Hooker Furnishings Corp (HOFT) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to Hooker Furniture's third quarter results conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Larry Ryder, Executive Vice President of Finance and Administration and CFO. Mr. Ryder, you may begin, sir.

Thank you. Good morning, and welcome to our quarterly conference call to review our third quarter 2006 operating results. We certainly appreciate your participation this morning. Joining me today is Paul Toms, our Chairman and CEO. During our call today we will make some forward-looking statements which are subject to risks and uncertainties. A discussion of factors that could cause our actual results to differ materially from management's expectations is contained in our SEC filings and the press release announcing our third quarter 2006 results.

Any forward-looking statements speaks only as of today, and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances after today's call. And with that out of the way, Paul has some opening comments.

Thanks, Larry. Good morning, everyone. Since this is our first investor conference call I thought it might be beneficial before we get into the specifics of the quarter to briefly review our corporate strategy and where we see ourselves positioned today in an ever-changing industry. Our mission, quite simply, is to bring the best home furnishings products values available and our price points to our customers. We add value through product development, sourcing, quality control, logistics, product flow and service.

Since 2001 when about 70% of our productline was domestically produced wood furniture, we have transitioned from a domestic manufacturer to a global marketing company. We don't particularly like the fact that we've had to change through downsizing and close four plants during that time. Yet we believe change is a way of life, and you either adapt or become irrelevant. As we've undergone this dramatic change and transitioned to a new business model, we've continued to grow and remain profitable, generally outperforming most other publicly traded furniture companies.

Over the last five years we've grown our imported wood furniture business, which is our largest segment, at a greater than 25% compound annual growth rate while improving margins. Today we believe that most of the transition is behind us and that we are poised to reap the benefits of adapting to the global marketplace and the changing expectations of our customers. We're improving in the competencies required to compete in today's environment. We're getting better at flowing product, inventory management, although most of our progress won't be fully realized until the next two to three quarters.

As an importer we have almost 20 years of experience. In 1988, beginning with our Seven Seas accent import line sourced in China, Hooker was one of the first players in the industry to import wood furniture. We believe that the best way to leverage our financial strength and differentiate our import business from the industry is through innovative and collaborative design, outstanding product, great value, consistent quality, ease of ordering, world class logistics and global distribution systems.

Currently with over 80% of our best-selling items in stock we are growing in sales when many producers in the country are flat or reporting reduced sales. Our plans are on target to reduce finished goods inventory from August 2006 levels by over 25% during the next six months without compromising service to our customers. We've aligned our domestic manufacturing capacity to the current and anticipated level of demand and restructured our corporate organization to align our corporate structure to our current business model.

Our industry's trade magazine, Furniture Today, has identified over 70 different distribution channels that furniture is sold through. Our product is sold through approximately 30 of those channels to more than 4300 accounts this year, with nearly 100 professional men and women out in the field every day to service those accounts working with customers to plan their business and resolve problems.

Now let's look specifically at our third quarter and how it fits into our unfolding strategy. Considering the challenging business environment in our industry, we were pleased to achieve $83 million in sales for the quarter, which actually was a very slight increase over last year's third quarter. We are also gratified that so far in 2006 we've had a topline increase in each of the first three quarters and been able to grow slightly in a difficult retail environment.

On the bottom line we also increased our net income to $1.2 million or $0.10 a share despite some larger than typical selling and administrative costs during the quarter. Our net sales increase on the wood side of our business slightly outpaced the upholstery sales during the quarter as wood and metal furniture shipments increased to just over 1% to $68.4 million from $67.6 million in last year's third quarter. Although lower unit volume for domestically produced wood furniture partially offset our sales gain on the wood side we're continuing to grow our import business at a double-digit rate with strong growth in both the container direct portion that ships directly from China to our retailers warehouses, and our shipped from stock business which is serviced out of our Virginia distribution centers.

Our Bradington-Young leather upholstery business was essentially flat at $14.7 million for the quarter versus $14.8 million a year ago. Given the current market environment it is not surprising that our leather business has been flat to slightly off much of this year. I think most people would agree retail is sluggish, and leather upholstery is under more assault from imports than fabric. We are combating that import challenge, however, through our own import Seven Seas seating line which is showing strong net sales growth. We are confident that Bradington-Young is well positioned to remain one of the leaders in the upper end leather seating market. Compared to 2003 when we acquired Bradington-Young actually January 2003, our leather productline is stronger and more diverse. Our delivery times are better. Our dealer base is expanded and our values are better with the addition of the imported Seven Seas leather seating line.

