Culp Inc (CULP) 2008 Q2 法說會逐字稿

Good day, everyone. Welcome to the Culp Inc. second-quarter 2008 results conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Ms. [Drew Anderson]. Please go ahead.

Thank you. Good morning and welcome to the Culp conference call to review the Company's results for the second quarter of fiscal 2008.

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 facts. 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 expectation.

In addition, during this call, the Company will be discussing non-GAAP financial measurements that exclude restructuring and restructuring-related charges. A reconciliation of these non-GAAP financial measurements to the most directly comparable GAAP financial measurements is included in the schedules in the Company's press release and 8-K filed yesterday. This information is also available on the Investor Relations section of the Company's Web site at www.CulpInc.com.

I will now turn the call over to Frank Saxon, Chief Executive Officer. Please go ahead, sir.

Good morning, everyone, 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 on the call today is Ken Bowling, our Chief Financial Officer.

I will begin the call with some brief comments and then turn it over to Ken, who will review the financial results for the quarter. I will then update you on some strategic actions in each of our operating segments and our third-quarter outlook. Then we will be glad to take any questions.

We delivered a solid performance in the second quarter of fiscal 2008 during what has continued to be a challenging retail environment for the furniture industry. Our year-over-year gains and profitability improvement reflects excellent growth in our mattress fabrics segment, primarily due to the acquisition of ITG's mattress fabrics business last year.

While our upholstery fabric sales have been affected by increasingly difficult industry conditions, we were profitable for the quarter. Also, our China platform and lower operating cost structure have positioned us to pursue sales growth more aggressively in this business, remain profitable on lower volume, and benefit from any upturn in demand. Additionally for the quarter, we were pleased with the strong cash flow from operations throughout the first half of the year, which has strengthened our financial position significantly.

I will now turn the call over to Ken, who will review our financial results for the quarter.

Thank you, Frank.

Total sales for the quarter were $64.3 million, up 9% from the second quarter of last year. These results reflect strong growth in our mattress ticking segment. However, our upholstery fabrics business continues to face a weak environment in the retail furniture business and soft demand for U.S.-produced upholstery fabrics. We will comment more specifically on each business segment in a moment.

Operating income was $3.2 million, or 5% of sales, compared with operating income of $2 million or 3.5% of sales last year, an increase of almost 60%, excluding restructuring and related charges for both periods. We reported net income of $1.6 million, or $2.12 per share, for the second quarter of fiscal 2008.

The financial results for the second quarter of fiscal 2008 included $503,000 or $0.04 per share in restructuring and related charges, after taxes. Excluding these charges, net income for the second quarter of fiscal 2008 was $2.1 million or $0.16 per share. These results reflect a significantly lower tax rate due primarily to the effect of the strengthening of the Canadian currency during the quarter on estimated Canadian taxable income. These results compare with net income of $812,000 or $0.07 per share for the second quarter of fiscal 2007.

The financial results for the second quarter of fiscal 2007 included $232,000 or $0.02 per share in restructuring and related charges, after taxes. Excluding these charges, net income was $1.044 million or $0.09 per share.

I'd like to now review our results by operating segment. With respect to mattress fabrics, also known as mattress ticking, we reported $36 million in sales for the quarter, a 53% increase compared with $23.5 million for the same period last year. These results include the additional incremental sales related to the Company's acquisition of ITG's mattress fabrics product line in January of 2007 and some organic growth. Mattress ticking sales accounted for 56% of overall sales during the quarter.

Total yards sold were up 48% compared with the same period a year ago. The average selling price of $2.39 per yard for mattress ticking for the second quarter of fiscal 2008 was 4% higher than the average selling price for the second quarter of last year, reflecting a shift in product mix through increased sales of substantially higher-priced knitted ticking.

Operating income for this segment was $3.9 million or 10.8% of sales. For the prior-year period, operating income was $2.5 million or 10.5% of sales. This improvement in our operating performance in mattress ticking over the same period a year ago reflects higher volumes, increased knitted ticking sales, and full plant utilization.

Now, turning to the results of our other operating segment, upholstery fabrics, sales were $28.3 million, which include both fabric and cut-and-sewn kits, representing a 20% decline from $35.5 million in the second quarter last year. Total fabric yards sold were down 25% compared with the same time last year, while average selling prices were approximately 3% higher than the same quarter of last year.

