Franklin N. Saxon - Chief Executive Officer, President, Director and Member of Executive Committee Kenneth R. Bowling - Chief Financial Officer, Vice President, Treasurer and Corporate Secretary

Chad Bolen Kevin Tracey John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Good day, and welcome to the Culp, Inc. Third Quarter Results Conference Call. Today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Ms. Drew Anderson. Please go ahead.

Good morning, and welcome to the Culp conference call to review the company's results for the third quarter of fiscal 2013. As we start, let me express that some statements made in this call will be forward-looking statements. Forward-looking statements are statements that include projections, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Actual performance of the company may differ from that projected in such statements. Investors should refer to statements filed by the company with the Securities and Exchange Commission, including the Form 8-K filed yesterday for a discussion of those factors that could affect Culp's operations in the forward-looking statements made in this call. The information being provided today is of this date only, and Culp expressly disclaims any obligation to release publicly any updates or revisions to these forward-looking statements to reflect any changes in the expectations. 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 measurements is included as a schedule to the company’s 8-K filed yesterday. This information is also available on the Investor Relations section of the company’s website at www.culp.com. A slide presentation with supporting financial information and additional quarterly performance charts are also available on the company's website as part of the webcast of today's call. I will now turn the call over to Frank Saxon, President and Chief Executive Officer. Please go ahead, sir. Franklin N. Saxon: Good morning, and -- everyone, and thank you for joining us today. I'd like to welcome you to the Culp quarterly conference call with analysts and investors. With me on the call is Ken Bowling, our Chief Financial Officer. I will begin the call with some brief comments about Culp today and Ken will then review the financial results for the quarter. I will then update you on the strategic actions in each of our businesses. After that, Ken will review our fourth quarter outlook, and then we'll be happy to answer your questions. Now looking at the third quarter. We are pleased with our results for the third quarter of this fiscal year with higher sales, profitability and margins, compared with the same period of last year. Both of our businesses delivered a solid performance by remaining focused on what is important to our customers: creative designs, a wide range of innovative products and outstanding service. We have worked diligently over the last few years to begin to build a culture of creativity and innovation. We are pleased to see positive gains from these efforts. We are also continuing to leverage our global manufacturing platform to enhance our service capabilities, meet the changing style demands of our customers and improve margins. These strategies have enabled us to significantly increase our return on capital this year from 18% to 28%. We have achieved this improvement by increasing operating income by 66% so far this year, while only growing capital by 2%. Additionally, our strong cash flow and balance sheet provide us with the financial flexibility to pursue our organic growth initiatives, make strategic investments in both of our businesses and return substantial funds to shareholders by way of dividends and share repurchases. We were also pleased during the quarter to have the cash surplus to be able to distribute a $0.50 per share special cash dividend to shareholders. I'll now turn the call over to Ken, who will review the financial results for the quarter. Kenneth R. Bowling: Thanks, Frank. Total sales for this quarter were $63.7 million, up 5% from the third quarter of last year. On a pre-tax basis for the quarter, we reported income of $4.5 million compared with $2.9 million for the same period last year, an increase of 57%. Pre-tax margin was 7.1% compared with 4.8% a year ago. Adjusted net income, which is a non-GAAP measure, was $3.9 million, or $0.32 per share, compared with $2.4 million, or $0.19 per share, for the prior year period, an increase of 68% on a per share basis. The company's overall adjusted effective income tax rate through the third quarter was 14% compared with 18% for the same period last year. This adjusted effective income tax rate or ongoing, estimated cash tax rate represents estimated cash income tax expense for Culp's non-U.S. entities divided by consolidated income before taxes. This information is important because the company currently does not pay cash taxes in the U.S. nor does it expect to for a number of years due to approximately $60 million in loss carryforwards as of the beginning of this fiscal year. Cash