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

Budd Bugatch - Raymond James & Associates, Inc., Research Division James Fronda - Sidoti & Company, LLC

Good day, and welcome to the Culp, Inc. Second Quarter Fiscal 2014 Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Ms. Drew Anderson [ph]. Please go ahead.

Thank you. Good morning, and welcome to the Culp conference call to review the company's results for the second quarter of fiscal 2014. 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 and the forward-looking statements made in this call. The information being provided today is as 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 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 measurement 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 summary 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 thank you for joining us today. I'd like to also welcome you to our quarterly conference call with analysts and investors. With me on the call today is Ken Bowling, our Chief Financial Officer. I'll begin the call with some brief comments about Culp today, and then Ken will then review the financial results for the quarter. I will then update you on strategic actions in each of our businesses. Then after that, Ken will review our third quarter business outlook, and then we'll be happy to answer any questions. Now looking at the second quarter. We are pleased with this quarter's performance, marking another excellent quarter with solid sales and profit gains over a strong second quarter of last year, with sales increased 13% and pretax income increased 58%. Our pretax income for the quarter is the highest level in 10 years for a second quarter period. We continue to experience favorable customer response to our designs and wide range of products, and we're excited about the progress we are making in product innovation and creativity. These efforts, which are our top strategic priority, are making significant contributions to our sales and profit performance, with an increasing percentage of our sales coming from recent product introductions. We compete in a product- and fashion-driven business that is always changing. It is imperative that we stay out in front of the trends and lead with product. As a result, our ability to create innovative fabrics, season after season, is the key driver to our long-term success. We're also pleased that our consistent financial performance, higher cash flow and sound balance sheet have enabled us to reward our shareholders with a 25% increase in our quarterly cash dividend. Looking ahead, we continue to expect another strong year of free cash flow for this year. I'll now turn the call over to Ken, who will review the financial results for the quarter. Kenneth R. Bowling: Thank you, Frank. As mentioned earlier on the call, we have posted slide presentations to our Investor Relations website that cover key quarterly and annual performance measures, as well as our capital allocation strategy. Total sales for this quarter were $70.6 million, up 8% from the second quarter of last year, reflecting the highest sales level for the second quarter in 9 years. On a pretax basis, we reported income of $4.8 million compared with $4.5 million for the same period last year, an increase of 6%. Pretax margin was 6.8% compared with 6.9% a year ago. Adjusted net income, which is a non-GAAP measure, was $4.1 million or $0.33 per share compared with $3.9 million or $0.31 per share for the prior year period. The company's overall adjusted effective income tax rate for the second quarter was 15.6% compared with 15% for the same period last year. This adjusted effective income tax rate or ongoing estimated cash tax rate represents 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 do we expect to for a number of years due to approximately $51 million of loss carryforwards as of last fiscal year-end. Here are the results for our 2 businesses. For mattress fabrics, we reported $40.3 million in sales for the second quarter, up 2% as compared with the second quarter of last year. Operating income in this segment was $4.7 million for the second quarter compared with $5.1 million last year. Operating income margin was 11.7% of sales compared with 12.9% a year ago. Margins were impacted by higher sampling and the development costs in advance of new customer rollouts for calendar 2014, as well as continued transition costs for our Culp-Lava operation. We believe the majority of these transition costs are now behind us. Return