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We are lowering our estimates for Culp following its 1QF23 results and management conference call. While cutting our sales projection modestly and our profit expectations dramatically, we remain sanguine on Culp for now. Working capital management remains robust and the cash position improved. We look for demand to turn late this year or early next as the end-market recovers from a post-COVID “hangover.”
Culp reported a loss of $0.47 per share in 1QF23, below our estimate of a loss of $0.27 per share. The variance lay almost entirely in the tax expense line—more on that below. Revenue and operating loss were consistent with expectations.
Consistent with Culp’s limited guidance, we forecast a 2QF23 loss of $0.47 per share versus a loss of $0.07 per share previously on sequential revenue decline.
For the full year, we are now modeling a loss of $1.32 per share, down from a loss of $0.27 per share in our earlier model. One-third of the cut, or $0.38, is the result of changes in our tax assumptions. We now assume that the company will continue to have a foreign tax expense and no tax benefit in the US despite ongoing operating losses.
We forecast sales to be 12% lower Y/Y, a cut of about 8% and about $0.14 in earnings. The remainder of change in expectations, or about $0.55, lies in deleverage on margins. We expect a regression in the general direction of normal volume late in the second half as downstream inventory clears. We caution that consumer demand is weak and vulnerable.
Our focus remains on working capital management and cash preservation. Over the last two quarters, management has done an admirable job. The company ended the quarter with $18.9 million in cash, about one-third of the company’s market cap, and no debt.

ESTIMATES

COMPANY OVERVIEW
Founded in 1972 and headquartered in High Point, North Carolina, Culp, Inc. manufactures, markets, and supplies a wide range of mattress and upholstery fabrics in the US and across the globe. Today, Culp has manufacturing and sourcing capabilities in the US, Canada, China, Haiti, Vietnam, and Turkey.
Culp reports operations in segments: (1) mattress fabrics, known as Culp Home Fashions (CHF), and (2) upholstery fabrics, known as Culp Upholstery Fabrics (CUF). Each is a leader in its respective markets.
Robert. G. Culp IV (Iv) became CEO in January 2020. He joined the company in 1998 and, for 15 years, led Culp’s mattress fabric segment. Culp’s innovation reinforces the market leadership it enjoys in its two reporting segments.

