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spk01: Good day and welcome to the CULP Incorporated Second Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on a touch-tone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Drew Anderson. Please go ahead.
spk00: Thank you. Good morning and welcome to the CULP conference call to review the company's results for the second quarter of fiscal 2022. 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 a 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 the non-GAAP financial measurements to the most directly comparable GAAP financial measurements, are included in the table to the press release included as an exhibit 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 is also available on the company's website as part of the webcast of today's call. I will now turn the call over to Ives Culp, President and Chief Executive Officer of Culp. Please go ahead, sir.
spk08: 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 are Ken Bolling, our chief financial officer, and Boyd Chumley, the president of our upholstery fabrics business. For today, I will begin the call with some opening 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, And after that, Ken will review our business outlook for the third and fourth quarters of fiscal 2022. We will then be happy to take some questions. As previously announced, our results for the second quarter reflected lower than expected sales, primarily for our upholstery fabric segment. Several external factors affected our sales results for the quarter, particularly COVID-19-related shutdowns in Vietnam and customer supply chain constraints for non-fabric components. Profitability also remained pressured in both of our businesses by the continued rapid rise in freight, raw material, and labor costs. Despite these challenging macroeconomic environment situations, I'm extremely proud of how our global platform and our associates have responded over the last 18 months to build a more robust supply chain that has kept pace with demand and met the delivery needs of our valued customers. Looking ahead, we are pleased that the shutdowns in Vietnam have been lifted, but the rapidly rising costs and the disruption throughout the industry supply chains do continue, and many of our customers have delayed their previously planned rollouts and their new product launches. We also believe that many customers have excess inventory for fabric and cover products that were purchased to support their expanding backlogs as they wait for their supply chain issues to subside. As a result, we expect it could take some time for customers to work through their existing fabric and cover inventory levels. We also have some concern that inflationary pressures are causing some slowing in new business from the peak levels of last year, leading to some lower demand once customers fulfill their existing backlogs, although the demand appears to remain high when comparing to pre-COVID levels. Based on these factors, we expect that current headwinds will continue to pressure results during the second half of this fiscal year, especially during the third quarter, but we expect to see a meaningful rebound in our business beginning in the fourth quarter and continuing into next fiscal year. We are positioned very well with stronger supply chains, strategic inventory reserves, and growing opportunities as a result of our innovation and strong delivery performance. We also expect some improvement in customer supply chain disruption by the fourth quarter of this fiscal year, which is traditionally a strong seasonal period. Notably, if we meet our expectations for the third and fourth quarters, then for the full fiscal 2022 year, we will sustain significant sales gains as compared to pre-COVID levels of fiscal 2020. We are also implementing further pricing actions during the third quarter to help offset current inflationary pressures, and we do expect to open our new Haiti facility during this third quarter, which will increase our capacity for cut and sewn upholstery kits. Our strong global platform, together with our long-term supplier relationships, does continue to provide a distinct competitive advantage, allowing us to quickly respond to the evolving needs of our customers. We frequently hear positive feedback from our customers regarding the value of our supply chain and delivery record, supporting our belief that we are continuing to outperform our competitors, which will support our future growth. We also remain focused on innovation and creative designs in both of our businesses, and we are confident in our product-driven strategy. The recent opening of our new innovation campus in downtown High Point, North Carolina has been extremely well received by our customers, providing them with a hands-on, first-class experience for viewing the scope of our products from fabric to sewn cover. Our balance sheet remains solid, and I'm extremely pleased that we have once again increased our annual dividend, making this the ninth consecutive year of dividend increases. Importantly, we have the financial strength to support our business in the current environment, and we look forward to the opportunities to deliver value for our customers, employees, and shareholders in fiscal 2022 and beyond. So with that, I'll now turn the call over to Kim, who will review the financial results for the quarter.
