Culp, Inc.

Good day, everyone, and welcome to CULT's first quarter 2021 earnings conference call. A quick reminder that today's call is being recorded. At this time for our opening morning introduction, we would like to turn the call over to Ms. Drew Anderson. Please go ahead.

Thank you. Good morning, and welcome to the CULT conference call to review the company's results for the first quarter of fiscal 2021. 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 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 measurement is included in either the tables to the press release included as an exhibit to the company's 8K file yesterday and posted on the company's website at cult.com or in the slide presentation with supporting summary financial information that is also available on the company's website as part of the webcast of today's call. With respect to certain forward-looking income tax information, the comparable gap in reconciling information is not available without unreasonable effort. and its significance is similar to the significance of the historical income tax rate information, which is available in the slide presentation with supporting summary financial information that is also on the company's website as part of the webcast of today's call. With that, I will now turn the call over to Yves Culp, President and Chief Executive Officer of Culp. Please go ahead, sir.

Thank you, Drew, and good morning, and thanks to everyone for joining us today. I would like to welcome you to the quarterly conference call with analysts and investors. With me on the call today are Ken Bowling, our chief financial officer, and Boyd Chumley, president of our mattress status business. We'll begin the call with some brief comments, and Ken will then review the financial results for the quarter. I will then update you on the strategic actions in each of our operating segments. After that, Ken will review our second quarter fiscal 2021 business outlook. We will then be happy to take your questions. As we continue to navigate our way through these uncertain times, we've remained focused on the health and safety of our employees, customers, suppliers, and the communities we serve. I'm incredibly thankful for our team's hard work, agility, and commitment to safety, and I'm proud of our leadership team for adapting and efficiently managing through this challenging environment. We are pleased that both of our mattress fabrics and upholstery fabric segments saw better than expected increases in orders and shipments during the quarter, particularly during the last eight weeks. We are especially pleased with the strong sequential improvement compared with the end of the fourth quarter, going from a significant pre-tax loss to profitability. We believe these trends are primarily being driven by a surge of consumer focus on the home environment and overall comfort. leading to an increased proportion of discretionary spending moving towards home furnishings. Although the ongoing impact and duration of the COVID-19 pandemic is unknown, we are cautiously optimistic that business will continue its solid return in the second quarter of fiscal 2021. We are confident that our product-driven strategy, strong management team, and solid financial position will enable us to capture market share as we continue to demonstrate the resilience and strategic advantage of our global platform and stable supply chain. Our balance sheet remains strong, as evidenced by a significantly improved liquidity as compared to pre-pandemic levels at the end of fiscal 2020 third quarter. We are also pleased to have maintained our quarterly dividend throughout this period of disruption. We have now maintained and increased our annual dividend for eight consecutive fiscal years, reinforcing our confidence in the company's future and our commitment to generating value for our shareholders. We are excited about the continued sequential improvement we expect for the second quarter and look forward to the opportunities ahead in fiscal 2021. I'll now turn the call over to Kim, who will review financial results for the quarter.

