Culp Inc (CULP) 2011 Q2 法說會逐字稿

Good day, and welcome to the Culp, Inc. second quarter 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 2011.

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 in 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 public release 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. A reconciliation of these non-GAAP financial measurements to the most directly comparable financial measurement is included in the schedule to the Company's press release and 8-K filed yesterday. This information is also available on the Investors Relations section of the Company's website, at www.culp.com. A slide presentation, with supporting summary financial information, is also available on the Company's website as part of the webcast of today's call.

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

Good morning, everyone, and thanks for joining us today. I'd 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 about Culp today and Ken will then review the financial results for the quarter. I'll then update you on some of the strategic actions in each of our businesses and, after that, Ken will review our third quarter business outlook, and then we'll be happy to take any questions you might have.

While our second quarter results reflect a much weaker US retail environment, our year-to-date sales, profitability and return on capital are up from the prior year. The uncertainty surrounding the economic outlook, a continued weak housing market, and high unemployment are all keeping US consumers on the sidelines. However, we have continued to perform well during this period, and we have strengthened our business models in both of our businesses. Additionally, we are pursuing international sales and marketing initiatives in our Upholstery Fabric business, especially in Europe and China. We are excited about the global appeal of our products, and the opportunity to reach new customers. Our strong financial resources are enable us to pursue a more active growth strategy during these challenging times.

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

Thank you, Frank.

Total sales for this quarter were $48.9 million, down 1.7% from the second quarter of last year. On a pre-tax basis, we reported income of $3.2 million, compared with $3.5 million in the second quarter of last year. We reported net income of $4 million, or $0.30 per share, for the second quarter of this fiscal year, compared with net income of $2.9 million, or $0.22 per share, for the second quarter of last fiscal year. Net income for the second quarter of fiscal 2011 includes an $801,000 income tax benefit, while the net income for the previous year included income tax expense of $625,000. The income tax benefit of $801,000 for the second quarter of this fiscal year is primarily due to the reversal of the non-cash valuation allowance against net deferred tax assets associated with the Company's China operations.

For the first half of fiscal 2011, total sales were $104.8 million, up 10% over the first half of last year. Pre-tax income was $7.5 million, compared with $5.5 million for the prior year, a 36% increase. We reported net income of $7.7 million, or $0.59 per share, compared with $4.8 million, or $0.37 per share, for the same period a year ago.

Overall return on capital was 25% for the second quarter of this year, compared with 23% for the same period a year ago. Capital employed at the end of this quarter was $62.7 million, compared with $55.6 million for the same time last year. Return on capital is a key measurement used by management for evaluating overall Company and business segment performance. The efficient use of capital contributes strongly to shareholder value.

Here are the results by operating segment. For Mattress Fabrics, we reported $28.3 million in sales for the second quarter, relatively even with sales of $28.2 million for the same period a year ago. Operating income for this segment was $3.3 million, compared with $4 million last year. Operating income margin was 11.7% of sales, compared with 14.3% of sales for the prior year period. For the first half of this fiscal year, Mattress Fabrics sales were $59.3 million, up 8.8% from the first half of last year. Operating income was $7.3 million, compared with $7 million last year, a 4.7% improvement. Operating income margin for the first six months of this fiscal year was 12.4%, compared with 12.8% for the same period last year. Return on capital for Mattress Fabrics segment was 29% through the second quarter of this fiscal year, compared with 30% for the same period a year ago. Capital employed for Mattress Fabrics was $51 million at the end of this quarter, compared with $47 million a year ago.

Now, turning to Upholstery Fabrics. Sales for the second quarter were $20.5 million, representing a 4.5% decline from $21.5 million in the second quarter of last year. Sales of China produced fabrics were $17.2 million in the second quarter of this fiscal year, a 4% decline over the prior year period, while sales of US produced fabrics were $3.4 million, down 6.8% from the second quarter of last fiscal year. Overall, the Upholstery Fabrics segment reported operating income of $802,000, or 3.9% of sales, compared with operating income of $1.1 million, or 5.1% of sales, for the second quarter of last year. For the first six months of this year, Upholstery Fabrics sales were $45.5 million, up 12% over the first half of last year. Operating income through the first half of this year was $2.4 million, up 30% over $1.9 million for the same period a year ago. Operating income margin was 5.3%, compared with 4.6% for the first six months of last year. Return on capital for Upholstery Fabrics segment was 39% through the second quarter of this fiscal year, which was unchanged from the same period a year ago. Capital employed at the end of second quarter of this year was $12.4 million, compared with $9.5 million a year ago.

