Culp Inc (CULP) 2021 Q2 法說會逐字稿

Good day, and welcome to the Culp's Second Quarter 2021 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Ms. Dru Anderson. Please go ahead, ma'am.

Thank you. Good morning, and welcome to the Culp conference call to review the company's results for the second quarter of fiscal 2021. As we start, let me state that this morning's call will contain forward-looking statements about the business, financial condition and prospects of the company. Forward-looking statements are statements that include projections, expectations or beliefs about future events or results or otherwise are not statements of historical fact. The actual performance of the company could differ materially from that indicated by the forward-looking statements because of various risks and uncertainties. These risks and uncertainties are described in our regular SEC filings, including the company's most recent filings on Form 10-K and Form 10-Q. You are cautioned not to place undue reliance on forward-looking statements made today, and each such statement speaks only as of today. We undertake no obligation to update or revise forward-looking statements.

In addition, during this call, the company will be discussing non-GAAP financial measurements. A reconciliation of these non-GAAP financial measurements to the most directly comparable GAAP financial measurements is included in either the tables to the press release included as an exhibit to the company's 8-K filed yesterday and posted on the company's website at culp.com or in the slide presentation with supporting summary financial information that is also available on the company's website as part of the webcast of today's call.

With that, I will now turn the call over to Iv Culp, President and Chief Executive Officer of Culp. Please go ahead, sir.

Thank you, Dru. Good morning, and thanks to everyone for joining us today. I would like to welcome you to the Culp quarterly conference call with analysts and investors. With me on the call today are Ken Bowling, Chief Financial Officer; and Boyd Chumbley, President of our Upholstery Fabrics business. I will begin the call with some opening comments, and Ken will then review the financial results for the quarter. I will then update you on the strategic actions in each of our operating segments. After that, Ken will review our third and fourth quarter fiscal 2021 business outlook. We will then be happy to take some questions.

We are pleased with our strong performance in the second quarter of fiscal 2021, which reflects the tireless efforts of our associates around the world and the strength and resilience of our global platform. As we continue to navigate our way through these uncertain times, our top priority remains the health and safety of our employees, customers, suppliers and the communities we serve. We are incredibly proud of our team's continued drive to deliver innovative products and satisfy the evolving needs of our customers while also integrating enhanced safety practices and new ways of working virtually throughout our business. Overall, we are very pleased with the top line performance for both our mattress fabrics and upholstery fabrics segment. This faster-than-expected recovery indicates an increased consumer focus on the home environment as well as our ability to service this increase in demand through our strong global platform and stable supply chain.

We are also benefiting from market share gains as our innovative products are resonating well with both new and existing customers. Additionally, we delivered significant sequential improvement in operating income as compared to the first quarter, consistent with our expectations. We further strengthened our balance sheet with increased liquidity as total cash and investments reached $56.5 million. Based on the strong financial performance and excellent cash flow for the first half of the year, we are pleased to announce that our Board of Directors approved a 5% increase in our quarterly dividend, marking the eighth consecutive year of increase. This is consistent with our capital allocation strategy and our commitment to generate value for our shareholders. We also expect to continue investing in working capital and planned capital expenditures during the second half of the year. Additionally, we have decided to maintain the suspension of our share repurchase plan at this time. These strategic decisions are based on our disciplined approach to capital allocation, as prescribed in our capital allocation strategy, which is posted on our website. The ongoing uncertainty relating to the COVID-19 pandemic, including the recent surge in cases and governmental considerations for new shutdown measures is certainly a factor we're taking into consideration with respect to capital utilization.

While we are also working to remain strategically positioned during the current environment, our current approach to capital allocation is conservative in terms of managing short-term COVID-19 uncertainty, but we also believe it is appropriately aggressive and allows us to be opportunistic on growth opportunities that may present themselves both organically and otherwise. As always, this is a strategy we evaluate continually based on current facts and circumstances.

Looking ahead, our customers' ability to meet their demand is being challenged by supply chain constraints related primarily to non-fabric components as well as some labor shortages, which could temporarily delay their scheduled delivery of fabric orders from both our divisions.

Additionally, the ongoing impact and duration of the COVID-19 pandemic remains unknown. We are prepared for a range of macroeconomic scenarios, and we are confident in our ability to weather these near-term headwinds.

