Culp Inc (CULP) 2018 Q3 法說會逐字稿

Good day, everyone. Welcome to Culp's Third Quarter 2018 Earnings Conference. Today's call is being recorded.

At this time, I'd like to turn the conference over to Ms. Dru Anderson. Please go ahead, ma'am.

Thank you. Good morning, and welcome to the Culp conference call to review the company's results for the third 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 to 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.

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

Thank you, Dru. Good morning, everyone, and thank you for joining us today. I would like to welcome you to the Culp quarterly conference call, and 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. After that, Ken will review our fourth quarter business outlook. We'll then be happy to take questions.

Our third quarter was highlighted by higher-than-expected sales, and we are pleased with the strong financial and operating performance for both of our businesses. Our mattress fabric sales showed solid year-over-year improvement, in spite of a more challenging marketplace and weather-related disruptions.

Sales of upholstery fabrics were exceptionally strong, as many customers were ordering ahead of the Chinese New Year holiday that occurred entirely in February this year, as opposed to January last year.

For both of our businesses, we continue to drive product innovation and creativity and provide a diverse product mix that meets the changing demands of our customers. Importantly, we have continued to build upon our strong financial position, with almost $56 million in cash and investments and no debt, which provides flexibility to capitalize on new growth opportunities, including strategic acquisitions.

I'll now turn the call over to Ken who'll 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 to cover key performance measures. We've also posted our capital allocation strategy.

Here are the financial highlights for the third quarter. Net sales were $85.3 million, up 12% compared with the prior year. Pretax income in the third quarter was $7.5 million, up 7.5% compared with the prior year period. Pretax income margin was 8.8% compared with 9.2% a year ago. Our net loss for the quarter was $748,000 or $0.06 per diluted share, which includes a $5.9 million charge, or $0.48 per diluted share, associated with the 2017 Tax Cuts and Jobs Act or Tax Reform. Excluding this charge for Tax Reform, our net income was $5.2 million or $0.42 per diluted share.

I will discuss Tax Reform in a little more detail in a minute. Last year's fiscal third quarter net income was $6.3 million or $0.51 per diluted share. Importantly, last year's net income included a $2.1 million reversal of an uncertain tax position associated with the foreign jurisdiction.

Trailing 12 month's adjusted EBITDA was $37.7 million or 11.7% of sales compared with $40.4 million for the same period a year ago. Annualized consolidated return on capital was 26% compared with 32% a year ago.

Now let's take a look at our 2 businesses. The mattress fabric sales were $49 million, up 6.8% compared with last year's third quarter. Operating income was $6.8 million compared with $6.4 million a year ago, with operating income margin of 13.9%, which was the same as a year ago. Frank will provide more color on the sales growth in a minute.

Annualized return on capital for mattress fabrics was 30%. For upholstery fabrics, sales for the third quarter was $36.3 million, up 20% over the prior year. We estimate that the timing of the Chinese New Year was the main driver of about half of the sales gains, as many customers move business forward in advance of the plant shutdowns. Frank will comment more on this later.

Operating income was $3.5 million for the quarter, up from last year's $3.1 million. Operating income margin was 9.7% compared with 10.2% last year. The cost absorption benefit of higher sales was partially offset by pressure coming from an unfavorable China currency exchange rate. Since the beginning of our fiscal year last May, the yuan has strengthened almost 9%. Annualized return on capital for upholstery fabrics business was 63%.

Here are the balance sheet highlights. As of the end of third quarter, we reported no outstanding balance on our lines of credit and $55.7 million in total cash and investments, up from $48.9 million a year ago. For the first 9 months of this fiscal year, we spent $10.4 million on CapEx, including vendor finance payments and $5.7 million on dividends. The company has not repurchased any shares so far this fiscal year, leaving $5 million available under the current purchase -- repurchase program.

