Culp Inc (CULP) 2014 Q1 法說會逐字稿

Good day and welcome to the Culp first-quarter fiscal 2014 conference call. As a reminder, today's call is being recorded.

And now at this time for opening remarks and introductions, I would like to turn the call over to Ms. Drew Anderson. Please go ahead, ma'am.

Thank you, and good morning and welcome to the Culp conference call to review the Company's results for the first quarter of fiscal 2014.

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 as a 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 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 the 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 is scheduled, 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.

The slide presentation with supporting financial information and additional quarterly and annual performance charts are 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 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 and Ken will then 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 second-quarter business outlook, and then we will be happy to take your questions.

Now, looking at the first quarter, we are pleased with our first-quarter performance, marking an excellent start to fiscal 2014. These results reflect strong operating performance in both of our businesses. Our total sales were the highest in nine years for the first-quarter period. And our pretax income was the highest first-quarter level in the Company's history.

We continue to experience favorable customer response to our designs and diverse range of products. We are very excited about the progress we're making in product innovation and creativity. These efforts, which are our top strategic priority, are making significant contributions to our sales and profit gains, with an increasing percentage of our sales coming from recent product introductions.

We compete in a product and fashion driven business that is always changing. It is imperative that we stay out in front of the trends and lead with product. Our ability to sustain excellence in creating innovative fabrics season after season is a key driver to our long-term success.

We are also pleased that our consistent financial performance, higher cash flow, and sound balance sheet have enabled us to reward our shareholders with a 33% increase in the quarterly cash dividend. As we look ahead for the year, we continue to expect another strong year in free cash flow.

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

Thank you, Frank.

As mentioned earlier on the call, we've posted slide presentations to our investor relations website that cover key quarterly and annual performance measures. In addition, we have updated our investor presentation, which covers the key aspects of both of our businesses.

Total sales for this quarter were $70.1 million, up 1.4% from the first quarter of last year. Last year's first-quarter sales were up 15% from the previous year.

On a pretax basis, we reported income of $5.5 million, compared with $5.4 million of the same period last year, an increase of 3%. Pretax margin was 7.9%, compared with 7.8% a year ago. Adjusted net income, which is a non-GAAP measure, was $4.7 million, or $0.38 per diluted share, compared with $4.3 million, or $0.34 per diluted share, for the prior-year period.

Results for the first quarter included a one-time charge of $206,000 for the tentative settlement of ongoing litigation related to environmental claims at a closed facility. This amount is included in the other expense line item of our consolidated statements of income.

The Company's overall adjusted effective income tax rate through the first quarter was 14%, compared with 19% 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 approximately $51 million in loss carryforwards as of last fiscal year.

During the quarter, free cash flow was $1.9 million, after investing $4.3 million in capital expenditures and working capital. This amount compares to $3 million of negative cash flow at the same time last year.

Here are the results by our two businesses. For Mattress Fabrics, we reported $38.2 million in sales for the first quarter, up slightly compared with the first quarter of last year. This is the highest first-quarter sales for this business in the Company's history.

Operating income for this segment was $5 million for the first quarter, compared with $5.2 million last year. Our operating income margin was 13.1% of sales, compared with 13.8% a year ago. It is important to note that last year's 13.8% margin included the positive absorption effects from a significant inventory buildup. Return on capital from Mattress Fabrics segment was 34% this quarter, compared with 38% a year ago.

Now on to Upholstery Fabrics, sales for the first quarter were $32 million, compared with $31.2 million for the first quarter of last year, a 2.4% increase. This is the highest first-quarter sales for this business in eight years.

The Upholstery Fabrics business reported operating income of $2.4 million, or 7.6% of sales, compared with operating income of $2.2 million, or 6.9% of sales, for the first quarter of last year. The $2.4 million in operating income is the highest first-quarter level in over 10 years. The return on capital for Upholstery Fabrics segment was 52%, about the same as a year ago.

As reflected in the high return on capital for both of our businesses, capital discipline is very important to us. We've established a culture of excellent stewardship of our capital throughout our organization. Further, as we've stated a number of times before, we tie our incentive compensation for divisional and executive management to returns on capital above certain thresholds, based on economic value added, or EVA principles.

Now, I'll turn to the balance sheet. Maintaining a strong financial position and generating free cash flow will continue to be top priorities for Culp in fiscal 2014. As noted earlier, we achieved free cash flow of $1.9 million after investing $4.3 million in capital expenditures and working capital.

