14. Income Taxes
Effective Income Tax Rate
We recorded income tax expense of $216,000, or 1.4% of income before income tax expense, for the nine month period ended January 26, 2014, compared to an income tax benefit of $188,000, or (1.3)% of income before income tax expense, for the nine month period ended January 27, 2013. Our effective income tax rates for the nine month periods ended January 26, 2014 and January 27, 2013 were based upon the estimated effective income tax rate applicable for the full year after giving effect to any significant items related specifically to interim periods. The effective income tax rate can be affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and foreign sources versus annual projections and changes in foreign currencies in relation to the U.S. dollar.
The income tax expense for the nine month period ended January 26, 2014 is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
·
|
The income tax rate decreased 36% for an income tax benefit of $5.4 million to record the U.S. income tax effects of the undistributed earnings from our foreign subsidiaries located in China. The $5.4 million income tax benefit recognized U.S. foreign income tax credits of $9.9 million offset by the U.S. income tax effects of the undistributed earnings from our China operations and foreign withholding taxes of $4.5 million. This $5.4 million income tax benefit was treated as a discrete event in which the full income tax effects of this adjustment were recorded in the three and nine month periods ended January 26, 2014, as it pertained to a change in judgment on prior periods' accumulated earnings and profits associated with our subsidiaries located in China (see below undistributed earnings section for further details).
|
|
·
|
The income tax rate increased 2% for adjustments primarily made to our state of North Carolina loss carryforwards for the decrease in future North Carolina corporate income tax rates commencing in fiscal 2015 and beyond. These adjustments were recorded in the first quarter, totaled $273,000, and represented a discrete event in which the full tax effects were recorded in the nine month period ending January 26, 2014.
|
|
·
|
The income tax rate decreased by 7% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
·
|
The income tax rate increased by 4% for an increase in unrecognized tax benefits.
|
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
·
|
The income tax rate increased by 4.4% for stock-based compensation and other miscellaneous items.
|
The income tax expense for the nine month period ended January 27, 2013 is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
·
|
The income tax rate was reduced by 84% for a reduction in our valuation allowance associated with our U.S. net deferred tax assets. This 84% reduction in our income tax rate is due to a change in judgment about the realization of our U.S. net deferred income tax assets in future years. Since the realization of our U.S. net deferred income tax assets is a result of a change in judgment about future years we recorded an income tax benefit of $12.1 million that represents a discrete event in which the full tax effects were recorded for the nine month period ending January 27, 2013.
|
|
·
|
The income tax rate was increased by 46% for the establishment of a deferred tax liability for U.S. income taxes that will be paid upon repatriation of undistributed earnings from our foreign subsidiaries located in Canada and China. This 46% increase in our income tax rate is due to a change in judgment in which our prior years’ accumulated earnings and profits associated with our subsidiaries located in Canada and China are no longer considered indefinitely reinvested. Since the establishment of our deferred tax liability is a result of a change in judgment about prior years’ accumulated earnings and profits, we recorded an income tax charge of $6.6 million that represents a discrete event in which the full tax effects were recorded for the nine month period ending January 27, 2013.
|
|
·
|
The income tax rate increased 5% for an increase in unrecognized tax benefits.
|
|
·
|
The income tax rate was reduced by 6% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
·
|
The income tax rate was increased by 1% for the establishment of a valuation allowance against our net deferred tax assets associated with our Culp Europe operation located in Poland.
|
|
·
|
The income tax rate was increased by 2.7% for stock-based compensation and other miscellaneous items.
|
Deferred Income Taxes
Valuation Allowance
In accordance with ASC Topic 740, we evaluate our deferred income taxes to determine if a valuation allowance is required. ASC Topic 740 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard, with significant weight being given to evidence that can be objectively verified. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, taking into account the effects of local tax law. Based on our assessment at January 26, 2014, we recorded a partial valuation allowance of $1.0 million, of which $715,000 pertained to certain U.S. state net operating loss carryforwards and credits and $291,000 pertained to loss carryfowards associated with our Culp Europe operation located in Poland. Based on our assessment at January 27, 2013, we recorded a partial valuation allowance of $926,000, of which $719,000 pertained to certain U.S. state net operating loss carryforwards and credits and $207,000 pertained to loss carryforwards associated with our Culp Europe operation located in Poland. Based on our assessment at April 28, 2013, we recorded a partial valuation allowance of $963,000, of which $722,000 pertained to certain U.S. state net operating loss carryforwards and credits and $241,000 pertained to loss carryfowards associated with our Culp Europe operation located in Poland.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
No valuation allowance was recorded against our net deferred tax assets associated with our operations located in China and Canada at January 26, 2014, January 27, 2013, and April 28, 2013, respectively.
The recorded valuation allowance of $1.0 million at January 26, 2014, has no effect on our operations, loan covenant compliance, or the possible realization of certain U.S. state net operating loss carryforwards and credits and our loss carryforwards associated with our Culp Europe operation located in Poland. If it is determined that it is more-likely-than-not that we will realize any of these deferred tax assets, an income tax benefit will be recognized at that time.
Undistributed Earnings
In accordance with ASC Topic 740, we assess whether the undistributed earnings from our foreign subsidiaries will be reinvested indefinitely or eventually distributed to our U.S. parent company. ASC Topic 740 requires that a deferred tax liability should be recorded for undistributed earnings from foreign subsidiaries that will not be reinvested indefinitely. Based on our assessment of the financial requirements of our U.S. parent company and foreign subsidiaries, we determined that our undistributed earnings from our foreign subsidiaries will not be reinvested indefinitely and will be eventually distributed to our U.S. parent company. The financial requirements of the U.S. parent company have changed over the past year due to a decision to return cash to its shareholders through dividend payments and common stock repurchases. Also, in order to keep up with the growth in consumer demand for our mattress fabric products, it is our intention to continue our investment in our domestic mattress fabric operations.
In accordance with ASC Topic 740, we assess the recognition of U.S. foreign income tax credits associated with foreign withholding and income tax payments and whether it is more-likely-than-not that our foreign income tax credits will not be realized. If it is determined that any foreign income tax credits need to be recognized or it is more-likely-than-not that our foreign income tax credits will not be realized, an adjustment to our provision for income taxes will be recognized at that time.
During the third quarter of fiscal 2014, our operations located in China achieved positive accumulated earnings and profits for both U.S. income tax and financial reporting purposes for the first time since we determined our undistributed earnings from our foreign subsidiaries would not be reinvested indefinitely in the second quarter of fiscal 2013. As a result, we recorded an income tax benefit of $5.4 million to recognize U.S. foreign income tax credits of $9.9 million offset by the U.S. income tax effects of the undistributed earnings from our China operations and foreign withholding taxes totaling $4.5 million. This $5.4 million income tax benefit was treated as a discrete event in which the full income tax effects of this adjustment were recorded in the three and nine month periods ended January 26, 2014, as it pertained to a change in judgment on prior periods' accumulated earnings and profits associated with our subsidiaries located in China.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We had accumulated earnings from our foreign subsidiaries totaling $69.8 million, $56.3 million, and $56.7 million at January 26, 2014, January 27, 2013, and April 28, 2013, respectively.
At January 26, 2014, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $1.7 million, which included U.S. income and foreign withholding taxes totaling $26.9 million, offset by U.S. foreign income tax credits of $25.2 million. At January 27, 2013, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $6.8 million, which included U.S. income and foreign withholding taxes totaling $21.9 million offset by U.S. foreign income tax credits of $15.1 million. At April 28, 2013, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $7.0 million, which included U.S. income and foreign withholding taxes totaling $22.0 million, offset by U.S. foreign income tax credits of $15.0 million.
Overall
At January 26, 2014, the current deferred tax asset of $7.5 million represents $7.3 million and $217,000 from our operations located in the U.S. and China, respectively. At January 26, 2014, the non-current deferred tax asset of $1.2 million represents $600,000 and $627,000 from our operations located in the U.S. and China, respectively. At January 26, 2014, the non-current deferred tax liability of $945,000 pertains to our operations located in Canada.