Thank you. 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. I also want to note that as a result of the sale of eLuxury during the fourth quarter of last year, the financial results for the home accessory segment are excluded from the reported financial performance of our continuing operations and presented as a discontinued operation in our consolidated financial statements. Here are the financial highlights for the first quarter, which included 13 weeks compared with 14 weeks for the prior year period. Net sales were 64.5 million, down 8.8% compared to the prior year period. On a pre-tax basis, the company reported income from continuing operations of 1.5 million, compared with pre-tax income from continuing operations of 3.5 million for the first quarter of last year. The current quarter was affected by the continued disruption from the COVID-19 pandemic, as well as significant inventory reductions and manufacturing inefficiencies associated associated with the dramatic ramp-up in operations for our mattress fabric segment. Partially offsetting this pressure was lower S&A expenses due primarily to lower compensation expense and reduced spending on professional fees and travel and entertainment. Net loss from continuing operations was 2.7 million or 22 cents per polluted share for the first quarter, which included a 3.7 million net income tax charge that I'll discuss in more detail shortly. Compare with net income from continuing operations of $1.8 million or $0.14 per diluted share for the prior year period. Adjust the net income from continuing operations non-GAAP with $1 million or $0.08 per diluted share. This excludes the $3.7 million net income tax charge, which consists of a $7.2 million non-cash income tax charge to record a full valuation allowance against the company's U.S. net deferred income tax assets, partially offset by a $3.5 million non-cash income tax benefit resulting from the reestablishing of certain U.S. federal net operating monetary forwards in connection with the U.S. Treasury's regulation enacted during the first quarter of this fiscal year regarding the global intangible low-tax income or GILTI tax provisions. Adjusted net income from continuing operations for the prior year period was $2 million, or 16 cents per diluted share. This excludes a $229,000 income tax charge, which represents the company's estimated guilty impact incurred through the first quarter of last fiscal year. The effective income tax rate for the first quarter of this fiscal year was 283.7%, compared with 48.9% for the same period a year ago. This significant increase in the company's effective income tax rate reflects the impact of the new GILTI regulations I just mentioned. The adjusted effective income tax rate and non-GAAP measure for the first quarter, which excludes the items I mentioned earlier relating to the new GILTI regulations, was 41.5% compared with 42.2% for the same period a year ago. Importantly, the enactment of the new GILTI regulations is expected to benefit our liquidity going forward and the company does not expect to pay any material amount of U.S. income tax for a number of years based on the facts we know today. Looking ahead to the rest of this fiscal year, we currently estimate that our consolidated effective income tax rate on a year-to-date gap basis will be substantially lower than the rate for the first quarter of this fiscal year, and the year-to-date non-GAAP adjusted effective income tax rate, which would exclude the net charge discussed earlier, will be comparable to the adjusted tax rate for the first quarter of this fiscal year. As a reminder, the effective income tax rate can be affected over the fiscal year by the future mix and timing of actual earnings from our U.S. operations and foreign subsidiaries located in China and Canada. Trailing 12 months adjusted EBITDA as of the end of the first quarter of this fiscal year was $12 million for 4.8% of sales. Now let's take a look at our business segments. For mattress fabric segments, sales were $36.1 million, down 7.1% compared to last year's first quarter, which included an extra week. Excluding this extra week, sales for the first quarter were comparable to the sales for the first quarter of last year based on average sales per week. Notably, sales increased sequentially by approximately 60% from the fourth quarter of last fiscal year to the first quarter of this fiscal year. Operating income for the quarter was $1.8 million compared with $2.6 million a year ago, with operating income margin of 5.1% compared with 6.7% a year ago. While we were energized by the sequential growth in sales and improving business conditions, our operating performance was negatively affected by manufacturing inefficiencies associated with the dramatic ramp-up in operations, as well as significant inventory reductions. This was partially offset by lower SG&A expenses. Despite these challenges, we believe business conditions are stabilizing and will result in improved profitability going forward, barring additional disruption related to the pandemic. For our post-year fabric savings, sales for the first quarter were $28.4 million, down 11% over the prior year, which included an extra week. Excluding this extra week, sales for the first quarter were down approximately 4% compared with the first quarter of last year, based on average sales per week. Operating income for the quarter was $2.1 million compared with $2.9 million a year ago, with operating income margin of 7.5% compared with 9% a year ago. Operating performance was primarily affected by the decline in sales in connection with the disruption of the COVID-19 pandemic, partially offset by lower S&A expenses. Here are the balance sheet highlights. We reported $47.4 million in total cash and investments and no outstanding borrowings as of the end of the quarter, up from our $38.7 million net cash position as of the end of last fiscal year. During the first quarter, we incurred $500,000 in capital expenditures and spent $1.3 million in regular dividends. Cash flow from operations and free cash flow were $10.6 million and $10 million, respectively, compared with cash flow from operations and free cash flow of $2 million and $1 million, respectively, for the prior year period. This year-over-year increase was used primarily to improve working capital management, especially related to inventories. The company did not repurchase any shares in the first quarter, leaving $5 million available under the share repurchase program approved by the board in March of 2020. As previously disclosed, the company has temporarily suspended the share repurchase program given the economic uncertainty related to COVID-19. With that, I'll turn the call back over to Yves.

