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

John Baugh - Stifel Bobby Griffin - Raymond James Marco Rodriguez - Stonegate Capital Markets Robert Vermillion - F/64 Capital

Good day, everyone and welcome to the Culp, Inc. Fiscal 2017 Second Quarter Conference Call. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Ms. Dru 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 second 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 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.

Good morning, everyone and thank you for joining us today. I would like to welcome you to the Culp quarterly conference call with analysts and investors. With me on the call today is Ken Bowling, our Chief Financial Officer. I will begin the call with some brief comments and Ken will then review the financial results for the quarter and then I will update you on the strategic actions in each of our businesses. After that, Ken will review our third quarter outlook and we will be happy to take your questions. Our overall sales for the second quarter were slightly below the same quarter last year, reflecting a softer retail demand environment for home furnishings. However, in spite of the lower sales, we delivered a strong operating performance in earnings, margins, return on capital and free cash flow as Ken will explain shortly. Our strategic focus on creative designs, innovation and exceptional customer service supported by an increasingly efficient and responsive manufacturing platform continues to drive our performance and set Culp apart. With respect to our year-to-date performance, we are pleased with a 16% increase in pre-tax income and the 150 basis point increase in pre-tax margin. Importantly, we also have the financial strength to make the strategic investments to further enhance our operations and support our growth. And at the same time, we returned funds to shareholders. We are pleased to announce a 14% increase in our quarterly dividend from $0.07 to $0.08 per share or $0.32 on an annual basis. We have consistently increased our quarterly dividend every year since we reinstated it in June 2012, which we started then at an annualized rate of $0.12. This is in line with our stated capital allocation strategy. Now, I will 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 to cover key performance measures. We have also posted our capital allocation strategy. Here are the financial highlights for the second quarter. Net sales were $75.3 million, down 2% over the prior year with mattress fabrics sales basically flat compared to last year and upholstery fabric sales down 5%. Pre-tax income was $7.2 million, up 17% compared with the prior year period. Pre-tax income margin was up 150 basis points from the previous year. Adjusted net income, a non-GAAP measure, was $5.9 million or $0.47 per diluted share compared with $5.2 million or $0.41 per diluted share for the prior year period. The company’s overall adjusted effective income tax rate through the second quarter was 17.8%, up from 15.7% for the same period last year. This increase was due primarily to higher projected pre-tax income for our China and Canadian operations. Trailing 12 months adjusted EBITDA was $40.2 million, up from $33.9 million for the same period a year ago, representing a 19% increase. As a percent of sales, trailing 12 months adjusted EBITDA was 12.9%, an increase of 220 basis points as compared to the same period a year ago. Annualized consolidated return on capital was 34% compared with 32% a year ago. We are pleased with this improvement as operating income through the first half of this fiscal year was up 16%, while capital employed only increased 7%. Now, let’s take a look at our two businesses. For mattress fabrics, operating income was $7.5 million, up 15% over a year ago and operating income margin was 16.4%, up 220 basis points. This performance reflects the benefit of our recent capital investments with improvement also coming from an increase in manufacturing efficiencies and lower input cost. Annualized return on capital for mattress fabrics was 42% compared with 38% a year ago. For upholstery fabrics, operating income was $2.5 million, up 1% and operating income margin was 8.4%, up 60 basis points over last year. Our focused efforts on product and customer mix as well as a more favorable currency impact this fiscal year contributed to the modest improvement in our operating performance. Annualized return on capital was 63% compared with 62% last year. One final comment regarding our operating performance, through the first half of this fiscal year, both divisions have 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 invoiced mostly in U.S. dollars, while operating expenses are paid in the local currency. Thus, as the Chinese yuan or the Canadian dollar weakens relative to the U.S. dollar, our operating costs go down. Of course, the opposite is true if the currency strengthens. Here are the balance sheet highlights. We have maintained a strong financial position with cash and cash equivalents, short-term investments and long-term investments held-to-maturity of $47.4 million at the end of the quarter, up $5.3 million from the end of last fiscal year. This increase was achieved despite spending $6.3 million on capital expenditures and $4.3 million on dividends during the first 6 months of this fiscal year. Notably, we paid our outstanding line of credit during the quarter and we are once again debt free. Free cash flow for the first half of this fiscal year was $9.5 million compared with $6.4 million a year ago, representing a 48% increase. This improvement is primarily due to increased earnings and improved working capital management, especially inventory and accounts receivable management. Looking ahead, we expect another strong year of free cash flow with capital expenditures mostly related to expansion and efficiency improvement projects for our mattress fabric business projected to be approximately $12 million along with some modest growth in working capital. Depreciation, amortization and stock compensation expense are expected to be approximately $10 million for the year. Frank?

