Culp Inc (CULP) 2014 Q3 法說會逐字稿

Good day and welcome to the Culp, Inc., 3Q 2014 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 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 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 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 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 summary financial information and additional quarterly performance charts are also available on the Company's website as part of the webcast of today's call.

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

Thank you, Drew. 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, and then Ken will review the financial results for the quarter. I will then update you on the various strategic actions in each of our businesses, and then after that, Ken will review the fourth-quarter business outlook, and then we will be happy to take your questions.

Now, looking at the third quarter, we continued to build our sales momentum thus far in fiscal 2014 with a 14% sales gain for the quarter compared with a year ago. Additionally, pretax income was $4.6 million, the highest third quarter in 15 years, even after absorbing the approximate $600,000 gross profit impact in our mattress fabrics business, as mentioned in the press release.

These favorable results are primarily related to our products, as we continue to experience excellent customer response to our creative designs and innovative fabrics. We have worked diligently as our top strategic priority to drive product innovation and creativity throughout our Company. It is very encouraging to see significant tangible progress resulting from these efforts with increased sales to existing key customers, as well as new customers.

As we have said on many occasions, we compete in a product and fashion-oriented business that is always changing. Our ability to adapt quickly to such changes and to create innovative fabrics season after season is the key to our long-term success.

We are on track to report another outstanding year of solid sales growth, consistent profitability, and excellent free cash flow. As a result, we have the financial strength to invest aggressively in capital expenditures and working capital to drive organic growth, as well as to provide added value to shareholders through regular and special dividends and share repurchases.

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 have posted slide presentations to our Investor Relations website that cover key quarterly and annual performance measures, as well as our capital allocation strategy.

Total sales for this quarter were $72.4 million, up 14% from the third quarter of last year, reflecting the highest level sales level for the third quarter in 10 years.

On a pretax basis, we reported income of $4.6 million, compared with $4.5 million for the same period last year. Pretax margin was 6.3%, compared with 7.1% a year ago. Adjusted net income, a non-GAAP measure, was $3.9 million, or $0.31 per share, compared with $3.9 million, or $0.32 per share, for the prior year.

The Company's overall adjusted effective income tax rate through the third quarter was 15.5%, compared with 14.4% 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 do we expect to for a number of years, due to approximately $51 million in loss carryforwards as of the end of last fiscal year.

Here are the results for our two businesses. For mattress fabrics, we reported $38.5 million in sales for the third quarter, up 9% as compared with the third quarter of last year. Operating income for this segment was $3.3 million for the third quarter, compared with $4.2 million last year. Our operating income margin was 8.6% of sales, compared with 11.7% a year ago.

Our operating results for the third quarter were affected by higher than expected transition costs in Culp-Lava, our mattress cover operation, as well as additional sampling and development costs in support of new customer rollouts for calendar 2014.

We experienced short-term challenges during the quarter that lowered gross profit by approximately $600,000 as we absorbed the production of some mattress covers acquired from a previous supplier. However, as these specific covers are phased out during the fourth quarter and new mattress covers are introduced, we expect significant improvement in our operating efficiencies and margins going forward.

Despite the operational challenges, we are pleased with the added sales contribution from Culp-Lava in the third quarter and are optimistic about continued growth in sales and improved productivity in the fourth quarter and beyond. Return on capital for the mattress fabrics segment was 29% through the third quarter, compared with 35% a year ago.

Now onto upholstery fabrics. Sales for the third quarter were $33.8 million, compared with $28.2 million in the third quarter of last year, a 20% increase. The upholstery fabrics business reported operating income of $2.7 million, or 7.9% of sales, compared with operating income of $1.8 million, or 6.3% of sales, for the third quarter of last year, an increase of 50%. Return on capital for upholstery fabrics segment was 45%, compared with 40% for the same period a year ago.

Now I will turn to the balance sheet. Our strong financial position continued to be an important advantage for Culp in this fiscal year. We achieved $8 million in free cash flow through the first nine months of this fiscal year after investing $6.2 million in working capital and $2.7 million in capital expenditures. We expect free cash flow for the full fiscal year to be comparable to the $13.1 million achieved in last fiscal year.

At the end of the third quarter, we reported $30.4 million in cash and cash equivalents and short-term investments. Total debt at the end of the quarter was $5 million, which includes long-term debt, plus current maturities of long-term debt and our line of credit. Notably, our net cash position, or cash minus total debt, was $25.4 million at the end of the third quarter. We do expect our net cash position to build during the fourth quarter. We have two remaining annual $2.2 million debt payments due this coming August and August of next year.

