Culp Inc (CULP) 2006 Q2 法說會逐字稿

Good day and welcome to the Culp Inc. 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.

Good morning and welcome to the Culp conference call to review the Company's results for the second quarter of fiscal 2006. As we start, let me express that some statements made in this call will be forward-looking statements. Forward-looking statements are statements that include projections, expectations or beliefs about future events or results or otherwise are not statements of historical fact. 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 those 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, during this call, the Company will be discussing non-GAAP financial measurements that exclude restructuring related charges. A reconciliation of these non-GAAP financial measurements to the most directly comparable GAAP financial measurements is included in the schedule to the Company's press release and 8-K filed yesterday. This information is also available on the Investor Relations section of the Company's website at www.culpinc.com. I'll now turn the call over to Rob Culp, Chief Executive Officer.

Thank you. Thank you and good morning and thanks for joining us today. I would like to welcome you to the Culp quarterly conference call for analysts and investors. With me on the call today is Frank Saxon, President of Culp. The purpose of this call is to review financial results and operating trends reflected in the second quarter of fiscal 2006. I will begin with some brief comments about Culp today and Frank will review the results for the second quarter. Then we will spend some time updating you on the strategic actions in each of our operating segments and our third-quarter business outlook.

During this fiscal year, we have been implementing ambitious plans in each of our segments, Mattress Ticking and Upholstery Fabrics, in response to the significant industrywide structural changes that are happening in the furniture and bedding markets. We're very pleased with how much we have accomplished this year. While we are not yet profitable in the Upholstery Fabrics segment, it is gratifying to see the improvement in this segment's operating results for the first six months on a year-over-year basis.

Although the transition to a leaner and more agile business model is affecting our reporting financial results, we believe we're taking the right steps to be competitive and position the Company for growth over the long term in today's global marketplace.

Like others in our industry, the second quarter was affected by a shortage of polyurethane foam used in furniture and bedding and by surcharges for raw materials that we started seeing in early September. Both of which factors are related to disruptions from the hurricane activity on the Gulf Coast. In response, we implemented a surcharge to our customers in both operating segments in October. Therefore having some time that increased costs were not covered during a quarter. We expect that these factors will continue to affect our business over the next quarter, although to a diminishing extent. I will give you further details in a minute but first I will ask Frank to comment on our financial results for the quarter.

Good morning, everyone and thanks for joining us as well. Total sales for the quarter were 67 million, an 11% decrease from the second quarter of last year. This overall sales decline is principally attributable to a continued softness in our U.S. produced Upholstery Fabric business, lower average selling prices in Mattress Ticking and the foam shortage Rob mentioned earlier.

Our gross profit margin was 10.9 compared with 14.2 in the second quarter of last year, excluding restructuring charges for both periods. The overall decline is primarily related to the lower sales of our U.S. produced upholstery fabrics. SG&A expenses declined 26% to 6.5 million or 9.7% for the quarter. This compares with 8.8 million or 11.7% last year's second quarter reflecting substantial cost reduction efforts, particularly in the Upholstery Fabrics segment.

The second-quarter results included after-tax restructuring charges of 3.8 million or $0.33 per diluted share after taxes. Excluding these charges, net loss was 332,000 or $0.03 per share. The second quarter of fiscal 2005 also included restructuring charges and goodwill impairment of 4.7 million or $0.41 per share after taxes. Excluding these charges, net income for the prior year period was 505,000 or $0.04 per share.

I would now like to review our results by operating segment. With respect to Mattress Ticking, we reported 24 million in sales for the quarter, an 11% decline compared to 26.9 million for the same period of last year reflecting lower average selling price as mentioned above and the industrywide shortage of foam. Total yards sold were 11.1 million, down 2% compared with 11.3 million a year ago. The average selling price was $2.16, 8% lower than the $2.35 for the same period a year ago primarily related to prices in our damask ticking productline. This pricing trend reflects the ongoing shift that mattress manufacturers are making to less expensive common border ticking, which is the fabric that goes on the side of mattresses and box springs.

Operating income for this segment was 1.7 million or 6.9% of sales. For the same quarter of last year, operating income was 2.7 million or 10% of sales. Operating income margins in this segment were affected by a U.S. Customs assessment of 375,000 related to products imported in prior periods, which reduced operating margin by 160 basis points.