Thank you, Ken. I'll start with the mattress fabric segment. The beginning of the quarter was materially affected by the virus. We experienced a greater than anticipated increase in demand beginning in mid-May as government restrictions were lifted and customers and retail stores resumed operations. This increase continued throughout the quarter across all product offerings, including our press mattress cover business, approximating pre-pandemic levels at quarter end. We returned all of our previously furloughed workers and rapidly expanded production schedules to meet this growing demand. As a result, sales increased by approximately 60% from the fourth quarter of fiscal 2020 to the first quarter of fiscal 2021. During this uncertain environment, we have continued to manage our business with a firm focus on creative designs, innovative products, and customer service. These efforts are supported by the strength of our global manufacturing and sourcing operations, including the US, Canada, Haiti, Asia, and Turkey, which provide us with flexible production and distribution capabilities to adapt to changing customer needs. We are also excited about our ongoing developments in product innovation, including continued opportunities through our reimagined cold pump fashions, a fleeting image rendering service. Additionally, demand trends for mattress covers remain favorable, driven by ongoing growth in the box setting space. and we continue to work collaboratively with new and existing customers to develop fresh and innovative products. We have an efficient global platform that allows us to maximize our full supply chain for these covers, from fabric to finished cover, in the U.S., Haiti, and Asia. We do expect our building extension in Haiti to be completed during the second quarter, which will provide additional capacity and enhance our ability to produce some covers in North America. Looking ahead, we recognize that the disruption and economic uncertainty from the COVID-19 pandemic may continue to affect our business, but we are encouraged by recent demand trends and believe we are well-positioned to exceed our strategy and increase market share as conditions improve. We have now decided to invest $4 million in additional MIT machines to expand our capacity in North America to support our future growth. Finally, we expect that the domestic mattress industry, and in turn our business, will benefit if there is success from the recent anti-dumping duty petitions filed with the U.S. International Trade Commission and U.S. Department of Commerce against seven countries for engaging in unfair trade practices. We look forward to the opportunities ahead for our mattress fabric business in fiscal 2021. Now I'll turn to our upholstery fabric segment. The disruption from the COVID-19 pandemic continues to affect our upholstery sales and operating results for the first quarter of fiscal 2021. We began the quarter slowly with a gradual increase in orders and shipments beginning in mid-May as customers and retail stores started to reopen, followed by a swift upturn during the month of June and further acceleration to end the quarter. We returned all of our previously furloughed workers to meet this rapid increase in demand. Also, our strong platform in Asia, including our cut-and-sew capabilities in Vietnam and our stable supply chain, has allowed us to respond quickly and meet the needs of our customers. We were pleased with the improvement throughout the quarter and demand increased in most of our businesses, including our residential upholstery business, which features our popular lines of LiveSmart and LiveSmart Evolve performance fabrics. We have benefited from our ability to continue representing our products for customers for our innovative virtual showcase presentations. Also, our strong product placements with customers prior to the COVID-19 outbreak have advanced our recovery as business conditions improve. Our hospitality business was pressured by the COVID-19 disruption during the first quarter due to ongoing disruption in the travel and leisure industries. However, Lead Window Products, a window treatment and installation services business, was less affected and provided a meaningful contribution due to the existing project orders already in progress prior to the virus outbreak, as well as its emphasis on Vacation Club properties. While we remain pleased with the diversification offered by this business, we recognize that the continued impact of COVID-19 may negatively affect it, at least in the short term, It remains uncertain whether hotels and other hospitality venues will undertake new refurnishing projects in the current environment. Looking ahead, the ongoing uncertainty surrounding the COVID-19 pandemic make it difficult to forecast the potential impact on our business. However, we are encouraged by the strong sales trends experienced in the last four weeks of the first quarter, as well as trends suggesting increases in consumer discretionary spending on home furnishings. Ken, we'll now discuss the general outlook for the second quarter of fiscal 2021, and then we will take your questions.

At this time, due to the continued economic impact of the COVID-19 pandemic and the lack of visibility as to its duration or ultimate impact, we are providing only limited financial guidance for fiscal 2021. Although subject to unforeseen changes that may arise as the pandemic and its economic impact continues to unfold, we are encouraged by improving business conditions. We expect sales and operating income for the second quarter of this fiscal year to be materially improved as compared to the first quarter, but not reaching the performance achieved in the second quarter of last year, which was an especially strong quarter for the postage fabric segment. Based on current expectations, including the $4 million investment in additional mint machines in our mattress fabric business that Yves mentioned earlier, Capital expenditures for this fiscal year are now expected to be in the $8.5 to $9 million range. Appreciation and amortization are expected to be approximately $7 million for this fiscal year. With that, we will now take your questions.

Ladies and gentlemen, for any questions, please join the queue by pressing star 1 on your telephone keypad. If you'd just make sure your mute function is turned off to allow us to receive that signal. Again, that's star 1 for any questions. And first, from Raymond James, we have Bobby Griffin.

