Culp Inc (CULP) 2018 Q1 法說會逐字稿

Good day, and welcome to the Culp, Inc. Fiscal 2018 First Quarter Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I'd like to turn the call over to Ms. Dru Anderson. Please go ahead.

Thank you. Good morning, and welcome to the Culp conference call to review the company's results for the first quarter of fiscal 2018.

As we start, let me state that this morning's call will contain forward-looking statements about the business, financial condition and prospects of the company. Forward-looking statements are statements that include projections, expectations or beliefs about future events or results or otherwise are not statements of historical fact.

The actual performance of the company could differ materially from that indicated by the forward-looking statements because of various risks and uncertainties. These risks and uncertainties are described in our regular SEC filings, including the company's most recent filings on Form 10-K and Form 10-Q.

You are cautioned not to place undue reliance on forward-looking statements made this morning, and each such statement speaks only as of today. We undertake no obligation to update or revise forward-looking statements.

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 and posted on the company's website at culp.com.

A slide presentation with supporting summary financial information and additional 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'll begin the call with some brief comments, and then Ken will review the financial results for the quarter. I'll then update everyone on the strategic actions in each of our businesses.

Our sales were in line with expectations for the first quarter compared with the very strong first quarter sales a year ago. During the quarter, our performance was affected by an uncertain and weak retail environment for home furnishing and other market disruptions specifically related to the mattress industry. Our profitability was primarily affected by these issues and by cost pressures associated with the significant transitions in our mattress fabric production facility. We do believe these transition issues will be behind us by the start of our third quarter.

Regardless of market dynamics, we have remained focused on creative designs, innovation and exceptional customer service with a diverse product offering that meets changing customer style trends. To support this strategy, we have made significant investments in our mattress fabric business with improved production and distribution capabilities that will enhance our ability to meet customer demand with outstanding service. We were also encouraged by the success of our diversification strategy in our upholstery fabrics business. Importantly, we have the financial strength to make the strategic investments to support our growth strategy, including acquisitions and continue to return funds to our shareholders. We are excited about our announcement yesterday of a nonbinding letter of intent to acquire a mattress fabrics operation in China. This acquisition is expected to extend our market reach in China and other parts of the world. I will talk more about this later in my update on mattress fabrics segment. With Culp's strong financial position, a key growth strategy for us is to make strategic acquisitions in areas synergistic with our core markets and our core capability.

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

Thanks, Frank. As mentioned earlier on the call, we have posted slide presentations to our Investor Relations website that cover key performance measures. We've also posted our capital allocation strategy.

Here are the financial results for the first quarter. Net sales were $79.5 million, down 1.4% compared with the prior year. Pretax income for the first quarter was $6.7 million, down 21% compared with the prior year period. Pretax income margin was 8.5% compared with 10.6% a year ago. Results for the quarter were affected by approximately $600,000 of one-time charges and by the cost pressures coming from the significant manufacturing inefficiencies associated with our plant consolidation project in the mattress fabrics business. We will comment in more detail about this project later. Partially offsetting this pressure was lower unallocated corporate SG&A expenses due primarily to lower incentive compensation costs.

Net income was $5 million for the first quarter compared with $5.3 million a year ago. The consolidated effective GAAP income tax rate was 24.3% for the first quarter compared with 37.8% for the first quarter of last year. The rate decrease was primarily due to the income tax benefits realized on certain stock-based compensation awards and differences in the mix of earnings between the company's U.S. parent and foreign subsidiaries. The company's overall consolidated adjusted effective income tax rate, a non-GAAP measure, for the first quarter was 15.5% compared with 17.8% last year. As a reminder, the company had approximately $9 million loss carryforwards as of the end of last fiscal year. As a result, the company currently does not pay a material amount of cash taxes in the U.S., nor do we expect to for approximately 1 more year.

Trailing 12 months adjusted EBITDA was $38.1 million compared with $39.2 million for the same period a year ago. Annualized consolidated return on capital was 27% compared with 38% a year ago.

Now let's take a look at our 2 businesses. For mattress fabrics, sales were $48.4 million, down 4.2% compared to last year's first quarter, which was an exceptionally strong and record quarterly sales performance.

Operating income was $6.4 million compared with $8.4 million a year ago with operating income margin of 13.1% compared with 16.6% a year ago, which was a quarterly record margin. While we still achieved a solid operating margin at 13.1%, the decrease was due to lower sales, one-time charges and greater-than-expected production disruptions from the extensive changes that took place across our production facilities during the quarter. Annualized return on capital for mattress fabrics was 30%.

For upholstery fabrics, sales for the first quarter were $31.1 million, up 3.2% over the prior year. Operating income was $2.9 million for the quarter, slightly down from last year's $3 million. Operating income margin was 9.3% compared with 9.9% last year, which was an exceptional quarter. Annualized return on capital for the upholstery fabrics business continues to be impressive, coming in at 65%.

