La-Z-Boy Inc (LZB) 2005 Q1 法說會逐字稿

Good morning. My name is Taylor and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the first quarter operating results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Mr Stegeman, you may begin your conference.

Thank you, Taylor. Good morning, I'm Mark Stegeman, Treasurer of La-Z-Boy Incorporated. Thank you for joining us on our fiscal 2005 first quarter conference call. Present on today's call are Kurt Darrow, La-Z-Boy's President and CEO, David Risley, our Chief Financial Officer and Pat Norton, our Chairman. Today's subject is La-Z-Boy's July first quarter fiscal 2005 operating results. As usual, Kurt and Dave will begin with some prepared remarks. We will try and end the call today by 10:00 as we have our annual shareholders meeting at 11:00. But we will be happy to extend beyond that if you still have unanswered questions. This call is being webcast live and a replay will be available on our website this afternoon. A telephone replay of the call will also be available for a week beginning early this afternoon. These regular quarterly investors conference calls are one of La-Z-Boy's primary vehicles for providing guidance to and communicating with investors and the investment community about the Company's current operations and future prospects. We will be making forward-looking statements during this call so I will repeat our usual caveat, while these statements reflect the best judgment of management at the present time, they are subject to numerous future risks and uncertainties as detailed in our regular filings with the SEC and they may differ materially from actual results due to a wide range of factors. We undertake no obligation to update any forward-looking statements made during this call. And with that, let me introduce La-Z-Boy's President and Chief Executive Officer, Kurt Darrow.

Good morning, everyone. Thank you, Mark. We appreciate you joining us today for our fiscal first quarter 2005 conference call. I will provide an overview of our operating results, an update on our key strategies, restructuring and business conditions as well as an outlook on the second quarter. I will then turn it over to David Risley, our Chief Financial Officer, for additional comments on our financials. First, let me touch on our first quarter operating results. For the quarter, our total sales were up 3.3% relative to last year's quarter. In our upholstery segment without VIEs first quarter sales were up 3.8%. This resulted from our continued focus on gaining market share in key product segments such as recliners, effective promotional activity and from new product introduced at both the April and last October's market. This is the third consecutive quarter of continued sales trend improvement in this segment. Casegood sales dollars for the quarter were down 9.3%. Without the impact of our hospitality business, presidential casegood sales would have been down less than 6.5% for the quarter. The contract portion of this segment serving primarily the hospitality industry continues to negatively impact the Casegoods Group, accounting for about 43% of the quarter's sales decrease. We believe the hospitality industry is in the beginning stages of recovering from a prolonged, severe downturn. However, we continue to have a cautious eye on this market given the state of today's current heightened terrorist alert status. With respect to orders, we continue to see solid increases in both unit and dollars year-to-date.

In addition, though we don't break it out separately, our La-Z-Boy residential branded business has continued to demonstrate greater order strength than the upholstery business as a whole. For the first quarter, upholstery segment orders were up almost 5% with La-Z-Boy's branded business being had in the low double-digit range. This was driven primarily by strong recliner sales and orders for new product coming out of our April market. The trends in our casegood orders are not as strong, in part due to the fact that many retailers build up their inventories prior to the anticipated anti-dumping terrorists. They should begin to reduce those inventories as we head into the important fall furniture retail selling season, opening up the opportunity for increasing orders. Orders in the casegoods segments were down 9% in the first quarter. While the reports at retail have remained mixed over the last several weeks, we believe the recent improved consumer confidence numbers are important indicators for our business. On the earnings side, before the 12 cents for the casegood restructuring, which I'll discuss in a moment, and 4 cents for VIEs, our earnings per share came in at 9 cents, which was just below our 10 to 14 cents guidance range without VIEs we provided at the end of our fiscal year in May. We are not pleased with these results and therefore, in addition to the fundamental strategic changes we are executing, we have put in place some near-term actions to improve our operating profitability for the second quarter.

Now a couple of comments on our operating margins. Our overall operating margin for the quarter before the restructuring and VIEs was 1.9%, down from 3.9% a year earlier. This decrease was largely the result of raw material increases in steel and wood and less than optimal capacity utilization. These raw material increases, primarily steel, have a disproportionate effect on us versus our competitors due to the size and share of our upholstery and emotion(ph) upholstery business relative to our total business. The cost of just steel and wood increases this quarter versus the previous year was about 1.2% of sales, amounting to $5 million across the Company. We have partially passed on these additional costs in the form of price increases, however, those increases did not have an impact in the first quarter. We also saw an increase in our SG&A spending of approximately $18 million versus a year ago. This increase is predominantly due to our larger retail business, which inherently has a higher SG&A -- SG&A cost than our manufacturing business and $15 million in SG&A from ViEs. We now have eight more stores than we did at this time last year and in addition, the business at our existing Company-owned stores has expanded significantly on a year-over-year basis. As retail continues to become a higher percentage of our overall business as it did this quarter, our SG&A expense will rise proportionately. Without the effect of retail and the consolidation of VIEs, our SG&A expense was flat in terms of both dollars and percentage. Taylor?

Yes, sir.

