Culp, Inc. (NYSE:CULP) Q2 2023 Earnings Call Transcript

Culp, Inc. (NYSE:CULP) Q2 2023 Earnings Call Transcript December 8, 2022

Culp, Inc. beats earnings expectations. Reported EPS is $-0.99, expectations were $-1.07.

Operator: Good morning and welcome to the Culp, Inc. Second Quarter Fiscal 2023 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to questions. Please note this event is being recorded. I would like to turn the conference over to Dru Anderson. Please go ahead.

Dru Anderson: Good morning and welcome to the Culp conference call to review the company’s results for the second quarter of fiscal 2023. 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 measurement is included in the tables to the press release included as an exhibit to the company’s 8-K filed yesterday and posted on the company’s 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 Iv Culp, President and Chief Executive Officer of Culp.

Please go ahead, sir.

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Iv Culp: Good morning and thanks everyone 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 Bowling, our Chief Financial Officer; and Boyd Chumbley, President of our Upholstery Fabrics business. I will begin today’s call with some opening comments and Ken will then review the financial results for the quarter. Following that, I will provide further updates on some strategic initiatives and opportunities specific to each of our operating segments. And Ken will then review the business outlook for the third and fourth quarter of this fiscal year. We would then be pleased to take your questions. Our sales and operating results for the second quarter reflected on-going pressure from the continuous slowdown and the consumer demand in the domestic mattress industry and to a lesser degree in the residential home furnishings industry.

As previously announced, our operating performance was significantly affected by inventory impariments and the inventory close out sales for our mattress fabrics division as well as higher than normal inventory markdowns and restructuring and related charges associated with our upholstery fabric segment. The timing of this inventory impact was mostly driven by our customers focus on new products offerings to introduce at the retail level, as well as inflationary pressures, changes in consumer spending and on-going macro conditions. We expect to ultimately benefit from a focus on new products as we continue to win new placements in both divisions. But it is difficult to predict the timing of new product rollouts due to the on-going excess of retail and manufacturer inventory.

I am pleased with our continued focus on cash generation and working capital management including inventory reductions throughout the quarter. Maintaining a solid financial position has been our major priority through these challenging times and I’m grateful to both of our segments for their excellent work in this regard. We ended the period with a higher cash position than the first quarter of fiscal 2023 with $19.1 million in cash and investments and no outstanding borrowings. We also generated cash flow from operations of $6.2 million and free cash flow of $4.8 million for the first six months of the fiscal year. Additionally, based on market dynamics for cut and sewn products, and the strength of our Asian supply chain, we took action during the quarter to rationalize and adjust our model for this platform with a closure of our Shanghai cut and sew facility, resulting in certain restructuring and related expenses.

We also began to implement a rationalization of our U.S. based mattress fabric cut and sew platform during the quarter, moving our R&D and prototyping capabilities from our high point North Carolina location to our Stokes Dale North Carolina facility and initiating the closure of two U.S. facilities associated with this business, which is expected to be completed during the third quarter. We believe but of these moves will generate meaningful cost savings, estimated at approximately $3 million annually without sacrificing our ability to support our customers, grow our cut and sew business and maintain our competitive advantages through our lower cost manufacturing and sourcing operations in Haiti and Asia. Importantly, we continue with a very robust platform for cut and sewn products driven both for market pricing and reactivity to customer demand for rapid prototyping, as well as ramp ups.

I remain encouraged by the market positions of both of our businesses and the actions our management teams are taking to improve performance in the face of extraordinarily difficult conditions. Later in these remarks, I will provide more color around specific strategies and each business with detail around Culp impressions. I’m encouraged by our leadership transition, which is within the Culp fashions business to generate improvement for the future. Across both segments, we are optimistic about new customer programs that are expected to launch in calendar 2023. As these programs will have the benefit of being priced in line with current market conditions as compared to the price cost lag we have experienced for the last several quarters. Looking ahead, we will continue to diligently manage the aspects of our business that we can control, including execution of our product driven strategy, on-going cost reduction measures and consideration of further adjustments to right size and restructure operations to align with current demand levels.

We are pleased to have entered into a term sheet for a new credit facility that will give us more flexibility as we navigate this difficult environment. And we remain focused on taking the necessary steps to weather the current headwinds and meet the needs of our customers both now and as conditions normalize. I’ll now turn the call over to Ken who will review the financial results for the quarter. And then I’ll talk more about some initiatives we have planned for both businesses as we move into the second half of the fiscal year.