As of the end of the first quarter, we reported $27.6 million in cash and cash equivalents and short-term investments, compared with $27.1 million a year ago. We paid a quarterly cash dividend of $0.04 per share in July, representing a 33% increase from the $0.03 per share paid in fiscal 2013.

Total debt at the end of the first quarter was $7.2 million, down from $9.9 million a year ago. At the end of this quarter, we made a scheduled $2.2 million principal payment, thus further lowering our total debt to $5 million. We have two remaining annual $2.2 million payments due August 2014 and 2015.

For fiscal 2014, we expect CapEx spending to be approximately $6 million and depreciation and amortization is expected to be $5.7 million. Frank?

Thanks, Ken. I will now provide you with an update on both of our operating segments. And let's start with Mattress Fabrics.

Our Mattress Fabrics business had a solid performance for the first quarter of fiscal 2014. We are pleased with our consistent sales, especially when compared with an unusually strong sales for the first quarter of last year.

We've continued to be on par with the industry during a more challenging business environment than we experienced a year ago. These results reflect our ability to keep pace with changing customer demand across all price points and fabric styles in the mattress industry.

With our extensive manufacturing platform, flexible capacity, and exceptional design capability, we have the ability to produce a diverse line of products for all categories. As a result, Culp has a strong competitive position as a full-service supplier of mattress fabrics. Our innovative designs and new product introductions are resonating with customers, resulting in strong future placements with the major players in the industry.

Importantly, we have also remained focused on providing outstanding customer service, reliable delivery performance, and the consistent quality and value that is synonymous with the Culp brand.

We continued to make progress during the first quarter with Culp-Lava, our most recent business venture, which was established to produce and market mattress covers. We are pleased with the sales contribution this quarter, as we have now completed most of the specialized training and development work necessary for production at our new Stokesdale, North Carolina, facility. We're focused on improving these operating efficiencies as we work through the startup period.

Additionally, we have the ability to adjust capacity in line with current and expected demand. We look forward to becoming a more mature business in the cut-and-sew operation that can efficiently react to the seasonality of the mattress industry. We are pleased with our results for the first quarter and look forward to the long-term growth opportunity for Culp-Lava.

Looking ahead, we anticipate a normal seasonal slowdown in the second fiscal quarter, as we always have, which will influence our sales and operating efficiencies. We also do not expect overall industry demand to be as robust as it was during the second quarter of last year.

Now I will comment on Upholstery Fabrics. We experienced better-than-expected sales in this business during the quarter. We were especially pleased with the sales performance as compared to last year, given the strong industry demand. These results reflect continued favorable response from key customers to our designs and new product introductions.

Sales of our China-produced fabrics continued to be the primary catalyst of our growth for the first quarter. China-produced fabrics accounted for 94% of our overall Upholstery Fabrics sales during the quarter, reflecting our ability to offer a diverse product mix of fabric styles and price points with excellent service and quality. Culp is uniquely positioned to meet the needs of our customers with our design capabilities and reliable China manufacturing platform, which is 100% owned.

I also wanted to note that we're celebrating our 10-year anniversary of Culp China this year, which started in the fall of 2003. Rob and I are very pleased with this operation, especially our long-term management team. We still have today the same senior managers we hired in 2003 and 2004. They have really grown and matured during this 10-year period, and we sincerely appreciate their contributions.

We are also pleased with the increasing level of fabric placements with customers in the US, China, and Europe. We have an excellent opportunity to build on this momentum, especially as the economy strengthens and the housing market makes a meaningful recovery.

We are pleased with our progress with respect to our Culp Europe operation, especially the sales performance in the first quarter. While Culp Europe is not quite yet profitable, we're still seeing significant sales gains over last year. We remain optimistic about the long-term opportunities for Culp Europe to enhance our global sales.

Finally, I want to talk briefly about our capital allocation strategy. During our fourth-quarter conference call and in our shareholder letter, I discussed this strategy and our priorities for capital in depth. So I want to refer everyone to those documents for a more detailed discussion.

In summary, however, we have been and continue to be in the very fortunate position of generating significant free cash flow above the requirements to grow our business organically and to maintain a strong net cash position. Therefore, we are well positioned to provide shareholders with the added value that comes from regular and special dividends, as well as opportunistic share repurchases.

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

We expect overall sales to be in the range of flat to 4% higher as compared with the second 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 and margin in this segment are expected to be lower than the same period a year ago.

In Upholstery Fabrics segment, we expect sales to be moderately higher as compared to the same time last year. We believe the Upholstery Fabrics segment's operating income and margin will be higher than the same quarter of last year.