Additionally, manufacturing variances related to the start up of the Company's capital project and higher raw material prices not offset by customer surcharges also affected margins for the second quarter in comparison to last year. On a sequential basis however, we were pleased with the improvement in second-quarter operating income margin from the first-quarter level of 5.9%, especially considering the external factors faced by this business during the quarter.

Now turning to the results of our second operating segment, Upholstery Fabrics. Sales were 43 million representing an 11% decline from the 48.5 million in the second quarter of last year. Upholstery Fabrics' sales for the quarter continued to reflect the significantly lower demand industrywide for U.S. produced fabrics driven by the consumer preference for leather and suede furniture and the increasing customer selection of other imported fabrics, including cut and sew kits. However, higher sales of offshore produced fabrics partially offset the lower sales of U.S. produced fabrics. Total yards sold were 10.4 million, down 9% with 11.5 million a year ago. The average selling price was $4.13, 3% lower than $4.24 for the same period a year ago.

We're pleased with the continued growth in sales of Upholstery Fabrics from offshore sources, including fabrics produced at our China operation. These sales were up 79% over the second quarter of last year and accounted for 29% of overall Upholstery Fabrics' sales. The Upholstery Fabrics segment reported an operating loss of 69,000 for the second quarter. This compares with operating income last year of 216,000.

For the first half of fiscal 2006, we have substantially reduced our operating losses in this segment to 448,000 compared with 2.4 million for the first half of last year even with sales down 9% over the same periods. For the quarter, SG&A declined 32% and represented 9.5% of sales for this segment compared to 12.4% of sales a year ago.

I will now turn to the balance sheet. At the end of the second quarter, our balance sheet reflected a cash position of 12.9 million compared with 5.1 million at the end of fiscal 2005 reflecting cash flow from operations of 5.1 million, capital expenditures of 5.6 million and proceeds from the sale of buildings and equipment of 4 million. At the end of the second quarter, we closed on a long-term mortgage on our corporate headquarters building for 4.3 million. Long-term debt stands at 54.9 million and our debt to capital ratio is 41%. Additionally and very importantly, we reduced inventories during the quarter by 8.7 million or 17% primarily related to Upholstery Fabrics. Now I will turn things back over to Rob.

Let me now talk about the progress we are making in both of our operating segments. I will start with Mattress Ticking. As you know, Mattress Ticking has become an increasingly important part of our business and we believe we have a strong competitive position in the marketplace. Mattress Ticking sales accounted for 36% of our total sales this quarter. We are pleased to show improvement in our operating income margins over the first quarter of fiscal 2006 as we have worked towards completion of our $7 million capital project designed to improve our globally competitive cost structure in this segment.

During the second quarter, we began to ramp up production on our new Stokesdale, North Carolina weaver facility and have made excellent progress. We expect to realize further productivity gains in this operation into the third quarter and reach our target productivity levels by the end of fiscal 2006. We believe we are well-positioned to achieve improved operating results in the second half of this year compared with those of the prior year with an operating income margin goal of 10% in the fourth quarter.

Now I'll give you an update on our Upholstery Fabrics segment. During the second quarter, we continued to make significant progress in our efforts to bring our U.S. manufacturing costs and capacity in line with current demand trends. As Frank noted, we have reduced our selling, general and administrative expenses this segment by 33% year to date. Since the beginning of fiscal 2006, we have taken very aggressive steps. During this period, we have consolidated two velvet manufacturing operations. We have consolidated our finished goods distribution and design center, closed two yarn manufacturing plants and announced a strategic alliance to outsource our decorative fabrics finishing services. We have also combined our sales, design and customer service activities for Culp Decorative Fabrics and Culp Velvet/Prints, the two divisions which formerly existed within the Upholstery Fabrics segment resulting in a more unified approach for our customers.

Once our outsourcing is finished, once our outsourcing initiative for finishing services is completed, which is expected by the end of February 2006, Culp will have three U.S. plants operating in the Upholstery Fabrics segment. One for velvet fabrics, one for decorative fabrics and one for specialty yarns. As a result of these past restructuring actions, the book value of our U.S.-based Upholstery Fabrics fixed asset is projected to be 15 million by the end of the third quarter of fiscal 2006 compared with approximately 52 million at the end of fiscal 2004.