Now let me spend a few minutes on the impact of Tax Reform. As mentioned earlier, the result of this quarter was impacted by a provisional charge of $5.9 million or $0.48 per diluted share related to Tax Reform. This amount includes a provisional $4.8 million charge for the mandatory repatriation of undistributed earnings and profits associated with the company's foreign subsidiaries and a provisional $1.1 million net charge for the company's U.S. deferred income taxes and reduction in the annual effective income tax rate. The deemed repatriation tax will be paid over 8 years. Estimates were required based on projection for U.S. taxable income, capital expenditures, working capital, among other areas, to determine the $5.9 million charge. These estimates may change based on actual versus projected results. Revisions to the company's estimates will be recorded during the measurement period allowed by the SEC, which is not to extend beyond 1 year from the enactment date.

We estimate that our consolidated effective income tax rate for the fourth quarter of this fiscal year will be in the range of 29% to 32%. Looking ahead to next fiscal year, we estimate that our consolidated effective income tax rate will be in the range of 26% to 29%. These rates are subject to revisions to our provisional estimates made in connection with Tax Reform. Importantly, as part of Tax Reform, we elected out of use in our NOLs to offset the mandatory repatriation tax in order to fully utilize our foreign tax credits. As a result, we have approximately $7 million in NOLs to apply against fiscal 2019 U.S. taxable income. This fact, coupled with lower corporate income tax rate and the ability to immediately expense all U.S. capital expenditures next fiscal year, is expected to result in minimal U.S. cash taxes paid in fiscal 2019, based on the facts and circumstances we know today.

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

Thanks, Ken. I'll start with mattress fabrics.

We had a solid third quarter financial and operating performance in this business with higher-than-expected sales. These results reflect our ability to execute our strategy in spite of an uncertain marketplace, seasonal holiday plant closures and some additional weather-related disruptions that occurred near the end of the quarter.

New product rollouts of mattress covers and other new fabric programs were key drivers of our strong sales performance. And we have continued to outperform reported mattress industry sales trends throughout this fiscal year.

Our operations performed well, following the completion of a period of major transformation across our North American manufacturing operations, which included significant capital improvement projects and supply chain enhancements in North Carolina and Québec. With our capital improvement projects and facility and equipment relocations behind us, we have started to realize greater operating efficiencies with favorable results.

We are pleased with our progress, and we remain focused on continuous improvement initiatives across our global platform that will further enhance Culp's strong value proposition.

We're also pleased with the performance of CLASS, our mattress cover operation, with a solid sales and profit contribution for the third quarter. We've continued to gain market share in this business, with increased sales to both traditional customers and new customer markets, including the fast-growing bed in a box base.

Our new mattress cover's production facility in Haiti complements our existing production capacity in North Carolina and further enhances our ability to expand our CLASS business and remain cost competitive. We have commenced production and started to shift some products from Haiti and we plan to gradually add more capacity to meet expected customer demand.

In line with our product diversification strategy, we recently launched a new line of bedding accessory products, including mattress pads and protectors at the recent Las Vegas market. This new line, being offered directly to bedding accessory retailers under the brand name Comfort Supply Company by Culp, introduces highly stylized design-driven products to the bedding accessories category. We are excited about the growth potential for this innovative new area and expect to begin sales early in next fiscal year.

Now I'll turn to upholstery fabrics. We're very pleased with the strong financial performance for upholstery fabrics for the third quarter with higher-than-expected sales and solid profits. We achieved the profitability despite significant pressure from unfavorable China currency exchange rates. We continue to see positive sales trends with our LiveSmart performance line of highly durable stain-resistant fabrics. Our focused marketing efforts have produced favorable results, as more manufacturers are featuring these innovative fabrics, and we are encouraged by the strong customer placement heading into the April furniture market in High Point this spring.

Additionally, upholstery fabric shipments were stronger in January, heading into the Chinese New Year holiday, which occurred entirely in February this year. Many of our customers were moving business forward in advance of the plant shutdowns in order to meet anticipated demand. While this pushed our sales higher for the third quarter, we expect this pace will slow down somewhat in the fourth quarter, with the disruption of February production in China.

