La-Z-Boy Inc (LZB) 2005 Q2 法說會逐字稿

Good morning. My name is Angela, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the second quarter 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, Angela. Good morning. I'm Mark Stegeman, Treasurer of La-Z-Boy Incorporated. Thank you for joining us on our fiscal 2005 second 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 October, second fiscal quarter 2005 operating results. Kurt will begin with some prepared remarks, and we'll leave plenty of time for questions. We'll try to end the call today by noon, but we'll be happy to extend beyond that if you you still have unanswered questions. This call is be 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 investor 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 SEC filings, 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.

Thank you, Mark, and good morning, ladies and gentlemen. This morning, rather than start my comments in the usual manner, I want to make a few non-numerical remarks. The present management team has just completed its first full year of responsibility. It has been a year of considerable turmoil within our industry, and our country. A struggling industry environment, massive challenges from low-priced, offshore manufacturing, particularly in case goods, unprecedented cost increases as far as raw material and components are concerned, changes in accounting rules, a hard-fought election, the threat of terrorism, the Iraqi war, and certainly the unprecedented runup in fuel costs. In the case of our Company, in retrospect, it is obvious we held on to our domestic case good manufacturing longer than we should have. But it is important for our shareholders to understand that we have not been sitting on our hands this past year. We have a clear strategy established, and many very difficult decisions have been made. We feel strongly we are on the correct path, as far as our case goods business is concerned, and have every evidence to believe that our blended strategy will work long term. The hospitality business has unquestionably turned around.

Our brand has never been stronger or more appealing to such a broad range of consumers. We will open more La-Z-Boy Furniture Gallery stores this year than any year in our history. Our retail system is performing above expectations. Our strategy has been worked through. We have many new talented people in place. We have the commitment of our organization, and certainly senior management is totally committed to do those things necessary, and to do them without undo delay. So while we are not at all pleased with the numbers we have shown these last few quarters, and the road ahead of us next quarter, we are optimistic about the future, and are prepared to make whatever decisions need to be made to bring this Company back to its historically profitable levels. We are quite confident the execution of our overall strategy will give us the results that have made this such a viable business and industry leader for the past 77 years.

Now, for some more specific remarks on our performance. As is our normal custom, I will provide an overview of our operating results, an update on business conditions, and an outlook on the third quarter. I will also spend considerable time outlining our longer term strategic view, and the expectations we have for each element of our business model. First, let me spend a few minutes on our second quarter operating results. For the quarter, in spite of a tough environment which featured weakened consumer confidence, our total sales were up 4.4 percent, relative to last year's quarter. This is the second consecutive quarter in which we have seen growth in our overall corporate sales. For our upholstery segment, second quarter sales were up in total 4.8 percent. Our La-Z-Boy branded business sales -- our La-Z-Boy branded sales increase was even stronger than upholstery segment as a whole. This resulted from a number of factors. First, we're seeing growth on a same-store and overall base with our Furniture Gallery system, as well as increasing sales with non-proprietary customers. Second, we have seen significant growth in the leather segment, particularly in recliners and motion upholstery. Thirdly, we have enjoyed stronger dealer participation than ever before in our national marketing programs, which allow us to capture a greater share of their advertising dollars and their overall focus. And finally, we're also encouraged by how well our new line of ultra plush recliners, that were introduced at last April's market, are retailing.

This is the fourth consecutive quarter of continued sales trend improvement in this segment, and we believe, based on the reported results of our competitors, that we are certainly gaining market share in our La-Z-Boy branded business. Case good sales dollars for the quarter were down 4.6 percent. We are encouraged that we continue to make progress with case goods sales trends, particularly as a result of improving conditions in the hospitality industry. American of Martinsville experienced solid top line growth this quarter and appears to be entering the beginning stages of recovering from a prolonged, severe downturn. As was the case last quarter, our orders have continued to show modest growth over last year, primarily on the strength of our La-Z-Boy branded business. Upholstery segment order dollars for the quarter were up about 1.5 percent, while unit order volume for the quarter was actually down just about 1 percent. This increase in dollars is being driven primarily by stronger leather sales, which carries a higher than average selling price than fabric. We've also added several new customers in our La-Z-Boy branded business that are beginning to positively impact our order trends. One of these is a regional department store chain on the East Coast with 39 stores, who has made a significant commitment to distributing and marketing La-Z-Boy products. The second is the predominant furniture retailer in San Diego who has 5 large locations. And finally, the largest Canadian retailer of furniture and appliances, with 57 stores, has added a broad range of La-Z-Boy upholstery, and are doing very well since starting with the line several months ago. Needless to say, we are excited to have these new retail partnerships underway in 100 plus stores.

