Dru Anderson - Investor Relations Frank Saxon - President and CEO Ken Bowling - SVP, CFO, Treasurer and Corporate Secretary

Beryl Bugatch - Raymond James & Associates, Inc. Marco Rodriguez - Stonegate Capital Markets

Good day and welcome to the Culp’s Fourth Quarter 2018 Earnings Conference Call. Today's conference is being recorded. At this time, for opening remarks and instructions, I'd like to turn the call 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 fourth quarter and fiscal 2018. As we start, let me state that this morning's call will contain forward-looking statements about the business, financial condition 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 fact. 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 measurement is included as a schedule to the company's 8-K filed yesterday and posted on the company's Web site at culp.com. A slide presentation with supporting summary financial information and additional performance charts are also available on the company's Web site as part of the webcast of today's call. With that, I will now turn the call over to Frank Saxon, President and Chief Executive Officer. Please go ahead, sir.

Thank you, Dru. 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'll begin the call with some brief comments and then Ken will review the financial results for the quarter and I'll then update you on the strategic actions in each of our operating segments. After that, Ken, will review our first quarter outlook and then we will be happy to take the questions. We were pleased to finish fiscal 2018 with higher sales for Culp, reflecting growth in both of our businesses. While we had some challenges in the fourth quarter, our mattress fabric division had another record year of overall sales, Our upholstery fabrics division finished the year on strong note as well and we are encouraged by the sales trends in that business. Our results for the year reflect consistent execution of our product driven strategy in both businesses with a relentless focus on design creativity and product innovation. Our ability to offer a diverse product mix and reach new market segments has been a key differentiator for Culp in the marketplace. We have realized the benefits of our substantial investments in our mattress fabric business with enhanced production capabilities and improved efficiencies, supported by excellent customer service. We’ve continued to diversify both our product and customer mix in upholstery fabrics with favorable results. And we recently completed the strategic acquisition of Read Window Products to support and expand our capabilities in the growing hospitality market. We are especially pleased today to announce that we’ve taken a majority interest in eLuxury, an e-commerce company focused on home textile. This strategic partnership substantially expands our addressable market and adds an exciting new sales channel for us. I will have more comments on this transaction in a moment. As we look ahead to the new fiscal year, we're facing a significant challenge with the growth of Chinese imported mattresses and its effect on fabric orders from many of our customers. We are aware of actions being considered by the industry to address this situation in the near-term, and we’re optimistic that these actions will be successful later in our fiscal year. Despite the short-term challenges in the bedding industry, we are confident Culp is well-positioned for the long term with expanding sales channels in markets, outstanding product development capabilities, a highly competitive global manufacturing platform, and a strong balance sheet. I'll now turn the call over to Ken who will review the financial results for the quarter and the year.

