Drew Anderson - Investor Relations Franklin Saxon - President, Chief Executive Officer, Director Kenneth Bowling - Senior Vice President, Chief Financial Officer, Treasurer and Corporate Secretary

Budd Bugatch - Raymond James John Baugh - Stifel Nicolaus Marco Rodriguez - Stonegate Capital Markets

Good day and welcome to the Culp, Inc. fiscal 2017 First Quarter Conference Call. Today's call is being recorded. At this time, for opening remarks and introductions, I’d like to turn the call over to Ms. Drew Anderson. Please go ahead, ma'am.

Thank you. Good morning and welcome to the Culp conference call to review the Company's results for the first quarter of fiscal 2017. As we start, let me say that this morning’s call will contain forward-looking statements about the business, financial conditions and prospects of the company. Forward-looking statements are statements that include projections, expectations or beliefs about future events or results or otherwise are not statements of historical facts. The actual performance of the Company could differ materially from that indicated by the forward-looking statements because of various risks and uncertainties. These risks and uncertainties are described in our regular SEC filings including the Company’s most recent filings on Form 10-K and Form 10-Q. You are cautioned not to place undue reliance on forward-looking statements made this morning and each such statement speaks only as of today. We undertake no obligation to update or to revise forward-looking statements. 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 and also posted on the Company’s website at culp.com. A slide presentation with supporting summary financial information and additional 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.

Thanks, Drew. Good morning everyone and thanks 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 then Ken will review the financial results for the quarter. I will then update you on our strategic actions in each of our businesses and after that, Ken will review our second quarter business outlook and then we will be happy to take your questions. We are pleased to report a strong start for Culp in fiscal 2017. The first quarter was highlighted by better than expected sales in our mattress fabrics business, up almost 6% and overall, higher profitability in margins in both of our businesses. Notably, our first quarter pretax income and margin were the highest quarterly results in the company’s history. Additionally, we are off to a great start for free cash flow and return on capital, both of which are very important metrics for us. As we look ahead to the rest of the fiscal year, Culp is well positioned, both competitively and financially. Our strategic focus on creative designs, innovation and exceptional customer service continues to set Culp apart. Importantly, we have the financial strength to make our strategic investments, to enhance our operations and support our growth strategy and importantly, return funds to shareholders. 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 performance measures. We have also posted our capital allocation strategy. Here are the financial highlights for the first quarter. Net sales were $80.7 million, up almost 1% over the prior year with mattress fabric sales up almost 6% and upholstery fabric sales down almost 7%. Pretax income was $8.5 million, up 15% compared with the prior year period, pretax income margin was up 140 basis points from the previous year. Adjusted net income, a non-GAAP measure was $7 million or $0.56 per diluted share, compared with $6.2 million or $0.50 per diluted share for the prior year period. The company’s overall adjusted effective income tax rate for the first quarter was 17.8%, up from the 15.7% from the same period last year. The increase was primarily due to taxable foreign exchange gains associated with our China operation and the mix of earnings between the company’s US parent and foreign subsidiaries. Annualized consolidated return on capital was 38%, compared with 34% a year ago. We are pleased with this improvement as operating income was up 16% while capital employed only increased 4%. Now let’s take a look at our two businesses. For mattress fabric, operating income was $8.4 million, up 20% over a year ago and operating income margin was 16.6%, up 200 basis points. Notably, these two financial metrics for this business were the highest in Culp’s history. This impressive performance reflects the impacts from our record sales quarter for mattress fabrics and the value of our recent capital investments with significant improvement in manufacturing efficiencies. We also continue to benefit from lower input costs and a more favorable currency exchange rate in Canada. Annualized return on capital for mattress fabrics was 44%, compared with 40% a year ago. For upholstery fabrics, operating income was $3 million, up 11% and operating income margin was 9.9%, up 160 basis points. The improved profitability in this business reflects a more favorable product mix with higher margins achieved on new product introductions. We continue to stress the importance of innovation and the improved margins reflects the success of that strategy. At the same time, we are succeeding with our plan to diversify both our customer and product mix to enhance our profitability. We also benefited from a more stable cost environment in China with lower input cost for raw materials and a favorable currency impact more than offsetting the continuing increases in labor and other operating costs. Annualized return on capital was 70% compared with 65% last year. The return on capital in this business continues to be impressive with significant growth in operating income while capital employed actually decreased as compared to last year. One final comment regarding our operating performance. As stated earlier, both divisions benefited from favorable currency rates 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 billed mostly in US dollars while operating expenses are paid in the local currency. Thus, as the yuan or the Canadian dollar weakens relative to the US dollar, our operating costs go down. Of course, the opposite is true if the currency strengthens. To the balance sheet highlights. We have maintained the strong financial position with cash and cash equivalents and short-term investments of $48 million at quarter end. As expected, the company borrowed funds to mitigate our foreign exchange exposure with $7 million outstanding on our line of credit at the end of the first quarter leaving a net cash position of $41 million. This compares with a net cash position of $42 million at the end of last fiscal year. The slight decrease in our net cash position was achieved despite spending $3.1 million on capital expenditures, $3.4 million on dividends and $2.5 million on working capital. Importantly, we’ve planned to reduce our outstanding debt as quickly as possible. Free cash flow for the quarter was $2.2 million, compared with a negative $1.8 million a year ago. This improvement is primarily due to improved working capital management, especially inventory. Looking ahead, we expect another good year of free cash flow with capital expenditures mostly related to expansion and efficiency improvement projects for our mattress fabrics business projected to be approximately $12 million along with modest growth in working capital. Depreciation, amortization and stock compensation expense are expected to be approximately $10 million for the year. One final comment about our cash position. Of the $48 million in cash on the balance sheet at the end of the first quarter, $36 million is located in the Cayman Islands as we have previously discussed, in order to mitigate foreign exchange exposure in China, we made the strategic decision to move significant amounts of earnings and profits from Culp China to our international holding company located in the Cayman Islands over the last 18 months. This action not only mitigates our foreign exchange exposure going forward, but also provides substantially increased flexibility to use those funds for various strategic purposes with minimal administrative hassle. It is also important to note that there is no impact or NOLs unless we bring funds from Cayman to the US. As such, the plan is to hold these funds in Cayman until the NOLs are fully utilized to normal US taxable earnings, which at our recent earnings rate, we estimate would take around two to three years. Frank?