At January 27, 2013, the current deferred tax asset of $4.1 million represents $3.8 million and $329,000 from our operations located in the U.S. and China, respectively. At January 27, 2013, the non-current deferred tax asset of $4.2 million represents $3.4 million and $793,000 from our operations located in the U.S. and China, respectively. At January 27, 2013, the non-current deferred tax liability of $856,000 pertains to our operation located in Canada.
At April 28, 2013, the current deferred tax asset of $7.7 million represents $7.4 million and $325,000 from our operations located in the U.S. and China, respectively. At April 28, 2013, the non-current deferred tax asset of $753,000 pertains to our operations located in China. At April 28, 2013, the non-current deferred tax liability of $3.1 million represents $2.0 million and $1.1 million from our operations located in the U.S. and Canada, respectively.
Uncertainty In Income Taxes
At January 26, 2014, we had $13.6 million of total gross unrecognized tax benefits, of which $4.0 million represents the amount of gross unrecognized tax benefits that, if recognized, would favorably affect the income tax rate in future periods. At January 27, 2013, we had $13.1 million of total gross unrecognized tax benefits, of which $4.2 million represents the amount of gross unrecognized tax benefits that, if recognized, would favorably affect the income tax rate in future periods. At April 28, 2013, we had $13.1 million of total gross unrecognized tax benefits, of which $4.2 million would favorably affect the income tax rate in future periods.
As of January 26, 2014, we had $13.6 million in gross unrecognized tax benefits, of which $9.6 million were classified as net non-current deferred income tax liability and $4.0 million were classified as income taxes payable –long-term in the accompanying consolidated balance sheets. As of January 27, 2013, we had $13.1 million in gross unrecognized tax benefits, of which $8.9 million were classified as net non-current deferred income tax assets and $4.2 million were classified as income taxes payable long-term in the accompanying consolidated balance sheets. As of April 28, 2013, we had $13.1 million in gross unrecognized tax benefits, of which $8.9 million were classified as net non-current deferred income tax liability and $4.2 million were classified as income taxes payable – long-term in the accompanying consolidated balance sheets.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
We estimate that the amount of gross unrecognized tax benefits will increase by approximately $808,000 for fiscal 2014. This increase primarily relates to double taxation under applicable tax treaties with foreign tax jurisdictions.
15. Statutory Reserves
Our subsidiaries located in China are required to transfer 10% of their net income, as determined in accordance with the People’s Republic of China (PRC) accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the company’s registered capital.
The transfer to this reserve must be made before distributions of any dividend to shareholders. As of January 26, 2014, the company’s statutory surplus reserve was $4.5 million, representing 10% of accumulated earnings and profits determined in accordance with PRC accounting rules and regulations. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them provided that the remaining reserve balance after such issue is not less than 25% of the registered capital.
Our subsidiaries located in China can transfer funds to the parent company with the exception of the statutory surplus reserve of $4.5 million to assist with debt repayment, capital expenditures, and other expenses of the company’s business.
16. Commitments and Contingencies
Chromatex Environmental Claim
A lawsuit was filed against us and other defendants (Chromatex, Inc., Rossville Industries, Inc., Rossville Companies, Inc. and Rossville Investments, Inc.) on February 5, 2008 in the United States District Court for the Middle District of Pennsylvania. The plaintiffs are Alan Shulman, Stanley Siegel, Ruth Cherenson as Personal Representative of Estate of Alan Cherenson, and Adrienne Rolla and M.F. Rolla as Executors of the Estate of Joseph Byrnes. The plaintiffs were partners in a general partnership that formerly owned a manufacturing plant in West Hazleton, Pennsylvania (the “Site”). Approximately two years after this general partnership sold the Site to defendants Chromatex, Inc. and Rossville Industries, Inc., we leased and operated the Site as part of our Rossville/Chromatex division. The lawsuit involves court judgments that have been entered against the plaintiffs and against defendant Chromatex, Inc. requiring them to pay costs incurred by the United States Environmental Protection Agency (“USEPA”) responding to environmental contamination at the Site, in amounts approximating $8.6 million, plus unspecified future environmental costs. We understand that the USEPA’s costs have exceeded $13 million, but are not expected to increase significantly in the future. Neither USEPA nor any other governmental authority has asserted any claim against us on account of these matters. The plaintiffs seek contribution from us and other defendants and a declaration that the company and the other defendants are responsible for environmental response costs under environmental laws and certain agreements. The plaintiffs also asserted that we tortiously interfered with contracts between them and other defendants in the case and diverted assets to prevent the plaintiffs from being paid monies owed to them. We have defended ourselves vigorously with regards to the matters described in this litigation. In addition, we have an indemnification agreement with certain other defendants in the litigation pursuant to which the other defendants agreed to indemnify us for any damages we incur as a result of the environmental matters that are the subject of this litigation, although it is unclear whether the indemnitors have significant assets at this time.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
In the first quarter of fiscal 2014, the parties to this lawsuit reached a tentative settlement of all matters, which would require us to contribute cash to a global settlement fund. Consequently, we recorded a charge of $206,000 for this tentative settlement. This charge was recorded in other expense in the Consolidated Statement of Net Income for the nine month period ending January 26, 2014. The corresponding liability was recorded in accrued expenses in the Consolidated Balance Sheet dated January 26, 2014. As of the date of this report, the settlement remains subject to government review procedures and approval by the court of the final agreement by the parties.
Other Litigation
The company is periodically involved in legal proceedings and claims which have arisen in the ordinary course of business. These actions, when ultimately concluded and settled, will not, in the opinion of management, have a material adverse effect upon the financial position, results of operations or cash flows of the company.
Purchase Commitments
At January 26, 2014, January 27, 2013, and April 28, 2013, we had open purchase commitments to acquire equipment for our mattress fabrics segment totaling $3.8 million, $1.1 million, and $170,000, respectively.
17. Common Stock Repurchase Program
On February 25, 2014, we announced that our board of directors approved an increase to $5.0 million in the authorization for us to acquire our common stock, an increase from the $2.0 million authorization that was approved by our board of directors on August 29, 2012.
Under the common stock repurchase program, shares may be purchased from time to time in open market transactions, block trades, through plans established under the Securities Exchange Act Rule 10b5-1, or otherwise. The amount of shares purchased and the timing of such purchases will be based on working capital requirements, market and general business conditions, and other factors including alternative investment opportunities.
As of January 26, 2014, there have been no repurchases of common stock on the $2.0 million limit that was authorized on August 29, 2012.
Culp, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
18. Dividend Program
On June 12, 2013, we announced that our board of directors approved a 33% increase in payment of a quarterly cash dividend from $0.03 to $0.04 per share, commencing in the first quarter of fiscal 2014. On November 25, 2013, we announced that our board of directors approved a 25% increase in payment of a quarterly cash dividend from $0.04 to $0.05 per share, commencing in the third quarter of fiscal 2014. On February 25, 2014, we announced that our board of directors approved a quarterly cash dividend of $0.05 per share to be paid on or about April 15, 2014, to shareholders of record as of the close of business on April 1, 2014.
Future dividend payments are subject to board approval and may be adjusted at the board’s discretion as business needs or market conditions change.
Dividend payments totaled $1.6 million and $7.2 million for the nine month periods ending January 26, 2014, and January 27, 2013, respectively. The dividend payments totaling $1.6 million for the nine month period ending January 26, 2014, represented quarterly dividend payments ranging from $0.04 to $0.05 per share. The dividend payments totaling $7.2 million for the nine month period ending January 27, 2013, represented a $6.1 million special cash dividend payment of $0.50 per share in the third quarter of fiscal 2013, and $1.1 million of quarterly dividend payments of $0.03 per share, respectively.
19. Deferred Compensation Agreement
We have a nonqualified deferred compensation plan (the “Plan”) covering officers and certain key members of management. The plan provides for participant deferrals on a pre-tax basis that are subject to annual deferral limits by the IRS and non-elective contributions made by the company. Participant deferrals and non-elective contributions made by the company are immediately vested.
