Culp Inc (CULP) 2004 Q1 法說會逐字稿

Good day and welcome to the Culp Incorporated 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. Drew Anderson. Please go ahead ma'am.

Good morning and welcome to the Culp conference call to review the company's results for the first quarter of fiscal 2004. We issued a press release to the wire services yesterday announcing these results. In addition, the press release and additional financial information were both filed as an 8-K with the SEC yesterday. Let me also note a press release has been issued advising of the accessibility of this conference call on a listen-only basis over the Internet. As we start, let me express that some statements made in this call will be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, expectations, or beliefs about future events or results or otherwise are not statements of historical fact. Actual performance of the company may differ from that projected in such statements. Investors should refer to statements filed by the company with the Securities and Exchange Commission for a discussion of these factors that could affect Culp's operations and the forward-looking statements made in this call. The information being provided today is of this date only and Culp expressly disclaims any obligation to release publicly any updates or revisions to these forward-looking statements to reflect any changes in expectations.

In addition, the company will be discussing non-GAAP financial measurements during this call such as information about free cash flow. These should not be considered an alternative to or more meaningful than GAAP financial information. A reconciliation of non-GAAP financial measurements are the most directly comparable GAAP financial measurements of cash flow from operating activities is included in the schedule to the company's press release and 8-K filing. This information is also available on the investor relations section of the company's website at www.culpinc.com. I will now turn the call over to Rob Culp, Chief Executive Officer. Please go ahead sir.

Drew, thank you and good morning and thanks 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 is Frank Saxon, Executive Vice President and Chief Financial Officer of Culp. The purpose of this call is to review financial and operating results for our first quarter ended August 3rd, 2003. I will begin the call with comments about the company's operations in the quarter and provide some additional comments on the status of our various initiatives. I will then turn the call over to Frank who will follow with a more detailed account of the financial results and key operating statistics.

As you are aware, the past quarter marked a continuation of extremely challenging period for most companies associated with the furniture industry. With the summer plant vacation shutdowns, this quarter is always the seasonally slowest of our business. The summer slowdown combined with the significant softness in consumer spending for home furnishings created further challenges for furniture retailers. In spite of the conclusion of the war in Iraq, the tax bill package and some sporadic indications that the economy is getting stronger, we saw little evidence throughout the quarter that consumer buying patterns were showing any consistent signs of improvement. However, even with the lower sales we are pleased that our net loss of 4 cents per share for the quarter was less than our projection earlier in the quarter of 6 to 13 cents per share.

Let me comment first on our sales results for the quarter which did include 14 weeks compared with 13 weeks for the prior year. Sales in the upholstery fabrics segment continued to be under pressure by the declining orders from our customers across the board. This is a direct reflection of the lack of consumer spending for furniture, in addition we think some of this decline has to do with an inventory correction by our customers. There is no question a lot of our customers had too much inventory going into the summer and part of our situation is related to an inventory adjustment. In addition, we believe the increasing popularity of leather furniture, suede’s, and the increase in imported fabrics and cut-and-sew kits which are imported are also having some impact on the volume of our upholstery fabrics sales.

On the other hand, we had a good quarter for sales on our mattress ticking segment. The 4.6 percent increase of sales marks the best quarter in this segment in over a year. Sales trends for the bedding industry tend to run counter cyclical to the upholstery business and the summer months, including August, are typically the strongest for mattress sales. Additionally, unlike the upholstery segment, the mattress ticking business does not appear to be as threatened by imports. However, as I mentioned last quarter, what is most encouraging for us is the fact that the bedding industry typically is one of the first categories in home furnishing industry to recover from a down cycle. So, with the indications we're seeing in mattress ticking sales we are cautiously optimistic that overall demand for furniture will pick up further.

Additionally, since the bedding industry is well into the transition to one-sided mattresses, which use about one-third less ticking, we are encouraged by our ability to maintain sales levels in this environment. Since we announced to you a year ago, our management team has been focused on restructuring initiatives related to our Culp Decorative Fabrics or CDF division that we discussed with you on previous calls. We have continued to make progress at CDF with respect to improved manufacturing efficiencies. However, we believe there is room for further improvement in CDF and we expect to achieve these benefits over the next few quarters. As an indication of our progress our number of employees was just under 2400 at quarter end, down 18 percent from 2900 a year ago. To further drive improvement profitability with our upholstery fabrics segment, we are focused on creating the selling products with better margins, continue to reduce low profit SKUs and identify additional ways of enhancing our manufacturing performance.