Barring additional shutdowns, we are optimistic, based on our current industry demand trends and market share opportunities, that we will deliver strong results for the second half of fiscal 2021. We believe that Culp has become a stronger company, both financially and competitively than we were pre-COVID-19, and we are well positioned for continued growth. I'll now turn the call over to Ken, who will review the financial results for the quarter.

Thanks, Iv. As mentioned earlier on the call, we have posted slide presentations to our Investor Relations website that cover key performance measures. We have also posted our capital allocation strategy. I also want to note that as a result of the sale of eLuxury during the fourth quarter of last year, the financial results for the home accessories segment are excluded from the reported financial performance of our continuing operations and presented as a discontinued operation in our consolidated financial statements.

Here are the financial highlights for the second quarter: Net sales was $76.9 million, up 10.5% compared with the prior year period. Both divisions had a strong sales performance for the quarter. Iv will go into more detail on divisional operational performance in a moment. On a pretax basis, the company reported income from continuing operations of $3.9 million, which included $680,000 of other expense related mostly to foreign exchange rate fluctuations associated with our operations in China. This compared with pretax income from continuing operations of $4.5 million for the second quarter of last year which included only $99,000 in other expense.

The current quarter was affected by the unfavorable foreign exchange rate fluctuations I just mentioned as well as higher SG&A expense due primarily to higher accrued incentive compensation expense, offset somewhat by lower T&E and marketing expenses. On a percent of sales basis, total SG&A came in at 12.7% compared to 13.1% for the same period a year ago.

Net income from continuing operations was $2.4 million or $0.19 per diluted share for the second quarter compared with net income from continuing operations of $2.2 million or $0.18 per diluted share for the prior year period. The effective income tax rate for the second quarter of this fiscal year was 41.4% compared with 50.1% for the same period a year ago.

The effective income tax rate is affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and foreign subsidiaries located in China and Canada, which have higher income tax rate as compared to the U.S. federal rate.

Looking ahead to the rest of this fiscal year, we estimate that our consolidated effective income tax rate for the third and fourth quarters of this fiscal year will be in the range of 40% to 50%, based on the facts we know today. Trailing 12 months adjusted EBITDA as of the end of the second quarter of this fiscal year was $11.5 million or 4.5% of sales.

Now let's take a look at our 2 business segments. For the mattress fabrics segment, sales were $40 million, up 12.2% compared with last year's second quarter. Operating income for the quarter was $4.4 million compared with $3.3 million a year ago, with an operating income margin of 10.9% compared with 9.2% a year ago. Our improved operating performance for the second quarter primarily reflects the benefit from fixed cost absorption from higher sales and improved operating efficiencies resulting from fully maximizing our production capacity.

For the upholstery fabric segment, sales for the second quarter were $36.8 million, up 8.7% over the prior year. Operating income for the quarter was $3.3 million compared with $3.5 million a year ago, with an operating income margin of 8.9% compared with 10.2% a year ago. Operating performance was materially affected by unfavorable China foreign exchange rate fluctuations as well as some impact from sales mix, offset somewhat by lower spending on T&E and marketing expenses.

Here are the balance sheet highlights. We reported $56.5 million in total cash and investments and no outstanding borrowings as of the end of the quarter, up from our $38.7 million net cash position as of the end of last fiscal year. For the first 6 months of this fiscal year, we incurred $2 million in capital expenditures and spent $2.6 million on regular quarterly dividends.

Cash flow from operations and free cash flow were $22.7 million and $20.5 million, respectively, for the first 6 months of the year, compared with cash flow from operations and free cash flow of $8.2 million and $5.6 million, respectively, for the prior year period. This year-over-year improvement reflects a focused attention on working capital management during the first half of the year.

While we're extremely pleased with our strong cash position and fortified balance sheet going into the second half of the year, it is important to note that our cash position will be affected by our strategic investments in working capital and planned capital expenditures during this period. The company did not repurchase any shares in the second quarter, leaving the full $5 million available under the share repurchase program approved by the Board in March 2020. As previously disclosed, the company temporarily suspended the share repurchase program during the fourth quarter of last fiscal year, given the economic uncertainty related to COVID-19. With that, I'll turn the call back over to Iv.