Sales of upholstery fabrics reflect very weak overall industry demand for furniture related to the slowing economy, a weak housing market, and high gas prices. We also see continued soft demand industry-wide for U.S.-produced fabrics driven by consumer preference for leather and suede-covered furniture and other imported furniture and fabrics. Sales of non-U.S.-produced fabrics were $16.9 million in the second quarter, down 18% over the prior-year period. Sales of our U.S.-produced fabrics represented 60% of total upholstery fabric sales for the second quarter. Sales of U.S.-produced fabrics were $11.4 million, down 24% from the second quarter of fiscal 2007. Overall, the Upholstery Fabrics segment reported operating income of $201,000 for the second quarter, compared with $393,000 for the same period last year.

Let me now turn to the balance sheet. At the end of the second fiscal quarter, our balance sheet reflected $16.8 million in cash and cash equivalents, representing a substantial improvement in cash flow from operations, which was approximately $10 million for the year-to-date period. This performance is due to increased profitability and significant improvement in working capital management. Examples of this working capital improvement are the reduction in Days Sales Outstanding to 32 days this quarter from 36 days this time last year, an 11% improvement, and the increase in working capital turnover to 5.5 this quarter from 5.2 a year ago, a 6% improvement.

Total debt was $39 million at the end of the second quarter, compared with $47 million a year earlier, a decrease of 17%. Our debt to capital ratio has improved significantly and was 32% at the end of the second quarter, compared with 37% a year earlier.

Included in our $39 million in total debt is $27.7 million of debt relating to our term notes. After the end of the second quarter, we prepaid and additional $4.3 million against a large principal payment on these term notes that is due in March, 2008. Originally, this principal payment was $19.8 million. Including the $4.3 million prepayment, the Company has now prepaid, over the last eight months, a total of $11.5 million against the original scheduled payment, which leaves only $8.3 million of this year's principal payment due in March 2008. Currently, the Company has sufficient funds available to make the remaining principal payment, which is due in March, 2008. Once the March 2008 principal payment is made, the outstanding balance on the term notes will be $15 million.

I will now turn the call back over to Frank.

Thank you, Ken. I will now talk about the progress we are making in both of our operating segments. We will start with mattress ticking. Culp's mattress fabrics business continued to build momentum with sales up over 53% over the same period a year ago. The mattress industry has consistently outperformed other home furnishings categories, even with the recent downturn in the housing market. The strong demand for mattresses has been primarily driven by a steady replacement business, as the industry has continued to promote the benefits of healthy sleep. Additionally, the trend toward building larger homes and vacation homes, demographic trends, targeted retail marketing strategies, and the growing popularity of specialty bedding products have all been positive factors for the mattress industry.

Culp has continued to enjoy excellent customer relationships, as we have benefited from a favorable customer retention rate following the ITG acquisition. With the integration of the ITG business completed, we are now fully realizing the benefits of the additional sales and more efficient production. Knitted ticking, which has a higher average selling price, continues to be a higher growth product category for us. The results for the quarter were affected by modestly higher raw material costs and increased Canadian operating costs due to the strengthening of the Canadian currency as compared with the same period a year ago.

For the second half of this fiscal year, we are implementing two significant capital projects in this business with the objectives of lowering cost even further and providing more internal reactive capacity in our U.S. operation. With an increase in internal capacity, we will also be able to operate on lower inventories and provide faster response time to our customers in the JIP environment which characterizes the mattress and mattress fabrics industry. Additionally, these capital projects will position us to more realistically consider further growth opportunities.

The first project, to be completed by March, is for a second state-of-the-art hotmelt finishing line. This equipment will allow us to improve product values offered in terms of cost, quality, and softness. Further, it will provide enhanced lamination capability.

The second project, to be completed by the end of April, is for the installation of new weaving machines in our North Carolina facility. This equipment will also help us lower cost and increase our internal reactive capacity, especially during the peak seasons of demand.

These projects total $4.4 million with $1 million spent in fiscal 2008, $1.5 million to be spent in fiscal 2009, and the $1.9 million thereafter.