In addition to improved sales from our residential market customers, we continue to have solid growth in sales of fabrics designed for the hospitality market. As we continue to diversify our customer base, we believe the hospitality market offers significant growth opportunities for Culp. We are actively pursuing acquisition opportunities in this area that will broaden our product capabilities and complement Culp's core strength of design, product innovation, and a substantial global platform.

Ken will now review the outlook for the fourth quarter, and then we'll take your questions.

We expect overall sales to be comparable with the fourth quarter of last fiscal year. We expect fourth quarter sales in our mattress fabrics business to be comparable with the same period a year ago, although we are seeing some softness in demand for mattress covers.

Operating income and margins are expected to show modest improvement over last fiscal year, as we continue to realize more efficiencies from our strategic capital investments.

In our upholstery fabrics business, we expect fourth quarter sales to be slightly higher compared with previous year's fourth quarter results, even with the expected impact from the Chinese New Year holiday. We believe the upholstery fabric segment's operating income and margins will be down slightly over last year, primarily due to continuing unfavorable currency, the China currency exchange rate trends.

Considering these factors, we expect to report pretax income for the fourth quarter in the range of $7 million to $7.6 million. Pretax income for the last year's fourth quarter was $7 million.

Looking at the full fiscal year, capital expenditures for the fiscal 2018, including vendor finance payments, are expected to be comparable to the $12.9 million spent last fiscal year and mostly related to additional improvement projects for mattress fabrics.

Full year projection for depreciation, amortization is around $8 million, plus $3 million for stock-based compensation.

With regard to cash flow, we expect another good year, even with the anticipated level of capital expenditures and modest growth in working capital.

Looking ahead to next fiscal year, we expect capital expenditures to be in the range of $7 million to $8 million.

With that, we will now take your questions.

(Operator Instructions) We'll go first to Bobby Griffin with Raymond James.

I just wanted to first talk about hospitality. It's been a nice growth area, in the upholstery segment, for the last couple of quarters. Frank, can you maybe give us an overview of what areas of the hospitality business you're in now? And then if you do target an acquisition, kind of what areas would you look at, and how those would relate to each other?

Sure, sure. Currently, we're in the -- think of the hospitality as hotel, motel. And when you think of a hotel, we are currently only participating in the chairs -- the upholstery fabric for chairs and benches in the hotel room, and in the fabric in the main lobby that could be sofa chairs, et cetera. The biggest area of fabric utilization in the hotel area is the window treatments. That's the area we're targeting. A next big area is also bed skirts and bed wraps and -- used in every hotel room. So the areas we're targeting for acquisition expand our product capabilities from just upholstery fabrics for chairs in the main lobbies to the window treatments. And of course, there are some draperies in the main lobbies, but the bigger volume is in the individual hotel room for window treatments. And this is an area that fits perfectly with Culp's core strength: Design, creativity, global-sourcing platform in China, you know we have almost around 350 employees with our China operation near Shanghai. So we are perfectly suited to pursue this area of the hospitality market.

Okay. I appreciate the detail. And then just touching there on China as well. Is there any estimate you could share with us about the costs, what amount of the cost in the upholstery segment is dominated in foreign currency there, to help us from a modeling standpoint?

There's not -- most of our sales in the upholstery fabric sales area are dominated in U.S. dollars. There is...

All the China expenses (inaudible).

We do have some in local currency in China. I'm going to say maybe, a little get back to $20 million, $25 million of $125 million total upholstery fabrics.

That's top line, right? You're referring to -- I was thinking more of just along the cost perspective where we can try to model in some of these -- well some of the currency drags that have been hitting the operating income.

Well, you would say, we disclosed over 90% of our sales are produced in China. 90% of our upholstery fabric sales, as we've consistently disclosed, are produced in China. And about -- a little less than 10% of our sales are produced in our one U.S. plant.