on capital for the mattress fabrics segment was 33% for the second quarter compared with 37% a year ago. Now on to upholstery fabrics. Sales for the second quarter were $30.3 million compared with $25.9 million in the second quarter of last year, an increase of 17%. The upholstery fabrics business reported operating income of $1.7 million or 5.8% of sales compared with operating income of $1.2 million or 4.6% of sales for the second quarter of last year. Stable SG&A costs as compared to the previous year based on much higher sales this year helped to more than offset the gross profit margin pressure stemming primarily from weakness in our U.S. operations. Although still profitable for the quarter, this operation did not equal the very strong performance experienced the same time last year. Return on capital for the upholstery fabrics segment was 43% compared with 40% for the same period a year ago. 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, as we have stated a number of times before, we tie our incentive compensation for divisional and executive management to returns on capital above certain thresholds based on economic value added or EVA principles. Now turning to the balance sheet. Maintaining a strong financial position and generating free cash flow will continue to be top priorities for Culp's this fiscal year. We achieved free cash flow of $7.5 million for the first half of this fiscal year compared to $5.7 million for the same period a year ago, representing a 31% increase. As of the end of the second quarter, we reported $30.5 million in cash and cash equivalents and short-term investments, even after spending $4 million for debt and interest payments, dividends and capital expenditures during the quarter. Our net cash position or total cash minus total debt was $25.5 million at the end of the second quarter, representing the highest net cash level in the company's history. We paid a quarterly cash dividend of $0.04 per share in October, and as previously noted, we have announced a 25% increase in the quarterly cash dividend to $0.05 per share beginning in the third quarter of this fiscal year. Total debt at the end of the second quarter was $5 million, down from $7.7 million a year ago. We have 2 remaining annual $2.2 million payments due August 2014 and August 2015. Looking ahead at the rest of fiscal 2014, we expect capital spending to be approximately $5 million and depreciation and amortization expected to be $5.7 million. Frank? Franklin N. Saxon: Thanks, Ken. I will now provide you an update on both of our businesses, and let's start with mattress fabrics. Our results for the second quarter of fiscal 2014 were in line with our expectations. We were pleased with the consistent sales performance during what has been an unsteady demand period in the mattress industry. Our mattress fabrics business has delivered solid results in spite of some intermittent industry headwinds. Our operating results for the second quarter were affected by higher sampling and development costs in advance of our new customer rollouts for calendar 2014, as well as the continued transition costs for Culp-Lava operation. We continue to capitalize on the growing consumer demand for better-designed bedding products. As the mattress industry has evolved into a much more decorative business, our customers are more selective in their fabric choices to achieve today's fashionable look. In response to this demand trend, we have increased our design staff, as well as expanded our design capability and technical expertise in order to develop an array of innovative fabric choices across all price points. Additionally, we have a scalable manufacturing platform and reactive capacity that supports our ability to deliver a diverse and favorable product mix in line with customer demand. As a result, we've enhanced our competitive position as a leading supplier of mattress fabrics and covers to all major players across all categories in the mattress industry. We are very encouraged by the response to our exciting new designs and recent product introductions, with strong placements for business in early calendar 2014. We've also continued to make excellent progress with Culp-Lava, our new mattress cover operation, and we are pleased with the increased sales contribution during the quarter. We are continuing to focus on improving our operating efficiencies through this transitional period for Culp-Lava. With most of the training and development work behind us now, we are