CULP - NYSE

Good day. And welcome to the Culp, Inc. Second Quarter Fiscal 2024 Earnings Conference Call [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Dru Anderson. Please go ahead.

Thank you. Good morning. And welcome to the Culp conference call to review the company's results for the second quarter of fiscal 2024. 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. Additional risks and uncertainties that we do not presently know about or that we currently consider to be immaterial may also affect our business operations and financial results. You are cautioned not to place undue reliance on forward-looking statements made today, 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 in the tables to the press release included as an exhibit to the company's 8-K filed yesterday and posted on the company's Web site at culp.com. At this time, I will now turn the call over to Iv Culp, President and Chief Executive Officer of Culp. Please go ahead, Iv.

Thank you, Dru. And good morning, and thank you for joining us today. I would like to welcome everyone to the Culp quarterly conference call with analysts and investors. Joining me on the call are Ken Bowling, our Chief Financial Officer; Boyd Chumbley, President of our Upholstery Fabrics Business; and Tommy Bruno, President of our Mattress Fabrics Business. I will begin the call with some detailed comments, including the discussion of key points and topics for the quarter and for both businesses as well as priorities as we look ahead. After that, Ken will review the financial results for the quarter, and then I'll briefly review our business outlook for the third quarter of fiscal ‘24, and we will then take your questions. I'd like to open with a general update of some overriding themes and discuss the current state of our business within the overall furniture and bedding industries. I'll further discuss some critical actions we are undertaking in both businesses, and I'll expand on these comments to illustrate where Culp is headed. First, we are pleased to report both sequential and year-over-year improvement in our consolidated sales and operating performance for the quarter, despite the challenging industry environment and ongoing demand softness with the two industries we service. These results are satisfying as we believe we are outperforming general market conditions in both businesses. Secondly, we continue to be excited about the comprehensive transformation within our CHF mattress fabrics business. And we are pleased to be gaining market position in the face of unit slowness in the domestic mattress industry. Our 19.6% year-over-year sales growth and 90% improvement of year-over-year operating loss represents strong evidence of our progress in the effectiveness of our CHF leadership. Third, although market conditions are also pressuring the residential home furnishings industry, our upholstery fabrics business continues to enhance its profitability despite these pressures, and demand remains solid in our growing hospitality business. And finally, we're continuing our diligent focus on prudent financial management, including maintaining a strong balance sheet and ensuring an appropriate level of working capital, while also making strategic capital investments, especially in the mattress fabric segment to further support our recovery and efficiency. So providing more detail on Q2 results. Again, our performance for the second quarter was in line with our expectations with consolidated sales and operating improvement both sequentially and year-over-year. This is a solid outcome if industry demand remains soft within residential furniture and bedding. The strong sequential and year-over-year sales growth in our mattress fabrics business with 7.4% improvement sequentially and a 19.6% improvement year-over-year was primarily driven by new fabric and cover placements during the period, as well as SKU rationalization and the repricing of some underperforming SKUs. As we have discussed in previous reports, we are pricing new placements we received in line with current raw material and operational costs. And this along with the remerchandised SKUs has resulted in higher average selling prices overall. While our unit volume was slightly down as compared to the prior year, we believe we are performing considerably better as compared to the significant unit contraction experienced by the domestic mattress industry through the first nine months of the 2023 calendar year. This demonstrates that CHF's revenue has grown not only because of the higher average selling prices but also because we've made gains with customers in a difficult market environment. We expect to continue this trend of growing CHF market position. CHF also achieved a 90% improvement in ts operating results as compared to the prior year period and a 33% improvement as compared sequentially to the first quarter. While not yet back to profitability, we are pleased with CHFs trajectory. The material reductions of our losses for the quarter were driven by balanced inventory management, higher sales, better pricing and margin, and our ongoing focus on operational efficiencies and cost reduction initiatives across our locations. For the upholstery fabric segment, we report significantly improved operating income as opposed to the prior year period due to better inventory management, fixed cost savings and other operational efficiencies along with continued solid demand in our hospitality contract business. But as expected, sales within our residential fabrics business were lower as compared to the second quarter of last fiscal year due to ongoing softness in the home furnishings industry and shifting consumer spending trends. While we understand that the furniture and bedding environment remains challenged, we are managing the aspects of our business we can control, taking necessary steps to withstand current market conditions and position our business for renewed growth. As detailed in earlier quarters, we have made platform changes to our cut and sew profile on both mattress fabrics and upholstery, and the cost benefits from those adjustments are paying off. We are also focused on managing our operational efficiencies across our fabric platforms, therefore, lowering overall costs. Beyond Q2, we believe our continuing recovery will be punctuated by our mattress fabric segment where our execution of a comprehensive transformation plan is laying the foundation for steady gains. I'm going to expand more on the mattress fabrics transformation