Culp Inc (CULP) 2011 Q3 法說會逐字稿

Good day and welcome to the Culp, Inc. third quarter results conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Ms. Drew Anderson. Please go ahead.

Thank you. Good morning, and welcome to the Culp conference call to review the Company's results for the third 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 & 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 nonGAAP financial measurements. A reconciliation of these nonGAAP financial measurements to the most directly comparable GAAP financial measurements is included as a schedule to the Company's 8-K filed yesterday. This information is also available on the Investor Relations section of the Company's website at www.culp.com. Additionally a slide presentation with supporting financial summary information is available on the Company's website as part of the webcast of today's conference call.

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

Good morning, and thank everyone 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 about Culp, and then Ken will row view the financial results for the quarter. I will then update you on the strategic actions in each of our operating businesses. After that, Ken will review our fourth quarter outlook, and then we will be glad to take your questions.

Given the continued macroeconomic challenges, and increased raw material costs we experienced, we are pleased with our results for the third quarter, even though they are down from last year's strong third quarter performance. For the year-to date-period, our sales and profitability are up over the prior year, and we continued to report solid returns on our capital. Further our net cash position, cash minus debt, is the highest in the Company's history, and our cash position of almost $23 million now represents almost 30% of shareholders equity.

Our strong finances are enabling us to pursue an aggressive growth strategy during these challenges times. We continued to identify new opportunities for growth by expanding our international sales and marketing initiatives primarily in our Upholstery Fabrics business. We are excited about establishing a European sales and distribution platform with our new operation in Poland, and a planned operation in the UK.

We are very encouraged by the initial reaction from customers as we enter these markets, and begin to capitalize on the global appeal of many of our products in Europe. These initiatives present an opportunity for us to build a significant presence over time in the world's second-largest furniture market for fabrics, with minimal risk and investment mainly in working capital only. We are optimistic that our European platform may also provide the opportunity to sell and distribute Mattress Fabrics in the future.

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

Thanks, Frank. Total sales for this quarter were $51.7 million, down 4.3% from the third quarter of last year. On a pre-tax basis, we reported income of $2.9 million, compared with $3.8 million in the third quarter of last year. We reported net income of $2.4 million, or $0.18 per diluted share for the third quarter this fiscal year, compared with net income of $3 million, or $0.23 per diluted share for the third quarter of last fiscal year.

For the first mine months of this fiscal year, total sales were $156.4 million, up 4.9% over the same period last year. Pre-tax income was $10.4 million, compared with $9.3 million for the prior year, an 11% increase. We reported net income of $10.2 million, or $0.77 per diluted share, compared with $7.8 million, or $0.60 per diluted share for the same period last year.

Overall return on capital was 23% through the third quarter of this fiscal year, compared with 25% for the same period a year ago. Capital employed at the end of this quarter was $65.7 million, compared with $58.9 million for the same time last year. We believe return on capital is a key performance measurement, and it is used by management for evaluating overall Company and business-segment performance. We also believe that the efficient use of capital contributes strongly to increased shareholder value.

Here are the results by operating segment. For Mattress Fabrics we reported $28 million in sales for the third quarter, up 3.9% compared with sales of $27 million for the same period last year. Operating income for this segment was $2.8 million, compared with $3.6 million last year. Operating income margin was 10.1% of sales, compared with 13.2% of sales for the prior-year period, for the first nine months of this fiscal year, Mattress Fabrics sales were $87.2 million, up 7.1% for the same period the prior year.

Operating income was $10.1 million compared with $10.5 million, down 3.9%. Operating income margin for the year to date period this fiscal year was 11.6%, compared with 13% for the same period last year. Return on capital for Mattress Fabrics segment was 26%, through the third quarter of this fiscal year, compared with 30% for the same period a year ago. Capital employed for Mattress Fabrics was $54 million at the end of this quarter, compared with $49 million a year ago.

Now turning to Upholstery Fabrics. Sales for the third quarter were $23.7 million, representing a 12.5% decline from $27 million in the third quarter of last year. Sales of China-produced fabrics were $20.7 million in the third quarter this fiscal year, an 11.6% decline over the prior-year period, while sales of US-produced fabrics were $2.9 million, down 18% from the third quarter of last fiscal year.

Overall the Upholstery Fabrics segment reported operating income of $1.1 million, or 4.8% of sales compared with operating income of $2.5 million, or 9.1% of sales for the third quarter of last year. For the first nine months of this fiscal year, Upholstery Fabrics sales were $69.2 million, up 2% over the same period last year. Operating income through the first nine months of this year was $3.5 million, down 18.1% from $4.3 million for the same period last fiscal year. Operating income margin was 5.1%, compared with 6.1% for the same period last year.

