Good morning, and welcome to the Culp, Inc. Second Quarter Fiscal 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I’d now like to turn the conference over to Dru Anderson. Please go ahead.

Good morning, and welcome to the Culp conference call to review the company's results for the second quarter of fiscal 2023. 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 today 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 in the tables to the press release included as an exhibit 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 is also available on the company's website as part of the webcast of today's call. I will now turn the call over to Iv Culp, President and Chief Executive Officer of Culp. Please go ahead, sir.

Good morning, and thanks to everyone 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 are Ken Bowling, our Chief Financial Officer; and Boyd Chumbley, President of our upholstery fabrics business. I will begin today’s call with some opening comments, and Ken will then review the financial results for the quarter. Following that, I will provide further updates on some strategic initiatives and opportunities specific to each of our operating segments. And Ken will then review the business outlook for the third and fourth quarter of this fiscal year. We would then be pleased to take your questions. Our sales and operating results for the second quarter reflected ongoing pressure from the continued slowdown in consumer demand in the domestic mattress industry and, to a lesser degree, in the residential home furnishings industry. As previously announced, our operating performance was significantly affected by inventory impariments and inventory closeout sales for our mattress fabrics division as well as higher than normal inventory markdowns and restructuring and related charges associated with our upholstery fabrics segment. The timing of this inventory impact was mostly driven by our customers’ focus on new products offerings to introduce at the retail level, as well as inflationary pressures, changes in consumer spending, and ongoing macro conditions. We expect to ultimately benefit from a focus on new products as we continue to win new placements in both divisions. But it is difficult to predict the timing of new product rollouts due to the ongoing excess of retail and manufacturer inventory. I am pleased with our continued focus on cash generation and working capital management, including inventory reductions, throughout the quarter. Maintaining a solid financial position has been our major priority through…

Okay. Thanks, Iv. As mentioned earlier on the call, we have posted slide presentations to our Investor Relations website that cover key performance measures. We've also posted our capital allocation strategy. Here are the financial highlights for the second quarter. Net sales were $58.4 million, down 21.7% compared with the prior year period. The company reported a loss from operations of $11.9 million compared with income from operations of $1.6 million for the prior year period, and compared sequentially with a loss from operations of $4.7 million for the first quarter of this fiscal year. As Iv touched on, the loss from operations for the quarter includes $5 million in inventory impairment charges and loss on sale of raw material and finished goods inventory associated with our mattress fabric segment. It also includes approximately$1 million in higher-than-normal inventory markdowns associated with our upholstery fabrics business and $713,000 in restructuring expense related charges associated with the closure of the upholstery fabrics segment’s cut and sew facility in Shanghai, China. I'll comment more detail on divisional sales and operating performance in a moment. Net loss for the second quarter was $12.2 million or $0.99 per diluted share, compared with net income of $851,000 or $0.07 per diluted share for the prior year period. Our overall operating performance for the second quarter was primarily affected by lower sales, impairment charges due to the write-down of inventory to its net realizable value, and inventory closeout sales for a mattress fabric segment, markdowns and inventory due to our age inventory policy for both segments, and restructuring-related charges associated with our upholstery fabric segment. Notably, we benefited from $829,000 in other income for the second quarter, as compared to $404,000 other expense during the prior year period. The change from other expense to other income is…

Thank you, Ken. I will now provide more comments about our strategic focus and initiative for each division as we look ahead, beginning with the mattress fabric segment, Culp Home Fashions. Despite the headwinds in this business, Culp Home Fashions has remained focused on inventory reduction and cash generation. This focus on inventory reduction will remain as we move into the third quarter as there are further reductions possible in both finished goods and raw materials. I am very pleased with the cooperation and support we have had in our transition of leadership within CHF. Sandy Brown and Tommy Bruno are working very well together. And Tommy is learning quickly and engaging the CHF team on a transformation plan in this business where every aspect of our operation has been reviewed, including the organizational structure, renewing the strength of our global platform with a continued and strong focus on North American supply opportunities, employee engagement and quality, design, sales and, of course, operational processes. In the short-term, the focus for CHF will be on free cash flow, turning our inventory into cash, controlling and reducing costs and working on overall improvement in every facet of the business. Innovation remains a hallmark for CHF, and customers continue to accept and prefer our design and product development. As mentioned earlier, we are optimistic that as new business placements move to retail floors, we will grow our sales commensurate with these market share gains. Additionally, these new sales opportunities are placed at current market cost and conditions, which will be better for our go-forward margins. We are also working to implement new order procedures to firm up customer commitments. We are focusing on SKU rationalization via an open express line that we will offer to various segments of the market. And we are…

