Culp Inc (CULP) 2013 Q2 法說會逐字稿

Good day, and welcome to the Culp Incorporated Second 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.

Good morning, and welcome to the Culp Conference Call to review the Company's results for the Second Quarter of Fiscal 2013. 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, including the Form 8-K filed yesterday, 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 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. A reconciliation of these non-GAAP 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. A slide presentation with supporting financial information is also available on the 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 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 about Culp today, and then Ken will review the financial results for the quarter. I will then update you on the strategic actions in each of our businesses, and after that, Ken will review our third-quarter outlook. Then we will be glad to take your questions.

Now looking at the second quarter. We are pleased with our results for the second quarter, which built upon the sales momentum and product successes that we experienced during the first quarter. Demand trends have been reasonably solid in both businesses, and we're encouraged by the continued favorable customer response to our exciting designs and wide range of innovative products. We have worked diligently over the last few years to drive creativity and innovation. We are also pleased to see positive gains from these efforts. We also will continue to leverage our efficient global manufacturing platform that creates the right product mix and meets the changing style demands of our customers.

Importantly for this quarter and the fiscal year to date, we have made solid gains and return on capital, our free cash flow generation, and margins. We also announced in our press release yesterday that our Board of Directors has approved a payment of a special cash dividend of $0.50 per share. In addition, the Board has approved the acceleration of payment of our scheduled January 2013, quarterly cash dividend of $0.03 per share. Both of these payments will be made on December 28 to shareholders of record as of December 19. The Board's decision to approve these dividend payments reflects Culp's solid and consistent operating performance, our strong financial position, and our confidence in the future. We are pleased to provide this additional and timely opportunity to reward our shareholders, many of whom have been long term holders of Culp. We are especially grateful for their loyalty. I want to assure you also that we will continue to maintain a strong cash position that first supports the capital needs of our businesses, and secondly keeps a substantial net cash position at all times. I'll now turn the call over to Ken, who will review the financial results for the quarter.

Thanks, Frank. Total sales for this quarter were $65.6 million, up 13% from the second quarter of last year. This marks the seventh consecutive quarter where we had year-over-year growth. On a pre-tax basis we reported income of $4.5 million, compared with $2.9 million for the same period last year, an increase of 58%. Pre-tax margin was 6.9%, compared to 4.9% a year ago. Adjusted net income, which is a non-GAAP measure, was $3.9 million or $0.31 per diluted share, compared with $2.3 million or $0.18 per diluted share for the prior-year period.

The Company's overall adjusted effective income tax rate through the second quarter was 15%, compared with 18% for the same period last year. This adjusted effective income tax rate, or ongoing estimated cash tax rate, represents income tax expense for Culp's non-US entities, divided by consolidated income before taxes. This information is important, because the Company currently does not pay cash taxes in the US, nor does it expect to for a number of years, due to its $60 million in loss carry-forwards as of the beginning of this fiscal year. Return on capital was 29% for the second quarter this fiscal year, up from 19% last year. Driving this improvement was the 68% increase in operating income, compared to only a 7% increase in capital employed. Cash flow from operations for the first six months was $7.7 million, up from $2.6 million at the same time last year.

Here are the results by our two businesses. For mattress fabrics, we reported $39.7 million in sales for the second quarter, up 13% compared with sales of $35.2 million for the same period last year. Operating income for this segment was $5.1 million for the second quarter, compared with $3.8 million last year, an increase of 34%. Operating income margin was 12.9% of sales, compared with 10.8% of sales for the prior-year period. Return on capital for the mattress fabric segment was 37% through the second quarter of this fiscal year, up from 26% a year ago. The key to this improvement was the 49% increase in operating income, while capital employed only increased 3%.

Now turning to upholstery fabrics. Sales for the second quarter were $25.9 million, representing a 14% increase from $22.8 million in the second quarter of last year. The upholstery fabrics business reported operating income of $1.2 million, or 4.6% of sales, compared with operating income of only $19,000, or 0.1% of sales for the second quarter of last year. Return on capital for upholstery fabrics segment was 40% through the second quarter this fiscal year, compared with 16% for the same period a year ago. The increase to 40% return on capital was driven by an over 200% increase in operating income, while capital employed increased only 36%.