Return on capital for the Upholstery Fabrics segment was 38% through the third quarter of this fiscal year, compared with 56% for the same period a year ago. Capital employed at the end of the third quarter of this year was $12.5 million, compared with $12.4 million a year ago.

Now I will turn to the balance sheet. We remain focused on maintaining a strong balance sheet throughout this uncertain economic environment. As of January 30th 2011, our balance sheet reflected $22.8 million in cash and cash equivalents and short-term investments compared with $19.3 million at the end of the second quarter. Total debt was $11.6 million.

Our next major scheduled principal payment of $2.2 million is not due until August 2011, and represents the first of five equal annual payments, our strong financial position provides us with a competitive advantage, giving us sufficient capital, and flexibility to support our growth strategy. Key working capital measurements were as follows. Days Sales and Receivables or DSOs were 28 days, compared to 33 days a year ago. Inventory turnover was 6.2 for the third quarter of this year, compared to 7.0 for the same time last year. Working capital turnover as of this quarter was 8.5, compared with 8.3 for the same period a year ago.

As we look forward to the fourth quarter of next fiscal year, we are encouraged by the positive outlook for building our cash position further. We expect continued solid cash flow from net income plus non-cash expenses, or what we call gross cash flow. With respect to uses of cash for next fiscal year, we expect lower CapEx spending in the $3 million range, modest working capital investment, and a debt payment of only $2.2 million.

Frank?

Thank you, Ken. I will now provide you with an update on both of our businesses. Our Mattress Fabrics business has continued to deliver consistent performance this year. Sales were higher compared with the strong third quarter period in fiscal 2010. Even with the discontinuation of our product line a year ago. On a comparable basis, we are pleased with the favorable sales trends in our continuing product lines, which were up 8%. We have benefited from our recent investments in initiatives to enhance our operations, and develop an efficient and scalable manufacturing platform.

However, our profitability for the third quarter was affected by higher raw material costs. To offset these costs we have announced price increases that will be in effect for most of the fourth quarter. Unfortunately, we are not seeing any improvement in global pricing trends for raw materials over the near term. We have continued to enhance our capabilities in Mattress Fabrics, and Culp is well positioned with a large and modern vertically integrated manufacturing platform in the major product categories.

We have substantially improved upon our supply logistics from pattern inception to fabric delivery. With the completion in the second quarter of this year, of our multi-year $45 million capital investment initiatives, we are now more focused on product development and sales and marketing initiatives. Most importantly, we remain committed to execution for our customers with outstanding service, reliable delivery performance, and consistent quality and value.

Now I will comment on Upholstery Fabrics. As expected, our Upholstery Fabrics sales were influenced by weak consumer demand for furniture. Our business was also affected by the rising raw material costs. However, in spite of these factors, we remain solidly profitable for the year-to-date period. Going forward to offset some of these higher costs, we have implemented price increases that will be realized during the fourth quarter.

Our China operation has continued to evolve, and China-produced products accounted for 80% of sales in our Upholstery Fabrics business. While most of the China-produced products have traditionally been sold to our US customers, we have also expanded our sales to the local China market, and certain international markets. We have been pleased with the positive response from customers in these areas, and are excited about the additional opportunities to leverage our substantial China platform.

I would now like to give you an overview of our new European growth initiatives. We have continued to look for new market opportunities outside of the US,and further extend our global reach in Upholstery Fabrics. As we discussed with you last quarter, we have recently formed a new wholly owned subsidiary, called Culp Europe, which is incorporated and located in Poland, to sell and distribute fabrics and to make and sell cut and sewn kits.

We believe the location in Poland has a number of advantages, including the highest concentration of furniture suppliers to the European market, low operating cost, an experienced work force, and close proximity to shipping to customers in most European countries. This is an attractive market opportunity for Culp, as Western and central Europe together represents the second largest furniture market in the world behind North America. During the fourth quarter of this fiscal year we expect to begin sales activities at Culp Europe for Upholstery Fabrics, which will be sourced from Culp China, Culp US, and certain outside suppliers. Also we are setting up a small fabric cut and sew operation at Culp Europe.

While this operation is still in its early stages of development, we are encouraged by the level of interest from our customers so far. The investment required for our Poland operation is principally working capital, which is estimated at 15% to 20% of sales generated, and only a minimal amount of fixed assets, under $100,000. We are investing some SG&A expenses in the start-up phase of Culp Europe. 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 same similarities with our current product line.

