Culp Inc (CULP) 2004 Q2 法說會逐字稿

Good day and welcome to the Culp 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 Miss Drew Anderson (ph). Please go ahead.

Good morning and welcome to the Culp conference call to review the Company's results for the second 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 afternoon. Let me also note that 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 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. 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. These should not be considered an alternative to or more meaningful than GAAP financial information. A reconciliation of these non-GAAP financial measurements to the most directly comparable GAAP financial measurements of net income, net income per share and cash flow from operations is included as a 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 very much and good morning and thank you for joining us today. I would like to welcome you to the Culp quarterly conference call with analysts and investors. With me today is Frank Saxon, Executive Vice President and CFO of Culp. The purpose of this call is to review financial operating trends reflected in the second fiscal quarter ended November 2nd, 2003. I will begin the call with some brief comments about the Company's operations in the quarter and provide some additional comments on the status of our other initiatives. I will then turn the call over to Frank, who will follow with more detailed financial information.

We are pleased with the solid second-quarter results we announced yesterday afternoon. Our top-line performance marked the best year-over-year quarterly sales comparison in five quarters. As we announced in October, these results primarily reflect better-than-expected demand, especially for upholstery fabrics. We also had another good quarter for sales at our mattress ticking segment. The 6 percent sales increased topped the 4.6 percent gain in sales in the previous quarter. This reflects better industry demand and continued gains with key customers.

The sales gain in this segment for the fiscal year to date of 5.3 percent is especially noteworthy because it is occurring during the bedding industry's transition to selling predominantly one-sided mattresses, which utilize about one-third less mattress ticking. This transition at retail began in mid to late calendar year 2002, and is expected to continue through early calendar 2005. Additionally, unlike the upholstery fabrics segment, we believe the mattress ticking business is not being threatened by imports because of relatively low selling prices, just-in-time customer delivery requirements, and the Company's globally competitive cost structure.

Let me provide some additional comments on our upholstery fabrics sales for the quarter. Sales in this segment were down 4.3 percent for the quarter, which is a substantial improvement over 22.5 percent decline we saw in the previous quarter, and the 17.2 percent in the fourth quarter of last year. Higher sales in the Culp Velvets/Prints, or CVP, division were a key driver of this improved performance in upholstery fabrics sales from the previous quarter.

While we had a solid quarter overall, I would still characterize the residential furniture market environment as spotty. There is little hard evidence we can point to that shows us consumer buying patterns are showing any consistent signs of improvement. However, we are encouraged by the fact that when we do see any pickup in demand, as evidenced this quarter, we can produce positive results. For the quarter, our gross profit margins were 18.6 percent in upholstery and 23.6 percent in mattress ticking. Related to the upholstery fabrics segment, I would also like to comment on the restructuring actions in our Culp Decorative Fabric division, or CDF, that we discussed with you on previous calls. We're pleased with the progress of CDF with respect to operational improvements, and these were reflected in the profitability gains we sell this quarter. During the second fiscal quarter, we really began to utilize the meaningful improvement terms of higher capacity utilization and gains in manufacturing efficiencies in CDF.

The startup of the Company's China operation is generally proceeding in accordance with previously announced plans, although delays of one to two months were experienced in receiving some manufacturing equipment. Equipment now has been received and installation is expected to be completed within two months. During the third quarter, the Company expects to begin incoming fabric inspection and testing and to start shipping fabric to customers. Limited finishing operations are anticipated to begin the fourth quarter of this fiscal year. As expected, the Company is experiencing modest operating losses in its China operation during the startup phase, which is expected to be completed by the end of this fiscal year, although some level of operating losses from China operation is expected to continue until sometime in fiscal 2005.

Ultimately, we believe our efforts over the past year with respect to these initiatives have set the stage for continued progress. We are pleased with the overall tone of our business and our ability to execute in an (ph) uncertain business environment. And as our latest sales volume profitability have indicated, we believe that Culp is well-positioned to capitalize on even a modest recovery in the home furnishings industry. With that, I will turn the call over to Frank, who will provide some additional further detail on our third-quarter results, and then I will wrap up with some comments and we will be glad to take your questions. Frank.