beginning to realize improved productivity that are lowering unit costs, gradually adding capacity and enhancing the reaction time to orders. We're excited about the opportunities ahead to leverage this new platform and enhance our leadership position in the industry. Now a few comments on upholstery fabrics. We had a solid performance in our upholstery fabrics business during the quarter, with higher-than-expected sales. The sales increase was product-driven as we continue to see very favorable customer response to our creative designs and new introductions. Innovation is a critical factor for success in the fashion-driven home furnishings business, and our design team has done an excellent job in anticipating customer style preferences. Our ability to offer diverse product mix of fabric styles and price points, supported by outstanding service, has enhanced our competitive position. As a result, we have increased sales both with our key customers and through additional orders from new customers. China-produced fabrics continue to drive our growth and accounted for 91% of our upholstery fabrics sales during the quarter. Our ability to leverage the design capabilities with our scalable and 100% owned China platform has been and continues to be an important advantage for Culp. We're also pleased with the steady progress made through our Culp Europe operation, which further supports our global sales efforts. We are pleased with the trends in the upholstery fabrics business, with strong placements with customers at the recent October furniture market, as well as having our highest backlog in almost 2 years. Looking ahead, we are well positioned to build on this momentum, especially as the housing market strengthens and consumer confidence improves. Finally, I wanted to talk briefly about our capital allocation strategy. In previous calls and in our annual shareholder's letter, as well as on the homepage of our Investor Relations website, we discussed this capital allocation strategy and our priority in depth. So I want to refer everyone to those documents for a more detailed discussion. However, in summary, we have been and continue to be in the very fortunate position of generating significant free cash flow above the requirements to grow our business organically and maintain a strong net cash position. Therefore, we are well positioned to provide shareholders with the added value that comes from regular and special dividends, as well as opportunistic share repurchases. Ken will now review the outlook for the third quarter, and then I'll have a few concluding remarks. Kenneth R. Bowling: We expect overall sales to be 5% to 9% higher as compared with the third quarter of last year. We expect sales in our mattress fabrics segment to be 3% to 7% higher compared with the same period a year ago. Operating income in this segment is expected to be higher than the same period a year ago while operating margins are expected to be comparable to last year. In our upholstery fabrics segment, we expect sales to be 6% to 10% higher than the previous year's third quarter results. We believe the upholstery fabrics segment's operating income will be higher than the same quarter of last year while operating margins are expected to be comparable to last year. Considering these factors, we expect to report pretax income for the third fiscal quarter of 2014 in the range of $4.5 million to $5 million. Pretax income of last year's third quarter was $4.5 million. Frank? Franklin N. Saxon: We are pleased with an excellent start of fiscal 2014, which reflects gains in sales and profitability over a strong first half of last fiscal year. We have many reasons to be optimistic about the future, with our outstanding design capabilities and innovative product offerings that are resonating with customers in both businesses. We will continue to leverage our scalable and global manufacturing platforms to deliver these products and keep pace with expected industry demands. We are also optimistic about an improved outlook for the economy, especially as the housing market gains more traction and supports higher consumer demand for home furnishings. We believe Culp is favorably positioned for continued growth in this environment, with the financial strength to execute our strategic initiatives and reward shareholders. Above all, we are committed to outstanding performance for our customers as a financially stable and trusted source for innovative fabrics. With that, we will now take your questions.