Turning now from sales to our profit performance, one of the brightest spots of the third quarter was our improvement in operating income and gross profit margin. Our gross profit margin increased to 28.3% of net sales in the third quarter compared to 25.8% in the third quarter last year. This improvement came primarily through product mix as a larger portion of our shipments were higher margin imported wood, metal and upholstered furniture. Margins continued to decline on domestic wood furniture which we attribute to higher sales discounts, material, labor and overhead costs increasing as a percent of net sales for that segment.

Our third quarter operating income increased just over 70% to $2 million from $1.2 million in the same period a year ago. As a percentage of net sales, operating income increased to 2.5% in the current quarter compared to 1.5% in last year's third quarter. The area where our bottom line really took a hit this quarter was selling and administrative expenses, where as I mentioned earlier we incurred some larger than typical costs. Selling and administrative expenses increased by 21% or $3.2 million to a total of $18.6 million this year, versus $15.4 million last year. There are several key reasons for this increase in selling and administrative expenses. First, we incurred higher warehousing and distribution costs to support increased demand for imported furniture and our ongoing supply chain initiatives.

As a result of the increase in our purchases of imported wood furniture this summer we've incurred higher receiving costs such as temporary warehousing and port storage costs. We expect these costs to continue through the next quarter, the current fourth quarter. We see ample opportunity to drive cost out of selling and administrative expenses just by getting our arms around inventories, vacating some of the excess warehouse space we currently have and improved scheduling of inbound goods in order to minimize our receiving costs. We expect to do this over the winter.

Beginning with the 2007 first quarter we expect to see these costs diminish from current levels. We've been aggressive in discounting to move excess and obsolete inventory, and will continue with that level of discounting for the next few quarters. We began to curtail ordering from our offshore suppliers to an appropriate level in May or June of this year and are beginning to see the benefit. Inventory levels peaked in June. Since then through the end of August we reduced finished goods inventory by 6%. We are on track to reduce finished goods inventory by an additional 8 to 12% by the end of our fiscal year, November 30.

On a domestic production side we are addressing finished goods inventories by taking the Roanoke Plant off-line in mid-August. Also during the upcoming fourth quarter through an early retirement offering and the release of temporary employees we expect to reduce our Martinsville production workforce by 20%. We've also scheduled some additional downtime at our Martinsville Plant. We expect that these steps will reduce finished goods inventories all without compromising delivery to our customers.

Another area of significant selling and administrative expense during the quarter was a special charge of $1.4 million for compensation costs related to the early retirement of Doug Williams, our President and Chief Operating Officer. Doug's retirement arrangement was more fully explained in our 8-K filed Tuesday, October 3 with the SEC. One other noteworthy area of increased selling and administrative expenses this quarter was a bad debt expense of $480,000 related to a potential default by a customer.

Also during the third quarter we recorded restructuring and asset impairment charges of $2.8 million or $1.8 million after-tax, $0.15 per share related to the August closing of the Roanoke Plant. On July 26 we entered into a definitive agreement for the sale of the Roanoke real estate, machinery and equipment for a purchase price of $2.2 million net of selling costs. We expect to close that sale by the end of the 2006 fourth quarter. If we step back and take a larger view of the entire year, including the first through third quarters, we're tracking even better on the topline and at the net income level. Year-to-date we're reporting net sales of $259 million, an increase of approximately $7.4 million or 3% versus last year's $251.6 million during the first three quarters. Year-to-date net income is up over 25% or $2.1 million to a total of $10.6 million or $0.89 per share versus $8.5 million or $0.72 per share during the same period last year.

As a percent of net sales net income rose to 4.1% for the first nine months compared to 3.4% during the same time period last year. We're pleased to have been able to leverage a 25% net income improvement based on a relatively small sales increase. With the larger than typical compensation costs and bad debt expense behind us we see ample opportunity to further improve profitability by containing warehouse and distribution costs and growing net sales going forward.

Looking ahead to the fourth quarter we see several factors, such as a slowdown in housing and economic activity that continue to cause consumers to be cautious. However on the positive side energy prices are down, interest rates have stabilized, consumer confidence is improving and the stock market is performing well. While business is marginally improved since August we are up against a strong fourth quarter last year. During the near-term we're certainly in a strong inventory position to capitalize immediately on any upturn at retail. For the longer-term we would expect business to improve as we move into this fall and winter.

Now I am going to call on Larry to take us through the balance sheet.