REFLECTIONS ON 1QF23
Current results and the near-term outlook for Culp continue to deteriorate, with a hangover from the COVID pandemic-induced boom in home furnishings, a glut in inventory in the channel, and a consumer nervous about higher interest rates, high inflation, and volatility in financial markets. These are issues in the economic environment beyond the control of Culp and a challenge for management. While there remains a debate about whether the US economy is in recession, there is little doubt that the home furnishing industry is in recession now. Management believes Culp is gaining market share with new products, high-quality customer service, and innovative new fabrics.
Management avers this environment will last at least through Q3. In an abundance of caution, we are assuming continued losses throughout the year. For Culp, the challenge focuses on keeping the company solvent, preserving cash, and avoiding debt until that turns. Despite a significant operating loss of $4.7 million, Culp generated cash from operations of $5.3 million and free cash flow (CFO adjusted for capital expenditures, exchange rate fluctuations, proceeds from equipment sale, and flows from the rabbi retirement trust) of $4.5 million. Higher payables contributed $9 million to cash and lower inventory by another $2.8 million, offset by operating losses, lower receivables, cash tax expense of $637,000, and limited capital expenditures of $711,000.
Culp ended the quarter with $18.9 million in cash, up from $14.6 million in the previous quarter. Management warned as we expected that the cash stash would deteriorate modestly in the next several quarters as Culp pays vendors for orders to restart the China facility (it had been closed in the fourth quarter because of a COVID-related shutdown).
Partially offsetting that use of cash in payables, Culp vows to manage inventory lower. The company reports a modest amount of excess finished goods in the Culp Home Fashions (mattress fabric) business and more raw material on hand than necessary. We expect both issues to resolve over the next quarter.
As noted above, Q1 results were in line with our expectations from the top line to the pre-tax income. The tax expense accounted for nearly all the variance from our expectations. Culp operates in multiple geographies and is confronting a valuation allowance limitation on tax benefits in the US. As a result, the company is paying taxes in China and Canada, where it shows a profit. The US entity incurs the losses and tax accounting rules disallow tax benefits until it reports sustained profits. In Q1, Culp reported an income tax expense of $896,000 despite the $4.8 million consolidated pre-tax loss. Management reported that in 1Q23, it paid $637,000 in cash taxes and that it expects to pay cash taxes of about $2.8 million in FY23.
See our discussion of the tax issues below for more information.
INSIGHTS: OPPORTUNITIES
New Haiti Facility Operational; Complements Strong Sewn Mattress Cover Business
According to the management, the new facility in Haiti continued to ramp up production and gain efficiency in the first quarter. Production in Haiti diversifies the manufacturing base and incrementally reduces Culp’s reliance on production in China. This new facility will enable the company to increase nearshore capacity for cut and sewn upholstery kits and support future development and supply chain resilience.
Long-Term Opportunities in Mattress Fabrics
The company has implemented a rock-solid service platform capable of servicing clients wherever they wish to be served and will help establish new business at current costs. With high-end 3D rendering capabilities and a great staff expert in designing new products, Culp’s platform offers excellent potential to sell textiles and sewed covers.
LiveSmart®&nbsp;is An Example of Culp’s Innovation in Upholstery Fabrics, Which Continues to Grow and Develop
Several years ago, Culp introduced&nbsp;LiveSmart®. The innovation with LiveSmart is in the encapsulated performance yarn that gives the fabric properties that are important to consumers. From this beginning of stain resistance, Culp then developed LiveSmart into a series of other products and brands: LiveSmart Outdoor®&nbsp;(durable fabrics that are pet-friendly, U.V. resistant, and moisture-repellent); LiveSmart Evolve®&nbsp;(partly made with recycled content, thereby diverting plastics from landfills to create a more sustainable future); and LiveSmart Ultra™&nbsp;(fabric that offers antimicrobial technology to protect the product). Culp’s leaders, while understandably circumspect about discussing specific future innovations, are committed to continued innovation.
Culp’s Virtuous Business Cycle Begins with Innovation and Superior Customer Service
From their 1972 beginning, Bob Culp Jr. and Rob Culp stressed service. Over the years, we have watched and appreciated the high regard that virtually all in the furniture and mattress industry have for the Culps. The furniture and mattress industry often seems parochial and backward to outside observers. Our observation, however, having spent nearly 50 years in and around the industry, is that personal relationships and trust are significant factors for lasting success in the industry. Those same principles continue to underpin Culp today: innovation and superior customer service that keeps and strengthens its long-term relationships.
In the challenging environment the company finds itself in now, these relations and commitment to innovation and customer service.
Culp’s Financial Disclosure Demonstrates its High Regard for its Stakeholders
As we have noted throughout this report, Culp now reports its operating results in two segments: mattress fabrics (CHF) and upholstery fabrics (CUF). Importantly, from our viewpoint, it discloses line-item detail for each of these segments, a disclosure technique that is all too rare for segment reporting companies. We applaud this practice and argue that it demonstrates management regard and respect for its stakeholders.