spk05: Thanks, Yves. 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 for the second quarter. Net sales were 74.6 million, down 3% compared with the prior year period. The company reported income from operations of 1.6 million compared with income from operations of 4.5 million for the prior year period. I'll comment in more detail on divisional sales and operating performance in a moment. Net income for the second quarter was 851,000 or 7 cents per diluted share compared with net income of 2.4 million or 19 cents per diluted share for the prior year period. Our overall operating performance was affected by several headwinds, namely lower sales, higher freight and raw material costs, unfavorable foreign exchange rate fluctuations, and inefficiencies due to labor shortages in the U.S. and Canada, among other factors. These pressures were partially offset by lower total SG&A expense for the quarter, due primarily to lower accrued incentive compensation expense. On a percent of sales basis, total SG&A came in at 12.2%, compared to 12.7% for the same period a year ago. Trailing 12 months adjusted EBITDA was 17.5 million or 5.5% of net sales compared to 11.2 million or 4.3% of net sales for the same period last year, reflecting a year-over-year improvement of 56%. Consolidated return on capital for the trailing 12-month period was 11.8%. The effective income tax rate for the second quarter of this fiscal year was 34.3% compared with 41.4% for the same period a year ago. Our effective income tax rates are affected over the fiscal year by the mix of taxable income that is mostly earned by our foreign subsidiaries located in China and Canada, which have higher income tax rates as compared to the U.S. federal rate. Looking ahead to the rest of this fiscal year, we currently estimate that our consolidated effective income tax rate for the annual period will be in the 30 to 40 percent range based on the facts we know today. The income tax rates for the third and fourth quarters could vary based on the facts and circumstances for those specific quarters. Additionally, we are currently projecting cash income tax payments of approximately $3.6 million for fiscal 2022. Importantly, our estimated cash income tax payments for this fiscal year are management's current projections only and can be affected over the year by actual earnings from our foreign subsidiaries located in China and Canada, versus annual projections, changes in the foreign exchange rates associated with our China operations in relation to the U.S. dollar, as well as the timing of when significant capital projects will be placed in the service, which determines the deductibility of accelerated depreciation. Now let's take a look at our business segments. For mattress fabric segments, sales were $40.9 million, up 2.1% compared with last year's second quarter. Operating income for the quarter was 3.1 million compared with 4.4 million a year ago with an operating income margin of 7.7% compared with 10.9% a year ago. Operating performance for the second quarter as compared to the prior year period was negatively affected primarily by higher freight, raw material, and labor costs, inefficiencies due to ongoing labor shortage in the U.S. and Canada, and unfavorable foreign currency fluctuations in China and Canada. The price increase in freight surcharge implemented during the first half of fiscal 2022 have helped us offset a portion of the current inflationary pressures we are facing. However, the lag in price visualization, as well as competitive market pressures that limit us from immediately passing on all of our cost increases, are expected to continue affecting our operating performance in the near term, and we may need to consider further pricing actions if operating costs continue to rise. For our Pulse View Fabric segment, sales for the second quarter were $33.7 million, down 8.5% over the prior year. Operating income for this quarter was $1 million compared with $3.3 million a year ago, with an operating income margin of 3.1% compared with 8.9% a year ago. Operating performance was primarily affected by lower sales in our residential business, as well as higher freight costs, startup costs for our new Haiti facility, unfavorable foreign currency fluctuations in China, and lower contribution from a re-windows products business. We implemented a freight surcharge during the second quarter to help offset rising freight costs. But due to continued rapid increase in operating material costs, we are instituting an additional price increase during the third quarter to help cover a portion of these inflationary pressures. Here are the balance sheet highlights. We reported $36.6 million in total cash and investments and no outstanding borrowings at the end of the quarter, compared with 46.9 million in total cash investments, and no outstanding debt as of the end of last fiscal year. Cash flow from operations and free cash flow were negative 1.3 million and negative 5.8 million, respectively, for the first six months of the year. As we continue to invest in our business, our cash flow from operations and free cash flow during the first half of this fiscal year were affected by the following uses of cash. increased inventory purchases to support our valued customers, to get ahead of rising raw material costs, and to strategically improve our in-stock position ahead of the Chinese New Year holiday. $3.9 million investment in capital expenditures, including