Culp, Inc. Form 10-Q Summary
Business context and reporting period
Culp, Inc. operates through mattress fabrics and upholstery fabrics segments. The filing covers the unaudited three and six months ended October 28, 2018, compared with October 29, 2017. Each six-month period represents 26 weeks. The company acquired Read, a hospitality and commercial window-treatment provider, effective April 1, 2018, and acquired an initial 80% interest in eLuxury, an online bedding and home-goods business, effective June 22, 2018.
Financial performance and liquidity
| Metric | Three months ended Oct. 28, 2018 | Three months ended Oct. 29, 2017 | Six months ended Oct. 28, 2018 | Six months ended Oct. 29, 2017 |
|---|---|---|---|---|
| Net sales | $77.0 million | $80.7 million | $148.5 million | $160.2 million |
| Gross profit | $13.3 million | $15.8 million | $23.9 million | $32.3 million |
| Gross margin | 17.3% | 19.6% | 16.1% | 20.1% |
| Income from operations | $4.3 million | $6.4 million | $6.4 million | $13.4 million |
| Operating margin | 5.6% | 7.9% | 4.3% | 8.3% |
| Net income attributable to Culp shareholders | $2.9 million | $4.0 million | $3.9 million | $9.0 million |
| Diluted EPS | $0.23 | $0.32 | $0.31 | $0.71 |
- Second-quarter sales declined 4.6%; first-half sales declined 7.3%. Second-quarter operating income declined 32.9%, while first-half operating income declined 52.4%.
- Mattress fabrics sales declined 13.6% in the quarter and 18.6% year to date, while upholstery fabrics sales increased 9.1% and 10.0%, respectively. Upholstery results benefited from Read.
- Net cash provided by operating activities was $6.6 million for the first six months, versus $10.2 million in the prior-year period. Capital expenditures were $3.5 million on a cash basis, including $1.4 million vendor-financed.
- Cash and investments totaled $41.5 million at October 28, 2018, compared with $54.5 million at April 29, 2018. Cash and cash equivalents were $14.8 million.
- No borrowings were outstanding under the U.S. or China revolving credit facilities. The U.S. facility was reduced to $25 million and expires August 15, 2020; management reported compliance with all financial covenants. Available revolving capacity was stated as $30.7 million.
- Total assets were $222.2 million and total liabilities were $54.7 million. The company had $5.7 million of contingent consideration related to the eLuxury acquisition and $4.6 million of non-controlling interest.
Material changes versus the prior comparable period
- The bedding market weakened as low-priced mattress imports from China increased. Management believes customers accelerated orders and promotions before anticipated tariffs and trade remedies, reducing subsequent demand for mattress fabrics and sewn covers.
- Gross margin declined 230 basis points in the quarter and 400 basis points for the first half, primarily reflecting lower mattress-fabrics volume and related operating deleverage.
- The Anderson, South Carolina upholstery facility was closed during the quarter due to declining demand. First-half restructuring-related charges totaled $1.2 million net, including inventory markdowns, employee termination benefits and facility costs, partly offset by a $1.1 million gain on equipment sales. The quarter included a $1.1 million equipment-sale gain and a $270,000 facility-related charge.
- eLuxury contributed $7.4 million of revenue and $64,000 of net income from acquisition through October 28, 2018. The preliminary purchase-price allocation includes $13.7 million of goodwill, $6.5 million of tradename value and a $5.7 million earn-out liability.
- SG&A increased 7.3% in the quarter, primarily from eLuxury selling expenses, but declined 4.1% for the first half due largely to lower incentive compensation.
- The effective tax rate increased to 35.1% from 29.1%, primarily because a greater proportion of earnings was generated in higher-tax foreign jurisdictions, along with effects from foreign exchange, GILTI and valuation allowances.
Guidance, outlook, risks and unusual items
- Management expects near-term mattress-industry demand and operating performance to remain challenged. It believes anti-dumping measures and expected punitive actions against Chinese importers could ultimately benefit the business, but the timing of a demand recovery remains uncertain.
- Fiscal 2019 capital expenditures were projected at $6.0 million to $6.5 million, with depreciation of approximately $8.0 million. Management stated that certain capital projects had been deferred and the capital expenditure budget reduced.
- Management believes cash, operating cash flow and available credit will fund foreseeable operating needs, contractual obligations and potential acquisitions.
- Key risks include tariffs and other trade-policy changes, imported-product costs, raw-material and petrochemical price inflation, foreign-exchange movements, international operations, changing consumer preferences, housing and general economic conditions, and integration of acquired businesses.
- The eLuxury goodwill and tradename valuations were provisional and could change significantly. Its earn-out is based on adjusted EBITDA through August 31, 2021. Read’s earn-out was not recorded because management did not expect a payment based on available projections.
- The company adopted ASC 606 in fiscal 2019; the filing states that the adoption did not materially affect earnings or financial position, but changed revenue-related presentation and disclosures. Lease accounting adoption is expected to have a material balance-sheet impact when implemented in fiscal 2020.
- On November 29, 2018, the board approved an increase in the quarterly dividend from $0.09 to $0.10 per share. Future dividends remain subject to board approval.
Important facts for investors to verify
- Whether mattress-fabric demand normalizes following tariffs, anti-dumping actions and inventory or order timing effects.
- The sustainability of upholstery-fabric growth after separating Read’s acquisition contribution from underlying performance.
- Progress and profitability of eLuxury, including the provisional purchase accounting and potential $5.7 million earn-out.
- Cash conversion, inventory levels and liquidity after acquisitions, shareholder returns and restructuring expenditures.
- The ultimate costs and proceeds from the Anderson facility closure and sale of remaining assets.
- Exposure to tariffs, foreign exchange, raw-material inflation and higher effective tax rates.
- Future capital expenditures, lease liabilities upon ASC 842 adoption and compliance with revolving-credit covenants.