plan momentarily. But our sequential and year-over-year operating improvement reflect some of the initiatives we've undertaken internally to manage our business. Now, while this challenging industry environment is expected to continue, our market position is strong and growing. And we are expecting to considerably better second half of fiscal ‘24, including a return to positive adjusted EBITDA on the third quarter and a return to consolidated operating profitability by the end of this fiscal year. Regardless of the current demand backdrop, we expect sequential and year-over-year operating improvement to continue, and we are not factoring in industry tailwinds to accomplish this. Essentially, it's evident we are making strong progress and our pace could be accelerated when we do eventually see macro industry growth. We are well prepared with our innovative product offerings, creative designs, resilient global manufacturing and sourcing platform, strong leadership team and focused financial management. These hallmarks of our business will support us into the future. I'll now expand a little more on the ongoing business transformation within Culp Home Fashions, our mattress fabric segment under the leadership of Division President, Tommy Bruno. As we've detailed before, our transformation plan focuses on long term improvement in every facet of the business, including quality, sales, marketing and operational processes, supply chain optimization, employee engagement and organizational management structure. As mentioned earlier, we are working to replace or re-merchandise underperforming SKUs and optimize our sales strategies to focus on partner selection, proper segmentation and execution of our product assortment. We believe CHF improvement is our best short term opportunity to grow revenue and to strengthen our year-over-year as well as our sequential performance. Tommy and the CHF management team remains dedicated to operational excellence. Even after our previous cost saving adjustment to our domestic North Carolina cut and sew capabilities, we continue with a robust global platform featuring manufacturing and sourcing capabilities in six countries, the United States, Canada, Turkey, Haiti, China and Vietnam. We are providing our mattress fabric and sewn cover customers with the agility and value they need for their business. Combining this platform with our expertise and design and product innovation, we are making excellent progress for sustainable improvement in fiscal ‘24, even as the domestic mattress industry continues to experience significant unit slowness. While this mattress industry contraction may remain for some period, we also know it's not permanent and we are improving our performance through new placements, SKU rationalization and repriced incumbent SKUs and more efficient operations. Our recovery in CHF is not fully dependent on the industry environment and we expect to see significant progress with steady sustainable improvement in CHF this year and beyond. Turning for a minute to Culp Upholstery Fabrics. We are pleased with continued and better profitability of this business. Consistently, Division President, Boyd Chumbley and his strong leadership team have managed effectively in the midst of abnormal, tumultuous times. CUF has grown its profitability with the focus on operational efficiencies and proactively taking strategic actions to reduce our cost structure, while also supporting customers with our flexible global platform. I believe CUF has been best in class in servicing customers through challenging supply chain conditions, and our design and product excellence combined with our effective global platform has led the way. This quarter, CUF’s operating performance improved both sequentially and significantly year-over-year as a result of better inventory management, lower fixed costs resulting from CUF’s prior restructuring of its cut and sew platform, lower freight costs and a more favorable foreign exchange rate associated with operations in China. CUF also had another solid hospitality contract business quarter, and sales accounted for 33% of segment sales for the second quarter. While this percentage remains higher than normal due to pressure to residential sales, it does reflect the ongoing strength of our hospitality contract business, as well as its importance to our overall strategy of product diversification for this segment. Also we remain committed to adjusting CUF’s global platform for the fabrics portion of our upholstery business as we look to provide options within our supply chain in China, Vietnam, and multiple other new countries. Customer service is a hallmark for Culp and a diversified platform is a critical strategy providing improved risk management and a more stable supply base. While we know this tough environment is likely to continue, Culp Upholstery Fabrics remains well positioned with our strong global platform and our innovative product offerings, including our popular portfolio of LiveSmart performance products and other new product technologies. We also believe we have seen the bottom in residential furniture demand as manufacture and retail inventories are largely back to normal and we are seeing increases in newly written fabric orders, which will support the second half of fiscal ‘24. We also expect the Upholstery Fabric segment will continue to benefit Culp through the [main goal] of fiscal ‘24 with better inventory management, a solid hospitality contract fabric business, including our Read Window business and a rationalized cut and sew platform. So lastly, I'd like to highlight our constant focus on prudent financial management, including maintaining a strong balance sheet and ensuring a strategic level of working capital. I'm very pleased with the management team for its continued effort in effectively managing our cash and total liquidity positions. We ended the quarter with $15.2 million in cash and no outstanding borrowings, and we have total liquidity of $41.4 million in cash, consisting of cash and borrowing availability under our domestic credit facility. We are continuing to carefully manage inventory against current demand levels. And we are strategically investing in our business, especially within our mattress fabric segment to support future profitable sales growth and further improve operating efficiencies. I'll now turn the call over to Ken, who will review the financial results for the quarter. And then I'll review the outlet for the third quarter of this fiscal year.

