Culp, Inc.

Good day and welcome to the CULP Second Quarter 2020 Earnings 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. Drew 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 2020. 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 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 as a schedule to the company's 8K 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 website as part of the webcast of today's call. With respect to certain forward-looking free cash flow information, The comparable gap in reconciling information is not available without unreasonable effort, and its significance is similar to the significance of the historical free cash flow information, which is available in the company's 8K filed yesterday and posted on the company's website. I will now turn the call over to Frank Saxon, Chairman and Chief Executive Officer of Culp. Please go ahead, sir.

Thank you, Drew. Good morning, everyone, 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 Yves Culp, President and Chief Operating Officer, Ken Bolling, our Chief Financial Officer, and Boyd Chumley, President of our Pulsary Fabrics business. As we previously announced, Yves will be taking over the role of CEO of Culp effective January 1, and I will be assuming the role of Executive Chairman. These changes are part of our long-standing succession planning process designed to provide continuity and a natural leadership evolution as the company continues to execute its growth strategy. Having worked with Ian for over 20 years, I am confident he is well-prepared and has the vision, skills, experience, and leadership capability necessary to be a great CEO. Yves will assume responsibility for oversight of each of the company's divisions, while I will remain actively involved in day-to-day operations with specific responsibility for corporate shared services. I look forward to working with Yves as we transition to the new position. I'll now begin the call with some brief comments, and Ken will then review the financial results for the quarter. I'll then update you on the strategic actions in each of our segments. After that, Ken will review the third quarter outlook, and then we'll be happy to take your questions. We are pleased with our performance for the second quarter of this fiscal year. While we had a modest drop in overall sales compared with the prior year period, we had improved operating performance in both our mattress fabrics and upholstery fabrics businesses. We believe the domestic Mattress industry is working to stabilize from the disruption related to low-cost mattress imports from China, and the continuing variability in the market is evident in recent industry sales reports. We're monitoring the development and demand trends among our legacy mattress customers and the rapidly growing roll-packed or boxed bedding segment with our broad product mix and flexible manufacturing platform, we've been able to respond to these changing demand trends. Additionally, while our poultry fabrics business has been affected by ongoing trade disputes and international tariffs, we were pleased with our ability to make supply chain adjustments to address these challenges and meet the needs of our customers. We also continue to refine our strategies for Kult Home Fashions, our finished product business. and we believe we are making some good progress in positioning this business for sequential improvement. We remain focused on leveraging this new online sales channel to expand our market reach with new products and customers. In each of our businesses, we're maintaining our product-driven emphasis with an unwavering commitment to product innovation and creative design. With the support of our global platform, We are confident we can sustain our strong competitive advantage and respond to the changing demand trends of our diverse customer base. Importantly, we have the financial strength to pursue our growth plans and to continue returning funds to shareholders. We're proud to announce another dividend increase commencing in the third quarter, marking our seventh consecutive year of increasing the annual dividend. 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 highlights of the second quarter. Net sales were $72.6 million, down 5.7% compared with prior year periods. On a pre-tax basis, the company reported income to $4.1 million, compared with pre-tax income to $4.3 million for the second quarter of last year. The financial results for the second quarter of last fiscal year included a net benefit of $543,000 in destruction-related charges and credits and other non-recruiting items, demoted to the closure of the company's Anderson, South Carolina, production facility. Excluding this net credit, pre-tax income for the second quarter of last year was $3.7 million. Net income attributed to pulp ink shareholders was $2.3 million, or $0.19 per diluted share, for the second quarter, compared with net income of $2.9 million, or $0.23 per diluted share, for the prior year period. The results for the second quarter of last fiscal year include the destruction of the rate of credit I just noted. The effective income tax rate for the second quarter of this fiscal year was 46.2% compared with 29.8% for the same period a year ago. The increase in the company's effective income tax rate reflects a significant increase in the company's global intangible low-tax income, or GILTI tax, which represents a U.S. income tax on the company's foreign earnings. The continued shift and mix of taxable income that is mostly earned by the company's foreign operations located in China and Canada at higher income tax rates in relation to the U.S. has also contributed to this increase in the company's effective tax rate. Importantly, income taxes incurred in the U.S. on a cash basis for this fiscal year are expected to be minimal due to the projected utilization of the company's U.S. federal net operating loss carry forward. Looking ahead to the rest of this fiscal year, we estimate that our consolidated effective income tax rate will be in the 45% to 48% range based on the facts we know today. The effective income tax rate can be affected over the fiscal year by the mix and timing of actual earnings from our U.S. operations and forms of city areas located in China and Canada versus annual projections. Notably, the U.S. Treasury Department and Internal Revenue Service have issued newly proposed regulations that, if and when enacted, and if enacted as proposed, could provide us with some relief from the GILTI tax under the proposed GILTI high tax exception election beginning in fiscal 2021 or later, subject to the