Now, turn to the balance sheet. In light of the ongoing economic uncertainties, we remain diligent in maintaining a strong financial position. As of October 31, 2010 our balance sheet reflected $19.3 million in cash and cash equivalents and short-term investments. Total debt was $11.6 million, which includes current maturities of long-term debt and long-term debt. Our next major scheduled principal payment of $2.2 million is not due until August, 2011, which is next fiscal year. Our financial position is the strongest in our Company's history, and provides us with a competitive advantage, giving us sufficient capital and flexibility to support our growth strategies.

Key working capital measurements were as follows. Days sales and receivables were 28 days, compared to 31 days a year ago. Inventory turnover was 5.5 for the second quarter of this year, compared to 7.5 for the same period a year ago, and working capital turnover as of this quarter was 8.9, compared with 7.4 for the same period a year ago.

Frank?

Thanks, Ken.

I'll now provide you with an update on both of our operating segments. I'll start with Mattress Fabrics. Our Mattress Fabrics business delivered a consistent performance, in spite of weaker demand in the bedding industry. While sales were about the same level as the second quarter of last year, these results also reflected the planned discontinuation of a certain product line a year ago. On a comparable basis, we're pleased with the favorable sales trends in our continued product lines which were up 7%. We have benefited from our recent investments and initiatives to enhance our operations and develop an efficient and scalable manufacturing platform, however our probability for the second quarter was affected by increased competitive pricing pressures and higher raw material costs.

We have recently completed a capital project to expand the internal production of our knitted fabrics product line, our fastest growing category. Including the second quarter capital expenditures, we have now completed a five-year expansion in the Mattress Fabrics business, with a total investment of nearly $45 million, which included $25 million of capital expenditures plus $20 million for two successful acquisitions. With these investments, Culp is now well positioned with a large and modern vertically integrated manufacturing platform in the two major product categories of the matter Mattress Fabrics industries, and they are woven and knits. We have substantially improved upon our supply logistics from pattern inception to fabric delivery, as a result of these projects. With the completion of these expansions, our capital spending in Mattress Fabrics for the foreseeable future will be substantially lower, estimated at $2 million to $3 million annually for maintenance CapEx. With these major projects behind us, we can focus the majority of our efforts on product sales and marketing initiatives. Above all, we remain focused on execution for our customers, with outstanding service, reliable delivery performance, and consistent quality and value.

Now, a comment on Upholstery Fabrics. As expected, our Upholstery Fabrics were influenced by weak consumer demand for furniture. In addition to lower volumes, our profitability has been affected by rising raw material costs. In order to offset some of these increases, we implemented a price increase on certain products late in the second quarter.

Our China operation has continued to be a steady performer for this business segment, and accounted for 84% of sales in Upholstery Fabrics. While most of our China produced products have traditionally been sold to our US customers, we are also expanding our sales to the local China market. While the level of these sales is still small, we have been pleased with the favorable customer response and are excited about the opportunities that this market brings. At the same time, we are expanding our global reach with greater emphasis on sales to customers in Europe and other international markets. For the European market, we have recently formed a subsidiary, known as Culp Europe, incorporated in Poland. Culp Europe will be leasing a 25,000 square-foot building beginning in January, 2011, near Poznan, Poland. We plan to begin sales and distribution activities at Culp Europe early in the new calendar year, for upholstery fabrics sourced primarily from Culp China, but also from Culp's US operations, and possibly directly from outside suppliers. Our sales and marketing efforts in Europe will also include a program for shipping containers of fabric and cut and sew kits directly from Culp China to customers in Europe.