Thanks, Ken. I will now provide you with an update on both of our operating segments. Let’s start with mattress fabrics. We continued to deliver a strong operating performance in mattress fabrics in spite of challenging market conditions during the second quarter. We are pleased with our strategic execution this year and our ability to outperform industry trends. Our results reflect the benefits of our major capital investments with increased capacity, enhanced finishing capabilities and overall improved efficiency and throughput. We also benefited from lower input costs compared with a year ago. Importantly, we are continuing to make additional significant investments that will drive greater efficiencies and responsiveness and enhance our ability to serve customers. We are near completion in North Carolina with our latest project to further expand our production capacity and make major improvements to our distribution capabilities. We are planning more facility consolidation and equipment relocation to further streamline our production platform and to support our continuous improvement initiatives and support our long-term growth strategy. This consolidation will involve relocating the knit fabric operation from our facility in High Point, North Carolina to our expanded facility in Stokesdale, North Carolina about 30 miles away. The benefits of this move include savings in the area of freight, labor and lease cost. Additionally, the move will improve our reactive capacity and provide our ability to substantially increase net production. We expect this consolidation to begin in February and take approximately 5 months to complete. We project annual savings of $1 million to $1.5 million once the project is completed. Additionally, we have made great progress with our Canadian expansion project, including additional knitting equipment, enhanced finishing capabilities and a new distribution platform that will allow us to improve deliveries and sell directly to our customers in Canada. We expect to commence our expanded distribution operations in the fourth quarter of this fiscal year. We also had a solid second quarter performance and year-to-date for CLASS, our mattress cover business. Importantly, CLASS provides opportunities to reach both traditional customers and new market segments, especially the fast growing Internet bedding space. We are also in the final planning stages to expand our production capacity for mattress covers through a new production facility located in Haiti. This cut-and-saw facility, which will be a joint venture with our existing marketing joint venture partner for mattress covers, will be located in a modern industrial park on the Northeast border of Haiti, which borders the Dominican Republic. This new facility which is expected to commence operations in the first half of next fiscal year will complement our existing production capabilities with a mirrored platform and enhance our ability to meet customer demand while remaining cost competitive. Other benefits of this strategic move include the lowest labor cost in this hemisphere and the most favorable tariff and duty rules also in this hemisphere. Culp’s investment in this project is expected to be $1.5 million to $2 million. With our enhanced infrastructure and competitive advantages, we believe we are well-positioned to drive our long-term performance in mattress fabrics. We will continue to be strategic in targeting customers who value our innovation and our compelling value proposition. Now, I will comment on upholstery fabrics. Our sales for the second quarter reflected softer retail demand for residential furniture. However, even with lower sales, we are pleased with our overall operating performance compared with the second quarter of last year. We continued to drive innovation and creativity as we execute our product driven strategy. Our flexible global platform supports this strategy and allows us to meet the changing demands of our customers with exceptional quality and service. We continue to drive innovation as we strive to stay current with the latest style trends. For example, one of our newest products is getting a lot of favorable attention. We previously mentioned the introduction of our new performance line of highly durable, stain-resistant fabrics with a favorable response in the marketplace. We are very encouraged by our showing at the recent October furniture market in High Point. We have recently launched a new marketing campaign to promote this innovative product line and we look forward to the sales opportunities ahead. Looking ahead, we are increasingly optimistic about the potential for an improved demand in the home furnishings industry given the recent uptick in consumer confidence and the improvement in other economic indicators. In summary, we are pleased with the second quarter and the year-to-date performance in both of our businesses. With our reputation for design excellence, innovative products, exceptional customer service, substantial investments in our mattress fabric business and our strong cash position, we are well-positioned for continued success in fiscal 2017, especially as the market conditions improve. Ken will now review the outlook and then we will take your questions.