Effective January 1, 2014, we established a Rabbi Trust (the “Trust”) to set aside funds for the participants of the Plan and enable the participants to credit their contributions to various investment options in the Plan. The funds set aside in the Trust are subject to the claims of our general creditors in the event the company’s insolvency as defined in the Plan. Commencing February 2014, the company will disburse funds to the Trust during the 2014 calendar year to fund existing participant account balances as of December 31, 2013.
This report and the exhibits attached hereto contain “forward-looking statements” within the meaning of the federal securities laws, including the Private Securities Litigation Reform Act of 1995 (Section 27A of the Securities Act of 1933 and Section 27A of the Securities and Exchange Act of 1934). Such statements are inherently subject to risks and uncertainties. Further, forward looking statements are intended to speak only as of the date on which they are made, and we disclaim any duty to update such statements. Forward-looking statements are statements that include projections, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often but not always characterized by qualifying words such as “expect,” “believe,” “estimate,” “plan” and “project” and their derivatives, and include but are not limited to statements about expectations for our future operations, production levels, sales, gross profit margins, operating income, SG&A or other expenses, earnings, cash flow, and other performance or liquidity measures, as well as any statements regarding future economic or industry trends or future developments. Factors that could influence the matters discussed in such statements include the level of housing starts and sales of existing homes, consumer confidence, trends in disposable income, and general economic conditions. Decreases in these economic indicators could have a negative effect on our business and prospects. Likewise, increases in interest rates, particularly home mortgage rates, and increases in consumer debt or the general rate of inflation, could affect us adversely. Changes in consumer tastes or preferences toward products not produced by us could erode demand for our products. Changes in the value of the U.S. dollar versus other currencies can affect our financial results because a significant portion of our operations are located outside the United States. Strengthening of the U.S. dollar against other currencies could make our products less competitive on the basis of price in markets outside the United States, and strengthening of currencies in Canada and China can have a negative impact on our sales of products produced in those places. Also, economic and political instability in international areas could affect our operations or sources of goods in those areas, as well as demand for our products in international markets. Further information about these factors, as well as other factors that could affect our future operations or financial results and the matters discussed in forward-looking statements, is included in Item 1A “Risk Factors” section in our Form 10-K filed with the Securities and Exchange Commission on July 12, 2013 for the fiscal year ended April 28, 2013.
The following analysis of financial condition and results of operations should be read in conjunction with the Financial Statements and Notes and other exhibits included elsewhere in this report.
General
Our fiscal year is the 52 or 53 week period ending on the Sunday closest to April 30. The nine months ended January 26, 2014, and January 27, 2013, represent 39 week periods, respectively. Our operations are classified into two business segments: mattress fabrics and upholstery fabrics. The mattress fabrics segment manufactures, sources and sells fabrics and mattress covers to bedding manufacturers. The upholstery fabrics segment sources, manufactures and sells fabrics primarily to residential furniture manufacturers.
We evaluate the operating performance of our segments based upon income from operations before certain unallocated corporate expenses and other non-recurring items. Cost of sales in both segments include costs to manufacture or source our products, including costs such as raw material and finished goods purchases, direct and indirect labor, overhead and incoming freight charges. Unallocated corporate expenses represent primarily compensation and benefits for certain executive officers and all costs related to being a public company.
Executive Summary
Results of Operations
| |
|
Three Months Ended
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
January 27, 2013
|
|
|
% Change
|
|
|
Net sales
|
|
$ |
72,389 |
|
|
$ |
63,695 |
|
|
|
13.6% |
|
|
Gross profit
|
|
|
11,837 |
|
|
|
11,685 |
|
|
|
1.3% |
|
| Gross profit margin |
|
|
16.4% |
|
|
|
18.3% |
|
|
|
(10.4%) |
|
|
SG&A expenses
|
|
|
7,041 |
|
|
|
6,822 |
|
|
|
3.2% |
|
|
Income from operations
|
|
|
4,796 |
|
|
|
4,863 |
|
|
|
(1.4)% |
|
| Operating margin |
|
|
6.6% |
|
|
|
7.6% |
|
|
|
(13.2%) |
|
|
Income before income taxes
|
|
|
4,574 |
|
|
|
4,523 |
|
|
|
1.1% |
|
|
Income taxes
|
|
|
(3,807) |
|
|
|
1,700 |
|
|
N.M.
|
|
|
Net income
|
|
|
8,381 |
|
|
|
2,823 |
|
|
|
196.9% |
|
| |
|
Nine Months Ended
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
January 27, 2013
|
|
|
% Change
|
|
| |
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
213,119 |
|
|
$ |
198,439 |
|
|
|
7.4% |
|
|
Gross profit
|
|
|
37,145 |
|
|
|
36,682 |
|
|
|
1.3% |
|
| Gross profit margins |
|
|
17.4% |
|
|
|
18.5% |
|
|
|
(5.9)% |
|
|
SG&A expenses
|
|
|
21,340 |
|
|
|
21,672 |
|
|
|
(1.5)% |
|
|
Income from operations
|
|
|
15,805 |
|
|
|
15,010 |
|
|
|
5.3% |
|
| Operating margins |
|
|
7.4% |
|
|
|
7.6% |
|
|
|
(2.6)% |
|
|
Income before income taxes
|
|
|
14,923 |
|
|
|
14,426 |
|
|
|
3.4% |
|
|
Income taxes
|
|
|
216 |
|
|
|
(188) |
|
|
N.M.
|
|
|
Net income
|
|
|
14,707 |
|
|
|
14,614 |
|
|
|
0.6% |
|
Net Sales
Our net sales for the third quarter and nine month periods of fiscal 2014 increased as compared to the same periods a year ago. The increase in net sales reflects the continued favorable customer response to our designs and wide range of products in both our business segments. Product innovation and creativity are our top strategic priorities, allowing us to develop new products and meet the changing style demands of our existing key customers, as well as to attract new customers.
Income Before Income Taxes
Income before income taxes was flat for the third quarter of fiscal 2014 as compared to the third quarter of fiscal 2013, and increased 3.4% for the nine month period of fiscal 2014 as compared to the same period a year ago.
These results reflect the increase in net sales noted above. However, the results for the third quarter were affected by higher than expected transition costs in our new mattress cover operation, and additional sampling and development costs to support new mattress fabric product introductions for calendar 2014. Also, the results for the nine months ending January 26, 2014, included a charge of $206,000 that was recorded in the first quarter for the settlement of litigation relating to environmental claims associated with a closed facility, as well as the effects of fluctuations in foreign currency exchange rates primarily for our subsidiaries domiciled in China.
Income Taxes
We reported an income tax benefit of $3.8 million in the third quarter of fiscal 2014 compared with income tax expense of $1.7 million for the third quarter of fiscal 2013. The income tax benefit of $3.8 million for the third quarter of fiscal 2014 included an income tax benefit of $5.4 million to record the U.S. income tax effects of the undistributed earnings from our foreign subsidiaries located in China.
We reported income tax expense of $216,000 for the nine month period of fiscal 2014 compared to an income tax benefit of $188,000 for the same period a year ago. The income tax expense of $216,000 for the nine month period of fiscal 2014 included an income tax benefit of $5.4 million recorded in the third quarter for the U.S. income tax effects of the undistributed earnings from our foreign subsidiaries located in China. The income tax benefit of $188,000 for the nine month period of fiscal 2013 included a $12.1 million income tax benefit recorded during the second quarter to reverse primarily all of the valuation allowance against our U.S. net deferred tax assets, offset by an income tax charge of $6.6 million during the second quarter to record the U.S. income tax effects of the undistributed earnings from our foreign subsidiaries located in Canada and China.
See the Income Taxes section located in the Results of Operations for further details.
Liquidity
At January 26, 2014, our cash and cash equivalents and short-term investments totaled $30.4 million and exceeded our total debt (current maturities of long-term debt, long-term debt, and line of credit) of $5.0 million. In August of 2013, we paid our required annual principal payment of $2.2 million associated with our unsecured senior term notes. We have two remaining annual $2.2 million principal payments due August 2014 and 2015.