Thanks, Ken. Let me start with the mattress fabrics business. We were especially encouraged by the strong growth in sales and operating income for the mattress fabric segment during the second quarter.

We built on the momentum generated during the last 8 weeks of the first quarter by utilizing our product-driven strategy for both mattress fabrics and sown covers, as well as our global supply chain and dedicated attention to our customers. The strength and flexibility of our global manufacturing and sourcing operations in the United States, Canada, Haiti, Asia and Turkey, enabled us to support current demand and serve the need for mattress fabric and cover customers.

We are also pleased with the continued growth of our sewn mattress cover business, with demand trends for mattress covers now exceeding pre-COVID levels. This trend is driven by the ongoing growth in the box bedding space, and we continue to work collaboratively with new and existing customers to develop fresh and innovative products. Our sewn cover production capabilities in the U.S., Haiti and Asia, along with our vertical ability to provide innovative product offerings from fabric to sewn cover, provide us with a strategic integrated advantage in supporting the rapidly changing demands of our customers. Additionally, our building expansion in Haiti was completed during the second quarter, providing additional capacity and enhancing our ability to produce sewn covers.

We are also excited about ongoing developments in product innovation, including expanding our specialty finish sessions to include features for sustainability, antimicrobial protection and other wellness-related properties. We also remain pleased with the continued opportunities for innovation through our reimagined Culp Home Fashions, our 3D rendering services, which have allowed us to continue showcasing our products and support our customers through virtual design collaboration in the face of travel limitation. Our virtual design emphasis began before the pandemic, and since that time, these capabilities have strengthened our position with customers.

We expect that our increased fabric capacity in North America resulting from our investment in additional equipment will be available during the fourth quarter of fiscal 2021. We also believe that the domestic mattress industry, and in turn, our business, will benefit from the recent preliminary anti-dumping duties imposed by the U.S. Department of Commerce on mattress imports from 7 countries. Additionally, despite these ongoing uncertainty relating to the pandemic, we have continued to focus on our commitment to environmental sustainability. We have now achieved landfill-free status in both of our U.S. manufacturing facilities, which reflects our ongoing effort to promote sustainable production across our operations.

Barring additional shutdowns or significant disruption in our customer supply chain for raw materials other than fabric, we believe we are well positioned in mattress fabrics to execute our strategy and increase market share during the second half of fiscal 2021.

Now let me turn some attention to the upholstery fabric segment. We were also very pleased with the solid growth in our upholstery fabrics business for the second quarter. Our residential upholstery business saw a significant increase in sales compared to the prior year period, driven primarily by the increased consumer focus on the at-home experience and overall comfort. Through our strong platform in Asia, including our expanded cut and sell capabilities in Vietnam and our stable, long-term supplier relationships, we were able to respond quickly to the upsurge in demand from our customers and increase our market share. We have also generated historically strong backlog in our residential upholstery business, reflecting the ongoing favorable demand trends for this segment.

Our line of highly durable, stain-resistant LiveSmart performance fabrics as well as our line of LiveSmart Evolve performance plus sustainability fabrics continue to experience favorable demand trends. We also recently launched LiveSmart Ultra, the next step in our LiveSmart performance brand evolution. This new product line features an antimicrobial finish and silver ion technology to protect the fabric from mold, mildew and odor-causing bacteria, and has been well received in our recent showings. We are focused on promoting these product lines and building our strong brand of performance products under our LiveSmart umbrella. These LiveSmart performance fabrics are important drivers of our residential growth.

Our hospitality business remained under pressure by the ongoing COVID-19 disruption that continue to affect the travel and leisure industries. These lingering pressures also affected Read Window Products, our window treatment and installation business during the quarter. While sales for our hospitality business remained relatively stable as compared to the first quarter, we expect that a disruption in hospitality and leisure will continue to affect this business in the near term. Additionally, while we saw solid sequential improvement in our operating income as compared to the first quarter of fiscal 2021, our second quarter results compared to the prior year period were materially affected by unfavorable China exchange rate fluctuations as well as some impact from sales mix. We expect these factors will continue to affect our operating income during the third quarter. Despite these pressures, we are encouraged by our solid operating margin in the second quarter. We are encouraged by the historically strong backlog in our residential upholstery business and are confident in our ability to meet this demand. We expect the strong performance in our residential upholstery business to continue, absent any additional pandemic-related shutdowns or material disruption to our customer supply chain.