It appears that we have somebody else that's on the broadcast line with us. Can you please correct that? We have somebody typing.

One moment. All lines are closed.

Thank you. To continue, another change this quarter was a planned increase in inventory of $27 million in order to service our customers more effectively this fall. As our leather business has been increasing, we have been bringing in larger amounts of cut and sewn leather kits from offshore. In addition, we launched a quick ship leather program on specific product for which we have been building inventory. Until recently, due to the high demand for this program, we've had difficulty keeping the product in stock. Therefore, we have started to increase our stock levels of these products with much of that hitting our warehouses last quarter. We are now well poised for the fall and as a result, expect leather to become a higher percentage of our mix on a go-forward basis. We also were in an improved in-stock position in casegoods prior to the anti-dumping decision to avoid any disruption in service to our casegood customers. Now I'd like to spend a few minutes discussing our restructuring charge. As I mentioned in our last call, we had spent a significant amount of time and effort over the -- over the previous several quarters developing contingency plans based upon a variety of possible outcomes of the anti-dumping activity. The relative -- the relatively low rates, preliminary anti-dumping tariffs imposed an average of 11% on bedroom furniture were not significant to significantly alter current or future domestic capacity utilization. It's become increasingly clear that the near-term competitive landscape of manufacturing for the domestic casegoods industry is at risk.

Consequently, we're in the process of executing our strategy, which will enable us to accelerate our transition to a greater mix of imported versus domestically produced product within our residential casegood companies. While we will continue to intensify our focus on casegoods merchandising, sales, marketing and product development, we must take the appropriate actions to ensure we can provide competitively priced products to our retail partners and consumers. Though we remain committed to some domestic production, where design and price points allow us to be competitive with imported product, we are intensifying our efforts to be a cost-competitive global manufacturer and sourcing Company in order to deliver compelling values to our customers. With these moves, we now have a 400 to $425 million residential casegoods business, which will be $300 million of imported product and about $100 million produced domestically after the plant closures we announced last night. Since the acquisition of LAD in 2000, we've had to close 15 of the 20 plants acquired in that transaction. This will leave us with 1 domestic solid wood casegood facility in Hudson, North Carolina and 1 youth casegood facility in North Wilkesboro, North Carolina. The Hudson facility will produce Kincaid and some of Pennsylvania House solid wood bedroom furniture and the Wilkesboro facility will produce Lea Youth product. Not included in this discussion is one plant dedicated to the contract business, which is primarily focused on the hospitality sector, which has, to date, been requesting domestically produced product. We believe that domestic manufacturing of solid wood is viable because of the difficulty in producing and shipping that product from Asia due to moisture content and other issues. Youth furniture, with its low labor content and inexpensive raw materials is another product category for which the dynamics work to make domestic manufacturing economically possible.

This more focused approach, combined with the changes I'll discuss next, will leave us with a mix of 75% imports and 25% domestic product in our casegood segment. This represents a higher percentage of import products than most other blended strategy casegood companies today. As announced last evening, during our third quarter, we will take the difficult but necessary step to seize manufacturing at our nearly 100 year old Pennsylvania House casegood plant in Lewisburg, Pennsylvania as well as the nearby Pennsylvania House dining room chair assembly facility in White Deer. Also, the three Lewisburg area warehouses will be consolidated as we assess the logistical needs of the casegood group's existing warehouse operations at an appropriate time in the future to minimize any disruption of service to our customers. This will result in the loss of 425 jobs or approximately 15% of the casegood group's current employee base. Production will be phased out at these facilities during the third fiscal quarter. Part of the production will be relocated to our other La-Z-Boy casegoods solid wood manufacturing facility and the remainder will be sourced globally. Additionally, a Kincaid plant in Hudson, North Carolina will be closed by mid-September, with a temporary layoff of 120 employees until our consolidated domestic solid wood casegood production demand can be determined. As a result of these changes, the forecast for our domestic casegoods capacity utilization will be 90 to 95% compared to today's rate in the mid-60s.

Separately, in our Upholstery Group, we're closing a small satellite upholstery manufacturing facility at our England subsidiary in Booneville, Mississippi, resulting in the loss of approximately 100 jobs. Production will be phased out of this facility by this October and its production absorbed into England's new Tazewell facilities as a result of production efficiencies gained at that location. Additionally, a former Clayton Marcus manufacturing facility, currently being used as a warehouse, will also be closed. In total, we are closing 4 facilities, reducing our employment by 520 to 550 people, which is 3.5% of our total workforce and improving our cost structure some 8 to $10 million as a result of these actions. We are deeply saddened by the additional plant closures and the disruption to the lives of our employees at the affected locations. But we strongly believe that these actions are necessary for the Company to remain competitive on a long-term basis. We will be providing transition assistance to these employees to assist them during this most difficult period. As a result of these actions during our fiscal first quarter, a noncash charge of 10.4 million or 12 cents per diluted share was taken to write-down certain fixed assets and inventories. These actions will result in a total pretax charges of approximately 13 million or 16 cents per share on an after-tax basis for the year. The majority of the balance of the charge representing severance and relocation costs will be incurred in the remainder of this fiscal year. These steps will take several months to implement and first and foremost we will do our best to make them seamless, smooth and transparent to our customers. During and after this transition, we'll continue to be committed to the high quality products and superior service that built Pennsylvania House and Kincaid's brand name reputations.