Thanks, Ken. I’ll now provide an update on both of our operating segments and let’s start with mattress fabrics. We continue to deliver a strong performance with higher than expected sales, compared with an exceptional first quarter last year. The first quarter is typically a strong seasonal quarter for this business. Overall, we continue to do an outstanding job in executing our strategic plan in mattress fabrics. Our result reflects sales growth, lower input cost and the benefits of our major capital investments. Importantly, we are continuing to make additional significant investments that will drive greater efficiency and enhance our ability to serve customers. We are underway with additional projects here in North Carolina to further expand our production capacity. We are also updating and expanding our design and admin facilities and making major improvements to our distribution capabilities. Additionally, we have commenced work on phase two of our Canadian expansion project including additional knitting equipment, finishing capabilities and a new distribution platform that will allow us to improve deliveries and better serve our customers in Canada. We expect to commence our expanded distribution operations in Canada in the second half of this fiscal year and once completed, we will have the ability to ship directly to our customers in Canada. Together, these investments in our mattress fabric business will enhance our ability to serve our customers and meet our goal to be their premier service provider for mattress fabrics and covers in North America. We are especially pleased with the first quarter performance for CLASS, which is what we call our mattress cover business. Importantly, CLASS has allowed us to reach both traditional and new customers and additional market segments, especially the fast-growing internet bedding space. We have expanded our sales team in this area and we are excited about the opportunities for further growth. Looking ahead, we see some uncertainty with respect to overall demand trends in fiscal 2017. With our enhanced infrastructure and solid competitive position, we believe we are well positioned for continued growth and we will be strategic in targeting customers who value our innovation and value proposition. Now I will comment on upholstery fabrics. Our sales for the first quarter of this fiscal year were somewhat lower than expected reflecting softer retail demand for furniture, as well as our customer mix strategy. We have been intentional on focusing our sales opportunities on higher margin business with less reliance on higher volume and lower margin promotional business. However, even with the lower sales, we were pleased with our overall operating performance and higher profitability and margins compared with the first quarter of last year. Our improved performance reflects the customer mix I just noted. A better mix of fabric styles and price points and a more favorable currency exchange rate in China. We continue to drive innovation as we strive to meet the changing demands of our customers and stay current with the latest style trends. For example, one of our newest products is getting a lot of favorable attention. We have previously mentioned the introduction of our new performance line of highly durable stain-resistant upholstery fabrics. As this new product has hit the market, we are encouraged by the trends in customer placements for the upcoming highpoint market. Looking ahead, we are hearing from many of our customers that the slowdown in the retail furniture market has persisted through the summer. However, we are optimistic that this is a more temporary low and not a longer term trend. Other indicators including an improved housing market and low interest rates should support higher consumer spending for home furnishings. In summary, we are pleased with the first quarter performance in both of our businesses with our reputation for design excellence, innovative products, exceptional customer service and a proven ability to execute our strategy, we believe we are well positioned for continued success with the remainder of this fiscal year. Ken will now review the outlook for the second quarter, and then we’ll be glad to take your questions.

