Dru Anderson - Investor Relations Frank Saxon - President and CEO Ken Bowling - Chief Financial Officer

Budd Bugatch - Raymond James John Baugh - Stifel

Please standby, your program is about to begin. Good day. And welcome to the Culp Incorporated First Quarter 2016 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.

Good morning. And welcome to the Culp conference call to review the company's results for the first quarter of fiscal 2016. 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 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 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 of Culp. Please go ahead, sir.

Good morning, 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 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 with you. I will then update you on the strategic actions and initiatives in each of our businesses. After that Ken will review the second quarter business outlook, and then we will be happy to take your questions. We are pleased to report a solid start to fiscal 2016 with our first quarter sales and operating results better than expected, driven by strong performances in both of our businesses. We are also pleased that pretax income for the quarter was the highest quarterly results in the company's history for any quarter. Overall, our total sales were up 5.4% compared with a year ago, which was a 14-week quarter. These results reflect favorable industry demand trends and positive customer response to our creative design and diverse product offering. Our strategic focus on innovation and product excellence continues to be the key driver of our performance in both businesses, and we intend to follow that same strategy in the current year. Everything begins with creative products in our business. Importantly, we have a scalable and global manufacturing platform that supports our ability to deliver these products and meet changing customer demand with exceptional service. We also have the financial strength to continue making strategic investments to support our growth. Finally, we are especially pleased that Culp is now debt free for the first time in our 43-year history. I'll now turn the call over to Ken who will review the financial results for the quarter.

Thanks, 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. We've also posted our capital allocation strategy. Total sales for this quarter were $80.2 million, up 5% from the first quarter of last year. The first quarter of this fiscal year had 13 weeks, compared with 14 weeks for the prior year period. On a pretax basis for the quarter, we reported $7.4 million or 9% of sales, compared with $5.5 million or 7% of sales, reflecting a 36% year-over-year increase. Adjusted net income for the quarter, a non-GAAP measure, was $6.2 million or $0.50 per share, up 37% from the prior year period. Overall, annualized return on capital was 34%, compared with 26% for last fiscal year. The company’s overall adjusted effective income tax rate for the first quarter this fiscal year was 15.7% compared with 16.7% 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 few more years due to approximately $32 million in loss carry-forwards as of the end of last fiscal year. Importantly, our NOL balance has been reduced by around $28 million over the last three fiscal years at an average of just over $9 million per year. Here the results for our two businesses, for mattress fabrics we reported $47.8 [ph] million in sales for the first quarter, up 11.6% as compared with the first quarter of last year. We experienced sales gains in all three of our key product categories, including our mattress cover business. Operating income for this segment was $7 million for the first quarter, up 51% from the same period last year. Operating income margin was 14.6% of sales compared with 10.8% a year ago. Contributing to this margin improvement has been the growth in sales, along with the benefits coming from the capital investment program we implemented last fiscal year. We also experienced continued reductions in input cost. Additionally, our mattress cover business continues to perform well and did experience year-over-year improvement. Annualized return on capital for the mattress fabric business is 39%, compared to 29% for last fiscal year. Although, capital employed for the mattress fabrics business did increase from the previous year due in large part to sales growth, operating income grew at a much faster pace thus contributing to the improvement in the return on capital. Now, let's look at upholstery fabrics, sales for the first quarter were $32.4 million compared with $33.2 million in the first quarter of last year, a 2.6% decline. The upholstery fabrics business reported operating income of $2.7 million, a 30% improvement over the first quarter of last fiscal year. Operating income margin was 8.3% of sales compared with 6.2% for the first quarter of last year. A key factor in this improvement has been the higher margins achieved on new product introductions. We continued to stress the importance of innovation in this business, and the improved margins reflect the success of that strategy. Additionally, our results for the first quarter reflect a more stable cost environment in China with lower input cost, materials and currency offsetting the continued increases in labor and other operating costs. Return on capital was 65% compared with 45% last fiscal year. Return on capital in this business continues to be impressive with significant growth in operating income while capital employed decreased slightly compared to the previous year. Now let me turn to the balance sheet, maintaining a strong financial position, generating free cash flow, and investing in strategic initiatives are the top priorities for this fiscal year. As of the end of first quarter, we reported $32.3 million in cash and cash equivalents in short-term investments compared with $31 million a year ago. Consistent with our capital allocation strategy, which is posted on our website, the company paid a $0.40 per share special dividend during the first quarter along with the regular $0.06 per share quarterly cash dividend totaling $5.7 million. Importantly, since June 2011, the company has returned approximately $35 million to shareholders in the form of regular quarterly and special dividends and share repurchases. Our cash position for the quarter broken down by country was as follows: cash located in the U.S. was approximately $3 million while cash located outside the U.S. totaled $29 million, of which $12 million was located in China. With respect to currency exposure in China, it is important to note that from February through July, we substantially reduced the amount of RMB cash held. And therefore we’re not materially impacted by the 3% devaluation in the RMB that occurred in August. Total debt was $2.2 million at the end of the first quarter, which represented the final installment on our term loan. Subsequent to the end of the quarter, we made this scheduled debt payment with no other debt remaining on the company's balance sheet at this time. Frank?

