Culp, Inc. Form 10-Q Summary
Reporting period: Three and six months ended November 2, 2014, representing the second quarter and first half of fiscal 2015. Comparisons are with October 27, 2013; the six-month periods contain 27 and 26 weeks, respectively. Culp operates mattress fabrics and upholstery fabrics businesses. Financial statements are unaudited.
Financial performance and liquidity
| Metric | Three months ended Nov. 2, 2014 | Prior comparable period | Six months ended Nov. 2, 2014 | Prior comparable period |
|---|---|---|---|---|
| Net sales | $74.0 million | $70.6 million | $150.1 million | $140.7 million |
| Gross profit | $12.3 million | $12.2 million | $25.0 million | $25.3 million |
| Gross margin | 16.6% | 17.3% | 16.7% | 18.0% |
| Income from operations | $4.9 million | $5.0 million | $10.2 million | $11.0 million |
| Operating margin | 6.6% | 7.1% | 6.8% | 7.8% |
| Net income | $3.0 million | $3.1 million | $6.3 million | $6.3 million |
| Diluted EPS | $0.24 | $0.25 | $0.51 | $0.51 |
Amounts are in millions except per-share data. Six-month net sales increased 6.6%, while gross profit declined 1.2% and operating income declined 7.4%. The effective tax rate was 38.7% for the first half, compared with 38.9% in the prior year.
- Mattress fabrics sales increased 6.7% in the quarter and 9.4% year to date; first-half operating income declined 3.7% to $9.4 million.
- Upholstery fabrics sales increased 2.3% in the quarter and 3.1% year to date; first-half operating income declined 10.3% to $3.7 million.
- Operating cash flow was $14.5 million, up from $9.4 million. Management attributed the improvement primarily to better inventory management.
- Capital expenditures were $5.1 million, compared with $1.9 million in the prior-year period. Fiscal 2015 capital expenditures were expected to total approximately $10.0 million, primarily for the mattress fabrics expansion.
- Cash and cash equivalents were $29.0 million and short-term investments were $6.3 million at November 2, 2014. Combined liquidity of $35.3 million exceeded total debt of $2.2 million.
- One remaining $2.2 million term-debt payment was due August 11, 2015. No borrowings were outstanding under the revolving credit facilities, although a $195,000 letter of credit remained outstanding. The company was in compliance with its debt covenants.
- Inventories declined 15% year over year to $38.2 million; inventory turns improved to 6.4 from 5.4. Accounts receivable were $25.0 million, and trade accounts payable were $25.4 million.
Material changes and unusual items
- Margins and operating income declined despite higher sales. Mattress fabrics profitability was affected by production complexity, overtime, higher-cost contract suppliers, and disruptions related to the capacity expansion.
- Upholstery fabrics profitability was pressured by lower volume and profitability in Poland, higher operating costs in China, and product mix.
- The company decided to phase out its finished-goods warehouse and distribution facility in Poznan, Poland. A closing-related charge of approximately $200,000 was recorded in the second quarter, with closure expected by the end of the third quarter.
- Other expense improved to $73,000 for the first half from $616,000, primarily because of more favorable foreign-currency effects and the absence of the prior-year $206,000 environmental-litigation settlement charge.
- The company paid $6.1 million of dividends in the first half, including a $4.9 million special dividend, and repurchased 43,014 shares for $745,000 under a $5.0 million authorization.
- On December 3, 2014, the board approved a 20% increase in the quarterly dividend from $0.05 to $0.06 per share beginning in the third quarter of fiscal 2015. Future dividends remain subject to board approval.
Outlook, risks, and contingencies
- Management expected to complete the $9.5 million mattress fabrics expansion in the second half of fiscal 2015 and believed margins would improve after completion, although construction-related disruptions and overtime continued.
- Management warned that third-quarter upholstery results could be affected by demand shifting around the Chinese New Year holiday and by continuing higher China operating costs.
- Key risks include housing and furniture demand, consumer confidence, raw-material and energy inflation, limited ability to pass through cost increases, foreign-exchange movements, international economic and political conditions, and changing customer preferences.
- The company had $14.1 million of gross unrecognized tax benefits at November 2, 2014 and estimated an additional increase of approximately $905,000 during fiscal 2015. A partial deferred-tax valuation allowance of $1.1 million was recorded.
- Open equipment purchase commitments totaled $3.0 million. Management stated that ordinary-course litigation was not reasonably expected to have a material adverse effect, and the previously disclosed environmental lawsuit was dismissed on June 5, 2014.
- The company identified no material changes to previously disclosed risk factors, legal proceedings, accounting policies, or internal controls. Disclosure controls and procedures were determined to be effective.
Investor verification points
- Verify whether the mattress fabrics expansion was completed on schedule and whether production constraints, overtime, and contract-supplier costs improved margins.
- Assess the financial impact and completion status of the Poznan facility closure.
- Track upholstery demand, China operating costs, Poland performance, and the timing effects of the Chinese New Year holiday.
- Confirm repayment of the remaining $2.2 million term debt and renewal or replacement of revolving credit facilities expiring in 2015.
- Reconcile operating cash flow with inventory reductions and monitor whether working-capital improvements are sustainable.
- Review the $14.1 million unrecognized tax benefit, the estimated fiscal 2015 increase, and the recoverability of deferred tax assets.
- Evaluate the sustainability of dividends and share repurchases relative to capital expenditures, debt repayment, and available liquidity.