We expect overall sales to be flat despite to slightly higher as compared with the second quarter of last year. We expect our mattress fabric sales to be moderately higher compared with the second quarter of last year. Operating income is also expected to be moderately higher, while margins in this segment are expected to be slightly higher as compared to the same period a year ago. Upholstery fabric sales are expected to be flat to slightly lower as compared to the same time last year, as we anticipate a continuing weak retail environment for furniture sales. Operating income and margins are expected to be flat to slightly higher than the same period a year ago. Considering these factors, we expect to report pretax income for the second fiscal quarter in the range of $6.6 million to $7.1 million. Pretax income for last year’s second quarter was $6.1 million. With that, we will now take your questions.

[Operator Instructions] And we will go first to Budd Bugatch with Raymond James

Good morning, Frank. Good morning, Ken. Congratulations on a very significant quarter. I had some questions about revenues if we can maybe get in drill down a little bit and thank you for the color. In the upholstery fabric business where you had really good revenue growth, could you perhaps parse that a little bit? I know there is CLASS in there and then you have price and units of the mattress fabrics. Could you maybe give us a little color?

Budd, are you speaking about the mattress fabrics business?

Yes sir.

Okay, okay. And really three factors in the sales growth of approximately 6%. Number one is our average selling price is higher due to various factors, higher price products and some specialty fabrics that we are doing, including lamination of certain products, fleeting et cetera. Second would be our mattress cover business had an excellent quarter versus the same year last year. So we’ve got some mix going on with that and third, we had some unit increase. So that would be the, or our 6% sales increase in mattress fabrics, that would be the three factors.

Could you rank them in any way or give us any numbers?

I think the – I would say the average selling price and the mattress cover business CLASS were the bigger pieces of it.

Okay. And in the upholstery business, where you essentially had a similar decline, you pointed to the weakness at retail and you are also pointing to the fact that you are walking away for some business, can you maybe parse that a bit for us and tell us which of those two was more significant?

I think the more significant one there is the retail softness. It’s – we are seeing that persist through the summer and currently. The furniture business certainly appears to be a good bit softer to us than the bedding business.

Okay. And as you look at your cost factors, you had some tailwind in costs. How do you look at that persisting, or are there any signs that that maybe – that tailwind maybe lessening?