I would also like to give you an update on our China strategic market initiative which we announced at the end of March. Mike Messer, our general manager for the China operations relocated to Shanghai in May and is in the process of assembling our management and production team there. We now have all we require business licenses approvals. Mike and his staff are now occupying office space in our 65,000 square foot manufacturing distribution facility, and we are getting all of the administrative functions in order. Our initial focus is just getting the China facility up and running. At this time, we expect to begin inspecting, testing and distributing fabric in China during the second fiscal quarter, and will have limited finishing operations under way by January 2004. While this will be a relatively small platform, we believe this initiative affords us an opportunity to add value to our product offerings.

Our strategy links together Culp's design expertise, finishing technology, and U.S. quality standards with low-cost fabric manufacturers in China. With these initiatives I have just highlighted, our strong financial position and improved cost structure, we believe we are well-positioned in the marketplace. Ultimately we believe all of our efforts over the past year has set the stage for achieving improved results and we remain optimistic that even with a modest recovery in consumer demand for home furnishings, we will realize greater benefits from our initiatives over the past year. Now I will turn the call over to Frank who will provide some further detail on our third-quarter results and I will wrap up with some comments about our outlook and then take your questions. Frank.

Thank you all. Good morning everyone and thanks for joining us. We are pleased to report results for the first quarter which were better than we had projected earlier in the quarter. First I would like to start with some balance sheet comments.

We continued to build our cash position during the quarter as a result of free cash flow generated a 5.7 million. Our cash, cash equivalents and short-term investments totaled 30.1 million at quarter end, up from 24.4 million at year end. Our long-term debt was 76.6 million, the same as fiscal year end. It consists of a $75 million unsecured term loan which with no principal payment due until March 2006, almost three years away. Because there are substantial prepayment penalties and fees associated with this loan, the company does not intend to make any early payments on principal.

We have continued to manage our working capital efficiently. With day sales and accounts receivable of 32 at quarter end and inventory turns at 5. Both improved from a year ago. We expect our cash position to build further throughout this fiscal year. However, we are expecting a lower level of free cash flow than the 25 million we have averaged annually over the last three years. The reason for this is that we do not believe we will generate as much cash from working capital this year as we have over the last three years. Our balance sheet during these uncertain economic times is providing the company with significant liquidity and financial flexibility and a definite competitive advantage. Now I will turn to the income statement.

Overall, sales decreased 14.3 percent for the first quarter which is somewhat less than we expected earlier in the quarter. Our gross profit margin was 15.7 percent compared with 16.1 in the first quarter of last year. Therefore, with the lower sales and lower gross profit margin, we reported a net loss of 4 cents per share down from net income of 8 cents per share in last year's first quarter, which excludes the cumulative effect of an accounting change. As far as the results of our two operating segments were concerned, the upholstery fabrics segments reported sales of 46.5 million for the quarter, a decline of 22.5 percent. Fabric yards sold through the quarter were 10.8 million versus 14.4 million in the same quarter of last year, a decline of 25 percent. The average selling price increased to $4.13 for the quarter, up 3 percent from $4.02 in last year's first quarter. And is due primarily to the CDF division's higher price points.

The gross profit in this segment for the first quarter was 5.5 million or 11.8 percent of sales, versus 8 million or 13.3 for the same quarter of last year. While gross profit in the CDF division was somewhat lower than the previous year, the majority of the gross profit decline was due to the Culp Velvets/Print division which experienced a substantial decrease in the sale of velvet fabrics.

With respect to our second segment, mattress ticking reported 27.2 million in sales for the quarter, a 4.6 percent sales increase better than we expected. Ticking yards sold during the quarter were 10.5 million, down less than 2 percent from 10.7 million in the corresponding quarter of last year. The average selling price for $2.57 for the quarter up 5 percent from $2.44 for the prior year's quarter. This increase reflects a higher mix of woven ticking versus printed ticking, and a growing but still small portion of the business that is knitted ticking which usually carries higher selling prices.

Gross profit in this segment for the first quarter was 6.1 million or 22.3 percent of sales, compared with 5.9 million or 22.5 for the same quarter of last year. In summary, we ended up the quarter in much better shape than it appeared early in the quarter. We are optimistic that the gradually improving business climate that we are seeing will in fact have some sustainability to it. For the second quarter, we are starting off with somewhat improved order rates and better production schedules in most of our facilities than we experienced in the first quarter. As you look at Culp, I think it is important to recognize we have overcome a much stronger and disciplined competitor in many ways during these challenging times. We believe we have now created significant operating leverage in our business model and are positioned to take advantage of this as sales levels improve. I will now turn it back over to Rob.