Our objective is to obtain a sustainable and profitable business model in the U.S. that in conjunction with our offshore operations will support our customers' fabrics requirements. Our near-term goal is to be profitable in this segment in the fourth quarter. We are pleased with the positive trends we are seeing in our offshore business.

As Frank noted, sales of upholstery fabrics produced outside of our U.S. manufacturing plants, which include fabrics produced at our China facility, increased by 79% over the second quarter of last year. Customer response has been favorable and we are excited about the innovative products that we are now offering. We believe the development of our China operation represents a compelling opportunity for Culp. As our U.S. customers have continued to move an increasing amount of their fabric purchase to Asia, we have moved with them and responded with an operation design to meet their fabric needs.

The cornerstone of our China strategy is our state-of-the-art fabric finishing and inspection facility located near Shanghai. With specialized equipment unique to China, we have the capacity to control the value added finishing process thereby assuring our customers that our fabrics will meet or exceed U.S. quality standards. By providing innovative fabrics, value added technology and a low-cost production environment, Culp offers differentiated products in value to our customers. Our vision has developed over the last two years and today we have a growing upholstery fabric operation in China with over 150 associates. Frank will now review the outlook for the third quarter of fiscal 2006.

As Rob stated at the beginning of this call, we are pleased with our progress to date in executing the significant strategic changes underway in our operations. Looking ahead to the third fiscal quarter, this is typically a slower period for our industry due to holiday vacation schedules. Additionally, we expect the foam shortage and surcharges for raw materials will continue to affect our business although at a diminishing rate as the quarter progresses.

Overall, we anticipate a larger year-over-year decline in sales than the 11% decline in the second quarter. With respect to our Mattress Ticking segment, we expect sales will show a decline over third quarter a year ago but to a slightly lesser extent than the decline in the second quarter. Operating income and margins in this segment are expected to improve over the same period last year primarily due to the benefits from our capital project. For last year's third quarter, operating income was 1.6 million and operating income margin was 6.2 for Mattress Ticking.

In the Upholstery Fabrics segment, we expect continued growth in sales of fabrics produced outside of the U.S. However, we believe sales of domestically produced upholstery fabrics will continue to reflect weak customer demand and result in a larger overall segment year-over-year decline than we had in the second quarter. Even with the lower sales however, we believe this segment's operating results will show a significant year-over-year improvement with an operating loss for our third quarter that is much less severe than the operating loss of $2 million for the same period of 2005.

Considering these factors, we expect to report a loss in the third quarter in the range of $0.07 to $0.12 per share, excluding restructuring charges. This is management's best estimate at present recognizing that future financial results are difficult to predict because the upholstery fabrics industry is undergoing a dramatic transition and many internal changes are still underway within the Company. The actual results will depend primarily upon the level of demand throughout the quarter, the Company's progress with respect to restructuring activities for our domestic upholstery operation and the impact of raw material costs.

We estimate that restructuring and related charges of approximately 900,000, 600,000 net of tax or $0.05 per share will be incurred during the third quarter. Including the restructuring and related charges, we expect to report a net loss for the third fiscal quarter of $0.12 to $0.17 per share. Our primary focus for fiscal 2006 is to restore Culp to profitability. As we continue to work through this important period of transition, we are very encouraged by the positive results of the strategic changes we have made throughout our operations.

The substantial cost and capacity reductions we have made in our U.S. upholstery fabric operations are moving us closer to our goal of being profitable in this segment. Our non-U.S. produced upholstery op (ph) business, including our China platform, continues to show favorable trends and we believe there are additional opportunities for extending our global market reach and capability in this operation. We have strengthened our competitive position in Mattress Ticking and look forward to realizing the full benefits of the capital project in this segment.

Overall, we believe we will see continued progress during the second half of fiscal 2006 with improved operating results for both the Upholstery Fabrics and Mattress Ticking segments over the same periods of last year. With that, we will now take your questions.

(OPERATOR INSTRUCTIONS). Laura Champine, Morgan Keegan.

Good morning. You mentioned in the press release that you expect to continue to make progress in the second half of the year and to hit your target productivity levels in Mattress Ticking. Can you talk about what those target productivity levels for the Ticking division are?

