Dru Anderson - IR Frank Saxon - President and CEO Ken Bowling - CFO

Dillard Watt - Stifel David Vargas - Raymond James Laura Champine - Cantor Fitzgerald

Good day and welcome to today's Culp Inc Second 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.

Thank you. Good morning. And welcome to the Culp conference call to review the company's results for the second 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 publicly release 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. Please go ahead, sir.

Good morning 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 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 then we will be happy to take your questions. Overall our second quarter sales were in line with expectations and we are pleased with our consistent overall growth trend through the first half of this year. The higher sales in both businesses for the second quarter reflected favorable customer response to our creative designs and broad range of innovative products. We also had an outstanding operating performance in both businesses with profitability, margins and return on capital all up significantly. We are also realizing the benefits of our recent capital improvement project in the mattress fabrics business. Importantly, we have the financial strength to continue to make strategic investments to support our growth and also return firms to shareholders. We are also pleased that our financial performance and strong balance sheet have enabled us to increase our quarterly dividend by 17% from $0.06 per share to $0.07 or $0.28 annually. Notably, we have consistently increased our quarterly dividend every year since we reinstated it in June of 2012. This action is consistent with our capital allocation strategy and confirms our commitment to generate value for shareholders. It is our long term intention to grow the regular dividend annually based on our performance and business outlook. I will now turn the call over to Ken, who will 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 that cover key quarterly and annual performance measures. It is important also to note that we have posted our capital allocation strategy through our website as well. Total sales for this quarter was $77 million, up 4% from the second quarter of last year. On a pretax basis for the quarter, we reported income of $6.1 million or 8% of sales, compared with $4.9 million or 6.6% of sales, reflecting a 26% year-over-year increase. Adjusted net income for the quarter, a non-GAAP measure, was $5.2 million or $0.41 per share, up 26% from the prior year period. Overall, annualized return on capital was 32%, compared with 25% last fiscal year. The company’s overall adjusted effective income tax rate through the second quarter this fiscal year was 15.7% compared with 16.1% 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 or NOLs 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 $45.4 million sales, up 5.6% as compared with the second quarter of last year. Operating income for this segment was $6.5 million for the quarter, up 37% from the same period last year. Operating income margin was 14.2% of sales compared with 11% a year ago. Notably, the 14.2% margin compares to the 14.6% achieved last quarter and the 14.7% achieved for the fourth quarter of last fiscal year. 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 costs somewhat offset by competitive pricing pressures. Annualized return on capital for the mattress fabric business was 38%, compared with 30% for last fiscal year. Although, capital employed in this business did increase from the previous year due in part to higher inventory balances, operating income improved at a much faster pace thereby contributing to the improvement in return on capital. Inventory balances are trending upward in this business as customers are required to hold higher inventory levels of key products. Now, let's look at upholstery fabrics. Sales for the quarter were $31.5 million compared with $31 million in the second quarter of last year, a 1.8% increase. The upholstery fabrics business reported operating income of $2.5 million, a 48% improvement over the second quarter of last fiscal year. Operating income margin was 7.8% of sales compared with 5.4% for the second quarter of last year. The primary factor in this improvement has been the higher margins achieved on new product introductions. We continue to stress the importance of innovation in this business, and the improved margins reflect the success of that strategy. Although the second quarter results reflect a more stable cost environment in China with lower input cost for materials and favorable currency impact more than offsetting the continued increases in labor and other operating costs, we are seeing some pricing pressures from key customers. Return on capital was 62% compared with 43% last fiscal year. The return on capital in this business continues to be impressive with significant growth in operating income while capital employed increased only slightly compared to the previous year. One final comment regarding our operating performance for the quarter. We did experience increases in SG&A spending at the division level as well as for unallocated corporate expenses. These increases were driven mostly by higher incentive compensation expense, as actual results exceeded our performance targets. As a reminder, our annual incentive compensation program is based on EVA, our economic value added principles. Accordingly, there is very high threshold before any balances are earned. Now let me turn to the balance sheet. We have maintained a strong financial position through the first half of this fiscal year even as we made our final 2.2 million debt payment, returned 6.4 million to shareholders through special and regular dividend payments and invested 5.3 million of capital expenditures primarily in our mattress fabrics business. As of quarter end, we reported 37.5 million in cash and cash equivalents in short term investments compared with 35.3 million a year ago. Importantly with the 2.2 million payment made on our term loan in August, we are now debt-free for the first time in our history. Our cash position broken down by country is as follows. Cash located in the U.S., Canada, and the Cayman Islands, totaled $19 million, while cash located in China also totaled approximately $19 million. With respect to dividends, consistent with our capital allocation strategy which is posted on our website, the Board has approved the 17% increase on our quarterly cash dividend from $0.06 to $0.07 per share or $0.28 per share on an annualized basis, effective this coming third quarter. Notably, since reinstating dividends in June 2012, the quarterly dividend payment has more than doubled. Further, during the first half of this fiscal year the Company paid $6.4 million in dividends, of which $4.9 million was for a special dividend. Importantly, since June 2011, the Company has returned approximately $36 million to shareholders in the form of regular quarterly, and special dividends, and share repurchases. Finally, with respect to currency exposure in China, it is important to note that from February through July of this calendar year we substantially reduced the amount of RMB cash held at Culp China due to our concern about the possible weakening of the Chinese currency. Thus when the 3% devaluation of the RMB occurred in August, we were well positioned and therefore experienced only a minor impact. Frank?