Our cash and cash equivalents and short-term investments increased from $28.8 million at April 28, 2013, despite spending $2.6 million on an asset purchase and consulting agreement associated with our mattress fabrics segment, $2.7 million on capital expenditures, $2.2 million on our annual principal payment noted above, and $1.6 million on dividend payments. This spending was funded by net cash provided by operating activities of $11.0 million.
Dividend Program
On June 12, 2013, we announced that our board of directors approved a 33% increase in payment of a quarterly cash dividend from $0.03 to $0.04 per share, commencing in the first quarter of fiscal 2014. On November 25, 2013, we announced that our board of directors approved a 25% increase in payment of a quarterly cash dividend from $0.04 to $0.05 per share, commencing in the third quarter of fiscal 2014. On February 25, 2014, we announced that our board of directors approved a quarterly cash dividend of $0.05 per share to be paid on or about April 15, 2014, to shareholders of record as of the close of business on April 1, 2014.
Future dividend payments are subject to board approval and may be adjusted at the board’s discretion as business needs or market conditions change.
Dividend payments totaled $1.6 million and $7.2 million for the nine month periods ending January 26, 2014, and January 27, 2013, respectively. The dividend payments totaling $1.6 million for the nine month period ending January 26, 2014, represented quarterly dividend payments ranging from $0.04 to $0.05 per share. The dividend payments totaling $7.2 million for the nine month period ending January 27, 2013, represented a $6.1 million special cash dividend payment of $0.50 per share in the third quarter of fiscal 2013, and $1.1 million of quarterly dividend payments of $0.03 per share, respectively.
Common Stock Repurchase Program
On February 25, 2014, we announced that our board of directors approved an increase to $5.0 million in the authorization for us to acquire our common stock, an increase from the $2.0 million authorization that was approved by our board of directors on August 29, 2012.
Under the common stock repurchase program, shares may be purchased from time to time in open market transactions, block trades, through plans established under the Securities Exchange Act Rule 10b5-1, or otherwise. The amount of shares purchased and the timing of such purchases will be based on working capital requirements, market and general business conditions, and other factors including alternative investment opportunities.
As of January 26, 2014, there have been no repurchases of common stock on the $2.0 million limit that was authorized on August 29, 2012.
Segment Analysis
Mattress Fabrics Segment
| |
|
Three Months Ended
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
January 27, 2013
|
|
|
% Change
|
|
| |
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
38,541 |
|
|
$ |
35,513 |
|
|
|
8.5% |
|
|
Gross profit
|
|
|
5,599 |
|
|
|
6,548 |
|
|
|
(14.5)% |
|
|
Gross profit margin
|
|
|
14.5% |
|
|
|
18.4% |
|
|
|
(21.2)% |
|
|
SG&A expenses
|
|
|
2,286 |
|
|
|
2,382 |
|
|
|
(4.0)% |
|
|
Income from operations
|
|
|
3,313 |
|
|
|
4,166 |
|
|
|
(20.5)% |
|
| Operating margin |
|
|
8.6% |
|
|
|
11.7% |
|
|
|
(26.5)% |
|
| |
|
Nine Months Ended
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
January 27, 2013
|
|
|
% Change
|
|
| |
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$ |
117,035 |
|
|
$ |
113,175 |
|
|
|
3.4% |
|
|
Gross profit
|
|
|
20,312 |
|
|
|
21,708 |
|
|
|
(6.4)% |
|
| Gross profit margins |
|
|
17.4% |
|
|
|
19.2% |
|
|
|
(9.4)% |
|
|
SG&A expenses
|
|
|
7,280 |
|
|
|
7,197 |
|
|
|
1.2% |
|
|
Income from operations
|
|
|
13,033 |
|
|
|
14,512 |
|
|
|
(10.2)% |
|
| Operating margins |
|
|
11.1% |
|
|
|
12.8% |
|
|
|
(13.3)% |
|
Net Sales
The increases in mattress fabrics net sales results reflect our ability to capitalize on the growing consumer demand for better designed bedding products. The mattress industry has continued to evolve into a much more decorative business, with customers being more selective in their fabric choices. In response to this demand trend, we have increased our design staff, as well as expanded our design capabilities and technical expertise, to develop a wide range of fabric choices across all price points. Additionally, we have a scalable manufacturing platform and reactive capacity that supports our ability to deliver a diverse product mix in line with customer demand.
In response to this growing demand, the majority of our capital spending for the fourth quarter of fiscal 2014 and fiscal 2015 will be for expansion related projects. Specifically, we are expanding the building at our main plant facility in North Carolina to accommodate the additional volume going through our knit finishing, fabric inspection, and warehouse areas. Most of our demand has been with our knitted fabric product line, and therefore we will be adding additional knit machines, a second finishing line, and related equipment to increase our capacity in knitted fabrics.
The adverse weather conditions experienced in many parts of the U.S. thus far in calendar 2014 and the related impact on furniture and mattress manufacturers and retailers could affect our net sales and profitability in the fourth quarter of fiscal 2014.
Gross Profit and Operating Income
Our profitability for the third quarter and nine months periods were affected by higher than expected transition costs associated with our new mattress cover operation (Culp Lava), as well as additional sampling and development costs to support new mattress fabric product introductions for calendar 2014. We experienced short-term challenges during the third quarter that lowered gross profit by approximately $600,000, as we absorbed the production of some mattress covers acquired from a previous supplier. However, as these specific covers are phased out of production during the fourth quarter of fiscal 2014, and new calendar 2014 mattress cover products are introduced, we expect improvement in our operating efficiencies and margins going forward. Despite these operational challenges, we are pleased with the added sales contribution from Culp Lava in fiscal 2014.
Bodet & Horst
On May 8, 2013, we entered into an asset purchase and consulting agreement with Bodet & Horst GMBH & Co. KG and certain affiliates (“Bodet & Horst”) that provided for, among other things, the purchase of equipment and certain other assets from Bodet & Horst and the restructuring of prior consulting and non-compete agreements pursuant to an earlier asset purchase and consulting agreement with Bodet & Horst dated August 11, 2008. This agreement was accounted for as a business combination in accordance with ASC Topic 805, Business Combinations. We agreed with Bodet & Horst to replace the prior non-compete agreement that prevented us from selling certain mattress fabrics and products to a leading manufacturer, which allows us to make such sales. In addition, the prior consulting and non-compete agreement, under which Bodet & Horst agreed not to sell most mattress fabrics in North America, was replaced, expanded and extended pursuant to the new asset purchase and consulting agreement. The purchase price for the equipment and the other assets was $2.6 million in cash.
Segment assets
Segment assets consist of accounts receivable, inventory, property, plant and equipment, goodwill, a non-compete agreement and customer relationships associated with an acquisition.
| |
|
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
April 28, 2013
|
|
|
% Change
|
|
|
Accounts receivable and inventory
|
|
$ |
36,818 |
|
|
$ |
33,323 |
|
|
|
10.5% |
|
|
Property, plant & equipment
|
|
|
27,822 |
|
|
|
28,578 |
|
|
|
(2.6)% |
|
|
Goodwill
|
|
|
11,462 |
|
|
|
11,462 |
|
|
|
0.0% |
|
|
Non-compete agreement
|
|
|
1,047 |
|
|
|
185 |
|
|
|
465.9% |
|
|
Customer Relationships
|
|
|
830 |
|
|
|
- |
|
|
|
100.0% |
|
Accounts Receivable & Inventory
Accounts receivable increased due to the increase in net sales of 8.5% in the third quarter and fewer customers taking advantage of sales discounts in the third quarter of fiscal 2014 as compared with the third quarter of fiscal 2013.
Inventory increased due to current and expected demand trends as of the end of the third quarter of fiscal 2014 compared with the fourth quarter of fiscal 2013, as well as the increased sales contribution from Culp Lava.
Property, Plant & Equipment
The $27.8 million at January 26, 2014, represents property, plant and equipment of $20.1 million and $7.7 million located in the U.S. and Canada, respectively. The $28.6 million at April 28, 2013, represents property, plant, and equipment of $20.4 million and $8.2 million located in the U.S. and Canada, respectively.