Thanks Ken. I'll now provide you an update on both of our operating segments, and let's start with mattress fabrics. Our mattress fabrics business continued to gain momentum in the first quarter of this fiscal year with better than expected results. Our sales for the quarter reflect favorable demand trends through the busy summer selling season. Importantly, we continue to outpace overall industry growth as our outstanding design and innovative product offering provide a strong competitive advantage in today's marketplace. From design to final delivery, we are doing an exceptional job in executing our vision to offer a full complement of fabrics and sewn covers across almost all price points and style trends, backed by excellent service. Our products are resonating with customers who are embracing today’s more fashionable and decorative looks. And we are well positioned to capitalize on these demand trends and expand our sales. Culp has a strong value proposition that combines outstanding design capabilities with an expanded manufacturing platform focused on mirrored manufacturing and reactive capability. Our improved operating results reflect solid execution of the strategic plan that we laid out at the beginning of last fiscal year, with consistent growth and progress since we began our $9.5 million capital project. We are realizing the benefits of this expanded capacity and new equipment with greater operating efficiencies, enhanced finishing capabilities and better overall throughput. We have completed the major work at our two North Carolina facilities, and we are now focused on expanding our operations and installing additional new equipment in our Canadian location during the early part of this fiscal year. Through our continued capital investments, we remain dedicated to outstanding product delivery performance and strive to offer the best possible service to our customers. Overall, the fundamentals of our mattress fabrics business are strong. And we have created a strategic infrastructure that will support our continued growth and innovation. We are also pleased with the increasing contribution from our latest venture into sewn mattress covers, which further supports our diversification strategy and enhances our value proposition. We remain confident in our ability to execute our strategy with continued success in the year ahead. Now, I'll comment on upholstery fabrics. Our upholstery fabrics sales were in line with our expectations for the first quarter, while our operating results improved significantly. Overall, we are pleased with our consistent execution of a product-driven strategy with a focus on creative designs and product innovation with asset-light manufacturing model. We also have pursued marketing strategies to diversify our customer base and expand our geographic reach. Together, these efforts have been the key drivers of our sales and operating performance, both with existing customers and new customers. We’ve continued to enhance our product mix with favorable results and we are especially pleased with our recent success in reaching additional end-user markets, including increased sales to the hospitality, lifestyle retail markets and international markets. Our global platform supports these marketing efforts, with the flexibility to adapt to changing furniture market trends and consumer style preferences. Culp China produced fabrics accounted for 93% of our upholstery fabrics sales during the quarter. This unique platform has allowed us to more effectively reach new customers with the ability to operate a diverse product mix of fabric styles and price points with outstanding service and quality. We are proud in this business of our growing reputation as an innovative and trusted industry leader and our ability to meet the demands of our customers. Looking ahead, we believe these strategies will continue to drive profitable growth, especially as the overall economy and the U.S. housing market continue to strengthen. Ken will now review the outlook for the second quarter and I'll have a few concluding remarks.

We expect overall sales to be 3% to 6% higher as compared with the second quarter of last year. We expect sales in our mattress fabrics segment to be 4% to 8% higher, compared with a strong second quarter and last fiscal year. Operating income and margin in this segment are expected to be moderately higher than the same period a year ago. In our upholstery fabrics segment, we expect sales to be flat to slightly higher than the second quarter of last fiscal year. We believe the upholstery fabrics segment’s operating income and margin will be moderately higher than the same period last year. Considering these factors, we expect to report pre-tax income for the second fiscal quarter in the range of $5.5 million to $6 million. Pre-tax income for last year second quarter was $4.9 million. With respect to the full year, capital expenditures for this fiscal year expect to be approximately $8 million to $9 million, mostly related to expansion and efficiency improvement projects for the mattress fabrics business. Additionally, the company expects a good year of free cash flow, even with the anticipated high level of capital expenditures and modest growth in working capital. Finally, although there is always uncertainty with longer term forecasts, we currently expect sales and operating performance for the second half of this fiscal year to be comparable or slightly better than the strong results achieved during the second half of last fiscal year. Now back to Frank.

