Culp, Inc.

Good day ladies and gentlemen and welcome to Culp's first quarter 2020 earnings conference call. I'd like to remind everyone that this call is being recorded and at this time for opening remarks and introductions, I'd like to turn the floor over to Ms. Drew Anderson.

Thank you. Good morning and welcome to the Culp conference call to review the company's results for the first quarter of fiscal 2020. 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 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 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. With respect to certain forward-looking free cash flow information, the comparable gap in reconciling information is not available without unreasonable effort, and its significance is similar to the significance of the historical free cash flow information, which is available in the company's 8-K filed yesterday and posted on the website. With that, I will now turn the call over to Frank Saxon, Chairman and Chief Executive Officer of CULP. Please go ahead, sir.

Thank you, Drew, and good morning, 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 Yves CULP, President and Chief Operating Officer, and Ken Bolling, Chief Financial Officer. I will begin the call with some brief comments, and Ken will then review the financial results for the quarter. I'll then update you on strategic actions in each of our segments. After that, Ken will review our second quarter business outlook, and then we'll be happy to take your questions. We are pleased to report a solid start to fiscal 2020 with our overall sales in line with expectations. We're especially encouraged to see the higher sales in mattress fabrics, following a difficult year of declining sales related to the influx of low-cost mattress imports from China, as well as retail disruption. The mattress industry appears to be stabilizing, and we are realizing some benefits from the punitive anti-dumping measures announced by the U.S. government early in our first quarter. We are optimistic our business will continue improving with the further reduction of excess inventory of the China mattress imports. We have also faced external challenges in the upholstery fabrics business due to the ongoing international trade disputes and recently imposed additional tariffs. However, we are pleased that in spite of the lower sales and uncertain market conditions, our upholstery fabric business showed improved profitability for the first quarter of fiscal 2020. Additionally, we continue to evaluate and develop our strategy for Culp Home Fashions, our business products business. We're focused on the best way to leverage this new online sales platform and expand our market reach with new products and customers. and expect improving results over the next few quarters. In each of our businesses, we executed our product-driven strategy with a relentless emphasis on design creativity and product innovation. With the support of our flexible and growing global platform, we are confident we can sustain our strong competitive advantage and respond to the changing demand trends of our diverse customer base. Importantly, we have the financial strength to pursue our growth strategy. I'll now 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 that cover key performance measures. We've also posted our capital allocation strategy. Here are the financial highlights for the first quarter. Net sales were $75 million, up 4.7% compared with the prior year period. On a pre-tax basis, the company reported income of $2.8 million compared with pre-tax income of $1.9 million for the first quarter of last year. The financial results for the first quarter of last year included approximately $2 million in restructuring related charges due to the closure of the company's Anderson, South Carolina production facility. Excluding these charges, pre-tax income for the first quarter of last fiscal year was $4 million. The current quarter was affected by divisional operating income pressures in the mattress fabrics and home accessories segments offset somewhat by improved year-over-year operating performance in the upholstery fabrics business. We'll cover more details shortly. Additionally, unallocated corporate SG&A expense was significantly higher this quarter as compared to the prior year period due primarily to a favorable adjustment related to share-based compensation plans that occurred in the first quarter of last fiscal year. Net income attributable to Colpink shareholders was $1.3 million or $0.11 per diluted share for the first quarter compared with net income of $957,000 or $0.08 per diluted share for the prior year period. The results for the first quarter of last fiscal year included the restructuring related charges I just noted. The effective income tax rate for the first quarter of this fiscal year was 59.1% compared with 46.5% for the same period a year ago. The increase in the company's effective income tax rate reflects