Dru Anderson - IR Franklin N. Saxon - President and CEO Kenneth R. Bowling - VP, CFO, Treasurer and Corporate Secretary

Bobby Griffin - Raymond James Marco Rodriguez - Stonegate Capital Markets

Good day and welcome to the Culp, Inc. Fiscal 2016 Third Quarter 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] [ph]. Please go ahead.

Thank you. Good morning and welcome to the Culp conference call to review the Company's results for the third 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 SEC, 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 Web-site at culp.com. A slide presentation with supporting summary financial information and additional quarterly performance charts are also available on the Company's Web-site 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 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'll begin the call with some brief comments and then 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 the fourth quarter business outlook, and then we'll be happy to take your questions. We continued to drive improvement in our operating performance in the third quarter. While we have achieved higher overall year-over-year sales through the first nine months of this year, we did experience a slight drop in the third quarter compared with the prior year period, which was an exceptionally strong sales performance for both businesses. We have remained focused on our top strategic priorities, to drive product innovation and creativity throughout our Company and to provide a product mix that meets the demands of our customers. I am very pleased with the progress we continue to make in these areas. Our efficient and flexible manufacturing platform supports this strategy and we continue to make the right investments to improve operating efficiencies and increase overall capacity. Overall, we have seen significant improvement in our profitability and margins this fiscal year with pre-tax income up 21% on a year-to-date basis and we are expecting another record year in earnings and return on capital. Importantly, we also have the financial strength to support our growth strategy as well as provide added value to shareholders through dividends and share repurchases. I'll now turn the call over to Ken who'll 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 Web-site that cover key quarterly and annual performance measures. We have also posted our capital allocation strategy. Total sales for this quarter were $78.5 million, down 3.4% from the third quarter of last year. On a pre-tax basis, for the quarter we reported income of $7.2 million or 9% of sales, compared with $5.9 million or 7% of sales, reflecting a 21% year-over-year increase. Adjusted net income for the quarter, a non-GAAP measure, was $5.9 million or $0.47 per share, up 18% from the prior year period. Overall, annualized return on capital was 32%, compared with 27% last fiscal year. The Company's overall adjusted effective income tax rate through the third quarter of this fiscal year was 17.8%, compared with 15.3% 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 $33 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 are the results for our two businesses. For mattress fabrics, we reported $44.3 million in sales, down 3% compared with the third quarter of last year, while year-to-date sales were up 4.5%. Operating income for this segment was $5.8 million for the quarter, up 11% from the same period last year. Operating income margin was 13.1% of sales, compared with 11.4% a year ago. Contributing to this margin improvement are the benefits coming from the capital investment program we implemented last fiscal year. We also benefitted from lower raw material costs and lower operating expenses due to more favorable exchange rates in Canada, offset somewhat by increased customer pricing pressures. Annualized return on capital for the mattress fabrics business was 36%, compared with 31% for the same period a year ago. Although capital employed for this business did increase from the previous year due primarily 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 higher in this business as customers are required us to hold higher inventory levels of key products. Now let's look at upholstery fabrics. Sales for the quarter were $34.2 million compared with $35.6 million in the third quarter of last year, representing a 3.9% decline. Sales for year-to-date period were down 1.7%. The upholstery fabrics business reported operating income of $3.8 million, a 51% improvement over the third quarter of last fiscal year. Operating income margin was 11.3% of sales, compared with 7.2% for the third quarter of last year. The 11.3% is the highest operating margin achieved for this business. A key 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. We also benefitted from a more stable cost environment in China, with lower input cost for raw materials and a favorable currency impact more than offsetting the continued increases in labor and other operating costs. It is important to note that we are also starting to see some pricing pressures from key customers. Return on capital was 69%, compared with 48% last fiscal year. The return on capital in this business continued to be impressive with significant growth in operating income while capital employed increased only moderately compared to the previous year. With respect to SG&A expenses for the quarter, we did experience year-over-year increases at the division level as well as for unallocated corporate expenses. These increases were driven mostly by higher incentive compensation expense, as our actual results exceeded our performance targets. As a reminder, our annual incentive compensation program is based on EVA or economic value added principles. Accordingly, there is a very high return on capital threshold before any bonuses are earned. At Culp, shareholders win first. One final comment regarding our operating performance. As stated earlier, both divisions benefitted from favorable currency rate as compared to the previous year. A key point to consider in looking at our favorable currency impact is the fact that both our Canadian and