For fiscal 2008, we are focused on maintaining our high level of execution and service for our customers, effectively managing an increased amount of working capital, and pursuing opportunities to build upon our leadership position in the mattress fabrics industry.

Now, I will give you an update on our Upholstery Fabrics segment. The results for the segment mirror the challenging operating environment across the retail furniture industry. The uncertain economy, depressed housing market, and high energy prices are all adversely affecting consumer spending for furniture. Likewise, overall demand for upholstery fabrics has been affected. While our non-U.S. operations now account for 60% of all Upholstery Fabrics sales, those sales have also recently been affected by the weaker furniture demand.

We were pleased to report another profitable quarter in Upholstery Fabrics in a very difficult operating environment. This performance is primarily driven by our non-U.S. operations, which are mostly in China. We have significantly improved our cost structure with lower U.S. manufacturing cost and substantially lower SG&A expenses for the second quarter of this year. SG&A expenses were down $1 million or 26% from the same period a year ago. As difficult as these decisions are, we are continuing to take steps to lower our costs and keep them in line with expected demand in this business. We've also reduced our inventory levels in the Upholstery Fabrics segment by almost $10 million or 32% since the second quarter of last year.

We continue to be excited about our progress in China and the business model we have developed over the last several years. As our customers and furniture retailers have moved increasingly more of their fabric and furniture purchases to China, Culp has moved with them. We've responded with a state-of-the-art operation designed to meet their fabric needs in terms of providing American design and color along with U.S. quality standards. Today, we have a substantial, wholly-owned operation with over 450 associates, which includes capabilities for finishing, velvet manufacturing, cutting and sewing, along with a network of key long-term strategic suppliers. With the excellent product values we are now offering from our China platform, we are aggressively pursuing topline growth, especially given the near-term industry outlook.

In addition, our focus for fiscal 2008 is on improving gross profit in our U.S. operations, developing differentiated products, and improving our supply chain.

Ken will now review the outlook for our third quarter, and then I will have a few concluding remarks.

We believe our Mattress Fabrics segment will continue to perform well. However, we do not expect to see any near-term relief from the challenges facing the Upholstery Fabrics segment.

Overall, we expect our third-quarter sales to be slightly higher than the third quarter of last year. We expect sales in our Mattress Fabrics segment to be up approximately 30% to 35% for the third quarter.

The third quarter of fiscal 2007 included $1 million in incremental sales related to the Company's acquisition of ITG's mattress fabrics product line completed in January of 2007.

Operating income in this segment is also expected to improve substantially, compared with the prior-year period, due to higher sales and the completion of the ITG integration.

In our Upholstery Fabrics segment, we expect sales to be down approximately 15% to 20% for the third quarter, due primarily to lower sales of U.S.-produced fabrics. We believe the upholstery fabrics segment's operating results will reflect approximately breakeven results, due primarily to lower sales and weak profits in our U.S. operations. However, we still expect continued solid gross profit margins in our non-U.S.-produced business and significantly lower selling, general and administrative expenses as compared to the third quarter of the prior year.

We are estimating approximately $500,000 of restructuring and related charges during the third fiscal quarter, due primarily to employee termination benefits and operating costs of closed U.S. facilities. At this point, we estimate that we will incur an additional $200,000 of restructuring and related charges during the fourth fiscal quarter for previously announced restructuring initiatives.

Considering these factors, we expect to report net income in the third quarter in the range of $0.07 to $0.11 per share, excluding restructuring and related charges for previously announced restructuring initiatives. This is management's best estimate at present, recognizing that future financial results are difficult to predict. The actual results will depend primarily upon the level of demand throughout the quarter.

As explained earlier, we estimate that restructuring and related charges of approximately $500,000, $415,000 net of taxes, or $0.03 per share, will be incurred during the third fiscal quarter. Including the restructuring and related charges, the Company expects to report net income in the third fiscal quarter in the range of $0.04 to $0.08 per share.

I will now turn the call back over to Frank.

We're making sound progress so far in fiscal 2008 as we execute our strategy and build upon the leadership positions we enjoy in both of our operating segments. Our mattress fabrics business will continue to be the key driver of our growth this year. We have significantly enhanced our competitive position in this business with the successful integration of the ITG purchase, and are excited about the incremental value and synergies this acquisition is bringing to us.