the continued shift in mix of taxable income that is now mostly earned by the company's foreign operations located in China and Canada at higher income tax rates in relation to the U.S. Additionally, the current mix of taxable income has resulted in a significant increase in the company's global intangible low-tax income tax, or GILTI, which represents a U.S. income tax on the company's foreign earnings. Importantly, income taxes incurred in the U.S. on a cash basis for fiscal 2020 are expected to be minimal due to the projected utilization of the company's U.S. federal net operating loss carry-forwards. Looking ahead to the rest of this fiscal year, we estimate that our consolidated effective income tax rate will be in the 45% to 48% range based on the facts we know today. The income tax rate can be affected over the fiscal year by the mix in timing of actual earnings from our U.S. operations and foreign subsidiaries located in China and Canada versus annual projections. Notably, the U.S. Treasury Department and Internal Revenue Service have issued newly proposed regulations that, if enacted, and if enacted as proposed, could provide us with some relief from the GILTI tax under the proposed GILTI tax high tax exception election beginning in fiscal 2021 or later, subject to the timing of the enactment. The proposed guilty high tax exception election is not available until the proposed regulations are finalized and effective. Trailing 12 months adjusted EBITDA as of the end of the first quarter of fiscal 2020 was 22.3 million or 7.4% of sales. Consolidated return on capital for the trailing 12-month period was 10.4%. Now let's take a look at our business segments. For the mattress fabric segment, sales were $38.7 million, up 12.5% compared with last year's first quarter. Notably, this is the first quarter-over-quarter sales increase since the third quarter of fiscal 2018. Operating income for the quarter was $2.6 million compared with $2.8 million a year ago, with an operating income margin of 6.8% compared with 8.1% a year ago. Our operating performance was affected by several factors during the first quarter of this fiscal year. We experienced temporary lower demand for our more profitable products as customers absorbed existing excess inventory, resulting in reduced production schedules. We also encouraged certain employee-related costs that were higher than expected. In spite of these challenges, we believe business conditions are stabilizing and will result in improved profitability going forward as we continue to rationalize production in the most cost-effective locations. Return on capital for the trailing 12-month period for the mattress fabric segment was 15.2%. For our postage fabric segment, sales for the first quarter were 31.9 million, down 7.6% over the prior year. Operating income of the quarter was 2.9 million compared with 2.5 million a year ago, with operating income margin of 9% compared with 7.3% a year ago. Our improved operating performance for the first quarter of this fiscal year reflects a favorable product mix and a better currency exchange rate than we experienced a year ago. Return on capital for the 12-month period for the upholstery fabric segment continues to be impressive, coming in at 57%. The home accessory segment, which includes the operations of eLuxury, reported 4.3 million sales for the first quarter with no full period of comparable results for the same period last year as a result of the June 2018 investment in eLuxury. The 4.3 million was comparable to the sales level achieved in the fourth quarter of last fiscal year. Operating loss for the quarter was 535,000, which was in line with expectations. Operating performance was affected by reduced demand for our legacy products and increased marketing fees and promotional expenses. Now turn to the balance sheet. We reported $44.2 million in total cash and investments and outstanding borrowings of $925,000 for a net cash position of $43.3 million. During the first quarter, we incurred $935,000 in capital expenditures and spent $1.2 million on regular dividends. Also, operating lease assets and liabilities totaling $6.5 million as of the end of the first quarter of this fiscal year were reported as a result of the adoption of a new lease accounting standard. Cash flow from operations and free cash flow were $2,986,000 respectively, compared with cash flow used in operations and negative free cash flow of $1.9 and $4.6 million respectively for the prior year period. This reflects a $4 million and $5.6 million year-over-year improvement in cash flow from operations and free cash flow respectively. The company did not repurchase any shares in the first quarter. With respect to our share repurchase program, the Board has approved an increase in the authorization for the company to acquire its common stock from the $1.7 million currently available back to a total of $5 million. With that, I'll turn the call back over to Frank.