Thank you. There is no question that the uncertainty in our economy and its impact on consumer spending has continued to challenge Culp and most companies in our industry. However, we believe we have taken and continue to take the action necessary to right-size of the company and strategically position Culp for a bright future. Furthermore, we believe that the design creativity and quality we put in our fabrics and our commitment to superior customer service will continue to differentiate Culp in the marketplace.

Looking to the second quarter, we recognize there are market dynamics that we cannot control. However, we remain optimistic that our overall sales will increase in the fall as is typical in the furniture industry. Overall, we expect the decrease in consolidated sales for the second quarter to be significantly less than the first quarter deline of 14.3 percent. With the improving order rates for mattress ticking, we expect sales in this segment to be about the same as sales in the second quarter of 2003.

For the upholstery fabric segment, we expect a year-over-year decline in sales to be substantially less than the 22.5 percent decline in the first quarter. With the softness in the furniture industry and a lack of visibility in the quarter to date, it remains difficult to predict the company's profitability level for the next quarter. However, at this time we expect to report net income in the range of 12 cents to 19 cents per share diluted, depending upon the level of demand we have throughout the quarter. Regardless of the course of the economy and its impact on our business going forward, we remain determined in our effort to improve the return on invested capital and generate free cash flow while maintaining a strong balance sheet. We believe in our strategy over the past few years have been successful in helping us enhance our market position and we look forward to the opportunities before us in fiscal 2004 and beyond.

I will now turn it over to you and be glad to take any questions that you might have.

The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) Laura Champine with Morgan Keegan and Company.

Good morning, Rob and Frank. I appreciate the information on units and average selling prices; that is very useful. I noticed that there was a slight decline in units for your mattress ticking segment but I would assume that the industry was down more than that because of the shift to one-sided. Can you hazard a guess as to what the industry yardage would have declined in the quarter?

Well, Laura, the one-sided mattress takes about one-third less fabric than the old conventional two-sided. We estimate that the industry is probably half way through the transition from two-sided to one-sided. We think by the end of the year, the transition will be pretty much complete. Two-sided mattresses are not going away, but a greater proportion of them are now one-sided. We feel like we are picking up significant market share in the ticking industry in spite of the shift to the one-sided mattress. So, the mattress business was down half single digits what the industry numbers report until the summer and then in the early summer, the mattress business started picking up. And I think most of our customers are having outstanding July and August in the mattress business. So to answer your question, it's certainly less yardage but we feel like we are picking up significant market share in that area. We have several large programs yet to kick in that we have, that are going to kick in next year.

Thanks. My second and last question is on earnings power. What could Culp earn if demand were to improve, let's say you had a full year up single-digit percentage in both segments of your business? I know you put up 77 cents last year, is that as good as it gets?

I will take that one. I think in the future, if business were to return to levels we have seen in the past, as you said a lot of earnings power and could certainly be north of 1 dollar.

Okay. Thank you.

Joel Havard at BB&T Capital Markets.

Good morning, this is actually Matt McCall (ph). Joel is out of the office today. Two quick questions. First one, you mentioned that the expectations for your ticking growth year-over-year next quarter were based on improving quarter rates. Your new guidance for the upholstery segments, are they -- is that guidance based on any change in your outlook?

If I understand your question, we certainly, this is Rob, we were certainly seeing a pickup in the upholstery business as well as we move into the fall season. Our incoming orders and plant schedules are much improved in August versus where they were first quarter. We are hearing from our many customers that August has been a much improved month over the previous months, and they expect that to maintain and maybe even increase a little bit for the fall. So August has been a much better month for the furniture industry.

Great. Moving on to gross margin, specifically for the ticking segment, it looks like ticking gross margins were down despite higher sales and higher average selling price year-over-year. Can you discuss what was behind that change a little bit?

I might take a first step at it then Frank can help. I think our gross profit, at least what we are showing, was about flat this quarter versus -- in mattress ticking -- versus last quarter. But, what is putting some pressure on the ticking business and in a way it's a good thing, is that a significant amount of our production is now sourced offshore with no capital involved. So, some of these products that we are bringing in from offshore, because of the lack of any invested capital we are able to hit some price points on some of the lower end items that we have not been able to do before. So, while the margins may be flat in ticking, we think we have a chance to grow sales which will generate additional gross profit dollars.