Looking ahead at the rest of this fiscal year, we expect capital expenditure spending to be approximately $5.2 million and depreciation and amortization is expected to be $5.6 million. For next fiscal year, we expect both capital expenditures and D&A to approximate $6 million. Frank?

Thanks, Ken.

I will now provide you with an update on each of our businesses, and let's start with mattress fabrics. Our mattress fabrics business had a solid performance in the third quarter of fiscal 2014. These results reflect the growing consumer demand for better-designed bedding products and strong market penetration.

Culp is well positioned to meet this demand, with our extensive design capabilities and technical expertise, supported by a scalable manufacturing platform and reactive capacity. We now offer a complete array of innovative fabrics and mattress covers to all major players across all categories in the mattress industry.

As Ken noted in his remarks, we incurred some short-term challenges in the third quarter related to the absorption of some mattress cover business that was acquired earlier this fiscal year from a major competitor. I wanted to give you some perspective on the strategic reasons we entered into this transaction.

The overall objective of the agreement was to help facilitate the exit and closing of this competitor's El Salvador operation by having Culp purchase most of the plant's equipment, which was knit machines, and transferring the fabric and mattress cover production to Culp facilities in North Carolina. Therefore, the key strategic benefit to Culp was gaining immediate access and current business to one of the largest bedding manufacturers in the US. This access contributed significantly to the successful new product placements we enjoyed at the recent Las Vegas bedding market.

Additionally, Culp received a long-term noncompete agreement from this major global competitor for the North American market. Although we did experience some significant cost pressure in the third quarter and, to a lesser extent, in the fourth quarter as the program winds down, we believe the long-term growth potential as a result of this transaction far outweighs the short-term profit impact.

The fundamentals of our mattress fabrics business are strong, and Culp has a solid competitive position with a favorable product mix that reflects today's style trends. We are very encouraged by the response to our designs and new product introductions. Culp had an outstanding showing at the recent Vegas bedding market, with strong placements from all key customers for both mattress fabrics and mattress covers.

Given our optimistic outlook for the business, the majority of our mattress fabrics CapEx for the fourth quarter of this year and next fiscal year will be for expansion-related projects. Specifically, we are expanding the building at our main location in North Carolina to accommodate the additional volume going through our knit finishing, fabric inspection, and warehouse areas.

The building expansion will allow us to handle a significant increase in overall volume. We are seeing the most demand in our knitted fabrics product line, and therefore we will be adding additional knit machines, a second finishing line, and related equipment to increase our capacity in knits. We have the manufacturing footprint to add any additional knit equipment beyond knits, as necessary.

We are excited about the opportunities ahead to grow this business and to enhance Culp's leadership position in the bedding industry.

Now I will comment on the upholstery fabrics side. Our upholstery fabrics business had an outstanding performance in the third quarter. The higher-than-expected sales primarily reflect continued positive customer response to our innovative designs and diverse product offerings.

In addition, we experienced a greater-than-expected level of sales in the third quarter as customers anticipated longer lead times related to the Chinese New Year holiday, which occurred in late January of this year. Notably, sales of China-produced products accounted for 92% of upholstery fabrics sales in the third quarter.

Our 100%-owned China platform offers significant manufacturing flexibility to produce a variety of product categories, and we have continued to leverage this capability to meet changing customer demand in line with furniture style trends. As a result, we have increased sales to our key customers with our exciting designs and new product offerings. We're also excited about our ability to reach new customers and to expand into some new market segments. Culp is well positioned for continued growth in this area, especially as business conditions improve along with the housing market.

With respect to Culp Europe, we have continued to make gradual progress throughout 2014 with modest sales gains and lower operating losses for the year-to-date period. We remain patient with this initiative and are optimistic about the long-term opportunities for Culp with a European market presence, although admittedly it is taking longer than we thought.

I would now like to talk about our capital allocation strategy. 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 maintain a strong net cash position. We expect this positive free cash flow trend to continue; therefore, I wanted to again review with you how we prioritize our use of capital.

The first priority for us is investing in our existing businesses with working capital and capital expenditures and to grow organically, as reflected in the high returns on capital we are realizing. It is important to note that we have minimal capital requirements for CapEx in our upholstery fabrics business because it is not fixed asset intensive. So, the majority of our annual CapEx requirements are in our mattress fabrics business, and we have invested over $40 million during the last seven years in the mattress fabrics area.

We believe our business internally -- we believe building our business internally with existing and new customers and new customer segments offers the highest returns with the least risk. For the current year, we expect to invest approximately $10 million in working capital and CapEx.

Secondly, we initiated a regular quarterly dividend almost two years ago at an annualized rate of $0.12 per share and we have increased it twice since then to the current level of $0.20 per share, annualized, or a cash requirement of $2.5 million per year.