Laura, the productivity levels are to reach the same levels of performance that we are having and have had in our Canadian facility and we expect to reach those by sometime in the fourth quarter. We are well on the way by the end of October.

I probably can't give you specific targets but the benchmark is our Canadian facility.

And Frank, it's to match the Canadian facility in terms of utilization or in terms of margins? What exactly are you ---?

In terms of operating efficiencies. We operate north of 90% operating efficiency and utilization is always very high. Both operations run 24/7.

Would you mind just for the sake of this discussion defining operating efficiency?

Operating efficiency is the amount of time that the weaving machines are running.

I'm sorry, Frank. What was that?

The amount of time the weaving machines are running.

Got it. Got it. Great. Thank you.

So it's obviously a very high level. Mattress Ticking runs at a very high level efficiency and as you all know, we have had a great operation in Canada for a number of years and we have set up a smaller version of that here in North Carolina. And it just takes them awhile to get to the level of performance that the Canadian operation, which has been doing it for over ten years. But they are making great progress and we are pleased with that so far.

Thanks a lot.

Joel Havard, BB&T Capital Markets.

A little bit here on the remaining U.S. plants as I understand it, that will be Burlington on the CDF side?

It is actually Graham, North Carolina.

Graham. Okay.

The cities are right next to each other so it's okay.

And CVP, which one is remaining?

That is the Anderson, South Carolina velvet plant. Then the third one is the specialty yarn plant, which is in Lincolnton, North Carolina, which is about an hour outside of Charlotte, West of Charlotte.

Okay. And both CHS stay in operation. As you blended basically the two into one in both CDF and CVP, where do you think you are from a utilization standpoint? Or I guess to start that off, where is total capacity and if you want to think in terms of yards or dollars, whatever is more convenient to you all, on where the combined operations are now or was this a matter of really just closing one and running what was left or did you blend a lot of equipment into the remaining plant?

Well on the velvet side, we combined our velvet operation in Burlington, North Carolina and we moved the equipment that made those velvets into our Anderson, South Carolina plant. We had room there so we moved it in and just combined the operations, eliminated the fixed costs and have a much leaner operation, which has a much lower breakeven point.

And again, would you be comfortable talking about what the capacity of the operation is and where you are today?

We still have capacity available in terms of machines. We have obviously staffed it for the lower level of sales that we are experiencing but we have machinery to respond if we needed to. Both locations, both velvets and the decorative fabrics, have room to expand our current sales base I would probably say 20 to 30%. Now it is not staffed for that but there is an equipment base and facility for that.

Okay. Versus where you are running now?

Where we are running now. Yes.

I was a little confused. The one part of the restructuring I didn't understand was the outsource of the finishing. I always understood the finished process to be one of your proprietary core competency type issues. Could you explain that to us?

That's a good question, Joel. In the United States, that has been a core part of the larger upholstery fabric operations. However as we have gotten smaller, there is one company that has been in the industry for over 50 years that has been the leader in commission finishing services, a company called Synthetics. And they do an excellent job and always have been and they know all of the customers of the major people. As we started working with them, it made sense that they could do as good a job as we do and do it on a variable cost basis at less than we can. So it just made all the sense in the world and that process is going well. We expect a transition to them by the end of February. Now in China, if you go across the Pacific here, it is a much different situation over there because the competency levels of finishing are not in place over there. So maybe that was -- I don't know if that was part of your question or not.

Well, you can be sure I was going to come around to China. Alright now, at the inverse where you are really -- your ownership is almost limited to the finish and you are bringing in sourced fabric, is that --?

That's correct. But I think when you look at that, it is important to note that there is a big difference in how you bring in sourced fabric. We have formed strategic partnerships with a few mills, which basically act as our own mills where we can control the quality, the production schedule. They don't sell to other people, competitors or customers, etc. So what we say we own where we think the value add really is and that is in finishing, in design, logistics, QC, customer relationships, and we have strategic control over fabric formation. And that is what we have done and it has worked. That model I think is working very well. We invest where the value is really added.

That makes sense. Now talking about that, I believe on the last call, you all hinted that China was above breakeven on an operating margin basis. Have you seen further improvement or are you holding steady? Where are we on the prophet curve? I know the top-line growth has been extremely strong.

Joel as you know, we don't break out that information but I would reiterate what we said last quarter.