I also want to discuss the Bruener situation and what its bankruptcy filing meant to La-Z-Boy. We were well aware for some time that their chance for survival were challenging as they struggled financially over the last several years in a very difficult period in our industry. Accordingly, we had manage our business with them down over the last few years from a high of approximately $40 million in sales to about $12 million annually. Most of this business was done with two of our nonbranded upholstery companies and represented less than 1% of our annual sales. We were unwilling to take the additional credit risk associated with the higher volumes(ph) and they moved our business to other manufacturers. We would expect that our existing distribution in the markets that Bruener served will pick up a significant portion of their business. From a credit perspective, although they were not past due with us until very recently, we were aware from receiving their monthly financial statements that a capital structure -- that from a capital structure perspective there was very high probability of bankruptcy. We therefore had reserved appropriately and did not have any special bad debt expenses during the quarter. Switching gears, I'd like to spend some time on one of the key drivers of our business our La-Z-Boy Furniture Galleries system. Again, let me repeat, we've been involved with a proprietary retailing system since 1975 and therefore are not new to retailing. We understand what makes a retail system work and I would repeat this is not a defensive strategy, it is something the consumer has validated time and time again, throughout our North American store system.

In the first quarter of fiscal '05, we opened four new generation Furniture Galleries, remodeled five and closed three, bringing our total to 77 in the new format out of our 325 stores. We plan on having at least 30 more in the new format by the end of fiscal 2005 with roughly half of those being new stores and the remainder being remodels or relocations of existing, older format stores. We currently own 36 stores and continue to look at future opportunities to achieve our market penetration targets in the major metropolitan areas. Our projections are to have approximately 350 stores by this time next year, with about 125 of them in the new format. For the upcoming second quarter, we will have 9 stores remodeled to the new format, three stores relocated and an additional 4 new La-Z-Boy Furniture Galleries outlets. As part of our comprehensive plan over the next 12 months, the Company will increase its number of Company-owned stores from 36 to 40, not including any acquisitions. Clearly, expansion of this system is a key focus area of ours, however, continuing to drive improved performance of the existing stores is equally important. We have been pleased that despite a difficult retail environment in the past several months, our Furniture Galleries operators have continued to find ways to grow their business. We know this as we have a clear and ongoing window into the system's performance, as all stores, including independent operators, are required to provide monthly performance data to us in a number of key areas including sales, traffic, closing rates and other relevant information. Same-store sales dollars for the Furniture Galleries system, including independent and Company-owned stores were up 4.1% in the first six months of calendar '04, while total Furniture Galleries sales were up 8.2%. In the first two months of this fiscal year, May and June, same-store sales dollars are up 3.9% while total system sales were up 7% in the same period.

We're currently putting a great deal of time and effort into leveraging the extensive retail experience both we and our Furniture Galleries operators have to create a comprehensive operating system and support structure that will enable us to drive even greater improvements in store sales and profits going forward. Also during the quarter, we open one new Kincaid store and one new England Custom Direct Comfort store as both of those programs continue to gain momentum each quarter. We continue to receive numerous questions about the different dynamics between the casegood and upholstery business as it relates to import pressures. A few of us have recently returned from a trip to China and I would like to share our point of view on that topic. There were four main reasons for our recent trip. First, we wanted to visit China after the anti-dumping announcement to shore up our relationships with our various partners. We had excellent discussions with all of our key partners and feel that our relationships are stronger than prior to the initiation of the anti-dumping activity. Secondly, we are constantly evaluating the state of Chinese furniture manufacturing, including factories, capabilities, and overall capacity as it relates to both casegoods and upholstery manufacturing. There clearly is a great deal happening on both fronts. However, on the upholstery side, the majority of activity continues to be focused on cut and sewn sets and increasingly components. There is definitely much more fully upholstered product being manufactured than there was 12 months ago, though at this point it's still a relatively minor part of the Chinese activity.

Third, we needed to evaluate the status of our La-Z-Boy global team on the ground in China and review and discuss plans to continue to expand that team and the role it plays in our Asian sourcing. And finally, we wanted to get a read on the competitive landscape. What -- what remains clear is that sourcing relationships are often fragmented with each major U.S. company split across numerous factories and each Chinese factory making product for several U.S. companies. We believe we have the opportunity to develop stronger relationships with fewer companies and that is what our global sourcing team is tasked to do. Though each trip brings new learnings resulting from the pace of progress in Asia, we still believe there are some fundamental differences between sourcing upholstery and casegood products. As I mentioned last call, speed to market is a factor that is pretty hard to eliminate and in the upholstery business a large segment of consumers are interested in their choice of fabric, on their choice of frame. There are serious hurdles to provide a have it your way solution from offshore. This is particularly an issue for our La-Z-Boy Furniture Galleries's consumers, who custom order roughly 40 to 50% of all the furniture they buy from our various stores. Finally, freight as a percentage of a $299 recliner is considerably different than it is with a $1500 bedroom suite. These issues make upholstery a more difficult product to successfully and properly import, however, difficult is a considerably different word than impossible.

