CULP INC Q2 FY2025 earnings call

Management Statement and Operational Highlights

• The company made progress on returning to consolidated profitability post-restructuring despite a challenged demand environment. The upholstery fabrics segment faced added headwinds from accelerated softness in residential upholstery, while the mattress fabrics segment showed sequential sales improvement.
• Restructuring efforts are ongoing, with the vast majority expected to be complete in the third quarter. This includes consolidating North American mattress fabrics operations, transitioning damask weaving to a sourcing model, and relocating equipment. The restructuring is expected to lower the cost structure and improve financial results even without significant sales growth.
• The upholstery fabrics segment's hospitality contract business remained solid, representing 35% of total sales, with potential in commercial fabrics and window treatments. The window treatments portion under Read Window is a profit improvement target for the second half of fiscal 2025.

Segment Performance

• Mattress Fabrics: Second quarter sales were $30.1 million, down 4.2% year-over-year but up 7.1% sequentially. Operating loss was $1 million, compared to $936,000 a year ago and $3.5 million prior quarter. The sequential improvement in sales was driven by higher order levels, indicating product innovation and improving market position.
• Upholstery Fabrics: Second quarter sales were $25.6 million, down 6.4% year-over-year and 10% sequentially. Income from operations was $615,000, compared to $1.4 million a year ago. The reduction in sales was due to demand weakness in residential home furnishings, with ordering variability affecting third quarter sales.

Guidance

• Consolidated net sales for the third quarter are expected to be flat to slightly down sequentially, with continued pressure on residential upholstery fabrics and one week less in shipping days due to customer holiday closures.
• The company expects positive adjusted EBITDA, excluding restructuring and related charges, for the second half of fiscal 2025 and a return to positive consolidated adjusted operating income, excluding restructuring and related charges, sometime in the fourth quarter of fiscal 2025.

Risks

• Demand pressure in the industry, particularly in the residential upholstery segment, which affected sales and ordering patterns.
• Restructuring-related inefficiencies impacting operating performance in the short term.
• Foreign exchange rate impacts, though a favorable currency impact was expected in Q3 for upholstery fabrics.
• Uncertainty around tariffs and trade regulations, which could affect supply chain strategies and costs.

Q: Good morning, everyone. First of all, thanks for taking my questions. Certainly a challenging quarter. My first question is on the sequential improvement that we saw in the mattress industry. I think it's pretty impressive given the current industry headwind. Is it right to think that you guys are gaining share in this business? And what do you attribute the strong order growth here?

A: Good morning, Brian. Thank you for jumping on with us today. Good question. I'm going to pivot this primarily to Tommy because he's managing that business, but we are very encouraged with where we're headed in mattress fabrics. As we talked about, the catalyst to us getting back to our commitment of profitability in this environment is mattress fabrics. And we are quite pleased with the performance and where they're ahead of it. Tommy, you may want to context as to what you see in share and what you see in general macro demand?

Q: Hey, good morning, everyone. First of all, thanks for taking my questions. Certainly a challenging quarter. My first question is on the sequential improvement that we saw in the mattress industry. I think it's pretty impressive given the current industry headwind. Is it right to think that you guys are gaining share in this business? And what do you attribute the strong order growth here?

A: Brian, yes, we are growing our share. That is the primary contribution in terms of regrowing sequentially from the bottom in Q4. The macro environment does remain challenged, but we have had some strategic placements and good run rates on new programs that we feel confident about to continue our growth through the back half of this year. So we see the run rates on our business being pretty stable.

Q: Just to follow up, do you see that positive momentum going through Q3, Q4?

A: Yes, sir, we do. We feel confident in the run rate. As Iv mentioned, we do have one week of less shipping days in Q3. But we have good momentum, and we've got a docket of new programs that are scheduled to launch in Q3 and Q4.

Q: My next question is on the upholstery side of the business. I mean I would say that the contraction that we did see, while it was potentially unexpected, it's definitely not surprising given what's happening in the industry overall. My question though would be how much of the change that you guys saw is a reflection of the underlying demand versus your customers just being more conservative in how they're building inventories for 2025? And do you have any insight into what that delta might be between the inventory build and the end demand dynamics?

A: Yes, Brian, I'm going to pivot that to Mary Beth because she is living the upholstery segment day by day. But it is a really good question and one we've thought a lot about. The upholstery segment has been a stalwart for us through a lot of ups and downs. It's been steady. It's remained profitable, and we're bullish on that segment. We have been. There's been a lot of interest from our customer base and new products, and there's a thirst to get that innovative product to retail floors. And I think that as we get out and start to see some improvement, there were some just some customers getting ahead of themselves and ordering more than they needed, and now we're being caught in an adjustment. But Mary Beth, you can add color as to what you see and what it means. And Brian, we're talking residential fabrics here at this point, right? That's your question. Mary Beth, add some color to that.