expenditures for machinery and equipment and IT investments, as well as expenditures related to our new innovation campus. $1.4 million in payments for the new building lease and startup expenses associated with our Haiti operation in upholstery and cut and sew operation, and increased accounts payable payments related to our return to normal credit terms as opposed to the extended terms previously granted in response to the COVID-19 pandemic. Additionally, during the first six months of this fiscal year, we paid $2.7 million in regular quarterly dividends and spent $1.8 million on share repurchases. While we're pleased with our solid balance sheet going into the third quarter, it is important to note that we will continue to utilize cash for strategic investments in working capital, planned capital expenditures, and investments in our operations located in Haiti. Based on our current expected uses of cash and our business outlook for the second half of this fiscal year, we expect total cash and investments to be lower at the end of the third quarter as compared to the end of the second quarter, but to increase by the end of the fourth quarter. The company repurchased approximately 73,000 shares of our common stock during the second quarter, leaving approximately $3.2 million available under our current share repurchase program. With that, I'll turn the call back over to Yves.
spk08: Thank you, Ken. I will begin with the mattress fabrics business. While mattress fabric sales for the second quarter were in line with our expectations, revenue was somewhat affected by our customers' supply chain constraints for non-fabric components, and existing inventory levels for mattress fabrics and covers. This caused our customers to temporarily delay taking some orders and push some new product launches into subsequent quarters while working through those limitations. However, we expect these pressures will be alleviated over the medium term. Despite the challenging environment during the quarter, we relied on our product-driven strategy with a focus on design creativity and innovation supported by the utilization of our resilient manufacturing and sourcing platform to service the needs of our customers. Our onshore, nearshore, and offshore supply chain strategy, as well as our fabric-to-cover model, remains a preferred platform, especially for our sewn mattress cover customers. Looking ahead, our market position remains solid, with strong new placements and product developments for fiscal 2023. Rising costs continue to pressure our profitability, but our team remains committed to ongoing efforts to control internal costs, improve efficiencies, and take reasonable pricing actions to mitigate and manage inflation. Over the long term, we are well positioned to sustain our competitive advantage and leverage our compelling business model to further expand our market reach, especially as our customer supply chain disruption and inventory positions begin to normalize. Now I'll make a few comments on the upholstery fabric segment. Our second quarter results were disappointing, largely driven by lower sales in our residential business due to COVID-19 related shutdowns of our sourcing partners and our customers in Vietnam throughout most of the quarter. These shutdowns were expected to be short term, but instead lasted significantly longer than anticipated and limited our ability to ship orders both within and outside of Asia. Residential sales were also pressured by our customer supply chain constraints and labor shortages at their U.S. facilities, which significantly reduced our ability to ship prepared fabric orders. Despite the headwinds in our residential business, we were encouraged by the recovery in our hospitality business during the second quarter, led by our hospitality contract fabric business. We also saw a measurable improvement in our reed window products business during the last month of the quarter. We are pleased the shutdowns that affected our Vietnam customers and sourcing partners during the quarter are now lifted, and we have resumed shipping at normalized capacity. Additionally, we expect to begin production at our new Haiti facility during the third quarter, which will expand our capacity for cut and sewn upholstery kits and mitigate some risk with near-shore capabilities that complement our strong Asian platforms. Looking ahead, there are lingering near-term challenges related to our customer supply chain constraints and existing levels of fabric inventory for the residential business. Also, while we believe demand trends remain favorable for the home furnishings industry, there is an expected slowdown in new business from the peak experience during the post-COVID stay-at-home surge. But despite these external conditions, our business is well-positioned for the long term with our product-driven strategy and innovative product offerings including our popular portfolio of LiveSmart performance products, as well as our flexible Asian platform, our long-term supplier relationships, and our expanded capacity in Haiti. We are also encouraged by the recent Showtime fabric market, where our products receive favorable reaction and strong support from our customers. Above all, we remain focused on meeting the changing needs of our valued customers in upholstery fabrics. Ken will now discuss the general outlook for the third and fourth quarters of this fiscal year, and then we'll take some questions.