Considering these factors, the Company expects to report pretax income for the second fiscal quarter of 2014 in the range of $4.1 million to $4.7 million. Pretax income for last year's second quarter was $4.5 million. Frank?

We are pleased with the strong start to this year. We have many reasons to be optimistic about the year ahead, with our outstanding design capabilities and innovative product offerings that are being well received by customers in both businesses.

We will continue to leverage our scalable and global manufacturing platform to deliver these products and keep pace with current and expected industry demand. We are cautiously optimistic about an improved economic outlook for this fiscal year, especially as the housing market gains more traction and supports consumer demand for home furnishings. We believe Culp is favorably positioned for continued growth in this environment, with the financial strength to execute our strategic initiatives and reward our shareholders. Above all, we are committed to outstanding performance for our customers as a financially stable and trusted source for innovative fabrics.

With that, we will now take your questions.

(Operator Instructions). Budd Bugatch, Raymond James.

Good morning, Frank. Good morning, Ken. Congratulations on the quarter. (Multiple speakers). I guess my most pressing question goes to the guidance for Mattress revenues, talking about it being flat to slightly down, I guess. What are you seeing in the industry? Are you losing share? Is it just the overall industry issue, and how short cycle is your visibility into that particular segment?

Budd, I would ---- the guidance is based on the choppiness that we are seeing in the industry currently.

Now of course, as you know, Labor Day weekend is just really huge for the industry and for our second quarter, and a week from today, I hope we've seen a great Labor Day. But the short-term visibility, that's exactly what we've got. This industry is just-in-time and it's just difficult to see much past a few weeks. But it does seem choppier across our customer base.

And yet, you all have Culp-Lava more in the results of this quarter versus last year, right? What would that (multiple speakers) and so, excluding Culp-Lava on a same-yardage basis or a same-location basis, what do you think revenues will be?

I think we will stick with the same guidance we have given. And really what affects our sales is only the added value from the cut-and-sew operation. We would have already had the fabric sales.

So while it is an important new operation for us, we're excited about it and they're starting up pretty well. There's not that much in added value when you look at the quarterly sales in the high $30 million range. But I hope we turn out to be conservative on our outlook for the second quarter.

(Multiple speakers) quarterly sales of the high $30 million is the quarterly sales for mattresses, or Mattress Fabrics total, right?

Correct, correct (multiple speakers). Correct.

And I guess my last question goes to Culp Europe. I think it's either breakeven or not profitable yet. What's the outlook for profitability there and when do you think you'll reach that?

Based on what we're seeing now and the sales gains we had in the first quarter and the placements we've got with major players over there, I believe it's going to happen this year.

We've been patient with that operation because we have limited costs over there. They only have five employees and limited capital -- no fixed capital, only working capital. So I believe it's going to happen. It almost happened in the first quarter. So I think we're going to see profitability this year sometime.

And it has really taken a positive turn on the sales side over the last, really, four months, which we are very pleased to see.

The benefits of Culp Europe to us as a global player really go beyond their performance. We pick up -- from traveling to Europe, we pick up so much about ---- maybe more than we thought -- about industry trends, fabric styles, etc. So we -- as long as we can have low investment over there and not much overhead, we think it's a very strategic place for us to be. And I believe we're going to be very successful long term and it's going to turn out to be ---- we're going to be very glad that we have a part of our business in Europe.

Very good. Congratulations. I'll let some other folks ask questions.

(Operator Instructions). James Fronda, Sidoti & Company.

Good morning. Could you just, I guess, elaborate a little more on the gross margin decline during the quarter? Was that just lower price points?

The gross margin during the quarter declined overall from 19% to 18.6%. It was actually up in Upholstery Fabric and is down slightly in Mattress Fabrics, and what Ken alluded to, really in the first quarter of last year we built finished goods too much in our Mattress Fabrics area, which we did not repeat, which we're happy for, this quarter.

So that really helped the absorption of fixed costs during last year's first quarter, and that's really the principal difference. Last year, it was 13%. The gross profit was 20.1% last year, 19.4% this year, still a pretty good gross margin. I wouldn't read into that any kind of indication about margin erosion or anything like that.

Right, okay. That makes sense. Could you just give us more of an update on Culp-Lava? I'm just guessing that there's not too much cost involved with that operation.

Certainly from a capital point of view, buying sewing machines and a cutting table, I think we may have invested, Ken, $600,000 ----

About $800,000.