Thank you, Ken. I'll now provide you an update on both of our businesses. Let's start with mattress fabrics. We're pleased with our performance for the second quarter, highlighted by steady sales growth over the prior period. These results were in line with our expectations as we continue to execute our strategy with consistent and favorable results. Notably, we were able to drive higher sales in what is typically a seasonal slowdown after the Labor Day holiday mattress promotional events. We've continued to outpace the industry due to our proven ability to meet changing customer demand. Our strategic focus on design creativity has been a critical driver of our success with an innovative and diverse product offering, including mattress fabrics, and mattress covers, across all price points. Along with our design, excellence, and innovation, we are well positioned to sustain our growth with our mirrored manufacturing platform, technical expertise, and expanded reactive capacity, all of which support our excellent service and delivery performance. We've also made steady progress in our operating results through the first half of this fiscal year. We're realizing the benefits of recent capital investments with increased capacity via newer, more efficient equipment, enhanced finishing capability, and better overall throughput. We also recognized lower raw material cost in the quarter compared with a year ago. But this benefit was somewhat offset by increased customer pricing pressures. We are near completion of our current expansion project in our Canadian facility, with the installation of additional equipment and other technological improvements. We look forward to the efficiency opportunities these investments will provide us as we prepare for the next seasonal promotions. We are committed to making further investments in our manufacturing platform to maintain our competitive advantage and sustain a strong value proposition. Now, I'll comment on upholstery fabrics. We're also pleased with our financial and operating performance in this business for the second quarter, which was in line with our expectations. These results reflect consistent execution of our product driven strategy. Our creative designs continue to resonate with our customers as we offer diverse range of innovative products that meet changing market trends and style preferences. At the same time we've extended our market reach to a more diverse customer base. We've continued growth in sales to the hospitality and lifestyle retail markets. Notably, Culp had an excellent showing at the recent October furniture market with a high level of customer placements. In addition to our growth in sales, our operating results for upholstery fabrics showed significant improvement over the same period a year ago, with an improved contribution also coming from our U.S. operations. Additionally, affecting the year-over-year comparison was the fact that last year's second quarter included the unfavorable impact of one time charges related to the closure of our comparable impact of one time charges related to the closure of our Culp Europe operation. Our flexible global platform continues to support our overall marketing efforts, and China produced fabrics represented 91% of Culp's upholstery fabric sales for the second quarter. We have also benefited from a more stable cost environment in China through the first half of this year compared with a year ago period. We look forward to opportunities ahead especially as a better economy and stronger U.S. housing market supports higher consumer spending for home furnishings. Ken, will now review the outlook for the third quarter and then I'll have a few concluding remarks.