spk05: We continue to navigate uncertainty in the macroeconomic environment related to customer supply chain disruptions for non-fabric components, significant inflationary pressures, a challenging labor market, and fluctuation of foreign currency exchange rates. Although we are well positioned over the long term with our product-driven strategy and flexible global platform, The current headwinds are expected to continue pressuring results throughout the second half of this fiscal year, especially during the third quarter. As a reminder, the third and fourth quarters will also be affected by the timing of the Chinese New Year holiday, which begins at the end of the third quarter and continues into the beginning of the fourth quarter. Due to the uncertain and rapidly changing inflationary environment, the lack of visibility relating to the duration and magnitude of customer supply chain disruptions and uncertainty related to the impact of the new Omicron environment of the coronavirus, we have withdrawn our previously issued annual guidance for this fiscal year and have only provided a limited outlook for the third and fourth quarters until the current volatility stabilizes. We expect our net sales and consolidated operating income for the third quarter of this fiscal year to be sequentially comparable to the second quarter of this fiscal year. We expect a strong improvement in net sales and operating income for the fourth quarter of this fiscal year as compared to both the sequential third quarter of this fiscal year and as compared to the fourth quarter of last fiscal year. Our confidence in this anticipated fourth quarter rebound comes from expected improvement in our customer supply chains and recognition of our customer placements and the scheduled timing for their release in a traditionally seasonal strong quarter. as well as positioning with our solid supply chains, strategic inventory levels, and pricing actions that will cover us more adequately in the fourth quarter. Notably, our expectations for the third and fourth quarters of this fiscal year are based on information available at the time of this call and reflect certain assumptions by management regarding the company's business and trends and the projected impact of the ongoing headwinds. Additionally, based on current expectations, capital expenditures for this fiscal year are now expected to be in the $10.3 million to $10.7 million range. Our capital investments will focus on ongoing strategy of maintenance CapEx centered in our mattress fabrics business, as well as spending in our upholstery fabrics business with investments in Reed Windows and our new Haiti startup. At the corporate level, CapEx spending will include investments in IT infrastructure and security, as well as our new innovation campus in High Point, North Carolina. Depreciation and amortization expect to be approximately $7.4 million to $7.6 million for this fiscal year. With that, we will now take your questions.
spk01: We will now begin the question and answer session. To ask a question, you may press star, then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Anthony Levodinsky with SOTY and Company. Please go ahead.
spk02: Yes, good morning, and thank you for taking the questions. So, yes, I know you guys did a... Pretty good overview of the two different segments. Just wanted to see if we could get a better understanding of the timing shifts, basically, of shipments. It sounds like something's going on with new product launches. Some of it is just your customers are asking to hold off on shipments. So just wanted to, if you could just kind of separate the two to just give us a better understanding of just the timing issues that are surrounding the back half outlook.
spk08: Yeah, it's Anthony. Thank you for the question and good morning. This is Yves. I'll start and certainly let Boyd chime in too. It is, there are some nuances between the two businesses, so your question is excellent. In the upholstery fabrics business, we've built up strategically some product in advance of Chinese New Year, but we also built up some inventory in preparation as our customers had planned to expand capacity to meet surge levels of demand. So what we've seen in some cases, our supply chain has been fulfilling better and keeping up with market demand, and our lead times are more normal today. So we're prepared to deliver at what would normally be increased levels of capacity that, in some cases, the customers haven't caught up to. And, Boyd, you may want to add to that to some degree, is why we're seeing a little delay in some of the shipping there.