Along where our efforts in Poland, we have signed a letter of intent to establish a joint venture in the United Kingdom, known as Culp UK, to sell and distribute Upholstery Fabrics throughout the United Kingdom. Culp will be the majority partner and again our investment will be mainly for working capital to support sales growth and minimal startup expenses. The UK market is sizable, and also unique due to the flame-retardant requirements of Upholstery Fabrics that are different from other countries in Europe, and anywhere in the world for that matter. Through this joint venture, we will partner with a local UK company called Flame Proofings, who has extensive expertise in the application of flame-retardant coatings, and also has significant business and customer relationships in the UK.

In addition to providing flame-retardant coatings for Culp UK, Flame Proofings, will contribute its small fabric distribution business to Culp UK providing a new venture with a base of business to start operations. Fabrics will be sourced from Culp China, Culp US, and outside suppliers. We believe this joint venture offers a unique opportunity to bring together Culp's innovative design and global supply network, with an established UK supplier of flame-retardant coatings, who has existing customer relationships and extensive market knowledge. We expect to commence operations at Culp UK during the May to June 2011 time frame.

We expect these two operations will work together to serve the European marketplace. Many furniture manufacturers in Poland also sell into the UK, and a number of UK retailers and manufacturers supplement their furniture production with sourcing from Poland and other Eastern European countries. To help provide excellent service to customers in these new operations, we have developed a standard set of globally integrated and web-based IT systems, for their sales distribution and sourcing activities. These systems will have multi-currency and multi-lingual capabilities.

While the initial focus for our European platform is to sell upholstery fabrics, we are optimistic about the potential opportunity to also sell and distribute mattress fabrics in the future. We are excited about these new opportunities and look forward to growing our business with many new customers throughout Europe. Ken will now review the outlook for the fourth quarter, and then I will have a few concluding remarks.

While there are some indications that the US economy is gaining traction, we believe the ongoing issues surrounding the housing market and high unemployment will continue to affect US consumer demand from furniture, and to a lesser extent bedding products. Overall we expect our sales for the fourth quarter of this fiscal year to be 2% to 7% lower than the fourth quarter of last year. We expect sales in our Mattress Fabrics segment to be flat to slightly lower than 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 pricing pressure.

In our Upholstery Fabrics segment, we expect sales to be down 4% to 9% for the fourth quarter. We believe the Upholstery Fabrics segment's operating income will be significantly lower than the same time last year, due to lower sales and higher raw material costs. Considering these factors, we expect to report pre-tax income for the fourth fiscal quarter in the range of $3.8 million to $4.4 million. Given the volatility in the income tax area, the income tax expense or benefit and related tax rate for the fourth quarter of this fiscal year are too uncertain to project. This is management's best estimate at present, recognizing that future financial results are difficult to predict because of overall economic uncertainties.

Frank?

Our results to date for fiscal 2011 demonstrates that we are successfully navigating through this challenging period of economic weakness and uncertainty. We have created flexible business models in both of our businesses that have allowed us to remain solidly profitable, and at the same time have positioned us for significant growth as demand in the US improves, and our international sales initiatives develop. Our Mattress Fabrics business has been a consistent performer this year even in the challenging environment, and we are realizing the benefits of our enhanced manufacturing capabilities. In the Upholstery Fabric business we have exciting new business opportunities ahead with our successful China platform, and our new sales and distribution initiatives in Europe.

Above all, we are focused on outstanding execution for our customers, as a financially strong and trusted supplier of innovative products with excellent quality and delivery performance.

With that, we will now take your questions.

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). We will proceed in the order that you signal us, and take as many questions as time permits. (Operator Instructions). We will pause a moment to assemble the queue. We will take our first question from Budd Bugatch with Raymond James.

Good morning, Frank, good morning, Ken, this is Chad filling in for Budd.

Good morning, Chad.

Thanks. Congratulations on another very solid quarter.

Thank you.

Thank you.

Frank, Mattress Fabrics up 8% when you adjust for the product line exits, that growth rate looks pretty healthy relative to kind of the ISPA stats that we have seen, at least so far for the quarter. How much of that do you think is the market growth rate, how much do you think is more specific to what you are doing?

I would say the majority is market growth, and we are certainly picking up some share gains, but the market has been pretty good for the third quarter.

Okay. And with regard to what you are doing in Europe, I mean obviously it is a pretty sizable market opportunity over there. Could you quantify for us, either kind of your expectations or maybe a reasonable range of expectations for a revenue contribution or profitability over the course of the next year or so?