Thank you, Rob. Good morning everyone and thanks for joining us. We are pleased to report results for the second quarter which were better than we had projected earlier in the quarter. First, I would like to start with some balance sheet comments. We have continued to build our cash position during the quarter as a result of free cash flow generated of 7.2 million for the year-to-date period. Our cash, cash equivalents and short-term investments totaled 31.8 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, and this consists of a $75 million unsecured term loan with no principal payment due until March 2006, almost 2.5 years away. Because there are substantial prepayment (ph) penalties and fees associated with this loan, the Company is not likely to make any early payments of principal.

We have continued to manage our working capital efficiently, with Days Sales and accounts receivable of 34 at quarter end, and inventory turns of 5.1, 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 (ph) we have averaged over the last three years. The reason for this is that we do not believe we will generate as much cash from working capital as we have over this three-year period. A solid balance sheet 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 1.2 percent for the second quarter, which is significantly less than we had expected earlier in the quarter. Our gross profit margin was 20.2, which compared with 17.8 in the second quarter of last year, which excluded restructuring charges. Therefore, with the better-than-expected sales and higher gross profit margin, we reported net income of 27 cents per share, up from net income of 19 cents per share in last year's second quarter, again excluding restructuring charges.

As far as the results of our two operating segments were concerned, the upholstery fabrics segment reported sales of 55.9 million for the quarter, a decline of 4.3 percent. Fabric yards sold for the quarter were 13.1 million versus 14.1 million in the same quarter last year, a decline of 7.1 percent. The average selling price increased to $4.13, up 2 percent from $4.05 in last year's second quarter. This is due primarily to the CDF division's products. The gross profit in this segment in the second quarter was 10.4 million, or 18.6 percent, versus 8.8, or 15.1, for the same quarter of last year, excluding restructuring charges. This gross profit margin in upholstery fabrics equals the highest quarterly gross margin in over five years.

With respect to our second segment, mattress ticking reported 26.8 million in sales for the quarter, a 6 percent sales increase. Ticking yards sold during the quarter were 10.9 million, up 8 percent from 10.1 million in the corresponding quarter of the prior year. Average selling price was $2.43 for the quarter, down from $2.48 for the prior year's quarter. The slight decrease reflects a product mix change -- a small product mix change and a higher concentration of closeout sales during the quarter. Gross profit in this segment for the second quarter was 6.3 million, or 23.6 percent of sales, compared with 6.1 million, or 24.1, for the same quarter of last year.

In summary, we ended up the quarter reporting much better sales and profits than we had expected early in the quarter. For the third quarter, however, we are starting off with softer incoming order rates in upholstery fabrics, particularly in CDF, and somewhat lower production schedules in this segment than we experienced in the second quarter. We are optimistic that we will begin seeing the some firming of orders over the next two months as we head into the second half of our fiscal year. As you look at Culp, I think it is important to recognize that we have become a much stronger and disciplined Company in many ways during these last two years. I will now turn it back over to Rob.

Frank, thank you. While this past quarter's performance has certainly been encouraging, the prevailing uncertainty in our economy and its impact on consumer spending continue to challenge Culp and many companies in our industry. However, we believe our results demonstrate that we have taken the action necessary to position Culp for more progress when market conditions improve on a more consistent basis. Furthermore, we believe that the design, creativity and quality we put in our fabrics and our commitment to superior customer service are hallmarks that will continue to distinguish Culp in the marketplace.

Looking to the third quarter, we continue to recognize that there are market dynamics that we cannot control. Combined with this uncertain market environment, we are also heading into one of our slower periods because of the scheduled holiday plant shutdowns. As I noted previously, while the overall residential furniture and bedding industry demand improved during the second quarter, there still does not appear to be a sustainable trend in incoming business, particularly in our upholstery fabrics section. Therefore, based on current issue trends, the upcoming seasonal (indiscernible), we expect third-quarter sales will decrease moderately from the same quarter of last year. While mattress ticking segments are expected to continue to improve in the third quarter, we expect the gains to be less than the 6 percent increase in the second quarter. The upholstery fabrics segment sales are expected to decline for the same quarter of last year at a higher rate than the 4.3 percent in the second quarter due primarily to softness in incoming orders in the segment's CDF division.