spk06: No, I think that's... very well covers what's happened on the fabric side of the business is. And then additionally to that, as we've discussed, we had the disruption on the cut and sew portion of our business from Vietnam in second quarter. But with that now, Vietnam now being back fully restored with capacity there, and with the Haiti operation now coming on stream, we certainly see a more normalized shipping pattern for the second half of the year on our cut and sew business as well.
spk08: That's right. I think, Anthony, then just to keep tacking onto that and spinning the mattress fabric some, you should expect, I mean, we would expect some sequential improvement in upholstery fabric from Q2 to Q3. And when we talk about mattress fabrics, especially mattress covers, normally in the end of our Q3, we will see strong ramp-ups of new product rollouts often target around calendar year January. Because of some of the demand in the business and just dealing with supply chains and making sure current orders can be delivered, a lot of those rollouts that we would expect normally for mattress fabrics in Q3 are being pushed into Q4 or later. So that's why it's a slight difference. And both businesses were able to deliver. And in each case, I guess, it's because our customers can't pull it all through that we've prepared. But it is a little different quarter to quarter. Upholstery used to start to improve some in Q3, where mattress fabrics may not feel that improvement until Q4. Got it.
spk02: Okay. Thanks for that explanation. And then I guess just from an overall demand perspective, you know, it sounds like you expect maybe a little bit of a moderation versus a year ago at kind of peak levels, but is it safe to assume that you guys are still seeing demand above pre-pandemic levels?
spk08: Yeah, Anthony, this is Ev. Again, that's an excellent question, too, and it is an important nuance to think about when we speak about sales slowing. When we say that, we mean they're slowing, as you pointed out, from a very high peak that we were seeing last year at this time, is everything we had was shipping quick, and we were a stay-at-home response that boosted really the entire industry. The business that our customers now, we believe, is still at a high level compared to pre-COVID levels, and they're working through really strong backlogs. It's just that the level has subsided somewhat on new orders as compared to that peak of last year. We feel this a little more acutely, as in some cases our customer's have ordered more fabric, as we talked about, to support increased production levels to work the backlog, that the capacity is not fully in place. So it's really a timing issue. And again, our supply chain has been solid, and most of our backlogs are now at normal lead times. So again, it's just timing of when we can start to deliver it. So generally, we do see positive long-term trend in the order level, which does continue supporting our business.
spk02: Got it. Okay. And the last question for me, as far as the planned price increases. Is it both for the third and fourth quarter or just for the third quarter that you're planning? And can you give us the magnitude of price increases that you're planning to do?
spk05: Yeah, Anthony, this is Ken. Yeah, if you look at Q2, the impact, kind of the cumulative impact of all the increases we've done so far, I'd say that's around 3% or so of total income, or total sales. And so when you look at the rest of the year, I mean, we do have more coming in, but those are going to accumulate over the period of time. So it's going to be higher, of course, than we are today, but they come in at different times, so they are going to be staggered. But I think by the time the end of the third quarter, guys, they'll all be in place at that point. Yeah.
spk02: Okay. Got it. All right. Well, thank you very much, and best of luck going forward.
spk04: Thank you, Anthony. Have a good day.
spk01: The next question comes from Bud Bugach with Water Tower Research. Please go ahead.
spk03: Good morning, Ev, Ken, and Boyd. I guess I'd like, if you could, you said that it would take, I think, Ev, I think your quote was some time for your customers to work through the additional problems that they had before they could get through to your fabric inventory. Can you quantify that? Maybe it's different by segment. It probably is. Maybe give us an idea of what you think that time is.
spk08: Yeah, I mean, but we tried for sure. Good question. We're just trying to be a little hesitant when we talk about some time, but we really, obviously when we're seeing the The strong rebound for Q4, we think it starts then. So it's not a long-term thing. We think it'd be Q4 and then heading into next year.
spk04: In both businesses. I'm sorry?
spk08: In both. In both businesses, although the rebound for Q4 will be first in mattress fabrics and then continuing strong for both through the rest of the year.