Ken will now discuss the general outlook for the third and fourth quarter for this fiscal year, and then we're going to take some questions.

At this time, due to the continued economic impact of the COVID-19 pandemic and the lack of visibility as to its duration or ultimate impact, we are providing only limited financial guidance for fiscal 2021.

Although subject to unforeseen changes that may arise in connection with the pandemic, we are encouraged by the ongoing execution of our product-driven strategy and continued strength in demand for home furnishing products as well as our opportunities for market share growth. Considering these factors, we expect sales and operating income for the third quarter of this fiscal year to be comparable to the prior year period, with the mattress fabrics segment continuing its strong year-over-year rebound, and the upholstery fabric segment facing ongoing headwinds relating to foreign exchange rate fluctuations associated with its operations located in China, customer and supply chain constraints and sales mix. We also expect sales and operating income for the fourth quarter of this fiscal year to be dramatically improved for both segments as compared to the fourth quarter of last fiscal year.

Based on current expectations, including the $4 million investment in additional net machines for our mattress fabrics segment that we mentioned last quarter, capital expenditures for this fiscal year are now expected to be in the $8.5 million to $9 million range. Depreciation and amortization is expected to be approximately $7.5 million for this fiscal year. With that, we will now take your questions.

(Operator Instructions) Our first question is Bobby Griffin with Raymond James.

So I guess, first, I wanted to talk about just the forward commentary here. So good momentum here in mattresses. You referenced, I think, in the prepared remarks, very good backlog and a pull-through record level backlog. So maybe just help me connect the dots between that type of momentum and then maybe -- and then the sales commentary are being roughly comparable year-over-year. Is there a timing issue? Or is the currency hurting the top line? Or is there anything else there that might be driving that or just general conservative -- just some conservatism in the guidance?

Yes. Thank you, Bobby. Good question, and thanks for asking. And I'll give you a commentary. I'll break it down by division, if that's okay. And then Ken, you certainly can chime in, too.

On the mattress fabric side, you just have to remember, there is some seasonality in our Q3 being generally a normally weaker quarter with our holiday shutdowns really across all locations. We have that in the U.S., Canada and also in Haiti. And what I would guess I'd point you to for Q3 is on the mattress fabrics side, it's significantly improved year-over-year, which we're very happy with.

On the upholstery side, the residential backlog, you're right, does remain historically high. There are some headwinds for that business like currency, and really more so maybe for the sale side, our customer supply chains. And so I would say for that business, if the raw materials and capacity for our customers improve, and there's certainly some upside for that business, not only for both businesses. A little bit of capacity of raw material freeing up for both sides of the business to get a little better on our customer side, we could ship them more fabric as we have prepared. So that is an upside to the Q3 that could be there. Ken, feel free to add to that if you'd like.

No. I think you've covered it all, I think the key there is the year-over-year improvement that we're looking at and the seasonality part of it. And of course, on the upholstery side, the headwinds that we're continuing to have to face. Those are factors.

And it's generally a story, Bobby, of -- for third quarter, mattress fabrics is continuing to rebound very well. In upholstery, we're just being a bit cautious on some of the headwinds we see.

Okay. Okay. That's helpful. And then we you look at the business and how you guys have ramped back up production stuff, I mean, where is efficiency versus historical levels within mattresses? Is throughput getting back close to normal. From your side, taking the other industry supply chains out, but it seems like the supply chain is more nonfabric-related issues than on your products.

Yes. If you think back on the mattress side, really, over the last couple of years, we did some significant capital expenditure work to really build a world class platform, both in the U.S. and in Canada, that gets complemented by our really strategic global options: Haiti, Asia and Turkey. So we're really pleased with that platform. And the more volume we run through it, the better that will perform. We have built a platform that will drive efficiently with volume. And so we're -- to see the sales start to rebound and our expectation is that we'll keep going, that does help us quite a bit with our efficiency in the mattress fabric side.