Good morning, everybody. I appreciate you taking my questions. I thought you could just circle back, or maybe your comments about how demand trended during the quarter. It looks like you saw kind of a notable pickup throughout the quarter in both segments. But can you maybe talk a little bit about what you saw in August? Did it continue to build versus, you know, July and June? And what are the expectations and kind of what are you hearing from customers about Labor Day and what the market's looking for?

Yeah, thank you, Bobby. For sure, you're right. Really, it's a similar refrain in both businesses for Q1, starting slow and then finishing very strong over the last eight weeks and continuing to kind of escalate throughout the quarter. So far, you know, as we're pointing to, we're seeing a material sequential improvement going into Q2. So we see those trends continuing to go. We have strong trends. backlogs of orders to produce in both businesses, so we're optimistic on both sides, on the sales side of it. Labor Day, you know, typically is a very strong holiday in the mattress side for us, and we expect that to be good. You know, I know a lot of our big customers have not so much rolled out new products, or they're just trying to fuel more success on the products already on the floor, and I think it should be in our opinion, looks like a good holiday sailing season.

Do you think the tight – one concern I've had, do you think the tight inventory situation could negatively impact the holiday, or is it pretty much everybody across the space in the same inventory standpoint? So, you know, consumers would be expecting a little bit higher lead times than normal.

Yeah, you know, I don't know. If I know the answer to that, Bobby, how it will impact. It doesn't seem like we're seeing any – slow down your consumer pressure for furnishing products. So, you know, I certainly can't speak to everyone's inventory position. I know that we're turning things very quick, as evidenced by inventory management and cash generation, and things are just flowing through very quick. I would hope and don't expect an impact to the selling season. You know, our customers have been spoiled over time to get things on demand, And I think the industry's got a lot of power behind it, and certainly with our capacity and others, I think the catch-up can happen. You know, I don't think it should be the other holiday selling season.

Okay. And if we stay in this kind of elevated demand environment like we're talking about here, you mentioned trends, you know, continue strong in August. How long do you think it takes for Colt and Colt's facilities to kind of get back to normal efficiency? I mean, you know, I understand it's, you know, it takes time to bring people back in the plants and get things working, you know, back up to this pre-pandemic type efficiency.

Yeah, we should, I mean, we pointed that in Q1. And remember, we were going from pretty much a standstill on bus business with a lot of people on furlough and plants running at very small outputs just to keep up with demand that was there. But as we went through the quarter and got busier, everyone came back. Today, we're running at what we consider to be very good efficiencies. You know, we have a little bit of juggling because there's so many priorities and we're pushing different things. But I would say today, and let's turn to that Boyd comment for upholstery, today we're at efficiencies we want to be and should be much improved for Q2. on our manufacturing efficiency. Boyd, do you agree with the Wall Street side?

Yes, Deb, I do. I think as we're looking at our supply base, we've come to a period where we have had to scale back up rapidly. But I think the entire supply chain right now is in a good position that it's back to pre-COVID levels of output and really don't see any constraints in the supply chain as we look ahead here.

Okay. Okay. And then I guess lastly, Ken, you know, when we talk, understanding that, you know, it's tough to predict going forward, but we kind of unpacked some of the forward commentary. If, you know, if demand stays at kind of the levels we're seeing, which is admittedly tough to predict, but is there a chance, you know, sales could surprise further to the upside and be close to last year and maybe even start to grow again year over year?

You mean as far as against Q2? Yeah.

Yeah, I mean, it just seems like, you know, trends have picked up again further in August. You know, understanding that they could change in, you know, September, October, and it's tough to predict. But if the August trends continue, is there an opportunity for, you know, the sales to surprise and maybe even grow versus two fields last year?

Yeah, Bobby, I think that's fair. I think that – You know, we're being cautious as we look out just because of the unknowns. You know, as I said, August has been strong. But, you know, we're optimistic. I mean, there's certainly a chance it could surprise on the upside for sure. But there's just so many unknowns out there. We're being cautious.

Okay. Okay. Well, I appreciate all the details. Thanks for answering my questions, and I'll get back in the queue.

Thank you, Bobby.

Bye.

And we'll move on to Marco Rodriguez with StoneCape.

Good morning, guys. Thank you for taking my questions. Hey, Marco. Hey, I wanted to follow up on some of the gross margin comments and discussion on mattress fabrics. In Q1, is there any way that you might be able to quantify the inefficiencies you saw there and that impact on your margins?