spk03: I got you. And let me put a, maybe this is a, maybe I don't mean it to be unfair, but it's probably a difficult question. If Haiti had been online during the second quarter, for all of the second quarter, what would that have done for your Vietnam operation? What kind of impact would you have had?
spk06: Yeah, Bud, this is Boyd. And certainly, and of course, the Haiti operation is coming online as we had planned. There really has been no delay in that facility coming on stream. But if that facility had been in place earlier, certainly we would have had an opportunity to shift some of the Vietnam production that was being disrupted by COVID. We could have shifted some of that potentially to the Haiti operation, which would have helped in regards to the disruption that we saw in Q2. We were able to shift some of the Vietnam production back to China for a period of time, so we weren't fully without capability of supplying cut and sewn kits during that time period. But, yeah, if Haiti had been available sooner, we certainly could have taken advantage of that situation as well.
spk08: And just for Buzz's knowledge there, Boyd, what you shipped back to China was an amazing statement to your supply chain, but that came at a cost because of the tariffs and some of the impacts that have been, is why we moved to Vietnam in the first place.
spk06: That is correct. There was some cost.
spk08: Okay.
spk03: That makes good sense. One of the words that's now been apparently retired by the chairman of the Fed was transitory and talking about inflation. And I don't think anybody in the business world has believed transitory for some time. But what is the status of what you're seeing in terms of inflation now? Are you seeing additional price increases in the last couple of weeks that are going on? Are we seeing any moderation in the in the rate of increases or where they're coming from?
spk06: This is Boyd again. I'll first speak in regards to the upholstery fabrics business. And we certainly have continued to see additional increases from the inflationary environment. We've seen additional increases in the recent weeks. So there are inflationary pressures that are continuing to emerge. most recently related to energy costs and raw material costs. So there are ongoing inflationary pressures. You know, other costs such as freight, I think we've seen those costs likely have peaked. But, yeah, to answer your question, we are continuing to see additional inflationary cost pressures.
spk03: Okay, but they seem to sound like that, if you're talking about energy, that's in the kind of the factors of production. So if you've seen a freight peak, that's probably peaks, and we're probably not too far away from a peak on that as well, I would suspect. I mean, those things, they have a way of factoring through a supply chain and economy over a period of time. So would that be the right way to think about it, or am I being too optimistic?
spk06: I think we're just in an uncertain environment right now, Bud, that, you know, there's been a lot of volatility that we've seen from month to month and week to week. So I'm not sure there's a, you know, how to think about that just yet other than as we are seeing these cost pressures, we are taking the necessary actions at the time and we'll continue to respond accordingly with whatever occurs.
spk08: Yeah, I think we're thinking about it like you are, Bud. We do hope we're at a peak of some of those costs. Raw materials is probably the one that I worry about the most that might have more inflation on it. Hopefully, you're right about freight, but I know, Boyd, we're not totally sure. On the mattress side, I'll just add in one more thing that's an impact is labor costs. You know, because of our strong North American production level in mattress fabrics, we've had an impact from labor. And certainly, we have higher labor rates, but what's impacted us more in the past has been so much labor shortage. and the inefficiency of being able to train and get new associates to operate efficiently. The good news is we have significant improvement there and are in much better shape as we get to middle of Q3 with a much stronger labor position. So even at a somewhat higher rate, having an efficient labor force will be a big help to us there. It starts to limit some of the pressures in leasing that part of the business.
spk03: Yeah, we've heard from a lot of people that they've been shortage in terms of being able to get appropriate associates. Can you quantify it? Are you at where you want to be in terms of your labor force? Or what's the shortage now versus maybe what it was two weeks ago, four weeks ago, six weeks ago?