timing of enactment. The proposed guilty high tax exception election is not available until the proposed regulations are finalized and effective. Trailing 12 months adjusted EBITDA as of the end of the second quarter of this fiscal year was 22.5 million or 7.6% of sales. Consolidated return on capital for the trailing 12 month period was 10.7%. Now let's take a look at our business segments. For mattress fabric setting, sales were 35.5 million, down 4.7% compared to last year's second quarter. Operating income for the quarter was 3.3 million compared with 2.9 million a year ago, with an operating income margin of 9.3% compared with 7.8% a year ago. We delivered an improved operating performance for the second quarter despite the modest decline in sales. Our recent investments in infrastructure and our focused efforts to rationalize both fabric and stone cover production in the most cost-effective locations improved our operating efficiency. We also benefited from more stable raw material prices compared with the second quarter of last fiscal year. Return on capital for the 12-month period for mattress fabric was 16.2%. For the upholstery fabric segment, sales for the second quarter were 33.9 million, down 3.2% over the prior year. Operating income for the quarter was 3.5 million compared with 2.7 million a year ago with an operating income margin of 10.2% compared with 7.8% a year ago. Our improved operating performance for the second quarter reflects a more favorable product mix due to the marketing success of our branded products and diversification of our customer base to include more hospitality business. We also benefited from a more favorable currency exchange rate as compared to a year ago. Return on capital for the 12-month period for the Tulsi Fabric segment continues to be impressive, coming in at 61%. The home accessory segment, which includes the operation of eLuxury, reported 3.3 million sales for the second quarter, compared with 4.8 million a year ago. Operating loss for the quarter was $350,000, which was in line with expectations and sequentially improved from the $535,000 loss experienced in the first quarter. We'll comment more on operating performance later. Here are the balance sheet highlights. We reported $47.2 million of total cash and investments and outstanding borrowing from $925,000 for a total net cash position of $46.3 million. For the first six months of this fiscal year, we incurred $2.4 million in capital expenditures and spent $2.5 million on regular quarterly dividends. Cash flow from operations and free cash flow were 8.2 million and 5.6 million, respectively, for the first six months of this year compared with cash flow from operations and free cash flow of 6.6 million and 3.6 million, respectively, for the prior year period. This reflects a 1.6 million and 2 million year-over-year improvement in cash flow from operations and free cash flow, respectively. The company did not repurchase any shares in the second quarter. With respect to our share repurchase program, as reported last quarter, the Board approved an increase in the authorization for the company to acquire its common stock from the $1.7 million previously available back to a total of $5 million. With that, I'll turn the call back over to Frank. Thanks, Ken. I will start with the mattress fabrics segment. Our results for the second quarter reflect changing market dynamics as the mattress industry attempts to recover from the turmoil surrounding the influx of Chinese imports and the subsequent anti-dumping measures. While demand is softer in our legacy business, we experience favorable demand trends for mattress covers from customers in the popular and expanding box bedding space. As a result, Class, our stone mattress cover business, delivering exceptionally strong performance for the second quarter, and we're optimistic about additional opportunities with existing and new customers. Our robust supply platform for covers, including our production locations in the U.S., Haiti, and Asia, supports diversification and creates a strong competitive advantage for CULP with the versatility and scalability necessary to serve our customers in an expanding global environment. Our ability to offer a broad product mix with a relentless commitment to product innovation distinguishes Culp in the marketplace. The recent addition of a dedicated innovation team ensures we are developing and offering the latest technologies and forward-looking products to our customers. We've also expanded our creative staff to offer enhanced design capabilities that complement our innovation strategies. and we are releasing a new digital library platform during the third quarter to support our marketing efforts. We're excited about these opportunities to further leverage our capabilities and expand our reach. Looking ahead, we believe CULP is well positioned in the marketplace, especially as industry conditions improve with a more stable demand environment. We are meeting the changing demands of our customers with creative designs, innovative products, and an efficient global platform with the critical abilities to provide vertical product offerings from fabric to sewn covers. We also intend to expand the footprint of our class sewn cover operations in Haiti and Asia during the second half of this fiscal year, giving us further flexibility and capacity for serving the needs of customers in the box bedding space. We look forward to the opportunities ahead in our mattress fabrics business. I'll now turn to the upholstery fabrics segment. Our sales in this segment were in line with expectations for the second quarter. The slight drop in sales over the prior year reflects the continued soft retail environment for residential furniture and ongoing issues surrounding international trade agreements and the associated tariffs. as well as the loss of a product category due to the closure of our Henderson, South Carolina, manufacturing facility during the second quarter of last fiscal year. We're satisfied with the execution of our plans during the quarter as we've benefited from strong product innovation. We've experienced favorable demand trends from our residential furniture customers for our popular line of highly durable, stain-resistant, lid-smart performance fabrics. Our recent introduction of LiveSmart Evolve, a new line of fabrics featuring the same performance combined with recycled fibers, has been very well received as a product that fulfills the desires of environmentally conscious consumers. We focused on promoting these brands and are pleased with the strong customer placements for these products