Thanks, Ken. I will start with the mattress fabric segment. We were energized by the return to a positive sales trend for mattress fabrics for the first quarter. In addition to an extra week of sales for the quarter, These results reflect strong performance from CLAS, our sewn cover mattress business, as well as higher-than-expected sales of woven mattress fabrics. We are benefiting from the growing demand for mattress covers from customers in the popular and expanding roll-packed or boxed bedding space. We have diversified our customer base in this segment, and we are encouraged by additional opportunities with existing and new customers. Our flexible global platform, including our production locations in the U.S., Haiti, and Asia, supports this strategy and has allowed us to meet changing customer demands with outstanding service and delivery performance. We remain committed to product innovation as we strive to deliver a favorable product mix of mattress fabrics and sewn covers. As a firm acknowledgement of the evolving trends in bedding and mattresses, We've established a dedicated innovation team to ensure we're developing and offering the latest technologies and forward-looking products for our customers. At the same time, we are enhancing our design capabilities with an expanded creative team to complement our innovation strategy. Culp has traditionally enjoyed a strong competitive position in the marketplace with our creative designs and innovative products. and these new initiatives will allow us to further leverage these capabilities and expand our market reach. Looking ahead, we are optimistic that the mattress industry is finally improving and is benefiting as a result of the anti-dumping measures against the Chinese importers and the continued sell-through of excess inventory. We have a compelling business model supported by creative designs, innovative products, and an efficient global platform with the ability to provide the latest product offerings from fabric to sewn covers. We look forward to the opportunities ahead for our mattress fabrics business. Now I'll turn to the upholstery fabric segment. Our upholstery fabric sales were in line with expectations for the first quarter. The modest drop in sales over the prior year period reflects the continued soft retail environment for residential furniture, as well as ongoing issues surrounding international trade agreements and the associated tariffs. This unstable environment has disrupted supply chains throughout the furniture industry. However, in spite of these challenges, we aggressively pursued our product-driven strategy and remained focused on the diversification of our customer base. We are continuing to make excellent progress with Reed Window Products, our window treatment and installation services business, which has supported our ability to expand our reach in the hospitality market. We are optimistic about the future contribution from Reed as we grow this business. We also continue to see favorable demand trends from our residential furniture customers for our popular line of highly durable stain resistant LiveSmart fabrics. Notably, we recently extended this brand with the introduction of LiveSmart Evolve, a new line of fabrics featuring the same performance technology combined with the use of recycled fibers to deliver a sustainable product. The LiveSmart Evolve launch has been very well received in recent showings and affirms CULP's ongoing commitment to environmental responsibility. Above all, we will continue to focus on product innovation and creative designs that meet the changing demands of our customers. While the additional tariffs took effect during the quarter, we have worked closely with our customers to make adjustments in response to these new tariffs. We are pleased with the efficient scale-up of operations of our strategic partner relationships in Vietnam for additional sourcing of our cut and sew kits. And we will further pursue this opportunity to support our customers in light of the ongoing trade disputes between the U.S. and China. Looking ahead, the uncertainty surrounding additional proposed tariffs and associated geopolitical risk makes it challenging to forecast the potential impact on our business. However, we're closely monitoring the situation and will enact appropriate responses as necessary. Despite these challenges, we believe Culp has the right strategy in place for upholstery fabrics and is well positioned for the long term. Next, I'll review our newest business segment, Culp Home Accessories, which includes the operations of eLuxury, our e-commerce and finished products business, offering bedding accessories and home goods. The sales of this business were consistent with the results for our fourth quarter of last year, and in line with our expectations. We are refining this business model with a more aggressive and strategic focus on the business to business market, along with greater customer diversification and new online retail marketplaces. We also remain committed to improving the performance of our legacy product lines. In tandem with our strategies, we're developing many new products and are excited about the opportunity to leverage this new sales channel and reach new customers for COPE. Ken will now review the outlook for our second quarter, and then we'll be glad to take your questions.