spk08: Yeah, I mean, it is significantly, drastically improved from where it was six weeks ago. So for whatever reason, we've just had a nice, we've done a great job of recruiting, a great job of engagement. Found a lot of success replacing or refilling jobs that were open, especially on our night and off shifts. That was where the biggest problem area was. We're not all the way filled, but we're in a place now where we can operate our equipment, which makes a big difference to our efficiency.
spk03: I can understand that. I guess last for me, I noted that inventories are up like $16 million today. year over year to kind of the highest level that I've seen since, I guess, the late 1990s when the company was being run with a different discipline, not as an asset-light company that you've been over now for the last decade or more. So is any of that inventory at risk? And is it finished goods? Is it whip, raw material? I worry about that, and I guess other investors might, too.
spk05: Yeah, but this can, I'll begin, and Yves, you can jump in at the end. I think as far as the buildup, as I, you know, I think I pointed this out. I mean, part of it has been, you know, the customer-related, you know, customers pushing back, getting ready for Chinese New Year, all that's finished goods. We have increased our raw materials on the mattress fabric side to get ahead of the price increases. So it is both sides of it. But those have all been recent increases in preparation for these periods. So, I don't see any exposure there as far as... Yeah, we don't believe there's any exposure.
spk08: In the upholstery side of the business, it is more finished goods prepared ahead of Chinese New Year and ready for the expanded capacity levels our customers expect to get to. And on the mattress side, yes, it's a lot of raw materials that have been purchased in advance. of pricing pressure that we can knit or weave or make a cover out of in any direction we get pulled. It feels like a positive position that's poised for an upturn in the market.
spk05: Yeah, and a lot of companies these days are really focusing on higher inventories just because of the uncertainty. So we feel good from that standpoint and are expecting that to turn in the fourth quarter.
spk03: Okay. And do you think inventories go back? I mean, everybody's talking today about having more inventory than less inventory. The era of just-in-time seems to be something now moving to the past because people are talking about having pockets of additional supply because they're worried about things like which we've experienced now for the last two quarters, supply chain. So about $16 million, how much would you think that would draw down?
spk04: Yeah, I think, again, this is Ken.
spk05: I think for the fourth quarter, of course, we think we can take, you know, a big, a sizable chunk out of that. And then from there, you know, you looked at over the past year, I think it was in mid-50s at one time. I think last year, I think it was $47 million was low. So I think going forward, it obviously depends on, you know, the uncertainty that we're looking at as far as what our customers are doing. But I don't know, Boyd, I think it would stay a little bit higher than normal.
spk06: Yeah, I think certainly, and we feel strongly, Bud, that our service reputation and our reliability for service throughout this volatile time period has certainly been an advantage for us. So, yeah, I think as we look at our inventory strategically now versus what we did in a number of years past, we certainly see it as a strategic advantage to be able to offer exceptional service continually to our customer base.
spk03: I understand that because I think that is the reputation of Culp, and with the stronger balance sheet than you have, I think you've got that strategic advantage. So good luck on the third and the fourth quarters, and I look forward to talking to you again shortly.
spk04: Thank you.
spk01: Thanks, bud. The next question comes from Marco Rodriguez with Stone Capital Markets. Please go ahead.
spk07: Good morning, guys. Thank you for taking my questions.
spk04: Good morning, Marco.
spk07: Hey, guys. I was wondering if maybe we can talk a little bit about the outlook that you had in your prepared remarks. Obviously, you pulled out a few headwinds that are impacting the second half of the year, inflation lowering demand, high customer inventory levels. supply chain issues at your customers. So I understand the Q3 guidance in light of that. But maybe if you can talk a little bit about Q4, your expectations there for a stronger improvement. If inflationary pressures are less than temporary and supply chain issues don't seem to be rectified anytime soon, what's sort of giving you the confidence for Q4 for that strong improvement?