Well first of all from a long-term basis, Europe is the second-largest market opportunity after the US. What we see already is that many customers value service and quality, and not always so much price as we see a lot in the US, which is encouraging to us. The near-term, we will have some sales next year, but probably in the fourth quarter, first and second, we are still in a start-up mode, so I wouldn't be looking for a whole lot the first fiscal year, although the second half of the first fiscal year, next fiscal year, we should start seeing some nice contribution in sales from those two operations. I think Chad, it is just most important that we have a substantial opportunity to build long-term significant growth in that marketplace. And when I said long-term, three to five years, and of course build a business that we can have there for many, many years, not to mention the benefits of diversifying our overall sales mix more globally with being important in Europe.

Okay. That is great. Thank you. As you look at the raw material issue, can you give us a sense of what the impact was, either it may be in dollars or margin-basis points in terms of what you saw this quarter, and as we look ahead, will that year-over-year impact get worse in the fourth quarter? Not taking into account any of the price increases?

Well, I think you see from our guidance that it won't be worse than the third quarter, because we have issued some price increases in both businesses, but it is still tough to stay totally ahead of the increases. It all began with cotton, and that has trickled down to polyester, rayon, and polypropylene, and what we are seeing there and cotton still is under prepricing pressure, prices are high, which has effected polyester, which is the main fiber we use, and most fabric and mattress fabric suppliers use, so I think that we are in for some continued pressure. But we will have to just continue to adjust pricing as we are doing in the last two quarters.

Sure. Can you quantify for us a range of what the price increases are? And will it be enough to completely offset the inflation, or is it expected to partially offset it?

Let me answer it this way. I would say that the majority of the margin decline in the third quarter is due to raw material pricing.

Yes.

The majority, and in the fourth quarter the same, and a little bit in fourth quarter is the lower sales in upholstery, but the majority of it is raw material price increases, and we are doing our best to try to get to adjust prices, but it is not easy when the demand is soft out there to get all of the price increases that we would like to have, so we are getting what we think we can realistically get in this environment, and it is affecting margins somewhat, but when you look at the big picture, given what we have gone through this year, in terms of the raw material pricing environment, high unemployment, all of the adverse economic factors, we really looking pretty good through nine months, and going to have a darn-good year given those factors.

Okay. And last question for me, and I keep having to ask the same question each quarter, because you continue to do a great job generating cash, and building up the cash on the balance sheet, so what are your strategic priorities for cash? I mean, how should we think about either potential acquisitions, or other shareholder-friendly-type actions?

As we disclosed last year, number one priority is to fund working capital growth, to fund sales growth as we are doing in the European initiative, and you could see more of those in the future, and we want to have the funds to do that, so that is number one, number two as we said is capital expenditures, as necessary, maintenance or expansion. In that area, we said we really see low capital spending for the next two years or so, with Mattress Fabrics having completed $25 million of expenditures over the last 4.5 years. We are in good shape on expansion of that, so we are looking at maintenance CapEx.

The third area we talk about is potential acquisitions, but we are going to be very diligent and cautious in any acquisitions that we might consider, and fourth is just we think the world is increasingly uncertain and volatile, and having a strong balance sheet in these times seems to be more important every quarter that progresses. It really hard to predict what the geopolitical environment will look like, the economic environment, so having a strong balance sheet these days is just continuing to be very, very important to us. And at this point, we have said no, we are not looking at any dividends or share repurchases until some of these other initiatives and priorities are fulfilled.

Okay. Well, thanks, Frank. Thanks, Ken for taking my questions. Congratulations again, and good luck to you.

Thank you.

Thank you, Chad.

(Operator Instructions). And we'll take our next question come from Jeff Matthews with Ram Partners.

Hi, I am just curious as most of the other people on the call probably know all of this already, but I wondered if you could talk about this European initiative, and why now, what makes it so attractive, especially now? And number two, overall what the competitive environment is like for you? I am not talking about day-to-day pressures, but just the major players. What the lay of the land is now today versus five years ago, ten years ago, for example? Thank you.

Very good question. Why now for Europe. We have been the past eight years, I don't know how well you know us, but we have been restructuring our US Upholstery Fabric business, and moving to China over an eight-year period, that was completed about two years ago. Over the last five years, we have spent $45 million in our Mattress Fabric business on two occasions and capital spending. So we really had our hands full, and were not in a position to really undertake another major initiative.

But once the Mattress Fabric multi-year program was complete, with the restructuring, now that we have got a little bit of time past us, a year and a half, two years on the Upholstery Fabric restructuring, and our China platform, we feel like is, with eight years of experience in China, we feel like it is pretty mature. We felt the time was right to proceed aggressively into the European marketplace, and of course, our balance sheet, also led us to believe that we could certainly support any kind of working capital funding that we needed.