We expect overall sales to be comparable to the second quarter of last year. We expect mattress fabric sales to be slightly up compared with the second quarter of last fiscal year, and operating income and margins are expected to be moderately up as compared with the previous year's second quarter. In our Pulsar Fabric segment, we expect sales to be comparable to the same period last year. Operating income and margins are expected to be slightly higher compared with the same period a year ago. However, our projections are as contingent upon any potential additional tariffs that could be imposed in the future and could therefore affect our operating costs. In our Home Accessory segment, we expect second quarter sales to be considerably down as compared with the second quarter of fiscal 2019, as we refine our strategies and focus on higher margin products. We expect an operating loss for the quarter, but with meaningful improvement as compared to the first quarter of this fiscal year. Considering these factors, the company expects to report pre-tax income for the second quarter of fiscal 2020 in the range of 3.2 million to 3.8 million. Pre-tax income for last year's second quarter was 4.3 million, which included a net benefit of $543,000 in restructuring the related charges and credits and other non-recurring items. Excluding these credits, pre-tax income for the second quarter of last year was $3.7 million. Based on our current budget, capital expenditures for fiscal 2020 are expected to be in the $7 million to $8 million range. Depreciation and amortization are expected to be approximately $9 million. Additionally, given the current outlook, free cash flow for fiscal 2020 is expected to be comparable to last year's results, even with an uncertain geopolitical environment. As a reminder, cash flow from operations last year was $13.9 million, and free cash flow for the year was $11.5 million. With that, we'll now take your questions.

And ladies and gentlemen, if you have any questions, please signal by pressing star 1 on your telephone keypad. if you would just make sure your mute function is turned off to allow us to receive that signal. Once again, at this time, star one if you do have any questions. We'll pause for just a moment. Okay, first from Stiefel, we have John Baugh.

Thank you, good morning. I guess my first question is just around the extra week and how that plays out. how that played out in the quarter you just reported. Is it 5%, 6%, 7% incremental to revenues overall, or is there some timing difference?

John, hey, it's Yves. Good morning. Thanks for the question. Yeah, for sure, any time we have an extra week, it's a good thing for a quarter, but it's really important to note that our sales are up more than just the extra week, which is why we have used the term being energized by the sales levels. So it's not just the week. It's actually a growth in our business on top of that week. Okay.

Yeah.

Yep. Go ahead. I was just going to say on the upholstery side, you know, sales were actually down. But, again, that extra week was a factor, plus, you know, the soft retail. And remember that last year we had the U.S. operation in Anderson. This year we did not. So that also affected sales year-over-year comparisons.

Okay. And then maybe could you go into a little more background or color behind the knitted fabric inventory issue, sort of what was basically happening at your customer level and your production and the timing and all that and how that sorts out?

Yes, sir. That's a really good question and one we've been trying to explain a lot, so I'm glad you asked us about that. Kind of what's happening is we're seeing a lift in the business or had a solid lift in the business in Q1. And a lot of that was driven by class, which is our cut and sew product, which we talked about pretty extensively, as well as the woven mattress fabrics, which is what's happened really strong in Q1 as well. But knits were impacted because most of the cut and sew business uses knits. And just like the mattress industry had inventory in the system, while they were waiting out the anti-dumping on the Chinese mattress imports, we had inventory in our system that we had built for the cut-and-sew business. So we had shipped inventory to Haiti or had it stored in the U.S., prepped it in the previous quarter, so we had the class sale in Q1, but we didn't have the production of the knit fabric in Q1 to service that class business. So it just kind of disrupted our efficiency and our production schedule, which impacted our profits on. We really pulled the slack out of our internal system with inventory, and that shows up in the inventory numbers and how pleased we were to have those much more in line, but it did impact efficiency in the short term. I hope that helps explain it.

And how does that sort of set up for Q2 as it relates to this topic?

Yeah, so Q2, I mean, just, you know, once we get the slack out, which we've done, we're back to much more efficient schedules and operating, and then we'll fuel it as normal fabric to finish cover and be able to drive those efficiencies like we expect.