The investment required for this is principally working capital, which is estimated at 15% to 20% of the sales generated, and only a minimal amount of fixed assets, under $100,000 for warehouse equipment and leasehold improvements. We are investing some SG&A expenses in the start-up phase of Culp Europe. Locating in Poland, versus other European countries, has a number of advantages, including a high concentration of production manufacturers supplying the European market, low operating costs, excellent workforce, close proximity for shipping to customers in most European countries, and low income tax rates. Western and Central Europe combined represents the second largest furniture market in the world behind the US and Canada. The vast majority of upholstery fabrics used in Europe today are produced in China and Turkey. Furniture manufacturers, and in some cases retailers, buy directly from mills in these countries, as well as from local fabric distributors that also source from China and Turkish mills. We have been pleasantly surprised that fabric styling in Europe has many similarities with our current product line. While it's still very early in the development of Culp Europe, we are encouraged by the level of interest we're seeing from customers about our products and our new operation. We expect to begin sales from Culp Europe during the fourth quarter, and we'll continue to focus on product development, sales, and marketing initiatives in this segment during the balance of fiscal 2011.

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

We expect that the economic uncertainties and ongoing issues surrounding the housing market and high unemployment will continue to affect customer consumer demand for furniture and bedding products. Additionally, our third quarter of last year was exceptionally strong, especially in Upholstery Fabrics. Overall, we expect our sales for the third quarter of fiscal 2011 to be 5% to 10% lower than the third quarter of last year.

We expect sales in our Mattress Fabrics segment to be comparable with the same period a year ago. Operating income in this segment is expected to be somewhat lower than the same period a year ago, due primarily to higher raw material costs and increased competitive pricing pressures. In our Upholstery Fabrics segment, we are comparing to a strong third quarter of last year. We expect sales to be down approximately 10% to 20% for the third quarter. We believe the Upholstery Fabric's operating income will be significantly lower than the same time last year, due to lower sales and rising raw material costs.

Considering these factors, we expect to report pre-tax income for the third fiscal quarter of 2011 in the range of $2.6 million to $3.3 million. Given the volatility in the income tax area, income tax expense or benefit, and related tax rate for the third quarter of fiscal 2011 are too uncertain to project. This is management's best estimate at present, recognizing that future financial results are difficult to predict because of the overall economic environment.

Now, I'll turn it back over to Frank.

We are making excellent progress in this uncertain and unpredictable business environment. It is in times like these that we can achieve the greatest gains for our long-term competitive position. Our financial strength is enabling us to be more aggressive in the marketplace, while a number of our competitors around the world are struggling with lower demand and a weaker financial position. We will continue to build upon our economic [motes] in both businesses, and pursue sales and marketing initiatives, especially in Europe. Above all, we are focused on outstanding execution for our worldwide customers as a financially stable and trusted supplier of innovative fabrics, delivery performance and quality.

With that, we'll now take your questions.

(Operator Instructions)

We'll get our first question from Budd Bugatch with Raymond James.

Good morning, Frank. Good morning, Ken. This is actually Chad filling in for Budd, who's traveling this morning.

Good morning, Chad.

Frank, if you would, could you talk a little bit more about the European opportunity? I think you had indicated that it's the second largest furniture market in the world. Can you give us some specifics, in terms of the size of the market, the expected growth rate, maybe help us understand the competitive dynamics and maybe how that differs from the US, any additional color you could give us there.

Okay. As I said, it is the second largest furniture market in the world. The principal markets in Europe would be Germany, the UK, France, and more the northern countries in Europe.

On the competitive dynamics -- so it's a large market. There's no question about it. It's not as large as the US and Canada, but it is quite large. We also have learned that they tend to replace and turn over their furniture more frequently than the US, maybe an average of five years. We've also learned, as I've mentioned, that the product styling there is more similar than we may have expected. And we're pleasantly surprised that, certainly the majority of our current product line fits for our European new customers. We'll need to have a few new colors and some new patterns, but in general, particularly our faux leather and simulated leather products and our recycled leather products, are perfect for the European customers.

Other competitive dynamics that I mentioned, of course the sourcing of the fabrics is principally from Turkey and China. Like the US, the major upholstery fabric mills in Europe all have gone away as a result of the rise of the China production over the last decade. So there's only high-end producers left in mainland Europe. And of course, we are in the low to medium range of fabrics, not necessarily high-end. And of course with our China platform, that suits pretty well what we're looking to do in Europe. And so it just seems like to us, now is a good time to move into Europe, with a lot of the restructuring behind us, with the major projects we've done in Mattress Fabrics behind us, that the timing seemed to be right to see what kind of sales gains and market share we can achieve in the European marketplace.