Thanks, Iv. Here are the financial highlights of the second quarter, starting with consolidated results. Net sales were $58.7 million, up 0.6% compared with the prior year period. The company reported a loss from operations of $2.2 million for the second quarter compared with a loss of operations of $11.9 million for the prior year period, which included $6.7 million related to certain inventory impairment and other charges and restructuring related expenses during the period. The $2.2 million loss from operations for the quarter also compares favorably with the $3.1 million loss from operations for the previous quarter. Net loss for the second quarter was $2.4 million or $0.19 per diluted share compared with a net loss of $12.2 million or $0.99 per diluted share for the prior year period. Our overall operating performance for the second quarter as compared to the prior year period was positively affected by a number of factors, including the better inventory management, higher sales and better pricing and margins for the mattress fabric segment, fixed cost savings in the Upholstery Fabric segment, improved operating efficiencies in both segments and a more favorable foreign exchange rate associated with operations in China. This year-over-year improvement in operating performance was partially offset by lower residential upholstery fabric sales and higher SG&A expense due primarily to increased compensation expense, higher professional and consulting fees and increased sampling expense, driven by new product rollouts among other factors. Importantly, with regard to SG&A expense, as business conditions improve and demand for our products rise, we believe that we'll get significant leverage from the increased sales. Adjusted EBITDA for the period was close to breakeven at negative $247,000 as compared to adjusted EBITDA of negative $8.2 million for the prior year period. The effective income tax rate for the second quarter of this fiscal year was a negative 27% compared with a negative 10.4% for the same period a year ago. Our effective income tax rate for the quarter was impacted by the company's mix of earnings between our US and foreign subsidiaries with an operating loss in the US while China and Canada generated income that was taxed at higher rates as compared to the US. Based on current assumptions, we expect cash income tax payments of approximately $3.2 million for this fiscal year. Importantly, our estimated cash income tax payments for fiscal ‘24 are management's current projections only and can be affected by a variety of factors over the course of the year. Now let's take a look at our two business segments. For the mattress fabrics segment, sales for the second quarter were $31.4 million, up 19.6% compared to last year's second quarter. This increase in sales is mostly driven by new fabric and stone cover placements that are priced in line with current costs and to a lesser extent, SKU rationalization and the repricing of some underperforming SKUs to reflect current costs. In each case, this has resulted in higher average selling price compared to historical per unit prices. While the domestic mattress industry remains pressured by ongoing demand softness, we believe we're outperforming industry trends and making gains with customers through our new product rollouts. Operating loss for the quarter was $936,000, a 90% improvement compared to an operating loss of $9 million a year ago, which included $5 million relating to certain inventory impairment charges and losses from inventory closeout sales. This substantial reduction in operating loss was driven by balanced inventory management, higher sales, better pricing in margins and improvement in operating efficiencies. These factors were partially offset by higher S&A expense during the period. For the Upholstery Fabrics segment, sales for the second quarter were $27.3 million, down 14.9% over the prior year period. Sales for our residential fabric business for the quarter were affected by ongoing softness in the residential home furnishings industry. However, demand remains solid in our hospitality contract business during the second quarter with sales for this business accounting for approximately 33% of the Upholstery Fabrics segments total sales. Operating income was $1.4 million for the second quarter, up significantly compared with $262,000 in the second quarter of last fiscal year, which included approximately $1 million in higher than normal inventory markdowns. Operating margin for the second quarter was 5.1%, again, a significant improvement compared to the prior year period. Operating performance for the second quarter was positively affected by better inventory management, lower fixed costs resulting from the reconstruction of this segment's cut and sew platforms during earlier periods, lower freight costs and a more favorable foreign exchange rate associated with operations in China. These factors were partially offset by lower residential fabric sales and higher SG&A expense during the period. Now turn to the balance sheet. We reported $15.2 million in total cash and no outstanding debt as the end of the second quarter. For the first six months of this fiscal year, cash flow from operations and free cash flow were negative $4.5 million and a negative $5.6 million respectively. As expected, our cash flow from operations and free cash flow during the period were affected by operating loss and planned investments in capital expenditures, mostly related to the mattress fabrics transformation plan. There was minimal impact from working capital changes during the quarter. Capital expenditures for the first six months of this fiscal year were $2 million. Based on current expectations, capital spending for this fiscal year is projected to be in the range of $5 million to $6 million, and we'll center mostly on maintenance CapEx and quick payback projects focused on improving quality and efficiency in our mattress fabrics business. Based on current expectations, depreciation for this fiscal year is expect to be approximately $7 million. With respect to liquidity, as of the end of the second quarter, we had $41.4 million, consisting of the $15.2 million in total cash and $26.2 million availability under asset based domestic credit facility. The company did not repurchase any shares during the second quarter of this fiscal year, leaving 3.2 million available under our current share repurchase program. We do not expect any repurchase activity during the third quarter of this fiscal year as we remain focused on preserving liquidity and being positioned to support future growth opportunities. With that, I'll turn the call over to Iv to discuss the general outlook for the third quarter, and then we'll take your questions.