I knew I couldn't get a number out of you. Can you share with us direction or magnitude?

Let's just leave it at this. It is profitable and contributing to our overall results.

I'll enter a formula in italics for that one. Finally, on the SG&A front, you guys are doing a good job on the saving side. Could you characterized the difference -- and I understand the big combination consolidation you did with CDF/CVP back office and it looks like it is top to bottom on the back office design to distribution. Putting that figure, whatever it is, relative to the number you report on an operating basis as corporate overhead, your corporate overhead burden in Q2 '06 was substantially lower than a year ago. Is that -- 800,000 is a good bogey for us over the second half of this year or is there further room for savings on the corporate side or do you see it more on the CDF/CVP side as that process gets fully absorbed?

We have taken out -- we are at 33% year-to-date of course in upholstery fabrics in terms of SG&A reduction. We are 8% down in Mattress Ticking and of course what we call unallocated corporate expenses, which I believe you're referring to. We are down 21%. I think it is fair to say that you will see further reductions in SG&A in absolute dollars as well. I'm not positioned to qualify that currently but we certainly know with the demand trends and we have got to keep our costs in line and I think as you see Culp over the last several years, we have done it over and over again and we will do what is necessary there.

Joel, this is Rob. I would just add to it that as we said in I think in our press release and our talk, our industry, both Mattress Ticking and Upholstery Fabrics, is going through significant structural changes. And it is becoming much more of -- even more of a worldwide business and we just got to continue to react to that and I think we are. But it is not business as usual in our industry ever again.

Well, Rob, I know you all have undertaken a lot of work here. Rob, one other question for you. The foam issue for the industry we understood is dampening demand in the quarter. We also understand that that situation has fairly much stabilized and is improving. What were the raw material issues you all were subject to in Q2? If I understood from your comments on an incoming basis, that you were subject to surcharges on yarn or --?

Yes. I will comment on overall and Frank can give some specifics. First of all on the foam, that is affecting us less now than it did in the October November time frame. It is still an issue. It is not so much an issue of demand or supply now. It is an issue that the price is real high. So our customers are struggling a way to pass those costs on. Usually when your costs go up, orders come down or demand is affected. But that is to a less effect. We got hit because of the hurricanes on the Gold Coast with significant surcharges in every synthetic yarn we have purchased. It really started in September, early September. We were not able to react to get our surcharges in place until mid-October. So we had roughly almost 8 weeks of the 12 week quarter, we were absorbing these costs thinking they would come back down. Polyester, polypropylene, acrylic, every fiber we use had significant increases and we are still seeing those increases in place now.

The good news is we did affect a surcharge and to my knowledge, we have got that surcharge across the board. We have not had one exception that we have not been able to secure the surcharge. So that should help us as we move forward.

Guys, I know you have got a lot of work to do. Best of luck.

Thank you.

(OPERATOR INSTRUCTIONS). Budd Bugatch, Raymond James.

A couple of questions if I might. Looking at the Upholstery segment, if I look sequentially at the growth between the offshore and the domestically produced items, I find that one, offshore looks like it is plateauing now. It looks like it is up about 6% from the first quarter and the growth there is kind of starting to plateau. Is that a proper read or not?

I think I would say by we are still growing sharply over last year. 79% in the second quarter and of course over 100% in the first quarter. But as the numbers get bigger, the percentage of growth is coming down.

That $12.5 million this quarter versus 7 million last year but verses about 11.8 million in the first quarter. Is that right?

That's correct. And you are right. We've had sequential growth in that business for probably two years as we have been ramping up.

So how should we think about that going forward? Do we still see about a 5, 6% growth sequentially going forward or does that now plateau and at what level, more function of industry?

I think as we get larger in that segment, it is going to more parallel the seasonality that we experience normally in the industry. Rates of growth -- we are not going to maintain 79% year-over-year. That is just as these numbers get bigger, that is not going to happen. But there is no question we see continued significant year-over-year growth as we go forward. And as we look at our products and our placements and anecdotal evidence, there is nothing to suggest that we wouldn't continue to have significant rates of year-over-year growth. Although not to the 80% levels. That is true.

What would you think third quarter would look like in terms of year-over-year? We're predicting about 60% year-over-year. Is that silly?