The change in this segment’s property, plant, and equipment is due to depreciation expense of $3.5 million, offset by capital spending of $1.9 million, and $890,000 in equipment acquired in the Bodet & Horst asset purchase.
Non-Compete Agreement and Customer Relationships
The increases in carrying values of our non-compete agreement and customer relationships at January 26, 2014, are a result of the asset purchase transaction with Bodet & Horst, which was effective May 8, 2013.
Upholstery Fabrics Segment
Net Sales
| |
|
Three Months Ended |
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
|
|
|
January 27, 2013
|
|
|
|
|
|
% Change
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non U.S. Produced
|
|
$ |
31,108 |
|
|
|
92 |
% |
|
$ |
25,351 |
|
|
|
90 |
% |
|
|
22.7 |
% |
|
U.S Produced
|
|
|
2,740 |
|
|
|
8 |
% |
|
|
2,831 |
|
|
|
10 |
% |
|
|
(3.2 |
)% |
|
Total
|
|
|
33,848 |
|
|
|
100 |
% |
|
|
28,182 |
|
|
|
100 |
% |
|
|
20.1 |
% |
| |
|
Nine Months Ended |
|
|
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
|
|
|
January 27, 2013
|
|
|
|
|
|
% Change
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non U.S. Produced
|
|
$ |
88,634 |
|
|
|
92 |
% |
|
$ |
75,582 |
|
|
|
89 |
% |
|
|
17.3 |
% |
|
U.S Produced
|
|
|
7,450 |
|
|
|
8 |
% |
|
|
9,682 |
|
|
|
11 |
% |
|
|
(23.1 |
)% |
|
Total
|
|
|
96,084 |
|
|
|
100 |
% |
|
|
85,264 |
|
|
|
100 |
% |
|
|
12.7 |
% |
Our total upholstery fabric net sales for the third quarter and nine month periods of fiscal 2014 were better than expected, reflecting the continued favorable response from key customers to our designs and new product introductions. Product innovation and creativity are our top strategic priorities, allowing us to develop a diverse product mix of fabric styles and price points. In addition, we experienced a greater than expected level of sales in the third quarter as customers anticipated longer lead times related to the Chinese New Year holiday, which occured in late January of this year.
Our 100% owned China platform continued to be the primary catalyst of our sales growth in the third quarter and year-to-date periods of fiscal 2014. This platform offers significant manufacturing flexibility to produce a variety of product categories, and we have continued to leverage this capability to meet changing customer demand in line with furniture style trends. As a result, we have increased sales to our key customers, and attracted new customers, with our designs and new product offerings.
Although net sales of upholstery fabrics produced by our U.S. manufacturing facility are lower as compared to last year, this operation remained profitable. This continued profitability reflects our ability to manage our production costs and align them with current and expected demand trends.
The adverse weather conditions experienced in many parts of the U.S. thus far in calendar 2014 that have impacted furniture and mattress manufacturers and retailers, combined with the Chinese New Year holiday occurring entirely in the fourth quarter of fiscal 2014, could affect our net sales and profitability in the fourth quarter of fiscal 2014.
Gross Profit, Selling, General & Administrative Expenses, and Operating Income
| |
|
Three Months Ended
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
January 27, 2013
|
|
|
% Change
|
|
| |
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$ |
6,238 |
|
|
$ |
5,137 |
|
|
|
21.4% |
|
|
Gross profit margins
|
|
|
18.4% |
|
|
|
18.2% |
|
|
|
1.1% |
|
|
SG&A expenses
|
|
|
3,572 |
|
|
|
3,360 |
|
|
|
6.3% |
|
|
Income from operations
|
|
|
2,666 |
|
|
|
1,777 |
|
|
|
50.0% |
|
| Operating margins |
|
|
7.9% |
|
|
|
6.3% |
|
|
|
25.4% |
|
| |
|
|
|
|
|
|
|
| |
|
Nine Months Ended
|
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
January 27, 2013
|
|
|
% Change
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$ |
16,833 |
|
|
$ |
14,974 |
|
|
|
12.4% |
|
|
Gross profit margins
|
|
|
17.5% |
|
|
|
17.6% |
|
|
|
(0.6)% |
|
|
SG&A expenses
|
|
|
10,007 |
|
|
|
9,857 |
|
|
|
1.5% |
|
|
Income from operations
|
|
|
6,825 |
|
|
|
5,116 |
|
|
|
33.4% |
|
| Operating margins |
|
|
7.1% |
|
|
|
6.0% |
|
|
|
18.3% |
|
During the third quarter and the nine month periods of fiscal 2014, our upholstery fabric segment’s profitability has increased compared to the same periods a year ago due primarily to the increase in net sales noted above, combined with stable SG&A expenses compared to prior periods.
Culp Europe
Although currently an immaterial part of our business, we are continuing our efforts to develop our Culp Europe operation located in Poland. We have continued to make progress and remain optimistic about the future opportunities for Culp Europe to support our global sales efforts.
Segment Assets
Segment assets consist of accounts receivable, inventory, and property, plant, and equipment.
| |
|
|
|
|
|
|
|
(dollars in thousands)
|
|
January 26, 2014
|
|
|
April 28, 2013
|
|
|
% Change
|
|
|
Accounts receivable and inventory
|
|
$ |
33,261 |
|
|
$ |
28,487 |
|
|
|
16.8% |
|
|
Property, plant & equipment
|
|
|
1,649 |
|
|
|
1,230 |
|
|
|
34.1% |
|
Accounts Receivable & Inventory
Our increase in accounts receivable and inventory reflect this segment’s increased business volume in fiscal 2014 compared to fiscal 2013.
Property, Plant & Equipment
The $1.6 million at January 26, 2014, represents property, plant, and equipment located in the U.S. of $1.0 million, located in China of $561,000, and located in Poland of $47,000. The $1.2 million at April 28, 2013, represents property, plant, and equipment located in the U.S. of $908,000, located in China of $265,000, and located in Poland of $57,000.
The change in this segment’s property, plant, and equipment balance is primarily due to capital expenditures of $694,000 offset by depreciation expense of $454,000.
Other Income Statement Categories
Selling, General and Administrative Expenses
SG&A expenses for the company as a whole were $7.0 million for the third quarter of fiscal 2014 compared with 6.8 million for the third quarter of fiscal 2013. As a percent of net sales, SG&A expenses were 9.7% in the third quarter of fiscal 2014 compared with 10.7% in the third quarter of fiscal 2013. SG&A expenses were $21.3 million for the nine month period of fiscal 2014, compared with $21.7 million for the same period a year ago. As a percent of net sales, SG&A expenses were 10.0% for the nine month period of fiscal 2014 compared with 10.9% for the same period a year ago.
Although SG&A expenses were flat in the third quarter of fiscal 2014 compared to the third quarter of fiscal 2013, SG&A expenses for the nine month period of fiscal 2014 decreased 2% compared to the same period a year ago. SG&A decreased primarily due to lower unallocated corporate incentive compensation accruals, reflecting financial results that were not as high in relation to pre-established performance targets set at more challenging levels than the prior year.
Currently, SG&A expenses are expected to be higher in the fourth quarter of fiscal 2014 compared to the fourth quarter of fiscal 2013, as a larger portion of incentive compensation was incurred in the nine month period of fiscal 2013, compared with the nine month period of fiscal 2014.
Interest Expense
Interest expense for the third quarter of fiscal 2014 was $91,000 compared to $145,000 for the third quarter of fiscal 2013. Interest expense for the nine month period of fiscal 2014 was $330,000 compared to $491,000 for the same period a year ago. This trend reflects lower outstanding balances of long-term debt.
Interest Income
Interest income was $148,000 for the third quarter of fiscal 2014 compared to $105,000 for the third quarter of fiscal 2013. Interest income was $343,000 for the nine month period of fiscal 2014 compared to $328,000 for the same period a year ago. This trend reflects higher cash and cash equivalent and short-term investment balances held with our foreign subsidiaries during fiscal 2014 compared to fiscal 2013. Cash and cash equivalents and short-term investment balances held by our foreign subsidiaries earn higher interest rates as compared to our cash and cash equivalents and short-term investment balances held in the United States.