We continue to navigate a convergence of headwinds, including significant inflationary pressures impacting discretionary consumer spending, high inventory levels at manufacturers and retailers, a stabilizing but inexperienced labor force, and other macroeconomic uncertainties. Although we remain well positioned over the long-term with our product-driven strategy and flexible global platform, current conditions are likely to continue pressuring results through at least the remainder of fiscal 2023. Due to the continued volatility in the macro environment, we are providing only limited sequential financial guidance for the second half of this fiscal year. We expect net sales for the third quarter to be moderately lower as compared to the $58.4 million in net sales for the second quarter of this fiscal year, with sales for the third quarter affected by fewer billing days to the longer-than-normal holiday shutdowns, both internally and by customers and suppliers, as well as the timing of the Chinese New Year holiday, which falls primarily within the third quarter. We expect a consolidated operating loss for the third quarter this fiscal year that is meaningfully lower than the $11.9 million operating loss of the second quarter of this fiscal year, but that is higher than the $4.7 million operating loss for the first quarter of this fiscal year due primarily to expected lower sales. We also expect our cash position as of the end of the third quarter of this fiscal year to be lower than the $19.1 million at the end of the second quarter this fiscal year, but higher than the $14.6 million at the end of last fiscal year. Looking ahead to the fourth quarter of this fiscal year, we are cautiously optimistic for some improvement in business conditions with an expectation for a sequentially improved sales and reduced operating loss as compared to the third quarter of this fiscal year, and with a cash position that is expected to be comparable to slightly lower as compared to the $14.6 million at the end of this fiscal year. As we weather the current challenges, we will continue to be laser focused on prudent financial management with the goal of always maintaining a strong balance sheet, especially with regard to ensuring a strategic balance in our working capital. We are optimistic about Culp’s future, and we know that financial stability is paramount to our success. With that, we will now take your questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Rex Henderson from Water Tower. You may now go ahead.

Thanks for taking my call. And Iv and Ken, congratulations on really doing a great job of maintaining liquidity in a really difficult environment. So, with that, I wanted to ask a couple of questions about -- your guidance seems to imply you're not -- it doesn't seem that you're quite as bleak as you were in the pre-release a couple of weeks ago. And it seems like you're thinking that there's some stability and maybe a little bit of turn towards the end of the year. Can you give me some color on why you think that's possible? What you're seeing in inventories downstream from you? And also, can you give me a little bit of color on what impact the billing days and holiday shutdowns will have on the third quarter as a percentage of revenues or some metric that will help me understand what impact that's going to have?

Yes, Rex, thank you. This is Iv. I really appreciate your kind comments about working capital management and just trying to maintain our balance sheet. It certainly is. Some numbers drilled into me from our Board and from our management here and from leaders before me and we definitely make it a paramount importance to us. So, it's one thing we can hang our head on and we're going to keep our focus there. So, thanks for mentioning that. To your questions, [don’t know] (ph) if I wrap those in. Really good questions. And maybe I'll couch it as kind of you're asking are we seeing any improvement as we look ahead in the run rate. And we were trying to touch on that in the outlook. Certainly, there is some Q3 concern, and I think you mentioned there are some billing days out of the cycle in Q3. We have the normal holidays where we are hearing that some customers are taking one and maybe even two weeks out of their schedules. Chinese New Year is also a primary third quarter impact for us. So, we recognize that there will be considerably lower billing days in the third quarter than we might have in a normal quarter just from shutdowns. And that may be as many as four to five days that could impact us and billing. So, that's why we're being a little cautious about Q3. Overall, we probably feel more optimistic about Q4 sales lift, mostly driven by the focus we keep talking about on innovation. But if you have to also break it down, Rex, just as I'm thinking through this, you got to break it down by our segments, too. We said, or I said, Culp Upholstery Fabrics has been more stable. And we are…

That's helpful. In your remarks about CHF and inventory rationalization there, I should be looking for Q3 inventories to be again lower than they are at the end of Q2. Is that -- more -- further cash generation from inventory reduction going in to the third and fourth quarters. Is that right?

