Hooker Furnishings Corp (HOFT) 2011 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to Hooker Furniture's quarterly investor conference call, reporting it's operating results for the fiscal second quarter 2011 earnings.

(Operator Instructions).

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.

Thank you, Ali. Good morning, and welcome to our quarterly conference call to review our sales and earnings for the 2011 fiscal year second quarter, which began May 3, 2010, and our first half, which began February 1, 2010, both ending on August 1, 2010. We certainly appreciate your participation this morning. Joining me today, is Paul Toms, our Chairman, President and CEO, and Alan Cole, President and CEO of Hooker Furniture Upholstery operations. During our call today, we may make 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 filing, and the press release announcing our 2011 second quarter and first half results. Any forward-looking statements speaks only as of today, and we undertake no obligation to update or revise any forward-looking statements to reflect events or circumstances after today's call.

On September the 8th, we reported increased sales and earnings for our second quarter. Net sales were up over 16%, as compared to the same period a year ago. Net income for the second quarter increased $1.6 million to $1.2 million or $0.11 per share, compared to net loss of $463,000 or $0.04 per share for the comparable period a year ago. For the six months of our fiscal year, net sales increased nearly 7% to $104.7 million, compared to $98 million for the fiscal 2010 first half. The Company reported net income for the 2011 first half of $2.3 million or $0.21 per share, compared to the net loss of $919,000, or $0.09 per share in the fiscal 2010 six month period. Now Paul will comment on our first quarter results.

Thanks, Larry, and good morning, everyone. After nine consecutive quarters of sales decreases during the recession and slow recovery, our double digit sales increase for this quarter was a real breakthrough. It was especially gratifying to have grown sales during the summer months. While the summer is typically the weakest quarter of the year for our industry, the retail environment this summer has been one of the most challenging in recent memory. Although much of the improved sales performance can be attributed our progress in reducing an order backlog, swollen by production delays and shipping bottlenecks in the previous two quarters, robust sales gains in Upholstery contributed as well. Net sales of imported upholstery increased approximately 56% from the prior year quarter, and domestic upholstery sales increased about 29%. Case good sales increased 8% during the quarter.

Our experience here at Hooker, with upholstery sales gained outpacing wood furniture, reflects what we are seeing in the industry, and what we have seen historically in past economic recoveries. Generally, upholstery and bedding have led the way in previous furniture industry recoveries. For sometime now, our primary challenge on the wood side has been to grow the top line, while our challenge in upholstery has been to bring profitability improvements in line with the sales increases. Although we were able to increase revenues on the wood side this quarter, we are still struggling with profitability in the Upholstery Division.

However, our upholstery division reported a small operating loss of 3.7% of net sales for this year's first quarter, which is a significant improvement over the operating loss of 10.3% of net sales in the same period a year ago, and a sequential improvement over the fiscal 2011 first quarter operating loss of 5.5% of net sales. Year-to-date, the operating losses improved from a negative 12.8% in the first half of last year, to a negative 4.6% in the first half of this fiscal year. We are disappointed that we have not yet achieved break-even or better results at these sales levels, but are encouraged by the progress, and confident we are moving in the right direction, in taking the necessary steps to return the Upholstery Division to profitability. At this point, I would like to call on Alan Cole, the President of our Upholstery division to give us more details on the significant initiatives underway in the Upholstery Division. Alan?

Thank you, Paul. As Paul indicated, we made some significant moves this quarter that we believe will have a positive long-term impact on our operational efficiency in Upholstery, and position us to achieve the kind of margin and profit performance that will contribute to Hooker's overall success. In mid July, we conducted a reorganization at Bradington-Young, focused on achieving upholstery labor efficiencies and cost reductions, increasing leather yield, and reducing overhead costs. This included the difficult, but necessary step of reducing over 35 positions, including indirect labor and support positions in factories, and manager and clerical employees in the office. We've given one of our key operating executives responsibility for significantly increasing leather yield and usage, and reducing material costs.

Complimenting this effort, is our move to import an increasing number of cut and sewn leathers, with final assembly done here in our cover plant and upholstery plants. Our goal to reduce material costs has gained a new urgency in months, due to raw material price increases. We did institute a price increase to our dealers at the April market, however, it has not totally compensated for the raw material and transportation cost increase that we've incurred this year. Also, Bradington-Young's Vice President of Manufacturing has been given the responsibility of increasing upholstery labor efficiency, while reducing non-value added costs. We are encouraged by the initial benefits of our lean manufacturing process. There are still gains to be made in efficiency and product -- productivity.