We will continue to put in place the people, the processes, the structure and the knowledge to enable us to effectively and profitably leverage a global supply chain, not only in casegoods, but in upholstery, if needed, as well. Lastly, I would like to touch on our guidance for the second quarter. Though retail results have been mixed as of late, we -- we believe that the recent consumer confidence numbers are encouraging. We have seen order trend remain reasonably firm, particularly in our upholstery segment. As a result, we currently expect our October 2 quarter sales to be up in the mid-single digit range, including our VIEs compared to the prior year. We would anticipate reported earnings to be in the range of 29 to 33 cents per share for the second quarter of fiscal 2005, this would include a penny for restructuring and up to 2 cents per share for potential losses from VIEs which Dave will discuss in more detail. This would compare to the 28 cents we earned per diluted share in fiscal '04's second quarter, which also included a 2 cent restructuring charge. We believe our margins will increase as a result of several actions. First, on the casegoods side, a higher percentage of our sales in the second quarter will be import product which carries higher margins. Second, we will achieve higher volumes and better utilization on both the casegood and upholstery sides of our business, as we will have approximately $100 million more sales in Q2 over Q1. And finally, we will be seeing the impact of the price increases we initiated throughout the majority of our companies at last April's market begin to offset our rising raw material prices.

In closing, we're making tangible progress in getting our Company back on a growth track, driven by our core marking and distribution strengths. As we've done that, we've driven much more clarity regarding what is our new business model. Remember that prior to 2001, we were solely a manufacturer and marketer of furniture. To arrive where we are today, we have significantly evolved our organization and will continue to change to ensure we lead in our very competitive environment. From a strategic standpoint, La-Z-Boy has evolved into three distinct areas. First, we're the world's largest upholstered furniture manufacturer with the most powerful brand name and an expanding market share. We significantly broaden the appeal of our products through creative and effective marketing and delivering a broader and more stylish line of upholstered furniture to our customer through multiple distribution channels. We have one of the best and most mature propriety distribution system and the only one that co-exists successfully with other distribution channels. In short, we intend to remain an industry-leading manufacturer and marketer of upholstered furniture.

Second, our focus in casegoods will primarily be as an importer, distributor and marketer. Our Casegoods Group focus will predominantly be on the rapid development and introduction of new product based on a more intimate understanding of our customers' needs, together with more intense attention to the effective marketing and merchandising of those products. We will continue to manufacturing -- to manufacture some casegood products in the United States, however, we will take a much more rationalized approach as I identified earlier. Third, we intend to strengthen the role the Corporation plays in the acceleration of growth in our propriety store system. We will intensify our overall retail focus and our ownership of retail locations throughout our system with a strategic focus on the top 25 retail markets. We continue to drive substantial changes in our business that will keep La-Z-Boy competitive in the future. However, the results these changes derive will not be apparent overnight so we deeply appreciate your patience as we execute the strategies and make the fundamental changes which will enable us to earn an appropriate return for our shareholders. Again, thank you for being with us today on our first quarter conference call. And now I'd like to turn things over to Dave Risley, our CFO, who will make further comments on our financial results.

Thanks, Kurt. The quarter results were not quite what we hoped for with a loss of 7 cents. But with the restructuring we announced last night, we are, as Kurt mentioned, going to be 75% sourced product in our Casegoods Group. Once we get through that transition, we should have a more profitably solid operating entity. Now, let me quickly review the numbers with you. First of all, we had the previously announced -- we had previously announced that the quarter would include as much as a 2 cent loss for our VIEs. That turned out to be 4 cents. FIN 46 requires us to consolidate our -- any entity in which we do business where we have more skin in the game than they do, regardless of the legal ownership of the entity. The operating results of that portion of these VIEs is less than desirable and we are working diligent with these dealers to improve their operating performance or they may be ultimately become Company-owned. Our goal is to make this happen in the next couple of quarters. VIEs also added about $13 million net to our top line. If you take their standalone sales they were approximately twice that number. The restructuring charge of 10.4 million or 12 cents per share was noncash this quarter. And we expect that through the end of the fiscal year, we will have an additional 2.6 million or another 4 cents per share over the balance of the year. So, doing the math, net of all the above, we were at 9 cents for the first quarter. Weak margins this quarter can be attributed to one, lower than expected volumes in casegoods, two, under utilization of facilities, particularly in casegoods, three, material price increases in steel, wood and transportation costs, and price increases that will go into effect in the second quarter of this year and the rising portion of retail to our total operations.