Thank you, Frank. As mentioned earlier on the call, we’ve posted slide presentations to our Investor Relations Web site to cover key performance measures and our capital allocation strategy. We've also posted slides that highlight our eLuxury investment. Here are the financial highlights for the fourth quarter. Net sales were $78.2 million, up 1% compared with the prior year. Pre-tax income for the fourth quarter was $6.5 million, down 7.6% compared with the prior year period. Pre-tax income margin was 8.3% compared with 9% a year-ago. Divisional gross profit pressures, which we will cover in more detail shortly were somewhat offset by a significant reduction in SG&A expenses due to much lower incentive compensation cost as compared to the previous year. Net income for the quarter under GAAP was $12.7 million or a $1 per diluted share compared with $6.2 million or $0.49 per diluted share last year. The results for the fourth quarter include a net income tax benefit of $8 million that pertains to requirements under the Tax Cuts and Job Act or Tax Reform, and a settlement of an IRS exam. Adjusted net income, a non-GAAP measure that excludes the impact of tax reform for the quarter was $4.7 million or $0.37 per diluted share. Looking ahead to next fiscal year, we estimate that our consolidated effective income tax rate will be in the range of 26% to 29%. These rates are subject to revisions to our provisional estimates made in connection with tax reform. Importantly, as part of Tax Reform, we elected out of use in our NOLs to offset the mandatory repatriation tax in order to fully utilize our foreign tax credits. As a result, we’ve approximately $7 million in NOLs to apply against fiscal 2019 U.S taxable income. This fact, coupled with lower corporate income tax rate and the ability to immediately expense all U.S capital expenditures starting this fiscal year is expected to result in minimal U.S cash taxes paid in fiscal 2019 based on the facts and circumstances we know today. Trailing 12-months adjusted EBITDA was $36.4 million or 11.2% of sales compared with $40.1 million for the same period a year-ago. Annualized consolidated return on capital was 25% compared with 32% a year-ago. Now let's take a look at our two businesses. The mattress fabric sales were $46.5 million, down 4.7% compared with last year's fourth quarter. Operating income was $6.1 million compared with $7.2 million a year-ago with an operating income margin of 13.1% compared with 14.6% a year-ago. Frank will provide more color on mattress fabric sales in a minute. Operating income was primarily pressured by lower sales which impacted manufacturing efficiencies and fixed cost absorption, offset somewhat by lower incentive compensation expenses in SG&A. Annualized return on capital for mattress fabrics was 29%. For upholstery fabrics, sales for the fourth quarter were $31.7 million, up 11% over the prior year. Operating income was $2.2 million for the quarter compared with $2.5 million last year's fourth quarter. Operating income margin was 6.9% compared with 8.8% for last year. Operating income and margins were impacted by unfavorable currency exchange rates in China and pressure coming from losses associated with our U.S operation located in Anderson, South Carolina. Annualized return on capital for the upholstery fabrics business was 64%. Here are the balance sheet highlights. As of the end of fiscal 2018, we reported no outstanding balance on our lines of credit and $54.5 million in total cash and investments, up slightly from a year-ago. For the fiscal year, we spent $11.8 million on CapEx, including vendor-financed payments, funding an acquisition and investment in Haiti for a combined $5.2 million, and returned $6.8 million to shareholders in regular and special dividends. The company did not repurchase any shares this fiscal year leaving $5 million available under the current repurchase program. With that, I will turn the call back over to Frank.

