Dru Anderson – IR, CCI Frank Saxon - President and CEO Ken Bowling - CFO, VP, Treasurer and Corporate Secretary

Bobby Griffin - Raymond James John Baugh - Stifel James Fronda - Sidoti & Company

Good day and welcome to the Culp Incorporated Second Quarter 2015 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. Dru Anderson. 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 2015. 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 facts. 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 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 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.

Good morning, everyone, and thank you 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 is Ken Bowling, our Chief Financial Officer. I will begin the call with some brief comments, 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 third quarter outlook, and we will be happy to take your questions. Overall our second quarter results were in line with our expectations, and we're pleased with our consistent performance to date in fiscal 2015. Higher sales in both businesses reflect favorable customer response to our creative designs and wide range of innovative products. In addition, our scalable and flexible manufacturing platform supports our ability to compete in a fashion-driven business, which is always changing. Importantly, we have the financial strength to make the strategic investments to support our continued growth, as reflected in our increased capital expenditures for this year. We're also pleased that our financial performance and strong balance sheet have enabled us to reward our shareholders with a 20% increase in our quarterly cash dividend, which has doubled since we reinstated the dividend in June 2012. Notably, our free cash flow for the year-to-date period has been excellent even after higher-than-normal capital expenditures. We're off to a solid start through the first six months and I'm encouraged about our outlook for the rest of the year. I'll now turn the call over to Ken to review the financial results for the quarter.

Thank you, Frank. As mentioned earlier on the call, we have posted slide presentations to our Investor Relations website to cover key quarterly and annual performance measures as well as our capital allocation strategy. Total sales for this quarter were $74 million, up 5% from the second quarter of last year. On a pre-tax basis, we reported income of $4.9 million compared with $4.8 million last year. Adjusted net income, a non-GAAP measure, was $4.1 million or $0.33 per share, unchanged from the prior-year period. Overall annualized return on capital was 26%. The company's overall adjusted effective income tax rate through the second quarter was 16.1% compared with 15.6% for the same period last year. This adjusted effective income tax rate or ongoing estimated cash tax rate represents income tax expense for the Culp's non-US entities divided by consolidated income before taxes. This information is important, because the company currently does not pay cash taxes in the US, nor do we expect to for a number of years due to approximately $46 million in loss carryforwards as of the end of last fiscal year. Here are the results for our two businesses. For Mattress Fabrics, we reported $43 million in sales for the second quarter, up 7% as compared with the second quarter of last year. Increased demand for our knitted products continues to be the main driver for our sales increase in this business. Operating income for this segment was $4.7 million for the second quarter, unchanged from the same period last year. Operating income margin was 11% of sales compared with 11.7% a year ago. Operating margin has continued to show steady improvement as compared with the first quarter operating margin of 10.8% and 10.3% for the fourth quarter of last fiscal year. Further, our mattress cover business or CLASS continued to make steady improvement, especially as compared to the previous year. Annualized return on capital for the Mattress Fabrics business was 30%. Now let's look at Upholstery Fabrics. Sales for the second quarter were $31 million compared with $30.2 million in the second quarter of last year, representing a 2% increase, which was in line with expectations. The Upholstery Fabrics business reported operating income of $1.7 million, unchanged from the same period last year. Operating income margin was 5.4% of sales, slightly lower than the 5.8% for the second quarter of last year. Importantly, operating income was flat as compared to last year despite absorbing $200,000 impact from the decision to close down the Poland distribution center. Annualized return on capital for the Upholstery Fabrics segment was 43%. Now let me turn to the balance sheet. We have continued to maintain a strong financial position even as we made significant investments in our Mattress Fabrics business, returned cash to shareholders and reduced our debt during the first half of this fiscal year. We generated $9.2 million in free cash flow through the first six months of this fiscal year compared with $7.5 million for the same period last year. A key factor in our strong free cash flow this fiscal year has been the efficient use of working capital, especially inventory. Overall inventory turns were 6.4 compared to the 5.4 for the same time last year. Both business units have done a great job of managing working capital this fiscal year. Our operating working capital is down almost 10% as compared to the same time last year even with higher sales. With respect to our overall cash position, as of the end of the second quarter, we reported $35.3 million in cash and cash equivalents and short-term investments comparable to the $35.6 million total at the end of last fiscal year even after spending $14.7 million in total for dividends, capital expenditures, debt payments and share repurchases during the first six months of this fiscal year. Total debt at the end of the second quarter was $2.2 million, which represents the final installment on our term loan due next August. Our net cash position or cash minus total debt was $33.1 million at the end of the second quarter, representing the highest net cash level in the company's history. As Frank mentioned earlier, our Board of Directors approved a 20% increase in our quarterly cash dividend, taking the dividend to $0.06 per share from $0.05 per share commencing in the fiscal third quarter. With regard to our share repurchase program, during the first six months of this fiscal year, the company purchased 43,000 shares of Culp common stock for $745,000 at an average price of $17.30. We have $4.3 million available for share repurchases under our current authorization. Importantly since June 2011, the company has returned a total of $27 million to shareholders in the form of regular quarterly and special dividends and share repurchases. Frank?