Now I'll turn to the balance sheet. We have continued to maintain a strong financial position, even as we returned significant cash to shareholders and reduced our debt during the quarter. As of October 28, 2012, we reported $28.7 million in cash and cash equivalents and short-term investments, up $1.6 million from the level at the end of the first quarter, after spending $7.6 million for share repurchases, a debt payment, and quarterly dividend during the quarter. Total debt at the end of the second quarter was $7.7 million, of which $6.6 million is term debt to be paid in three remaining annual payments beginning August 2013. For fiscal 2013 we expect capital expenditure spending to be approximately $5 million, and depreciation and amortization is expected to be $5.7 million. Since June 2011, when we began our share buyback initiative, the Company has repurchased 1.1 million shares, or 8.5% of its outstanding shares, for a total of $10.4 million at an average price of $9.23. Frank?

Thanks, Ken. I will now provide you with an update on both of our operating segments. I'll start with mattress fabrics. We are pleased to report another strong performance in our mattress fabrics business. The overall sales growth in the quarter reflects solid gains in all major product categories. We have continued to capitalize on the growing consumer demand for better bedding products, and therefore, a higher-quality mattress fabric. The mattress industry is continuing to evolve into a more decorative business, and many of our customers are upgrading their fabric choices to achieve a more fashionable look.

Culp is well-positioned to meet this demand, with an extensive manufacturing platform and flexible capacity that allows for production of value products, as well as a higher-end product mix. Additionally, we have the unique ability to leverage Culp's outstanding design capabilities and expertise in the upholstery fabric business to enhance our product offerings, as more upholstery-type fabrics are being used in the specialty bedding arena. Our improved operating results reflect our ongoing focus to create great products and maximize the efficiencies and flexibility of our manufacturing platform. We have worked diligently to take advantage of the newest technologies available and have continued to modernize our equipment.

We are pleased with the progress we are making at Culp Lava, which is our mattress cut and sew operation, to design, produce, and market mattress covers. This new operation further enhances our strategy to leverage our design and manufacturing capabilities, and produce a diverse product category that keeps pace with the changing industry trends. We have established Culp Lava's new manufacturing facility in Stokesdale, North Carolina, directly adjacent to Culp's mattress fabric headquarters and primary plant operation. During the second quarter, we completed most of the initial equipment installation, and conducted training for the start-up associates in this location. We began production in November, and we expect to gradually develop this operation over the next two quarters. We are excited about the future growth opportunities ahead, as we work to develop this new product category and enhance our leadership position in the bedding industry.

Now I'll comment on upholstery fabrics. We are also pleased with the growth in sales in our upholstery fabric business during the second quarter of this year. The higher sales primarily reflect positive customer response to our designs and new product introductions. Our China-produced fabrics continued to drive our growth, and accounted for 88% of our upholstery fabric sales during the quarter. Our design capabilities and capacity to offer innovative products at excellent values has been an important advantage for Culp in expanding our sales in the US and around the world. We continue to be encouraged by the increasing level of fabric placements with key customers, not only in the US, but also Europe and China.

Our US operation has continued to gain traction, with improved sales and profitability compared with this time last year. We are pleased with the demand trends for both velvet and woven texture fabrics, which are the product categories produced at that facility. We have a flexible and scalable manufacturing capacity designed to meet the changing demands of our customers, and we continue to create innovative products from this platform. We have also benefited from a more stable raw material cost environment during the second quarter as compared with this time last year.

We also remain focused on developing new growth opportunities through Culp Europe. In spite of the current challenges, current macroeconomic challenges in Europe, we believe Culp Europe will play an important role in our global sales efforts as the market conditions improve, and as we learn more in that marketplace. Ken will now review the outlook for the third quarter, and then I'll have a few concluding comments.