Okay. You mentioned changes in design. Any specifics in terms of people, talent, you said a dedicated, are these existing people you're sort of repositioning, or Give us some flavor for exactly what you're doing there.

Yeah, sure. I'm pleased to talk about that. It's both. The business has changed a lot in the last year to two years as you followed so closely. And there's just more than our traditional betting customers, which we are still there and very strong. So much of the new business that we're capturing in new customers is just demanding a different type of product. So we've taken... and internal resources and established a really aggressive, purely innovation team that's sort of irrespective of design, just focused on what's the best innovation we can find. Then we've added some new resources that we're really excited about, just on a pure creative standpoint. And then those two teams will marry things together and not be tied on, they're not both having to think about it jointly as they can do it separately, and then we'll pull that together, put the right design on the right innovation. It's a nuance that we're really excited about as we move forward.

Okay. My last question is on eLuxury. It just sounds to me like you're going to walk away from some unprofitable business, maybe on the B2C side. I don't know any color there, what precisely you're doing and prospects for getting that business to break even.

Yes, sir. We have to get that business to break even and better. And we've learned a lot over the last year that we've invested in it. There are some places in e-commerce that just are hard to be profitable. The fees can be much more than we expect. They can change without a lot of warning. And we're just refocusing products that fit in that space. and then refocusing products for B2B business, which is our core customers, as well as our current customer base in some new areas and some new growth that we can do with finished products to find places along with retail marketplaces that don't carry such heavy fee. So we're not walking away from the major markets. We have to be on those. We just have to be on them with products and fee base that fits our profit model. We're happy, we're excited about the service platform I believe is critical to our future to have the way we're servicing that finished product business, but we just have to be smarter on what the fees are and where we can make money.

All right, thanks. Good luck.

Yes, sir.

And our next question will come from Bud Bugach with Raymond James.

Hi, it's Bud for Bobby Griffin. Good morning.

Hey, Bud.

A couple of questions. Could we dig into what the, in the mattress segment, the employee-related costs were? Can you talk a little bit about what the elevation was? Looks like operating expense was about $500,000 more than last year. So can you quantify what those, what that delta was and what the surprise was?

Yeah, the buzz is Ken. We can't really quantify it. I mean, it's employee-related costs in the area of healthcare and some workers' comp that from time to time will get out of, I guess, out of trend. That did pressure the quarter. Also, too, as a part of that operating cost, we had some inefficiencies that Yves mentioned as well. So, Those two pressured the quarter, obviously, when we look at breaking down exactly the impact. I think if you rank the two, I think the inefficiencies were greater, obviously, than the other one, but in tandem, they both affected the quarter.

So looking forward, how do we think about the run rate of OPEX for mattress fabrics? Do we Do we continue to run it at a $3 million level of quarter? You should have some extra week costs in there, I would think. What's the right way to model that?

I guess, but I'll start, and then, Eve, you can jump in. I think the way I would look at it is if you look at the, as we're projecting for the second quarter, we are guiding that the margins will be improved. Again, because we're thinking that this event with the employee-related costs will not be there, plus as if it explains the improvement in efficiency, getting all this flow-through out of the way, which will help the margins going forward. So I think beginning the second quarter, we'll see that improvement. And then going forward from there, depending on sales level, we'll get the lift in margins as well, or at least in bearable profits. Yeah, but I don't know if you want anything to that or.

Sorry, but you can ask the question there.

Well, yeah, I mean last year's second quarter and gross margin for mattress fabrics. I think you were at 15 and a half percent. Are you you think you'll be there again this quarter or above where you were? Somewhere between the 14 seven and 15 five. Where how do we think about that? What's the what was the? the impact of the NIT and the inefficiency on gross margin?

Yeah, I think, Bud, as we look ahead, again, looking at second quarter, I think I would say the gross margin would be comparable to last year, or at least last year's first quarter. So, yeah, I think that we would be back up in that range, in the 15-ish range, back up from the 14-7 this quarter. once we achieve those improvements?