We also expect improved efficiencies, as we better assimilate our new April market introductions, including the Envision Leather line into our production, and complete the learning curve on these new products. In the area of warehousing and distribution, we have accomplished a great deal this quarter, as we successfully moved our entire Seven Seas import leather inventory from Cherryville, North Carolina to Martinsville, Virginia. Consolidating our warehousing and distribution, staffing, and administration with Hooker's in Martinsville will have a number of benefits, including better forecasting, improved in-stock position, cost savings, and faster shipment, and better service to our customers. We were gratified to have had such a strong shipping month in leather imports in the midst of this kind of transition.

In conclusion, I will reiterate Paul's comments that while we made substantial progress, it has not come as quickly as we would of liked. Several of these cost saving initiatives in this quarter will have a lag time effect, as they have in the past before savings are realized. We know we are taking the right steps. It's a matter of speeding up the impact. As we enter what is traditionally the strongest selling season of the year for furniture, we have a little more of a cautious view than we did at the beginning of this quarter, because June, July, and August were softer than expected at retail. However, if we are able the maintain approximately the same order levels that we have throughout most of the year, we will still expect to be profitable during the second half of the year in Upholstery. Now I would like to call on Larry to discuss factors that drove our sales and earnings performance this quarter.

Thanks, Alan. Much of the sales increase realized in our second quarter and first six months was due to improved shipment of our order backlog, as Paul had mentioned earlier. Case goods unit volume increased compared to the prior year quarter, but was essentially flat due to the prior six months. Upholstery unit volume continues to be encouraging, as we realized significant unit volume increases, at both Sam Moore and Bradington-Young, for both the quarterly and the six months periods. Overall, average selling prices decreased in the low single digits during the second quarter and first half, as compared to both prior year periods, primarily due to increased sales of lower priced products.

Gross margins for the second quarter and first half improved primarily due to lower freight costs, as a percentage of sales for case goods and savings from the closure of our California warehouse, partially offset by the $500,000 charge related to the fire at one of our distribution facilities during the first quarter, and increased margins at our Upholstery Division, primarily due to increased upholstery sales. Selling and administrative expenses decreased as a percentage of sales compared to the corresponding three and six month fiscal year 2010 periods, primarily as a result of cost cutting measures implemented during last year, and lower employee benefit expense, selling expenses, professional fees, and bad debt expense. Selling and administrative expenses also decreased in absolute terms for the fiscal 2011 first half for essentially the same reasons.

Operating income for the second quarter was $1.6 million or 2.9% of net sales, compared to an operating loss of $499,000 or a negative 1.1% of net sales in the 2010 second quarter. For the six month period, operating income was $3.3 million or 3.1% of net sales in the 2011 first half, compared to operating loss of $1.1 million or a negative 1.2% last year. This improvement was principally due to improved domestic upholstery plant utilization, and the lack of asset impairment activity during the fiscal year 2011 first half, as compared to the corresponding prior year period, partially offset by expenses related to the fire at our distribution center during the first quarter.

Our balance sheet remains strong, and continues to help cushion us from some of the impact of the current difficult sales environment, and our lower profitability. At quarter-end, we had cash and cash equivalents of nearly $30 million. We remain debt free, and have over $13 million available under our revolving credit facility, which remains in place until March of 2011. Additionally, we have $14.2 million available to borrow, on a cash surrender value of Company life insurance policies, if needed. We continue to maintain our quarterly dividend at $0.10 per share, thanks to our cash position, and the belief that our product and business model position us to take advantage of the economic recovery as it develops. Our strong financial position also gives us the ability to take advantage of opportunities that may present themselves, in this still challenging financial environment. Now I will turn the discussion back over to Paul for his outlook.

[Music].

Alright, are we back in conference?

Please go ahead, sir.

Okay. I am not sure what happened, but we were listening to a symphony there for a few seconds. Thanks, Larry. And I would like to talk just a little bit about our outlook for the fall. While we expect our performance to continue improving this quarter, due to the normal seasonal fall uptick, our expectations have been tempered somewhat by continued weakness in consumer demand,in large ticket discretionary purchases. As both Allen and I mentioned previously in this call, the June through August period at retail was much weaker than expected. Demand is particularly weak for wood furniture, with case goods orders tracking lower both on a sequential and year-over-year basis. Our consolidated orders were up 3% year-to-date at the end of the first half. Sequentially, orders were down Company-wide, 11.8% in the second quarter. That is a reflection of the soft business at retail this summer.