Additionally, what is important about Europe to us is like the US, the China mills have come on so strongly over the last decade, and a number, and you might even say most major mills in the United States and Europe have gone out of business, due to China being admitted to the WTO in 2001, and subsequently all of the business that moved to China. So the competitive landscape, and I will talk about Europe first. There just aren't any more major mills left in upholstery fabrics.

The void has been picked up by fabric distributors, a number of distributors, and some direct sourcing from Turkey or China, but it is a pretty scattered marketplace without any dominant players like there used to be before the world change with China coming into the WTO. That also happened in the US as well, so we view the competitive landscape pretty favorably in Upholstery Fabrics worldwide, although there always is competition, and I don't want to say there is not competition, but 10 or 15 years ago before China, there were major players, well capitalized, charge, big design staffs, major players that we had to compete with. That just does not exist today. We believe that will build over the next ten years, but we feel we are pretty uniquely positioned as being one of the major people that survived through this China transition.

Okay.

In the Mattress Fabrics business, it is a different story. The competitors there, while there were some players that did go out of the market in the US, we bought one of them, and another major one of them went bankrupt, it is pretty much the same players, large few players in Europe and in the United States. That market is more concentrated both from a customer and mattress fabric standpoint.

Okay.

That gives you a little overview of the competitive landscape as we see it on a long-term basis, and why Europe, we believe presents such a terrific opportunity for us.

Great. Thanks very much.

And we will take our next question from Barry Vogel with Barry Vogel and Associates.

Good morning, Barry.

I have a question on that subject you were just talking about, mattress fabrics. You talked about the Upholstery Fabrics in your press release, and you do have a comment that there will be an opportunity to sell and distribute Mattress Fabrics in Europe, and of course if we look at the profitability of Upholstery Fabrics today, despite everything that you have done positive over the last few years, and the big shakeout that has occurred, the Mattress Fabrics far and away are very, very profitable compared to Upholstery Fabrics, and we are seeing that happen again, a little bit of softness, a little bit of raw material cost increases, and all of a sudden, you are hardly making any money. So the question I have is the model that you are thinking about in terms of Mattress Fabrics that you are looking for in Europe compared to the United States, which obviously has turned out very favorable, can you achieve the same kind of model in Mattress Fabrics in Europe as you have in the United States? And if not, why not?

All I would say at this point, it is just very early in the game on Mattress Fabrics. As we said in the release, we are optimistic that we may be able to have opportunity to sell and distribute Mattress Fabrics in Europe, but all of our efforts the past six to nine months in Europe has been on the Upholstery Fabrics side in building these platforms, and of course in the fourth quarter, we are just starting the Poland operation in this fourth quarter, and the UK operation will start in our first quarter. So what shape Mattress Fabrics would take in Europe, we just haven't done a lot of work on it. We have done some high-level thinking, but that is about it at this point.

I would also make one point. When you look at upholstery, you also, if you just look at margins your comment is correct, but you have to look at the capital versus the operating income that is generated, and upholstery is still a very high return because the capital is so low to generate the earnings. So mattress ticking of course is higher margin and higher dollar, but we like the returns get on Upholstery Fabrics, and remember, Barry, we are getting these kind of returns in about the most difficult market you can have, housing market has just been decimated, housing activity is weak, and that is not going to stay forever. We probably got another six months to a year, maybe a little longer, but after the housing market does come back, you will see furniture sales pick up, and pick up very nicely whenever that does happen.

I agree with you about those comments, I was just curious as the timing of the move in to Mattress Fabrics, what you are saying is it is going to be down the road compared obviously to your thrust in Upholstery Fabrics?

Yes, I would give us, I would say give us at least six months to a year. Let us get the Upholstery Fabrics established, and that is where at least where the initial opportunity is for us as we see today. In Europe and Mattress Fabrics, we have entrenched competitors. The competitive landscape is still very strong in Mattress Fabrics, and we do not believe it is as strong with major players in upholstery. So that certainly is one reason our efforts are going into upholstery first, and once we get the platforms established, everything working well, then we can look at some ways to become gradually a factor in Mattress Fabrics.

Okay. Thank you very much. Good explanation.

Alright. Thank you.

And it appears there are no further questions at this time, I would like to turn the conference back over to management for any additional or closing remarks.

Okay. Operator that is all, so everyone thank you for joining us today, and we look forward to updating you next quarter. Have a good day.

That concludes today's conference, thank you for your participation.