We expect overall sales to be 4% to 9% higher as compared to third quarter of last year. We expect sales in our mattress fabric segment to be 3% to 7% higher compared to the same period a year ago. Operating income and margin in this segment are expected to be higher than the same period a year ago. In our upholstery fabrics segment, we expect sales to be 7% to 11% higher than the previous year's third-quarter results. We believe the upholstery fabric segment's operating income and margins will be significantly higher than the same quarter of last year. Considering these factors, we expect to report pre-tax income for the third fiscal quarter of 2013 in the range of $4 million to $4.5 million. Pre-tax income for last year's third quarter was $2.9 million. Frank?

Our success to date in this fiscal year reflects our ability to execute our strategy in a dynamic marketplace and an uncertain global economy. Our outstanding design capabilities and strong value proposition are distinct competitive advantages for us in both businesses. We have the unique ability to leverage our scalable and global manufacturing platforms, and offer the innovative fabrics that meet the changing demands of our customers. Importantly, we also have the financial strength and depth of management to support our growth initiatives and enhance our competitive position, as well as return significant funds to shareholders through share repurchases and dividends.

The depressed conditions that have prevailed in the US housing industry and with the consumer for the last few years are finally improving. In spite of these headwinds, Culp has performed well during this period. We are excited about the opportunities ahead for Culp, and we believe we are well-positioned to capitalize on a gradually improving economy, as both the housing market and consumer confidence strengthen. Above all, we are committed to outstanding performance for our customers as a financially stable and trusted source for innovative fabrics. With that, we'll now take your questions.

(Operator Instructions)

Chad Bolen, Raymond James.

Frank, both segments had sales and operating profit ahead of our model. I think the upside in upholstery was a bit more pronounced, at least relative to your guidance. Can you give us a little color on what drove the upside in upholstery versus what you had thought going into the quarter?

Yes, Chad. Good morning again. Certainly, the second half of that second quarter, the September and October, were better than we had expected. We had reasonably good demand, as you saw throughout the quarter. In the mattress area it was better than we had expected as well. It's seasonally slower during the late September, October period, but we held up better than we expected. It was later in the quarter that we performed better.

Can you give us any indication on how things trended through November?

Well, I think you can see from the guidance. We're still looking at nice sales gains for the second quarter as well. Although we've had very good strong double-digit gains in the first six months, I'm not sure we see quite as strong in the third quarter and looking ahead, because the industry last year was a lot started, having a lot of -- gathering a lot of steam in the second -- from really December through April of last year.

Sure. In upholstery, you talked about winning new placements. Any way for you to parse or give us a sense for how much of the growth you're seeing is coming from market-share gains versus just overall industry demand?

Certainly both, and a large part is the gains with our key customers, which we're very excited about -- so it's both. We're gaining market share every month, and the key factor driving that is the innovation that we focused so hard on the last few years.

Also in that regard, on the mattress side of the business you talked about mix as folks use more decorative, more expensive fabrics. Can you parse for us sort of the units or yardage versus the benefit from pricing or mix on your sales?

Sure. We're doing various things now, so it's not as easy as it used to be, like we're slitting fabrics before shipping them to customers. But to give you an estimate, it's probably at least 50% average selling price increase and 50% unit, and it could be a little more 50% to 60% sales price improvement, average selling price, as the product mix moves up.

Okay, and a little more technical question. SG&A, the unallocated corporate was a bit higher than we were modeling this quarter. Can you give us a sense of what drove that, and how we should think about that for the balance of the year?

Sure. Through the first six months, we've obviously had a very good performance for the first six months and therefore, we have accrued accordingly a fair amount of our annual bonus incentive payments. We accrue that as earned, so when you look at the first six months of this year, particularly second quarter versus last year, we've accrued a lot -- earned a lot more of it at this point in the year than the prior year, which therefore means in the second half of the year, we won't have as much to accrue as we did in the first half.