Thank you, Paul. On August 31st assets totaled $196 million, increasing from $189 million at our November 30, 2005 year end. Principally due to a $15 million increase in inventories, partially offset by a $6 million decrease in cash. The Company's long-term debt declined by $1.7 million to $11.6 million at August 31 as a result of scheduled debt repayments. Working capital increased $10 million to $120 million as of August 31st from $110 million at the end of last year reflecting a $9 million increase in current assets coupled with $1 million decrease in current liabilities.

Inventories increased nearly 22% to $84 million from $69 million at year end principally due to higher receipts of our imported wood and metal furniture. During the nine months ended August 31, 2006 a decrease in cash and cash equivalents totaling $6 million, receipts from the sale of property and equipment of $1 million which was principally the sale of our Pleasant Garden North Carolina real and personal property, and cash generated from operations of $300,000 funded our cash dividends of $3 million, the purchase of property, plant and equipment of $3 million and payments on our long-term debt of $1.7 million.

We generated cash from operations during the first nine months of 2006 of $300,000, a decrease of $8 million from the 2005 same period. The decrease was primarily due to higher inventory purchases during the period. We believe that the efforts that we had made in our forecasting logistics and supply chain management will be apparent in inventory levels by year end. We anticipate, as Paul has pointed out, an 8 to 12% reduction in finished goods inventory by November 30, which should improve cash flows in the fourth quarter. Purchases of plant, equipment or other assets to maintain and enhance the Company's facilities and business operating systems amounted to $3 million for the first nine months and are expected to approximate an additional $2.4 million to $3 million in the fourth quarter.

Thanks, Larry. We will now open the lines to questions.

(OPERATOR INSTRUCTIONS) Todd Schwartzman, Sidoti & Co.

Good morning, guys. Could you talk about, please, where you are with respect to your supply chain initiatives, specific actions that you've already taken, things that you still have in front of you as well as the results that you have seen so far and also to give a sense of how much further you have to go?

I'll take a stab at that first and Larry may have some additional comments, but Todd, I think we are well along the way with our initiatives. I guess it is really a never-ending, but going back approximately a year and a half ago we reorganized our company, created the supply chain department, hired a professional from outside the industry with supply chain experience to manage it and staffed that department with approximately 12 people. We have also invested with software from a company called Logility; it has quite a bit of experience in our industry as well as other industries. I think like a lot of chains, it is taking a little bit longer than we would have anticipated, and there has been a learning curve but I do feel like we've got disciplines in place that we didn't have previously. I will let Larry talk a little bit about the current module that we are implementing which I think is going to tremendously increase communication and accountability from our offshore vendors to us, and enable us to communicate a lot better internally and to our customers.

But I feel like we've made progress mainly measuring the number of our best sellers or the percentage of our best sellers that are either in stock or available within 10 to 15 days. And if we look at our A items, 80% of our business that is probably 20, 22% of our SKUs that drive about 80% of our business, those are in stock at a level of 80% now. And if you look out 15 days it is approximately 90% that those SKUs are in stock and it hasn't always been that way. So I think we're making real headway there. We also measure delivery times to our customers across all of our business, and those are at the highest levels we've ever measured. And they are continuing to improve. The next step is we've got to do it with less inventory, and we have put disciplines and controls in place to try to target inventory levels, 6, 8, 9 months out. And I think that is the progress we anticipate seeing in reducing inventories over the next 60 days, 75 days and also over the next 6 months are a result of those controls.

Todd, I would just add that most of the efforts thus far have been in our forecasting and I think we have really seen some improvement as a result of those systems rolling out. As Paul said, as a result of that we have started to curtail some of the ordering that we have been doing in the past back in May and June of this year. And as you can see from what our comments have been thus far, we do anticipate, have already seen some decrease in finished goods inventory, anticipate more in the fourth quarter and even beyond that. We believe that, as Paul has pointed out, we believe that we can reduce those inventories without detrimentally affecting delivery to our dealers.

We do have additional software developments that are going to be coming out in the fourth and first quarter of next year. They are primarily enhancements to our purchasing system that will give us much more visibility of orders on our suppliers shop floors so that we can watch for potential bottlenecks, move our people that we have on the ground in Asia in to work with our suppliers to hopefully avoid bottlenecks and slowdowns in deliveries. We think that that program should be fully operational by the first of March of next year. But I would say that we were fairly far along in the process. And again, those changes I pointed out earlier our capital expenditures expected to be from 2.4 to 3 million in the fourth quarter should capture most of the additional development costs that we see in that program.

And how heavily does a reduction in SKUs play into or weigh upon your inventory goals, and where have you gone from what to what in terms of total SKU count in particular on the import side. Assuming this is something we really should be paying attention to?