We expect overall sales to be flat to slightly higher as compared with a very strong performance for the third quarter of last year which reflected a 12% year-over-year improvement. We expect sales on our mattress fabric segment to be 1% to 3% higher compared with the same period year ago, which was an exceptionally strong quarter with a 19% improvement over the prior year period. Operating income and margins in this segment are expected to be moderately higher than the same period a year ago. In our upholstery fabric segment, we expect sales to be comparable to the previous year's third quarter results. Forecasting third quarter sales for this business can be challenging given the timing of the Chinese new year, which will occur in early February 2016. We believe the upholstery fabric segments operating income and margins will be moderately higher than the same quarter of last year. Considering these factors, the Company expects to report pre-tax income for the third quarter in the range of $6 million to $6.6 million. Pretax income for last year's third quarter was $5.9 million. Looking at the full year, capital expenditures are expected to be approximately $10 million to $11 million, most related to expansion and efficiency improvement projects for mattress fabrics. Depreciation and amortization including stock based compensation is expected to be around $9.5 million for the year. Additionally, the Company expects another good year of free cash flow even with the anticipated high level capital expenditures and modest growth in working capital. Finally, given our strong start for this fiscal year and our current expectation at sales and operating performance for the second half of the year will be comparable or slightly better than the same period last year, we expect the full year's operating performance to show meaningful improvement over last fiscal year. Now, back to Frank, for some closing comments.

We are pleased with our results to date for fiscal 2016. The steady overall growth in sales compared with the same period a year ago and a solid operating performance with pre-tax income for the six months up over 30% compared with last year. Our creative designs and ability to consistently innovate have distinguished our products in the marketplace, and we have done an outstanding job in meeting the changing demands of our customers. We have created a strategic infrastructure through our flexible and scalable global platform that supports our ability to respond to new opportunities. Importantly, we have the financial strength to continue to invest in our business and at the same time reward our shareholders. We look forward to opportunities ahead for the balance of this fiscal year. With that, we'll now take your questions.

[Operator Instructions] And we'll go first to Dillard Watt with Stifel.

Thanks, good morning. Can you guys hear me okay?

Good morning, Dillard.

Let's just start on the mattress side, obviously Frank, I know raw materials have been helping you. Where are we in terms of lapping those cost reductions, what point did you really start to see the benefit and kind of how much longer do we have to go where we're going to still see that favorable impact on a year-over-year basis?

Dillard, it's a great question. One, we watch every week and every month. As of this week, raw material prices continue to -- we see downward pressure globally. With the lower oil prices and the excess of supply over demand, we are continuing to see gradual downward pressure. Obviously, a positive for us. When will it turnaround? I think we probably turnaround a few months ago but we -

Well, I understand, if they stay where they are now when are you going to sort of stop seeing a year-over-year help? A – Frank Saxon: If they stay where they are now we are good through at least fourth quarter maybe first quarter.

Okay. That’s helpful. You mentioned some competitive pricing, is that at any particular price point, is that with certain knits versus woven or is there any area where you are seeing that more and does that change what you are doing in terms of where you are focusing your product introductions and your sales efforts? A – Frank Saxon: No, I don’t think so. I think we are seeing that from two perspectives. Number one is the industry consolidates the bigger players are more demanding. Secondly, the larger players are seeing the raw material cost decline as well.

Got it. Nothing more on year on – sorry? A – Frank Saxon: There will be an after lower prices.

Sure. You mentioned some of those and probably this maybe even go along you mentioned some of your customers are kind of wanting you to carry more inventory to service them quicker I guess, is that I guess maybe Ken, how much of an impact might that have on working capital through you know, the end of the year if any?

I mean, as we said, it’s been – I mean, it’s been an impact this quarter you’ve seen in the financials. You know the balance sheet inventory is up. It just depends. I mean, we did – we did get to a point where a lot of that has been caught up now, so looking ahead we should be in position for it won’t be as big of an impact going forward but that’s an area as we look at every day and obviously work with our customers in making sure that you know there is a balance there between what they wants to hold and what we want to hold. A – Frank Saxon: I think, less working capital – less working cash flow directed to working capital in second half as we did in the first half.