Thank you very much.

(OPERATOR INSTRUCTIONS) Tom Lewis at C. L. King & Associates.

Good morning, guys. All things considered, not a bad quarter. Can we talk a little bit about this increase in your SG&A expense? You cite increased professional fees. Is that, can we understand that as an increase back to a more normal level relative to where a year ago or are there some unusual things in there?

I think I would say two words, Sarbanes-Oxley. Like a lot of people, the implementation of these various requirements are causing additional legal fees and additional auditing fees. There is just no way around it. So, that is up some over our normal levels over the past couple of years.

Is there much to speak of with respect to things you might be expensing as opposed to capitalizing in your China initiative?

No, I would say not, very little impact in the first quarter from the China initiative.

All right. Thanks.

Michael Christodalu (ph) with Inwood Capital.

I got on the call a little bit late, but I thought I heard you mention a trend towards single-sided mattresses. I was wondering if you could quantify this trend as a percentage of units manufactured and possibly quantify the volume of ticking used in those products as opposed to the traditional mattress?

Yes. Michael, there has been a trend; it was started by Simmons two years ago to go to a one-sided mattress. Just this last year, Sealy has gone to all one-sided, and Serta and Spring Air have a blended of some two-sided, some one-sided. We estimate somewhere maybe 40 to 50 percent and growing of the mattresses could be one-sided, and the one-sided mattress takes a third less cover than a two-sided mattress. Now, we pick up a little bit on it because of the border clause, they are doing some tops that come off. In other words, you can flip the top of the mattress and still be one-sided, but basically you are looking at a one-third less cover used. Now offsetting that as we said, we think we picked up some significant market share in ticking. We are continuing to grow with the major bedding manufacturers, and we have also benefited a little bit with the strength of the euro. There is not, we feel like there is a lot less European goods coming into this country now because of the strength of the euro.

Just to clarify that was used as a less cover, but it's also less ticking?

It uses less ticking; that is correct. One-third less ticking.

Thank you.

Todd Cohen at MTC Advisers.

You earlier made reference to your long-term debt, your term loan. I just kind of missed that. You indicated there was no, you were not going to make any prepayments at least until 2006. Could you just again reiterate what you said? The dollar amount.

Long-term debt is 76.6 million at quarter end which is about the same as year end. Of that, 75 million represents an unsecured term loan that has no principal payments due until March 2006. On these types of loans there are substantial prepayment penalties and fees. Therefore, the company does not intend to prepay any of this loan with available cash.

What is the interest rate on that debt?

7.7 percent.

Also, you indicated in the last few years you've generated free cash flows, about 25 million a year. Some of that having to do with working capital. Where do you see that going forward? Did you make reference to that?

We did not. We do not give a specific forecast other than to tell you it is going to be not nearly that level this year. So somewhat lower than the 23 million that it was last year.

Somewhat lower than that, but not by a wide margin though?

Not too bad.

What is your CAPEX budget?

CAPEX is 8 million this year. That number is subtracted in our free cash flow as well.

So you have already backed that out.

We have already backed that out. Free cash flow what is available to retire debt, repurchase stock, build cash whatever.

What do you plan on doing with the cash? If you don't have to make any payments until 2006? Also, at what level can you pay that debt down in 2006?

In 2006, the first payment on that loan is only $11 million. So, it is not like a lot. Right now, we just enjoyed having the cash in the balance sheet during these tough times. But it obviously gives us lots of financial flexibility for the company to consider repurchase of stock, to consider dividends, to consider other things. And at this point, none of those are on the near-term horizon, but we certainly have the financial flexibility to entertain those.

One last question. You indicated that in July and August you were just hearing from customers that things were beginning to improve. Any one particular part of the business? Or just kind of a broad base?

Certainly it is broad based. The bedding business, I talk to our major bedding customers on a weekly basis it has been very strong in July and August. I think when you see the folks that report their numbers from the bedding manufacturers you'll see quarters that are certainly up, sales increases. I am hearing from the major furniture manufacturers that their sales are anywhere up 5 to 7 percent in August, which is really high numbers considering where they have been in the past. So we are hearing August is a pretty good month incoming order wise for most of our customers.

Thank you very much.

(OPERATOR INSTRUCTIONS) David Fondrie with Heartland Funds.

Good morning. Nice quarter. A couple of questions. In the China initiative, you said that there is a nominal expense impact to date?

Yes.

Even though you have leased the building and put people in there, it is really not very significant?