Ken Bowling: Okay, thanks Iv. 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 $58.4 million, down 21.7% compared with the prior year period. The company reported a loss from operations of $11.9 million compared with income from operations of $1.6 million for the prior year period, and compared sequentially with a loss from operations of $4.7 million for the first quarter of this fiscal year. As Iv touched on the loss from operations for the quarter includes $5 million in inventory impairment charges and loss on sale of raw material and finished goods inventory associated with our mattress fabric segment.

It also includes approximately$1 million in higher-than-normal inventory markdowns associated with our upholstery fabrics business and $713,000 in restricting expense related charges associated with the closure of the upholstery fabrics segment’s cut and sew facility in Shanghai China. I’ll comment more detail on visual sales and operating performance in a moment. Net loss for the second quarter was $12.2 million or $0.99 per diluted share, compared with net income of $851,000 or $0.07 per diluted share for the prior year period. Our overall operating performance for the second quarter was primarily affected by lower sales, impairment charges due to the write down of inventory to its net realizable value, and inventory close out sales for a mattress fabric segment, markdowns and inventory due to our age inventory policy for both segments and restructuring related charges associated with our upholstery fabric segment.

Notably, we benefited from $829,000 in other income for the second quarter, as compared to $404,000 other expense during the prior year period. The change from other expense to other income is due mostly to more favorable foreign exchange rates applied against our balance sheet accounts denominated in Chinese renminbi to determine the corresponding U.S. dollar financial reporting amounts. During the second quarter of this fiscal year, we reported a foreign exchange gain associated with our China operations of $1 million, which is mostly non-cash compared with the foreign exchange loss of $151,000 during the second quarter of last fiscal year. The effective income tax rate for the second quarter of this fiscal year was a negative 10.4% compared with 34.3% for the same period a year ago.

Our effective income tax rate for the second quarter of this fiscal year was affected by the company’s mix of earnings between our U.S. and foreign subsidiaries. We incurred a significant pretax loss in our U.S. operations during the second quarter of this fiscal year. But we were unable to record an income tax benefit in connection with this loss due to the valuation allowance applied against our U.S. net deferred income tax assets. This — with the fact that all of our taxable income for the second quarter was earned by our foreign operations in China and Canada, which have higher income tax rates in the U.S. resulted in the negative income tax rate for the quarter. Our cash income tax payments totaled $1.7 billion for the first six months of this fiscal year.

And we currently expect cash income tax payments of approximately $3.2 million for the entire fiscal 2023 year. 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, Canada versus annual projections, changes in the foreign exchange rates associated with our China operations and other factors. Now let’s take a look at both of our business segments. For the mattress fabric segment, sales for the second quarter were $26.2 million down 35.8% compared with last year, second quarter and down 10.7% compared sequentially with the first quarter of this fiscal year. Sales for the quarter which included pricing and surcharge actions that were in effect during the period were significant pressured by the on-going slowdown in consumer demand in the domestic mattress industry.

The impact of this industry softness was heightened as mattress manufacturers or retailers continue to work through excess inventory, delaying the timing of shipments and new product rollouts. Operating loss for the quarter was $9 million compared with operating income of $3.1 million a year ago. Our operating performance for the second quarter of this year was significant pressured primarily due to operating inefficiencies driven by lower sales volume and $5 million in inventory impairment charges and losses on the closeout sale raw material and finished goods inventory. For the upholstery fabric segment sales for the second quarter were $32.2 million down 4.5% over the prior year, which was affected by Culp related shutdowns in Vietnam. Sequentially sales in upholstery fabric segment were down 3.3% compared with the first quarter of this fiscal year.

Sales for Residential Upholstery Fabric products were pressured during the quarter by reduced demand, driven by the slowdown in new retail business for the residential home furnishings industry. However, demand remains solid in our hospitality business with higher sales in both our hospitality/contract fabric business and our Read Window business as compared to the prior-year period. Income from operations for the quarter was $262,000 compared with income from operations of $1 million a year ago. Our operating performance for the second quarter of this fiscal year as compared to the prior year period was primarily pressured by lower residential sales and approximately $1 million in higher than normal inventory markdowns as well as operating inefficiencies in this segments Haiti cut and sew facility.

These pressures were partially offset by a significant more favorable foreign exchange rate associated with this segments operations in China, as well as an improved contribution from our Read Windows business. Now turning to the balance sheet, we reported $19.1 million in cash and investments in the last any debt as of the end of the second quarter. This compares with $18.9 million in cash and investments and no debt as of the end of the first quarter this fiscal year and $14.6 million in cash and investments and no debt as of the end of last fiscal year. Cash flow from operations and free cash flow were $6.2 million and $4.8 million respectively for the first six months of this fiscal year, as compared with cash flow from operations and free cash flow of negative $1.3 million and negative $5.8 million respectively for the first six months of last fiscal year.