Thank you, Ken. Due to the uncertainty in the macro environment, we are only providing financial guidance for the third quarter of fiscal ‘24. We expect consolidated net sales for the third quarter to be sequentially comparable to the second quarter of fiscal ‘24 and moderately higher as compared to the third quarter of fiscal ‘23, even in the face of ongoing demand headwinds. We expect consolidated operating loss for the third quarter of fiscal ‘24 in the range of $1.2 million to $1.6 million, sequentially improved from the second quarter results and a significant improvement compared to the $7.8 million operating loss for the prior year period. Again, I'll comment that we believe we are poised for a considerably better second half performance with a return to consolidated operating profitability by the end of the fiscal year. Finally, we will continue to be laser focused on balanced financial management with the goal of always maintaining a strong balance sheet, especially with regard to ensuring a strategic balance in our working capital. We are optimistic about Culp’s future and we know that financial stability is paramount to our success. With that, operator, we can take some questions.

[Operator Instructions] The first question today comes from Budd Bugatch with Water Tower Research.

Iv, I wonder -- and congratulations on the improvement in the quarter, it's very heartening to see that. Iv, you mentioned that you think you're starting to see bottoming in some parts of the residential industry, obviously, upholstery and mattresses are slightly different. Can you give us a little bit more color of what you're hearing from your customers in terms of what they're seeing going forward and their confidence that we may be at bottom in these areas?

Sure, Budd, and I'll let Boyd comment more specifically and Tommy too if he wants. But the comment I made in the script is, we do believe we've seen the bottom in residential home furnishings upholstery fabric sales, and we really say that's primarily due to inventories of both manufacturers and retailers seem to have corrected and back to a normal level. So while we aren't saying that the industry is getting stronger and we recognize we still have tailwinds, we just think for us with inventories flushed out, it's more normal ordering course and we're able to see our sales grow and incoming orders pick up. Boyd, would you add any more to that?

Budd, I think that's exactly right. We did, during the quarter, see some pickup in our incoming orders at the beginning of the quarter and really throughout much of the quarter. And again, as you say, Iv, I think that is partly a result of the inventory now being depleted in terms of furniture inventory in the pipeline at both manufacturers and retailers. And so we are now seeing the benefit of retail orders coming through to us in fabric orders. So I think with that -- certainly, I think from a market perspective, it's likely that the retail sales will continue to be soft for a period of time. But I think from our standpoint, we have seen and probably will continue to see some better business due to those factors.

So it's really not -- it's not the fundamental demand, but as much as it is the fact that what was really hampering sales was the manufacturers over-inventory position and really, I guess, extending down into their customers over-inventory that prevented them from adding new products and new placements -- that's the fair way to think about it?

I think that is fair, Budd. I do think that we are with our broad product offering and innovative products that we do have the opportunity for gains with our customer base and our ability to reliably supply. So I think those things also will benefit us in the coming quarters. So I think it's a couple of those factors are coming into play.

Budd, the theme you're going to keep hearing from us as we look ahead here in the short term is we aren't -- and I said it’s kind of clear, we aren't factoring industry improvement for our improvement. We're going to improve our business, because we're getting better operationally and we're making gains with customers, and that's going to happen in both businesses. So we're not going to rely on market -- macro tailwinds, that will come some point. But for now, we're going to make our steady sequential improvement just because we're going to do a better job, not only operationally but also in growing our share.