Chinese operations bill mostly in U.S. dollars while operating expenses are paid in the local currency. Thus, as the yuan or Canadian dollar weakens relative to the U.S. dollar, our operating costs go down. Of course, the opposite is true if the currency strengthens. Now let me turn to the balance sheet. Our financial strength continues to be an important advantage for Culp this fiscal year. As of quarter end, we reported $36 million in cash and cash equivalents and short term investments even after spending $19.6 million in dividends, capital expenditures, debt repayments and share repurchases through the first nine months of this fiscal year. We have the financial strength to continue to make strategic investments to support our growth strategy and return funds to our shareholders. Our cash position broken down by country is as follows. Cash located in the U.S., Canada, and the Cayman Islands was approximately $30 million, while cash located in China was approximately $6 million. During the quarter, the Company purchased 100,776 shares of Culp common stock or nearly 1% of outstanding shares for $2.4 million at an average price of $23.79 per share, pursuant to the $5 million share repurchase program. This leaves approximately $1.9 million available for additional share repurchases. With regard to dividends, the Board of Directors has approved the payment of a quarterly cash dividend of $0.07 per share. This compares with $0.06 per share paid for the same period last year, reflecting an increase of 17%. Notably, since reinstating dividends in June 2012, the quarterly dividend payment has more than doubled. Before turning the call back to Frank, let me make a few more comments about our balance sheet. We are planning to increase our U.S. line of credit during the fourth quarter to enable our China operations to accelerate the movement of eligible dividend that will eventually make it back to the U.S. Let me explain in more detail. As we reported in the past, we have a very [successful] [ph] strategy to mitigate foreign exchange exposure. Through maintaining a natural hedge with respect to assets and liabilities denominated in Canadian dollars and Chinese yuan, we have been successful in keeping foreign exchange charges very low this fiscal year despite significant weakening of both currencies over the past several months. We have also mitigated further foreign exchange exposure in China by making the strategic decision to move significant amounts of earnings and profits from Culp China to our international holding company located in the Cayman Islands. During the third quarter, we moved approximately $13 million [from] [ph] Culp China to our Cayman company, which is in addition to the approximate $8 million we moved last April. Accordingly, our cash balance in China has been reduced to approximately $6 million as of quarter end, which compares to $19 million at the end of last quarter. We believe that moving excess fund out of Culp China to our Cayman company not only mitigates our foreign exchange exposure going forward but also provides increased flexibility to use those funds for various strategic purposes with minimal administrative hassle. Obviously, a major point of consideration in this strategy has been the potential impact to our U.S. NOLs. It is important to note that there is no impact to our NOLs unless we bring the funds from Cayman to the U.S. So for now, the plan is to hold these funds in Cayman until the NOLs are fully utilized through normal U.S. earnings, which at recent earnings rate we estimate could take around three years. Looking ahead, we have significant additional dividends available to be moved from Culp China in the amount of approximately $16 million related to calendar years 2014 and 2015. However, we currently do not have enough cash on hand in Culp China to pay those dividends. We have a couple of options to address this issue. We could move funds from our Cayman company to the U.S. and transfer those funds to Culp China through paying down the inter-company receivable in Culp China. That strategy however will cause our NOLs to be utilized much faster, leading Culp having to pay higher U.S. taxes sooner. This is an expensive option. The other alternative involves borrowing money in the U.S. at a very low interest rate and using those funds to pay down the inter-company receivable in Culp China. Culp China will then have the funds to pay the eligible dividends to our Cayman company. We have run the numbers and we project it will be far less costly over the coming years to borrow the funds in the U.S. compared to the tax consequences involved with utilizing our NOLs at a faster pace. Therefore, in order to give us maximum flexibility with respect to our overall liquidity in the U.S., we are in the process of increasing our line of credit with Wells Fargo from $10 million to $30 million. We believe that a $30 million line of credit will be plenty of capacity to support our operational needs as well as to accomplish this strategic initiative. Rest assured that we will focus on paying down any outstanding debt as quickly as possible. Frank? Franklin N. Saxon: Thank you, Ken. I will now provide you an update on both of our operating segments and let's start with mattress fabrics. While our sales were slightly lower than last year for the third quarter, we have continued to deliver a consistent and strong operating performance this year. Our sales for the third quarter were affected by several factors, including a weather event at the end of the quarter which affected our production and shipping schedules. Additionally, we experienced a timing difference related to customer rollouts of new product lines that typically occur in our third quarter, as they did in the previous year. We expect to recognize that business in the fourth quarter, following the Presidents Day holiday promotional events. In spite of these factors, we continued to outpace the overall mattress industry growth, and we are pleased with our ability to respond to changing customer demand trends. Our mirrored manufacturing platform, technical expertise and expanded reactive capacity