$800,000 to date, last year and this year. So it's not a capital-intensive business; it's a labor-intensive business, as you would guess.

And we have now around 100 employees. So it's not a high cost look. And you really have to be flexible, as I mentioned in the comments. The demand for those covers can be pretty erratic because the industry is seasonal, so you've got to be able to have -- set up the operation to have flexibility in your output, which we're doing.

That's all I had. Thanks, guys.

(Operator Instructions). Kevin Tracey, Oberon Asset Management.

Hi, thanks for taking my question. I wanted to ask about the transaction you did with Bodet & Horst in May. I think it was $2.7 million where you bought the equipment and were released of a noncompete agreement, which I think was set to, I guess, end in August of next year.

So I guess I was hoping you could talk about the value of that transaction. Was it accelerating, being released of the noncompete agreement, or I also saw that they agreed to enter into a noncompete agreement in North America? Could you just explain what the value of that transaction was?

Sure, be glad to. In May, as you said, we did enter into an agreement with Bodet & Horst, which we call B&H, where we paid $900,000 for the purchase of some knitting machines which were located in B&H's El Salvador operation.

We also paid $1.7 million for modifications to an existing, that you referred to, noncompete consulting arrangement. We also -- as part of the modification, we also agreed to transition some mattress fabric and some mattress cover business from B&H El Salvador's operation into our North American platform.

The key modifications that we made to the original agreement were that Culp would no longer be subject to the noncompete provision to a major bedding customer -- again, you referred to that, which is very significant for us -- and that B&H agreed to a noncompete agreement in North America for 15 years.

Additionally, we extended the mutual consulting agreement with B&H that we had as our companies have worked together well for many years.

So in summary, Kevin, we removed the existing noncompete we had, so now Culp has access to all major bedding players, which was quite timely. We bought some additional knitting equipment, which we needed. We have a consulting arrangement with a company we've had good relationships with for many years and worked together closely. And also, importantly, we have a noncompete from that company for 15 years in North America.

Okay, good. And I wanted to ask about what you see in terms of raw material prices for the rest of the year. For the past few months, we've seen oil prices steadily march up before spiking in the past couple weeks. Do you see any pressure from raw material prices going through the rest of the year?

We do not. We are watching them closely, as with the recent oil spike, but we've been fortunate.

Raw material prices are staying stable. We've had a nice period here for enough ---- three quarters, maybe, something like that, where we've had stable raw material, and our outlook still is for stable, unless something in the Middle East just really blows up more than it is and drives oil prices up.

Okay, good. And then, lastly, I just wanted to follow up on the environment in your Mattress Fabric business. The way you described it as the environment was more challenging currently and into the second quarter than it was last year. Was that primarily just because the big first half of last year was unusually strong, or are you seeing anything else change? I guess it seems like economic growth continues to pick up or be positive. That's a little surprising to us.

Well, you know what? It's interesting to us as well for ---- if you look back over maybe a three-year period, the mattress industry had really pretty good demand and growing. And the furniture end didn't have such good growth.

But you look at today, and the furniture business is clearly, in our view, better industry demand than bedding. Now we know furniture demand, upholstered furniture demand, is tied very closely to housing activity, which is certainly up and projected to be up more, and we're seeing that in our customers. Customers are optimistic, they are bullish on into -- for the next couple of quarters. I sense that in talking to a lot of them.

On the mattress side, the business is, across the coast, still choppy. It's not ---- I wouldn't characterize it as strong. Now we do hear a lot of talk about much higher advertising spend in the back half of this calendar year, which we are certainly optimistic that will counter some of this choppiness that we are seeing. It is certainly not market share loss; I don't see it at all. And advertising spend usually does help. So that could be a positive factor that is not in our thinking as of today.

One of the answers to, I think, maybe Budd's question, it's hard to see ---- we don't have a lot of forward visibility in the mattress industry because it's so much of a just-in-time business. But it's not tied to housing as much as people might think. It is more tied to overall economic activity and GDP growth, which is okay, as you pointed out.

That's certainly how we see it today and I certainly hope Labor Day, again, is better, a strong Labor Day. There is certainly tremendous advertising going on, as everyone may see. If you just turn on the TV, you're going to see a mattress ad. And we're certainly hopeful that's going to be good, which would be certainly positive for our second quarter.

Okay, thank you.

(Operator Instructions). And it looks like we have no further questions at this time. So I'd like to turn it back over to our speakers for any additional or closing remarks.

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

And that does it for today's call. We thank everyone for their participation.