Thanks, Ken. I'll start with mattress fabrics. Our results for the fourth quarter reflect more challenging market conditions with soft demand trends across the bedding industry. And we are starting to realize the impact of the lower-priced imported mattresses from China. Despite these headwinds late in the fiscal year, we’re still pleased to report another year of solid annual sales in this business. Having a favorable product mix of mattress fabrics and sewn covers across most price points and style trends has supported our diversification strategy with favorable results. Importantly, CLASS, our mattress cover business as it's called, has allowed us to develop new products with our core customers and to reach new customers and additional market segments, especially the boxed bedding space. In addition, our new line of bedding accessories, marketed under the brand name, Comfort Supply Company by Culp, will further extend our market reach and we expect sales to begin this fiscal year in that new venture. We are also pleased to achieve these results during a period of major transition across all of our production facilities during the year. With the substantial investments and significant changes in our operations in fiscal 2017 and '18, we have enhanced our ability to serve our customers. Our operating results for the year were affected by the production disruptions and costs associated with these changes, including one-time moving expenses and transition costs. However, going forward, we have a sustainable production and distribution platform that will favorably position Culp for the long-term. Fiscal 2018 was a transformational year for our mattress fabrics business with many operational accomplishments. We believe the investments we have made in our global platform and our strategic initiatives will further enhance our competitive position in the industry. While the recent softness in market conditions has prevailed through early summer due to the increasing impact of Chinese imported mattresses, we remain optimistic about our long-term growth prospects. As noted in our press release, we signed a definitive agreement for Culp to become a majority owner in eLuxury, an Internet company offering bedding accessories and home goods direct to consumers whose primary products include a line of mattress pads manufactured at eLuxury's facility in Evansville, Indiana. We expect to close this transaction in 30 days. ELuxury also offers handmade platform beds, cotton bed sheets and other bedding items. eLuxury's revenue is on a current run rate of $22 million for the calendar '18, excluding some related businesses with EBITDA expected to be slightly positive for the same period. Their products are available on eLuxury's own branded Web site, eluxury.com, Amazon and other leading online retailers for specialty home goods. This investment will provide us with a new sales channel in the bedding accessory category and expand our opportunity to participate in the rapidly growing e-commerce direct to consumer space. This business combination brings together eLuxury's experience in e-commerce, online brand building and direct to consumer shopping and fulfillment expertise with Culp's extensive global production, sourcing, product development and distribution capability. We also have an opportunity to market our new line of bedding accessories from Comfort Supply and other finished good that we may develop, including items made from upholstery fabrics through this e-commerce platform and extend our market reach to consumers. We are very excited to work with Paul Saunders, a successful entrepreneur who has built a great business and we look forward to having his associates as partners with the Culp team. We strongly believe our company share similar values and a common business culture centered around product excellence and exceptional customer service. Now I'll turn to upholstery fabrics. We are pleased with the strong finish to fiscal 2018 with higher than expected upholstery fabrics sales for the quarter. Our performance reflects the strength of our product mix, led by continued growth in LiveSmart, our popular performance line of highly durable stain resistant fabrics. For the full-year, we saw annual growth in sales over last year, reversing multiyear trends of lower annual sales. Throughout the year we have pursued a product driven strategy with a sustained focus on innovation and creative design, supported by our substantial manufacturing global platform. Notably, we have favorable sales trends with both our residential and hospitality market customers. Although fiscal 2018 sales were up, our operating results were slightly lower, primarily due to unfavorable currency exchange rates in China, particularly, in the second half of the year. We've also seen a decline in sales for products manufactured in our U.S based operation in Anderson, South Carolina. This decline reflects changing consumer style preferences and related customer demand. For fiscal 2018, products from the Anderson facility accounted for about 6% of total upholstery fabric sales. With the declining volumes, this operation has reached a level where we determined it is not sustainable to continue. Therefore, we will be closing the Anderson facility and expect to cease production by the end of our second quarter October 30. This trend -- during the transition period, we will work closely with our customers to fulfill any outstanding orders and we also intend to develop alternative fabric supply from other cloth locations to ensure their needs are met. We appreciate the hard work and dedication of our loyal associates and the community of Anderson for its many years of support for Culp. As previously announced, during April we completed the acquisition of Read Window Products, a source for custom window treatments and other products for the hospitality and commercial industries. The addition of window treatments and other soft goods to our product line will allow Culp to be a more complete source of upholstery fabrics for the hospitality market. We believe there are significant growth opportunities in this market segment in the years ahead. And we have a great opportunity to combine Culp's outstanding design and global production capabilities with Read Window's expertise and strong customer relationships. We welcome Dale Read and his team to Culp, as we integrate Read's operations and extend our market reach in the growing hospitality market. Ken will now review the outlook for the first quarter and then we'll take your questions.

At this time, we expect overall sales to be approximately 10% lower as compared with the first quarter of last year. With ongoing uncertainty in the mattress industry, we expect first quarter sales, operating income and margins in our mattress fabric business to be significantly lower than the first quarter of last fiscal year, as we continue to battle soft demand trends due to the increasing impact of imported mattresses from China. Looking ahead to the remainder of fiscal 2019, we're optimistic that the actions being considered by the industry in the near-term to address this situation will be successful. Assuming such action is successful and factoring in the incremental sales from the eLuxury partnership, we expect sales and operating performance for the remainder of fiscal 2019 to be positively affected by these events, especially in the second half of the fiscal year. In our upholstery fabrics business, we expect first quarter sales to be moderately higher compared with the first quarter of last year due to the Read Window Products acquisition. We believe the upholstery fabrics segment's operating income and margins will be down from the same quarter of last year, primarily due to continued pressure from an unfavorable currency exchange rate in China and the impact of closing the Anderson facility. Looking ahead to the remainder of the fiscal year, particularly the second half, we’re currently projecting improving results on a comparable basis. This projection is based on business expectations, the impact of the Anderson plant closing, contributions from Read Window Products and a more stable currency exchange rates. Considering these factors, we expect to report pre-tax income for the first quarter of fiscal 2019 in the range of $3.8 million to $4.8 million. Pre-tax income for last year’s first quarter was $6.7 million. Based on our current budget, capital expenditures for fiscal 2019 are expected to be in the range of $6 million to $7 million, as we move to a more maintenance level of capital expenditures. Depreciation and amortization for fiscal 2019 is expected to be approximately $9 million. With that, we will take your questions.