Thank you, Ken. I will now provide you with an update on both of our businesses. Let's start with Mattress Fabrics. We are pleased with the performance for the second quarter, highlighted by solid sales growth over the prior year. These results reflect our ability to meet growing demands of our customers with an innovative and diverse product offering across all price points. Our strategic focus on design creativity has been the critical driver of our success. As the mattress industry has embraced a more fashionable and decorative look, we have further enhanced our design capabilities to keep our fabric designs current with the latest fashion trends and to meet changing customer style preferences. Along with our design excellence and innovation, we're well positioned to support our customers' demand with our myriad manufacturing platform, technical expertise and reactive capacity. We also have made steady progress in our operating performance since the end of fiscal 2014, as Ken mentioned. We are well underway with the previously announced $9.5 million expansion plan to increase our production capacity, add finishing capabilities and improve our overall efficiency and throughput. In spite of the ongoing expansion and disruptions in our operations and the related short-term production challenges, which there have been many during the quarter, we are pleased with our ability to meet the higher demand with outstanding delivery performance and speed to market. As we continue to expand our capacity, we expect to more fully benefit from these operational improvements in the second half of this year. These investments further demonstrate our commitment to our customers, and we look forward to the additional opportunities to grow our Mattress Fabrics business. Culp Lava, our mattress cover operation, had a much improved performance also in the second quarter, and we're pleased with the added contribution from our newest product category. Our management team has done an outstanding job in developing a stable mattress cover operation with the ability to deliver the same style and value that is synonymous with the Culp brand. With the addition of mattress covers, we have further enhanced our competitive position as a fully integrated and leading supplier of all product categories in Mattress Fabrics. Now I'll comment on Upholstery Fabrics. We are pleased with our financial and operating performance for Upholstery Fabrics for the second quarter, which was also in line with our expectations. These results reflect consistent execution of our strategy with steady growth in sales since the beginning of the year. Our sales for the second quarter include significantly higher sales of cut-and-sewn kits compared with a year ago. Our creative designs and focused efforts on product innovation continue to be the key drivers of our sales performance. We are optimistic about the positive response from our key customers, with strong placements at the recent October furniture market. We are also diversifying our customer base as a result of our marketing strategies to target additional end-user markets for Upholstery Fabrics, including the hospitality market and the lifestyle retail category. Our flexible global platform supports these marketing efforts and allows us to respond the changing market trend and consumer style preferences. Culp China-produced fabrics represent 92% of our Upholstery Fabrics sales. Importantly, our China operation allows us to produce a diverse mix of fabric styles and price points with outstanding service and quality. As previously announced, our sales from Culp Europe have not met our expectations, primarily as a result of the ongoing economic concerns in Europe. After considerable review, we've decided to phase out the finished goods warehouse and distribution facility located in Poznan, Poland. As a result, we incurred a modest charge of approximately $200,000 for closing costs during the second quarter. We expect minimal operating expenses going forward as this closure will be completed by the end of the third fiscal quarter. We intend to continue assessing the best strategy for selling our products into the European market as conditions improve. Finally, as most of you know, we have been and continue to be in a very fortunate position of generating significant free cash flow above the requirements to grow our business organically and maintain a strong net cash position. We expect this positive free cash flow trend to continue for the foreseeable future. Again, as many of you know, we have a clearly defined strategy for capital allocation, which is presented in a separate document on our website. I have covered this strategy previously on many of these calls. The key elements of our strategy is to return funds to shareholders that exceed our net cash threshold of $25 million as measured at fiscal year-end and assuming the following: that we have not already used the funds for opportunistic share repurchases of stock, our economic and business outlook remains favorable and there has not been an acquisition and we do not see a near-term opportunity to invest the funds in our business. Through the first six months, we are off to a solid start, as reflected in our $9.2 million of free cash flow and our net cash position of $33.1 million. Our strong financial position along with our free cash flow generation helps us sleep very well at night and have the dry powder to be opportunistic and to provide additional value to shareholders through dividends and share repurchases. We believe it also gives our customers confidence that Culp will be around for many years to come and can and will invest in capital expenditures and working capital as necessary to provide more value to them and support their growth. Additionally, having a strong financial position contributes significantly to our thinking about and running our businesses for the long term. Ken will now review the outlook for the third quarter and then I'll have a few concluding comments.

