Culp, Inc. (CULP) Q1 2014 Earnings Report, Transcript and Summary

Good day, and welcome to the Culp First Quarter Fiscal 2014 Conference Call. [Operator Instructions] And now at this time for opening remarks and introductions, I'd 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 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 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 a schedule to the company’s 8-K filed yesterday. This information is also available on the Investor Relations section of the company’s website at www.culp.com. A slide presentation with supporting financial information 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'll 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 9 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 are 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 has 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'll 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. 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 recorded 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 onetime 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 for 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-U.S. entities divided by consolidated income tax -- consolidated income before taxes. This information is important because the company pay cash taxes in the U.S., 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 of our 2 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. 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 for 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 8 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. Return on capital for upholstery fabrics segment is 52%, about the same a year ago. As reflected in the high return on capital for both of our businesses, capital discipline is very important to us. We have established a culture of excellent stewardship of our capital throughout our organization. Further, as we have stated a number of times before, we tie our incentive compensation for the visual and executive management to returns on capital above certain thresholds based on economic value-added or EVA principles. Now turning to the balance sheet. Maintaining a strong financial position and generated 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 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 2 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'll 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 have 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 fabrics 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 are synonymous with the Culp brand. We continue 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're 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 are 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'll 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 continue 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 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 capability and reliable China manufacturing platform, which is 100% owned. I also wanted to note that we are celebrating our 10 year anniversary of Culp China this year. We've 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're also pleased with the increasing level of fabric placements with customers in the U.S., 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 are 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 and debt, 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 a very fortunate position of generating significant free cash flow above the requirements to grow our business organically and 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'll 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 with 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 demands. 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] The first -- we'll go to Budd Bugatch with Raymond James. Budd Bugatch - Raymond James & Associates, Inc., Research Division: 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? Or how short cycle is your visibility into that particular segment?

Budd, I will -- 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 at 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. Budd Bugatch - Raymond James & Associates, Inc., Research Division: Okay. And yet you will have Culp-Lava more in the results of this quarter versus last year, right? What would that add? And so excluding Culp-Lava on our same yardage basis or a same -- kind of a same location basis, what do you think revenues will be?

I think that we'll stick with the same guidance we've 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 it's -- while it is an important new operation for us, we're excited about it and they're starting up pretty well, it'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. The second quarter is [indiscernible]. Budd Bugatch - Raymond James & Associates, Inc., Research Division: The quarterly sales of the high $30 million is the quarterly sales for mattresses or mattress fabrics solely, right?

Correct. Correct. Correct. Budd Bugatch - Raymond James & Associates, Inc., Research Division: All right. 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. And we've been patient with that operation because we have limited costs over there. We only have 5 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's really taken a positive turn on the sales side over the last, really, 4 months, which I was -- we're very pleased to see. And 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, et cetera. 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 we're going to -- 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.

[Operator Instructions] Next, we'll go to James Fronda with Sidoti & Company. James Fronda - Sidoti & Company, LLC: 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's actually up in upholstery fabric, and it's down slightly in mattress fabrics. And what Ken alluded to, really, in the first quarter of last year, we've built finished goods too much in our mattress fabric area, which we did not repeat, which we're happy for, this quarter. So that really helped the absorption of fixed cost during last year's first quarter, and that's really the principal difference. In the last year, it was 13 -- the gross profit was 20.1% last year, 19.4% this year, still a pretty good growth margin. It's not -- I wouldn't read into that any kind of indication about margin erosion or anything like that.

Right. James Fronda - Sidoti & Company, LLC: Right, okay. All right, it makes sense. And I guess, just -- could you just give us some more of an update on Culp-Lava? I'm just guessing that there's not too much costs involved with that operation.

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

$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. And you really have to be flexible, as I mentioned in the comments. The demand for those covers is indeed pretty erratic, and because the industry is seasonal. So you've got to be able to have -- set up the operation to have flexibility in your output, in what you are doing.

[Operator Instructions] We'll next go to Kevin Tracey with Oberon Asset Management.

I wanted to ask about the transaction you did with Bodet & Horst in May. I think it was $2.7 million where you bought equipment and for release 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 kind of accelerating, being released with 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, I'll be glad to. In May, as you said, we did enter into an agreement with Bodet & Horst, which we will -- 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 and consulting arrangement. We also -- as part of the modifications, 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. And the key modifications that we made to the original agreement, were that Culp would no longer be subject to the noncompete provision will may be then [indiscernible] 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 have. 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 have 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, I guess, what you see in terms of raw material prices for the rest of the areas. For the past few months, we've seen oil prices steadily march up before spiking in the past couple of weeks. I guess, do you see any pressure from raw material prices going through that for the rest of the year?

We do not. We're watching them closely as the oil -- recent oil spike, but we've been fortunate. Raw material prices are staying stable, which -- we had a nice period here for 3 quarters maybe, something like that, where we've had stable raw material. And our outlook for steel is stable, unless something in the Middle East just really blows up more than it is and drives oil prices up.

Okay, good. And then I guess, lastly, I just wanted to follow-up, I guess, on the environment in your mattress fabric business. I guess you -- the way you described it as -- the environment was more challenging currently and into the second quarter than it was last year. And I guess, was that primarily just because the 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 3-year period, the mattress industry had really pretty good demand and growing. In 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, upholstery 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're bullish. All in the -- for the next couple of quarters. I sense that talk into a lot of them. On the mattress side, the business is across skilled shopping. 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're certainly optimistic that, that will counter some of this choppiness that we're seeing. It's certainly not market share loss, I don't see that at all. In advertising spend, usually, they'll tell. So that could be a positive factor that's not in our thinking as of today. And as 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 adjusting time business. But it's not tied to housing as much as people might think. It's more tied to overall economic activity and GDP growth, which is okay as you pointed out. So I -- that's certainly how we see it today, and I certainly hope Labor Day, again, is better, a strong Labor Day. There's 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 certainly hope that that's going to be good, which would be certainly positive for our second quarter.

[Operator Instructions] And it looks like we have no further questions at this time, so I'd like to turn it back 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 conclude today's call. We thank everyone for their participation.