Thank you. [Operator Instructions] We can now take our first question. It comes from Budd Bugatch of Raymond James. Your line is open. Please go ahead.

Good morning, Frank. Good morning, Ken. I have a couple of questions.

Good morning, Budd.

Good morning.

eLuxury, can you give us a little bit of a color as to how the inside, the operating statement looks in terms of gross margin and operating expense? Talk about its gross profit level.

Budd, at this point, what we’ve disclosed is the last year is around the EBIT breakeven level as you know, and at this point we -- I don't think have a good enough handle on this gross profit SG&A due to classifications. They – And I don't think I would be comfortable breaking that out at this point.

Okay. I would agree.

Okay. And where are you going to report it? Is it going to be reported inside mattress, or is there going to be a separate segment, or how are you going to consolidate it?

It will be reported as part of the mattress fabrics segment, and principally because of the bedding accessories focus of that business.

Correct.

Okay. You do talk about the fact that mattress fabrics in the first quarter looked like they will be down significantly, if I do the math on that, it looks like it's down about 25% to 30% of the sales line, is that a reasonable guess?

20% to 25%. I would say 20% to 25%, yes.

Okay. So that would make – and including in the -- the upholstery segment includes Read, and how much is the Read addition into the upholstery's outlook [indiscernible] in other works?

It’s running about $12 million annual run rate, so $2.5 million to $3 million in Q1.

Okay. So excluding that -- excluding Read, then essentially it's just up a little bit -- included and that will still include Anderson, right, and that will stillget reported as revenues.

That is correct. Yes.

Okay. And when will you book a restructuring charge or will there be any restructuring and other severance type charges that you will book? I know the severance will have to be -- have to wait, but what’s the restructuring outlook?

Yes, Budd, this can -- we are going to be evaluating that as we work with our customers, so probably as we near the end of the first quarter, we will be able to evaluate how much inventory we have and need for the remainder of the time. The way it’s planned right now and the way we have it to run out, we will have the severance costs and all that, we’re probably booked at the very end, which will be in the second quarter. And then as it stands now, the live assets, the fixed assets are looking to be basically -- probably be able to get funds exceeding that value. So I'd say right now it looks like we will have some charges in first and some charges in the second quarter.

Right. And lastly for me on that, that you talked about Anderson getting -- coming out and that’s obviously been a disappointment that you have to close that. What do you think the operating margin target then for upholstery looks like after Anderson? What do we think that can be?

The effect of the Anderson results in fiscal '18 just ended, affected our annual results by about $1 million on sales for that operation. So we will have, obviously continuing losses for Q1 and some in Q2 until we close the facility, but we expect a nice benefit on the second half of the year with the elimination of those losses. We’ve given that product line and product category probably more time than we should have in retrospect, but we really wanted, Budd, as you and I’ve talked many times, we wanted to keep a U.S facility if there was any way possible. And it's just not going to be possible or the customers are not wanting to buy much from the U.S products as they do other locations like China. And the product out of that plant, the velvets was a category that just is not in style nearly as much. So unfortunately we had to reach the decision to close the facility. We bought that facility in 1985, and while it's the right thing to do of course from a business standpoint, nonetheless it's a tough day when you have to do these kinds of things. But it will contribute nicely to the second half of our year in upholstery fabrics and it will contribute meaningfully.