Yes. Rex, this is Ken. Yes, third quarter especially, fourth quarter may require a little bit of build when we come out of the -- with the projected sales growth that we're looking at. But right now, we're looking for further reductions in Q3.

Okay. And then finally, one point of clarification on the credit agreement. If I recall correctly, you just executed a new credit agreement. I don't know, one or two quarters ago. And I'm wondering, what's the improvement here? What -- is it -- first of all, is this increment -- is this additional, or is it replacing the existing agreement? And, what's the benefit of the new agreement for you?

Yes. Rex, this is Ken again. It is replacing the current agreement. It just -- it comes down to giving us more -- really a higher ability to borrow with the way it's structured, and also a lot more flexibility with minimal covenants. So, that -- those are the two main benefits of that. And so, with this new agreement, it really positions us well going into the future.

And what's the -- is it out for a year or two years, five years, what's the limit on it again?

Well, right now, we're looking at the current one is three, we're looking at three again. But we're still going through all the motions, but right now, we're looking at three years.

Okay. And then, finally, one thing -- one question about China. We've been reading a lot about disruption of business in China due to the government's COVID restrictions. Have you experienced any of that? And what -- has it had any impact on you?

Rex, this is Iv. I’m going to let Boyd answer that. He is certainly very close to our China operations. I'll let him make some comments. Good question.

Yes, Rex, thank you for that question. And in terms of from a business perspective, no, we have not been experiencing disruptions in China through this time period of the restrictions that have remained in place there. It has not had any effect or impacts to our managing our business or to our supply chain there. So, quite frankly, our China supply chain has been functioning and operating very well to support our business. So, no issues there. It is important to note, as we've noted before, we have pivoted some of our platform to other locations, just as a diversification strategy, which includes Vietnam and Haiti and Turkey -- more recently, Turkey. So, we have continued to diversify our global platform just to have options for our customer base. But yes, to your question, we have not experienced any business-related disruptions due to those restrictions.

Okay. Well, thank you again. Good job in a difficult situation. And I'll let someone else got -- ask a question now. Thank you.

Thank you, Rex. Have a good day. Appreciate it.

Our next question will come from Anthony Lebiedzinski with Sidoti & Company. You may now go ahead.

Good morning, and thank you for taking the questions. And likewise, it's good to see that you guys are proactively managing your liquidity as well. So, I guess, just first just a quick housekeeping question. So, I think, Ken, you mentioned that there was some pricing and surcharge actions taken in the third quarter. Can you just share with us how much of that was impacted as far as the quarter here?

Well, as you know, Anthony, we took, we started those pricing actions last year, and we really had him out all throughout last fiscal year. So, we're getting the benefit of having the -- when you compare it to last year, the benefit of having the third and fourth quarter increases in there. I don't -- I can't quantify exactly what those amounts are. But they're certainly helping. We're trying to navigate the pricing with all the different cost measures and efficiency projects that we've got going on. But as compared to last year, it’s definitely some tailwind there. But as we've said, in the past, especially on the CHF side, we did lag in our ability to keep up. So, that's one thing that -- as Iv said in his remarks, that with these new products, we're hoping to really get better pricing to reflect the current market.

Anthony, this -- thank you for the question. Ken answered it well. But just a couple of – I’ll add a couple of things. As we've touched on a lot, we've been chasing price to cost in both businesses all year, and we passed on several price increases. And we have always lagged. It's never been enough. So, we're thankful that we're now seeing some relief in ocean freight, not inland yet, but in ocean, and in raw materials, which will be a big help going forward. Certainly, it takes a little time to work through the system. But seeing costs finally become -- I think we can see costs maybe become a tailwind for us in the medium term. And I just want to -- I want to call it, don't discount our labor stabilization that I touched on. Getting some stability with our associates and having them trained effectively will definitely be a cost control measure going forward. So, we have done some surcharges and increases, but we've lagged demand. I think that can turn for us in the back half of our year.