flow from operations through the first 9 months was $10.8 million, up from $2.7 million at the same time last year. Here are the results of our 2 businesses. For mattress fabrics, we reported $35.5 million in sales for the third quarter, up 2% compared with sales of $34.7 million for the same period last year. Operating income for this segment was $4.2 million for the third quarter compared with $3.1 million last year, an increase of 33%. Operating income margin was 11.7% of sales compared with 9% of sales for the prior year period. Return on capital for the mattress fabrics segment was 35% to the third quarter this fiscal year, up from 25% a year ago. The key to this improvement was the 44% increase in operating income so far this fiscal year, while capital employed only increased 6%. Now turning to upholstery fabrics. Sales for the third quarter were $28.2 million, representing a 10% increase from $25.7 million in the third quarter of last year. The upholstery fabrics business reported operating income of $1.8 million for the third quarter compared with $754,000 last year, an increase of 136%. Operating income margin was 6.3% of sales compared with 2.9% of sales for the third quarter of last year. Return on capital for upholstery fabrics segment was 40% through the third quarter this fiscal year, compared with 17% for the same period a year ago. The increase to 40% return on capital was driven by 193% increase in operating income so far this year, while capital employed increased only 5%. As reflected in the high return on capital for both of our businesses, capital discipline is very important to us. We have established a culture of excellent stewardship of our capital throughout our organization. Further, we have even tied our incentive compensation for divisional and executive management to how we use our capital based on economic value added, or EVA, principles. Now turning to the balance sheet. We have continued to maintain a strong financial position even as we have invested in our businesses for working capital and CapEx and returned significant cash to shareholders during the quarter and fiscal year. For our third quarter, we reported $24.7 million in cash and cash equivalents and short-term investments after payment of a special cash dividend of $0.50 per share and the payment of the company's quarterly cash dividend of $0.03 per share, both payments totaling $6.5 million. Thus far, during fiscal 2013, we have also spent $5 million to repurchase approximately 503,000 shares at an average price of $10 per share. Since June 2011, the company has repurchased 1.1 million shares, or 8.5% of its outstanding shares, for a total of $10.4 million at an average price of $9.23 per share. Over the last 2 fiscal years, we have returned $17.6 million to shareholders in the form of dividends and share repurchases. Total debt at the end of the third quarter was $7.3 million, which includes long-term debt plus current maturities of long-term debt and our line of credit. Of this amount, $6.6 million is term debt to be paid in 3 remaining annual payments beginning August 2013. For fiscal 2013, we expect CapEx spend to be approximately $4.5 million, and depreciation and amortization expect to be about $5.5 million. Looking ahead for fiscal 2014, we expect CapEx and D&A to approximate these amounts. Frank? Franklin N. Saxon: Thank you, Ken. I'll now provide you with an update on both of our operating segments. Let's start with mattress fabrics. For mattress fabrics, they had a solid performance in the third quarter. While our overall sales moderated later in the quarter in tandem with industry demand, we continued to achieve consistent growth over the prior year. Our improved profitability reflects our ability to maximize the efficiencies and flexibility of our manufacturing platform. As the market demand has evolved for higher-end bedding and more decorative mattress fabrics, Culp has effectively responded to this trend by providing our customers with the high-quality fabrics they need. More than ever, the bedding industry is demanding innovation and Culp is uniquely positioned with a flexible and diverse manufacturing platform that offers a wide range of product offerings and rapid speed to market. In addition to Culp's wide array of fabrics, we can support this functionality with our excellent design capability and expertise from our upholstery fabrics business. This flexibility allows us to maintain our focus on design development and product innovation to drive our sales growth, as more decorative fabrics are being used in bedding products to achieve today's fashionable look. We are also making excellent progress with respect to our latest business venture, cutting and sewing of mattress covers, which we call Culp-Lava. Our new Stokesdale, North Carolina manufacturing facility, developed specifically for this operation, further leverages our design expertise with the ability to produce and market mattress covers. With this expanded capability, Culp now has a manufacturing