Just to make sure I understand, you’re saying you had a $1 million drag on EBITDA or an EBIT loss on about $7 million or $8 million worth of sales out of Anderson last year?

That is correct, Budd. That’s correct, Budd. That is correct.

Okay. Yes, I got you. I understand how tough that is. You talked about the fact that you’re hearing things about things in the industry, we are, too. Any venture on timing as to when something might be formally filed?

I mean, you may be more up-to-date on these things than I am, but we here in the -- around the August one time frame. Late July, the mid-August, kind of time frame. We are hearing -- and that the good news and Budd, you may comment on this, because you know a lot about this that the impact of a filing of some antidumping filing can be fairly quickly, a preliminary ruling by the Department of Commerce is very likely to be no more than 45 to 60 days from the filing date. And at that time, preliminary duties are assessed and we understand beginning -- the duties begin accruing at that date. So, under that kind of time frame what we're looking at is certainly effect in Q1 and Q2, but potentially look good bit better in our second half of the year. Budd, you may comment as well from what you're hearing and your knowledge of these proceedings.

I’ve just -- I would refer to you. You’re not -- you can't be a party to it though, is that correct? You can't be a party to the filing, its [indiscernible]?

We cannot be a -- that’s correct. It's all -- it can only be producers in the U.S. And we also understand the majority of the participants, a very high percentage of domestic producers are part of the petition, which is also helps the strength of the case. Unfortunately, we also are hearing and seeing U.S a report yesterday that unfortunately that the Chinese imported mattress are accelerating into the calendar Q2. But while that’s painful short-term, it probably does mean a higher duty rate could be shown at the preliminary ruling states. And obviously the higher the duty rate the Department of Commerce sets the better for the industry.

Okay. But I was -- I’m curious just to, if CLASS gives you the opportunity to be a part of the filing?

No, it does not. This is a -- and we understand the scope is domestically produced mattresses, not the fabric or mattress covers it all.

Okay.

Now if [indiscernible] that its possible, Budd, that our -- that the -- if the industry would like some of our data to help the case, we are certainly willing to provide that.

Okay.

But we cannot be part of the petition is my understanding.

Got you. Okay.

And it's really not needed. [Indiscernible] percentage of the producers ended it already.

Got you. And your -- in mattress, it's going to be impacted. Is CLASS more impacted for you than your legacy products?

That’s a good question. We are affected by both. The bed and the box folks have equally been affected by this the imported mattresses as the -- what you might call the traditional players. Both are affected. I think there's when I look at our numbers too, I think with the what apparent acceleration of the imported situation in Q2, calendar Q2, I think we're also feeling the effect of some inventory adjustments from customers in the first quarter as they don't orders much, because they've already got inventory. That should work its way through by the end of Q1.

Got you. I understood. Thank you very much. I will let others ask questions.

Right.

Thank you. [Operator Instructions] We can now move along to our next question. It comes from Marco Rodriguez of Stonegate Capital Markets. Your line is open. Please go ahead.

Good morning, guys. Thank you for taking my questions. Just kind of a bit of a follow-up here on the mattress fabrics with the impact you guys are seeing with the Chinese imports. It there anyway that you can quantify the impact you saw there in Q4 on the revenue side and then the margin side as well?

You know our revenues for the fourth quarter were down in that segment 4.7%. so that’s -- and that was due to the imported mattress situation across our customer base. And you saw our margins in that segment were down about little over 100 basis points. So it started affecting us than seeing it, but it has accelerated -- the unit impact is affecting us more. But I think one thing to keep in mind for Culp is that we're very pleased that even with the impact in the first quarter, which we're not happy with at all, but it is what it is. We're still going to achieve a pretty darn good operating margin on a -- on the sales decline of the 20% to 25%. We are very likely to be 9 -- 8%, 9%, maybe 10% operating margin for Q1 even with sustaining this kind of unit volume. So we have got a very profitable business that we built over time. And Marco this Chinese mattress imported situation will pass. We strongly believe this is short-term. We’ve seen other similar things in other industries get handled and we will -- we strongly believe it is a short-term, and we will start to see benefit and return to some kind of normalcy in the second half of our fiscal year.