Our case good orders continue to be under some pressure, though we saw progress over last quarter's decline of 8 percent, as this quarter our orders were only down 3 percent. We attribute a portion of the difficulty in quickly turning around the top line, to a cautious wait-and-see attitude on the part some of retailers, as we shift our business model from being primarily a domestic case good manufacturer, to primarily an importer, marketing,and distribution model. In our hospitality business, we are very encouraged by recent business trends, with orders up substantially for the quarter and the first half. Industry data for the hospitality industry are currently favorable, and we expect continued growth in this market. In terms of earnings, the 45 cents for the VIEs, which I'll discuss in detail later, a penny for restructuring, and a penny for extraordinary gain, our earnings per share came in at 22 cents, which was at the high end of the range of revised guidance we provided several weeks ago.

Now, a couple of comments on our operating margins. Our overall operating margin for the quarter was 3 percent, down from 5.3 percent a year earlier. Both quarters had restructuring charges, which cost us 10 basis points this year, and 40 basis points last year. Our operating results in the second quarter were negatively impacted by 3 key issues. First, continued and unprecedented increased raw material costs, coupled with our inability to immediately pass on rising costs to our retail customers. As I mentioned on our last call, raw material increases, primarily steel, have a disproportionate effect on us versus our competitors, due to the size and share of our upholstery and motion upholstery business relative to our total business. Hot roll steel is up more than 100 percent over last year, with plywood being up 20 percent. Steel costs increased our cost of sales this quarter by 1 percent of net sales, and plywood by three tenths of a percent, or a combined $7 million of additional costs. To offset these raw material increases, we have taken several price increases across most of our companies, which began in April. These increases are now beginning to impact our average selling price. Unfortunately, raw material costs have continued to rise significantly beyond the levels we previously used to model the necessary increases. We therefore have communicated further price increases in most of our businesses at the October market. We expect this increase to begin to positively impact our margins, as we move into calendar year 2005.

Second, we had a pretax losses from VIEs which amounted to almost $4 million for the quarter. We have been extremely active in this area over the past few months, and I will discuss our plans in greater detail to largely eliminate the losing VIEs over the balance of our year. And lastly, as we had previously mentioned in our press release, we had some production inefficiencies in connection with the announced shutdown of our Pennsylvania House case good facilities. These operational performance inefficiencies cost us $2.7 million for the quarter, or 3 cents a share compared to last year. As you can see, 2 of the 3 primary issues we experienced this quarter, including the Pennsylvania House transition, and addressing the VIE situation, our problems we are getting behind us, and their impact will be greatly diminished as we move into next year.

SG&A for the quarter was 19.9 percent, which was down from 21.3 percent in this year's first quarter, though up from 17.2 percent compared to the year ago. As I mentioned before, with the evolution of our business model to a greater mix of proprietary retail ownership, we expect that our SG&A percentages will rise and that we'll also see a corresponding positive impact on our overall gross margin profits. Absent the VIEs and the retail businesses that we own directly, our SG&A for the quarter was flat in percentage terms, to last year. If at some point in the future we achieve significant size in the retail business, we would certainly consider separating the retail operations from our manufacturing structure, to provide more clarity to our financial performance. Also, please keep in mind that the retail business requires a much lower comparable capital investment in comparison to manufacturing. Therefore, we would expect our return on capital measurements to be consistent or higher than our historical achievements.

I have several comments on our balance sheet, with the first being that it remains solid and strong, and we intend to keep it that way. We will continue to use our cash to pay down debt in order to bring our debt-to-cap ratio within our targeted range of the mid-20s. However, we'll continue to be opportunistic in repurchasing our stock. We have 6.7 million shares remaining under our current shareholder authorization. Our inventories are at higher levels than we expect them to be long term. This is a direct result of insuring we can service our dealers on a timely basis, as we transition our business model to a greater percentage of sourced product. We are currently addressing several different ways to better manage our supply chain to reduce inventory levels through quicker vendor shipments and improved inventory controls at the SKU level. The last point I will touch on is accounts receivable, which increased this quarter primarily as a result of increased sales. As you know, Rhodes filed for chapter 11 bankruptcy last week, and we had an exposure of approximately $2 million, for which we had adequate reserves in place. We are disappointed to see yet another long-time retailer file for bankruptcy. Since the year 2000, retail bankruptcies have accounted for approximately $5 billion loss of furniture sales, many of who were significant customers of the various La-Z-Boy companies. We estimate our Company lost approximately 250 to $300 million of volume, which gives even further credence to the wisdom of having a viable and thriving proprietary store system. Between Bruener's and Rhodes, last fiscal year they accounted for approximately $30 million in annual sales.