I guess what we say is we see and we have said in our press release and I would reiterate here, we see significant growth, substantial growth, something bigger than significant, continued year-over-year substantial growth in offshore produced business.

Then as I look at domestic, and this makes sense with the seasonality, your domestic sales were sequentially up about 10% from the first quarter to about $30.5 million versus $27.6 million in the first quarter. Is that right?

That's in the ballpark. That's correct.

Then I'm trying to get to the profitability. Last quarter, what I think you said is that for the first time the non-U.S. gross profit dollars exceeded the U.S. gross profit dollars. I think that was the way you characterized it. Is that correct? Do I remember that right?

I'll have to look, Budd. I don't remember. I don't have that in front of me.

I think that's the way you characterize it. I'm just trying to look at -- it looks to me --.

I would say this. In the first quarter, of course the first quarter is always the weakest quarter sales and profit wise. Domestically, that has always been the case. It wouldn't be unusual. I don't have that in front of me but that wouldn't be unusual.

And looking at -- if you turn it mathematically come up to the $4 million worth of gross profit of the Upholstered segment and on that basis and looking at the same kind of relationship we did last quarter, a little bit more now non-U.S. It looks to me like the difference in gross margin is somewhere about over 1000 basis points. And it seems to me that the U.S. gross margin really deteriorated significantly further even from the first quarter of this year. Am I wrong question? Not significant, about 100 basis points or so to the mid-single digit level.

I think what I would say, Budd, is how we have -- we don't break out that profitability, as you know. I know you would like us to break that out. But what we have said is the most significant factor in the Upholstery Fabric operating results is the U.S. situation.

It looks to me like it is still deteriorating. That's the point I'm trying to get to. Maybe not the magnitude but we're still not getting an improved -- even though we've taken more capacity out and we have now better utilization or a higher throughput in that U.S. operations. The gross margins of the U.S. operation looks like sequentially it is still deteriorating and certainly deteriorating year-over-year.

Certainly still tough. During the quarter, you have got to remember another thing that really hurt the U.S. side of things was these surcharges. As Rob talked about, we had unprecedented surcharges on raw materials. Polyester in one week went up 15% with surcharges.

The deterioration from the first quarter to the second quarter can be explained almost all by the pricing?

Let's say that's a significant factor. It is still tough without a doubt even as we shrink capacity with sales declining in the U.S. It's still tough.

So when you put a number to the amount of your surcharges that you are going to start seeing from your customers because you're not alone in this cost equation, what are you getting from your customers? What is the percentage of increase that we should plan for because that would through flow through to the bottom line if your prices hold?

I'm not sure -- you mean what was our surcharge verses the --.

Yes. Percentage of selling price. What will -- you didn't get it in this quarter. You started to get it in the quarter we are in right now.

We'd answer it this way. We got most of the surcharges that we have been hit with.

Can you give us a percentage or a number of that of overall sales, however you want to characterize it? Something that allows us --.

I would say probably we have got 80 to 90%. That's the way -- that's the best guess I would quantify that. The majority of the cost --.

I didn't ask what you're recovering. I'm just trying to understand what percentage of sales that is.

3% -- 2 to 3% probably.

And let me just give one last question. I don't know whether you were responding to this with Joel or not. I kind of got lost, which is probably my problem not yours. But the tariff issue, the duty issue, can you explain what happened there or did you already and I should just go back and reread it?

We were assessed in our Mattress Ticking business. We're now one of the top 15 importers in North Carolina. So we are getting more scrutiny from our friends at the U.S. Customs office. And we -- they assessed us for classification differences and it resulted in higher duties for periods prior to the second quarter. And customs and their regulations can go back -- it is either 12 or 13 months. So they have assessed us for that. Half of that we don't agree with them and we are contesting. But it is highly subjective how these classifications work. We are learning as we are going here but we just don't agree with half of what they have assessed us with and we are contesting it.

So I guess the $64 question, maybe more, is what does that do to your competitiveness of the import fabric? This is imports from Canada or Turkey or where?

From Turkey. From Turkey.

And does that make you now less -- if those (indiscernible) classifications hold, does that make you now uncompetitive to make those (indiscernible)?

No, it is not. It's not a great deal but it certainly -- it just makes the cost to import a little more and makes our U.S. and Canadian operations more cost competitive.