[Operator Instructions] And we'll take our first question from Budd Bugatch with Raymond James. Budd Bugatch - Raymond James & Associates, Inc., Research Division: I guess a first question is a little bit strategic and talks about Europe. And can you kind of give us a feel of how that's progressing for upholstery? Franklin N. Saxon: Sure. Europe, as we've said the last couple of quarters, continues to progress gradually. We'll have a nice sales gain for the year in Culp Europe, and we'll make some good headway on the operating profit side. Although we're still not profitable yet, but certainly much closer to breakeven than we were last year. We're making continued progress, and we still believe Europe is a place for us to be. It's the second-largest market of furniture in the world, and it just is taking time to learn the market, learn the customers, the products needed, desired. And so we're still very optimistic about Europe. But it's not -- it's moving at a gradual pace. And we don't have a lot of capital there. We've got 5 employees there, and we're there for the long haul. We do hear recently, over the last several months, how good business is in Europe. The furniture manufacturers are all running -- seem to be running pretty good from our intelligence. Budd Bugatch - Raymond James & Associates, Inc., Research Division: And what do you think is the opportunity there? What -- can you quantify any of that? Franklin N. Saxon: I don't think -- Budd, it's a huge opportunity. It's the second-biggest market behind North America, and it's just -- that's why we have to stay the course. Things sometimes just take longer, and we got to have patience. We have $2 million -- $2 million to $2.5 million of capital there, just a few employees. We're learning every quarter. And so -- but it's a big opportunity, big, big opportunity, it's -- in our opinion. Budd Bugatch - Raymond James & Associates, Inc., Research Division: Okay. And the next area of questioning is kind of on Anderson. And can you talk about the outlook there and what do you think -- how that looks over the next year to 18 months? Franklin N. Saxon: Okay. Anderson is our -- for the rest of the folks on the call, is our U.S. operation. By way of background, we kept -- we closed 15 to 16 plants last decade, but we kept one. It's in Anderson, South Carolina, and it makes woven velvet and textures. Small plant, less than 50 employees, but we make woven velvet, which nobody in the world makes except us. So it's a category that we'd really like to hang on to. Last fiscal year, they had their best year in probably 8 years. This year, the demand is off somewhat, the first half of this year, and so we're not making the money we made last year. But remember, the U.S. operation is 9% of our total sales in upholstery, so it's a small operation, but we think, strategically important for the long term. What we really focused on over the last, really, 6 months is bringing our strategy of innovative products to Anderson. We focused on the innovation mostly out of China first, and we really hadn't turned our attention necessarily to the Anderson product category, which we have now done. So we are encouraged with some new introductions that we're seeing down there and out of our -- out of that location for the next 6 months to a year. And there also appears to be some uptick in demand for those products as well. So I think we've weathered a little downturn the first 6 months of this year, but we see it turning up over the next 6 months and in the next fiscal year. Anderson, we were patient for many years. Many folks said, "You need to close it. You don't need it. You weren't making any money," but we stayed with it. We were patient, we trimmed the costs, and we've got a very low overhead operation there. We've got a great group of people. And all we need is some few good innovative products that take hold, and we're going to be exceptionally pleased with their performance out of our Anderson location. Budd Bugatch - Raymond James & Associates, Inc., Research Division: Okay, all right. Last question for me is kind of just a housekeeping question. We adjust earnings and you adjust earnings from a more normalized tax rate. I think it was 10.4%, is that 15%? Franklin N. Saxon: No, 15.6%, 15.6% is the adjusted tax rate. Budd Bugatch - Raymond James & Associates, Inc., Research Division: Okay. And that should be consistent for the next several quarters? Franklin N. Saxon: Yes, yes, yes. That's -- yes, I would say so, yes. And of course that relates to our -- we do that, again, because of the large NOLs that we have that are -- of $51 million, so we're not paying taxes in the U.S. for a number of years to come. Budd Bugatch - Raymond James & Associates, Inc., Research Division: But the accounting makes you book that as if you were, right? Is that... Franklin N. Saxon: That is correct. Kenneth R. Bowling: That is correct, yes. You notice the GAAP rate is always higher, especially this year. So we adjust all that out to give us... Franklin N. Saxon: GAAP rate is 35%, something like that. So we're -- it's 20 percentage points of taxes that there's no cash expenditures for, for a number of years. Kenneth R. Bowling: Right. Budd Bugatch - Raymond James & Associates, Inc., Research Division: And the offset to that is deferred taxes? Franklin N. Saxon: Deferred tax asset, that's correct.

At this time, we do have one question remaining in the queue. [Operator Instructions] And we'll take our next question from James Fronda with Sidoti. James Fronda - Sidoti & Company, LLC: Did you break out the sales for Culp-Lava during the quarter? Franklin N. Saxon: We do not, we do not break that out. James Fronda - Sidoti & Company, LLC: Okay. And I guess can you talk about, I guess, current capacity that you have currently within your facilities? Franklin N. Saxon: We are in -- if you look at the mattress fabrics side first, we have ample capacity in our woven products area. I would say we've got really pretty much 30% capacity there. We also have a supplier in Turkey that we're close to that also provides additional capacity for us. So really no limitation. And on the knitted fabrics side, a little less, probably, current capacity, 20%, 25%, more volume. It's easy to buy the machines. Machine delivery is 3 months. So we really don't worry much about capacity.

[Operator Instructions] And it appears we have no further questions at this time. Franklin N. Saxon: Great, okay. Thank you, everyone, for joining us, and we look forward to updating you on our next quarter call. Have a good day and a good Thanksgiving.

Again, this does conclude today's Culp, Inc. Second Quarter Fiscal 2014 Conference Call. We thank you again for your participation.