And do you have many more things to do in upholstery fabrics and CUF to get that, you've made some changes in sourcing and obviously, you had to take your inventory medicine a couple -- in the quarter and previous quarters. So are there any initiatives that give you confidence that you can actually improve the margins there?

I think Budd, you've called out a couple of the things that we have already done that are -- did certainly assist with our performance in Q2 and will on an ongoing basis, where we did restructure our global cut and sew platform and aligned that with the current demand, and did some consolidation there to have all of that now in our Asia platform. And so I think that's one of the key things that we have done. I think, we will also -- one of the other key tasks that we have is continuing to expand our global platform as we keep looking at supply in locations other than China. And we've made great progress on that in expanding within Vietnam. We've got a couple of other countries that we're very heavily invested and involved in right now to develop platforms in some other locations. So that's one of the key things I think is we're seeing is our objective over this second half of our year.

And mattress fabrics has been also a main topic, because your desire to get back to a double digit operating margin basis on a profitable basis. Tommy, how are you seeing that? What's the timeframe to getting back to a double digit operating margin?

Budd, we continue to focus, like Iv mentioned in his prepared comments, on taking market share at the correct margins on an ongoing basis. We continue to look at our assortment for SKU rationalization and improved profitability. And an extremely large initiative that we're undergoing is looking at our efficiency and operational improvements across all facets of our operation. As those things start to continue to layer in sequentially, I think, we believe we'll be back in double digit profitability later this year, early in fiscal year 2025.

You're talking gross margin…

Gross margin, yes, that’s right. But I think for us to get back to -- we always have for the CHF business, a double digit operating income target. And what we're saying is we're going to keep making our steady sequential improvements in the current depressed market environment. And we say we're going to return to consolidated operating profitability in the fourth quarter, that's not normal profitability, that's not that. So we'll look and we'll springboard, we'll get -- stop our losses and springboard into FY25 with every goal of moving back to normal historical margins at the operating line, but it just takes time. And we will need some tailwinds to go all the way back. And we know those will come, we just have a hard time knowing exactly when. So I hope that helps understand that.

The next question comes from Anthony Lebiedzinski with Sidoti.

So first, just continued great job maintaining a strong balance sheet in this difficult operating environment. So first, I gues, my first question here is as far as ASP increases that you talked about at CHF, and you sort of -- can you guys maybe put a number on that as far as how much ASPs drove the overall sales increase? And what is your confidence level in terms of being able to maintain these higher ASPs?

Anthony, it's a combination of two things driving ASP, one is the types of programs that we're getting that are higher end programs in the market and then in general, we're mix -- our product mix is driving our ASP based on the mix of covers and higher end fabrics.

I mean, Anthony, we say the units are down, industry units are reported down almost everywhere and our units are slightly down. We think we are performing on units but a lot of our sales gain, majority of it is better prices, better margins, new products priced properly, all the things we didn't do for a period of time that Tommy and his team are really correcting. So we're seeing that offset. That's why we're really encouraged. We're growing our sales without units where we expect they will eventually be. That's why it even drives more optimism if you look at it that way.

And then, I guess, as far as this whole transformation process that's been taking place at the CHF. I guess, if we were in a kind of a baseball game, what inning are we in as far as the process and what are some of the initiatives left to do?

So I would say we're still in the middle innings. We're still continuing to work on changing some things within our product assortment to drive productivity through all of our SKUs. We're still continuing to work on operational efficiencies after we made some restructuring changes within our leadership team. So in general, I would say we're still in the middle innings. I think it's generally a two year transformation process and I just feel comfortable that we're going to show steady improvement through that process on our way back to historical results over time.

And then as far as the SG&A, I know you guys talked about that being up because of some higher business investments. Can you share with us a little bit more details on how should we think about SG&A going forward?

I think as we've said, SG&A is up but it's due to factors that are really supporting the business. We're putting in the right people in the right seats, we're getting back on the road again to traveling to customers and shows. We've had some restructuring things relating to our sampling. With the business levels being up, we are sampling a lot more with new programs. So all of those factor in. I think, when you look at where we are currently with our SG&A, we feel very good about where we are. We feel that going forward as sales start to rise, we will get that positive leverage. So we think we're well positioned. We've just got to get the lift going forward and get that positive leverage. But overall, we see that SG&A is an investment and we feel like we're in good shape at this point on both sides of the fence.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Culp for any closing remarks.

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