With the free cash flow we are currently realizing and expect to continue generating, we have ample runway to increase the regular dividend in the future. Our goal is to grow this regular dividend annually on a moderate basis over the years ahead, based upon our performance.

Third, we are open to strategic acquisitions in our mattress fabrics business. As you may remember, we've invested $20 million in two great acquisitions in this segment, in fiscal 2007 and fiscal 2009, both of which added significant value to the business. We will continue to be disciplined and patient with any acquisition that we consider. In reality, however, there just isn't a lot of current opportunity that we see. Nevertheless, we will remain open and patient and we have the capital necessary if something did fit strategically and financially.

Fourth, we wanted to build our net cash position this fiscal year to $25 million, which we have now accomplished. This level represents just under 10% of annual sales. This seems to us as a prudent level to maintain at this time. Importantly, this cash level helps Rob and I sleep very well at night and always have the dry powder to be opportunistic. It also gives our customers confidence that Culp will be around for many years and has the ability and will invest as necessary to provide more value to our customers.

Also, having a strong financial position contributes significantly to our thinking about and running our businesses for the long term.

If after the above-mentioned priorities, and assuming an acquisition does not materialize, we expect to generate free cash flow that exceeds our net cash target level beginning this fiscal year and into the future. Therefore, our Board will consider returning funds above $25 million in net cash by way of share repurchases and/or special dividends.

With respect to share repurchases, because we do not necessarily want to decrease our available float, we are only interested if the market is valuing Culp at what we would consider a discount to our estimate of intrinsic value.

We announced yesterday that our Board of Directors increased our share repurchase authorization program to $5 million, up from $2 million. With respect to special dividends, our Board will consider distributing such dividend after our year-end. Obviously, considerations for such distribution would include the economic and business outlook, as well as the possibility of funds being required for an acquisition.

The bottom line is that we are in the fortunate position to be generating significant free cash flow above the requirements to grow our business organically and maintain a strong net cash position. Therefore, we can provide shareholders with the added value that comes from a growing, regular quarterly dividend, opportunistic share repurchases, and special dividends.

Ken will now review the outlook for the fourth quarter and full year, and then I will have a few concluding remarks.

Given the adverse weather conditions experienced in many parts of the country thus far in calendar 2014, and the related impact on furniture and mattress manufacturers and retailers, providing guidance for our fiscal fourth quarter has become more difficult.

At this time and even with the weather-related challenges, we expect overall sales to be up 3% to 7% as compared with the fourth quarter of last year. For the year, we expect overall sales to exceed last year's annual sales by approximately 5%.

We expect fourth-quarter sales in our mattress fabrics business to be up 3% to 7% as compared to the same period a year ago. Operating income in this segment is expected to be flat to slightly higher, while margins are expected to be slightly lower as compared with the same period a year ago. This performance reflects significant improvement over the results of the third quarter of this fiscal year.

For the full fiscal year, we expect mattress fabrics sales to be approximately 4% higher than last fiscal year, and operating income margins are expected to be somewhat lower than the same period a year ago.

In our upholstery fabrics business, we expect fourth-quarter sales to be up 1% to 5% as compared to the previous year's fourth-quarter results. Because the Chinese New Year holiday falls entirely in the fourth quarter of this fiscal year, our sales and production schedules will be affected by the extended break. We believe the upholstery fabrics segment's operating income and margins will be flat to slightly lower when compared with the same quarter of last year.

For the full fiscal year, we expect upholstery fabrics sales to be approximately 10% higher than last fiscal year. Operating income in this segment is expected to be significantly higher than last year, while operating margins are expected to be moderately higher as compared to last year.

Considering these factors, we expect to report pretax income for our fourth quarter in the range of $5 million to $5.9 million. Pretax income for last year's fourth quarter was $5.9 million. For fiscal 2014 as a whole, we expect pretax income in the range of $19.9 million to $20.8 million, compared with $20.3 million last fiscal year. Notably, last year's $20.3 million was the highest level in 15 years and was up 43% from the prior year. Frank?

We are pleased with our performance to date in fiscal 2014 and our ability to grow our business in the global marketplace.

Our creative designs and innovative fabric styles are resonating with our customers in both businesses with favorable results. We are building a strong economic moat in both businesses with our flexible and scalable global manufacturing platform, which is supported by our design expertise, product innovation, and outstanding customer service. We look forward to our future growth prospects and our ability to continue generating strong free cash flow. 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. Thank you for all of the color and thanks for taking my question. I guess the thing that I would like to explore -- have you explore more is the surprise or what happened to the additional $600,000 of cost of goods sold that came in the quarter. And then, what's the persistence of that? I know you told us it's some smaller amount going forward, but maybe you could quantify what that is in the fourth fiscal quarter and maybe in fiscal 2015 and beyond.