What is the impact per yard? How many yards did you import that got affected by this?

That is not something we disclose but it is -- it's not a lot per yard. It is something like maybe -- it is 375 over a twelve-month period of prior year shipments. So maybe $0.03 to $0.04 a yard, something like that in that range. It's not that significant on a per yard basis and happened to be significant this quarter.

I might add that these regulations are so subjective and we can read it one way and the Customs dock could read it another way and somebody else could read it a third way. And so if they read it differently than we do and we lose that battle than what we do is just change the construction or change the finish or alter it so that it fits the category we want it to hit. So it is not -- as we have gone through the process what we have learned -- we are also going to be facing this with some of these duties now, the quotas in China, that we have got to be smart enough to get the ruling upfront so that when we bring it in, we make sure that they agree with the classification we're bringing it under. And that is just -- I guess that is just another one of our classes of being a world company of understanding how this works and it is really very disappointing to us because we are convinced that we had the right classification on the fabric. But the U.S. Customs are convinced they have the right classification. So at the end of the day, we have got to use their classification, not our classification.

And Rob said the key change going forward for us internally is we are going to seek what is called binding rulings in the beginning. We didn't think we needed to do that but they've taught us that that is a practice we need to begin implementing over the next three or four months.

Understood. Thank you very much.

(OPERATOR INSTRUCTIONS). John Baum (ph), Private Investor.

A couple of questions, depreciation and amortization for the second quarter, Frank?

It is in our 8-K on page 5 of 7. Total depreciation, including what is called by the accountants accelerated depreciation, which is basically write-downs of facilities and equipment you're getting out of was 9.8. But ongoing regular depreciation was 5.0.

Do you anticipate that still declining with the write-offs of the U.S. domestic fabric facilities? I know the go forward -- I'm trying to search for a go forward depreciation amortization number that I can work with for third and fourth quarter.

It is going to be maybe a shade less than -- Upholstery Fabrics for the second quarter was 3.2 million. Probably a shade less than that but not a lot.

All right. Are you guys still on target -- I think you said your CapEx for the first half was 5.6? Did I get that number right? How much was the second quarter and are you still on target for the third and fourth quarters? I thought the CapEx was pretty minimal.

The second half of the year, John, is at most 1.5 million. Cash requirements for the second half of the year are going to be down significantly from the first half in terms of CapEx, in terms of restructuring of those things.

Is it too early to look at next year? Are you doing any budgeting for CapEx for fiscal year '07?

I would say, as you look forward, next year is very primarily -- Rob and I see no more than 3 million. Really next year is in the 2 to $3 million range and we have spent $10 million the last two years in Mattress Ticking to get where we needed to be cost wise there. So there is nothing of any consequence there. We are not spending any money on U.S. upholstery and we have done what we needed to in China for awhile. And even if we have expenditures in China, they are not big expenditures. We are not investing in the weaving side of the equation. So I would say next year, the next two years, in the 2 to $3 million range very low.

That is obviously the goal and as I take a look at the go forward depreciation amortization, excluding restructuring, I am somewhere in the maybe $10 million range. So we should see a cash flow bump to the bottom line somewhere in the 8 to -- 7 to $8 million range. Is that ballparkish there? Is that the right zip code?

That's probably right, yes, I would say, yes.

Any further plans to -- first of all congratulations on reducing inventories. Can we see more of that in the third and fourth quarter as we go forward? Is that all part of the restructuring too. At what point do you start cutting into bone there to reach a level of inventory that you can't really shock without impacting production?

Well let us both answer that. I will start. We started cutting into bone awhile ago. But that doesn't mean we still can't make a lot of progress and we still see -- significant progress can be made in inventories over the next six to nine months as well as costs, both SG&A and manufacturing.

I think I got half your -- one-half the answer but could we be looking at a reduction to inventory similar to second quarter and third quarter? Can you quantify that?

Probably. I don't know that the next six to nine we're going to make that much progress. 8.7 million or something like that in one quarter. We started that work back in May and June. So that was better than I expected. We challenged our folks and they just did a fantastic job. We hadn't targeted that much but we exceeded the goal. I don't expect that much over the next six months but you certainly could see three or four. If we do really well, maybe 5 over the next six months.