Other Expense
Other expense for the third quarter of fiscal 2014 was $279,000 compared with $300,000 during the third quarter of fiscal 2013. This change primarily reflects fluctuations in the foreign currency exchange rates of our subsidiaries domiciled in China. We have been able to mitigate the effects of foreign exchange rate fluctuations associated with our subsidiaries domiciled in Canada and Poland through maintenance of a natural hedge by keeping a balance of assets and liabilities denominated in foreign currencies other than the U.S. dollar. Although we will continue to try and maintain this natural hedge, there is no assurance that we will be able to continue to do so in the future reporting periods.
Other expense for the nine month period of fiscal 2014 was $895,000 compared with other expense of $421,000 for the same period a year ago. This increase primarily reflects fluctuations in the foreign exchange rate for our subsidiaries domiciled in China and a charge of $206,000 for the tentative settlement of litigation relating to environmental claims associated with a closed facility.
Income Taxes
Effective Income Tax Rate
We recorded income tax expense of $216,000, or 1.4% of income before income tax expense, for the nine month period ended January 26, 2014, compared to an income tax benefit of $188,000, or (1.3)% of income before income tax expense, for the nine month period ended January 27, 2013. Our effective income tax rates for the nine month periods ended January 26, 2014, and January 27, 2013, were based upon the estimated effective income tax rate applicable for the full year after giving effect to any significant items related specifically to interim periods. The effective income tax rate can be affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and foreign sources versus annual projections and changes in foreign currencies in relation to the U.S. dollar.
The income tax expense for the nine month period ended January 26, 2014, is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
|
●
|
The income tax rate decreased 36% for an income tax benefit of $5.4 million to record the U.S. income tax effects of the undistributed earnings from our foreign subsidiaries located in China. The $5.4 million income tax benefit recognized U.S. foreign income tax credits of $9.9 million offset by the U.S. income tax effects of the undistributed earnings from our China operations and foreign withholding taxes of $4.5 million. This $5.4 million income tax benefit was treated as a discrete event in which the full income tax effects of this adjustment were recorded in the three and nine month periods ended January 26, 2014, as it pertained to a change in judgment on prior periods' accumulated earnings and profits associated with our subsidiaries located in China (see below undistributed earnings section for further details).
|
|
|
●
|
The income tax rate increased 2% for adjustments primarily made to our state of North Carolina loss carryforwards for the decrease in future North Carolina corporate income tax rates commencing in fiscal 2015 and beyond. These adjustments were recorded in the first quarter, totaled $273,000, and represented a discrete event in which the full tax effects were recorded in the nine month period ending January 26, 2014.
|
|
|
●
|
The income tax rate decreased by 7% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
|
●
|
The income tax rate increased by 4% for an increase in unrecognized tax benefits.
|
|
|
●
|
The income tax rate increased by 4.4% for stock-based compensation and other miscellaneous items.
|
The income tax expense for the nine month period ended January 27, 2013 is different from the amount obtained by applying our statutory rate of 34% to income before income taxes for the following reasons:
|
|
●
|
The income tax rate was reduced by 84% for a reduction in our valuation allowance associated with our U.S. net deferred tax assets. This 84% reduction in our income tax rate is due to a change in judgment about the realization of our U.S. net deferred income tax assets in future years. Since the realization of our U.S. net deferred income tax assets is a result of a change in judgment about future years we recorded an income tax benefit of $12.1 million that represents a discrete event in which the full tax effects were recorded in the nine month period ending January 27, 2013.
|
|
|
●
|
The income tax rate was increased by 46% for the establishment of a deferred tax liability for U.S. income taxes that will be paid upon repatriation of undistributed earnings from our foreign subsidiaries located in Canada and China. This 46% increase in our income tax rate is due to a change in judgment in which our prior years’ accumulated earnings and profits associated with our subsidiaries located in Canada and China are no longer considered indefinitely reinvested. Since the establishment of our deferred tax liability is a result of a change in judgment about prior years’ accumulated earnings and profits, we recorded an income tax charge of $6.6 million that represents a discrete event in which the full tax effects were recorded for the nine month period ending January 27, 2013.
|
|
|
●
|
The income tax rate increased 5% for an increase in unrecognized tax benefits.
|
|
|
●
|
The income tax rate was reduced by 6% for taxable income subject to lower statutory income tax rates in foreign jurisdictions (Canada and China) compared with the statutory income tax rate of 34% for the United States.
|
|
|
●
|
The income tax rate was increased by 1% for the establishment of a valuation allowance against our net deferred tax assets associated with our Culp Europe operation located in Poland.
|
|
|
●
|
The income tax rate was increased by 2.7% for stock-based compensation and other miscellaneous items.
|
Deferred Income Taxes
Valuation Allowance
In accordance with ASC Topic 740, we evaluate our deferred income taxes to determine if a valuation allowance is required. ASC Topic 740 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard, with significant weight being given to evidence that can be objectively verified. Since the company operates in multiple jurisdictions, we assess the need for a valuation allowance on a jurisdiction-by-jurisdiction basis, taking into account the effects of local tax law. Based on our assessment at January 26, 2014, we recorded a partial valuation allowance of $1.0 million, of which $715,000 pertained to certain U.S. state net operating loss carryforwards and credits and $291,000 pertained to loss carryfowards associated with our Culp Europe operation located in Poland. Based on our assessment at January 27, 2013, we recorded a partial valuation allowance of $926,000, of which $719,000 pertained to certain U.S. state net operating loss carryforwards and credits and $207,000 pertained to loss carryforwards associated with our Culp Europe operation located in Poland. Based on our assessment at April 28, 2013, we recorded a partial valuation allowance of $963,000, of which $722,000 pertained to certain U.S. state net operating loss carryforwards and credits and $241,000 pertained to loss carryfowards associated with our Culp Europe operation located in Poland.
No valuation allowance was recorded against our net deferred tax assets associated with operations located in China and Canada at January 26, 2014, January 27, 2013, and April 28, 2013, respectively.
The recorded valuation allowance of $1.0 million at January 26, 2014, has no effect on our operations, loan covenant compliance, or the possible realization of certain U.S. state net operating loss carryforwards and credits and our loss carryforwards associated with our Culp Europe operation located in Poland. If it is determined that it is more-likely-than-not that we will realize any of these deferred tax assets, an income tax benefit will be recognized at that time.
Undistributed Earnings
In accordance with ASC Topic 740, we assess whether the undistributed earnings from our foreign subsidiaries will be reinvested indefinitely or eventually distributed to our U.S. parent company. ASC Topic 740 requires that a deferred tax liability should be recorded for undistributed earnings from foreign subsidiaries that will not be reinvested indefinitely. Based on our assessment of the financial requirements of our U.S. parent company and foreign subsidiaries, we determined that our undistributed earnings from our foreign subsidiaries will not be reinvested indefinitely and will be eventually distributed to our U.S. parent company. The financial requirements of the U.S. parent company have changed over the past year due to a decision to return cash to its shareholders through dividend payments and common stock repurchases. Also, in order to keep up with the growth in consumer demand for our mattress fabric products, it is our intention to continue our investment in our domestic mattress fabric operations.
In accordance with ASC Topic 740, we assess the recognition of U.S. foreign income tax credits associated with foreign withholding and income tax payments and whether it is more-likely-than-not that our foreign income tax credits will not be realized. If it is determined that any foreign income tax credits need to be recognized or it is more-likely-than-not that our foreign income tax credits will not be realized, an adjustment to our provision for income taxes will be recognized at that time.
During the third quarter of fiscal 2014, our operations located in China achieved positive accumulated earnings and profits for both U.S. income tax and financial reporting purposes for the first time since we determined our undistributed earnings from our foreign subsidiaries would not be reinvested indefinitely in the second quarter of fiscal 2013. As a result, we recorded an income tax benefit of $5.4 million to recognize U.S. foreign income tax credits of $9.9 million offset by the U.S. income tax effects of the undistributed earnings from our China operations and foreign withholding taxes totaling $4.5 million. This $5.4 million income tax benefit was treated as a discrete event in which the full income tax effects of this adjustment were recorded in the three and nine month periods ended January 26, 2014, as it pertained to a change in judgment on prior periods' accumulated earnings and profits associated with our subsidiaries located in China.