support our ability to meet this demand with exceptional service and delivery performance. We are encouraged by the execution of our strategy as we continue to realize the benefits of our recent capital investments with increased capacity via newer, more efficient equipment, enhanced finishing capabilities and better overall throughput. During the quarter, we also benefited from lower raw material cost and lower operating expenses due to the more favorable exchange rates in Canada, offset somewhat by customer pricing pressures. As planned, we completed the initial phase of our expansion project in our Canadian operation and we plan to install additional new equipment and make other technological improvements throughout our manufacturing platform during the fourth quarter. These investments demonstrate our commitment to our customers and we look forward to the opportunities to drive further operational improvement. Design and innovation remain our top priorities to meet customer style preferences and demand trends. As such, we are in the process of enhancing our design services and facilities to further our value proposition. Additionally, we had an excellent showing at the January Las Vegas bedding market, with strong placements, especially in the premium product lines. We are pleased to see the continued contribution from our mattress cover business. With our complete array of innovative fabrics and mattress covers across all price points, Culp is well positioned for a solid performance in this fiscal year. I'll now comment on upholstery fabrics. As expected, our sales for the third quarter were slightly lower compared with the same period last year, which was an exceptionally strong quarterly performance. However, we achieved significant improvement in our operating income and margins for the third quarter compared with the prior year period. We continue to benefit from our strategic focus on product innovation and sales diversification. Our changing product mix resulted in greater operating efficiency and capacity utilization in our Culp China cut and sew operation. Additionally, we experienced a more stable cost environment as well as lower operating expenses due to more favorable exchange rates in China compared with the third quarter of last year. Customer response has also been very favorable to our creative designs and diverse range of innovative products. Our flexible global platform supports our marketing efforts and allows us to quickly respond to changing market trends and consumer style preferences. Sales of China produced fabrics accounted for 92% of our upholstery fabric sales in the quarter. While the short-term outlook is challenging given the current uncertainties in the global economy, we believe we are well-positioned for the long-term. An improving U.S. housing market, low interest rates, higher employment rates and lower gasoline prices, are all positive indicators that support higher consumer spending for home furnishings. As market conditions evolve, we expect to benefit from more favorable demand trends and we look forward to the opportunities ahead in this business. Ken will now review the outlook for the fourth quarter and then I'll have a few concluding remarks. Kenneth R. Bowling: At this time, we expect overall sales to be comparable with the fourth quarter of last fiscal year, which was a strong quarter. For the year, we expect overall sales to be slightly higher than last year's annual sales. We expect fourth quarter sales in our mattress fabrics business to be comparable with the same period a year ago. Operating income and margin are expected to be flat to slightly lower than the same period last year. For the full fiscal year, we expect mattress fabric sales to be 2% to 4% higher than last fiscal year, and operating income and margins are expected to be significantly higher than last fiscal year. In our upholstery fabrics business, we expect fourth quarter sales to be comparable with the previous year's fourth quarter results. We believe operating income and margin will be moderately higher compared with the same quarter of last year. For the full fiscal year, we expect upholstery fabric sales to be comparable with last fiscal year. Operating income and margins are expected to be substantially higher than last fiscal year. Considering these factors, we expect to report pre-tax income for the fourth quarter in the range of $6.7 million to $7.2 million. Pre-tax income for last year's fourth quarter was $6.7 million. For fiscal 2016 as a whole, we expect pre-tax income in the range of $27.5 million to $28 million, compared with $23 million last fiscal year, which was the highest level achieved in the Company's history. Looking at the full fiscal year, capital expenditures are expected to be approximately $12 million, mostly related to expansion and efficiency improvement projects for mattress fabrics. Depreciation and amortization together with stock-based compensation is expected to be approximately $9 million. Additionally, the Company expects another good year of free cash flow, even with the anticipated high level of capital expenditures and modest growth in working capital. Looking ahead to next fiscal year, our preliminary estimate for capital expenditures is in the range of $11 million to $12 million as we continue to invest heavily in our mattress fabrics business. Now back to Frank. Franklin N. Saxon: We are pleased with our ability to consistently execute our strategy in fiscal 2016 with improved profitability in both businesses. We have maintained a strong competitive position with our creative designs, innovative product offerings, and a flexible and scalable global manufacturing platform that supports our ability to deliver these products. At the same time, we have continued to invest for the future to further enhance our operations and provide outstanding service to our customer base. We look forward to the opportunities ahead for Culp. Above all, we are committed to providing excellent value for our customers as a financially stable and trusted source for innovative fabrics. With that, we will now take your questions.