following a successful October furniture market. We also recently launched a new outdoor product line, Live Smart Outdoor, which pairs performance with the ability to withstand the outdoor elements. This product line builds on the strength of our Live Smart brand and has been well received at recent showings. Additionally, our overall sales reflect growth trends within our hospitality customers as we continue to expand our market reach into this segment. Reed Window Products, or RWP, our window treatment and installation services business, supports this strategy, and we're optimistic about the future contribution from Reed. We have also recently strengthened our creative team to further support our commitment to creating innovative products and creative designs that meet the changing demands of our customers. We've made supply chain adjustments and product engineering changes to mitigate the impact of recently imposed tariffs and to meet the needs of customers. We continue to develop our strategic partner relationships in Vietnam for additional sourcing of our cut and sewn kits. And we will further pursue this opportunity along with other sourcing options to support our customers through the ongoing trade disputes between the U.S. and China. Going forward, while geopolitical uncertainties remain, we're optimistic about the opportunities for Culp. We believe we have a strong strategy in place for upholstery fabrics and are very well positioned for the long term. Next, I'll review our newest business segment, Culp Home Fashions. With sales and operating performance for our home accessory segment, we're in line with expectations as we further refine our business models. We are working diligently to execute new strategies with a more aggressive approach to the business-to-business market, along with greater customer diversification and new online retail marketplaces. We have implemented key initiatives that are already driving improvement and creating greater long-term opportunities. We also remain dedicated to improving our performance on Amazon, a principal sales channel for our legacy e-commerce business. As noted in recent press reports, the Amazon marketplace and many of its trusted third-party sellers have been affected by new sellers operating outside of Amazon's normal terms of service. We are collaboratively discussing several options and rationalizing our offerings to enhance the sales channel. We continue to develop new products that are synergistic with the company's core businesses, and we're excited about the opportunity to leverage this sales channel and reach new customers for CULT. Kim will now review the outlook for the third and fourth quarters and the second half of this fiscal year, and then we'll be glad to take your questions. In the outlook, I will comment specifically on the expectations for the third quarter, but I will also touch on the fourth quarter given how we see our businesses performing during the second half of this fiscal year. We expect overall sales to be comparable to the third quarter of last year. We expect mattress fabric sales to be slightly down and operating income and margins to be moderately down compared to the third quarter of last year. The third quarter is a traditionally slower sales period and is affected by the loss of multiple weeks of production and distribution for our class cover business as a result of government-mandated holiday shutdowns in Haiti and the timing of Chinese New Year. The impact of these seasonal shutdowns during this period is greater this year as compared to the third quarter of last fiscal year because the class phone cover business is a more significant part of our current operations. For the fourth quarter of this fiscal year, we currently expect sales to increase slightly and operating income and margins to be significantly up as compared to the fourth quarter of last fiscal year. We anticipate benefits from a return to strong growth for our class cover business, continued improvement in overall industry conditions, and improved operating efficiencies across all product lines. As a result, we expect sales for the second half of this fiscal year to be comparable to sales as compared to the second half of last fiscal year, and operating income and margins for the period are expected to be moderately higher as compared with the second half of the prior year. In our policy fabric segment, we expect third quarter sales and operating income and margins to be comparable to the same period last year. Similarly, for the second half of this fiscal year, we also expect sales and operating income and margins to be comparable to the second half of last fiscal year. In our home accessory segment, we expect third quarter sales to be slightly down compared to the third quarter of last fiscal year. We expect an operating loss for the quarter, but with meaningful improvement as compared to the second quarter. For the fourth quarter, we expect operating performance to be near break-even as we continue to refine our strategies and focus on higher margin products. Considering these factors, as well as increased unallocated corporate expenses due mostly to the comparison of last year's reversal of accrued incentive compensation costs, the company expects to report pre-tax income for the third quarter in the range of $3.2 million to $3.8 million, excluding any restructuring in related charges or credits and impairment charges, if any. Pre-tax income for last year's third quarter was $4.3 million, which included a net charge of approximately $769,000 in restructuring and related charges and credits and other non-recurring items. Excluding these charges, pre-vaccine income for the third quarter of last fiscal year was $5 million. The company currently expects our performance for the fourth quarter of this fiscal year to be significantly better than the results achieved in the fourth quarter of last fiscal year. And as a result, our performance for the second half of this fiscal year is currently expected to be better than the results achieved during the prior year period. Based on our current budget, capital expenditures for fiscal 2020 are expected to be in the $7.5 million to $8 million range, and depreciation and amortization are expected to be approximately $9 million for the year. Additionally, given the current outlook, free cash flow for fiscal 2020 is expected to be comparable to last year's results, even with an uncertain geopolitical environment. As a reminder, cash flow from operations last year was $13.9 million, And free cash flow for the year was $11.5 million. With that, we'll now take your questions.