Okay. You said that you've now started production at Culp Lava. What's a reasonable expectation for what the revenue contribution there could be over the first year? I would imagine there's a drag on profitability now because of the start-up costs associated with that. Any stab at when you can get that to break-even?

That business, we've got the demand. It's a matter of just scaling it up, training associates, and I believe certainly by first quarter we will be at a break-even, and it's possible fourth quarter. I do not see a long period of time where we -- until we reach break-even. It will be -- the sales will be driven by what our output -- and we have minimal small losses coming from there in Q2, and a small in Q3, but not meaningful by any means. We don't have that many people yet, less than 20 people for now. As we train them we'll add more, and as we can get them trained, we'll bring them on and produce more mattress covers.

What do you think the revenue opportunity is there for Culp Lava?

We obviously believe the trend as we've seen the last number of years in specialty bedding. Almost every specialty bed uses a mattress cover, and specialty bedding sales have been growing north of 20% for five or six, seven years. We see that trend continuing, and we want to be in a position to gain part of that business. We've had a lot of the mattress fabric business, obviously, but we would like to also capture the mattress cover part of that business. Chad, I don't know that I'll venture but it's significant. It certainly could be significant over time.

Fair enough. Well, thank you Frank. Thanks again for taking my questions, and good luck to you guys for the rest of the year.

Thank you, Chad.

(Operator Instructions)

Ethan Steinberg, Friess Investors.

Just a couple questions, and sorry if I missed it. I wasn't on for the entire call, but the expenses in the first two quarters, particularly the quarter that we just got through, can you talk about how much of that bonus accrual hold down the operating income? I'm also curious, were there any other expenses that -- extra expenses that hurt earnings, or hurt the operating profit, more than you might see going forward, like that plant start-up, if you could quantify that stuff a little bit more?

Bonus expense in the first six months, around $1.5 million, to give you an idea. Of course, we did not have any minimal bonus expense accrued in the first half of last year, because we earned more of last year's bonus in the second half of the year. That did affect the SG&A for the first six months and the quarter; however, that will level out over the full year and will actually benefit us in the second half of this year.

How much do you think that was in the second half of last year?

It was a big number.

Like a couple million?

Yes.

And that could potentially be sort of closer to zero this year because you front-end loaded the --

Not zero. I think I'd put it at -- we've probably accrued 60% to 65% of the annual bonus through the first six months, 65%.

Right, okay. I guess I'm just looking it could be $1 million plus or minus decrease in expense year over year?

In the second half?

Yes.

Yes, that's fair. Sure.

Okay, and then -- sorry. Any other one-time, or not necessarily one-time, but like non-recurring expenses that won't repeat, or will start to go down like that plant ramp you mentioned?

The only other areas are the start-up of our Culp Lava operation, which is really -- I don't want to quantify it, because it's not a lot of money. It's just not. In the fourth quarter, we will be at or close to break-even. Our Culp Europe operation is still operating at a small loss, but we only have five people. We only have $2 million of capital, but we're still very optimistic about the longer term for Culp Europe. We believe we should be in Europe, and it's important to Culp as a whole for the long term to be an important player in Europe. That is a small drag on the overall results, but again, we've got it down to not a lot of -- I think we're down to $25,000, $30,000 a month of SG&A expense in our European operation, so it's not much. I don't see a lot of other of these one-time things affecting us.

There were not a lot of other things?

There were not a lot. No, this is from the business.

Okay. A couple of other things just on that same vein. The incremental margin -- and I just eye-balled this, but it looked like it was around 26% in Q1, and dropped to 23.5% or so in this quarter, which is still -- you guys did a good job of dropping the revenue upside to the bottom line, but I'm just curious why did that -- if I'm doing that right -- why did the incremental go down? Was that the -- did you juice or increase that comp accrual even more, or something else?

That's really not much of a change in our numbers. Incremental, you're talking about the incremental operating margin?

Yes, the year-over-year drop to operating profit, the year-over-year revenue growth that drops down to the operating profit line.

I mean, it could be partly the incentive comp accrual.