Right.

So maybe that gives you some perspective of the -- so it's significant, the impact of currency.

All those operating expenses are in RMB too.

Yes, all the cost of sales is in RMB. Local currency.

Okay, that will be helpful. That's very helpful. I appreciate that. And then lastly, just wanted to switch to mattress just real quick. As we continue to see, kind of, this trend of a more box bedding. One of the opportunities, I guess, from a margin standpoint is, where you guys do the -- where you guys use your fabric and you also do the cut-and-sew aspect of the cover as well. Can you maybe update us or give us a little color on what portion of the covering business right now does the whole process through you? Or -- and then what portion, I guess, where you're just doing the cut-and-sew aspect and using somebody else's fabric?

Okay, sure. Currently, we've evolved to most of our cover productions today utilizes Culp's fabric. When we started that was not the case. But it really is a great solution for the customers, be it a bed in a box customer, be it a traditional customer, for the fabric supplier and the cut-and-sew company to be one and the same. And of course, in Culp's case, we've got solutions out of China for covers, out of Haiti or out of our North Carolina for customers that want a quicker delivery time but a little higher cost. So I mean, that's certainly the goal, Bobby. We will do it without the people's fabric, but you're exactly right, we want to use Culp fabric, and of course, all of our sales presentations emphasize that. And it seems that customers increasingly realize that, it is a lot better in their supply chain to have one vendor doing the fabric and the cut and sew.

(Operator Instructions) We'll move next to Marco Rodriguez with Stonegate Capital Markets.

I wanted to follow up on one of the prior questions there on the hospitality business. Can you, kind of, remind us the margin profiles for that type of business, the hospitality business versus your other upholstery fabrics?

Yes. One of the reasons we also really like this area is the gross margins in hospitality are double our residential margins. So it is a -- about far the highest-margin opportunity that we have in all of Culp today. Now the volume is not a big market, obviously, as the residential fabric. But it's a plenty of growth opportunity for us in that marketplace for fabrics, be it upholstery fabrics, be it fabrics for window treatments, be it bed skirts, bed wraps. I think it's a very high-margin market profile. Hence, a lot of focus on that part. The other thing, I want to follow up on the earlier question. Another reason we really do like this is all, literally all of the customers are U.S. based for the U.S. market. It's -- while it may use fabric from overseas, obviously, from our China platform, all of the fabrication and installation is done in the United States. And it is on a quick delivery cycle, is very much desired by these customers. So I don't think we -- we're going to see that industry trend change.

Understood. That's very helpful. So is that a function of just the end-market customer there? Or is that a function of -- I'm assuming that most hotels and motels, their specific bed skirts, window treatments, are all going to be somewhat customized, more so than just kind of a general product, if you will.

That's right, Marco. And there're really 2 reasons. First, they are customized. Even though there may be brand standards from the major chains, each is customized. And secondly, the -- all the window treatments and bed skirts, et cetera, always tend to be the last parts of a new hotel or a renovation project, and the owner is screaming to get his hotel back generating revenue. So they just do not -- one of the issues in the industry today were -- and one of the reasons Culp has been successful is our lead times. In our upholstery fabrics, we ship everything next day. So it's a very desirable feature to do business with Culp. While I don't believe we're going to be able to do that well, that quicker lead time on window treatments, it is something that is an industry issue today. It takes too long to source and produce the window treatments. So I think one of our focuses will certainly be shortening those lead times. And with our total control of the supply chain from design to China to the U.S., we believe we'll be able to help do that and offer better customer service like we do in each of our other businesses today.

Got you. That's helpful. And just to confirm, I thought I heard you guys on your prepared remarks in upholstery, you realized $6 million increase year-over-year from a revenue standpoint. I think I heard you say that about half of that was because of the Chinese New Year happening when it happened and then you had advanced orders, so I'm assuming that means $3 million of that $6 million was pulled forward if you will?