However, as we enter the fall selling season there are several reasons to be encouraged. First, and I would just like to share, that we are calling in from High Point -- with -- at -- in the middle of pre-market, which is a time twice a year when we get to visit with about 50 to 70 customers, typically large retailers and multiple channels, geographically dispersed across the country. And almost universally, everybody we've spoken with in the past two days, had a good Labor Day sales in their stores, and have done pretty well in the week to seven or eight days since Labor Day. So I think everybody's attitude is a little bit more optimistic, than it has been. Almost to a person, they experienced a weak -- very weak August, and June and July were not that great either, but I think August was particularly weak. However, they are all encouraged and optimistic about the fall, based on successful Labor Day weekend events, and business since then.

Looking internally at Hooker, we've made significant progress in shipping our backlog, and improving our in-stock inventory position this quarter. We've seen robust sales increases, that represent both share of market, and share customer gains in Upholstery throughout the year. In addition, some of our newer wood furniture lines like Sanctuary, Abbott Place, and Envision are performing well at retail, with strong initial response from consumer, despite the weak retail environment. We expect to grow our business in the near term through continuing to improve our supply chain management, offering superior product availability, and in-stock positions on best sellers, through market share gains. Thank you, and that concludes our formal remarks. At this point, I will turn it back over to Ali, and we will take questions. Thank you.

(Operator Instructions).

Our first question comes from Todd Schwartzman of Sidoti. Please go ahead.

Hi. Good morning, gentlemen.

Good morning.

Morning.

First on the supply chain, you had mentioned that the -- your partners and vendors have not yet back to traditional lead times. So it seems like there has been some progress, at least sequentially. Is there anything else, any other puts and takes regarding the supply chain, that you would want to call out, at this point?

Todd, I'm -- not much more than what we've said in the call and in the earnings release. I think if you compare to it a year ago, when our industry was coming out of nine months of terrible business, there was a lot of difficulty for the manufacturers in Asia to ramp up. I think at this point, they are ramped up. I think -- the lead times may be a little bit longer than they were in peak times of two or three years ago. But they are significantly better than they were late last year, and through the winter and spring of this year. So I feel like -- at least our manufacturing partners in Asia, have done a good job of getting capacity back up, and getting closer to historical lead times.

And can you share with us your outlook for the back half of the year, as far as freight and raw material costs?

Well, from a case goods standpoint, we are not seeing as much pressure on our inputs in Asia, as we were maybe six months ago. It seems like you don't hear as much from our suppliers about labor increases. The currency is not really an issue right now, the exchange rate. And petroleum prices seem to have stabilized somewhat, so inputs that are based on petroleum, specifically finishing materials, are not much of an issue right now.

Ocean transit, the rates we are paying are close to double what we were paying a year ago. But we have seen improvement in availability of space on container ships, ocean vessels, and the shortage of actual boxes of cans seems to have dissipated somewhat. Probably, as they gotten prices up all of those issues have seem miraculously to have been resolved. But we have seen actually recently, a little bit of softening of some of the surcharges on ocean freight too. So, we are maybe 10% less than we were at the absolute highest price, which would have been around May or June. It's come back a little bit, and we expect a little bit of further softening, but I think nowhere near where we were a year ago.

And excluding those surcharges, it sounds as though your rates are about flat, both year-over-year increase. And the absolute rates that you are paying are --have been fairly constant, roughly since the Chinese New Year, is that accurate?

No, that is not correct. Actually, our rates went up probably in the 25% to 30% range in the spring of this year. So after Chinese New Year, we continue to see price increases, and additional surcharges peak season surcharges. And I would say, rates kind of peaked in a May, June and they've come down about maybe 10% since then. But they're still higher than they were after Chinese New Year.

Did you quantify the incremental freight cost, Q2 over Q1?

Well, on product that's flowing now, today versus end of April, probably 15% higher. But remember too, on the wood side, we have a significant amount of inventory in our warehouses in Virginia. And that inventory has come at all different sorts of freight rates. Some of it late last year at a lower rate, and some in the May time frame at highest rate, and some more recently, at a slightly lower rate than we saw two or three months ago. So I can't really say that everything we are shipping now is at highest rate, or the most current rate, because a lot of our inventory was brought in when rates were lower. So we are seeing less of an impact from low rates as we ship older inventory, but there is still a little bit of that in our system.