Here are the balance sheet highlights. At the end of the first quarter, we reported $51.7 million in total cash and investments and $5 million outstanding on the company's line of credit for a net cash position of $46.7 million. This amount compares to $41 million of net cash at the end of the first quarter of last year.

During the quarter, we spent $3.5 million on CapEx, including vendor-financed payments and $3.6 million on regular and special dividends, consistent with the first quarter of last year, the company borrowed funds for working capital requirements at the beginning of the fiscal year, and we expect to renew this outstanding balance -- or outstanding debt as soon as possible.

Cash flow from operations was $2.4 million compared with $6.2 million for the first quarter of last fiscal year due in part to higher inventory levels. Both business segments have implemented plans to reduce inventory in the second quarter. In line with our capital allocation strategy, the company paid a $0.21 per share special dividend during the first quarter, along with the regular quarterly dividend of $0.08 per share, totaling 3.7 -- $3.6 million.

With that, I'll turn the call back to Frank.

Thank you, Ken. And I will start with mattress fabrics. Our sales for the first quarter reflect the ongoing uncertainties in the mattress industry compared with marketing conditions a year ago. As Ken noted, we're also comparing to a record quarterly sales performance from a year ago. However, we continue to outperform overall mattress industry sales trends. In addition to lower sales, our operations were affected by several factors, as Ken mentioned. As previously announced, we've been working through a period of major transition across our manufacturing operations. We completed the move of the majority of our knitting equipment and relocated our mattress cover operation to new locations in North Carolina during the last month and first quarter. Both of these significant moves created more disruption to our production than we had anticipated and especially during a weaker sales environment. We remain on schedule with our previously announced joint venture of a mattress cover production facility in Haiti. Following initial sample, production and training, we expect to commence customer production activities in October. The new Haiti operation will complement our U.S. operations with additional capacity via a mirrored platform, enhancing our ability to meet customer demand and remain cost competitive.

The sales results for the quarter include a growing contribution from CLASS, our mattress cover operation, and we're excited about the additional sales opportunities ahead. We continue to expand this business with both our traditional customers and new market segments, especially the fast-growing Internet bedding space.

Looking ahead, we see continued uncertainty in the mattress industry that could affect short-term demand trends and our operating performance. We also expect some continued impact on our operating efficiencies in the second quarter related to the equipment relocations and changes in production that occurred towards the end of the first quarter. However, we believe these issues will be behind us by the end of the second quarter.

Accordingly, we expect to see solid improvement in our quarterly results as we move into the second half of this year. We have worked hard over the past year to create a sustainable platform with enhanced capacity and distribution capability. And we look forward to the results from this platform in a stronger market.

As mentioned at the beginning of the call, we've executed a nonbinding letter of intent to acquire a knitted mattress fabric operation in China. The business to be acquired has annual revenues of approximately $12 million and pretax income of approximately $2.5 million. We currently expect to fund the acquisition with cash and investments on hand without incurring any additional debt, with closing expected to occur within 90 days.

We are excited about this opportunity as the proposed acquisition is expected to establish a beachhead for our mattress fabrics business in Asia with potential for growing sales to North American markets. It will also serve as a low-cost source for mattress fabrics being sold through our North American bedding customers. We believe this new platform provides opportunities for synergies with our current upholstery fabric operations located at Culp China, which includes a substantial cut-and-sew operation that can serve both traditional bedding customers and the growing Internet bedding market. The letter of intent is nonbinding and remains subject to the completion of due diligence, negotiation of a definitive purchase agreement and other approvals, without which the acquisition will not occur.

Now I'll turn to upholstery fabrics. Our upholstery fabric sales were in line with expectations with slightly higher sales compared with the strong first quarter a year ago. Our ability to execute our product-driven strategy and diversify our customer base has been the key driver of our sales performance. Our creative designs and new product introductions continue to resonate with our global customer base. Our performance line of highly durable stain-resistant fabrics has been well received by both traditional customers as well as new customers with favorable sales trends. We also achieved meaningful sales growth in fabrics design for the hospitality market, which accounted for a significantly higher percentage of our sales for the quarter. We are excited about the additional growth opportunities for this market as we focus on targeting a more diverse customer base. To further support this strategy, we are exploring potential acquisitions in the hospitality marketplace that will complement our upholstery fabrics business, which is principally in the residential market.

Looking ahead, we look forward to the opportunities for our upholstery fabrics business in the current year. We have the unique ability to leverage our China platform, which accounted for 95% of Culp's upholstery fabrics sales during the quarter. We will continue to pursue the same product-driven strategy and identify new customers. We believe Culp is well positioned to benefit from any uptick in consumer demand for home furnishing in more stable market conditions.