As you are aware, retail carries a different gross margin and SG&A structure as well as a lower return on sales ratio. The plus side of that equation is normally the return on invested capital. The tax rate for the quarter and last year were 38 for both periods and we expect that to continue through the end of this year. On a cash flow basis, we used about $7 million more in cash from operations for the quarter than we generated, primarily from the planned increase in inventories. Capital expenditures were 9.5 million and total stock repurchases were 120,000 shares at a cost of 2.5 million. Due to last quarter's intangible write-down, i.e. the cumulative effect adjustment and the consolidation of the VIEs as well as this quarter's restructuring charge, our debt-to-cap ratio is at the high end and at 32%. Given our stated preference of debt-to-cap ratio in the mid-20s, you can expect only minimal stock repurchases until that ratio recovers. As to future guidance, we will continue to go out only one quarter at a time. And as Kurt has already indicated, we expect a reasonable increase in volume for the second fiscal quarter. You can expect an increase in upholstery with casegoods basically flat with last year's second quarter. Margins will improve with increased sales volumes and the price increases which we have taken to help offset the material price increases. Expected EPS will be in the 29 to 33 cent range and that includes a potential 2 cent loss for the VIEs and 1 cent for restructuring. For modeling purposes, capital expenditures for '05 will be in the 30 - $35 million range, depreciation should continue in the 28 - $30 million range, and the tax rate will remain steady at 38%. Thank you. With that, Mark,

Taylor, if you would just again review the instructions for asking a question on the call.

At this time, I'd like to remind everyone, in order to ask a question, please press star and the number 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Charles Grom of JP Morgan.

Good morning, guys.

Morning, Chuck.

Your mid-single digit revenue forecast seems a little aggressive given that you only posted flat growth in the first quarter if you back out the VIE. What gives you confidence that you're going to be able to reach these goals?

Well, Chuck, as we mentioned, our orders in upholstery for the first quarter were up 5%. They're up the first two and a half weeks of our new quarter and in addition to -- in that forecast is -- is the VIEs which would probably on a seasonal basis be 15 to $17 million increase that wasn't factored into last year's number. So, it's a combination of our upholstery strength and the addition of the VIEs.

What were your orders in the fourth quarter, Kurt? For the upholstery segment? In other words it was 5% in this quarter, what was it in the prior quarter?

I'm not sure we have the order number handy, Chuck, we can get that to you, but if my memory serves me right it was up slightly but not quite as much as the 5% for the first quarter.

Okay, great.

And we had -- and we had a change of calendar and market. Market was late this year and some of that fell into last April and some of it fell into May so there's a -- there's a timing differential, as well.

All right. And second question is I know there's been some discussion with potential casegood division closings but in light of your plant closing announcement yesterday, can we imply that you're planning on holding onto these seven units for the foreseeable future?

Well, I -- I'm not sure of the seven units, we have -- we have five casegood, domestic casegood residential companies and one contract company. And yes, we're making the moves at the present time to ensure their long-term stability.

And if I could hop back to the revenue question, you know, what are you guys going to -- did you say that you think in the second quarter that the revenue per casegoods could be flat, did I hear you correctly?

That's correct.

So, you think it's going to go down from negative 9 to flat this quarter? And what kind of gives you that confidence that you're going to be able to swing from such a wide loss to, you know, to flat when the comps really, you know, only get -- yeah, they do get a little bit easier, but...

Well, I think there's two -- there's two factors that have some optimism for us. First, we're -- we're delivering a lot of new product from the April market a lot faster into the system than we have previously so a lot of the new casegood introductions, including Summer Retreat from Pennsylvania House, will begin hitting retail in August. Secondly, we have seen some improvement in the hospitality business and as that continues to improve, even on a relative basis, it won't be the -- the anchor that it's been to the Casegoods Group.

Okay. And then last question is, you know, how many new generation format stores did you have at this point a year ago. You have 36 now, I'm sorry 77 now. What did you have a year ago?

I would -- I would guess, based on our rate of opening we had in the low 50s, 52, 53. We've been -- we've been opening, Chuck, about 25 new stores a year and remodeling an equal number so that would probably be an accurate -- that would be the average.

Okay. And just a as a followup to that and then I'll get off the line. Do you have a sense of some of the same-store sales lift you're seeing post the remodel?

Ask that question again?

Yes, do you have any sense of what the same-store sales lift is post, you know, post the new generation format?

Yeah, there's about a 15 to 20% same-store lift in that -- in that changeover for two factors. One, most of the stores are going in much better locations and two, a lot of the stores are -- are slightly bigger. In addition, as we've -- as we've stated in our public filings, the -- the average transaction -- the sales per customer and the average ticket is all higher in those stores because we're selling much more a room situation there as we are an item situation in our older format.

All right, good luck and thanks.

Thank you.

Your next question comes from Todd Schwartzman of Sidoti and Company.

Good morning. When you get to the 75/25 mix in casegoods, 75% imports to total casegoods, what's the best case scenario, what's your most optimistic expectation for where gross margin will be on the casegoods side?

I think that would be tough for us to ascertain right now, Todd. It -- it -- we have -- we have two of our companies that are primarily all import today and their gross margins are considerably higher than our -- than our domestic casegood companies, but depending on the mix, depending on competitive pressures, depending on some other situations that -- that I think would be difficult for us to ascertain right now, I think it would be dangerous for us to get a number out there that we couldn't substantiate.