Our upholstery fabrics business is being affected by the extremely challenging conditions in the furniture industry. However, we believe we are positioned well to withstand the current downturn and report better results as conditions improve.

Our China platform provides the sustainable business model for Culp to compete effectively in the global upholstery fabrics industry and to begin growing this business again.

Overall, we are pleased with our progress and remain focused on achieving profitable growth over the long-term.

With that, we will now take your questions.

Thank you. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). Chad Bolen, Raymond James.

Good morning, Frank. Good morning, Ken. I had a couple of questions for you. In the press release, you did mention the significantly lower tax rate due to the strengthening of the Canadian currency. Could you sort of walk me through the mechanics of that, and just help me understand how that works, and then what implications do you see going forward?

Well, Chad, that's a difficult question because of the uncertainty we've seen in the currency over the last, as you know, September and October. What it was is we have of course operations in Canada, and we have certain accounts that are denominated in U.S. dollars that have to be converted to Canadian dollars. All of that affects how we calculate our tax rate going forward, which we have to calculate each quarter. We project out what our tax provision is going to be for the year, and we look at that each quarter based on the current facts we have on-hand. So with the strengthening of the Canadian currency in September and October, when we sat down and did our tax provision, it came out to be a tax benefit this quarter.

Now, going forward, it's kind of hard to predict. We have seen, after the quarter ended, we have seen the Canadian currency begin to weaken, but who knows what's going to be, what lies ahead in our third quarter. But that's kind of what happened to us in the second quarter.

Okay. You gave us the details on the expenditures for the two new capital projects. Could you give us an idea of your total expectations for CapEx for '08 and '09?

The '09 numbers, we're still -- will be relatively small in the -- probably right now $3 million, $4 million. We haven't firmed up anything but will not have a lot of capital expenditures in those years. In '08, on a GAAP basis, rather than a cash basis, we are looking at probably $7 million. As I mentioned in my remarks, most of this new project, the cash portion is deferred until '09, '10 and fiscal '11.

Okay. Given that you guys will have the $8 million payment left in March and you do have sufficient cash on the books right now to take care of that, fairly modest expectations for CapEx going forward, what do you anticipate as being kind of your priorities for cash going forward?

The first priority still for us is debt reduction, and second would be we will build cash and we will see where we go from there. Today, it's still debt reduction.

Okay. Can you give us a sense, as far as the Upholstery segment, the gross margins there? U.S. versus China, are you upon a year-over-year basis in both?

Chad, as you guys know from earlier comments, we really don't break out those. But I will tell you, as we have certainly implied in all of our disclosures, the China gross profits have been solid, as we've characterized them, and the U.S. have been weak. One of our top priorities each year of course is improving the gross profit in our remaining U.S. operations, which we have one plant left in Anderson, South Carolina, our velvet operation. So, that's how I would answer that for you.

Okay. A last quick question -- in the Upholstery segment, as far as the revenue that's not related to yards, is that all cut-and-sew, or are there other components there? It looked like there was about $1.3 million, $1.4 million in the quarter.

Yes, all cut-and-sew.

So it looks like that was more than doubled year-over-year?

Yes, the cut-and-sew business is growing very nicely.

All right, thanks, guys.

Laura Champine, Morgan Keegan.

This is actually Ike Borcia calling in for Laura this morning. Could you talk about the market share that you guys have in both the mattress ticking and the upholstery fabrics segments?

Let's answer it this way, Ike, that there's not industry data available anywhere, as you may know, in either of our segments. What we have said is we believe we have the leading market share in certainly mattress ticking, a substantial lead in that industry. In the upholstery fabric area, we believe we're still the largest, although not by the same amount as mattress ticking. The upholstery fabrics business is much more fragmented than the mattress fabrics business.

I'm a little concerned about the double-digit declines in the non-U.S. upholstery sales in the last two quarters. Could you give a percentage of total upholstery sold in the U.S. that's direct-sourced from Chinese producers?

You know, again, nothing publicly available on that. It's anecdotal evidence and what we see from our customers, what we see and estimate for furniture coming from China, but it's obviously, in our review, north of 50% and could be approaching 60%, 70%.