Budd, that’s a great question and you would guess, we look at that every week. We are benefiting from tailwinds, lower polyester prices globally and favorable exchange rates in China versus the USD as well as Canada. As we look at this in the future, it seems to us that these conditions will continue for the next several quarters. No guarantee of course, but if the polyester pricing, there is a lot of production capacity in China and our intelligence in China on the ground tells us that it’s still a very weak economy, potentially weaker than published information. So given that exports remain weak out of China, consumer spending, we don’t think it’s that great from what our own on the ground. I am intelligent to tell this, China is likely to remain soft and underutilized in this particular area in the polyester fiber, polyester yarn production areas. So, therefore, we believe the currency will – has a most likely to continue weakening gradually over time. So those are two big tailwinds for us that seem to us in the near term to continue the way they are.

Okay. Thank you very much. I’ll let others have the floor.

All right. Thank you, Budd.

Thanks, Budd.

[Operator Instructions] We’ll go next to John Baugh with Stifel.

Thank you. Good morning. Congratulations, Frank, Ken and all Culp team. Great quarter.

Thank you.

Yes, thanks.

Let’s start with bedding, some uncertainty with respect to demand trends for the rest of fiscal 2017, what’s precisely does that mean, because you’ve had pretty good numbers obviously, I think you commented slight unit growth here in Q1. Are you trying to tell us the uncertainty going forward is worst, I don’t know the calendar year-to-date or am I reading something in there that’s not there?

I think I would characterize it is this, John, we see the mattress business as just okay. I am not sure we see a lot of growth. Everybody is waiting on, of course, this weekend, are we going to be flat, up, backwards. It seems to us that we are going to be about equal to last year. We are not going to have much growth, but it’s not going to be too far off either. Of course, the election concerns us as what consumers will do over the next two months, heavy political advertising may get in the way of mattress advertising. So, October is the weakest month of the year in bedding, one of the we have not the weakest and so we are just a little concerned about that and we were hopeful post-election maybe it will pick up some. And we’ll see a little strength there, but it concerns us. It seems an uncertain outlook. So, what we do and what the strategy has been is you’ve seen, we’ve diversified our offerings. We have got in the last few years into the mattress cover business. We also are doing specialty products, not just mattress fabrics, but fabrics with lamination, with FR treatments, other things that drive the ASP up on the same unit sales level. So we are getting sales – a pretty good sales gain without a whole lot of unit growth and so, that’s been our strategy and will continue to be.

Great. Thanks for the color. Segment gross margins were up dramatically in both businesses and you had SG&A which is up slightly. So I am curious on the dynamic that’s driving SG&A up a little bit. Is that mix related? And talk to us about the gross margin gains, how sustainable is that? You call that – or you talked a little bit already about inputs in Canadian and Chinese currency is helping, but just trying to get a sense to how we model that going forward.

Okay, again, great question, John. In the mattress fabric area, there is three factors. Number one, sales growth, clearly helps. Number two, lower input costs and number three the benefit of our capital improvement projects and all three are benefiting and maybe the yarn input cost would be the biggest impact of the three, but they are all three pretty sizable. So then the question is, which ones are sustainable? Without a doubt, the capital improvements we’ve made have been on point and those are clearly sustainable to lower our conversion cost in our facilities and offer better service and throughput to our customers. The raw material, we can see out probably two quarters at most in terms of our purchase orders and it seems to hold for a couple of quarters. After that, we will see what happens. We think it’s likely to stay down with the global growth situation still weak, that probably argues for lower for longer on polyester prices. On sales growth, we like our strategy of diversifying our – as you’ve heard us talk about diversifying with the mattress cover business, we’ve got a full core press going on the internet bedding space. Anybody’s guess how strong that will be, but we are positioned perfectly to benefit from whatever growth that new segment garners. And we continue to do things that can add value to our customers like when we take products and laminate FR treatments and then we slip down. So we can ship to customer a finished 13 inch border fabric and they don’t have to have that operation in their plant or they can have reduced FR components in the body of the mattress. So, things like that we will continue doing as well.

What about on upholstery gross margin comments there? And then, working SG&A and what’s driving that? Thanks.