Once the closures are complete, or at least this announced round of closures are complete, how long from that point, how many quarters or however you want to express it before we start to see some initial benefits?

Well, I would think we'd start to see some benefit from that in the -- probably in the fourth quarter of this year. But, you know, you have to also temper that with, and unfortunately we've had a lot of experience, closing down plants, transitioning of them, keeping your workforce together, doing all those things, is a very cumbersome and difficult process. And our -- and our first goal in this transition is to be sure we do an absolutely superb job of servicing our customers. So, we -- we've got some work ahead of us here before we start seeing improvement in our bottom line.

Got it.

Your next question comes from Margaret Whelan of UBS.

Good morning, Kurt.

Good morning, Margaret.

Okay, so here's the thing that I don't understand. The -- the profitability on the wood business has proven pretty elusive and now your profitability in upholstery is plummeting, and so the margins -- or the, you know, the assumptions you're making for the next quarter just seem very aggressive, but over the long-term what are you going to do to get back to double-digit margin in upholstery?

Well, I think given our historical base, our margin expectations are not unrealistic, Margaret. And we've tried to lay out what happened this quarter, this -- the rapid increase of raw materials, the timing of our price increases, once that levels out and balances out and we do the types of volumes we're talking about, we're not overly worried that we can't get our margins back to the areas they've been historically.

And -- but if you look back even at some of your peers over the last couple of years, take Stanley, for example, who has maintained or sustained double-digit operating margin, they've said clearly they're not getting any margin improvement from import, it's just giving them wider product rep for gaining sales. So, why do you think that you would be different?

I don't know. I can't comment on Stanley's situation. We see -- we see both things happening, we see imports making us more competitive and giving us margin opportunity. And we need to balance that pricing formula delicately but we intend to try to pick up both increased market share and improved margins based on these transitions.

And -- and so you think having a wider product rep will give you better sales and better leverage, but then, you know, you know yourself, you just came back from China, everyone is over there, the retailers like Haverty who have gone from zero to 40% in private label on wood, they're just going to increase that now that upholstery is available to them. So, how do you think you will sustain your share? Don't you think it will be similar to the wood business over the last couple of years?

Well, it -- it could be but, you know, there's a lot of retailers it this country, Margaret, that don't have the capacity to go overseas and do their own private labeling and do the things that Haverty's can do. And there is a wide range of mid-size retailers who need companies that are distributing imported casegoods and that's primarily our focus.

Yeah, there's also, you know, a ballooning number of import agents who are happy to consolidate containers for them, though, and they wouldn't have the overhead you have.

Well -- but we have the opportunity to consolidate containers within our -- within our four or five casegood companies that are in Asia. So, we're going to be on a much more even keel competitively with the importers going forward.

Okay. And -- and then moving on, I mean you obviously did a super job of avoiding the blowup of Bruener's over the last couple years, a lot better than some of your pubic competitors, but -- and going forward, are there other retailers that you're avoiding right now?

I wouldn't say there's any that we're avoiding and I don't think it would be fair to mention any of them by name. There have been a couple out there that I think the industry has some concern on and a little bit a watch over, but there's nobody that -- that comes up as high profile as what we just went through with the Bruener situation.

Okay. And I understand that you're, you know, why you'd be sensitive to mention them by name, but is it a significant part of your business in aggregate or of the industry?

No, it's not -- I don't think it's significant in either case.

Okay.

And most anybody of any size is either gone or on pretty firm footing right now, so, I don't think you're going to have somebody of -- of huge magnitude have a devastating effect on either us or the overall industry.

Okay. And then just finally, I know you don't want to buy in much stock to maintain the debt-to-cap ratio, but what do you think the use of the cash will be over the next 12 months?

Well, we will be bringing the debt down basically to get the ratio back in line, Margaret. In terms of the CapEx, it's -- we aren't a heavy user of CapEx, as you know. For the most part, you know, you're not adding new plants, it's just equipment replacement and some modernization of IT equipment and so fourth.

Okay. Debt-to-cap's already pretty conservative given how cheap debt is right now.

Well, our board has, you know, and we publicly announce that we prefer a debt-to-cap ratio in the mid-20s and that's what we're comfortable with. It maintains our -- our high debt rating and we produce enough cash that we don't have excessive needs in that regard, so we're very comfortable with that mid-20 range.

We're also, Margaret, probably going to be spending a little more money on the stores and getting all the Company stores remodeled, getting the new ones open and while we're not buying much real estate as a Company, there is capital requirements to get new stores up and running for remodeling, grand opening, signings, et cetera.

Yeah. I mean my concern is that you're being -- you know, you're a little too comfortable terms of the execution. The balance sheet is fine, but you're going to have to go out and capture more market share, you know, invest more in your brand. When do you think SG&A will be going forward as a percent of sales?

Well, that would all depend on how big of a percentage -- how big a percentage our retail business became and how many VIEs come in and out of the equation. So, that's a difficult -- we don't think our SG&A on the manufacturing size of the business needs to -- needs to increase dramatically and I think over the last six to nine months, our Upholstery Group, particularly the branded side, has done a pretty good job of picking up market share.