platform that adds further value to the mattress industry supply chain. From weaving, knitting, finishing to our cut-and-sew operation for mattress sewn covers. We are very pleased with the production results to date, and the favorable operating synergies we are beginning to realize. The initial equipment installation has been completed early in the quarter and we expect to incrementally add more capacity for this product category to meet anticipated demand. This cut-and-sew operation is not capital-intensive. For the current fiscal year, we'll spend about $600,000 in CapEx. And for next year, we look to spend about the same amount. Looking ahead, we're excited about the potential growth opportunities as we continue to enhance Culp's leadership position in the bedding industry. Now I'll comment on upholstery fabrics. We continue to be pleased with the performance of this business as well. The higher sales in the third quarter primarily reflect favorable response to our innovative designs and diverse product offering. Sales of our China-produced fabrics accounted for 90% of upholstery fabrics sales during the quarter. It is important to note that we have a significant manufacturing flexibility and the ability to offer a variety of product categories through our China platform, allowing us to meet the changing style and demands in a global marketplace. Our customers are increasingly recognizing the value in our creativity, innovation and relevance to current furniture styles. As a result, we have continued to enhance our competitive position and expand our global sales with key customers. Also encouraging to us is that we are seeing nice growth with customers that have recognized brand equity. In general, these customers value creativity as well as value doing business with a company they can trust to perform. We are also making steady progress with respect to Culp Europe. Even as we continue to face a weak European business climate, we continue to be optimistic about the long-term opportunities for Culp Europe, and we believe building a significant European presence is strategically important for Culp. Ken will now review the outlook for the fourth quarter and then I'll have a few concluding remarks. Kenneth R. Bowling: While we expect overall sales to be 4% to 9% lower compared with the fourth quarter of last year, which had strong industry demand, we expect overall sales for fiscal 2013 to exceed last year's annual sales by approximately 5%. We expect sales in our mattress fabrics business to be 4% to 9% lower than the same period a year ago due to softer industry demand for the fourth quarter of this fiscal year, as compared with stronger industry demand in last year's fourth quarter. Operating income and margin in this segment are expected to be flat to slightly lower than the same period a year ago. For the full fiscal year, we expect mattress fabrics sales to be approximately 5% higher than fiscal 2012 and operating income and margins are expected to be up approximately 20% compared with last fiscal year. In our upholstery fabrics business, we expect sales to be 3% to 8% lower than the previous year's fourth quarter results. Because Chinese New Year holiday falls entirely in the fourth quarter of fiscal 2013 versus occurring mostly in the third quarter of last year, our sales and production schedules will be affected. Additionally, industry demand was stronger in the fourth quarter of last year. We believe the upholstery fabrics segment's operating income and margin will be comparable to the same quarter of last year. For the full fiscal year, we expect upholstery fabrics sales to be approximately 6% higher than last fiscal year. Operating income and margins are expected to be approximately 80% higher as compared to last year's results. Considering these factors, we expect to report pre-tax income for the fourth quarter of this fiscal year in the range of $5.2 million to $5.8 million. Pre-tax income for last year's fourth quarter was $5.5 million. For fiscal 2013 as a whole, we expect pre-tax income in the range of $19.6 million to $20.2 million, as compared with $14.2 million last fiscal year. Frank? Franklin N. Saxon: Thanks, Ken. We are pleased with our results to date in this fiscal year and our consistent ability to execute our strategy in a dynamic global marketplace. Our creative designs and innovative products are resonating with customers and are allowing us to grow our business with both existing and new customers. Culp has a unique operating structure with a flexible and scalable global manufacturing platform supported by design expertise, product innovation and outstanding customer service. We believe this model is a distinct competitive advantage for us and will provide for further profitable growth as the economy improves and consumers gain more confidence. Above all, we are committed to outstanding performance for our customers as a financially stable and trusted source for innovative fabrics. With that, we'll now take your questions.

