferences, tariffs and trade policy, foreign exchange, international operations, raw material and petrochemical costs, inflation, interest rates, acquisition integration, and potential goodwill or intangible-asset impairments.
On September 5, 2019, the board authorized a new $5.0 million share repurchase authorization and approved a quarterly dividend of $0.10 per share, payable October 15, 2019. No shares were repurchased during the quarter, and $1.7 million remained available under the prior authorization at August 4, 2019. Management reported no material changes to legal proceedings or risk factors and concluded that disclosure controls were effective.
Investor Verification Items
- Confirm whether mattress-fabrics demand and knitted-product production schedules improved as projected for the second quarter.
- Track upholstery-fabrics sales, tariff exposure, retail furniture demand, and the effect of the Anderson facility closure.
- Assess whether the home-accessories segment can reduce operating losses and avoid future goodwill or intangible-asset impairment.
- Reconcile reported liquidity with the maturity of investments, cash held by geographic jurisdiction, lease obligations, and the $925,000 subordinated loan.
- Monitor the effective tax rate, GILTI exposure, foreign earnings mix, and utilization of U.S. tax attributes.
- Review capital spending against the $7.0 million to $8.0 million fiscal-year projection and the $1.5 million equipment commitment.
- Evaluate the potential cash impact of the eLuxury earn-out obligation and the company’s dividend and repurchase programs.