We expect overall sales to be 2% to 5% higher as compared with the third quarter of last year. We expect sales in our Mattress Fabrics segment to be 3% to 6% higher compared with the same period a year ago. Operating income and margins are expected to be substantially higher than the same period a year ago due primarily to the significant operational improvement in the Culp Lava mattress cover business as compared to last year. We also expect to realize some initial benefit from our capital investment program late in the third quarter. In our Upholstery Fabrics segment, we expect sales to be flat to slightly lower than the previous year's third quarter results with operating income and margin expected to be slightly lower than the same time last year. These projections compare to an exceptionally strong third quarter for Upholstery Fabrics' last fiscal year as demand was affected by customers anticipating longer lead times due to the Chinese New Year holiday occurring in late January. In 2015, the Chinese New Year holiday falls in mid-February, therefore potentially causing some demand to be pushed into our fourth fiscal quarter. Additionally, we are experiencing a higher operating cost associated with our Culp China operation. Considering these factors, the company expects to report pre-tax income for the third fiscal quarter in the range of $5 million to $5.8 million. Pre-tax income for last year's third quarter was $4.6 million. For the full fiscal year, we expect sales and pre-tax income to be higher than last fiscal year, with an improvement in profitability expected in the second half of this fiscal year as compared with the first half of the year. Capital expenditures for this fiscal year are expected to be approximately $10 million primarily related to the expansion projects for Mattress Fabrics. And depreciation and amortization together with stock-based compensation is expected to be approximately $7 million. Additionally, as mentioned earlier, the company expects a strong year of free cash flow even with a higher-than-normal level of capital expenditures. Looking ahead at next fiscal year, our preliminary estimate for capital expenditures is in the range of $5 million to $7 million. Now I'll turn it back over to Frank for some closing comments.

We are pleased with our results for fiscal 2015, which reflect consistent growth in sales compared with last year. We have many reasons to be optimistic about our future direction and our ability to meet our growth objectives. Our outstanding design capabilities and innovative product offerings are resonating with customers in both businesses. We have the ability to leverage our scalable and global manufacturing platforms to deliver these products and to meet changing customer style preferences. I am excited about our future and I believe Culp is well positioned for continued growth in this environment with the financial strength to execute our strategic initiatives and reward our shareholders. Above all, we are committed to outstanding performance for our customers as a financially strong and trusted source for innovative fabrics. With that, we'll now take your questions.

[Operator Instructions] We'll now take our first question from Budd Bugatch with Raymond James.

This is actually Bobby filling in for Budd. Good morning Frank and Ken, and congratulations on the strong quarter. I just have really two questions. One, you gave a little bit of detail about the moving parts around the upholstery guidance, but maybe you could give us kind of your sense of the industry and how it's currently trending. And also, could you provide a little color on the extra operational costs that you are experiencing in the China segment or the China business?

First, the current business environment in the furniture side, residential furniture seems pretty good. We're hearing reports from last weekend that they were very strong, actually stronger in furniture than bedding. Not sure we understand why, but that's a report we're hearing. So I think the sense of the industry on the furniture side seems pretty good going into our third quarter, and we certainly hope that will continue into the stronger selling season in February through April. The second part of your question is the higher cost we're seeing in China, and this is really nothing new. China raises the labor rates every year anywhere from 12% to 15%, and that's what we've been experiencing as are most people over there. Additionally, as China tightens regulatory matters, whether it's environmental, labor, safety, fire, a variety of things, we're having some additional costs in those areas, as are most people in China. So those costs are continuing. I think that's just the way it is for the foreseeable future. Also, we've been fortunate that the raw material prices over there and around the world are somewhat lower, which are helping to offset some of the highest overhead costs that are in China.

We'll now take our next question from John Baugh with Stifel.

Thank you. Good morning, and congratulations on a terrific quarter. I guess just to follow up on that raw material, [there is a pretty good lag] [ph] between changes in oil, nat gas on your costs. Are you already seeing some relief and would you anticipate potentially seeing significantly more? And if not, why?