[Operator Instructions] And we'll take our first question from Chad Bolen with Raymond James.

Frank, I think you touched on this so I just wanted to kind of hit on it again, I guess. You talked about slowing demand later in the quarter, really, on both sides of the business. And obviously, your revenue guidance for fiscal 4Q is down year-over-year. I think that makes sense given what we've seen from the industry and how tough your prior year comparisons are. I guess just curious to see kind of what your thoughts are beyond Q4. I mean, is the Q4 issue sort of a temporary blip on the radar? Or is there something more going on that we should be worried about maybe from a consumer standpoint? Just how are you thinking about that? Franklin N. Saxon: Okay. We see the fourth quarter as temporary, Chad. And while we've all read about the various reasons, we think the 2 biggest reasons affecting the current industry demand are rising gas prices and the delayed tax refunds. Both of those are we believe will be temporary. The payroll tax cut, the Washington political dysfunction, we believe those aren't as big a factor as the gas prices and the delayed tax refunds. And we believe they'll be -- these will be temporary in nature. We also look for next year to be a lot like what we've been seeing, sluggish growth, nothing great, but still, positive as we get towards the end of the year, into this calendar year. And I think most of the economic forecasts are calling for better GDP growth in the second half of this calendar year. So that's how we would see it. And see these, this fourth quarter, sales impact as a 1-quarter phenomenon. I think also in the upholstery fabrics business, the furniture business is a little better demand than mattress currently. And the fourth quarter's being affected by Chinese New Year; all the impact of Chinese New Year is in our fourth quarter. Whereas last year, it was mostly in the third quarter. So that affects us and we will not have that obviously going forward in the next few quarters.

Okay, that's very helpful. And Frank, can you talk a little bit about how raw material costs are trending right now? Anything kind of worrisome on the horizon there? Franklin N. Saxon: Raw material costs are always our biggest risks and the thing that we watch very carefully. As of this month, we are not seeing raw material price increases. We are hearing a lot of talk about it around the world. But we've not told people we haven't placed a PO yet with a higher price. But we are concerned that, that could come about in the future. But so far, prices are not -- price increases that had been talked about are not sticking. So to date, and for our fourth quarter, we will not have any raw material impact from an increase standpoint.

Okay. And obviously, cash flow has been a big highlight for Culp this year. Just a couple of questions kind of thinking about modeling it going forward. I mean I think last year Q4 was seasonally your biggest quarter for operating cash flow. Is that sort of what we should expect in this fiscal fourth quarter coming up? And then just kind of maybe it sounds like for next year, in fiscal '14, Ken, thinking that CapEx and D&A sort of offset, which should suggest to me free cash flow anywhere in the $14 million to $15 million range is feasible for you guys. Is that a reasonable way to think about it next year? Franklin N. Saxon: Let me tackle the first -- the fourth quarter part of your question first. Historically, you're exactly right. The fourth quarter has been a large percentage of our annual cash flow. In fact, on our website, we've got a chart we've added on quarterly trends of our -- of various financial measures, one of which is cash flow from operations. And you will see that in the fourth quarter. Yes, we think fourth quarter will be another strong quarter of cash flow capping 9 months of terrific cash flow so far. I think that's really one of the real solid points when you look to Culp in the future. Our margins, our cash flow have continued to get stronger, become more stable, which have allowed us to do the actions we've done this year. As Ken mentioned, we've distributed in the last 2 years over $70 million returning funds to shareholders in the most efficient manner. And that is, we are -- when we are not sacrificing at all investing in our business, whether it's working capital, CapEx. But with that, it's certainly the priority. But as we look ahead, we do see those strong cash flow trends continuing. And as Ken mentioned, we see modest CapEx next year of the currently about what we're doing this year, $4.5 million to $5 million. And if growth is more modest next year, with the overall economic environment as we see, that would mean working capital growth is modest. And that's where we put -- a lot of our free cash flow is used for working capital or our growth cash flow is used for working capital investment and CapEx. So it looks pretty good from our end as well. I don't think I can comment on exactly the numbers, but they're not that hard to model when you look at our current year.