We've enjoyed up to 20% gross margins in this, and if you are in innovating territory, I would think you would want to get back to that bogey again where the gross margin begins with a two. I know that may not be possible in today's competitive arena, at least in the near term, but is that how we should think about it? Is that something we're looking forward to?

But, yeah, this is Ev. Yes, sir. I mean, there's nothing that has changed in the way we're approaching the business and the cost that we're putting behind it. I just think we need to get back to that stability and all product lines firing like they have in the past. The cost level that we're applying to the business has not increased. So some of the things that impact us temporarily are not carried forward. And, yes, sir, I think we should be thinking about moving back to those gross margins.

But one of the things that has changed is the percentage of class, the penetration of class in that category. And I would think class carries a lower gross margin because it's more labor-intensive. Is that not the right way to think about it?

No, yeah, I wouldn't think about it like that. I mean, with class, we really have an incredible platform based with our Asian production, our Haiti production, and our U.S. production, all three. doing very well um for sure it's a labor intensive business but what's really good about us with class is we're generally if we're doing our jobs well or supplying the fabric through to the finished cover and there's no reason that should be a any lower profit expectation than we expect on any other product but for our us bean counters that doesn't have a lower gross margin than the other side of the business You mean just a pure fabric versus a sewn cover?

Yes, sir.

No, but I mean that should, we're not making extra because, you know, it is consuming our internal production, but we shouldn't be sacrificing margin as we sell mattress covers.

Okay. And looking at e-luxury or the home accessories segment, When do you think we get to break even? What's the likely, what's the right, how should we hold you accountable for getting that segment to break even? When should we get there?

Well, the expectation we have, Bud, is by the end of this fiscal year. So the improvement plan that we're undertaking is really targeted for this year.

Okay. All right, and so not in the second quarter, but by the time we get to the third quarter and the fourth quarter, we should be at a run rate for an annual break even. Is that right?

Yes. Yes.

Okay. And for me too, I know in the corporate overhead, you had a low stock comp last year and we've got the extra week this year. What's the right level of corporate overhead right now? Is it in that 2.2, 2.3 million a quarter? How do we, what and how much of that is fixed and how much of it's variable?

Yeah, but that's a great question because last year was such a, you know, a unique event with the reversal. Yeah, I would say in that two, you know, in the 2-2, 2-3 range is a good point.

Okay, and how much of it's fixed, Ken, and how much of it's variable? Does it have much variability to it, to revenues?

Yes, some of it, Bud, but there's some bonus expense in there, obviously the stock comp expense, but there's a lot of fixed in there as well. So I would say much more fixed than variable.

And strategically, I know you've got a major operation in China that's been a real success, and this trade dispute, as we've watched, has caused a lot of disruption. You've moved some partnershipping to, I think, to other parts of the world. Tell me, Frank, how you think about that strategically now, to the extent that you're willing to. It's got to be on your mind, I would think.

It is, Bud, and that's something we've looked at for a number of years. And as we've looked around the world, which we've always done, we've looked for other sources of upholstery fabrics particularly, whether that be Turkey, Indonesia, India. maybe the Asian countries, we still today, China, even with 30% tariffs on it, is still more cost-effective, A, and B, more breadth of product. We're dabbling in a couple of small areas, but as hard as we've looked, we don't see other good sources of opportunity for fabrics. And we hear this from our customers as well. So this is actually, we feel like it's pretty good news, is China is going to be there. Our best guess is 85% to 90% of upholstery fabrics come out of China today. And they have for the last 10, 15 years, as you know. And we just don't think that's going to change. But I'll tell you, we've looked, our teams have looked all over the world. We've made trips to Indonesia, Vietnam, Turkey. And the competitive fabrics aren't there, nor, importantly, the breadth of product we can get. And the reason is the textile infrastructure in China is so extensive. And it's just not that extensive in these other... You can get pockets of fabrics. You know, India might do sheets real well. Turkey might do certain woven fabrics well, for example. So I... Our best guess right now, as hard as we've looked, China is going to serve us very well.