In third -- what we're talking about is in the third quarter -- third quarter sales were up almost 20%.

Yes, 20%. That's a $6 million (inaudible).

$6 million, yes. About half was due to orders being pulled up in the time of the Chinese New Year.

But Marco, the key there, too, is when you look at the guidance, we're saying sales are going to be slightly up. So it's not like we totally took all the sales out of fourth or third so. It's -- when you combine the 2, it's a good growth story.

And on that point too, we are very pleased with the performance of this business on an operating profitability standpoint given the drastic improved strengthening of the China currency in this fiscal year from [RMB] 6.9 exchange rate to RMB 6.3. I -- we just don't believe we're going to see that kind of movement going forward and if anything, we could see it reverse.

Got you. And then switching gears here to mattress fabrics. Maybe if you could talk a little bit more, as far as your expectations, see that we're entering here a new calendar year. You got 3 different types of product lines if you will. You've got your mattress fabrics, your mattress covers, and now you're going to be entering the mattress pads. What are some of the overriding drivers you, kind of, see for those markets? And then if maybe you could also discuss if there are any, sort of, nuanced different drivers that affect the mattress pads and protectors versus the mattress fabrics, it would be helpful.

Okay. I think, first of all, historically, the mattress business has been closely correlated to GDP growth. There have been a number of regression analysis people do. That seems to be a -- one of, maybe, the highest correlation factor. So that obviously bodes well for us as we look with a growing GDP in the U.S. and Canada this year. So we feel good about that. We feel good about the consumer discretionary income on the rise, with rising wages, et cetera. And so we feel pretty good about the economic backdrop. Now having said that, it has not started that well off for the calendar year, as you've probably heard in the industry. We believe that's going to pick up as tax refunds start being distributed in a very -- very shortly, they've been delayed somewhat. I think when you also look at the CLASS business, our mattress cover, that's also being driven by the growth in the bed in the box as well as a lot of the hybrid mattresses, which is the new trend, many of those require covers. There does seem to be a market share shift going on, 2 more foam mattresses and hybrids from Innerspring, which bodes well for mattress covers. So we think that's a -- also a positive trend as we look forward. And of course, the key reason why we've expanded and put in enough capacity for -- the -- our cut-and-sew mattress cover business. As far as mattress pads and protectors, we're really very, very early in that process. It's a new area for us. So I wouldn't expect a lot of contribution next fiscal year. We're learning the market, talking with retailers and we will grow as we can gain business and learn that market. But probably not a lot of impact the first half of next year. But it's certainly related, all of our capabilities sit well with that marketplace. Most of those products are produced in China. They're produced and packaged in China, and with our platform there, there's just no reason why we shouldn't be a player in that segment of the market. It also uses similar products that we make already, knitted fabrics. So it seems to fit real well with our core mattress fabric business for mattresses, kind of, like, the hospitality fit well as an additional area to supplement our residential market area.

Got you. And maybe if you can, kind of, help us size the opportunity you might be looking at the pads and protectors. And if they -- if there's a different growth rate as far as expectations are concerned there?

I think, probably, right now, too early on that. We just -- we've just put our toe in the water. Certainly, there's a lot of business being done there, as you may know with some of the -- most the players are all privately held. But there's plenty of opportunity there. But certainly, not the size of the mattress fabrics market. Again, like the hospitality. A smaller segment, but a lot of synergies for us to be in that area. And we'll -- as next year develops, we'll certainly add more color to that market to our efforts in that industry. But another, really good, over time, over several years, another excellent growth opportunity for us.

(Operator Instructions) And there are no further questions at this time. I'll turn the conference back to you all for any closing [remarks].

(technical difficulty)

Okay. Thank you, operator, and thank you, guys, for your participation today, and the interest in Culp. We look forward to updating you on our progress next quarter. Have a good day.

And again, that will conclude today's conference. Thank you, all, for joining us.