Culp, Inc. Form 10-Q Summary
Business context and reporting period
Culp, Inc. operates three segments: mattress fabrics, upholstery fabrics, and home accessories. The report covers the quarter and six months ended November 3, 2019, representing the second quarter and first half of fiscal 2020. The six-month fiscal 2020 period included 27 weeks, compared with 26 weeks in the prior-year period. Financial statements are unaudited.
The company adopted the new lease standard, ASC Topic 842, on April 29, 2019. Adoption added approximately $7.2 million of right-of-use assets and $7.1 million of lease liabilities, with no material impact on net income or cash flow.
Financial performance and liquidity
| Metric | Three months ended Nov. 3, 2019 | Prior-year comparable period | Six months ended Nov. 3, 2019 | Prior-year comparable period |
|---|---|---|---|---|
| Net sales | $72.6 million | $77.0 million | $147.5 million | $148.5 million |
| Gross profit | $14.1 million | $13.3 million | $27.5 million | $23.9 million |
| Gross margin | 19.4% | 17.3% | 18.6% | 16.1% |
| Income from operations | $4.0 million | $4.3 million | $6.7 million | $6.4 million |
| Operating margin | 5.5% | 5.6% | 4.5% | 4.3% |
| Net income attributable to Culp shareholders | $2.3 million | $2.9 million | $3.6 million | $3.9 million |
| Diluted earnings per share | $0.19 | $0.23 | $0.29 | $0.31 |
- Quarterly sales declined 5.7%, while first-half sales declined 0.7%. Quarterly gross profit increased 5.8%; first-half gross profit increased 15.0%.
- Quarterly net income attributable to Culp shareholders declined 21.6%, and first-half net income declined 6.5%, primarily reflecting higher income taxes and the absence of prior-year restructuring-related benefits.
- First-half income tax expense was $3.6 million, with a 51.5% effective tax rate versus 35.1% in the prior year. The increase primarily reflected foreign earnings mix and higher Global Intangible Low-Taxed Income tax.
- Net cash provided by operating activities was $8.2 million, compared with $6.6 million in the prior-year period. Capital expenditures were $2.4 million, dividends paid were $2.5 million, and cash paid for acquisition-related obligations was $1.5 million.
- Cash and cash equivalents were $47.2 million at November 3, 2019, compared with $40.0 million at April 28, 2019. Management reported total cash and investments of approximately $47.2 million because held-to-maturity investments had matured.
- Borrowings totaled $925,000 under eLuxury’s subordinated loan arrangement. No borrowings were outstanding under the U.S. or China revolving credit facilities. Available revolving credit capacity was approximately $30.7 million, and the company was in compliance with financial covenants.
- Total assets were $231.7 million and total equity was $165.9 million at November 3, 2019. Inventory was $55.2 million, up 9.1% from the prior-year comparable date and 12.6% from April 28, 2019.
Material changes versus the prior comparable period
- Mattress fabrics: Second-quarter sales declined 4.7% to $35.5 million, but operating income increased 13.2% to $3.3 million. First-half sales increased 3.6% to $74.1 million, with an 8.0% operating margin. Management cited improved efficiency, favorable raw-material prices, and demand for sewn mattress covers, partially offset by softer legacy-market demand.
- Upholstery fabrics: Second-quarter sales declined 3.2% to $33.9 million, while operating income increased 27.6% to $3.5 million. First-half sales declined 5.4% to $65.7 million, while operating income increased 20.9% to $6.3 million. Margin improvement reflected product mix and favorable foreign exchange, while demand was affected by a soft residential furniture market, tariffs, trade uncertainty, and the Anderson, South Carolina facility closure.
- Home accessories: Second-quarter sales declined 31.5% to $3.3 million and the segment reported a $350,000 operating loss. First-half sales were $7.6 million, but the segment reported an $888,000 operating loss. Management attributed weakness primarily to reduced bedding demand on Amazon and is pursuing lower marketing costs, business-to-business growth, customer diversification, and new online marketplaces.
- Gross margin improved by 210 basis points in the quarter and 250 basis points in the first half. However, quarterly operating income declined because prior-year results included a net restructuring and other nonrecurring benefit.
- Prior-year first-half results included $1.2 million of net restructuring-related charges, whereas fiscal 2020 included a $35,000 restructuring credit. The Anderson facility closure was completed in fiscal 2019.
- SG&A increased 14.9% in the first half, primarily because fiscal 2019 benefited from a stock-based compensation credit, while fiscal 2020 included stock-based compensation expense, higher incentive compensation, and higher selling expenses.
Guidance, outlook, risks, and unusual items
- Management projected fiscal 2020 cash capital expenditures of $7.5 million to $8.0 million and depreciation expense of approximately $8.0 million.
- Management expected third-quarter mattress-fabrics operating income and margins to be negatively affected by multiple weeks of production and distribution shutdowns in Haiti and the timing of Chinese New Year.
- Management expected interest income to decrease for the remainder of fiscal 2020 because of lower interest rates.
- The company identified risks related to housing activity, consumer confidence, furniture and bedding demand, tariffs and trade policy, foreign exchange, international operations, raw-material and petrochemical prices, inflation, and interest rates.
- The home accessories segment remains exposed to possible goodwill or intangible-asset impairment if its refined business model and strategic initiatives do not improve performance. Management determined that no impairment indicators existed at November 3, 2019.
- The company had a $2.2 million open equipment purchase commitment for the mattress fabrics segment and $402,000 of unpaid capital-expenditure invoices.
- The eLuxury acquisition includes an earn-out obligation, recorded at $6.0 million at November 3, 2019, based on adjusted EBITDA for the twelve-month period ending August 31, 2021.
- Management stated that ordinary-course legal proceedings were not reasonably expected to have a material adverse effect. No material changes to previously reported risk factors or legal proceedings were identified.
- On December 5, 2019, the board approved a quarterly dividend of $0.105 per share, or $0.42 annualized, subject to customary board discretion.
- The company had $5.0 million remaining under a September 2019 stock-repurchase authorization and had made no repurchases under that authorization through the quarter-end.
Most important facts for investors to verify
- Whether weaker demand in mattress fabrics and upholstery fabrics persists after the quarter, particularly in legacy bedding, residential furniture, and tariff-affected markets.
- Whether the home accessories segment can return to profitability through reduced marketing spending, Amazon-channel improvements, and business-to-business diversification.
- The sustainability of gross-margin improvement after accounting for seasonal shutdowns, tariffs, raw-material costs, and foreign exchange movements.
- The effect of the 51.5% effective tax rate, GILTI tax, foreign earnings mix, and any potential future tax relief from proposed regulations.
- Inventory levels and turnover, given purchases exceeded demand in the latter portion of the quarter and inventory increased materially from fiscal year-end.
- Progress toward the projected $7.5 million to $8.0 million of fiscal-year capital expenditures and the related $2.2 million equipment commitment.
- Future obligations under the eLuxury earn-out, subordinated loan, operating leases, and other acquisition-related arrangements.
- Whether home accessories goodwill and intangible assets remain recoverable if operating losses continue.