Understood. And just to also kind of follow back up here on a prior question on the timing of the antidumping filing. I believe you mentioned that July, August kind of timeframe, so I'm assuming or I'm just trying to guess -- I guess kind of understand how quickly you think your Q2 revenues can kind of assuming that the filing or everything gets done here by August? How things -- how quickly things can kind of return to a normalcy, if you will?

If we -- if a filing would occur, let's say between August 1 and August 15, 21 days from the filing date, the lawyers for the industry will meet with the Department of Commerce. Then 45 to 60 days from the filing date, which would put that mid-to-late September, maybe early October. We are told the Department of Commerce will issue a preliminary ruling and establishment of preliminary duties. We're also told, and we are far from experts, but what we hear is that there can be some impact, favorable impact in reducing upon the filing of the petition, because duties do begin to accrue after the preliminary ruling. We hear the significant impact occurs at the preliminary filing -- right after that preliminary filing. So it's certainly possible that we’re going to see some reduction, some benefit and our customers have some relief in our second fiscal quarter ended in October. I think more likely it's going to be Q3 and Q4. Some of these orders probably are 30, 60-day orders and then some of that may to need to run off as well.

Got you. Okay. And -- so, just also to be clear here on fiscal '19 expectations for mattress fabrics, if we’re excluding the fact that obviously the eLuxury has not closed yet, but assuming if you kind of exclude that revenues for fiscal '19 for mattress fabric should be down probably somewhere in the mid single digits or so. Is that fair?

I think what our expectation as we said in the -- in our remarks, that we will see positive impacts in our second half of the year from eLuxury in sales and profitability. We will also see favorable results from a reduction in import -- imported mattresses, which will obviously affect our customers and we will have more orders in the second half. It is still possible that the second half of our year could be equal to the second half of the year just ended. So, we're going to see a rebound in the second half, it just depends on probably those two factors, also depends on the overall industry demand, in general, for it. But certainly our goal is to get second half of the year rebounded and comparable to last year.

Got you. And were the SG&A expenses in the mattress fabrics segment, were they held at an abnormally lower levels just given the fact that you’ve got those impacts going around or were -- or people let go, anything of that nature?

You mean in the mattress fabrics business?

Yes, yes.

Yes. No, that was reduced incentive compensation. As we said before, we based on incentive compensation on EVA and their performance for the fourth quarter did not meet expectations. And so it was -- we had to adjust downward.

Got you. Okay. And last quick question just here on the upholstery side, just making sure I heard this correctly. So it was about a $1 million impact from the Anderson plant to Q4 operating income, so obviously then -- had you not had that issue, it probably would have been somewhere in the $3 million range or so?

Marco, that’s for the full-year.

Yes.

For the full-year? Got you.

Yes. And upholstery fabric earned just under $11 million for the year in operating income. So non-excluding Anderson, it was $12 million even with the currency unfavorable impact during the year. So pretty darn good performance once you start carving out that.

Okay. And so would FX account for the remaining impact that you saw at least with the gross margin level there in Q4 for the -- on the upholstery side or other mattress?

Well, Anderson is including that, yes. Yes, that’s FX, right. That’s the vast majority of the other side of that impact.

Got you. Okay, great. Thank you, guys. I appreciate your time.

All right. Thank you.

Thank you. We’ve no further questions at present. [Operator Instructions] Thank you.

All right. Thank you, operator. And again, thank everyone for your participation and your interest in Culp, and we look forward to updating you at the end of our next quarter. Have a good day.

That will conclude today’s conference call. Thank you for your participation ladies and gentlemen. You may now disconnect.