With these sales expectations and industry outlook, we expect to report net income in the range of 13 to 17 cents per diluted share, with actual results depending on the level of demand throughout the quarter. As we enter the second half of our fiscal year, we are determined in our efforts to grow our business, continue to improve efficiency of our operations and generate free cash flow. We believe that our strategies of the past few years have been successful in helping us enhance our competitive position. We believe there are additional opportunities ahead for Culp in fiscal 2004 and we look forward to sharing our progress with you. Now, Stephanie (ph), I will turn it over to you for any questions.

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

Actually this is Arnan Krishnan (ph) for Laura. Laura is traveling. First question. Can you give a sense of what will be the price differential between products sourced from your finishing plant in China and, say, comparable quality product manufactured in your U.S. plant?

Yes. Of the product that we produce in China, and that product stays in China -- in other words, it's China to China -- we produce it in China, finish in China, sell it to a U.S. manufacturer who produces furniture in China or a Chinese manufacturer produce -- to sew (ph) to come back to the U.S. The price differentiation (ph) is somewhere 30 to 40 percent lower in China than it is in the U.S. If fabrics are produced in China and come in roll goods in the U.S., if it's a chenille product, in today's environment because of the quota price on chenille, the price is comparable. It may be a little less in China than in the U.S. If it is non-chenille, then you're looking at maybe a 20 percent or so lower price of roll goods coming to the U.S.

That is very helpful. Can you comment on the sales trend of your largest customers?

On the bedding side, the sales trend with our largest customers is at best flat because of their transition from two-sided mattresses to one-sided. So, for example, if Sealy, Simmons, Serta, Spring Air, those books, as they transit (ph) from two-sided to one-sided, they use one-third less fabric, and that -- certainly that challenges us to grow the sales. Although we have not lost as much business as they have bought less ticking, so we feel like we have gained market share, and we certainly have gained with other bedding manufacturers, witnessed by our sales increase.

On our upholstery side of the business, our largest customers are the La-Z-Boys of the world, the furniture brands of the world, all of those groups that you folks are aware of. And if you look at their numbers the past couple of quarters, that they have had some challenging sales quarters as well. So we are challenged to grow our business with them; although we have not lost market share, our success would be (ph) to larger customers is going to be dependent on their growth.

I understand. Also, on leather trends, like in terms of reporting (ph) industry upholstery sales, how much do you think would leather be in terms of (indiscernible)? And where do you see that number going forward?

Well, for four or five years, we had hoped it was going to stop. I would guess now, between leather and suedes -- and Culp is participating in the suede market, so that is a good thing for us -- but if we put suedes and leather together, I think as much as 50 percent of retail floors -- 40 to 50 percent of retail floors could be those two categories.

Do you see rapid growth slowing down or --?

Certainly we see the growth slowing down in leather. We think leather has peaked at 25, 30 percent of the floor. The new kid on the block is the tremendous popularity of these microdenier suedes that are just all over, and we think there is much as 10, 15, 20 percent of the floor now. The good news is Culp is a very major player in that business, and we are able to source that through our China operation.

Finally, on near-term use of cash, can you give some hints on that?

Near-term use of cash will be to keep it right where it is. We would -- our first priority remains retiring debt if that would be possible with any of these private placement lenders. That has not been possible up to now. The Board, of course, always has financial options with respect to this cash in terms of dividends or stock repurchases or things of that nature. We don't think you're going to see uses of cash being too much capital expenditures as we look down the road.

That's helpful. Thanks a lot. Best of luck.

John Baugh with Wachovia Securities.

Good morning. Congratulations. Your customers, particularly your big guys in the furniture side, can jockey their inventories around pretty good. Do you have any sense of -- you talk about this spottiness -- do you have any sense how much that is an issue at retail versus maybe what your bigger customers are doing with their inventory levels?