[Operator Instructions] We'll first go to Budd Bugatch from Raymond James.

This is Bobby actually filling in for Budd. I appreciate you guys taking my questions and congrats on another good operational quarter. Frank, I was hoping that maybe you could provide a little bit of color on what you're hearing from your customers today versus maybe three, four, five months ago and help us understand a little bit of how much the slowdown as a result of prior year comparisons which are very difficult versus kind of the current economic environment that we're in here in the U.S.? Franklin N. Saxon: I think in our take, Bobby, it's both of those. How much is each, it's a little slower, business is still good but just a little slower than it had been. And of course we did have significantly tough comparisons for last year.

Okay. And then maybe lastly for me, could you touch a little bit on the health of some of your key suppliers and partners in China, given some of the recent economic data that we've heard from that market? Franklin N. Saxon: Yes. Culp historically has partnered with a few important mills in China. We call them our partner mills. We've always focused on a few and we believe the ones we currently deal with are all in good shape and have no concerns with any of them.

I appreciate you guys answering my questions and best of luck moving forward.

We'll now go to Marco Rodriguez from Stonegate Capital Markets.

I was wondering if one of you guys can maybe talk a little bit more about the timing impact you guys saw from that specific customer rollout in the mattress segment. I'm assuming that took you guys by surprise. Can you maybe talk a little bit about the conversations you had with the client and then is it possible for you to kind of quantify the impact and have you recouped that revenue yet? Kenneth R. Bowling: This is Ken. Last year we had – I guess the Vegas market rollout kind of goes in cycles where you have the premium mattresses versus the more volume related types of mattresses, and last year it was one of those where there were a lot of different programs and so various customers wanted to rollout their programs faster. So that put pressure or increased the demand level for the third quarter as opposed to this year where it was more premium based, so there wasn't as much demand as compared to last year. So that did have an impact on last year's third quarter. I mean that was a tough comparison. They had, the mattress fabrics business, I think they were 90% above the previous year. So that was a tough comp to compare to. But that part of it, it was an acceleration of customer rollouts that we had last year as compared to this year.

Got you. And can you quantify or talk about has that revenue flown through yet? Kenneth R. Bowling: No, I mean we don't really quantify it. I think as we said in the press release, some of that will be made up in the fourth quarter with this particular rollout period, but last year was kind of unique in that particular setup, but there will be some movement in the fourth quarter but we would not be able to quantify that.

Got you, perfect. And kind of sticking on the mattress side, you guys were talking about adding new equipment and making some new technological improvements again on the mattress side in Q4. Can you maybe talk a little bit more about that in more specifics as far as what is being done, any expected costs and benefits? Franklin N. Saxon: What we've been doing, Marco, with both our key product lines, in the knitted product line and the woven product line and the finishing related to each, it was just more of the same in each of those major product lines. And the goal is to continue to increase the efficiency of those operations and we would expect to see benefits starting next year. These are all projects that can pay off very quickly. Kenneth R. Bowling: And Marco, I'll add to that that we have been focused in that business over the years to make sure we constantly replace aged out equipments to maintain that high efficiency rate. So that's always a part of our CapEx plan to look at equipment, replace it and maintain that efficiency at a high level.

Got you. Franklin N. Saxon: And I think also when you look at our financial performance, what's encouraging to us also is we can have these couple of years here of higher than historical CapEx and still generate a really nice free cash flow.

Got you. And last quick question here, if I might. On the inventory levels, I know you guys called out the clients are expecting you guys to hold a little bit more inventory for [them] [ph]. That's why it's kind of been ticking up here sequentially. But how should we be thinking about where that level sort of troughs, if you will, or should we be expecting it to continue to I guess increase or accelerate in the next few quarters? Franklin N. Saxon: We are expecting that to be in the flatfish range in the next quarter end. We believe we've seen the bulk of the inventory increase because the customer demands happened over the last year. And I think future increases, if we do have them, will be small and relative to sales growth. But we've seen the bulk of it.

Got you. Perfect. Appreciate it, guys. I'll jump back in queue.

[Operator Instructions] It appears there are no further questions. I'll turn the conference back over to our presenters for any additional or closing remarks. Franklin N. Saxon: Thank you, operator, and thank you everyone for your participation and your interest in Culp. We look forward to updating you on our progress next quarter. Have a great day.

This concludes today's presentation. Thank you for your participation.