spk08: Thank you, Marco. Good question. And that's something we've talked a lot about. And as we've touched on throughout, it comes down to a timing question. And then Q4 also being traditionally a strong seasonal period historically. And as we've been saying internally and to anyone we've spoken to, investors or customers or suppliers, it's not really a question of if it's going to come back strong, it's when. So we've built a solid supply chain, terrific production locations, And as Boyd mentioned a few times, we're outperforming our competitors in delivery. And we hear this all the time, and we do think that's driving new opportunity. So in Q4, let's think about some of the good things. We'll be fully operational in Haiti for upholstery kits. And we have both businesses then operating with some combination of onshore, nearshore, and offshore capabilities. So really boosting and ramping up the supply chain even more. will be much more covered to inflationary costs in our business in Q4 with the price increases and the surcharges of being in place. And our labor situation, as I touched on, is stabilizing nicely now, which helps quite a bit on the mattress fabric side. We strategically built some good inventory levels that we've touched on in both finished goods and raw materials. And we're positioned well as our customers start to increase their capacity levels. And we think there'll just be a strong pull through of that and we also are hearing about new strong placement conditions for both businesses and we just see expectations for when those customers are now scheduling through all those new items. And that all seems to be pointing much more towards Q4. And then just a couple more quick things. Our new innovation campus has been a home run. We had Showtime there a couple weeks ago and just great momentum coming from that Showtime market. And then we just think we're in a strong position with our market reach for medium to long term, and just very much looking forward to what we think with our price actions finally catching a little hold to some more normalized conditions in Q4. So I hope that helps.
spk07: Very helpful. Thanks. I appreciate that. I also want to kind of follow up on a prior question as it relates to, in your prepared remarks, you discussed kind of the potential dampening of demand due to prices. And I understand the difficult year-over-year comps, but is there, and I heard your response that demand is a little bit better than pre-COVID levels. I just want to make sure that the, I guess what I'm trying to get at is whether or not inflation, the price increases are really starting to impact the consumer's ability or willingness rather to buy new stuff.
spk08: I mean, it's a great question, Marco, and one we've talked about a lot, and we spoke about it, and Boyd's sitting here beside me shaking his head. We asked every customer we saw during our Showtime market about that exact question, and we just aren't hearing that concern yet. Fair, Boyd? That's fair, yeah.
spk06: That's the feedback we've received.
spk08: We wonder the same. I know the increases we're passing on aren't going to be the kind of thing that would disrupt the market, but we do know Some of our customers have done increases as high as the mid to higher teens, I guess. But we have not heard of a dampening of demand.
spk07: Got it. I mean, it's down from the peak, but we're not here.
spk08: It's still at a high level. So we're not hearing that yet.
spk07: Got it. Got it. Okay. And last question for me. You know, you guys in your prepared markets also called out some competitive pressures recently. potentially impacting your ability to push through cost increases or raise your prices in the mattress fabric segment. Can you maybe expand a little bit more on that and what you're seeing?
spk08: I think, Marco, it's a good question, too. And we tried to be smart in the way we talk about it. The competitive pressures are not as much about us ultimately being able to pass it through. It's the timing of when we can do it. So We will get there, we just lag on it. So there's just always competitive pressure when we're dealing with customers and trying to think long term for developing big business with our most trusted partners. Sometimes we just can't pass it as quick as we want, so we do it in chunks and do it over stage periods, where ultimately we catch up to the full effect, but just not immediately. Boyd, do you want to add anything to that, how you think about it from pricing?
spk06: Yeah, I mean, I would just agree, Yves, with what you said there, that there's typically a lag that will take place. But, yeah, I don't see any other significant impacts from that.
spk08: Yeah, so it's not much about passing it through, Marcus, just how quick we can get it through.
spk07: Got it. Understood.
spk04: Appreciate your time, guys. Yes, sir. Thank you. Thank you, Marcus. Thanks.
spk01: This concludes our question and answer session. I would like to turn the conference back over to Mr. Culp for any closing remarks.
spk08: Thank you, Operator. And again, thank you all for your participation and your interest in Culp.
spk04: We do look forward to updating you on our progress next quarter. Have a great day.
spk01: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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