We expect overall sales to be flat to slightly lower than the third quarter of last year, primarily due to the timing of the Chinese New Year in our upholstery fabrics business. We expect mattress fabrics sales to be slightly higher than in the third quarter of last year. Operating income and margins are expected to be slightly higher compared to the same period a year ago. Upholstery fabrics sales and operating income and margins are expected to be moderately lower when compared with the same period last year. The timing of the Chinese New Year holiday will have a greater impact on our upholstery fabrics business in the third quarter as the holiday occurs in January this coming year as opposed to occurring in February last year. Considering these factors, we expect to report pre-tax income for the third fiscal quarter in the range of $6.7 million to $7.3 million. Pre-tax income for last year’s third quarter was $7.2 million. With that, we will now take your questions.

Thank you. [Operator Instructions] And we will first hear from John Baugh of Stifel.

Good morning. Thanks for taking my questions. Could you first address, I think you mentioned mix trends were favorable? Could you maybe go into each segment, tell us what you are seeing, particularly in mattresses maybe what you saw in the units versus dollars? And I am curious, you are building this facility in Haiti, does that somehow imply that you expect maybe stronger demand at the lower end of the future or no, that’s just a low cost producing decision that makes sense?

Okay. Good morning, John. I hope you are doing well. I will take your second part of your question first. And the key reason for Haiti is to expand our production. We believe we are going to see – we are seeing and we will continue to see growth in the mattress cover area both from traditional customers and the new internet bedding space customers. So, it is a capacity expansion move. We also believe that as we said in the comments that we need both facilities, the North Carolina and the Haiti location, because the bigger customers with fewer SKUs, bigger volumes, will want to move to a lower cost option while many customers who have smaller volumes will have the responsiveness that we offer with the North Carolina facility. So, we are excited about that. I think it’s a great move to expand capacity for us and we are excited about it. Secondly, the mix trends in terms of pricing, is about the same, no change in pricing or units that we have been seeing. Certainly in our second quarter, we called out the fact that our mattress cover business is having a nice year. So, that certainly is the higher growth part of our business today and certainly looks good. But I would also recall something I have said on earlier calls we are agnostic about whether we sell the Internet bedding people or the traditional customers. They all use mattress tickings and they all use covers, mattress covers.

So Frank, were your units in mattress covers down slightly, flat, what were the unit trends there?

Units in mattress covers were up. I think it’s about the same. I don’t see any major changes there. But also just on the other one, I know that we have got about – when you look at the Internet bedding players, we have got business and projects currently with about 20 of them going on now. So, we have – we continue to have a full core press on this growing new segment.

Okay. And then could you tell us – I know it’s early days with Trump tariffs, new policies, but perhaps discuss your furniture business, which is obviously Chinese-centric. How you think about changes that could come and what impact they might have to Culp? Thank you.

Okay. It’s certainly our belief that we are going to benefit and our industry is going to benefit from a higher economic growth rate in the United States and that will benefit and we will see more mattresses and furniture purchased over the years ahead, certainly, our hope. As it pertains to trade policies and tariff policies, we don’t believe we are going to see anything significant out of that in China to affect us. We do believe we could continue to see a lower Chinese yuan vis-à-vis the U.S. dollar. As interest rates move up in the United States, China really has to keep its currency in line with other currencies, the euro and the yen and the other currencies in Asia. So, this benefits us. As you have seen in our margins in upholstery fabrics over the last 2 years, it’s a very nice tailwind which we believe is going to continue and I just don’t see major trade tariffs put on to hurt our shipments from China.