Our cash flow from operations and free cash flow during the six months of this fiscal year were favorably affected by working capital management including higher accounts payable and lower inventory. Importantly, since the end of the third quarter of last fiscal year, inventory reduction has contributed approximately $13.7 million to the company’s cash position. Consistent with our focus on inventory, we are tightly managing our capital spending with an emphasis on business critical only. Capital expenditures through the second quarter of this fiscal year were $1.1 million compared with $3.9 million for the same period of last year. For the full fiscal year, we expect capital expenditures to be in the range of $2.5 million to $3 million. We also executed a non-binding term sheet during the quarter for a new revolving credit facility of up to $40 million secured by the company’s assets.

This proposed credit facility will replace our existing secured credit facility and based on the information available at this time is expected to provide improved borrowing availability with minimal financial covenants. While we do not currently foresee a need to borrow under this facility, we are pleased that it will give us more flexibility as we continue to navigate a difficult environment. The completion of the credit facility is subject to the parties entering into a definitive agreement, which may contain additional or different terms from those that I’ve just described. The company did not pay any dividends during the second quarter of this fiscal year following the suspension of our quarterly cash dividend on our common stock earlier in the year.

The company also did not repurchase any shares during the second quarter of this fiscal year, leaving approximately $3.2 million available under our current share repurchase program. Despite the current share repurchase authorization; we do not expect any activity during the third quarter of this fiscal year, as we remain focused on preserving liquidity and being positioned to support future growth opportunities. With that, I’ll turn the call back over to Iv.

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Iv Culp: Thank you, Ken. I will now provide more comments about our strategic focus and initiative for each division as we look ahead, beginning with the mattress fabric segment called home fashions. Despite the headwinds in this business, Culp Home Fashions has remained focused on inventory reduction and cash generation. This focus on inventory reduction will remain as we move into the third quarter as there are further reductions possible in both finished goods and raw materials. I am very pleased with the cooperation and support we have had in our transition of leadership with MCHF. Sandy Brown and Tommy Bruno are working very well together. And Tommy is learning quickly and engaging the CHF team on a transformation plan in this business where every aspect of our operation has been reviewed, including the organizational structure, renewing the strength of our global platform with a continued and strong focus on North American buyer opportunities, employee engagement and quality, design, sales and of course operational processes.

In the short-term, the focus for CHF will be on free cash flow, turning our inventory into cash, controlling and reducing costs and working on overall improvement in every facet of the business. Innovation remains a hallmark for CHF, and customers continue to accept and prefer our design and product development. As mentioned earlier, we are optimistic that as new business placements move to retail floors, we will grow our sales commensurate with these market share gains. Additionally, these new sales opportunities are placed at current market cost and conditions, which will be better for our go-forward margins. We are also working to implement new order procedures to firm up customer commitments. We are focusing on SKU rationalization via an open express line that we will offer to various segments of the market.

And we are revising minimum run sizes and implementing specialty raw material controls. We are also improving our cut and sew platform so we can still meet customer needs for rapid prototyping in North Carolina, and speed to market via our Haiti location, but saving $2 million annually with the closure of our two high point facilities. And we will still have strong and competitive production and sourcing capabilities in both Haiti and Asia. Regarding operating costs, we are pleased that we are beginning to see raw material pricing relief and a stabilizing labor force. We still need to work through some long supply chains for raw materials. And we must continue training our newer associates. But it is positive to see trending towards a better, more normal condition.

I do want to call out a bit more our stabilizing labor force. Over most of this calendar year, we have been faced with significant turnover, up to 40% of the total workforce in some North American locations and departments. The good news is that today we are much more stable and in a good position with jobs being filled by talented associate. But it’s important to note this is inexperienced talent that is still learning and as they grow our efficiencies can improve. We also have a tailored focus for CapEx within CHF that will not involve any major platform expansion, but rather fine tuning, updating and maintaining equipment to produce quality products at competitive prices. While we do expect the current economic environment will continue to affect the mattress fabric segment to at least the remainder of fiscal 2023.

Our market position in this business remains solid, and we believe we are well positioned for the long-term. We know that CHF is the business that we must quickly improve, and we are optimistic that we will do so. As mentioned, the business is undergoing a significant review and forecasts are being built from the bottom up factoring in the baseline, close out sales from impaired inventory, as well as the layering of the exciting new programs we’ve spoken of. We are confident that our new strategies along with our innovative products, creative designs and global manufacturing and sourcing platform will serve us well into the future in Culp Home Fashions. Now a few comments on the upholstery fabric segment. Despite changing consumer spending trends affecting the residential home furnishings industry, CUF’s business remains well positioned for the long-term with its scalable global platform and innovative product offerings.