John, you're exactly right. It's a good four to six months normal lag time between the changes in oil prices, particularly when oil prices are going down. When oil prices are going up, the changes we seem to get them sooner for some reason. But we are beginning to see some of that, not very much. Now we're optimistic we'll see some of that. But oil prices, as you know, have been trending down over the last six to eight months anyway. So we've gradually seen some lower raw material prices, but nothing of great significance. And it puzzles us, to your question, it's quite appropriate. Whenever oil prices go up, we're sure the polyester people get the price increases to us. But when they go down, it always seems to be not nearly equal to the decline or as fast. Now we push as hard as we can, as you would imagine, but I think we do expect some gradual decreases in the next four to six months as we look ahead. We're certainly hoping for that. On the Upholstery Fabrics side, I'm not sure we're going to see as much benefit, because the lower raw material prices will offset hopefully the overhead cost increases. We're hearing as China economy has slowed, as everyone knows, there is a lot of more turmoil in a lot of companies over there that weren't financially strong to begin with. Those are people we deal with, but we're certainly hearing about companies that are filing more bankruptcies and things like that. So I don't think we're going to see a lot of reduction on the raw materials side on the Upholstery Fabrics side.

And Frank, would your customers, obviously, they don’t live in a cave, they know your costs could be coming down, are they going to be clamoring for that and hitting you up, so that even if you saw raw materials coming in and you wouldn’t necessarily take it to the bank?

Already area, John. Our customers are on top of global trends, you can count on it. And we're already getting the questions and we just have to explain the situation. On the upholstery side, they're not decreasing. The overhead increases are real. Everybody knows about them. So in the Mattress Fabrics side, the yarn don't continue to come down as much as you would think, given the change in oil prices. But they are asking already, yes.

Inventory turns, 4 point improvement, I mean this in a serious form of flattery, but you've been so good at working capital management and judicious with capital in general that it's hard to believe you found a full turn in a year. And I guess the question is twofold. One, what happened, what did you do? And two, is this sustainable or may there be some timing included, is there things that fall back the other way? Or put another way, is there much more room from here?

John, another very good question. Working capital is not the most glamorous area of a business to manage, not certainly versus sales and design, et cetera, but it's a very, very important part of the business. We have always done it well. The first six months we’ve had our best performance in working capital management, basically AR and inventories that we've had to date. A third of that benefit though, I need to point out comes from the phasing down of the European operation. So we're not getting that 4 points is not continuing improvement. So I would say two-thirds is real improvement and one-third comes from the one-time phasing out of the European inventory. And we didn't make a big deal about it, but we really wanted to improve our inventory turnover this year. And we've got a number of initiatives behind the scenes to work on that. And whether it's in North Carolina or Canada or China, inventory is our biggest risk. You look at our balance sheet and by far the biggest asset risk we've got. So it's very important that we have long-term initiatives to gradually improve the inventory turnover. And I believe a lot of the things we've done this first half of the year are sustainable. I don't think I see another 0.5 point turn in the next six months. But our goal is just to gradually improve it. And if we can do that year-after-year, then we'll be quite happy. But again, why we're so happy, John, in the first six months of the year, the working capital as a source of cash and it's almost paid for our $5 million of capital expenditures. So it's a real benefit to manage the working capital well.

And, Frank, just closing, on upholstery, it sounds like success in the lifestyle arena and then we're going after hospitality, I don't know if you had success there yet or not, but I'll try to put that in the context of either flattish kind of 2% this last quarter, I think guidance to flat, and I know you had a big bang up quarter a year ago. But I guess the indirect question, is the residential furniture business that you're serving actually down and you're offsetting that with market share gains in other distribution channels or any color on some of the core upholstery business, if you will?

Our sales are being affected. And while they might not be up more than you think, it's certainly the European down from last year. And we are down with some customers in the promotional segment of the business. As you know from earlier conversations on these calls, we have the strategy to really go after this lifestyle category, which is really better stationary fabrics. And we are succeeding with the folks you would know of. And while we're still interested in the promotional category, we don't have to fill that maybe as much as we used to. And we would be quite happy to have the mix of customers improve over time.

And I presume that's because you don't have a fixed asset base that you've got to run. So you can be somewhat choosy about who you want to do business with.

That is correct. If our price doesn't meet their requirements, that's okay. We weren't always in that position, but there is a real move in the residential industry not just the lifestyle retailers themselves, but other people that want to have products that are in that vein, as you know.

We'll now take our next question from James Fronda with Sidoti & Company.

Just on the promotional activity, are you seeing any of that? And I guess do you think that might happen over the next year-and-a-half between either the mattress side or the upholstery side?

Not anymore than we would normally say. And maybe I don't know if you've heard when I mentioned promotional, that really refers to the lower end of the furniture producers, necessarily promotion as you generally think about it.

And it appears there are no further questions at this time. I'd like to turn the conference back to today's speakers for any additional or closing remarks.

Thank you, operator, and thank all of you for your participation and your interest in Culp. We'll look forward to updating you on our progress next quarter. Have a great day.

And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.