John, you know, to be honest, I don't think I have a feel. We hear from our bigger customers that our third quarter, meaning the months of November, December and January, business is going to be good. Our customers tell us the mood is much better this three months than it was the previous six months. Having said that, our incoming orders the last three or four weeks have not been as strong as we thought they would be, particularly upholstery fabrics section. I guess we know that our three or four largest customers are really doing everything they can to generate cash and reduce inventory. So to that point, we know that is happening.

We're betting because of the -- and we're trying to be careful, but we feel that beginning in mid-December through January, we are going to have a nice run of business because there is huge tax refunds going to take place in early January, and plus the fact that January is always a huge month. So, our customers tell us that the next couple of months are really going to be strong. We have not seen that yet, but because our lead times are so short, those orders would not be on our books yet. We would not receive those orders until early to mid-December.

I wanted to go back to the suede, and can you discuss where you're making it, sourcing it, and your competitive advantages or disadvantages in that category?

Frank is in charge -- he has the dubious distinction of being in charge of our China platforms. I'm going to let him answer that.

John, the suede is sourced from that area of the world, and we're obviously participating in that to some degree. And we are placing that very well. We think the suede still has a good bit of room to grow from what we're seeing at retail and on our customer showroom floors. So, that is something we're participating in through our China platform.

John, I might also add that one of the benefits we think we bring with our China platform is managing the supply chain, managing the quality. All of these suedes are piece-dyed, so there is huge dye lot variations, and the value-added we bring and our success is we can deliver a first quality piece of goods on time, the right quality, to our customers in the U.S. I think people trust us to provide that service for them. So we've been very fortunate on the suedes to pick up several large programs in the U.S., and if we are successful with our China platform, there will be no difference in the delivery or quality or creativity of products from the Far East versus the product that we do in the U.S.

All of the stuff you are doing in terms of finishing and the infrastructure you're building over there right now, will that have any influence on enhancing the suede business? Or is that just something you've already got up and running and is what it is?

Right now, the products are not -- the manufacturing is not up and running yet, as you know. We're not running any additional processes of the suedes through that operation. Although in future product development, that is certainly something we're looking at and want to take advantage of.

Okay. CDF, average price point I think was up. Can you discuss whether -- what is going on there with the mix? What kind of placement you have had with higher priced goods and any kind of forecast on that number over the next 3, 6, 9 months?

Certainly on the CDF area, the progress there is wonderful. As Frank said, it is the best quarter we've had in five years or so for upholstery fabrics in CDF, so that is very encouraging. We set out on a plan a couple of years ago to rationalize our manufacturing capacity to get rid of low performance SKUs and to raise the profit margin in these goods. And we have systematically done that through our creative effort and also the plants have gotten a lot more efficient. So, it's been a concerted effort to try to sell higher priced products with more margin. And certainly, we are successfully doing that.

The downside of that is we have had to give up some business that had lower margins that just did not have the right margin in it. And we are still facing some issues of having to drop or get out of styles, patterns, that don't have the correct profit margins, although it is a lot less now that it was before. So, now with our manufacturing really in good shape and running at standard and really making tremendous progress each and every day and week and month, I think we're now in a position to go after some of the more promotional business that we will have more margin in because we now are a better manufacturer and a better marketer. So we expect the selling price to continue to increase modestly, but we're not going to leave our price range. We are a medium to medium-high marketer of upholstery fabrics and that is where we feel comfortable.

Okay. All right. That is helpful. Last question, on the ticking side. Where do you think we are, what inning, if you will, how far along are we in transitioning? You mentioned the bigger guys are doing it and the smaller guys maybe aren't. Do they then catch up? Are we halfway there, are we a third of the way, two-thirds? What do you think in terms of (multiple speakers)?

John, I think we are, just based on Sealy by January 1st will be 100 percent one-sided; Simmons is already 100 percent one-sided; Serta, Spring Air are 75, 80 percent. I would have to say we're probably two thirds there of one-sided mattress. The two biggest players are 100 percent one-sided by January 1st.

