Culp, Inc. — Fiscal 2021 First-Quarter Form 10-Q Summary
Business context and reporting period
Culp, Inc. designs, manufactures, sources, and sells mattress fabrics and upholstery fabrics. Continuing operations consist of mattress fabrics and upholstery fabrics, including Read Window Products. The company sold its eLuxury ownership interest on March 31, 2020; the home accessories segment is therefore presented as a discontinued operation.
The quarter ended August 2, 2020, covered 13 weeks, compared with 14 weeks for the prior-year quarter ended August 4, 2019. Results were materially affected by the COVID-19 pandemic, particularly early in the quarter.
Key financial metrics
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Net sales | $64.5 million | $70.7 million | Down 8.8% |
| Gross profit | $9.9 million | $12.4 million | Down 20.2% |
| Gross margin | 15.4% | 17.6% | Down 220 basis points |
| Income from continuing operations | $1.9 million | $3.3 million | Down 42.9% |
| Operating margin | 2.9% | 4.7% | Down 180 basis points |
| Income before taxes from continuing operations | $1.5 million | $3.5 million | Down 56.0% |
| Net income from continuing operations | $(2.7) million | $1.8 million | Declined to a loss |
| Net loss per diluted share | $(0.22) | $0.09 income | Unfavorable change |
| Operating cash flow | $10.6 million | $2.0 million | Improved |
Income tax expense was $4.3 million, producing an unusually high 283.7% effective tax rate on pretax continuing income. The expense included a $7.2 million non-cash valuation allowance charge against U.S. deferred tax assets, partially offset by a $3.5 million non-cash benefit from re-establishing U.S. net operating loss carryforwards following final GILTI regulations.
At August 2, 2020, cash and cash equivalents were $40.0 million. Including available-for-sale and held-to-maturity investments, total cash and investments were $47.4 million, compared with $77.1 million at May 3, 2020. Total assets were $184.6 million, total liabilities were $58.7 million, and shareholders’ equity attributable to Culp was $125.9 million.
There were no borrowings outstanding under the U.S. or China revolving credit facilities at quarter-end. The U.S. facility provides a $30 million commitment, with $250,000 of letters of credit outstanding and $750,000 available for additional letters of credit. The $7.6 million PPP loan and all prior revolver borrowings were repaid during the quarter. Management reported compliance with debt covenants.
Material changes versus the prior comparable period
- Mattress fabrics sales declined 7.1% to $36.1 million; gross margin declined to 12.8% from 14.6% and operating income declined to $1.8 million from $2.6 million.
- Upholstery fabrics sales declined 11.0% to $28.4 million; gross margin declined to 18.7% from 21.1% and operating income declined to $2.1 million from $2.9 million.
- Lower sales reflected COVID-19-related closures and restrictions and one fewer reporting week. Demand improved from mid-May through quarter-end as customers and retailers reopened.
- Profitability was pressured by manufacturing inefficiencies during the rapid production ramp-up and significant inventory reductions. Lower compensation, professional fees, travel, and entertainment costs partially offset the pressure.
- Accounts receivable increased to $29.9 million from $23.7 million, reflecting slower collections and extended customer terms. Company-wide days sales outstanding increased to 41 days from 30 days.
- Inventory declined to $40.4 million from $47.6 million, reflecting improved inventory management. Operating working capital declined to $43.5 million from $48.7 million.
- The prior-year quarter included a $610,000 net loss from the discontinued home accessories operation. No discontinued-operation loss was reported in the current quarter.
- SG&A declined 12.4% to $8.0 million. Other expense increased to $366,000, primarily due to less favorable foreign currency exchange rates, while interest income declined to $58,000.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected the pandemic to continue affecting the business through at least the second quarter of fiscal 2021, although demand trends improved late in the quarter. The filing does not provide quarterly revenue or earnings guidance.
- Fiscal 2021 cash capital expenditures were projected at $8.5 million to $9.0 million, with depreciation of approximately $7.0 million. The company also planned approximately $4.0 million of additional knit-machine investment and expected completion of a Haiti facility expansion in the second quarter of fiscal 2021.
- Management believed cash, investments, operating cash flow, and approximately $35.7 million of revolving-credit availability were sufficient for foreseeable business needs.
- The $5.0 million share-repurchase authorization remained available, but the program was suspended in April 2020 and no shares were repurchased during the quarter. The company paid a quarterly dividend of $0.105 per share and announced the same rate for the next payment.
- The Seventh Amendment to the U.S. credit agreement temporarily modified the debt-to-EBITDA calculation, increased applicable pricing margins, reduced fiscal 2021 permitted capital expenditures to $10 million, tightened certain covenant limits, and restricted dividends and repurchases to $10 million in aggregate during the modification period.
- COVID-19 creates risks involving demand, customer and supplier financial condition, employee health, production levels, collections, and global economic conditions. Additional risks include foreign currency movements, tariffs and trade policy, raw-material and petrochemical costs, interest rates, hospitality weakness, and potential asset impairments.
- The company guarantees 70% of unpaid lease payments for eLuxury’s Indiana facility through September 2024. eLuxury and its owner have provided indemnification, and the filing states that related loans and trade receivables were paid in full.
- Open capital-equipment purchase commitments totaled $2.0 million. Management stated that pending litigation was not reasonably expected to have a material adverse effect.
- The company adopted the current expected credit loss standard effective May 4, 2020; adoption had no material effect on the financial statements.
Most important facts for investors to verify
- Whether improved demand and production trends persisted after quarter-end and whether COVID-19 materially affected the second quarter and subsequent periods.
- Whether gross margins recovered from the 15.4% consolidated level as manufacturing inefficiencies and inventory reductions subsided.
- The collectability and aging of the increased $29.9 million accounts receivable balance, including the effect of extended customer payment terms.
- The realizability of approximately $10.1 million of U.S. deferred-tax-related valuation allowances and the sustainability of the unusually high effective tax rate.
- Compliance with the amended credit agreement covenants and the availability of revolving credit if operating conditions deteriorate.
- Execution, timing, and funding of the Haiti expansion and planned $4.0 million knit-machine investment.
- Potential exposure under the eLuxury lease guarantee and the commercial performance of the related supply and royalty arrangements, which contain no minimum purchase or sales guarantees.