Okay, that's good to hear. So, just a follow-up on the labor front. So, you mentioned today and your release last night about a stabilizing, but inexperienced labor force. So, in your experience, I mean, what's been a typical learning curve for new associates or -- like, when would be a reasonable timeframe as to when you expect your labor force to be as efficient as they should be?

Yes, good question, Anthony. And I'm glad you picked up on that. I tried to call it out. Especially, for a while, labor has been a big challenge for us. And as I mentioned, our North American facilities, which is primarily impacted home fashions, some in upholstery business, too, we've had turnover of 35% to 40% in some locations. Now, we don't have that kind of issue in other parts of the world, but in the U.S., it's been challenging. Today, our turnover rate is very low. And we have a lot of talented people placed in roles but they're new. And we're not a major skilled labor operation, but we are skilled labor. And it does take some expertise to run equipment and to understand what's acceptable and to view it and inspect it properly. So, you know what, it just takes a little time. We typically will have -- we'd like to have a month type of training for any associate, and then we would say, well, it may take them two or three more months to get up to what's a normal cadence. So, it could easily take a quarter to get someone fully trained. Doesn't mean they can't be productive. But to get fully trained and really start to improve. And for many, many years, we had the benefit of a very stable, high retention labor force. And that just changed in the last year. And we're getting back to a place where we can build on some people in place, which should -- always has been a hallmark for Culp is our people. We value that as much as our balance sheet. People are so important. And we just -- we got to get the right folks in the right places and give them time to succeed.

Well, that's great to hear. And then -- so you mentioned, obviously, ocean freight costs have come down. And you're expecting some labor stabilization. Any other costs tailwinds that you're seeing or you expect to see?

Raw material?

I mean, I think when we think about costs, Anthony, outside of that, certainly we're starting to see some tailwind with raw materials. We know we got to work through supply chains, and in some cases, we have to work through some inventories we've already built. But we are seeing raw material tailwind. And that's the biggest portion of our cost on the CHF side. So, seeing raw materials turn in a positive direction for us is very helpful.

And the $3 million in cost savings we called out, too.

And certainly, the cost savings from adjusting the cut and sew platform, yes, sure.

Yes.

Right. And as far as that -- just to follow up on that. So, will that be mostly SG&A and more of cost of goods as far as that $3 million number that you called out?

See, it's a little bit of both. It's just now starting. So, we're seeing some impact in Q4 and then beyond. But it's really -- it's lease cost. That's a big piece of it. Labor cost is a big piece of it. Other fixed expense is down. So, there's just an array of different areas that incorporate that close to $3 million in savings.

Got you. Okay. And then lastly, you talked about SKU rationalization and the better inventory management. Just wondering how quickly can you do that? And how should we think about the significance of this?

Yes, good question, too, Anthony. That's specific to the CHF business. And we're just trying -- we have become, over time, a very custom-design business. And we don't want to say no to any customers. It's just not in our makeup. But what we can do a better job is of having a more rationalized product line with more rationalized raw materials to be able to develop still a lot of very fashionable and exciting looks for some segments of the market that we don't need to develop custom. And that just is the process of designing, and then selling, and marketing that project. So easy to do. Just takes a little time to flush through to the market. So, certainly, for our bigger customers, we are always going to do things they want to do and we'll do custom work. For some of the smaller opportunities, we need to make products of common raw material banks. We need to make them with efficient processes, and we need to have customer commitment to take the goods. And those are all pretty much blocking and tackling things that we just need to get better at. So, I'd say, I mean, it's going to take us -- you're going to see the fruits of that in FY ‘24 for sure. I'd like to have the goods go quicker. It depends on how quick we get these products released and placed. That’s so much of what's driving us, is when we get them placed into the market. Hope that helps.

Yes, absolutely. Well, thank you very much, and best of luck.

Thank you, Anthony.

Thanks, Anthony.

This concludes our question-and-answer session. I would like to turn the conference back over to Iv Culp for any closing remarks.

Thank you so much operator. And again, thanks to everyone for your participation and your interest in Culp. And we look forward to updating you on our progress next quarter. Happy holidays.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.