Earnings Call Transcript - CULP Q2 2023

Operator, Operator

Good morning, and welcome to the Culp, Inc. Second Quarter Fiscal 2023 Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I’d now like to turn the conference over to Dru Anderson. Please go ahead.

Dru Anderson, Moderator

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.

Iv Culp, CEO

Good morning, and thanks to 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. Ken will then review the business outlook for the third and fourth quarters of this fiscal year. We would then be pleased to take your questions. Our sales and operating results for the second quarter reflected ongoing pressure from the continued slowdown in 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 impairments and inventory closeout sales for our mattress fabrics division as well as higher than normal inventory markdowns and restructuring and related charges associated with our upholstery fabrics segment. The timing of this inventory impact was mostly driven by our customers’ focus on new product offerings to introduce at the retail level, as well as inflationary pressures, changes in consumer spending, and ongoing 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 ongoing 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 fabrics cut and sew platform during the quarter, moving our R&D and prototyping capabilities from our High Point, North Carolina location to our Stokesdale, 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 both 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 in each business with detail around Culp Home Fashions. I'm encouraged by our leadership transition 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’ve 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, ongoing cost reduction measures, and consideration of further adjustments to right-size and restructure our 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, CFO

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 restructuring 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 divisional 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 closeout sales for the 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 UAnd the company's net deferred income tax assets. This was due to all our taxable income for the second quarter being earned by our foreign operations in China and Canada, which have higher income tax rates in the U.S. and 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 and 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 fabrics segment, sales for the second quarter were $26.2 million, down 35.8% compared with last year’s 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 significantly pressured by the ongoing slowdown in consumer demand in the domestic mattress industry. The impact of this industry softness was heightened as mattress manufacturers and 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 significantly pressured primarily due to operating inefficiencies driven by lower sales volume and $5 million in inventory impairment charges and losses on the closeout sale of raw material and finished goods inventory. For the upholstery fabrics segment, sales for the second quarter were $32.2 million down 4.5% over the prior year, which was affected by COVID-related shutdowns in Vietnam. Sequentially, sales in the upholstery fabrics segment were down 3.3% compared with the first quarter of this fiscal year. Sales for residential upholstery fabrics 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 Windows 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 of higher-than-normal inventory markdowns as well as operating inefficiencies in this segment’s Haiti cut and sew facility. These pressures were partially offset by a significantly more favorable foreign exchange rate associated with this segment’s 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 and no outstanding 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, emphasizing only business-critical projects. 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.

Iv Culp, CEO

Thank you, Ken. I will now provide more comments about our strategic focus and initiatives for each division as we look ahead, beginning with the mattress fabric segment, Culp 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 within CHF. 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 supply 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 regarding 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 associates. 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, closeout 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 service 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 for 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, such as fabrics featuring infrared technology that promotes 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 systems and new products are delivered to retail. Ken will now discuss the general outlook for the third and fourth quarters of fiscal 2023, and we'll be happy to take some questions.

Ken Bowling, CFO

We continue to navigate a convergence of headwinds, including significant inflationary pressures impacting discretionary consumer spending, high inventory levels at manufacturers and 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 pressuring 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 to 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 fewer billing days due 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 a 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 of 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 sequentially improved sales and reduced operating loss compared to the third quarter of this fiscal year, and with a cash position that is expected to be comparable to slightly lower 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 a strategic balance in our working capital. We are optimistic about Culp’s future, and we know that financial stability is paramount to our success.

Operator, 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, Analyst

Thank you for taking my call. Iv and Ken, congratulations on your excellent job of maintaining liquidity in a challenging environment. I wanted to ask a couple of questions. Your guidance suggests that the outlook isn’t as negative as it was a couple of weeks ago. It seems you believe there may be some stability and perhaps a slight improvement towards the end of the year. Could you explain why you think that's possible? What are you observing in terms of downstream inventories? Additionally, could you provide some insight on how the billing days and holiday shutdowns will affect the third quarter as a percentage of revenues or any other metric that might help me understand the impact?

