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

Dillard Watt - Stifel Marco Rodriguez - Stonegate Capital Markets

Good day and welcome to the Culp, Inc.’s Fiscal 2017 Third Quarter Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference 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 third 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 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 of Culp. Please go ahead, sir.

Good morning, and thanks everyone, and thanks 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. I will then update you on the strategic actions at each of our businesses. And then after that, Ken will review the fourth quarter and full year outlook. We will then be happy to answer your questions. We are pleased with our operating performance for the third quarter and year-to-date period. Our overall sales for the third quarter were slightly lower than the same quarter last year, reflecting an uncertain economic environment and softer consumer demand trends for home furnishings. Our mattress fabrics sales showed year-over-year improvement, in spite of a more challenging marketplace. While our upholstery fabric sales were affected by the timing of the Chinese New Year holiday, they started in January of this year as opposed to February last year. For both businesses, we have remained focused on our top strategic priorities to drive product innovation and creativity, and provide a diverse product mix that meets the changing demands of our customers. At the same time, we continue to make the right investments to enhance our operating efficiencies and take advantage of new growth opportunities. We’re especially pleased with our performance in our mattress fabric business in spite of the significant disruptions related to the ongoing transformational projects in each of our facilities this fiscal year. Importantly, we’ve also strengthened our financial position with excellent cash flow from operations and free cash flow and also high returns on capital through the first nine month of this fiscal year. I will now turn the call over to Ken.

Thank you, 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 for your review. Here are the financial highlights for the quarter. Net sales were $76.2 million, down 3% compared with the prior year with mattress fabrics sales up almost 4% while upholstery fabric sales were down 11%. Pre-tax income was $7 million, which included approximately $200,000 of plant consolidated expenses, down 3% compared with the prior year period. Pre-tax income margin was up 10 basis points from the previous year. Net income was $6.3 million, up from $4.9 million a year ago. Contributing to this year-over-year improvement was a lower effective GAAP income tax rate as compared to last year. The effective income tax rate was 9.2% for this quarter compared with 32.3% from the third quarter of last year. This decrease in the effective income tax rate was primarily due to a $2.1 million reversal of an uncertain income tax position, associated with the foreign jurisdiction in which statute limitations expired. Adjusted net income, a non-GAAP measure, was $5.8 million or $0.47 per diluted share compared with $5.9 million or $0.47 per diluted share for the prior year period. The Company’s overall adjusted effective income tax rate through the third quarter was 16.6%, down from 17.8% for the same period last year. This decrease in our adjusted income tax rate was primarily due to lower projected pre-tax income for our China operations. Trailing 12-month adjusted EBITDA was $40.4 million, up from $36 million for the same period a year ago, representing a 12% increase. As a percent of sales, trailing 12 months adjusted EBITDA was 13%, an increase of 90 basis points as compared with the same period a year ago. Annualized consolidated return on capital was 32%, which was equal to the same time last year. Now, let’s take a look at our two businesses. For mattress fabrics, operating income was $6.4 million, up 10% over a year ago and operating income margin was 13.9%, up 80 basis points. This performance reflects lower input cost and the benefits of our recent capital investments. Notably, we were to able to achieve a strong operating performance in spite of the extensive changes underway across our production facilities within this business. Annualized return on capital for mattress fabrics was 39% compared with 36% a year ago. For upholstery fabrics, operating income was $3.1 million, down 19% from last year and operating income margin was 10%, down 110 basis points. These results reflect the lower sales due to the soft retail demand production disruptions related to the Chinese New Year holiday. Despite these challenges, the upholstery fabrics business still achieved a double-digit operating margin. Annualized return on capital for the upholstery business continues to be very impressive, coming in at 65%. Here are the balance sheet highlights. We continue to maintain a strong financial position with cash and cash equivalences, short-term investments and long-term investments held to maturity of $48.9 million at the end of this quarter, up $6.8 million from the end of last fiscal year. This increase was achieved despite spending $10.3 million on capital expenditures including expenses that were vendor-financed and $5.3 million on dividends during the first nine month of fiscal year. Notably, we had no outstanding balance on our lines of credit at the end of the quarter, thus remaining debt free. Year-to-date cash flow from operations was $24.2 million compared with $15.9 million last year. Year-to-date free cash flow was $12.2 million compared with $8.2 million a year ago, representing a 48% increase. This significant improvement is primarily due to increased earnings and improved working capital management, especially with regard to inventory management. Operating working capital which represents accounts receivable plus inventory less accounts payable was down 17% from the previous year period. Frank?