We had accumulated earnings from our foreign subsidiaries totaling $69.8 million, $56.3 million, and $56.7 million at January 26, 2014, January 27, 2013, and April 28, 2013, respectively.
At January 26, 2014, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $1.7 million, which included U.S. income and foreign withholding taxes totaling $26.9 million, offset by U.S. foreign income tax credits of $25.2 million. At January 27, 2013, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $6.8 million, which included U.S. income and foreign withholding taxes totaling $21.9 million offset by U.S. foreign income tax credits of $15.1 million. At April 28, 2013, the deferred tax liability associated with our undistributed earnings from our foreign subsidiaries totaled $7.0 million, which included U.S. income and foreign withholding taxes totaling $22.0 million, offset by U.S. foreign income tax credits of $15.0 million.
Overall
At January 26, 2014, the current deferred tax asset of $7.5 million represents $7.3 million and $217,000 from our operations located in the U.S. and China, respectively. At January 26, 2014, the non-current deferred tax asset of $1.2 million represents $600,000 and $627,000 from our operations located in the U.S. and China, respectively. At January 26, 2014, the non-current deferred tax liability of $945,000 pertains to our operations located in Canada.
At January 27, 2013, the current deferred tax asset of $4.1 million represents $3.8 million and $329,000 from our operations located in the U.S. and China, respectively. At January 27, 2013, the non-current deferred tax asset of $4.2 million represents $3.4 million and $793,000 from our operations located in the U.S. and China, respectively. At January 27, 2013, the non-current deferred tax liability of $856,000 pertains to our operation located in Canada.
At April 28, 2013, the current deferred tax asset of $7.7 million represents $7.4 million and $325,000 from our operations located in the U.S. and China, respectively. At April 28, 2013, the non-current deferred tax asset of $753,000 pertains to our operations located in China. At April 28, 2013, the non-current deferred tax liability of $3.1 million represents $2.0 million and $1.1 million from our operations located in the U.S. and Canada, respectively.
Uncertainty In Income Taxes
At January 26, 2014, we had $13.6 million of total gross unrecognized tax benefits, of which $4.0 million represents the amount of gross unrecognized tax benefits that, if recognized, would favorably affect the income tax rate in future periods. At January 27, 2013, we had $13.1 million of total gross unrecognized tax benefits, of which $4.2 million represents the amount of gross unrecognized tax benefits that, if recognized, would favorably affect the income tax rate in future periods. At April 28, 2013, we had $13.1 million of total gross unrecognized tax benefits, of which $4.2 million would favorably affect the income tax rate in future periods.
As of January 26, 2014, we had $13.6 million in gross unrecognized tax benefits, of which $9.6 million were classified as net non-current deferred income tax liability and $4.0 million were classified as income taxes payable –long-term in the accompanying consolidated balance sheets. As of January 27, 2013, we had $13.1 million in gross unrecognized tax benefits, of which $8.9 million were classified as net non-current deferred income tax assets and $4.2 million were classified as income taxes payable long-term in the accompanying consolidated balance sheets. As of April 28, 2013, we had $13.1 million in gross unrecognized tax benefits, of which $8.9 million were classified as net non-current deferred income tax liability and $4.2 million were classified as income taxes payable – long-term in the accompanying consolidated balance sheets.
We estimate that the amount of gross unrecognized tax benefits will increase by approximately $808,000 for fiscal 2014. This increase primarily relates to double taxation under applicable tax treaties with foreign tax jurisdictions.
Income Taxes Paid
Although we reported income tax expense of $216,000 for the nine month period of fiscal 2014 and an income tax benefit of $188,000 for the same period a year ago, we are currently paying income taxes associated with our subsidiaries located in China and Canada. As a result, we had income tax payments of $2.3 million for the nine month periods of fiscal 2014 and 2013, respectively.
Liquidity and Capital Resources
Liquidity
Our sources of liquidity include cash and cash equivalents, short-term investments, cash flow from operations, and amounts available under our unsecured revolving credit lines. These sources have been adequate for day-to-day operations, capital expenditures, debt payments, common stock repurchases, and dividend payments. We believe our present cash and cash equivalents and short-term investment balance of $30.4 million at January 26, 2014, cash flow from operations, and the current availability under our unsecured revolving credit lines will be sufficient to fund our business needs and contractual obligations.
At January 26, 2014, our cash and cash equivalents and short-term investments totaled $30.4 million, exceeded our total debt (current maturities of long-term debt, long-term debt, and line of credit) of $5.0 million. In August of 2013, we paid our required annual principal payment of $2.2 million associated with our unsecured senior term notes. We have two remaining annual $2.2 million principal payments due August 2014 and 2015.
Our cash and cash equivalents and short-term investments increased from $28.8 million at April 28, 2013, despite spending $2.6 million on an asset purchase and consulting agreement associated with our mattress fabrics segment, $2.7 million on capital expenditures, $2.2 million on our annual principal payment noted above, and $1.6 million on dividend payments. This spending was funded by net cash provided by operating activities of $11.0 million
As a result of our increased liquidity, we have made the decision to return more funds to our shareholders. On June 12, 2013, we announced that our board of directors approved a 33% increase in payment of a quarterly cash dividend from $0.03 to $0.04 per share, commencing in the first quarter of fiscal 2014. On November 25, 2013, we announced that our board of directors approved a 25% increase in payment of a quarterly cash dividend from $0.04 to $0.05 per share, commencing in the third quarter of fiscal 2014. On February 25, 2014, we announced that our board of directors approved a quarterly cash dividend of $0.05 per share to be paid on or about April 15, 2014, to shareholders of record as of the close of business on April 1, 2014.
Dividend payments totaled $1.6 million and $7.2 million for the nine month periods ending January 26, 2014, and January 27, 2013, respectively. The dividend payments totaling $1.6 million for the nine month period ending January 26, 2014, represented quarterly dividend payments ranging from $0.04 to $0.05 per share. The dividend payments totaling $7.2 million for the nine month period ending January 27, 2013, represented a $6.1 million special cash dividend payment of $0.50 per share in the third quarter of fiscal 2013, and $1.1 million of quarterly dividend payments of $0.03 per share, respectively.
On February 25, 2014, we announced that our board of directors approved an increase to $5.0 million in the authorization to acquire our common stock, an increase from the $2.0 million authorization that was approved by our board of directors on August 29, 2012.
Under the common stock repurchase program, shares may be purchased from time to time in open market transactions, block trades, through plans established under the Securities Exchange Act Rule 10b5-1, or otherwise. The amount of shares purchased and the timing of such purchases will be based on working capital requirements, market and general business conditions, and other factors including alternative investment opportunities.
As of January 26, 2014, there have been no repurchases of common stock on the $2.0 million limit that was authorized on August 29, 2012.
Our cash and cash equivalents and short-term investment balance may be adversely affected by factors beyond our control, such as weakening industry demand and delays in receipt of payment on accounts receivable.
Working Capital
Accounts receivable at January 26, 2014, were $26.4 million, an increase of $2.1 million or 9% compared with $24.3 million at January 27, 2013. This increase in accounts receivable is primarily due to an increase in net sales of 14% for the third quarter of fiscal 2014 compared to the third quarter of fiscal 2013, partially offset by a slight decrease in our days’ sales outstanding. Days’ sales outstanding decreased from 32 days for the third quarter of fiscal 2013 to 31 days for the third quarter of fiscal 2014.
Inventories as of January 26, 2014, were $43.7 million, an increase of $1.5 million, or 4%, compared with $42.2 million at January 27, 2013. This increase primarily reflects increased business volume in fiscal 2014 compared to fiscal 2013, expected demand trends in the fourth quarter of fiscal 2014, and the increased sales contribution from Culp Lava. Inventory turns for the third quarter of fiscal 2014 were 5.4 compared with 5.3 for the third quarter of fiscal 2013.