Again, nothing available, but there has been significant pressure on demand for U.S.-produced fabrics. Of course, in the last year, we've lost two major U.S. fabric producers in Mastercraft and Quaker Fabrics.

Right. I mean, I know that's an estimate on your end. Could you shed any color on what Culp presents in terms as a percentage of that number?

Well, we believe we are the largest. We are in the medium to lower-priced category; we're not in the high-priced, higher-priced categories. But we believe are the largest from the data and anecdotal evidence that we see.

All right, thank you very much.

Kevin Oram, Praesidium.

Thinking long-term, I don't know how much you can actually comment on this, but in the upholstery business, after we get through this downturn in, whenever that is, I'm not asking for kind of timing on this, but you know, if you kind of look out however many years, a few years, kind of at normalized state, or kind of the new normalized state in the upholstery industry, can you give us any idea what kind of margin structure you guys think you could get in the upholstery business?

I think, long-term, Kevin, as we work through the current downturn, we could -- it would not be unreasonable to have a 5% operating margin.

Remember, this is a -- the model we've developed is a low-capital model, so even a 5% operating margin could be a very excellent return on capital.

Yes.

I would say take the opportunity is -- we are as excited about this business as we've ever been, including me and our team. Yes, things are difficult now, but you know, you can make the most progress in gaining market share in downturns than you can when everything is going well. So the steps we've taken in China, which we've only been in China four years, from what we've put together, I'm just very confident that will bring very good results for us as we see the downturn end, which will occur sometime in late 2008 probably, maybe even 2009. But we are very -- it's very optimistic about where -- how our position is today.

Okay. All right, good. Thanks, guys.

(OPERATOR INSTRUCTIONS). Michael [Wasserman], Moors & Cabot.

It's nice to see the progress the Company is making despite the difficult environment in upholstery. Are you actively looking at any acquisitions now in either ticking or upholstery?

Michael, we are always open to opportunities over the last year, as you saw with the purchase of ITG's mattress fabrics business. As our balance sheet has improved, we certainly have more capability to consider opportunities that might arise. So, we really don't comment on anything specifically, as you may know from earlier calls, but we are open to additional opportunities.

Is it fair to assume, given the difficult environment, that there's a fair amount of stuff for sale out there at the moment?

I don't know that I would say that. I think it is fair to say that a lot of competitors in both businesses -- it's a very challenging time and many people are struggling. That's from our view. So, there could likely be opportunities down the road.

Okay. I know you said the goal is a debt reduction, which I know it's been for a number of years. Assuming you don't have any acquisitions in which to put your money in the next several years, would the goal be debt elimination?

I would think so, yes. But my guess is we will have -- from what I can see, I think there probably will be places to put our money to work, where we can return excellent returns on capital. You know, in our mattress fabrics business, as you see, we are over 30% return on capital the first six months of this year, and so you know, that's certainly better than return than even repurchasing stock or things like that.

Last question -- should the Chinese currency appreciate more rapidly, how will that impact the Company and how are you planning for that possibility?

That's a good question, and that certainly is in our planning. It has increased over 10% since August '05, when the Chinese government began letting or removing the fixed peg to the U.S. dollar. Our expectation is in line with many other sources. It's probably 5% to 7% appreciation against the U.S. dollar, annually, for the foreseeable future. Our plans are we will continue to do what we've always done -- engineer products with the cost structure that we have. That's the environment we lived in, in the U.S., for years and years.

Secondly, the other initiative that we are beginning is to begin to go after the local market in China where that currency change and strengthening doesn't affect us. China is still the fastest -- fastest or one of the fastest-growing economies in the world. It is important to us to participate in that, in the consumer market there, with our fabrics going to furniture producers in China. That's a longer-term strategy, but it's now something we're able to turn our attention to with the progress we've made.

Okay, thank you very much. I appreciate the good job you gentlemen are doing.

Super. Thank you very much.

It appears we have no further questions at this time. I'd like to turn the call back over to our speakers for any additional or closing remarks.

That's all we have. Thank, everyone, for joining us today, and we will look forward to updating you on our next quarterly call.

Once again, that does conclude today's call. We do appreciate your participation. You may disconnect at this time.