Thank you, Ken. I will now provide an update on both of our operating segments. And let’s first start with mattress fabrics. Our mattress fabrics sales for the third quarter were in line with expectations as we continued to demonstrate consistent execution in a challenging market environment. With our strategic focus on creative designs and innovative and diverse product offerings, we have outperformed current mattress industry trends thus far in fiscal 2017. Our mirrored manufacturing platform, technical expertise and expanded reactive capacity support our sales efforts with outstanding customer service and delivery performance. We are especially pleased with our strong operating performance during a period of transition across our production facilities. We have been very strategic with our planned capital investments over the past 15 months providing increased capacity via newer, more efficient equipment, expanded finishing capabilities and better overall service and throughput. Throughout this fiscal year, we have improved our operations and enhanced our ability to serve customers, while at the same time reacting to changing demand trends. Our expansion projects in North Carolina including our new distribution center, are expected to be completed in the fourth quarter of fiscal 2017. We are underway with our planned knitted fabric plant consolidation project in North Carolina that will streamline our production platform and more effectively support our continuous improvement initiatives and long-term strategy. The estimated annual cost savings for this project are in the $1 million to $1.5 million range. Additionally, we have made excellent progress with our Canadian expansion project, including the installation of new finishing equipment and a new Canadian distribution center, both of which are expected to commence operations in our fourth quarter. Finally, we’re excited about and have started construction on our previously announced joint venture mattress cover production facility in Haiti, which will complement our existing facilities with a mirrored platform, thus improving our ability to meet customer demand while adding the lower cost operations to our cut-and-saw platform. We’re expecting production to begin in our second fiscal quarter of next year. Notably, even with all these major projects, we continued to deliver favorable results in the third quarter. More importantly, we’re strategically positioned to capture new market opportunities and drive long-term performance. As we have mentioned, industry disruptions and demand trends have called some short-term uncertainty in the mattress fabric and mattress businesses. Some of these disruptions involve major customers of our mattress fabric division, including changes to the distribution channels of at least one significant customer. As a result, we have indications from a customer that there will be reductions in orders from them, but at the same time, we have indications from other large customers that our level of business with them is expected to increase. The structure of our supply arrangements and contracts with major customers is such that it’s difficult to demand predictions with certainty. However, we’re increasingly optimistic that we can expect that challenges with certain customers will be offset by sales gains and increased opportunities with others. We believe that our supply agreements are aligned with customers that depend on and support Culp’s value proposition and upon which we can earn a fair return. In spite of the recent changes in the mattress industry, we’re well-positioned to execute our strategy. Design and innovation continue to distinguish us in the marketplace and remain our top priorities to meet customer style preferences and changing demand trends. With a full complement of mattress fabrics and sewn covers across all price points, we’ve have a solid market position throughout the industry. CLASS, our mattress cover business, offers new opportunities with both our traditional customers and new market segments, especially the fast-growing internet bedding space. Looking ahead, while we expect some uncertain demand trends in the short-term, we’ve worked hard to create a sustainable platform in this business that will position us for the long term. We’re confident in our ability to deliver another solid performance this year and beyond in our mattress fabrics business. Now, let’s turn to upholstery fabric. As expected, sales in this because were lower compared with same period last year, primarily due to timing of Chinese New Year. With 92% of our upholstery fabric sales coming from our China platform, this extended holiday break had a significant impact on our business in Q3. We also faced continued soft demand across the furniture -- residential furniture business as the U.S. economic uncertainties have kept more consumers on the sidelines. In spite of the challenging conditions, we’ve remained focused on our product-driven strategy. For example, we’ve seen positive trends in demand for our latest ‘performance’ line of highly durable stain-resistant fabric. We are also pleased with the meaningful sales growth for this fiscal year in the hospitality segment, which is a key focus area for our diversification strategy. We are excited about the potential growth opportunities for both of these product areas. While the short-term outlook is challenging given the current soft trends in the economy and our industry, we believe we’re well-positioned for the long-term in upholstery fabrics. As market conditions evolve, we expect to benefit from more favorable demand trends and look forward to the opportunities ahead. I also wanted to take a moment and update you on our acquisition strategy and efforts. As we have stated earlier, we have been open to acquisition opportunities in the mattress fabrics industry after completing three excel acquisitions over the past 10 years. For the foreseeable future, however, it does not appear likely that target companies will either be available or available at prices that are acceptable to us. Additionally, as part of our strategy to grow our business in the hospitality market, we are open to acquisition opportunities in this segment. We have experienced excellent organic growth in this business over the past several years. We believe our value propositions market is strong and that this segment offers excellent long-term growth opportunity for Culp both organically and through acquisitions. In summary, we’re pleased with our results to date in fiscal 2017, in spite of a challenging retail environment and the implementation of ongoing major projects in our mattress fabrics business. We’ve maintained a strong competitive position in both businesses with creative designs, innovative product offerings and a flexible and scalable global manufacturing platform. At the same time, we believe our ongoing significant capital investments and strategic initiatives will enhance our ability to respond to new market opportunities. It will strengthen our competitive position and provide increased value to our customers. While the short-term outlook remains uncertain, we believe that fiscal 2017 as a whole will reflect another strong operating performance for Culp. Ken will now review our outlook for the fourth quarter and year and then we’ll take your questions.