Great. Thank you. Good luck.

Joel Havard with BB&T Capital Markets.

Good morning, guys. Good questions so far. Wonder if you all could (ph) walk us through the -- particularly the inventory side of the working commitment -- working capital commitment as China gets up and running. I understand that you are going to be bringing in product from local vendors, running it through various processes internally and then shipping that. I'm just trying to get a sense of what it takes to fill that supply chain.

Joel, I think there will be some increase, but we hope to manage that increase within our overall current levels of inventory. We certainly do not plan to increase these overall inventories. But, having said that again, it's probably -- depending on sales volume over there, of course, but anywhere from 1 to $2.5 million of commitment. And to grow over time as those sales grow. But you've got to remember one thing. Part of the platform over there -- an important part of the platform, is selling our customers cut-and-sew operations. There is no inventory commitment there. We bring it in, we finish it, inspect it, test it, apply all our U.S. quality standards to it, with Culp's stamp of quality on it, and then goes right next door, an hour away.

Okay.

That could be easily a third or more of the business.

Joel, I might add, and maybe you're not coming from this direction, but if you look at the inventory on our balance sheet this quarter versus last year the same quarter, our inventory would be much reduced with the exception of a couple huge ticking programs that are kicking in -- first of the year, they were having to build inventory to meet the commitments of these customers. So our inventory is in really good shape right now, and it usually is the highest of the year at this time of year, and then it starts trending down the next four or five months.

That is an interesting point, and really on two sides. Frank, if I'm hearing you right, you're saying that the China volume ought not to look a whole lot different from an inventory commitment standpoint than does domestic volume?

I think so, because we're going to ship a lot of it locally.

Rob, your follow-up then indicates that you all are doing something with -- is it new customers or new really just share gains?

This is share gains.

And that is with our big four plus another five behind them, then. Is that correct?

That is correct.

Very good. Can you give us some idea of where you would be seeing share gains? Is there a new -- above and beyond the one-sided issue, is there some new thrust by any customer that you all can talk about?

No, I think they just all like us better because we are so nice.

Well, that, and maybe Burlington is still thrashing around a bit?

I think they just like us better.

I will let somebody else ask. Thanks, guys.

Tom Lewis with Risk Reward Advisory. We will move to Budd Bugatch with Raymond James and Associates.

Good morning. Good morning, Rob. Good morning, Frank.

Did you go to the football game last night?

Yes, I was there.

I thought about you.

I'm operating I'm just three cylinders today.

I'm happy about that.

Thank you very much. Let's just talk a little bit about the microdenier and the other imported products coming from the Far East in the upholstery segment. Can you quantify that at all in terms of what maybe percentage of the overall 13 million yards that is, and maybe its profitability versus manufactured goods?

Overall in the industry, I think that we would probably say it's somewhere in the 10 percent range. Something like that, just judging by retail floor space -- 10 to possibly 15. And of course, you can visit the stores yourselves. Here, it is still a small part of our business, but a growing part. I don't think I'm comfortable probably saying how much of our business.

When you look at the ASPs of that yardage, what is the average selling price of microdenier today?

That probably averages $5, I'd say. It is a higher price point.

So that would be a reason to take the 2 percent higher selling price up? Would that be fair?

Yes, as that business grows -- the suedes are down to $4 -- they're $4 to $6.50 really these days, but an average of around 5.

When we look at your gross profit performance in upholstery, which was quite nice in the quarter, that I think 350 basis point improvement, can you can pinpoint maybe what caused that in terms of --?

Obviously, the suedes helped that, but by far and away, the biggest contributor was the improvement in CDF from second quarter of last year to this quarter.

And that is primarily utilization driven?

Two things -- higher capacity utilization and better manufacturing efficiencies.

And of that 350, would you take two-thirds of the improvement came out of --?

More. Eighty percent probably.

Eighty percent. All right. That is very helpful. Very good. Congratulations on the quarter. Good luck on what's going forward.