Okay. Let me address, Budd, the second part of your question first. You know, we've said in our release that this program will be ending in the fourth quarter. We will be winding down the production.

So we do not expect any impact next year, and I guess as an estimate in Q4, maybe $100,000 to $200,000 in operating in the gross profit area in our mattress fabrics area. So, a much lesser extent because most of the production that we absorbed for these covers was in the third quarter. And only a much less significant piece is being produced in the fourth quarter.

Additionally, and what is very encouraging is that the fourth-quarter mix of business for our mattress cover business, which is relatively new -- only a year old, is with a broader mix of customers all at excellent programs. So we've made very solid progress, particularly resulting from the Vegas market where we got a growing number of programs and we are currently hiring in that operation now. So the mix is significantly better, only a small amount of the maybe unfavorable mix, I would say, that we incurred in the third quarter.

And I guess to answer the first part of your question, you know we are still relatively new at the cutting and sewing of mattress covers, and as I said in the press release, the major benefit to the transaction we did enter into back in May of this fiscal year was to gain access to one of the large bedding manufacturers in the US. And that has proven to be a very good situation as to the future growth prospects with the customer.

I wish we'd have known it earlier, but we simply didn't. We are new in the business and we just didn't. So I don't know what else to say.

Okay. All right. Just one other issue on that. Of the $600,000, is there any way to classify what kind of expenses they were? Were there asset write-downs? Was it simple process or (multiple speakers)

No. It is just overhead. Overhead and productivity, labor and productivity in the plant, in the cut and sew operation itself.

In the El Salvador plant or in the US?

No, in the US. We began producing the mattress covers only in our third quarter. It took a while to transition the business to us. We had to go through supplier qualification, approval, etc. So we didn't actually begin producing the covers until the third quarter.

And a substantial part of the production in the third quarter was this program. Now the good news, helping keep -- making a smooth transition for the customer of this program was very, very important, and we excelled at that. And we think that contributed -- had some impact on the receptivity to the number of placements we got at Vegas. So again, some short-term pain for long-term gain.

And the good news, the program's over in the fourth quarter. As you know, Budd, in the mattress industry, most of the programs run two years or so, thereabouts, and a lot of new introductions at Vegas, so that particular program is over from our production point of view. I don't think it's quite over for the customer. They've got to work through whatever -- how they wind those things down. But it's through from our perspective.

I see. And you talked a little bit about Europe coming on slower than you would have liked. Can you give us some feel of when that becomes material? Or does it become material to the business, and what the opportunity is there? Is it still the same opportunity that you saw when you made the decision to expand in Europe, I think now, the year and a half, two years ago?

Okay. Absolutely. No question, the European theater is the second largest furniture market in the world. It is a large area that we would like to participate in.

Most of our -- the skill set and core competencies in our upholstery fabric area, with the China platform, our design capabilities, all should work well in Europe as they do in the US and other parts of the world. So today, we still think the opportunity is as good as it's always been.

We've got about $2.5 million of capital in Europe. We've got five employees. We've got $3 million to $4 million in annual sales and we've reduced our operating losses this year. We are not going to be at breakeven yet, but we are not a big operating loss at all. It's a small operating loss, and it's just taken time to learn the customer base, learn the products they need, which are somewhat different from the US market, just learn about how to do business in Europe. So it has taken us some additional time. I would hope next year, we will see additional sales growth and we will see breakeven results at some point next year.

We have made great progress with a very large customer in Europe and across the world. I will even say it, IKEA is a big customer in Europe and across the world where we made very good progress with them year over year, but it is not easy. So for really that reason alone, the positive traction we are gaining there gives us more optimism to stay the course and be patient. As long as we have a lot of capital, as long as we don't lose a bunch of money, let's just hang with it.

Okay. Thank you very much. Good luck on the fourth quarter and in 2015.

Kevin Tracey, Oberon Asset Management.

Thank you for taking my question. In the past, you all have talked about your mattress fabrics business growing about GDP rates, but it sounds like you all are gaining market share and you now have access to a new major customer. So is it fair to expect your mattress business to grow at a faster rate than GDP over the next couple of years?

That's a great question, Kevin, and that's exactly how we see it internally today. We talk about growing the business faster than the industry grows, given the success we are having with product innovation and access to all customers and our cut and sew operation there. We do see us growing faster than the industry grows.

Okay. Great. Thanks. Good luck.

(Operator Instructions). It appears we have no further questions at this time.

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

Thank you. Ladies and gentlemen, this does conclude today's presentation. You may now disconnect.