Okay, in upholstery fabrics, it’s really – I would say, three factors. Number one is our focus on innovation and creativity like our new line of stain-resistant fabrics, the I-CLEAN that we are doing at La-Z-Boy and then our list LIVESMART brand that we are doing with other customers being introduced at this October market. We are – our new product introductions are carrying higher margins than they used to. Secondly, we continue to diversify there as well, for example, in our growth in our hospitality and contract area, that has been – we were very pleased with the growth in that segment although a smaller piece of the upholstery fabric segment, we also are growing, again the small piece with our shipments out of China both within China and exports. And lastly, we are benefiting on the margin side from the lower currency and the Chinese currency versus a year ago is considerably weaker. Now a lot of – a good portion of that is given back to customers due to competition and customer request or demand as it might be. But we are benefiting from the lower currency. SG&A in both divisions with the better performance, incentive comp is up year-over-year, but those who have followed us for a long time know we do control our costs very well and that was something we will continue doing not only manufacturing but SG&A as well.

Super. CapEx $12 million this year, could you tell us how much is maintenance? How much is going to expansion? And how much is going to – what I would – I don’t know if cost or productivity related benefits down the road?

Of the $12 million, most of that is in the mattress fabric segment as we’ve said and it is a combination of both factors, most of which is expansion and productivity. For example, the knit machines we put in up in our Canadian operation is an expansion of the knit capacity. We are adding – expanding our distribution facility in our Stokesdale, North Carolina operation. You know, that’s not an equipment expansion but it is an expansion it is allowing us to do a better job of delivering quickly to our customers. So, the majority on an ongoing basis, I think maintenance level is probably our best guess is 3 to 4 for maintenance level on an ongoing basis.

Okay, and last quickly, AR looks like it was down $3 million year-over-year and inventories grew very little sustainable unusual timing?

Ken and I are very pleased with the working capital management and again, those who have followed us for a long time know that working capital management, while not glamorous, it’s not sexy, it’s very, very important to free cash flow. I am pleased with our inventory. We’ve done a great job start-off the year in our mattress fabric division and upholstery fabric inventories are up, but they are only up because we were getting prepared for the G20 shutdowns which are happening this week and next week in the Hangzhou area of China. And I think we are going to – we will see those trend back down. So, even with the build in upholstery fabrics, we had improved turns and I think some of the initiatives we have going on in both businesses will improve inventory turns over the rest of the year. In terms of receivables, some of that is mix too. Our days sales in mattress fabrics are less than upholstery because most of the people take the discount and so we have a higher mix of mattress fabrics in Q1 than we’ve traditionally had in upholstery. So mix is helping. But we are also doing a great job. Hats off to our credit department and they are on top of – when we ship it we want to be paid and we are on top of it, if that didn’t happen.

Congrats. Good luck. Thank you.

Thank you, John.

We’ll go next to Marco Rodriguez with Stonegate Capital Markets.

Good morning guys. Thank you for taking my questions.

Good morning.

Most of my questions have actually already been asked and answered, just a couple quick follow-ups in regard to some of your responses. Just first on the mattress side, in response to the question on the bedding environment that you see for the second half of 2017 that uncertainty, you made a comment that said that you are kind of expecting that business to be about equal to last year. Now are you referring to a revenue standpoint or a growth standpoint of that revenue or something else?

We are referring to industry demand.

Industry demand. Got you. Got you, okay. And then, last question here, on the gross margin improvement that you saw in mattress fabrics here a year for example, solid 280 basis points. Just wondering if you can give us a little bit better of a sense, kind of put some numbers on it, what – of that growth, I mean, how much of that is the improvements and efficiencies and how much of it is in the lower input costs?

Well, I think what I said earlier was those three factors. Sales growth, input cost and capital expenditure projects, the two bigger ones of the three were the benefit from sales growth, fixed cost leverage and lower input cost. But that doesn’t mean that the other one was small. So, that gives you any flavor to the relative contributions of each.

Okay, great. Thanks a lot guys. Appreciate it.

You bet. Thank you, Marco.

Thanks.

And with no further questions in queue, I’d like to turn it back over to our speakers for any additional or closing remarks.

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

This does conclude today’s conference. We thank you for your participation. You may now disconnect.