Got it. Last quarter, you had mentioned that you expected $2 million in benefit cost savings from the announced initiatives in the second half of the year. Do you have any update to that guidance?

I think we were probably addressing moves that we've made in our Upholstery division. With that comment, I'll let Allen speak to that.

Right.

I think that number still is a valid number on annualized basis. The reorganization that we managed in July, was pretty significant in terms of cost impact, in the $2 million range, is just -- we think is where it's tracking at this point annualized. And we didn't -- and by the way, we didn't get a huge amount of benefit out of that in the second quarter. And I referred in my comments, to the lag time of some of the savings. And we are tracking those savings virtually on a weekly basis, and we see them very much in line with that number.

Will that be more loaded towards Q4. versus Q3?

Probably, in total, yes. Although we are seeing very nice results from virtually all of the initiatives that should impact Q3 as well.

Okay. And, Alan, what about capacity utilization for upholstery.

It's still running slightly less than full capacity -- and part of that is the summer months are always a difficult time in the leather business. For some reason when it's hot outside, people aren't thinking about going out and buying a leather sofa, I can't imagine. So we run relatively full schedules, but occasionally four day weeks here and there. If I -- this would be an estimate -- I -- because we are continuing to contract the kind of the cost structure domestically. But I would say generally, we're running at an 80% rate plus or minus. So this fall if we get the seasonal uptick, which we typically always have, and that should take it in to the 90% range we believe.

And for Larry, where should we see inventory at the open telephone quarter, Q3 as well as year-end?

Well, I think we geared up our inventories about where we feel that we need to be right now. We don't expect much additional growth, between now and then. So I would estimate that inventory should stay about the same, maybe slightly lower at the end of the fourth quarter -- or third quarter, I'm sorry.

Okay. And the customer base, the health of the customer, is anything there to call out?

No, we continue to be pleased with the lack of bad debts that we have to book right now. So our -- so far we haven't seen a lot of customer failures, and hope that -- that continues on that track.

And maybe, can you possibly give us some color by brand, in terms of sales, to the extent that you can, speak directionally if you can't quantify, maybe Envision, Sam Moore, BY, Opus? And maybe, in addition to talking about the growth by brand, was there any evidence of cannibalization by any of those of the Hooker brand?

Let me lead by talking a little bit about Hooker, case goods, Envision, and Opus. And we do have Envision and Upholstery too, but I'll let Allen speak to that. On the wood side, Envision is up nicely as you would expect. It's a lot of new introductions. It's relatively new brand, and our sales targets for this year I think with Envision, was around $20 million. We are going to be -- we are tracking a little bit less than that through the first half. But we still believe with new placements, and a little bit better retail this fall, but -- that target is attainable.

Opus, it -- has been a little bit more challenging. We think -- we had to reposition Opus, and move out of some groups that have been part of Opus since we acquired it, and try to kind of carve out a little bit different niche, a fresher product. We've done several things in the quarter that I think will benefit us on Opus. The group we introduced in April actually is the best selling group we've ever introduced. We got quite a few placements with large top 100 accounts across the country. We have not shipped that product yet. So we are probably a couple of weeks away still from shipping what was our largest new placement ever in Opus.

We showed at the Las Vegas market, just in a very small space dedicated to youth furniture. In July, I think we probably picked up a few new customers out there. We re-done the Opus catalog. And that's just been finished for about the last month. But we gotten it out in to the field, and we've gotten some good special orders that I think were generated by a better photography and catalog. So Opus, we're behind projections for the year, but I think there is a lot of positive things, that we feel like will make the second half of the year stronger than the fist half for Opus.

Hooker case goods, at the more traditional Hooker price points, are doing reasonably well. There has probably been some cannibalization by Envision. But you know what? I'm not sure that's a significant impactment. I just think the consumer that's been the core Hooker consumer, buying Hooker price points and traditional styles over the years, is probably little less likely to spend right now for large ticket items. Having said that, in the Hooker price range, and niche of our business, Sanctuary has been a home run.

I mean, we've just now in the last -- this quarter, the second quarter, have gotten the majority of the Sanctuary introductions and orders out, that were result of the October market last year, and our first entry into Sanctuary. That product has retailed extremely well. Almost everybody that has received it, and had it on their floor for a month or six weeks, has reported good activity in a very slow economy, or slow environment. So we're really encouraged by that. The introductions that were brought last market, probably additional 80 or 90 SKUs, will ship in the next month or so. So we are optimistic that that will have the same sort of reception that the initial Sanctuary product did.