Now, Marco, you know, I appreciate the question. It's just real difficult given all the hoops that we had to jump through and the, you know, bringing people back. getting people back in order. I mean, it was a significant impact. I think also, too, just, you know, the process around the dramatic decrease in inventory, you know, that's the way we account for that. That pressured results, too. But it was just a very difficult time in the first part of the quarter. Now, granted, things improved in June and July, but it's very difficult to quantify. But it was a significant impact for sure.

Got it understood. And then in terms of you guys bringing your efficiencies back, if I heard the response to the prior question, it sounded like operationally you're back to normal, if you will. So first off, I just want to kind of confirm that that is the case itself. And then also if you can maybe talk a little bit about where your inventory levels are now. It sounded like the supply chain is okay. So are you going to be seeing a dramatic increase in inventories, or is it still just very difficult to kind of build that up for the coming demand, just given the quick turns you need to come through?

Yeah, Marco, thanks. This is Dave, and I'll touch base. Yeah, answer is yes. In both businesses, we are – Both businesses are built to operate best with more demand. I mean, we've built certainly to match this fabric. We've done so much capital spending over the last four to five years. Our real success comes when we have solid orders flowing through our facilities. Really, in both businesses now, we have both operating full scale, both internally and using our global platforms. So really excited about what that can do. We haven't for a long time had a chance to show the success we can have when we have strong throughput. So that will be positive. Inventories, I'll let Ken touch on it too. Today, inventories are really proud of where they are, but we need to build them back gradually just to support business better. So we're not expediting and doing some things that would impact our efficiency. But we do not expect certainly inventory needs to be in lockstep or sales increase. We don't expect it to jump dramatically, although we do need to add some inventory just to provide better service to our customers.

Yeah, Marco, that's exactly right. And, too, you know, as I mentioned in my notes, we had a very strong start to the year with respect to free cash flow, and a lot of that was tied to the inventory reductions. And as Ed said, you know, the challenge is, But the goal is obviously be prepared and meet our customer needs. But, you know, we will require some working capital going forward. Now, obviously, we're going to pay special attention to make sure that we balance that need with the cash flow. But, you know, that was a very strong start, but we will need to invest going forward, but at a controlled pace.

And then in terms of the expansion of the mattress fabrics, the $4 million that you'll be investing for additional machines, as well as the additional just overall capex spend for fiscal 21, can you maybe talk a little bit about the cadence of the spend there and when you think the machines will be in and then producing?

Yeah, sure. Marco, good question. We just have recently made that decision, and it's really a bullish statement for us to expand our North American capacity. We have terrific NIT capacity, really, in multiple countries, U.S., Canada, Turkey, and Asia. And we just are seeing some opportunities. We don't intend to reduce our global footprint. We just think we need to boost our North American footprint some. Our expectation is that those machines can be in and operating really towards the very tail end of the fiscal year, so probably February and March next year will be our timeline to have those in and running. Not a huge impact to this fiscal year other than the spend, but certainly a great future opportunity for us as we look out into 2022 and past.

Yeah, Marco, as you saw in the financials, we have $500,000 of capex this quarter. Obviously, we're projecting to be eight and a half to nine, so we've got some more spending to do. But it's going to be back-loaded second, third, and fourth quarter. But as things ramp up, but, you know, we got off to a great start in Q1, but we will need to fund those expenses starting in Q2, Q3, and Q4.

Understood. And then lastly, a question for me on the Alphonse Fabric side. Can you talk about maybe a little bit more color on the virtual showcases? I mean, how have those been proceeding? Have they sort of met your guys' expectations or are there still some learning curve issues that need to be gone through there?

Yes, Mark, and this is Boyd. And I would tell you that that whole platform has really exceeded our expectations. We have been very pleased with how our customers have reacted to pivoting to a more virtual and online representation and presentation of our fabric. We've done this via the Zoom video platform as well as utilizing an online virtual presentation of our fabric. The reaction we've gotten has just been very, very positive. I believe that this will become a part of what we're doing on a more permanent basis, that we will see this type of representation of our products and the method for doing so will become a normal part of how we do this going forward. It's just very effective. We've received exceptional feedback. I think we've certainly learned a lot through the process. We have continued to develop and enhance, and I'm sure there will be some further steps forward with that. But it's been a significant new tool for us that we think is going to be important to us for the long term.

Very helpful. Thank you, guys. I truly appreciate the time.

Thanks, Mark. Appreciate it.

And with no further questions in the queue, I'd like to turn the floor back to management for any additional or closing remarks.

Thank you, Operator. And again, thank you for your participation and your interest and call. We look forward to updating you on our progress next quarter.