And, Bud, this is Yves. I can just tack on to what Frank's saying, and I agree with everything he said. But what we are doing in all of our businesses is tariffs have for sure been disruptive to the industry and without any doubt to us. But we're rationalizing so much of where we're producing products that we're able to mitigate some tariffs by what we're doing in Vietnam. with our cut and sew. So we're adding some extra processing to Chinese fabric in advantageous countries, whether it be Vietnam or Haiti, and helping our customers mitigate tariff impacts. That's a big strategy that we'll keep going forward all throughout this year and further if tariffs continue to be a hindrance.

Well, I'm thinking outside of tariffs. I'm just wondering if there's any regulatory issues that you're seeing in China that are start to worry you that maybe it makes it harder for a non-domestically owned business to operate there.

And, you know, we've obviously watched that real closely and we're staying in tune with other businesses. We've actually seen none to this day. No non-tariff type barriers, no disadvantageous treatment to a foreign-owned company. In fact, Bud, We've seen some examples of the opposite. They really want to help exporters of products from China. And that would make common sense. And we've seen that. So we're not seeing any of that treatment that some people may talk about. And we obviously are watching for that. But one of the strategies we've done over there for years is we have a totally China operation. We have no expats. So our relationships with the government are all local Chinese to Chinese, and we've enjoyed terrific relationships over the years. And I don't see that today.

Gotcha. Well, thank you very much. Good luck on the balance of the year and the next couple of quarters.

Yes, sir. Thank you.

And another reminder, folks, star one for any questions. We'll move on to Marco Rodriguez with StoneGate Capital Markets.

Good morning. Thank you for taking my questions. I'm wondering if I could kind of follow up on a prior question in regard to the innovation initiatives that you talked about today. Just kind of wanted to get a little bit better of a sense, you know, if you talked about the betting market, trends that have changed over the last year with, with the box, uh, uh, the box beds, if you will. Um, I was just wondering if you can maybe talk a little bit more is the change that you're making there. Is that something that was being driven internally? Something maybe that you had been discussing with particular clients or were there some sort of competitive pressures that kind of pushed you in that direction?

You know, I think it's really something we were driving internally, Marco. We, um, We just recognize that, and I'm recognizing a lot as I think about the business on the mattress side and the upholstery side. We, for such a long time, diversified the two businesses and let them target accounts or segments of the business that made sense. And mattress fabrics were for mattress fabrics and upholstery fabrics were for furniture companies. And we didn't blend them that much intentionally because we wanted to keep them targeted to their markets. What's happening today is there's just so much cross-functional things. People that were making furniture are now making mattresses and vice versa. And we just have new customers coming at us, and we need to have different offerings. And so we don't need to be constrained by the way we were always constrained in the past, and we need to have the businesses cooperate more. So that's really what's driving it. We just see an innovation need to be thinking different than we always thought. It doesn't mean we've always had high marks for innovation and we're thrilled with where we've been. We just think there should be more attention paid to it. And then obviously we've got to have creative design, which we're going to bolster that up. But we just need design to be design and innovation to be innovation and not be constrained by what type of fabric or what division it's coming from. So we're just looking across all the borders now.

Understood. Very helpful. And then just to confirm, your response to the question on the native fabric inventory that negatively impacted Q1 margins, if I understood the answers correctly, it sounded like that issue is gone, and so it shouldn't be a negative impact in Q2. Did I understand that correctly?

Yes, sir. That's right. Exactly right.

Got it. And any sort of sense that you can provide in terms of where you're kind of thinking about the excess inventory levels in the mattress industry? Any color, any thoughts or conversations you've had with customers?