As we face an uncertain U.S. economic outlook and challenging retail environment for home furnishings, we expect overall sales to be slightly lower compared with the fourth quarter of last fiscal year. For the year, we expect sales to be flat to slightly lower than last year’s annual sales. We expect to report pre-tax income for the fourth quarter in the range of $6.5 million to $7.1 million, including approximately $400,000 of expected plant consolidation expenses. Pre-tax income for last year’s fourth quarter was $7.2 million. For fiscal 2017 as a whole, we expect pre-tax income in the range of $29.2 million to $29.8 million, exceeding $27.9 million in pre-tax income last fiscal year, the highest level achieved in the Company’s history. With regard to capital expenditures, we expect spending for fiscal 2017 to be in the range of $12 million to $15 million, mostly related to expansion and efficiency improvement projects for mattress fabrics. Depreciation, amortization and stock compensation expenses are expected to be approximately $10 million for this fiscal year. As we take a closer look at our capital expenditure spending over the past few years, we have incurred a higher than normal level of spending. We believe the significant investments we have made will support our growth strategy and provide flexibility to meet expected demand trends. Looking ahead to fiscal 2018 and beyond, we expect our CapEx spending to be somewhat lower in fiscal 2018 as compared to fiscal 2017, and return to a more normalized level by fiscal 2019. Finally, we expect another year of strong free cash flow in fiscal 2017. And with that, we’ll take your question.

[Operator Instructions] We will go first to Dillard Watt of Stifel.

I wanted to talk about mattress margins a little bit. I think a year or two ago, we had talked a little bit about sort of goal or longer term assumption, somewhere in the low teens; obviously here in the mid teens today. And I know over some previous quarters, there has been some raw material benefit. But I wanted to hear your thoughts on what you expect from mattress fabrics margins moving forward.

Okay. Good morning, again, Dillard. Good question. We have -- we are certainly performing this fiscal year at a higher level than those long-term margins -- operating margin targets that we mentioned a few years ago. And that is due to of course favorable raw material climate that we’ve had the last 18 months to two years and the benefits of all the capital projects that we’ve done, and of course some sales growth as well. I think my -- our guidance at this point would -- we’re performing at a very high level in terms of our current operating margins. While we always hope they can go up, I think we’re at certainly record margin levels. And it’s probably a reasonable assumption that we near the peak of those.

Okay, thanks. And Frank, would you say that -- obviously, it’s clear you outperformed the overall industry -- at least the industry group reports sales figures at least for the December quarter, we haven’t really heard significant amount of pick up in January. So, I can imagine all of a sudden you swung wildly positive in January. So, I wanted to just get your thoughts on what you think is driving that growth. I have an idea or two. I assume a lot of it is from your work with the online players and of course your product innovation that you discussed. Would you say that it’s correct or anything else that I’ve missed?

No, that’s exactly correct. As you know, a few years ago, we went into the mattress cover business and 18 months ago we really focused even more on that area by adding sales and design resources to go after the bed and the box trade. And that has proven to be two very good moves on our part. I think the, what we call, CLASS, that mattress cover operation will continue to be a significant part, maybe even major part of sales growth. The opportunities there are very good, it seems to us. Also supporting that growth was the key reason for our announcement to expand our production facilities and in Haiti. And we believe we need a hybrid manufacturing model where we have the low cost country facility for larger run that you can plan out better, plus we still have the U.S. facility for the shorter, more timely, shorter delivery time requirement. So, yes, -- the largest factor of our growth is the mattress cover operation and secondly is the design. I mean, our customers are continuing to drive us to more decorative fabrics.

Great, thanks. And Ken, just a couple of quickies for you. Would we expect corporate expense to trend up maybe at similar percentage to sales growth kind of in the fiscal 2018 and beyond or anything there to look out for in the model?

No, I don’t think so. I think if you look at this year’s expenses, we’ve had some stock comp expense increase, but that’s going to even out over the next year. So, I think if you look at next year, I don’t expect any -- it should be pretty comparable.