Q: Sure, sure. Brian, yes, I would definitely say that most of our customers have reported continued pressure in the industry, perhaps longer than we anticipated earlier in the year. While we did see some uptick in enthusiasm in Q1, the customer proved us wrong and proved that we were perhaps too aggressive, some of our customers too aggressive in building their inventory in Q1. So now assuming that the industry recovery is delayed into that calendar year, we saw these customers normalize their inventory level. And specifically, the key customer that had significant change in ordering patterns. If you normalize that key customer Q1 to Q3, we believe we're on pace or slightly better than the industry with positive placement going into the spring season.

Q: If I could pivot just very quickly, though, to the contract and hospitality side, and that on a relative basis was an outperformer. Could you maybe break down the difference between what's happening on the office side versus the hospitality side?

A: Sure. Good question. So within our contract hospitality numbers, a subsection of that is office furniture, primarily seating. And since COVID with the -- just decline and changes in how we work in offices, that portion of that channel is down significantly. So if you tease out the two parts, we're seeing extreme favorability with hospitality with the large pipeline of hotels and the number of brand standards that we've been able to capture. So that is outpacing and overcoming this loss on the office seating side.

Q: More of a question for Ken. There's obviously a lot of moving parts with the restructuring. I was hoping that maybe we could get a little bit more insight into what the economics of the mattress business is going to look like when we move through the current restructuring. Kind of more specifically, how should investors be thinking about what the breakeven point for this segment could be? And then what do contribution margins look like on the other end of this?

A: Yes, Brian. Yes, it's a great question. I think, obviously, getting through the restructuring is priority one, and that's -- we're making great progress on that, and we're looking forward to that point. I think I would look at it as the -- we said that on an annualized basis, once all activity had been completed, we would generate at least $10 million in savings. So if you refer to that slide in the deck, the restructuring slide, it shows the potential that CHF has once we get past the restructuring. The other thing that we're excited about, I mean, that's step number one is to get to that point and get those savings implemented. The second part is the confidence and the encouragement that we have with regard to as the business grows, the leverage that we get from just being able to have the current platform in place, both fixed cost and SG&A and the leverage we would get from there as we grow sales. I mean, that's the exciting part. I mean we're going to be profitable at the current level. But when we start growing, we're going to leverage those fixed costs and be able to really take advantage of a lot of opportunity there to grow the bottom line. So get the restructuring in place first, get profitable and then grow the business. And that's where the real growth comes from in opportunity.

Q: How concerned are you about the potential for increased tariffs under the new administration? And what the set of options that you guys have at the ready to respond to any potential changes that you see on that front?

A: Brian, great question. We're getting that discussion frequently with customers today. It's in the news a lot, of course. And while there are no sure answers, there aren't safe easy plug-and-play options. I think on that topic, I feel as good as I could feel the way both businesses are set up and I'll let each of them -- I'll let Tommy and Mary Beth both speak to it, why they're confident. But I think we've always had a mindset of maintaining optionality in our supply chain and being able to flex our business to where we need to serve a customer. And that will be no different with tariffs. And we have great strategies in both businesses. From an asset-light model in CUF that allows flexibility to budding U.S. stronghold in the mattress side. So I'm excited about both. But I know Tommy and Mary Beth both have bigger pieces than just as they think about it. So Tommy, you want to go first on how you're hearing about tariffs in your space?

A: Yes, Brian, for us, we are -- we're very pleased with the fact that we've now moved all of our capabilities into the U.S., which really insulates us quite a bit versus the things that we're hearing from the incoming administration. So having our mega plant be in North Carolina, we feel is a value to our customers. It can provide confidence and security. And then across the world, one of the things we like about our nearshore cut and sewn -- our nearshore cut and sewn is that it allows us to bring fabrics in duty and tariff free and cut and sew them into final covers and then bring them in to the U.S. So we feel like we're pretty well insulated on the mattress side. And then we have options in Vietnam now that we've set up and we started manufacturing. So depending on how things go, we feel like we've got a lot of different varied options to present all of our customers.

A: Brian, I would say from the upholstery side, the vast majority of our products do not ship into the U.S. So we are fairly insulated from that as well for the portion that does ship into the U.S. The nice thing about an asset-light model and two to three decades of relationships with global suppliers means that we are nimble. We have begun a few years ago some setup in Vietnam. We are continuing to focus there. But again, we can pivot as needed.