It's so hard to be definitive about that, but we definitely are feeling and believe there's some positive impact to our business as that inventory has waned. I think I feel a lot better that the business for the North American producers is in the short term looking very, very strong. We don't see inventory being that burden that it was for so long through last year. So we see orders. We see replenishment. We see things being done. We see e-commerce slots now being filled by customers that we would expect to fill them. So I think that's really starting to flush itself out.

Gotcha. Yeah. And on the upholstery fabric side, I'm just trying to get a little bit better sense in terms of your thought process as the year kind of progresses. Obviously tariffs are a big wild card. Sounded like you're starting to make some, rather mitigate some of that impact through shifting some of the supply chain aspects of your product through Vietnam and Haiti. Is that what is kind of the main driver? It kind of sounds like top line should be kind of pressure because of the weak retail environment, tariffs, etc. But then it seems like you're talking about margins might be improving as the year kind of progresses. Can you kind of help me walk through those effects there?

Sure. I'd be happy to give my best on that. We We definitely believe sales have been impacted by some retail just uncertainty. I mean, there's pockets of our customers that are doing very well and others that have been struggling. And just generally speaking, there's a lot of uncertainty about what tariffs will do, where they'll go, and then how should we respond to those. So our customers are thinking about that almost every day. From a profit standpoint, we're very pleased that we've been able to navigate through all those difficulties and maintain actually improved profitability which we're pleased about so we haven't just passed all that on we've worked with our customers to mitigate parts of it find alternative channels to add value and then help to to stem some of the tariff increase at the same time we are benefiting some by currency that's happening in the market that's benefiting us too And so that's helping to wash some of the tariffs out. So on balance, we feel like we can maintain profitability in an uncertain time, but we have to be prepared to make some moves to help that further if and when the tariff fight doesn't subside.

And Marco, this is Ken too, just to add on that, you know, we talk about the currency, obviously, but we also talk about the product mix. I mean, as I mentioned before, with the U.S. operation at Anderson gone now, you know, that pressure that we had in previous years, or at least last year, is now gone. So we're focusing more on more profitable products, you know, our growing hospitality business, Our new performance fabrics, especially now with this evolved product line, all those are giving us confidence as we go forward that we'll be able to continue to perform well in the future.

Got it. And can you quantify what was the positive impact for FX at the gross margins in the quarter?

We don't quantify it, Marco, but it was significant. If you look at the range that's taken place over the last, I guess, quarter, it was a significant impact. But there's a lot of different pieces in there that makes it hard to nail down the exact number. But it was a material impact this quarter.

Gotcha. And last quick question here, just wondering a little bit more about read window, you know, a year and a half here now since, or so since you've, you've acquired it, just wondering what may be sort of lessons you've kind of learned versus the initial expectations you guys had. And then what sort of your expectations for that segment in terms of growth and margins?

Okay, Margaret, this is Frank. We are almost a year and a half in, as you said, And we are more excited about this market segment today than we even were in the beginning. We like it for a number of reasons. It uses a lot of the same capabilities that we do internally, cut and sew, fabric from offshore. But we have domestic customers. It's higher margin, significantly higher margin. It's a more stable environment. So we've learned a lot about producing window treatments, both draperies and roller shades, and that marketplace. Of course, we're a producer and installer as well. And I believe what you'll see from Culp in the years ahead is more investment in this category. So we're very pleased with it. They're off to a great start. I think it's only going to get better. The synergies between Culp's operations in Reed are pretty much as we thought they would be. And Culp Hospitality is going to be a force in the years ahead in that marketplace. And I think we're going to see organic growth and acquisition growth as well in that category.

Thanks a lot for your time, guys. Thank you.

And it looks like at this time we have no further questions from the audience. I'd like to turn the floor back to Frank Saxon for any additional or closing remarks.

Okay. Thank you, everyone, for your participation today and your interest and call. We'll look forward to updating you next quarter. Have a great day.

And once again, ladies and gentlemen, that concludes our call for today. Thanks for joining us. You may now disconnect.