Would you give us an update on Todd Oldham? That's my last question.

The Todd Oldham program is working very well for us. It's now out at retail. We're starting to get a lot of reorders, not just placements and we're very pleased with the results to date and are going to continue to expand that line this October at market.

Okay. Thanks very much.

Thank you, Margaret.

Your next question comes from Carlos Ribeiro of Credit Suisse First Boston.

Good morning, gentlemen.

Good morning.

You gave us same-store sales for the first two fiscal months. Can you give us the same-store sales for July?

Carlos, we don't give our month sales until the 12 or 15 of the month. We get our data in by the 10 or 11 of each month. You got to remember we're dealing with a lot of independent dealers and the way that they get the data is not electronically, it takes us a while. So, we're always going to have probably a one-month lag in our reporting based on our retail reporting.

Okay, fair enough. Can you quantify the margin pickup or the margin lift you guys expect? What the price increase is now flowing to the P&L in the second quarter?

Well, I would say that our -- that our price increases range from 1 to 5% based on the Company, based on the product category, based on where we feel there's any pricing power available. So, to give you a broad stroke of what it will do, the only thing I can probably say with some degree of confidence is it won't cover all the raw materials if they continue to go up like we've seen them in the last 90 days, but they will cover a significant portion of them, some other moves we made in the Company to be more efficient and control our spending, we think will negate the negative impact it had on us in the first quarter. Okay.

You should also take into account, you know, the price increases go in effect at different points of time for different products and you could also have promotional programs going on at the same time, which has an offsetting negative impact, if you will, so the -- even though we're having the 1 to to 5%, you shouldn't expect that big of an increase in the overall.

That's fair. And just lastly, and I apologize if you have answered this, in terms of the FIN 46, the VIE adjustments, how many dealers does that incorporate?

Today it incorporates six dealers and the confusing thing, though, is depending on their performance, some of those could fall out and new ones could fall in. So, it's kind of a moving number. But, for right now and last quarter, the same 6 dealers were in the -- were in the equation.

Okay. And can you guys breakout what the VIE impact on the revenue side is for -- between -- by segment? Or is that not possible.

It's prime -- it's 98% -- 95% in the upholstery --

No, it's not, it's in the other.

Oh.

It's not in the -- it's not in the upholstery segment, it's located in corporate and other revenue.

Okay.

But from a sales standpoint, the VIEs sell primarily upholstered furniture because their operating the La-Z-Boy Furniture Galleries store system.

Got it. Thank you, guys.

You're welcome, Carlos.

Your next question comes from Budd Bugatch of Raymond James.

Good morning, Kurt.

Good morning, Budd.

Do me a favor and look, if you would, one year, three years and five years into the future and describe La-Z-Boy as you see it structurally? Additionally, if you would, tell me what metrics would management look at to gauge both the success and the wisdom of the strategy and the execution and finally what metrics will investors have to be able to look at?

Well, Budd, I'm -- with how fast the world is changing and our industry is changing, speaking about where we're going to be five years from now, I think would -- I think would be pretty dangerous at this point, but -- but certainly the strategies I outlined in my talk about us being a manufacturer and marketer of upholstered furniture, a distributor of casegoods and a retailer in the major markets for the -- with La-Z-Boy Furniture Galleries, is something that we're committed to doing and something that we think can -- and to deliver appropriate returns and we have modeled in the retail business the returns that Haverty's, Ethan Allen, other public retail companies are -- are earning and we don't see any reason why our system can't model those. So, I think it's going to be a combination of a number of different things. As the retail business grows, the amount of business that we do under the La-Z-Boy brand will increase. Today we do about 55% of our business under the La-Z-Boy brand and I think that will continue to grow as a percentage of -- of our business because the branded business has a greater upside than -- than some of the nonbranded business. But we will -- we will continue to pursue that strategy and -- and improve our operating performance as we go forward.

But there are at least three other brands of some consequence.

Excuse me?

There are at least three other brands -- three other brands of consequence in the La-Z-Boy portfolio, Kincaid, Pennsylvania House, Englander -- England.

Is there a question there?

Is that a question?

Yeah, it's a question.

Well, we -- we think each of those serve a different segment of the market. We are very focused on being a home furnishings supplier and we're into most every category in the home with the exception of decorative accessories in a big way and -- and why we have a small presence in bedding it's certainly not significant compared to the bedding industry, so, our strategy of being a home furnishings supplier, be it manufactured or importer, is not -- is not being altered at this point.

But what is the likelihood that you would own or -- those retail businesses? Or own portions of them?

Well, I think that would depend on how mature they get and how good the returns are and how well of a job we do running the retail we already have. And I think our first focus has to be on -- on doing an appropriate job with the 36 stores we have and we see that increasing fairly rapidly over the next couple of years and our focus is to run that professionally before we consider any other retail format.

What are the metrics -- metrics of success in terms of growth and returns on capital? Do you use note pad returns on invested capital? What -- what are -- what should we look at? What do you look at?