Okay. And has anything been done -- have you guys passed through any price yet related to the currency changes happening in China? Or is that still -- maybe going forward, you'd have to make some adjustments?

Yes. I'll let Boyd speak to that, and I'll just tee it up a little bit. Over time, we have shown as these currency impacts, in this case, primarily related to the China foreign exchange rates, for sure, we do our best to adjust our cost and things within China to offset some of that. But if there are continued pressures, then we do have to adjust our prices, and we always have [reason] do that. And Boyd, you may speak to your time line, how you're thinking about that?

Yes. No, that's exactly right, Iv. And always, currency is a consideration in our business. And when we see periods where there's a more significant and more rapid movement, then yes, we always monitor that and take necessary actions when appropriate. So we're evaluating all that right now. And price considerations and adjustments were one of the things that we will be considering.

(Operator Instructions) Our next question is Marco Rodriguez with Stonegate Capital Markets.

I wanted to follow-up on one of the prior questions there in regard to, I guess, the guidance as it relates to mattress fabrics, specifically here first, and your seasonality. Just kind of want to get your guys' thoughts on, if you can, what sort of perhaps demand you saw perhaps pull forward from quarters that come? Or was this maybe kind of the pent-up demand that nobody were shopping during the shutdowns and how that impacted kind of the above expectation revenue growth you saw in Q2. And then if you can kind of layer in, historically, the Q3, Q2 seasonality has been down about 2% to 3%. Kind of all of the names, I was wondering if you can provide a little more color on how you guys are thinking about that and how we should think about that.

Okay. I'm going to -- let me start, and Marco, this is Iv, and I'll let Ken finish it off with a little bit of thought towards how he's thinking about our look forward. But let's think about the mattress fabrics segment. And we do have -- we have significant tailwinds in that business. Some that you're touching on that have already happened and some that we see might be coming. And so for certain, the faster-than-expected recovery for the business at the sales level is, no doubt, impacted by a strong home focus that was generated by COVID-19. So that gives us just a focus on home environment, updating, upgrading your comfort values, whether it be furniture or mattresses. There's certainly focus on health. People want a healthier, more well night's sleep.

But on top of that, there's a lot -- and anti-dumping is a tailwind that could come. And we're optimistic that will common make a difference. But on top of that, there's go forward headwinds for us that we're excited about, through our innovation, some of the things we've done there that are really neat on the product side, both fabric and sewn cover. And we are getting market share. We're winning market share gains effective for calendar year 2021. And we have new capacity in both fabric formation and in Haiti for fabric and sewn sun covers that we think will make a difference.

So there's tailwinds that have lifted -- kind of a rising tide has lifted all boats with the pandemic, but we're really confident in our market share gains and our product-driven strategy to carry us forward past Q3 and 4 and into next year. And Ken, I don't know if you want to give me context to how you're think about guidance for Q3. Marco, you may want some more details around that, but that's -- so why I'm thinking about the general lift of market share and general tailwind trends.

Yes, Marco, this is Ken. I think when you look at -- as we look at the past couple of quarters, we've had that sequential improvement from the lows back in the first quarter to now. And then as we pivot toward the second half of the year, it's more of a year-over-year. And so when we look at, of course, the seasonality for mattress fabrics is an issue, but when you look at the seasonality part of it, that's the reason why that sequential growth just doesn't keep going.

But that said, the year-over-year impact that we're looking at is going to be significant. And so we're very encouraged about that. And then, of course, for both businesses, as we look to the fourth quarter, we're excited to see that continued business level going to the fourth quarter. And, of course, compared to a very rough quarter last year, we see dramatic improvements on both sides. So it's definitely a year-over-year pivot situation, but obviously, too, continued performance as we take what we've got and we continue that performance into the second half of the year.

Got it. Very helpful. And then in terms of your market share gains, if we can talk about mattress fibers here for a minute, can you maybe talk a little bit about what sort of feedback or color you're getting from the customers as to why you are increasing that market share versus competitors? And what sort of are the main driver behind that?