Okay. And Frank, you talked about returning cash to shareholders in the most efficient way and I guess over the course of this year, you've done buybacks, you've done a regular quarterly dividend, you've done a special dividend. Just kind of give us your updated thoughts on how you and the board are thinking about returning capital going forward? Franklin N. Saxon: Okay. First of all, we initiated a regular quarterly dividend, which was very important to Culp. We had to discontinue a dividend back in 2001, so we were very excited and glad to reestablish a quarterly dividend. And we've said on the call, over time, certainly, our intention is to grow the regular quarterly dividend on an annual basis based on our performance. We've also said if we can buy the company's stock back at discounts to conservatively calculated intrinsic value, in other words, a good buying opportunity, that is of interest to us. We've also indicated over time that we think a reasonable amount of cash cushion in our business is $20 million to $25 million of net cash, now -- as measured as of fiscal year end. Now we're a little short of that today with the $6 million special dividend we paid in Q3, but we believe we'll be there or close by fiscal year end. And as we have cash -- accumulate cash higher than that, cash cushion, if you will, we will consider doing stock repurchases and special dividends. And of course, we will talk about, as we've said, increasing the quarterly regular cash dividend.

Okay. And another one. I guess, probably my last question, Frank. How do you see acquisitions playing into the picture going forward? Do you think there could or may be attractive M&A opportunities? Franklin N. Saxon: Well, as we've said, we're always known to look out for acquisitions in our mattress fabrics business. We are not on the lookout for, I mean, upholstery fabrics. We believe that is an organic growth story, since there's not much capital investment there. And to date, it's a relatively small industry. There's not a lot of opportunity that we have seen. It doesn't mean things might not change in the future, but today, we haven't seen many opportunities. In any opportunities that we might have seen are above our price parameters in terms of we would be disciplined in whatever acquisition we might make in that area. So I'm not -- you never say never, but it certainly doesn't look like there's too many acquisition opportunities in the mattress fabrics area. I will point out that the 2 we've made in the last 6 years now were both high-, low-, high-return acquisitions that we did and were strategically very important to us. But we are definitely open to it if one would come to us that fits our strategy and is a reasonable price.

We will now go to Kevin Tracey with Oberon Asset Management.

I guess, first, I was curious to ask, you guys cite kind of the expectation for sluggish GDP growth going forward next year. And I guess I'm curious, it seems like the housing market recovery is accelerating. Can you kind of talk generally about how your mattress business is at all correlated to the housing market? Or GDP growth and I guess what kind of opportunity for growth a recovery might present? Franklin N. Saxon: Sure, Kevin. What we hear from our large customers, the economic indicator that most highly correlated to bedding sales is GDP growth, not housing. Housing has some impact, but not as much as you would think. In the furniture fabric side -- our upholstery fabrics side, however, it is driven by the housing market. Housing resales, housing starts, that's the key variable we look at for correlation to furniture demand. So when we look at bedding sales and GDP growth, that's our -- has been the best indicator of industry demand as you look ahead.

Okay, all right. And then I guess lastly, I guess related to Culp-Lava. You mentioned I think on your last call that you expect breakeven in the first quarter of 2014. I know you're not investing much, I guess the capital requirements aren't too large. But I guess I'm curious if you could talk about how big the market opportunity is there and who are the big competitors you might be competing against? And I guess what is kind of your intermediate or long-term goal and how much of that market you guys can get? Franklin N. Saxon: Okay, very good question. First, from a big picture standpoint, most mattress -- most mattresses in the specialty bedding category, and that could be foam, that could be latex, gel, most of those are using, if not all, are using a mattress cover, a cut-and-sewn mattress cover. And we hear estimates that on the retail floor now, the slots for specialty is 30% to sometimes 35-plus percent of the slots at retail for specialty bedding, and that's double from 5, 6 years ago. So the growth in specialty is necessitating the need for these cut-and-sewn mattress covers. So we're in a -- we certainly are in a sweet spot. Now we are -- I think our current view is that specialty growth is slowing down, is more moderating. But still, there's a lot of mattresses in the specialty category that need a mattress cover as far as the competition. The competition currently today, I would classify as fragmented. There's no dominant supplier at all and there's not top 6 competitors, something like that. Not a lot, but more fragmented in terms of who they supply, what they do, et cetera. So there is a real need for one company to come in and we believe that's -- it's going to be us, to lead in the cut-and-sew mattress cover area. We're the leader by far in terms of the mattress fabrics being supplied to the industry here in the U.S. and Canada. And our goal is to certainly do that in the mattress cover area as well. And we think the situation is there right for us. We have partnered with a very good company, the Lava folks, who've been one of the leaders in the business, and we're working together with them, and that's proven to be a very good decision so far. We have excellent demand there. And we're expanding as we can.