If they did for some reason go up, Frank, what are your options or is everybody in the same boat? So, it’s not a relative competitive issue or any speculation if we did see some measurable tariffs?

John, if they did go up, as we talk about a lot here, 90% of upholstery fabrics on residential furniture in the United States come from China. So, everybody is in the same boat and there just isn’t the infrastructure in the U.S. to handle it. And as we look worldwide at other places where it might move to which you might guess we are always and have been looking at that, it’s not going to move to India, too bureaucratic, too high cost. It’s not moving to Turkey with all the problems there, not moving to South America, so China is it. And I think what appears to us we invoice mostly, as Ken mentioned, in U.S. dollars and both – 90% of our cost of goods sold is in renminbi. And then this has been good for us and I expect it will continue to be good for us.

Great. Thanks for taking my questions and answering them. Good luck.

Next we will hear from Budd Bugatch of Raymond James.

Hey, guys. This is Bobby filling in for Budd. I appreciate you taking my questions.

Good morning, Bobby.

Good morning. Just I wanted to touch quickly on the mattress fabrics again and really on the margin and the 220 basis points that we saw in year-over-year expansion. Can you maybe parse out how much of that is from the better throughput and the new efficient machinery and the capital investments first, how much is coming from just favorable raw maternal environment?

Yes. Bobby, as you said, those are the two key reasons. There is a third reason also is the Canadian operation is benefiting from a lower currency. But the bigger two reasons are the lower input cost and the benefits of the capital investments we have already made. So that of those three reasons, the input, lower input cost is the largest, then the benefits and then the Canadian currency gain. And it’s also makes sense because as we have said before, mattress fabrics, 65% of our cost of goods sold is raw materials. And Bobby, it’s kind of added to that as we have caught out in the prepared remarks I mean they have done a great job in their inventory management too. So we have year-over-year pressures from that. I mean that was part of the improvement this quarter as well.

Okay, that’s helpful. And then Frank, can you maybe refresh us on exactly I guess how do your contracts for raw materials work and maybe what is the typical lag between changes that we might see on our side of the street in the spot market versus when you guys start to see kind of a tick up in raw material costs?

Okay. Bobby, that’s a great question and we look at that every single week. We are now out – our typical pattern is out 16 to 20 weeks. So, we are pretty well now. We feel well covered through our Q4 period and starting to feel pretty good about Q1, with the POs that we place every week now. I think we don’t see any impact on higher polyester prices. We might have been expecting a little but we are not seeing it globally.

Okay. And then just lastly on the upholstery side just into some of the cost, is the wage inflation in China that we have talked about before in the past still kind of taking in the same direction around the same pace?

It is. You are going to see China continue to raise their wages, probably 12% to 13%, countrywide. What’s also affecting cost over there is the environmental focus on their dye houses. So, the dying cost is going up as there is fewer players, more pollution, control equipment, etcetera. However, the weaker currency is offsetting those increases.

With your partners there and the focus on the dye houses and stuff like that, I mean is that something that we should be thinking about in terms of increased costs that you guys might face, your partners might face?

I mean they have been. That’s something that had been going on.

Okay.

But it’s been more than offset by the favorable currency rates. Currencies are down over the last 2 years, 10%. The currency, Chinese currency who little over 2 years ago was 6.05, right now it’s almost 6.9. It’s hit a 7, 6 – 7-year low.

Okay, I appreciate the detail. Those are my questions. So, best of luck next quarter and thanks again.

Super. Thank you.

Thanks.

Next we will hear from Marco Rodriguez of Stonegate Capital Markets.

Good morning, guys. Thank you for taking my questions.

Good morning.