Culp’s Disciplined and Balanced Approach to Capital Use and Deployment is a Priority
Culp has shown a disciplined approach to capital deployment over decades. It’s been a significant attraction and never more so than now. We expect capital spending in FY23 will be at or near maintenance level, consistent with FY22 emphasis on cash preservation.
It is rare that textile companies need to invest heavily in plants and equipment. To wit, between 1981 and 2000, Culp did not consistently evince the capital discipline it does now. Management now describes its approach as capital light for upholstery fabrics and more capital intensive for mattress fabrics. This reflects the realities of each market as they exist today. Upholstery manufacturers can project needs farther out; mattress makers are often faced with shorter-cycle needs, which means that Culp needs its knitting and finishing capacity nearby if it is to maintain its market presence. In summary, Culp has emerged as a more-nimble and capital-savvy company. On its website, in the investor relations tab, it enunciates its&nbsp;capital allocation strategy&nbsp;and principles.
Since 2010, Culp has followed a disciplined approach to capital allocation with respect to paying down debt as needed (it has no debt outstanding). Culp rewarded its shareholders with a consistent dividend from 2012 through the present. The dividend has been suspended. We expect it to be reinstated when the operating outlook improves and the cash position of the company is secure. We decline the opportunity to predict when that will occur.
During FY11, the company implemented an EVA platform for incentive compensation. Over the long term, this promotes the efficient use of capital. For FY22, in light of the pandemic, the incentive compensation plan was tweaked to be based on free cash flow and operating income.
High Point Innovation Campus
During its 3Q22 earnings conference call, management announced opening of Culp’s new innovation campus in downtown High Point, North Carolina, which will bring together its most innovative and creative minds and foster collaboration among its businesses. Management opined that it will be a transformative space for Culp and allow its teams to share best ideas across its divisions and better showcase its entire product lines to its customers. CEO Iv Culp noted that the new innovation campus “has been extremely well-received by our customers, providing them with a hands-on, first-class experience for viewing the scope of our products, from fabric to sewn cover.”
We hosted two fireside chats with Culp management that touched on the innovation campus. We attach links to those documents below:
https://www.watertowerresearch.com/content/fireside-chat-what-s-new-at-culp-upholstery-fabrics-may-12-2022
https://www.watertowerresearch.com/content/fireside-chat-innovations-at-culp-home-fashions-march-16-2022
INSIGHTS: CHALLENGES, NEAR TERM AND LONGER TERM
Complex Tax Structure
As noted above, tax expense is expected to be a significant drag on the bottom line for the remainder of the year, despite significant operating losses.
With its operations spread across the globe—from Asia to the Caribbean to the US and Canada—Culp faces a dizzying variety of tax regulations and tax rates across its various jurisdictions. Ironically, a favorable tax expense provision in one jurisdiction may trigger a higher expense in another. Adding to the complexity is a modest alphabet soup of abbreviations discussing the implications of different legislation and tax rules: Global Intangible Low Taxed Income Tax (GILTI), Tax Cut and Jobs Act of 2017 (TCJA), alternative minimum tax (AMT), and US Federal Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES). To wit, we refer investors to the company’s tax footnotes, which are typically multiple pages long.
Investors typically focus on consolidated tax rates (the mathematical result of dividing reported tax expense by income before tax) and the amount of cash paid for tax. To wit, in 1Q23, Culp’s recorded income tax expense was $896,000 on a pre-tax loss of $4.8 million, equating to a tax rate of a&nbsp;NEGATIVE&nbsp;18.7%.
In discussing its recorded and prospective tax expense for investors, management focuses on the following: (1) its effective overall tax rate in any period is affected by the mix of income earned in its foreign operations in Canada and China, which have higher statutory income tax rates than the US.; (2) its eligibility for the GILTI High Tax exemption (requires effective foreign tax rates to be greater than 18.9%, or 90% of the US 21% statutory rate); and (3) the expected cash tax expense it believes it will incur.
At some point the future, Culp investors may see a large tax benefit from the US business. First, the company must build a track record of US profits and establish an expectation that future profits will use the benefit. Because of past and ongoing operating losses in the US, Culp is now ineligible to accrue a US tax benefit. Currently, that tax asset lives off-balance sheet.
On the 1Q23 call, the company called out a cash tax expense of $637,000 and expected a full-year cash tax outlay of $2.8 million.
In projecting taxes for 2023, we can only guess about the magnitude of the accounting tax expense. We assume it will be higher than $2.8 million based on the 1Q numbers. But by how much? We are modeling a full-year tax expense of about $3 million. That may be too low.


CULP ECONOMIC MODEL: INCOME STATEMENTS, BALANCE SHEET, AND CASH FLOW




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Slashing Estimates After 1QF23 Report; Tax Expenses Hit Hard Despite Losses, but Sales Outlook Remains Stormy for at Least Two More Quarters

Culp Inc

Slashing Estimates After 1QF23 Report; Tax Expenses Hit Hard Despite Losses, but Sales Outlook Remains Stormy for at Least Two More Quarters