Ken will now review the outlook for the second quarter, and then we'll be glad to take your questions.

We expect overall sales to be comparable with the second quarter of last year. We expect sales in our mattress fabrics segment to be comparable to the second quarter of last fiscal year. Operating income and margins are expected to be moderately lower compared to the same period a year ago as we continue to face uncertain business conditions and work to return to normal operating efficiencies and production schedules.

In our upholstery fabrics segment, we expect sales to be slightly higher as compared to the same time last year. Operating income and margins are expected to be slightly higher compared with the same period a year ago. Considering these factors, the company expects to report pretax income for the second fiscal quarter in the range of $5.4 million to $6.1 million. Pretax income for last year's second quarter was $7.2 million. Looking ahead to the rest of the year, our performance for the second half of this fiscal year is currently expected to be more in line with the results achieved during the second half of last fiscal year, excluding any impact from acquisitions.

Capital expenditures for this fiscal year, including vendor-financed payments, are currently expected to be comparable to the previous year, mostly related to additional improvement projects for mattress fabrics. Additionally, the company expects another good year of free cash flow, even with the expected same level of capital expenditures and modest growth in working capital.

With that, we'll take your questions.

(Operator Instructions) We'll take our first question from John Baugh with Stifel.

I guess I wanted to focus on hospitality. Could you talk about the success you're having there? Is that 1 or 2 account wins? Have you already designed a different product line to address that market? Is that -- how are the margins in that business currently? Are you chasing business? Or is it a better margin than residential? Just kind of getting some feel for the longevity of that. I doubt you'll break out the sales mix, but I'm trying to think forward here how much of an impact growing hospitality without an acquisition could have on your upholstery fabric business.

All right. John, thanks for the question. First of all, the customer base, there are no large customers. We have a very broad group of customers in this business so far, and that is a characteristic of the market that we like. There are no 800-pound gorillas, so to speak. It is a collection of very diverse, small to medium-sized customers across the market. So that's a favorable characteristic. Second, you asked about product designs. Most hospitality and hotels now are moving towards a residential look. And that's favorable because the products we're selling are mostly products we've done in the residential area as well. They do require some extra steps to meet the more stringent quality requirements, but for the most part, the product designs and the products we're selling come from our existing design portfolio, which, again, we're very pleased with. And we see the trend in the marketplace definitely move into more homey, more residential looks in -- across all the brands that we sell. As for margins, as I mentioned in earlier conference calls, the margins are significantly above our consolidated margins. And that's -- we're very pleased with that. And Culp, a real strength of us in this marketplace is we are vertical. All of the competitors are converters. So with Culp's presence in China, for example, on upholstery fabrics, we are vertical, so the margins are all -- I think I've even quoted earlier as much as 50% above our current margin. And so -- go ahead.

Yes. And finally, any sense of how important this is to the segment in terms of either percentage of sales or the growth trajectory because you did have growth in upholstery. And typically (inaudible) look by the negative numbers for a while.

Yes, that is -- it is certainly a growing percentage of our business there. It is still small relative to the upholstery fabrics segment in total, but it is becoming more meaningful every year. Of course, our strategy is to expand the product offerings that we do to this market. Currently, we are offering upholstery fabrics to the marketplace for furniture, et cetera. We also are offering the bed skirts and the bed wraps that we're able to do from a China platform. What we would like to find, of course, is an acquisition in the window treatment area. And that is what we're seeking actively, to find an acquisition to expand our product offerings into that area. And I'm reasonably, as I've said on the last call, cautiously optimistic that we will be able to make one of those acquisitions within our current fiscal year.

Okay, super. And then on bedding, I guess, I'm curious of your view of the bedding industry and let's talk units of mattresses. And as we look at sort of last year and now, whatever, year-to-date intel you have, you seem to be negative at least by ISPA count. And I guess, I'm wondering, is that really true. Or are there bids coming from other places that are not being counted and there's actual flat performance or growth? And then more specific to Culp, and you mentioned the pending acquisition, but are you -- if the business is morphing to other channels of distribution or other things outside of this, is this discounting your ability to participate in that shift?

Okay, John, we -- as you stated, we believe some of the ISPA reporting certainly could be understated, and it is difficult to capture the imports from China. And we have been studying that market in China for some time, and that is why we ended up wanting to make an acquisition in China so we can participate in that growing segment of the distribution channel. This certainly follows -- 3 or 4 years ago, as you know, we got into the mattress cover business, and that has helped us significantly in participating in the growing Internet bedding market. So I would say, yes, we're seeing more imports. And your guess is as good as mine where that trend will go, but we want to be able to participate in that. And with the China -- this acquisition, we will be very well positioned to participate and sell into those manufacturers in China.

(Operator Instructions) We'll take our next question from Budd Bugatch with Raymond James.