I was wondering if you guys could talk maybe a little bit more about the Canadian expansion and specifically on the distribution aspects, if you could provide a little more color in terms of what that’s going to look like and is it a function of getting product to clients faster or is it a wider net that you are able to spread? Any kind of color there would be helpful.

Sure. The primary objective in Canada, first of all, Canada bedding business is about the size of California. So, it’s a nice size market, but it’s not anywhere near the size of the entire U.S. And the Canadians up there generally like to buy from the Canadian players. There is only one other local producer in Canada. Historically, what we have done is we have done knitting and weaving up there and we have done the finishing and distribution from North Carolina and then ship the product back up to Canadian customers. Well as you can imagine, we have got some extra cost and we aren’t quite as competitive as our competitor in Canada. So, we decided to put finishing capabilities and distribution in Canada, which we are in the process of doing now. And that will be ready to go in our fourth quarter and we will have the space for distribution and we will have the full finishing capability there and we will be able to start shipping customers. And by the way, our customers up there are very excited to have another player in the market that can ship, can produce and ship and bill in Canadian dollars. So, it’s a nice area of growth for us. It could be over time – it’s not a big market in Southern California, 5 million to 10 million of incremental volume.

Got it. Very helpful. And then a follow-up question here on the Asian [ph] expansion or the Haiti expansion. I heard your response to the prior question that you are seeing demand there from traditional mattress and Internet mattress sales. I am just curious here, is this demand that you are seeing, is this something anecdotal you are noticing or is this something specific coming from particular clients? Any kind of color there would be helpful.

I would say it’s certainly the demand from the Internet bedding space customers. All of those products require a mattress cover. They do not have any production facilities as you probably know. So all of that business as it grows needs mattress cover. And secondly, the traditional customer service, Simmons, Sealy Tambour, that part of that memory foam business also is pretty significant. And they – each of them have big programs which they like having some of those larger programs made in lower cost countries on the cut-and-saw aspect. But important to note the fabric manufacturing is not moving fast and none of our competitors or us, the fabric manufacturing is remaining in the United States. And the reason is labor costs are so low in making mattress fabrics that it doesn’t make economic sense to move the fabric manufacturing. So, we like Haiti, because it’s the lowest labor cost in this hemisphere. We like the tariff and duty rules, the favorable there and the lead times. The shipping times are 5 days, 3 to 5 days we can get it from Haiti to North Carolina.

Got it. That’s helpful. And then last quick question, I will jump back in queue. The new – on the fabric side, the new performance line that you have recently launched here, you talked a little bit in your prepared remarks about a new marketing campaign. Can you provide a little bit more detail in terms of what that looks like and how long it’s going to be rolled out?

Well, the marketing campaign is basically advertising in our trade paper, the Furniture Today, and we are doing a number of ads over several issues over the next few months. And of course, we have also got all the point of sales materials for our customers. So when they are showing their product in High Point in April, we provide all of that material for them also as well as hangtags on furniture that they might make and ship to retail.

Got it. Thanks a lot guys. I appreciate your time.

Super. Thank you.

Thank you.

[Operator Instructions] Next, we will hear from Robert Vermillion of F/64 Capital.

Yes, hi good morning. Thanks for taking my question.

Good morning.

Good morning. My question is on the operating margin guidance in mattresses, I believe you said that it will be slightly higher year-over-year in Q3. That implies a sequential decline from Q2 and obviously much less improvement than what we saw in Q2, which I think has a little over 200 basis point improvement year-over-year. What’s driving that decline in margin exportation?

And there is one of the factors there, as we start looking at this, there is some cost of relocation projects that we talked about. And also we could be on the conservative side there for that guidance. When – so, you are right to point out we have had darn good margins over the first two quarters and certainly hopeful that we could do better than that guidance.

Okay, great. Thank you.

[Operator Instructions] It appears there are no further questions at this time.

Okay. Thank you everyone for joining us today and we look forward to updating you after our third quarter. Have a great day.

And that does conclude today’s conference. Thank you all for your participation. You may now disconnect.