Okay. Thinking about the second half, that's a big swing from having a $1.5 million headwind from comp accrual to $1 million benefit. That should have pretty nice implications for that incremental margin.

No question that's a positive factor in the second half, particularly though in the fourth quarter, because we will be in a position to accrue a lot more of the annual incentive in the third quarter, so were not going to see much benefit of that in Q3, but certainly Q4.

Sure, but certainly less drag in Q3?

Certainly -- well not necessarily, because we're still -- I said 65% approximately of annual incentive accrued in the first half. We'll accrue some more based on the guidance we've given. We're going to accrue probably up to maybe 90%, so we'll have some bonus expense in the third quarter.

Yes, okay, but not quite as much as last year maybe, but okay, that's helpful to think about it. It will really be Q4 where we see the year-over-year difference.

Correct.

Okay. Are there any other variables that you can help us think about that might help or hurt the incremental margins in the second half versus first half?

Well, I think as you look at the second half of the year, we've got to remember that both industries started picking up in the December, January time frame, so we are coming up against stronger quarter comparisons in the second half versus the first half. That's why our sales guidance is still very good, but down somewhat from where the gains in the first half of the year; but we're up against tougher quarterly comparisons, sales and otherwise -- certainly sales-wise in the second half of the year.

Okay, and I think Chad sort of asked or did ask this, but in hindsight you handicapped the October sales a lot more than the world ended up playing out, or you did a lot better. Was that mostly just conservatism, or did the run rate really accelerate or something through as you got through the quarter?

The run rate was better. We don't have a lot of visibility in our business. We've got -- in mattress fabrics, it's a just-in-time business. Upholstery, we've got two, three months forward visibility. But we are encouraged. I have to -- all the, you look at every piece of housing data that comes out, it's better than people expect. You look at consumer confidence was the highest in five years, last week announced or this week. We are encouraged by the -- and we certainly believe we're going to be in a better environment, gradually improving as I said over the next few quarters. In spite of all the noise we hear about on the news, the underlying economy is getting better, and it's getting better particularly in the sectors that matter to us.

But then is it just conservatism? The guidance implies you think it's going to be down sequentially by flat to down $1 million sequentially, which doesn't --

Remember, we had a better -- we were comparing against tougher comparisons, as well.

But I'm saying sequentially, the guidance implies you're flat to down from Q2.

We are, as you follow us for a while, we are on the conservative side. (multiple speakers)

Okay, I just wanted to make sure it was that, and not something you saw.

That has certainly been our nature over the years, over many years.

Okay, great. Thank you. Oh, I just -- the approach that the special dividends, great, is there -- how are you or how is the Board or what you'd recommend to the Board thinking about the ongoing dividend? Is there -- I mean you've obviously still got a lot of cash, even after this distribution. Why not return, I guess, a slightly greater degree of that on an ongoing basis?

Well as we've said in earlier communications and calls, when we introduced the dividend it is the Board's intention to increase the recurring quarterly dividend based on our performance. We introduced the dividend in June of this year, and we would review it in the June after our year-end time frame. Based on our performance, it's certainly the intent to increase the recurring quarterly dividend.

Got you. Yes, that pay-out ratio just dropped quite a bit, given this quarter.

That did. It did.

Does pulling in the Q1 dividend preclude you from increasing the dividend before Q2 -- I mean, yes, of calendar Q2?

I'm sorry?

By pulling in the calendar Q1 dividend of $0.03 into December, does that preclude you from raising it before you would distribute the Q2 calendar dividend?

I think what we've said over time is we'll review it annually in June, so of our annual Board meeting after the full year is over, and we look at the results for the year, and that would be an appropriate and normal time to consider increasing the dividend.

Got you, very helpful. Okay thank you guys, congratulations.

Super, thank you.

(Operator Instructions)

At this time we have no further questions in the queue.

Okay. Well, thank you everyone for your participation and your interest in Culp, and we look forward to updating you on our progress next quarter. Have a great day.

That does conclude our conference for today. Thank you for your participation. You may now disconnect.