Through Q2, our upholstery business is performing better than CHF in these tough conditions, supported in part by our strong contract hospitality business. We remain excited about opportunities within contract hospitality, especially with fabric development. We also continue to pivot and diversify our sourcing strategies to develop additional geographic options to serve as customers. But we remain extremely proud of our associates in China and the great job they have done in difficult circumstances. We have maintained excellent customer service via our China platform, and we continue to develop products of great value in China. But we also understand the need to derisk our supply chain and we have options or supply around the world. We think a diversified strategy is critically important to our customer base.

Innovation certainly continues within CUF as we see growing success with our portfolio performance products including LiveSmart and LiveSmart Evolve, as well as our recent new introductions of any space and Culp powered by Nanobionic, a fabric featuring infrared technology to promote recovery and wellness. Customers are reacting positively to our product lines as reflected at the recent interwoven market and we believe we will see overall residential business improvement as our customers clear inventories from their system and new products are delivered to retail. Ken will now discuss the general outlook for third and fourth quarters of fiscal 2023 and we’ll be happy to take some questions.

Ken Bowling: We continue to navigate a convergence of headwinds, including significant inflationary pressures impacting discretionary consumer spending, high employee levels at manufacturers retailers, a stabilizing but inexperienced labor force and other macroeconomic uncertainties. Although we remain well positioned over the long-term with our product driven strategy and flexible global platform, current conditions are likely to continue pressure results through at least the remainder of fiscal 2023. Due to the continued volatility in the macro environment, we are providing only limited sequential financial guidance for the second half of this fiscal year. We expect net sales for the third quarter will be moderately lower as compared to the $58.4 million in net sales for the second quarter of this fiscal year, with sales for the third quarter affected by pure billing days to the longer than normal holiday shutdowns both internally and by customers and suppliers, as well as the timing of the Chinese New Year holiday which falls primarily within the third quarter.

We expect that consolidated operating loss for the third quarter this fiscal year that is meaningfully lower than the $11.9 million operating loss of the second quarter of this fiscal year. But that is higher than the $4.7 million operating loss for the first quarter of this fiscal year due primarily to expected lower sales. We also expect our cash position as of the end of the third quarter of this fiscal year to be lower than the $19.1 million at the end of the second quarter this fiscal year, but higher than the $14.6 million at the end of last fiscal year. Looking ahead to the fourth quarter of this fiscal year, we are cautiously optimistic for some improvement in business conditions with an expectation for a sequentially improved sales and reduced operating loss as compared to the third quarter of this fiscal year and with a cash position that is expected to be comparable to slightly lower as compared to the $14.6 million at the end of this fiscal year.

As we weather the current challenges, we will continue to be laser focused on prudent financial management with the goal of always maintaining a strong balance sheet, especially with regard to ensuring strategic balance in our working capital. We are optimistic about Culp’s future and we know that financial stability is paramount to our success. With that we will now take your questions.

Q&A Session

Operator: We will now begin the question-and-answer session. Our first question will come from Rex Henderson from Water Tower. You may now go ahead.

Rex Henderson: Thanks for taking my call. And Iv and Ken congratulations on really doing a great job of maintaining liquidity in a really difficult environment. So with that, I wanted to ask a couple of questions about your guidance seems to imply, you’re not it doesn’t seem that you’re quite as bleak as you were in the in the pre-release a couple of weeks ago. And it seems like you’re thinking that there’s some stability and maybe a little bit of turn towards the end of the year. Can you give me some color on why you think that’s possible? What you’re seeing in inventories downstream from you? And, and also, can you give me a little bit of color on what impact the billing days and holiday shutdowns will have on the third quarter as a percentage of revenues or something, some, some metric that will help me understand what impact that’s going to have?

Iv Culp: Yes, Rex, thank you. This is Iv, I really appreciate your kind comments about working capital management and just trying to maintain our balance sheet. It certainly is. Some numbers drilled into me from our board and from our management here and from leaders before me and we definitely make it a paramount importance to us. So it’s one thing we can hang our head on and we’re going to we’re going to keep our focus there. So thanks for mentioning that. To your questions, I’m going to in a second Rex. Those are really good really good questions, then maybe I’ll catch it is kind of you’re asking are we seeing any improvement as we look ahead in the run rate and we were trying to touch on that in the outlook. Certainly there is some Q3 concern and I think you mentioned there are some billing days out of the cycle in Q3.