Okay, great. And then, CapEx, you said lower in fiscal 2018 versus 2017, and then I think I heard you say more normalized levels in 2019. I assume that means even lower in 2019 versus 2018.

Yes. I mean, 2017, obviously we’ve got a bunch of things going on and the reason why we put that range in there is to really give us some room to considering if we had a strong free cash flow quarter, we might pull some things ahead, which will affect next year. But looking ahead, 2018 is going to be lower. And then, 2019, it’s kind of back to what we call, normalized level.

And just what, if you want to through a number out there?

I mean if you look that 6 to 8 overall with maintenance being $4 million to $6 million of that. So overall. $6 million to $8 million maintenance means 4 to 6.

Great. Thank you so much. That answers my questions.

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

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

Good morning.

I wanted to talk a little bit more about the mattress fabrics area specific to the capital investments you’ve been making and the expansion there. Were there any sort of impact to revenue or missed opportunities of revenues there or is that kind of just trending the way you’re expecting right now?

Marco, I would say absolutely no revenue opportunity we’ve missed. I was with our folks yesterday and reviewing everything. And they’ve really done a fabulous job, given all of the moving parts in each facility this year to perform outstandingly for our customers. I have not heard of a single issue. And it really is quite extraordinary.

Great. And if I heard you correctly, it sounded like two of the operations you’re doing, they’re are going to be closing or rather finishing here in this next quarter. Is the capacity that you’re adding there, is that kind of already been spoken for, are you going to need to fill that? And if so, what’s sort of an uptake should we expect there?

It’s pretty much spoken for. We are moving the knitted fabric manufacturing operation. It’s about 30 miles from High Point, North Carolina to Stokesdale, which is really our flagship location where our distribution center is being expanded. So, we’re just moving the machinery and equipment and people from one location to another. But it does give us more square footage to expand our knitted operations. We were really curtailed at the current facility with space. So, as we complete this move by the end of the first quarter next year, we will have ample manufacturing square footage to expand as needed in the knitted fabric area.

Got you. And if you could just remind me the Haiti JV facility that you’re starting construction on, when is that expected to be complete?

We expect that to be completed by the end of the first quarter, we complete it sometime in Q1 of next year and we’re hoping to start production in the second quarter.

Second quarter of fiscal year of 2018?

Yes.

Okay, got you. And then just kind talking about the industry disruptions on the mattress fabric side there, obviously a major customer has some issues here reported that were pretty well documented. I just want to get a little bit better of a feel from you. I know in your prepared remarks you talked about some difficulty in obtaining demand trend. But, you did sound optimistic that you would be able to replace any lost revenue. Can you just kind of walk us through what’s providing you with that optimism level?

It’s difficult because as you know we do not like to mention any particular customers in any kind of our conference calls. But, it’s pretty well documented what is going on in the industry. And for one customer who is losing a lot of business that obviously affect us. But since we’re a major player with those all large customers, we’re increasingly optimistic that we’re going to pick up and offset the business we’re losing with one, we’re going to pick it up with other customers.

Got you. And are you guys having any conversations that are indicating that sales to other customers are going to start to ramp?

Well, as I said in the prepared remarks, we are increasingly optimistic that we will gain business from other customers. For as a result of this disruption in the industry, yes, we’re getting strong indications of that and are increasingly optimistic that will be the case.

Got you. And last quick question and I’ll jump back in the queue, just switching gear to the upholstery fabric side. Just wondering if you might be able to provide any sort of anecdotal information from your end customers, just their thoughts and feelings. I know that obviously the retail environment is being kind of challenging for furniture. If you can just -- maybe talk about what they might be saying as far as their confidence levels or expectations as we go through the rest of this calendar year?

I think what we’re hearing and certainly we share this view, while it has been softer the last couple of months and certainly February started out softer, due to tax reform’s delay, but we’re seeing some pick-up over the last couple of weeks. Our customers are more optimistic over the next few months and certainly for the balance of this calendar year. There is just too many strong macroeconomic indicators that are favorable to keep the consumer spending at what we think. So, we’re quite optimistic we’re going to see a pick up from the consumer over the balance of the year, calendar year. And we’re hearing the same from a lot of our customers.

[Operator Instructions] At this time, we have no further questions. I would like to turn the call back over to our speakers for any additional or closing comments.

Everyone, thank you for joining us today. And we look forward to updating you for our fourth quarter in June. Thank you, operator and everyone.

Thank you, sir. That does conclude our conference for today. We thank you for your participation.