Well, on the -- I'll speak to the growth side. And our -- our internal goals are to grow at a rate faster than the industry. And you know, if you can -- if you can tell me what the industry is going to do the next few years, I can approximate perhaps what we would do, but we certainly use the industry's growth rate as -- as a key barometer. As far as our -- as far as our returns, I -- I'm not sure that -- I'm not sure we want to talk about that today because we're going through a change here and we're -- I don't want to set up some expectations that -- that we can't fulfill, but getting back to the kinds of returns and returns on sales, returns on capital that we had prior to 2000, 2001, we don't think that's unrealistic.

I'm not as much interested in the numerical goal as a -- as a actual --

You got cut off, Budd, what's your question?

One of the most -- one of the most critical of the -- of the (inaudible-no sound) prioritize, then, if you would please.

Are you on speakerphone, Budd, cause you're cutting in and out.

Your question comes in and out, we can't quite hear you, Budd.

How's that, is that better?

That's much better.

Prioritize for me, if you would, the metrics that you use to judge success. That's what I'm trying to get to. What are the more important metrics?

Well, I think the three that we're most comfortable with is growth, operating profit and return on capital.

Okay. All righty. Lastly, Kurt, I'll just -- I'll quickly get off -- thank you, by the way, for the additional disclosure on the cost increases, I noticed that was a little bit more -- more detailed there and I think that's helpful. Capital expenditures, I think, are going to be more than depreciation this year, is that right? And if so, maybe explain that?

Slightly more, Budd. You know, we've had a -- averaged around 30 million in the last couple of years it could get as high as 35. But with the shutdown of the number of plants and so forth, you know, the -- the -- there's been a -- a degradation there in the fixed assets, if you will, in terms of total size, so, the depreciation is probably going to be less than -- less than 30, in that 28 to 30 range.

We don't have -- excuse me, we don't have any, you know, huge, major single projects out there and so I -- I wouldn't look for anything, you know, particularly unique in our capital spending.

Okay, thank you.

Your next question comes from Laura Champine of Morgan Keegan.

Good morning. Could you breakout your unit growth in the quarter?

Laura, you asked that question last quarter and we don't really want to give those information, we give our dollars and we think, you know, our unit growth, obviously with the kind of growth we're having, is up. But for competitive reasons we think we want to keep that information to ourselves.

Okay. I noticed from looking at the -- at the Q that you filed that you've added one net standalone store, La-Z-Boy store in the quarter, but it looks like your galleries declined from 364 at the end of the fiscal year to 342 now. Can you confirm that and sort of walk me through what happened there?

Well, your first question in the quarter, we opened a store in Scarsdale, New York in Westchester County. It opened just before the 4th of July and it's off to a great start. As far as the in-store galleries are concerned, we have a wonderful relationship with a dealer in -- in the Twin Cities called Slumberland. They have been a long-time, very important customer of La-Z-Boy's. They have decided to re-merchandise their stores into lifestyle segments and spread our product out among this -- throughout their store as opposed to being in a confined gallery. So, the amount of product we have in the store hasn't changed. The amount of business we do with them is still increasing and our commitment to one another is the same. They've just chosen a different merchandising approach and we've reclassified them as a non gallery.

Okay. Do they account for those 22 galleries?

They account for all of it.

Okay, great. But could you walk me through a little more specifics? I heard you say that your efforts will be to improve the operating results of the VIEs. Can you talk about why those dealers are losing money now and what La-Z-Boy can do to pull them along?

Well, I think the -- probably the biggest issue is that in certain of those markets they're under stored and they don't have the marketing clout to drive the traffic that they should and one of the reasons they've become VIEs is we've helped them in the past to expand. They've had capital constraints, which we've -- we worked with them on and we need to either move forward with more stores or streamline their operations to today's existing volume so that they don't have the type of losses that we've incurred here recently. And also on -- on the balance, all the VIEs are not unprofitable. Certain of them are and certain of them are not.

But the ones that are consolidated right now are losing money because they're under stored, am I -- ?

Well, for the most part they're under stored or they have old locations and aren't in the "A" locations to properly serve the market.

Okay, so your aim would be to move those locations -- ?

Well we have a number of options. Move them. See what we can do to control some expenses, try to get in and help them analyze their business more professionally. You know, we've -- this is a new area for us and while we provide support and guidance to all of our dealers, they are independent dealers and they are running their own independent operation, now to the degree that we are consolidating them, we're going to be a little more involved in -- in their business. But we have a number of options from helping them to expanding with them to ultimately making them part of our retail division if we think that's the most prudent thing to do.

Okay. And lastly if you look at La-Z-Boy corporate, what percentage of your revenues are currently being generated by propriety distribution?

Well, I -- as a general rule, the La-Z-Boy Furniture Galleries, the propriety stores, not the in-store galleries, but the propriety stores are about 50% of the branded business, which then by default would make them 25% of the overall corporate retail business. Not the ones we own, the entire system. But it's -- it's a billion-plus retail business with -- through the La-Z-Boy Furniture Galleries system and that's about 20 -- 25 -- 28% of our $4 billion retail business.

Thank you.

There are no further questions.

Okay, Taylor. Thank you.