Iv Culp, CEO

Thank you, Rex. I appreciate your comments about our working capital management and balance sheet. It is a top priority for us, a principle drilled into me by our Board and management team, and we will continue to focus on it. To address your questions, you asked about any potential improvement we might see in the run rate looking ahead. We touched on this in our outlook. There are concerns for Q3, particularly due to some billing days affected by the holidays. We anticipate that some customers may take one to two weeks off, and Chinese New Year will also impact us significantly in the third quarter. We expect to have fewer billing days than normal, possibly around four to five fewer, which is why we are cautious about Q3. However, we feel optimistic about Q4 sales, primarily due to our continued focus on innovation. When we break it down by segments, Culp Upholstery Fabrics has remained stable, and we are seeing good conditions in contract hospitality. Our residential business is still under pressure, but we have new innovations that give us hope. In performance fabrics, we believe we are well positioned for opportunities. For Culp Home Fashions, we need quicker improvement, and we are starting to see that. We have taken a detailed approach to forecasting, categorizing it into three parts: the baseline business, closeouts we're shipping, and new programs. While the baseline is currently under pressure, we're optimistic about further reducing inventory and increasing cash flow. Retailers appear excited to introduce our new products, which is a positive sign as we have been anticipating these rollouts for some time. Importantly, these new products are aligned with current market costs, which is a significant improvement for us as we've struggled with price increases this year. We're cautiously optimistic about improving our run rate, especially moving into Q4. I hope this answers your questions, but please let me know if I missed anything.

Rex Henderson, Analyst

That's helpful. In your comments about CHF and inventory rationalization, I should expect Q3 inventories to be lower than they were at the end of Q2. Is there additional cash generation from inventory reduction anticipated in the third and fourth quarters? Is that correct?

Ken Bowling, CFO

Yes, Rex, this is Ken. For the third quarter, we anticipate some reductions, especially with the projected sales growth we expect for the fourth quarter. However, for now, we're focused on further reductions in Q3.

Rex Henderson, Analyst

Okay. I’d like to clarify something about the credit agreement. If I remember correctly, you recently signed a new credit agreement, maybe one or two quarters ago. Can you tell me what the improvement is? Is this additional credit, or does it replace the existing agreement? What advantages does the new agreement provide for you?

Ken Bowling, CFO

Yes, Rex, this is Ken again. It is replacing the current agreement. It comes down to giving us a higher ability to borrow based on the way it's structured and also provides a lot more flexibility with minimal covenants. Those are the two main benefits of that. With this new agreement, it positions us well going into the future.

Rex Henderson, Analyst

What is the duration of the agreement? Is it for a year, two years, or five years?

Ken Bowling, CFO

Well, right now, we're looking at three; 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, Analyst

Okay. And finally, one question about China. We've seen a lot of reports regarding disruptions to business in China due to the government's COVID restrictions. Have you experienced any of that? And has it affected you in any way?

Iv Culp, CEO

Rex, this is Iv. I’m going to let Boyd answer that. He is certainly very close to our China operations. I'll let him make some comments. Good question.

Boyd Chumbley, President of Upholstery Fabrics

Thank you for your question, Rex. From a business standpoint, we have not encountered any disruptions in China during the period of ongoing restrictions. These measures have had no impact on our business operations or supply chain there. In fact, our supply chain in China has been running smoothly to support our business needs. Additionally, we have expanded some of our operations to other locations as a strategy for diversification, which now includes Vietnam, Haiti, and more recently, Turkey. This diversification allows us to provide more options for our customers. So, to answer your question directly, we have not faced any business-related disruptions due to the restrictions.

Rex Henderson, Analyst

Okay. Well, thank you again. Good job in a difficult situation. And I'll let someone else ask a question now. Thank you.

Iv Culp, CEO

Thank you, Rex. Have a good day. Appreciate it.

Operator, Operator

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

Anthony Lebiedzinski, Analyst

Good morning, and thank you for taking the questions. And likewise, it's good to see that you guys are proactively managing your liquidity as well. So, I guess, just first just a quick housekeeping question. So, I think, Ken, you mentioned that there was some pricing and surcharge actions taken in the third quarter. Can you just share with us how much of that was impacted as far as the quarter here?

Ken Bowling, CFO

We began implementing pricing changes last year, and these have been effective throughout the past fiscal year. As a result, we're benefiting from the increases in the third and fourth quarters when compared to last year. While I can't provide specific figures, these changes are definitely having a positive effect. We're working to manage pricing alongside various cost measures and efficiency initiatives. Compared to last year, there is certainly a boost in our position. However, as we've noted previously, especially regarding the CHF side, we faced challenges in keeping up. As Iv mentioned, with our new products, we are optimistic about improving pricing to better reflect the current market conditions.