Thank you.

(OPERATOR INSTRUCTIONS) David Fondry with Heartland Funds.

I'm sorry. Could I just follow up that last question? I did not quite catch -- 80 percent came from manufacturing efficiency?

No, in the upholstery fabric segment, we have two divisions. We have a Culp Decorative Fabrics Division and a Culp Velvet/Prints Division. And we have done some restructuring actions in the Culp Decorative Fabrics Division over the last three years. And we have been letting folks know that we are at some point going to start seeing that benefit for those restructuring actions really start to show up in our numbers. And in our second quarter just completed, that division really showed some of its best gains in over a couple years, in that Culp Decorative Fabrics Division. So, 80 percent of the upholstery fabric gross margin improvement is what Budd was asking about is attributable to that CDF division within that segment.

Okay. The margins were extraordinarily good at almost 20 percent overall for the Company. Is that a sustainable gross margin?

Remember, second quarter and fourth quarter are our best quarters in terms of margins, and the first and third are the weakest. So that is a -- we certainly hope so, that that's sustainable. That's what we've been shooting for, and a model of 20 percent gross profit is certainly what we have targeted for a long time.

On the mattress ticking side of the business, there has been a lot of talk in the (indiscernible) and I think some regulations in certain states on fire retardancy in mattresses. Does that have any impact at all upon your business, and will it drive potentially some abnormalities in regular ordering patterns as these regulations come into effect?

That's a good question. Thank you. Yes, the thought is that as it stands now, the mattresses flammability standard is going to go in effect January 1, '05. Now, Arnold Schwarzenegger has now suspended that for a 90-day review because it was going to take place in California. So now it is sort of up in the air whether it might be '05 or it could be delayed a year to '06. But I think we all feel like it will take effect. We have aligned ourselves with a nonwoven product that we're very excited about that will act as a barrier cloth on a mattress. And not only do we not have an issue with it, we see this as a potential sales increase -- a potential for doing additional sales selling this barrier cloth to the bedding manufacturer. So, we're all ready to go regardless of which way it goes.

When you say you've aligned yourself with a nonwoven manufacturer, you would then incorporate that into your product, I take it?

No, we can do two ways. We could bond it to our actual product -- that would be one way to do it. But probably what will happen more often is the bedding manufacturer just buys and upholsters as a barrier cloth. In other words, they will put between the foam and the mattress ticking.

I got you.

But it could be done either way.

When you say you've aligned yourself with a nonwoven manufacturer, do you mean from an R&D standpoint or from a sales into the manufacturers standpoint?

For both. We have a very strong partnership with, we feel, a leading company in this area to market these products to the bedding trade.

Great. Finally, if I could return to do the China operation as you were talking about the microfibers -- or microdenier product. Did you say you're not manufacturing that yet but you are running it through your quality inspection process?

We are right now -- we are not manufacturing the product at all. We are currently inspecting the product at the location where it is manufactured. The plan will be, when our China platform is in place, to inspect that product in our platform and consolidate and shift it to the U.S., but that will not happen until a couple months.

I mean, if you already have people that are inspecting it in that plants, so you don't have to move it, how do you gain, I guess, cost efficiency if you move out of that plant into your moving it over to your own plant versus on-site inspection?

Well, I think it is just going to be more efficient and less costly when we are able to consolidate things at one location. Right now, it is not real efficient -- and it is not real efficient nor is it real effective the way we're having to check these goods. And the inspection process on these goods is mostly a color matching process rather than your typical fabric inspection. So, that is certainly not as labor-intensive and can be done in the China operation with the proper equipment.

Very good. Thank you.

It appears there are no further questions at this time. I would like to turn the conference back over to Mr. Robert Culp for any additional or closing remarks.

Stephanie, thank you, and again thanks to each of you for your participation. We appreciate your interest in Culp and we look forward to updating you on our progress next quarter. Thank you and have a great Thanksgiving. Best of luck to each of you.

That does conclude today's teleconference. We would like to thank you for your participation. You may now disconnect.