I guess we have seen -- you've seen some really good strategic growth in adding value to your fabric with both cut and sew in your China operation and now with CLASS and the joint venture. Could you break out a little bit of what -- how important it is to the revenues now of each of the segments and give us a little bit of a feel on the growth of that, the growth of basically -- the fabric side of each of those segments?

Budd, I'll do the best we can. As you know, we don't break out those individual parts of our businesses. In the mattress side, of course, the mattress cover operation has grown significantly and continues to grow double-digit amounts quarter-on-quarter. And we believe that will -- based on the opportunities that we see and what's happening in the marketplace that we believe we will continue to see that kind of growth rate in our operation. Now of course...

When you say that, are you talking total units? So it'd be fabric and labor year-over-year? Or just...

No, it would be -- we look at it in its entirety, fabric and labor and overhead. Yes. Of course, a big part of a mattress cover product is the fabric. That's the majority of the cost. And of course, a lot of -- most of the cut-and-sew products that we sell are our own fabric, not always all, but most.

And you say that's growing double digits. What's the degree of penetration of that either last year or this year, that $48 million of mattress fabric revenue reported in the segment this year versus $50 million last? Is it 10% now? Or is it 15%, 20% coming out of the...

I would just say, Budd, it's not something we've been breaking out and not something we want to break out, but it is growing nicely. And that's about the best I can do. We are participating with the new channels, the e-commerce particularly, across many of those new customers. We are a key supplier. And as I've mentioned before, we have a full-court marketing and sales pressed on gaining penetration in that market.

So the growth of double digits, is that only because of e-commerce? Or is your legacy customer usage also growing at that kind of rate?

No, it's -- I would say, Budd, it's both. And we are expanding into Haiti because a lot of our larger customers want to have a lower-cost option for mattress covers. Some customers, the speed is more important than the lower cost, so they want to have the mattress cover produced in our North Carolina facility. But there are a few of the larger people that do want a low-cost platform. And we're able to provide that not only in Haiti, but we're able -- now we will be able to provide it with our mattress fabric operations in China. We'll be able to provide that in China. None of our competitors have the global cut-and-sew platform that we have; North Carolina, Haiti, China. And whatever a customer wants, we're able to meet that. We believe, Budd, where you're headed, though, I think, we certainly believe there are going to be more mattresses sold, sewn and hybrid, that require a mattress cover. So we need to be participating and positioning our capabilities to serve that growing part of the market.

Now that market is a much more -- is much simpler to operate as opposed to the upholstery fabric cover business, right? An upholstery fabric cover kit has many more parts and complexity than does a mattress kit because the profiles are vastly different. Isn't that correct? Is that something I should...

You are exactly right. Many of the mattress covers are 4 to 5 parts. A recliner could be 60 to 80 parts.

And so -- how do we think about the barriers to entry if that is that simple or that less complex, nothing is simple?

Even though, I would tell you based on our experience so far in the last 3 to 4 years now in mattress cover cut and sew, even though it is simpler on a parts-wise basis, it is still difficult. You can screw it up really quickly. So it has its own other challenges to do it correctly. So the quality, consistent quality is a barrier to entry, with no doubt in my mind from what we've seen.

Okay. And lastly for me on this issue, Frank, beating this horse fairly well. If this side of the business is growing at double digits, that means that the other side of the business is shrinking at maybe double digits? Is that a way to think about it? And -- or is it more in line with the overall industry, which, I think, with the housing.

Budd, I think, what we -- we want our fabric to go into the mattress cover, of course. So when we look at total sales and we talk about double-digit growth, that does include our fabric. So what you were getting to earlier, the real incremental revenue to us is the labor and overhead of the cut-and-sew cover. So I think it's still -- we're still going to do fine on the fabric side because the cut-and-sew component basically is like we did on the furniture side. It is a value add. So the customer can come to us for one-stop shopping all the way from design to delivery of the cover.

Okay. And I would think the labor when you price that in, that's got to be at less than a fleet average kind of margin. Is that not correct or is this...

Yes, the margin is -- the cut-and-sew is an okay margin, but your margin is more in the fabric than in the cut and sew, which is the same on the furniture side. So good questions, Budd, and that's a key area for us as we see what's happening in the marketplace.

Well, it would be greatly helpful if we had a little more visibility into the penetration of that. I know that you don't wish to do that for obvious reasons, but we'll continue to probe that area for a while.

You know I understand. And Budd, if that can be done without hurting us competitively, that's something we'll take a look at.

(Operator Instructions) And it appears there are no further questions. I'd like to turn the conference back over to our speakers for any additional remarks.

Thank you, operator. And thank you, everyone, for your participation today and your interest in Culp. We look forward to updating you on our progress next quarter. Have a great day.

And once again, that concludes today's presentation. We thank you all for your participation, and you may now disconnect.