So Hooker price points are not growing like Envision. But I still think there is a very good business in the same niches that we've always been strong in, home office, home entertainment. Accent pieces, we've really -- almost totally remerchandised our accent program over the last two markets, and have gotten very good response to that too. I think we are fine in the Hooker price points, as well. And Allen, I'll let you speak to Upholstery.

The -- as I'm sure you picked up the Bradington-Young business grown considerably. And it needed to, because of all of our major brands, Bradington-Young suffered the most over the last two years in the downturn. Bradington-Young was positioned very much at the upper end for leather. And we felt that we had to do some repositioning, because the -- the more the top end of the leather business like so many other things was drastically impacted. So the Bradington-Young core business as I call it, is up nicely, nicely being probably in the 25% plus range. Envision, was a new effort for us last year. That's all been shipped as far as the initial portions of it. And we think Envision is not the same customer at all, as the Bradington-Young core business, so that largely seems to have been plus. So -- so that's doing well.

Our Seven Seas imported leather business, which we transferred the distribution of that business to Martinsville back in the summer months, is really growing by leaps and bounds. That business is up over 50% for the year. And we are projecting that it will continue to run, close to that kind of increases. So we think of leather today, we think of Seven Seas imported leather being our good, Envision being our better, and that's produced domestically. And then, Bradington-Young being our best, although it's been slightly moderated from the higher end Bradington-Young traditionally. And then the other pieces, Sam Moore. At Sam Moore, we've done a lot of restructuring the product line, we had a phenomenal April market. Sam Moore's business is up about 10% or 12% for the year so far. And if retail holds this fall, we think at least that kind of increase, and -- and -- and very possibly more is in store over the next couple of quarters.

Sounds good, thank you, gentlemen.

Thanks, Todd.

Our next question comes from Matt McCall of BB&T Capital Markets. Please go ahead.

Thank you. Good morning everybody.

Good morning, Matt.

I wanted to follow up on a little bit of the upholstery commentary, maybe Allen or Paul. But first, it was interesting to hear some costs being taken out. I don't know what -- I guess it's -- necessarily, you are doing from a capacity standpoint. But it's interesting to hear you say you would be at 90% capacity, maybe in the back half of the year. We are still in a pretty depressed environment, so I guess how flexible is that capacity, as we start to ramp our -- I'm assuming more shifts that you can open. That 90% is probably based on --

There is two ways to look at capacity, Matt. And one is bricks and mortar, and the other is your standing cost structure and labor force. I tend to look at your cost structure and labor force, because that's the part that you can flex. So we do have the brick and mortar in place, that we could do more capacity if we needed to. Frankly, I would tell you that our domestic leather -- I see over the next several quarters, as being up more in the low single digits. So is we see that business leveling out to a level that is more commensurate to where we taken our capacity to.

Okay.

I don't see the domestic leather as having the kind of growth, as import leather has had. So I feel good about the match of capacity and demand there. It's a matter now of controlling costs, and just finally getting over the hump, as far as getting our break-even down to the level where our -- where our business level is. So does that answer your question? I think what I heard your question was, was if we are going to be at 90% capacity, are we going to be tapped out? The answer to that is absolutely not. We could flex more capacity, if we found we needed it.

Okay. Yes, that was helpful. On the -- as you address kind of the next question, that is along the line of mix. Another benefit or way you can improve your profitability I guess is through volume. We've talked about that cost, we talked about that, but then on the price mix side. Talk about, what you might be able to be do to improve profitability by your increasing the percentage of imported leather? Or just address the price mix opportunities, from upholstery stand point, and the opportunity there to improve profitability?

Sure. There is no question, the imported leather --and I think all along the way, our imported leather has been profitable. But at the growth rates we are having now, the profitability, as part of the total upholstery picture of the import leather becomes very, very important. So we are looking for imported leather to continue to gain, as far as a profit contributor on the upholstered side. I would tell you along with that, one of the reasons the imported leather is growing so fast, is we decided two years ago to jump in to the mainstream home theater motion business which is not a high end business. Home theater is more of a mid market and down. So the margins on the home theater is not quite, as full if you will, as it is in the balance of the Seven Seas line, but it's been purely growth business. It's a business we didn't have.