We are pleased with a solid start to this year. Going forward, we are well positioned to capitalize on our core strengths, our outstanding design capabilities, innovative product offerings, and a scalable and global manufacturing platform that enables us to provide exceptional service to our worldwide customers. Executing on these core strengths for our customers is only possible because of the outstanding team of dedicated and highly motivated associates at all locations around the world. I am constantly amazed and inspired by their talent and their ability to exceed expectations. At the same time, we have a strong balance sheet and the financial flexibility to continue to drive innovation and enhance our operations and pursue strategic initiatives. We are very excited about the opportunities before us, as we look ahead to the rest of this year and beyond. With that, we'll now take your questions.

Thank you. [Operator Instructions] We will take our first question from Budd Bugatch with Raymond James. Your line is now open.

Good morning, Frank. Good morning, Ken. Congratulations to you and your team for a solid start to this fiscal year.

Thank you.

Thanks.

I guess the question I have is the one to try to connect all of the dots of what's happening in China. I know you have reduced the cash exposure, but maybe if you could connect, help us connect the dots and see how that -- the slowdown in China and the changes and maybe the change in policies of the government and the change in valuation on the currency affect you inside and outside of the country?

Okay. First of all, the large majority of our sales, 90 plus percent are denominated in U.S. dollars. We principally sell to U.S. and North American based customers. We source 93% approximately of our upholstery fabrics from China, therefore the lower the currency, the lower our cost structure. In general, it is a positive for us to have a lower Chinese currency. Over the past, really five years, we've had to deal with a strengthening Chinese currency which raised our costs. So, lower Chinese currency valuations are good for us. We do have to be cautious, however, within China to the weakening economic situation and the viability of certain suppliers. We’ve always followed a strategy of partnering with our mills, as many of you may now, and we believe the value of a long-term relationship with financially viable suppliers have been the right approach and continues to bear fruit today. Nevertheless with the weakness in China, we are very mindful of the financial viability of any supplier we do business with.

Okay.

Does that connect some of the dots for you?

It does. And do you have any of your partners now that you’re particularly worried about, or are you feeling that your partners are in good enough shape, and do we have a window into that?

We’ve just gone through that with you and we feel very good about them. There are some we are glad we didn’t pursue. We are the strongest of the competitors in China with our financial position. So, all the suppliers want to do business with us because of our financial strength and our volume. So, our strategy of sticking with a few solid family companies has been -- has proven to be a wise strategy over the years. And I think particularly so now as China is going through this economic restructuring, and I think we all don’t know where bottom is for that. It’s highly uncertain though whether they are going to have a soft, hard landing or whatever. But we are well prepared and I believe we will be a beneficiary of a weaker Chinese currency.

Okay. Thank you on that. The next area of inquiry is what you are seeing with raw material costs or your cost of acquisition. You’ve talked about some benefit and your customers certainly are aware of that. Give us an outlook of what you think will unfold not just next quarter, but over the next 12 to 24 months in terms of prices, if your crystal ball has got any degree of clarity to that?

Our sense today of raw material pricing, and this affects us mostly in the mattress fabric business is that we’ve seen such, some meaningful reductions over the last year with the lower oil price and the weakness in demand on international fiber plants. However, it is seeming to us that we are near bottom in these things. And oil prices have gone from $100 to $40 plus. There is -- even if they go a little lower, there is not a lot of absolute change and we are closer to the bottom of that. And we do not expect to see continued downward movement in raw material prices in the balance -- it’s certainly latter part of this year and into next year. We are preparing that they could be flat to up.

Okay. So just as a follow-up on that, how does that impact your pricing to your customers?

Well, we’ve obviously benefited the last several quarters from a lowering raw material input cost, and we’ve certainly -- as you see in our guidance for Q2, we are -- that’s obviously built into the guidance for Q2. Where Q3 gets a little more questionable because we’re only starting to place orders for Q3 now and of course Q4 and into next year. But I think from a big picture standpoint, we’ve enjoyed low commodity prices here for a long period of time and in our long experience in this business, it just doesn’t continue. And we know we are getting pressure from customers, who see the same thing that we’re seeing, and that’s something we will deal with. But it is not our expectation that we’re going to see continued reductions in raw material prices.

Okay. And my final area of inquiry is capital expenditures. Ken told us what to expect. For this year, what are the capital needs as your business grows, there is certainly got to be some additional capital needed as you look into the out-years. What facilities are you running into issues with? Where are the stresses in your business?