If you go back about a year our SKU count including domestic and import was just over 4,000 items. We set a target of reducing that to 3,000 in total, and I think we are pretty much at that 3,000 level. We've got some inactive or discontinued SKUs that we need to move out of the system, but where our line of active, ongoing SKUs is currently around 3,000. And certainly driving inventory levels down was part of the rationale for that but also part of it is just being able to manage to physically look at the SKUs and keep up with them and order them appropriately and follow them in the factories. 4,000 was more than we needed to drive our business, and we've been able to slightly increase our sales in a difficult environment while reducing our SKU count. So I think that was absolutely the right decision, although we probably questioned it a little bit a year ago.

Do you think you will level off at that 3,000 number?

I think so and actually we may be able to drive it a little bit further down. I think at some point if we are going to continue to expand our business by entering new product categories and also some new distribution channels, there is probably a push to add SKUs for proprietary products for some customers, or let's say if we wanted to expand certain categories that we are in we are probably going to need increased SKUs. But I think in the short-term we can perhaps drive it down a little bit; longer term we will probably need to grow it back. And I think that was our plan all along; when we can get our arms around it and can manage 3,000 or slightly fewer SKUs, then we can gradually build it back.

What kind of progress have you made with respect to reducing the number of Asian vendors? I know that that was I think about 75 or so as of a year ago. Is that correct?

I think a year ago we had approximately 80 vendors total. Most of them were in Asia, a few were not, and our goal was to drive that down by 25% to 60. And I don't know that we are at 60, but I think we are much closer to 60 than we are to 80 today.

When should we expect to see imports level off as a percentage of the sales mix?

You know, that is really going to be driven by our customers. I don't think we ever said any percentage is a target of our business. What we try to do is bring the best product we could to market from wherever we could source it or produce it ourselves and let our customers and ultimately the consumer decide and I don't know what the answer is there. I think obviously in wood it is a higher percentage sourced offshore than produced here than in our leather business. But we've never set a target for a certain percentage of imports to our total business.

My last question is what should we look for as far as CapEx in '07?

Todd, at this point in time we really haven't finalized all of our capital budgets for 2007. We are in the process of doing that now, including our software and other development costs that we anticipate. I would expect that that will be done shortly and probably will be announced with our fourth quarter earnings. I think I can probably say that generally speaking I don't anticipate much of a higher level than we've seen this past year.

Great. Thanks.

(OPERATOR INSTRUCTIONS) Joel Havard, BB&T Capital Market.

This is actually Sean Connor for Joel. He is traveling right now. I believe you may have just answered; I was hoping to get some more detail on the volume and the SKU count coming into the system with relation to the evolution of your mixed container program. I believe you just discussed a lot of that.

We have covered that but there is one thing related to the mixed container program and SKU count that I think validates some of our decisions. And that is that our largest source plant in Asia has warehousing attached to it that they own and we operate. And at the start we had almost 800 SKUs coming out of that factory or its really a combination of factories, but 800 SKUs. And we felt like going to our customers and saying pick any of these 800 SKUs and we can do them in mixed containers and you don't have to buy very deep in anything. Was a tremendous marketing advantage, and we implemented that and had inventory target levels that we thought would service it and probably 9 to 12 months into that program we had grown inventories by double what we thought we should have. Customers were upset because they couldn't get the mixed containers quickly, and we realized that we had been too aggressive in trying to offer the entire SKU count in that program. So we dropped the number of SKUs available back from 800 to 300. We looked at the business and said what SKUs are driving the mixed container business, and in that case it was typically larger groups, dining rooms and bedrooms. So we limited the program available mixed container out of that China warehouse with the 300 best-selling SKUs. We've been able to drive the inventory levels down and the volume up in the nine months since we implemented that change. And I think that just validates that we really need to focus on the product that is driving the business, and you can't offer everything, mixed container in that case to the customers and really deliver.

Great. Thank you.

(OPERATOR INSTRUCTIONS) Budd Bugatch, Raymond James.

I'd like to focus on inventory, if I could. It is up significantly over last year, you've noted and I think, Paul, you said it was down in finished goods. If I remember the number right, 6%, in the most recent time. Can you give us a little bit of, Larry, some detail in the composition of inventory right now in terms of finished goods, work in process and raw materials?

Well, the largest component by far is finished goods. (technical difficulty) wood side and that is the largest part of our total business. I guess at August 31st we were right at 82.5 million in finished furniture before LIFO that was 82.5 million out of about 94.4 million, 8.5% maybe?

So that's up over the $72.5 million from last year the same time, so it is up still $10 million year-over-year. Is that right?

That's correct.