So the margin mix on the imported leather side is still strong and good. It's down, probably just a touch for historical leathers just because -- or historical levels, because just of the mix of the home theater, in the total scheme of things. Domestic leather margins, again, are -- and I'm not sure anybody is getting the gross margins they did a few years ago, because the market has just been that much more value conscious. So our domestic selling margins, if you will, gross margins, are also affected by that. And we are having to continually look for every cost savings opportunity we can, to be sure that we can manufacture profitably at those -- at those margin levels. And then, for Sam Moore, again, the margins are -- I think the margins at Sam Moore are very good, and always have been. It's a matter of just getting the volume levels continually over the break-even point, and we are at that right now. Did that answer your question, did that give you some flavor?

Yes. Thank you, very helpful. Let's see -- I think the question was asked by Todd. But the -- so if we looked at the impact -- and I think Allen, you talked about specifically, from the upholstery standpoint price. You said your price increases had not fully offset the raw material cost increases, and transportation cost increases. Can you talk about, Paul, I think the question was asked, I didn't get the answer. What was the dollar impact, on the year-over-year basis from those two? And you can talk about from just an upholstery, or from a case goods, and a upholstery perspective.

I don't know that we've spelled out, what the dollar impact was from cost increases on transportation. I think that was part of your question.

It was.

And I would say, probably in the second quarter, we would have seen gross margins erode by a couple of hundred basis points, due to freight ocean transit freight. Raw materials, on the wood side, our costs are pretty well fixed. And we haven't taken price increases -- significant price increases from our vendors on the wood side in the second quarter. We did implement a price increase, that's actually effective tomorrow, that averages about 3% across our wood lines. We expect that -- well we know that we will probably see some price increase adjustments with our vendors in Asia later this year. And some of that was trying to anticipate those increases, and also recover some of the increased freight cost. On upholstery side, Allen, what are you seeing?

The -- on the upholstered side, because of the growth in the imported leather area, the freight rates have impacted us there as well, pretty much in proportion to what Paul expressed on the wood side. The -- probably -- the more bothersome issue has been pricing in leather, from the stand point of the raw leather hides, all the way through to the finished leather. And our increase at the April market, as a impact to the total P&L, was about 300 basis points, actually slightly higher than that in some cases. But we think, when you mix it out, the net effect will be about 300 basis points. So that should cover both the freight and the leather increases that we were experiencing at that time. And our anticipation is, is this fall -- that as Paul expressed with freight, that we think the rates will stabilize, similar with leather. The challenge is, they are stabilizing at a much higher level than they were, say a year ago.

So you said that your price increase is hundred basis points, you expect that to fully offset those cost increases. But yet in Q2, it did not, is that just is lag effect?

Right. There is a lag effect always on your price increases.

And then Paul, you kind of addressed this, you said that you were seeing a better supply of containers out there, and you were able to work down your backlog. But then, you also talked about softer order patterns. So was the -- it's probably both, but was the opportunity to work down the backlog, the result of better supply in the form of more container availability? Or was it because you just had a softer order environment sequentially?

Well, probably a little bit of both. But I think we went into the quarter, with a significant amount of product sitting in Asia, ready to ship. We had orders for it over here. A lot of it was market introductions from October of last year. And we just couldn't get it on the vessel at any price. And we don't have the issues anymore. I think we have gotten the -- kind of the glut of inventory that was intended to be brought to the US, in the US. And it's had an impact on our inventory levels. It's also positively impacted our service levels. And -- but certainly having sales income and orders down almost 12% in the second quarter versus the first, has had a negative impact on our backlogs as well. And we are hopeful we will be able to reverse that, and that the fall will continue as it has started out with Labor Day.

But going back to one of the earlier comments that we made on inventory levels. I think we made a conscious decision in the second quarter, and really going back to earlier in the year to the first quarter ,when we were placing orders that we were going to try to increase our inventory levels on our best sellers. We got almost -- on the wood side about 2000 SKUs. There is 650 of them that are driving our business, and we want to be never out of stock on those SKUs. And to do it, we are going to have to carry more inventory, to take into account if there is sales blip up, or if there is production delays on the other side, we need to have more of a buffer stock. And so we are making progress on that. We are not completely where we want to be. But that's part of the increase -- was to accomplish that.