We did not have to start our lease expense until our building construction had been completed. Which we ended in late July. So we really have not started our rent until the month of September. We got some delays in there. And we only have one general manager, and we have three employees at this point.

You indicated that you would start up some limited inspection and stuff in the second quarter. How many employees would you expect to have over there as you exit the second quarter? And what, I don't know if that is a revenue-generating situation or if it is really a cost reduction situation for you. Can you describe that?

I think what we are trying to do in China is go in gradually. And I think by the end of the second quarter, we may have -- I will venture a guess, it may be 10 employees, we are going in gradually. We are going to start with our office and inspection first, and then we will move into our limited finishing operations which is the manufacturing component in our third quarter. But we do intend to generate revenue out of there. The facility when we initially announced this initiative, we told folks that capacity of this facility is $25 million in annual sales. About 150,000 yards per week. So that gives you some sense of what we could do in that facility, but our approach is very gradual. While everything is possible in China, nothing is easy. Things tend to take longer than one expects.

Do you already have some customers lined up? Have customers responded favorably? And do you have some customers lined up so that when you do get into the production aspect of it, that it is kind of already locked in, so to speak?

I'm glad you asked the question because I was going to comment on that anyway. If anything we are having to slow our customers down. We are a little bit overwhelmed with the number of people that want to do business with Culp in China. And we have to be very careful not to over-promise what we are able to do. So, we have already received a couple placements from major retailers on our China platform. We are doing a lot of fabric for case goods, and as I said if anything we are having to slow people down so that we can make sure that we deliver out of China just as we deliver out of the U.S. We just don't if anything, we got a little bit too much demand right now.

Okay. Can you talk us if there is any impact on your mattress ticking business of the fire retardant initiatives that are going on in California? I think they have been delayed a year, but what are your customers telling you, and does that have any impact at all on you?

Yes, you are right it has been delayed a year. I think it is now 2004, and from what we understand and we have been very involved in it from day one, that most of the customers will use some type of non-woven barrier cloth between the mattress and the fabric. We are now in discussions with several people that Culp might be able to distribute that product, one of those products for the mattress business. So, if fire retardant -- if and when, it's not if, it's when it takes place -- we should be in good position to take advantage of that.

So you would become -- you would not actually produce that material -- would you incorporate that into what you are providing, or just become a distributor of it?

We initially, because of the nature of the fabric, would be a distributor of that fabric. At some point, we could produce it, but we don't see that. We see our -- we have a wonderful entree with these big customers. They trust us and do a lot of business with us and for us to provide the barrier cloth as part of the package. It just makes sense.

I'm sorry to try to focus on this, but would it actually be incorporated, would you send them for example the material incorporating your mattress ticking?

No, it is two separate, it would be two separate cloths.

But it would be cut to size or whatever? So they would assemble that?

They would upholster it on a bed just as they upholster our mattress ticking fabric now. It would be a barrier cloth between the inside of the mattress and the cloth on the outside.

Got you. Why would they come to you rather than going directly to the manufacturers?

Because most of the manufacturers that would do this cloth do not have entree into that business. Since we have such a strong foothold in it, they would rather work through us because we have the relationships and the distribution and the various warehouses to give them the service they need.

Got you. That makes sense. Lastly, can you talk a little bit about what you, I guess visibility is as to the inventory that is residing at your customers today? You talked in the conference call about there being a little bit of excess inventory I think entering this quarter. Do you sense those inventories have been substantially reduced and in fact maybe have been overcorrected?

Yes. We certainly feel like as a whole the furniture industry has really been through a tough few months. The good companies have done a wonderful job of reducing their inventory. What really hurt us is if we were running on a run rate of 100,000 yards with a customer a week and then he slowed down, then not only did his business slow down, but he had to correct his inventory. So, while our sales and upholstery were down 22 percent this last quarter, none of our customer sales were down that much. So, we feel there has been a huge correction and we feel like most of this excess inventory is out of the system. If anything, there is a little concern that it could come back and all of a sudden we could be overwhelmed with -- this is a cyclical business, when it gets going again, they want it quick. We sense there is not much inventory in the system.

That is what I was trying to get at.

We sense there's not much inventory in the system.

Great. Thank you very much.

There are no further questions. I will turn the conference back over to you for any additional or closing remarks.

Thank you very much. And we thank you for your participation and your interest in Culp and look forward to reporting a great quarter next quarter. Thank you very much. Have a great day.

That does conclude today's conference; again thank you for your participation.