Okay. Okay. So is there any way you could maybe give a ballpark idea of what you think the total size of the market might be today? Franklin N. Saxon: I think other than -- it's a 30% to 35% of the retail floor space. So obviously, it's a large opportunity, a significant opportunity. I don't want to quantify exactly, but it is significant. We have a lot of runway to grow there. And the other thing we bring to the party though, which is different from some other competitors, we can now create, we can design a mattress cover. Up to now, we've just been designing fabrics. We can now design, with our expertise in mattress fabrics and upholstery, we can actually design the full cover for the mattress and we believe offer more choices and more value to our customers.

[Operator Instructions] And we will now go to John Baugh with Stifel, Nicolaus. John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division: I wanted to go into your comments on, I guess, it was bedding first. And that was that you felt that the gasoline price and the delayed refunds have had an impact. I guess that would imply that your promotional covers weaken more than your higher-end or specialty covers? Is that what you've seen in your business or no, that's not true, because I know the specialty comparison a year ago was extremely, extremely high? Franklin N. Saxon: We're seeing it -- John, we're seeing it in both categories, both promotional and better end. Without a doubt, yes. John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division: And do you have any possible explanation for why you think furniture has all of sudden been stronger in recent months than bedding? Is it... Franklin N. Saxon: Sure, sure, John, it's housing. Because it's housing, furniture, you know from all the things we've talked about over the years, furniture is related to housing statistics, housing resale, housing -- mostly housing resales, but all the housing numbers are certainly better. I think also maybe another factor is the better customers, the better people in the industry are doing better than the weaker ones. We're having a bifurcation going on and we're seeing -- you know the names, all seem to be doing better than certain other players. I think that -- and Culp sells most to those better players. So I think that's probably helping. I think that's helping the industry as well. I mean you heard La-Z-Boy's numbers or what their comments were last week. So I think housing. And that could continue to play a really strong role in the demand for upholstery fabrics. When you look at Culp, we've all been focused -- everybody's looked at the mattress fabrics results and we all like that. It's the majority of our profitability. But sort of the sleeper could be the upholstery fabrics business in terms of growth opportunity over the next few years. We look at the improvements that are being made this year in margin, in sales, and innovation. And we're very excited about mattress fabrics. But we're also increasingly excited about the progress we're making in upholstery. John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division: Good. And then just lastly on the gasoline issue. That doesn't look like it's going to go away near term. Although, it may be seasonal. We'll see. But on the tax refund issue, obviously, that was just a delay kind of deal. Are we sufficiently removed from that period of delay that you can look at your order rates in either upholstery or mattresses and sort of see it coming back to some degree from very difficult comparisons for the few weeks there where you're probably comparing -- where you had to refund out there and you didn't this year? Or no, it is nothing on your order pattern that you've really seen? Franklin N. Saxon: On mattress fabrics, we want to see it. I promise you. But we're not seeing it yet. Not seeing it yet. Hence, our guidance for the fourth quarter. That's our -- I certainly like to be seeing it. I think furniture has a chance to be a little better. When we look at that, we think we have a little better chance to be on the better end of our range there with what we see in that business and from our key customers. And what we see also, we're beginning to have some nice improvement in our European operation, which we're excited about. John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division: And lastly, are your competitors -- I mean your customers who I know aren't retailers, but are they complaining about weather this year versus last year? Franklin N. Saxon: John, I should've mentioned that. That's another important factor that we heard. Absolutely. The weather this year versus last year in the January through March time frame, absolutely. It's another important factor that's often overlooked.

[Operator Instructions] And it appears there are no further questions in queue at this time. Franklin N. Saxon: Thank you, operator. And again, thanks, everyone, for your participation and you're interest in Culp, and we look forward to updating you next quarter on our progress. Have a good day.

Ladies and gentlemen, this concludes today's conference. We thank you for your participation.