Okay.

I know it is very early, but do have a sense maybe, or a long-term goal, of ultimately what percentage of Culp sales Europe could account for? Or, maybe asked another way, could your market share in Europe approach which your market share is in the domestic market?

I think it could. I do think it could approach our domestic market share. It's the second biggest market in the world, so if you're in the -- let's take upholstery fabrics, you want to be in the US and Canada, and you want to be in Europe, and you want to be in China. Then we can serve a few other international markets, like South Africa, the Middle East, Australia, South Asia, from China.

Okay.

It's certainly, now that we have the product range and the product for it, it is certainly a place we want to be.

Great. That's very helpful. Thank you.

Talking a little bit about -- switching gears to the domestic bedding market. We saw the release of the October ISPA data yesterday, which seemed to show a bit of a slowing or worsening trend. Could you give us a sense of what the pace of business was in the Mattress Fabrics through the quarter, was there any notable change in the year-over-year growth, and any sense of what you're hearing about retail demand for the month of November?

The highlight during the second quarter was the Labor Day weekend. And outside of that, it was pretty slow. It was a slower last part of the summer, and certainly slow, slower than maybe last year in October and September. It has picked up some from those periods, which is normal seasonal trends. And I'd say business today is okay. Certainly not maybe like it was, but we're hearing more signs, anecdotally, that it could be better come January through March. And we're hearing that on both sides, furniture and mattresses. Now, whether that will come true or not is, your guess is as good as mine, but we are hearing more optimism on the next few months.

Okay.

Frank, you had also said that CapEx for Mattress Fabrics, about $2 million to $3 million ongoing for maintenance CapEx. What's a decent expectation for Upholstery, or just kind of getting at a consolidated run rate going forward.

Half a million.

Probably half a million. Remember, the Upholstery Fabric model is not capital intensive. So, not a lot. So maybe a half a million a year.

So we're heading into a period of low capital expenditures, after coming off of several years of pretty high capital spending.

Absolutely. Okay.

One last question. You did a terrific job managing unallocated corporate expense in the quarter. Given how much it dropped sequentially, I'm sure part of that was incentive comp, but what's a decent way to think about that for the rest of the year, or maybe a run rate for the full year?

Somewhere in between second quarter and last year's --

The second quarter is a good barometer of where we are at going forward, so that's not very far off. Maybe plus or minus some money there, but that's pretty close. You won't be too far off if you use that number.

Chad, we are -- to wrap up here, too -- we are very well positioned in the US market here for our business to recover. When it'll get stronger, we don't know. But we are ready for both sides of our Upholstery and Mattress to respond really well to any pickup in demand in the US market.

Great. Well, thank you very much, guys, for answering my questions. Congratulations are due to you. You've managed extremely well through a pretty difficult environment. So, good luck for the rest of the year.

Thank you.

(Operator Instructions)

We'll go next to Craig Sirois with Value Line.

Hello, Frank. Hello, Ken.

Hello, Craig.

I'm just still stuck on trying to figure out your effective tax rate. Can you quantify the benefit from the evaluation allowance reversal?

Yes. It was about $1.3 million.

Excellent.

And keep in mind, too, that this is the way we put it in our release. Taxes are very, very hard to predict.

Right.

And we have to go through a very detailed evaluation and analysis each quarter, but when you factor out all the different issues with valuation allowances. I don't know, Frank, maybe 15% or 20% normalized rate. Again, we're not predicting that rate. That's just if you factor that out, and try to come out with a quote, unquote normalized rate. That's going to get you close.

And that's been more of our cash tax rate.

But keep in mind that we have to do this evaluation each quarter and it's a difficult process, and that's why it's so hard to predict.

And the Company still has a $60 million

Something like that.

US NOL.

$20.6 million valuation allowance that's still out there. All that has to be evaluated each quarter.

Okay. Thanks. That's all.

Thank you.

(Operator Instructions) At this time, it appears there are no further questions in queue.

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

Thank you, ladies and gentlemen, for your participation. This will conclude today's conference call.