Accounts payable-trade as of January 26, 2014, was $25.2 million, a decrease of $1.0 million, or 4% compared with $26.2 million at January 27, 2013. This decrease primarily reflects the timing of our payments on outstanding vendor invoices resulting from the Chinese New Year holiday occurring in late January.
Operating working capital (comprised of accounts receivable and inventories, less accounts payable-trade and accounts payable-capital expenditures) was $44.7 million at January 26, 2014 compared with $40.2 million at January 27, 2013. Operating working capital turnover was 7.0 and 7.9 during the third quarters of fiscal 2014 and 2013, respectively.
Financing Arrangements
Unsecured Term Notes
We entered into a note agreement dated August 11, 2008 that provided for the issuance of $11.0 million of unsecured term notes with a fixed interest rate of 8.01% and a term of seven years. Principal payments of $2.2 million per year are due on the notes beginning August 11, 2011. The remaining principal payments are payable over an average term 1.5 years through August 11, 2015. Any principal pre-payments would be assessed a penalty as defined in the agreement. The agreement contains customary financial and other covenants as defined in the agreement.
Revolving Credit Agreement – United States
At April 28, 2013, we had an unsecured Amended and Restated Credit Agreement with Wells Fargo Bank, N.A. (“Wells Fargo”) that provided for a revolving loan commitment of $7.6 million that was due to expire on August 25, 2013. This agreement provided for a pricing matrix to determine the interest rate payable on loans made under this agreement.
Effective August 13, 2013, we entered into a Credit Agreement (“Credit Agreement”) with Wells Fargo that replaced the agreement noted above. This Credit Agreement contains terms and covenants similar to the previous agreement and extends the term of the credit facility through August 31, 2015. Interest is charged at a rate equal to the one-month LIBOR rate plus a spread based on our ratio of debt to EBITDA as defined in the agreement (applicable interest rate of 1.76% at January 26, 2014).
This Credit Agreement provides for an unsecured revolving loan commitment of $10.0 million to be used to finance working capital and for general corporate purposes. The amount of borrowings that are outstanding under the revolving credit agreement with Culp Europe noted below decrease the $10.0 million available under this Credit Agreement.
At January 26, 2014, January 27, 2013, and April 28, 2013, there was a $195,000 outstanding letter of credit (all of which related to workers compensation) provided by the Credit Agreement. There were no borrowings outstanding under the agreement at January 26, 2014, January 27, 2013, and April 28, 2013.
Revolving Credit Agreement – China
We have an unsecured credit agreement associated with our operations in China that provides for a line of credit of up to 40 million RMB (approximately $6.6 million USD at January 26, 2014), expiring on June 8, 2014. This agreement has an interest rate determined by the Chinese government. There were no borrowings outstanding under the agreement as of January 26, 2014, January 27, 2013, and April 28, 2013, respectively.
Revolving Credit Agreement – Europe
Prior to August 13, 2013, we had an unsecured credit agreement associated with our operations in Poland that provided for a line of credit of up to 6.8 million Polish Zloty (approximately $2.2 million USD). This agreement bears interest at WIBOR (Warsaw Interbank Offered Rate) plus 2% (applicable interest rate of 4.5% at January 26, 2014). There were $573,000, $576,000 and $561,000 (1.8 million Polish Zloty) in borrowings outstanding under this agreement at January 26, 2014, January 27, 2013, and April 28, 2013, respectively.
In connection with the Credit Agreement effective August 13, 2013 noted above, the outstanding borrowings, totaling $573,000 at January 26, 2014, are due on August 31, 2015 and decrease the $10.0 million available under the Credit Agreement.
Overall
Our loan agreements require, among other things, that we maintain compliance with certain financial covenants. At January 26, 2014, the company was in compliance with these financial covenants.
At January 26, 2014, the principal payment requirements of long-term debt during the next two years are: Year 1 – $2.2 million; and Year 2 - $2.2 million.
Capital Expenditures and Depreciation
Capital expenditures on a cash basis were $2.7 million for the nine months ended January 26, 2014 compared with $2.8 million for the nine months ended January 27, 2013. In addition, we acquired equipment for our mattress fabrics segment totaling $890,000 in connection with the Bodet & Horst asset purchase agreement. Capital expenditures, including the assets purchased in connection with the May 2013, Bodet & Horst asset purchase agreement, for the nine months ended January 26, 2014 and January 27, 2013, mostly related to our mattress fabrics segment. Depreciation expense was $4.0 million and $3.8 million for the nine months ended January 26, 2014 and January 27, 2013, respectively. Depreciation expense for the nine months ended January 26, 2014 and January 27, 2013, primarily related to the mattress fabrics segment.
For fiscal 2014, we currently expect cash capital expenditures to be approximately $5.2 million compared with $4.4 million in fiscal 2013 and $5.9 million in fiscal 2012. Planned capital expenditures for fiscal 2014 primarily relate to the mattress fabrics segment. For fiscal 2014, depreciation expense is projected to be $5.4 million, which primarily relates to the mattress fabrics segment.
Currently, for fiscal 2015, we expect capital spending and depreciation expense to each be approximately $6.0 million.
These are management’s current expectations only, and changes in our business needs could cause changes in plans for capital expenditures and expectations for related depreciation expense.
Critical Accounting Policies and Recent Accounting Developments
As of January 26, 2014, there were no changes in the nature of our significant accounting policies or the application of those policies from those reported in our annual report on Form 10-K for the year ended April 28, 2013.
Refer to Note 2 located in the notes to the consolidated financial statements for recently adopted and issued accounting pronouncements since the filing of our Form 10-K for the year ended April 28, 2013.
Contractual Obligations
As of January 26, 2014, there were no significant or new contractual obligations from those reported in our annual report on Form 10-K for the year ended April 28, 2013, with the exception of open purchase commitments to acquire equipment with regard to the mattress fabrics segment totaling $3.8 million at January 26, 2014, compared with $170,000 at April 28, 2013.
Inflation
Any significant increase in our raw material costs, utility/energy costs and general economic inflation could have a material adverse impact on the company, because competitive conditions have limited our ability to pass significant operating increases on to customers. As discussed in our Form 10-K for the year ended April 28, 2013 (see “Segment Analysis”), significant increases in raw material costs led to lower profit margins for both of our business segments during fiscal 2012 and 2011.
We are exposed to market risk from changes in interest rates on our revolving credit lines. Our U.S. revolving credit agreement bears interest at a rate equal to the one-month LIBOR rate plus a spread based on our ratio of debt to EBITDA as defined in the agreement. Our revolving credit line associated with our China subsidiaries bears interest at a rate determined by the Chinese government. At January 26, 2014, there were no borrowings outstanding under our U.S. or China revolving credit lines. Our unsecured credit agreement associated with our operations located in Poland bears interest at WIBOR plus 2%. At January 26, 2014, $573,000 was outstanding under this agreement, and this amount is required to be paid in full by August 31, 2015, when this agreement expires.
Except as noted above, we are not exposed to market risk from changes in interest rates on our long-term debt. Our unsecured term notes have a fixed interest rate of 8.01%.
We are exposed to market risk from changes in the value of foreign currencies for our subsidiaries domiciled in China, Canada, and Poland. We try to maintain a natural hedge by keeping a balance of our assets and liabilities denominated in the local currency of our subsidiaries domiciled in Canada and Poland, although there is no assurance that we will be able to continually maintain this natural hedge. Our foreign subsidiaries use the United States dollar as their functional currency. A substantial portion of the company’s imports purchased outside the United States are denominated in U.S. dollars. A 10% change in the above exchange rates at January 26, 2014, would not have had a significant impact on our results of operations or financial position.
We have conducted an evaluation of the effectiveness of our disclosure controls and procedures as of January 26, 2014, the end of the period covered by this report. This evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, we have concluded that these disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports filed by us and submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized, and reported as and when required. Further, we concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports filed by us under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, in a manner to allow timely decisions regarding the required disclosures.
There has been no change in our internal control over financial reporting that occurred during the quarter ended January 26, 2014, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.