And we've increased our leather inventories, both raw materials with cut and sewn kits, and hides. And then also, with finished goods. I think we been chasing our backlog in the leather import business all year. It's still almost four times what it was a year ago. But we had, I think our biggest shipment month ever, recently in leather. And I think we will have more -- obviously, if it's growing 59% or 56%, we are going to have a lot of record months. But I think we got to continue to bring in the significantly larger amount of finished goods inventory in the Seven Seas leather. So our inventories have grown, a lot of it's by design. And the only thing when we are looking at the end of next quarter, and where inventory levels will be is, the wild card is, what is going to happen with sales. We didn't expect sales to be down 12% income in the summer. So if we continue to lag last year, I think you could see inventory levels go a little bit higher third quarter than second.

Okay, and you mentioned, this is my final question. You mentioned, that your pre-market comments, and the trends that you are seeing as you are talking to your retailers. Doesn't sound like that's enough to trump -- the caution that Allen spoke about. But can you talk about the make-up of that strength, is it still upholstery and the bedding categories that are leading? Or is case goods showing up, as well as an improving category?

Well, I think for our retailers over Labor Day, and the week since, it's been strong across the board. I haven't had them say, that they had really strong upholstery, but not so strong case goods. They've just said, we've done really well the last ten days. Labor Day, was maybe the biggest we ever had, and I think it was pretty much throughout their product mix. So I'm encouraged by that. But I don't want to call one holiday, and a week after a trend either. We got to see -- really a shift in consumer sentiment, and some of the recent things look a little bit encouraging. I saw something today on retail sales being slightly stronger than forecast, maybe for August. So we will hope, but I'm not ready to say that the trend we saw over the summer has completely reversed itself either.

I understand, thank you, guys.

All right, Mat.

Our next question comes from Budd Bugatch of Raymond James. Please go ahead.

Good morning, Paul. Good morning, Larry. Good morning, Allen.

Good morning, Budd.

Good morning, Budd.

My first question really goes to that -- to your last comments, Paul, talking about the fact that Labor Day was strong. We saw that as well. And the issue was what was going to happen after Labor Day. And you've talked to, I guess, some of the larger retailers, and they told you that post Labor Day sales were hanging in there? Is that the way we should read that?

Yes, that's the way I would read it. And I think in your comments on this topic, believe they were yours. You talked about the largest retailers probably did the best, the mid size pretty good, and maybe the smaller ones not as well. And at pre-market, we don't see a loot of the smaller retailers. We are generally seeing the major retailers, department stores and chains, and major retailers within market or a region. So I can't say that I talked to a whole at lot of, small independent mom and pops. But certainly the people we talked to have all been very happy with Labor Day, and most of them happy with the week since.

And you would see that from the smaller guys, in the order flow, as you open up the daily mail I guess. Or look at your -- or look at your online orders, because you have a wide base of retailers, correct? So how can you give us any feel as to what you are seeing in the order flow.

We had a good week for orders, actually the back half of the week was better than the first. There is always a few days lag, people getting whatever business they wrote over a holiday weekend, or any period to us. So it's probably a little premature. And I haven't looked at the composition of orders to see how many of them were, new product placements versus sold orders. But my sense is, that it was probably skewed more towards the larger and mid size retailers. I still think small independents are struggling somewhat, and losing market share.

Okay. And my next area of inquiry goes with kind of incremental margin. You all have a lot of moving parts. Allen is doing a lot in the upholstery side. And you all have done a lot to change the business model over the last several years. And just looking at the incremental margin, on incremental sales it looks like -- in this quarter, it was in -- the overall sort of like in the high 20s, if you look at it on a operating income basis. And yet for the year-to-date, it was much higher than that, which would lead you to believe there might be some deceleration in operating margin improvement. Tell me how -- what is the the best way to think about that, with the changes, and what will be the kind of the operating margin, incremental margin, on -- in each of the segments or overall Company or both? As you get to some sort of normalcy or impact?

Well, Budd, we -- this is Larry, Budd. When we look at the -- when we look at our operating margins for the first half of the year, obviously, our case goods margins have improved dramatically over the year-over-year. We are about 7.5% I think operating margin on the case goods piece, compared to about 3.7, I think, on the previous year-to-date. On a upholstery, again, pretty good improvement on operating margins. We are still below water for the first six months, down a negative about 5%, compared to about 13% negative for the first six months of that's last year. So I think I we are starting to make progress. Earlier in the year, I said that I felt that when case goods, got good traction, I would expect us to be in the high 20% gross margins, and starting to approach double digits in operating margins. And I think we've hit that on the gross margin side. We are operating at about 28% for the first half of the year, down slightly about 27%, for the quarter. But again, on the upholstery side of the house, at a 13.3% gross margin, we are actually up, in the -- from where we were -- where we were last year. And for the quarter, we are at 13.8, compared to 1.6. So I think we are seeing the improvement. I think, as Allen has pointed out in the upholstery area, there is a still a lot of work going on. And as we hopefully ramp up the efficiency, with capacity utilization as we go throughout the year, we are hoping to see that those margins continue to improve. And as he said earlier, expect to be -- to show some profit by the end of the year.