All right. That’s helpful. Last question on mattresses. Any update on the [level] on the coverage business? A – Frank Saxon: I am still doing well. It’s a seasonally soft period during our third quarter but still doing well. That s a small piece of the business. I mean, we have talked about it frequently but I want to still make sure we know that it’s 10% to 15% of business. It’s not a large piece.

Got it. A – Frank Saxon: It's still pretty good -

And then turn it over to upholstery, you talked about how your new products and some of the stuffs you are doing with the lifestyle brands and all that has been helpful. Should we expect to continue to see a mix improvement in the next I don’t know six to 12 months? A – Frank Saxon: In terms of a better mix of -

Well, it sounded like you had talked about and maybe I misunderstood. It sounded like you had mentioned that perhaps you are basically selling more higher margin products, because of the new products you’ve introduced and the design work that you’ve done but maybe correct me if I am wrong? A – Frank Saxon: No, that is correct. But I would say it's not only in those markets hospitality or the lifestyle category. It's also in the residential category. And the mix is helping because the lifestyle retail category and hospitality are growing at a faster rate than the core residential business.

Got it. A – Frank Saxon: Both are positive factors to margin.

Understood. All right. I think that’s take care of me. I appreciate it and congrats on the quarter and good luck. A – Frank Saxon: Thank you.

And we’ll go next to Budd Bugatch with Raymond James.

Good morning, this is David Vargas on for Budd. Maybe Frank, can you give us a little bit of color on what you’re seeing in earnings from customers today versus the same time last year or even earlier this year kind of what changed and what is new?

Okay. I would say, this time last year business was very robust and you saw nine numbers, you saw another people the industry was growing at a faster rate than it is currently. We are still seeing growth today. We still see a lot of optimism with customers but after let’s say three or four quarters of above trend growth rates its now moderating. Still up, still a lot of optimism, still growing but as not as robust as it was a year ago.

Okay. Great. Thanks a lot. I appreciate and good luck.

All right. Thank you.

And we’ll go next to Laura Champine at Cantor Fitzgerald.

Hi, Frank. First a clarification on that last question. Was that about end market demand at both segments or just mattresses because we are interested on both segments? And then secondly the shift towards having to carry more inventory for your mattress customers is that more towards one specific player or is that an industry shift that’s just ongoing, I know there has been some management and at least one of the big players I am wondering how that’s impacting your business?

Good morning, Laura. I hope you’re doing well and welcome to the Culp and glad to have you and Cantor Fitzgerald covering call. The first part of your question that does my comments reflect both business, upholstery as well as bedding. Secondly, the inventory is the large customers and it's not just one let’s call it two large customers are more demanding about what we actually carry in finished goods inventory to support them. So it's not an industry trend. I don’t see anything but the industry you know there’s two players that are pretty sizeable part of the industry, but it is those two.

And does your size in that category give you any advantages as against some of your ticking competitors who might have trouble carrying that much inventory?

Absolutely Laura, as we’ve said for a long time. As the bedding industry consolidates further and we saw it yesterday with the Matt Firm announcement for their acquisition the bedding manufacturers need larger suppliers. Culp's strength has been servicing large customers for years. So it absolutely benefits us because we can take care of them number one, we can take care of them with our capacity. Number two, they are more demanding. And we’ve always demanded in the mattress business specialty equipments, wide weaving machines, wide -- did only do mattress fabrics now the inventory commitment is increasing so the financial commitment to play within the game is increasing. And so, absolutely the bed the more consolidates the net benefit to us is better. Yes, also what goes along with that the bigger they get the more they press you on price, but that’s really nothing new we’ve already seen that but we believe and see the benefits of our capacity, our service, our outstanding service day-in and day-out because of our capacity and commitment to inventory pays off, the more consolidation the better.

Thanks, Frank. Happy holiday.

Happy holiday to you.

And at this time we have no further questions on the phone lines. So I would like to turn the call back over to your speakers for any additional or closing remarks.

Thank you, Operator. And again thanks everyone for your participation and your interest in Culp and we look forward to updating you on our progress next quarter. Have a great day

This does concludes today's conference. Thank you for your participation.