As I said in my comments, we’ve made really good progress on the manufacturing platform. And we’ve got another -- we’ve got a year to two years there with the increasing demand and increasing volume in knits and other products which are larger roll sizes. Probably, our next area is our logistical and warehouse area that sometime next year we will have to address. But when you look at overall CapEx for the company, I don’t think we are going to be at the level that we’re last year and we are this year $8 million to $9 million. We will more in the $6 million to $8 million range even with those needs.

And going beyond next year, what’s a good level if we project out a couple of years?

I think 6 to 8 is probably given the size of mattress fabrics and the growth in our Canadian operation, 6 to 8.

That sounds fair.

Okay. Thank you very much. Congratulations again.

Thank you, Budd.

[Operator Instructions] We will take our next question from John Baugh with Stifel. Your line is now open.

Thank you. And my congratulations to the entire Culp team, another great quarter. Could you just address -- was there anything in Q1 in mattress? With those numbers being that strong, was there anything in terms of a pipeline fill, program build, anything that you would call out that maybe was unusual in terms of a year-over-year growth rate that was also strong?

John, I think the three factors that benefited mattress fabrics or the three factors we expected, they just benefited us each more than expected. We grew sales higher than we thought. Raw materials helped us more than we thought. And maybe thirdly, and importantly, the benefits of our capital projects last year. We started the beginning of fiscal ‘15 and laid out, and we told everybody about it, margins were under pressure. We have strategic plan of $9.5 million of variety of capital projects in each of our facility. All of those projects in combination are delivering excellent results. And I would certainly point out among those our Canadian facility. We have mentioned in the quarter before we part of that $9.5 million was an expansion into the knitted fabric product category in Canada. As we can made -- they’ve just done a super job and that really helped the quarter as well. And I would not -- there is nothing that I would call out really other than each of those areas benefited more than we expected.

So the -- the sales -- I was really focused on the sales with that question. There wasn't anything you would really call out that was unusual or put another way, if the trade had similar growth results, would your results mirror the same kind of out performance in the next few quarters or if not, why?

I think, John, that, if the industry were to continue at the same pace, I think, we would perform very well, maybe not to a 14.6% operating income margin, that’s on the high-end of any range. But I’ll tell you, we certainly don't think the industry is going to continue at high-single digits, as it has for the last three quarters. And I think that’s fairly not what we're expected. We would love to see it. Particularly, as you look into next year, too. You’ve got election year, advertising going on next year. So, I wonder if advertising isn’t going to be more expensive. So there could be factors, if industry demand isn’t as good as high single-digits. That’s historically very high.

And Frank, could you maybe address -- Budd asked it a little bit about CapEx. But I was wondering if you could maybe tell us with capacity where you are in the U.S., where you are in Canada. Can you run more shifts? If we got a couple of back-to-back years in a row of double-digit revenue growth in that area, would that constrain capacity and CapEx would need to go higher, which is a high-class problem but just kind of a capacity question in general?

Okay. And we called last year, the capital projects. We call them strategic capital projects because we build the infrastructure to handle a higher amount of sales, for example in Canada. We can double very easily the number of knitting machines we have there today. We’ve already got the infrastructure, the manager, the people, the floor space, so we can double capacity output in China very easily. We also have plans in place and with what we did last year to grow at necessary our two North Carolina facilities. So, we really don’t see a capacity constraint. And supporting the internal production, you may remember, our model is 80-20, 80% internal, 20% external with our partner in Turkey and to some in China. We've got that with flexible capacity, if you will as needed.

Okay. And my last question is just quickly, Labor Day is essentially upon us in terms of the promotional environment. Any color or insight not necessarily in the rate of sales but what your customers are doing? And sort of how you expect Labor Day to pan out, given what transpired on July 4th? Thank you.

Okay. I think what we’re hearing for Labor Day, which is one of the two biggest weekend sale periods for the industry. Advertising is going to be up 5% to 10% is what we're hearing, significant promotional activity for the Labor Day weekend.

Is that for both bedding and upholstery?

Yes. And we’re preparing with the mattress industry just in time. So we have been really preparing for a strong Labor Day. So you know how -- if they advertise, it usually drive the sale.

It’s great. Thank you and good luck. Congratulations again.

Thank you, John. And one last question John, one last answer. What the key is not -- Labor Day is obviously a key. But what happens post Labor Day, in the rest of September and October, we don’t needed to fall out of bed right after Labor Day.

Yeah.

And it appears that we have no further questions at this time. At this time, I'll turn it back to Frank Saxon for any additional or closing remarks.

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

This does conclude today's teleconference. You may now disconnect. Thank you and have a great day. Speakers, please hold for your post conference.