I understand all, that Larry. I was trying to get kind of going forward where the incremental margin might be, on an incremental sales dollar. I understand the gross margin targets and op targets. I was curious -- of the case goods business today, is by in large, at least at the gross level, pretty much a variable cost business, right? You're purchasing goods from offshore. And you're mostly paying your suppliers their cost, so -- agreed upon contract cost. So it doesn't vary that much with volume. You have some differences as you absorb the incoming freight issue, or able to offset that. So therefore, you are just covering what fixed operating expenses you might have. Is that the way to think about that, that incremental margin?

Absolutely, as far as the case goods go, that's correct.

And in upholstery, it's much more -- much different. Although, you are increasing the variable side of that business by increasing the level of imports, both of the cut and sew, and of the Seven Seas. Is that also the way to think about that?

That's correct. And I think as Alan pointed out earlier, we don't anticipate great deal of incremental growth in volume in our domestic business in upholstery going forward. And expect - and expect to, try and find that level ground, where we got a good match of capacity compared to expected orders. And I think we are still approaching that, and still working towards that. But, yes, I would expect that, that going forward most of the growth in upholstery is going to come from import side in leather. And as he pointed out earlier, that's been profitable business. We expect obviously, that to continue to be profitable. So that's where the margin increase is going to come from, I believe, as we find the right mix of domestic versus imports in leather.

And Alan has talked about the fact that there is a lag effect. But I'm not sure he put a timing on when the lag effect will no longer be lagging. Would he care the venture a compression or a time guess on that?

Yes. Budd, I expect that the price increases from the April market will be pretty fully implemented, if not fully implemented by the middle of the third quarter. We have certainly some older programmed orders that might spill over into the third quarter. But virtually all of the increases will be final and full, by the mid to end third quarter.

And what about the cost savings of the restructuring -- and was that the $2 million, or not in the $2 million. I'm not sure I under --

Yes. Yes. That was in the $2 million we referred to. I would say 75% of that will impact the -- will be impacted in the third quarter, with the balance coming into play, by the end of the fourth quarter certainly.

So you will have about a $3 million -- or well, 75% of the $2 million -- so you will get you will get about a couple of $100,000 improvement in the third quarter, then the balance in the fourth? Or you will be running about a 500 --

I would say, I would say that's a fair estimate of it, yes, absolutely.

Alright. Thanks a lot. Good luck, good luck to you all.

Thanks, Budd.

Thanks, Budd.

(Operator Instructions).

Our next question comes from [Stephen Gregory] of [Mandalay Research]. Please go ahead.

Thanks a lot. Good job, guys. You always seem to come through on these challenging quarters. Couple of questions, for you Peter. Basically are you guys ever looking to go more online, and be able rather to get away from the retail strategy, more so sell e-commerce site, where the customer can go on and have a good shopping experience? The reason why I ask that question, is two months ago in the Wall Street Journal, there was an article that mentioned that in 2011, retailers are really looking now to take their business to the next level, provide a good shopping experience for customers online, make it very easy for them to get to their website, buy particular products and merchandise, and have a good shopping experience. Do you have a vision for your business over the next couple of years, on moving to that trend?

No, this is Paul. And we don't have a plan to go online with sales of our products direct to consumers. We feel like one of the core strengths of our Company is a distribution that we have. We are in about 26 different channels of distribution. We are selling the best department stores, the best furniture stores the best online retailers. We are in the best catalogs. We are in interior design channel, with a pretty significant presence. And to go direct to the consumer would put us in competition with our customers. So we don't have I have plans to do that.

Okay, thank you very much.

Thanks.

I'm showing no further questions at this time, sir.

All right. We appreciate everybody's spending an hour with us to review our second quarter results. And we'll look forward to talking with you again, in about three months, and hope we can continue the positive gains we've made through the first half of this year. Thank you for joining us.

Ladies and gentlemen, that does conclude -- that does conclude today's conference. You may all disconnect, and have a wonderful day.