We have the normal holidays where we are hearing that some customers are taking one and maybe even two weeks out of their schedules. Chinese New Year is also a primary third quarter impact for us. So we recognize that there will be considerably lower billing days in the third quarter than we might have in a normal quarter just from shutdowns. And that may be as many as four to five days that could impact us and billing. So that’s why we’re being a little cautious about Q3. Overall, we probably feel more optimistic about Q4 sales lift, mostly driven by the focus we keep talking about on innovation. But if you have to also break it down Rex, just as I’m thinking through this, you got to break it down by our segments to. We said, or I said, Culp upholstery fabrics has been more stable.

And we are seeing solid conditions and contract hospitality. So our residential business does still remain pressure. But we’re optimistic about new innovation that we have in that business. We have a great opportunity in performance fabrics and we feel certain we are positioned well. CHF, Culp Home Fashions is a business where I really detailed, we have to see quicker improvement, and we are starting to see it. We’ve done a really detailed approach to the business. We built up the forecast really in depth and three buckets from a baseline of business, to close outs that we’re shipping, somewhat from our impairment of inventory and other things. And then new programs that we see, we’re layer in those volume to get a forecast. We understand the baseline is pressure today, we know business is a little bit tight.

But we’re optimistic about reducing inventory further, and driving that cash. And we’re really optimistic about new market share wins. We are certain in both businesses, retailers seem excited to draft new products on their floors. And that’s going to be a benefit to us. And we’ve been waiting for these rollouts for some time. And then lastly, I just I hate to not mention it. The good part about new products hitting the floor is that they are placed in line with market costs, which is I mean, it seems obvious that’s a big deal for us, because we’ve been lagging on price increases most of the year, and to get new products to the market that accosted on in line with current market is going to be very helpful. So yes, we’re cautiously optimistic that we can begin to improve our run rate, especially as we think about in Q4.

So long answer, I hope I hope I got all your questions. If I missed something.

Rex Henderson: That’s, that’s helpful. And in your remarks about CHF, and inventory rationalization there shouldn’t be looking for Q3 inventories to be again lower than they are at the end of Q2. Is that is that more further cash generation from inventory reduction going in to the third and fourth quarters? Is that right?

Ken Bowling: Yes. Rex, this is Ken Yes. Third quarter especially, fourth quarter may require a little bit of bill when we come out of the, with the projected sales growth that we’re that we’re looking at. But right now we’re looking for further reductions in Q3.

Rex Henderson: Okay. And then finally, one point of clarification on the credit agreement. If I recall correctly, you just executed a new credit agreement. I don’t know, what, one or two quarters ago. And I’m wondering, what, what’s the improvement here? What is it? First of all, is this increment? Is this additional? Or is it replacing the existing agreement? And, what’s the benefit of the new agreement for you?

Ken Bowling: Yes, Rex this is Ken again. It is replacing the current agreement. It just, it comes down to give it a score, really a higher ability to borrow with, with the way it’s structured, and also a lot more flexibility with minimal covenants. So that those are the two main benefits of that. And so with this new agreement, it really positions us well, going into the future.

Rex Henderson: And what’s the goal? Is it out for a year, two years, five years? What’s the what’s the, what’s the limit on and again?

Ken Bowling: Well right now we’re looking at the current one is three, we’re looking at three again. But we’re still going through all the motions, but right now we’re looking at three years.

Rex Henderson: Okay. And then finally, one thing, one question about China. We’ve been reading a lot about disruption of business in China due to the government’s COVID restrictions. Have you experienced any of that and what has it had any impact on you?

Iv Culp: Rex, this is Iv. I’m going to let Boyd answer that he is certainly very close to our town operations. I’ll let him make some comments. Good question.

Boyd Chumbley: Yes, Rex, thank you for that question. And in terms of from a business perspective, no, we have not been experiencing disruptions in China through this time period of the restrictions that have remained in place there it has not had any effect or impacts to our managing our business or to our supply chain there. So quite frankly, our China supply chain has been functioning and operating very well, to support our business. So no, no issues there. It is important to note, as we’ve noted before, we have pivoted some of our platform to other locations, just as a diversification strategy, which includes Vietnam and Haiti and Turkey more recently Turkey. So we have continued to diversify our global platform, just to have options for our customer base. But yes, to your question, we have not experienced any business related disruptions due to those restrictions.

Rex Henderson: Okay. Well, thank you. Thank you, again. Good job in a difficult situation. And I’ll let someone else got to ask a question now.

Iv Culp: Thank you, Rex, having a good day. Appreciate it.

Operator: Our next question will come from Anthony Lebiedzinski with Sidoti & Company. You may now go ahead.