Culp, Inc. Form 10-Q Summary
Business context and reporting period
Culp, Inc. manufactures, sources, and sells mattress fabrics to bedding manufacturers and upholstery fabrics to residential and commercial furniture manufacturers. The filing covers the quarter and six months ended October 30, 2011, representing the second quarter and first half of fiscal 2012. Comparisons are to October 31, 2010. Amounts are in thousands except per-share data.
Financial performance and position
| Metric | Three months ended October 30, 2011 | Three months ended October 31, 2010 | Six months ended October 30, 2011 | Six months ended October 31, 2010 |
|---|---|---|---|---|
| Net sales | $58,013 | $48,879 | $118,283 | $104,791 |
| Gross profit | $8,646 | $7,609 | $17,524 | $17,318 |
| Gross margin | 14.9% | 15.6% | 14.8% | 16.5% |
| Income from operations | $2,926 | $3,407 | $6,047 | $7,910 |
| Operating margin | 5.0% | 7.0% | 5.1% | 7.5% |
| Income before taxes | $2,863 | $3,201 | $5,827 | $7,479 |
| Net income | $6,252 | $4,002 | $8,071 | $7,749 |
| Diluted earnings per share | $0.49 | $0.30 | $0.62 | $0.59 |
Six-month operating cash flow was $2,581, compared with $2,577 in the prior-year period. Investing cash flow used $5,178, including $2,551 of capital expenditures. Financing cash flow used $6,831, including $2,305 of long-term debt repayments and $4,776 of common-stock repurchases. Cash and cash equivalents were $13,795 at October 30, 2011, and short-term investments were $10,482, for total cash and short-term investments of $24,277.
Total debt was $9,219, consisting of $2,401 of current maturities and $6,818 of long-term debt. The company had no borrowings under its U.S. or China revolving credit facilities, although $125 of letters of credit were outstanding under the U.S. facility. The company was in compliance with its financial covenants. Shareholders’ equity was $84,097, and total assets were $127,124.
Material changes versus the prior comparable period
- Second-quarter sales increased 18.7%; first-half sales increased 12.9%. Mattress fabrics sales rose 24.4% in the quarter and 13.8% for the first half. Upholstery fabrics sales rose 10.8% and 11.7%, respectively.
- Despite higher sales, second-quarter operating income declined 14.1%, and first-half operating income declined 23.6%. Gross and operating margins contracted due primarily to higher raw-material costs, increased SG&A, and weak profitability in the velvet product line.
- Upholstery fabrics operating income fell to $19 in the quarter from $802 and to $991 for the first half from $2,420. The segment was affected by higher raw-material costs, lower velvet demand and profitability, and start-up expenses for Culp Europe.
- Mattress fabrics remained stronger, with second-quarter operating income of $3,806 versus $3,326, although first-half operating income declined to $6,953 from $7,319 as margin pressure offset sales growth.
- SG&A increased 36% in the quarter and 22% for the first half, primarily reflecting Culp Europe start-up costs and the absence of certain prior-year reductions in incentive compensation and bad-debt expense.
- Net income benefited from a $3,389 quarterly tax benefit and a $2,244 first-half tax benefit. These amounts included a $4,400 non-cash reduction of the valuation allowance on U.S. deferred tax assets.
- The company repurchased 550,245 shares for $4,776 during the first six months under a $7,000 authorization. Shares outstanding declined to 12,767 from 13,264 at May 1, 2011.
Guidance, outlook, risks, and unusual items
- Management expects fiscal 2012 cash capital expenditures of approximately $4,000, with $2,551 spent on a cash basis through the second quarter. Projected fiscal 2012 depreciation is approximately $5,000.
- Management expects a modest working-capital investment to support higher sales and believes available cash, investments, operating cash flow, and revolving credit capacity will fund fiscal 2012 needs and contractual obligations.
- Raw-material prices had recently stabilized, but customer price increases were not expected to fully restore prior operating margins. Competitive conditions may limit the company’s ability to pass through further cost increases.
- Key risks include weaker housing and furniture demand, consumer confidence and disposable-income trends, inflation, raw-material and energy costs, foreign-exchange movements, international economic or political instability, and changes in customer preferences.
- The company retained a $12,200 valuation allowance against certain U.S. deferred tax assets and reported $12,100 of gross unrecognized tax benefits. Management estimated that unrecognized tax benefits could increase by approximately $1,000 during fiscal 2012.
- A lawsuit related to alleged environmental contamination at a former Pennsylvania manufacturing site involves claims approximating $8,600 million plus unspecified future costs. The company does not believe it is liable, has indemnification rights from certain defendants, and recorded no reserve because a loss was not probable or estimable.
- The U.S. revolving credit commitment was increased to $10,000 and extended through August 25, 2013. The China credit line provided approximately $6,300 of capacity and expired September 2, 2012.
Most important facts for investors to verify
- Whether sales growth, particularly in mattress fabrics and international upholstery fabrics, continues without further margin deterioration.
- Progress in restoring upholstery-fabrics profitability and the financial performance of Culp Europe and the velvet product line.
- The sustainability of operating cash flow, inventory growth, and working-capital requirements.
- Future scheduled debt repayments, revolving-credit availability, and compliance with financial covenants.
- The recurring earnings impact of the $4,400 non-cash U.S. tax valuation-allowance reversal and the remaining deferred tax assets.
- Developments in the environmental litigation and the practical value of related indemnification agreements.
- Use of the remaining share-repurchase authorization and its effect on liquidity and shares outstanding.