And you're still on target to reduce long-term debt, which obviously short-term debt right now, 8.1 million, 7.54 for the subordinated debt, and was it about 625 for the Canadian?

Yes. 500 on the Canadian.

And that will be paid off -- I think the U.S. -- the subordinated portion, that's in like March 15th, March 1st of next year?

That is correct. John, you hit on a real point there I want to harp on or make sure everybody hears it. The cash flow, when you look at the next six months, is with some inventory reduction and less CapEx, less restructuring; you know, it looks positive. And it looks like we can build upon the cash that we began building in the second quarter.

To maintain your balance sheet and actually pay down debt in the midst of this restructuring, you guys have done a tremendous job.

Billed even with the debt service requirements we have got in March.

Yes. Any idea where you guys are standing? At what point -- can you give us some idea as you look forward when sales are going to start to moderate? Either on yardage or pricing, we are going to start seeing some flattening of the downward curve?

John, this is Rob. That's a tough one. On the ticking side, actually our damask yards are trending upward, not selling price but yard. And that is the predominant product line in that category, and I think that we are certainly concentrating on units in mattress ticking in the damask area, making sure that we continue to pick up market share there. We will definitely see the units increase on the knit side in mattress ticking. We have got our act together there now, and that is going to be a good driver for us in these next coming months. On the upholstery side, it is just a heart read. I mean, there is such structural changes going on and the industry is really in such turmoil, it's hard to predict.

This is anecdotal, but is some of the reduction in overall sales planned in terms of closing unprofitable U.S. sections? So some of this, I don't want to say you are putting bullets in the chamber yourself, but I would imagine that some of the U.S. reductions are baked in.

There's no question in the U.S. particularly, John, because of SKU reduction and the plant closures that when you add all this capacity, you made a lot decision (ph) to sell goods on variable costing just try to keep the plant running, and we've all been down that road. Now that we have a lot less capacity in the U.S., there is really no need to do that anymore. So we just, you know, we are just not taking business that is not profitable.

I understand. Two quick ones here. Again, anecdotally, as you look forward would you ever see China growing to say 50% of overall sales?

John, no question.

We might even go out on a limb, and I would think that would occur next fiscal year.

And then mattress ticking, mattress ticking probably the units are very close to being up on a year-over-year basis, but the transition to border ticking, which is common borders, probably got a few more quarters to go. So we're still likely to see average selling prices under pressure for the next two to four quarters.

On that point, and I understand the public nature of this call, but when you pass on the price surcharges for increases in raw materials on both the upholstery fabric and mainly mattress ticking, are those temporary charges and quotes, or do those have a way of kind of sticking? And how do you manage that if, in fact, you see some price moderation?

Yes, surcharges I guess are implied to be temporary and that is certainly the way we are approaching it with our suppliers. However, you are not going to see us be quick to take surcharges off.

I understand. And finally, are we going to be -- again I understand the public nature of this call, are we going to be looking at anymore big restructuring for the third quarter or the fourth quarter? Are you guys on an automatic pilot here for a little bit or where do you stand there?

Well as we've said, we certainly hope so. After the finishing outsourcing, we are down to three plants in our U.S. upholstery business. One decorative fabrics, one velvet, one specialty yarn. So we are down to pretty much the bare minimum. The only other thing that could happen is if we decide to close one of the plants if the profitability was not enough to keep it open. That could be the only thing generating restructuring. But the good news is too we are probably, when we look at it, we are well down the path, 80% plus done of the restructuring that possibly could be done. The big cash restructuring costs of the past several years were related to combining plants. There are no more plants to combine anymore. We can downsize some within the plants or we would close. So we just don't see any big cash restructuring charges in the future. If one of these plants were not profitable enough for us to sustain, we would have a book value of fixed assets to write off non-cash.

Well Nietzsche said that which doesn't kill you strengthens you. So you guys have been tough enough and you're doing a wonderful job managing the balance sheet and you've got to look for a little help on the top line right there but that's all I have. Good morning, gentlemen.

There are no other questions at this time. I'd like to turn the call back over to you for any additional or closing comments.

Thank you. And again thank you for your participation and your interest in Culp. Happy holidays to all of you and we look forward to updating you on our progress next quarter.

That does conclude today's teleconference. Again, thank you for your participation. You may disconnect at this time.