Yes, sure, Marco. Thank you. Good question. There's 2 things. So first, we have, for some time, and we're working on this well before any COVID-19 pandemic issues, a dedicated product-driven strategy. And we've put a lot of emphasis into innovation from fabric to finished cover. So we really believe we have a preferred model of designing innovative fabrics, and then now, being able to take them into the growing bed in the box space to a finished cover. That's an advantage.

And then if you layer that product focus on top of a very robust global supply chain, and especially in mattress covers with our North American platform, capped with Haiti and then backed up really strong with Culp China, just is a winning strategy. So I think it's design and service really are 2 factors driving us into new placements.

And I guess, what we're excited about in the market share is it's really across the board. So it's the new, exciting bed in the box space that everyone is intrigued by. But we're also having some gains with our legacy business, we call it, for new product lines that will roll out in calendar year 2021.

Got it. Very helpful. And then in terms of the gross margin pickup that you saw here in Q2, obviously, the volumes helped quite a bit. The efficiencies that you've also put into the system is also great I'm just wondering if you can maybe comment on the -- those capital investments that you've made, the additional capacity you have, and the potential new volumes that should come through that business in the next, say, 12 -- in the next year, have you bought share to offset the operating margin performance to where maybe you're above that low 20% gross margin that you saw before all the anti-dumping issues or around in '19 and '20?

Yes, Marco, let me -- I'll start, and Iv, you can jump in. I think Iv touched on this a little bit ago. Given the -- all the improvements that we've made over the years, I mean, that's really set us up for being able to take advantage of this increase in sales. I mean, the structural changes that we made, moving certain products to different locations and getting to be able to take maximum -- being able to maximize that move. I mean, that has certainly helped. So I think as we -- obviously, as we look forward, that was definitely a factor in the second quarter. But as we look forward, those are going to be -- contribute to the improvement in the third and fourth quarter and beyond.

Now as far as -- I don't remember the second part of that question as far as where -- the gross margin. But I mean that -- to me, what I've just described is really the -- where we are at today and all the improvements we've made. So Iv, I don't know if you want to add in anything to that or...

Yes. We've had -- we did -- last quarter, we announced a $4 million additional capital expenditure on fabric forming equipment that's for North America. That's in addition to our Haiti expansion that we had done and got completed in the second quarter. So and then we're making a nod in our capital allocation strategy, just making sure we keep our opportunities available for further organic expansion because we just do see some opportunities coming. And I guess, for sure, the more volume we put through our platform, there is margin opportunity to improve. Ken, I definitely want to talk about what that is, and there is opportunity to improve.

Yes, I think, too, one other point related to our -- the $4 million investment that we talked about, I mean, that certainly will give us increased capacity. But that also gives us the flexibility to trade out old equipment for new, more efficient equipment. It gives us the flexibility to ramp production up and down. And so all that is a part of our strategic effort to be more nimble, more -- be ready for anything that customer can provide or give us as far as demand. So all those come into play. And again, all the efficiency limits that we've made, the investment that we're going to make, all those will contribute in the future.

Understood. And if I can squeeze one more question in, just real quick. On the upholstery fabrics side, the supply constraints outside of the fabrics. When speaking to your customers, do you have any sort of sense as far as what their thinking time frame lies or they'll kind of be past those supply constraints and back to a more normalized environment, if you will?

Yes, Marco, and This is Boyd. The -- there's progress being made. I think, throughout the industry, there are adjustments to capacity that are taking place to meet this significantly higher level of demand. And there's a lot of that underway, and I think progress is being made. It's probably going to take another quarter or so to fully see the impacts of new capacity coming on stream. I think part of the difficulties are both the constraints in staffing and hiring and training. But also, there's been some constraints on the component supply side, such as phones. So that's another issue that's kind of held back some of the throughput and that probably is going to carry forward a bit during this current quarter. So I think we're going to see some steady improvement in that regard. We certainly hear that from our customers, that capacity, more capacity is coming on stream. So it's just going to take a little more time. But I think we'll look at another quarter and then probably see certainly in the fourth quarter, much more improvement in that regard.

(Operator Instructions) And there are no further questions at this time.

Thank you, operator. And again, thanks to everyone for your participation and your interest in Culp. We look forward to updating you on our progress next quarter. Have a great day.

And this concludes today's call. Thank you for your participation. You may now disconnect.