Iv Culp, CEO

Thank you for the question. Ken answered it well, but I’d like to add a couple of points. As we've mentioned frequently, we've been trying to align prices with costs in both businesses throughout the year and have missed several opportunities for price increases. We've consistently lagged, and it's never been sufficient. We are grateful to see some relief in ocean freight, although inland freight is not yet showing improvements, as well as in raw materials, which will be beneficial moving forward. It will take some time to work through the system, but we believe that costs may become a supportive factor for us in the medium term. I also want to highlight that we shouldn’t overlook the stabilization of our labor. Achieving stability with our associates and ensuring they are effectively trained will be an important cost control measure going forward. While we've implemented some surcharges and increases, we have not kept pace with demand. I believe this can shift for us in the latter half of our year.

Anthony Lebiedzinski, Analyst

It's encouraging to hear that. Regarding the labor situation, you mentioned today and in your release last night that the workforce is stabilizing but lacks experience. Based on your experience, what has been the typical learning curve for new associates, and when do you anticipate your labor force will reach optimal efficiency?

Iv Culp, CEO

Yes, that's a great question, Anthony. I'm glad you brought it up. Labor has been a significant challenge for us for some time. Specifically, our North American facilities, especially in home fashions and some areas of upholstery, have seen turnover rates of 35% to 40% in certain locations. While we don't face this issue in other regions, it has been particularly tough in the U.S. As of today, our turnover rate is quite low, and we have many talented individuals in new roles. Although we're not primarily a skilled labor operation, we do require skilled labor, and it takes expertise to operate equipment and properly inspect and evaluate it. Therefore, it requires some time to adjust. Typically, we aim to provide about a month of training for new associates, but it may take two to three additional months for them to reach a normal level of productivity. Overall, it could take a full quarter for someone to become fully trained and truly start making improvements. Despite this, they can still be productive in that time. For many years, we enjoyed a stable and high-retention labor force, but that has shifted in the past year. We're now returning to a stage where we can build on having the right people in the right positions, which has always been a hallmark of Culp. We place just as much value on our people as we do on our balance sheet. It's crucial for us to have the right individuals in the right spots and to allow them the time they need to succeed.

Anthony Lebiedzinski, Analyst

It's great to hear about the changes. You mentioned that ocean freight costs have decreased and you're anticipating some stability in labor. Are there any other cost benefits you are experiencing or expect to experience?

Ken Bowling, CFO

Raw material?

Iv Culp, CEO

I mean, I think when we think about costs, Anthony, outside of that, certainly we're starting to see some tailwind with raw materials. We know we got to work through supply chains, and in some cases, we have to work through some inventories we've already built. But we are seeing raw material tailwind. And that's the biggest portion of our cost on the CHF side. So, seeing raw materials turn in a positive direction for us is very helpful.

Ken Bowling, CFO

And the $3 million in cost savings we called out, too.

Iv Culp, CEO

And certainly, the cost savings from adjusting the cut and sew platform, yes, sure.

Anthony Lebiedzinski, Analyst

Right. To follow up on that, will the $3 million number you mentioned primarily relate to SG&A and more of the cost of goods?

Ken Bowling, CFO

It's a combination of factors. We're starting to see some impact in the fourth quarter and moving forward. A significant part of it is related to lease costs, as well as labor costs. While other fixed expenses have decreased, there are various areas contributing to the nearly $3 million in savings.

Anthony Lebiedzinski, Analyst

Got you. Okay. And then lastly, you talked about SKU rationalization and the better inventory management. Just wondering how quickly can you do that? And how should we think about the significance of this?

Iv Culp, CEO

Yes, that's a good question, Anthony. This is related to the CHF business. Over time, we have become a very custom-design business, and we don't want to decline any customers. It's simply not in our nature. However, we can improve by having a more streamlined product line with standardized raw materials. This will allow us to create many fashionable and appealing designs for market segments that do not require customization. The process involves designing, selling, and marketing the products. While it can be straightforward, it does take time to bring them to market. For our larger customers, we will continue to meet their needs and perform custom work. For smaller opportunities, we need to focus on using standard raw materials, efficient processes, and ensuring customer commitment to the products. These are foundational aspects that we need to enhance. I believe you will begin to see the results of this in FY '24. I would prefer a quicker turnaround, which depends on how swiftly we can release and position these products in the market. That's a significant driver for us. I hope that clarifies things.

Anthony Lebiedzinski, Analyst

Yes, absolutely. Well, thank you very much, and best of luck.

Iv Culp, CEO

Thank you, Anthony.

Ken Bowling, CFO

Thanks, Anthony.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Iv Culp for any closing remarks.

Iv Culp, CEO

Thank you so much operator. And again, thanks to everyone for your participation and your interest in Culp. And we look forward to updating you on our progress next quarter. Happy holidays.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.