And the LIFO number still looks like then it is about $11 million?

Maybe just under $10.6 million, I believe.

Larry, what is going to happen to that as you reduce domestic manufacturing even more? Isn't most of the LIFO attached to domestic goods?

Budd, it is really a dollar value flow. LIFO is attached to both. We don't anticipate a great deal of change as we flow more into the imported product. As you can imagine our imported product inventory today is tremendously higher than our domestic, and it has changed dramatically in the last few years as we've moved in. And yet our LIFO reserves have not changed that much over that period of time. I would not anticipate a great deal of change in the future.

You don't see a delayering as much of that inventory and comes out with the domestic wood?

No, I think there will be a delayering in the domestic most likely as most of that comes out but I think it will be evenly or more than offset by the increase in the LIFO reserves for the imports.

Of the $82.5 million, can you kind of help us how we should think about, how much is offshore, how much is on the water and how much is in your DC's here?

I don't have that information right here in front of me, but I think it is probably if you look at our total finished goods inventory on the wood side and that is where most of our inventories are; Bradington-Young has some imported leather inventory. But the word is 95% plus of our inventory, and I would say of that we probably got 80% in the U.S. in our warehouses. We probably have 10% in a warehouse in China or several warehouses attached to our largest source plant, and we have about 10% that is on the water. On the water I would also, that would include at port and off-site storage facilities, that port. We still have a backlog of containers at port that we are pulling into our warehouses and expect that (multiple speakers).

Is most of the reduction then going to come off of the goods that are in the foreign and the offshore warehousing or do you think it is kind of split between the offshore and the domestics? You can't really do much about what is on the water, that is hopefully that increases because that tells you business is increasing, right?

Right now we have more inventory than we need to support our business even with projected growth, and so we have curtailed ordering as we said back in May/June. And we are seeing the impact of that now and will for the next few months. So a lot of our reduction of inventories is going to be from the fact that we slowed ordering down and we are going to work through the inventories that we have here and at port and in China. I think they will all come down; I think we will have -- the goal is obviously to have less in transit in the short term and in port storage here and less in our warehouse. We think that is where the opportunity is. The import inventory in China is probably closer to the right size than what we have here.

Okay, and when you look at your terms and how you're paying for it, it looks to me like most of that inventory has already been paid for. Is that correct, or am I -- you've got $11 million in trade payables.

That's correct.

Any change in terms? I'm starting to hear people getting terms now from offshore.

We've changed our terms with some of our offshore suppliers but pretty much all the vast, vast majority of the inventory that we are showing --

All that we are showing is owned, right?

It is owned but I mean, and paid for as opposed to (multiple speakers) payables?

Most of it is, Budd, and additionally as Paul says we are beginning to see some changes in our supplier arrangements. Some of our suppliers are holding inventories for us at their costs. That hasn't been flowed onto us but they are producing those inventories in anticipation.

You mean bill-and-hold kind of stuff, or may not even build, just held for consignment, ready for shipping?

Yes, that's beginning, and we are also seeing with one of our larger accounts that we do have thirty-day terms with one of our premier accounts in China.

And I take it that the warehouse is in southern China. I would think it is -- would that be fair to say?

Yes.

The vendor that has the largest number of SKUs?

That's correct.

A couple of other just quick questions; any capital expenditures offshore? Are you planning to -- do you need another DC? Obviously some of the provinces have different rules to get goods out, right?

Near-term, Budd, no, there is no plans for capital expenditures and actually the warehousing that we have attached to our largest plant was not a capital expenditure. That was their expenditure, and it is operated by a third party.

He owns it, over there?

That's correct.

Did you comment or I think you stopped giving us import dollars of revenues, is that correct, do I remember that right? We have it from last quarter but I don't think we have it from this quarter.

I think we now just report our businesses wood and upholstery and break it out that way. But we did say today that our import business continues to grow at double-digit rates, and I guess 25, over 25% compound annual growth rate for the last five years.

So that would put that at about $55 million for this quarter?

I don't know that we broke it out for this quarter.

Well you had 50.7 last quarter. Double digits in the quarter, right?

Yes.

Okay. All right. That's very helpful. I thank you very much. Good luck on this quarter.

Thank you.

Gentlemen, seeing no further questions I will turn the conference back over to Mr. Tom for any additional or closing remarks.

Actually I don't have closing remarks. I just like to thank everybody for participating. This is our first attempt at a quarterly conference call. I hope we did okay. And if there are improvements you'd like to see, let us know. Thank you for joining us.

That does conclude today's conference. Thank you all once again for your participation, and have a wonderful day.