Those bankruptcies are particularly difficult on our Bauhaus division, which was a major supplier to both customers. Between these 2 retailers we had $3.9 million in accounts receivable, and we're adequately reserved in both cases. Rhodes plans on emerging from bankruptcy, but Heilig-Meyers, Montgomery Ward, Sears Homelife, and Bruener's did not. We used about $19 million more in cash for operations for the quarter than we generated, primarily from a normal seasonal build in our accounts receivable, and a modest planned increase in inventories. We fully expect that the last half of the year will generate positive cash flows. Capital expenditures were 7.7 million. I should also note that our Board of Directors declared an 11 cent dividend yesterday, and that continues to be a high priority for our free cash flow.

Finally, I want to highlight the actions we're taking to improve our performance, clarify the expectations we have for our various businesses moving forward, and make sure everyone understands the 3 key elements of our business model. Those 3 elements include being a marketer and manufacturer of upholstered product, an importer, marketer, and distributor of case goods product, and a La-Z-Boy Furniture Gallery's retailer with a strong focus in the top 25 markets in North America. We wish the transition to this model could be easier and faster. However, we have substantial work to do to refocus this Company to reflect the dramatic shifts which have occurred in this industry in the last several years, on both the manufacturing and retail fronts. So let me spend a few minutes on each of our 3 areas of focus -- upholstery, case goods, and retail. Upholstery is a core capability of La-Z-Boy. We have the best brand in the business, and one of the best in the home, period. A mature, tested, refined retail store system, and a powerful integrated marketing system. Today, we do not think the same dynamics that exist in case goods, exist in our middle market focus in upholstery, relative to the threat of Chinese imports. This is because of 3 primary factors -- consumer choice, speed to market, and cost competitiveness. We do believe, however, as I've said before, that the impact import products and components will have on the upholstery business will be substantial, and we are taking appropriate steps to integrate a global supply chain wherever it creates an advantage for us.

There are many areas we are working on in upholstery to ensure we remain competitive on a world-class basis. First, we're critically examining and changing our manufacturing processes at our plants to increase productivity, quality, and shorten delivery times for our products. We have been importing a significant quantity of cut and sewn leather sets, and this has been one of the drivers of our leather growth. In fact, in our La-Z-Boy branded business, 14 percent of all the upholstered product we sell is using a cut and sewn cover, and that continues to grow each month. We are also going to be importing cut and sew fabric sets beginning in early 2005, which will enable us to compete even more effectively at key competitive price points in upholstery, with improving margins. We are also constantly having finished or upholstered component level product cost in Asia to determine if there is an advantage to bringing in fully assembled products or kits. To this point, we are finding that at our price points, freight cost equalizes much of the overseas labor and other advantages. We will, however, continue to monitor the situation closely, and if there is a meaningful change, we will act accordingly and swiftly. We believe once our price increases are fully implemented and/or our raw material costs subside, along with our improved manufacturing and sourcing efforts are realized, we will be fully capable of returning to our historic operating margins of 8 to 10 percent in the upholstery business.

Now, let me turn to case goods. As I mentioned a moment ago, the playing field in case goods changed rapidly over the last several years. We have several of our companies that have already made the transition to our new model of importing, marketing, and distributing case goods, and several more that are deep into that transition process. Today we have a global sourcing operation, which has enabled to us gain efficiencies, as we consolidate shipment of our products and expand our direct container capabilities. We expect to have a residential case goods business that will be 75 to 80 percent import driven by the end of our fiscal year, which provides us with positive margin opportunities. In order to support this model, we are in the process of integrating a centralized 650,000 square foot warehouse facility into our case goods group, to support the more complex logistics of our changing business model. We are implementing a new warehouse management system, and we'll initially use the facility for American Drew, Lea, and Pennsylvania House products. The prime driver is to reduce cycle time, increase case goods inventory turns, and enhance the service we provide for our customers. We have the ability to consolidate a customer's order from several of our case good companies, and thus reduce not only delivery time, but also the cost and logistical issues of our customer experience associated with receiving multiple smaller shipments. We will also be reducing warehousing costs by consolidating 8 smaller warehouses into this 1 new facility. Ultimately this facility will be capable of receiving and more effectively distributing all of our case good company's products to our consumers in a timely and efficient manner.

As you can see in our case goods business, based on the significant changes we have, and are still undertaking in our business structure, we have some distance to go. But I do want to leave you with our expectations for the business, which is to mature to a 4 to 6 percent operating margin, as we head into next fall. The fundamental operating changes we have made, and are making, combined with an intensified focus on the top line through new products, designs, and effective sales and marketing actions, will get to us our targets. The third leg of our model is retail, both our proprietary system as a whole, as well as that portion which is Company-owned. Performance of our La-Z-Boy Furniture Gallery system continues to show growth, versus last year on a year-to-date basis, though that growth moderated somewhat due to weaker sales in August, resulting from decreased consumer demand. Same store sales dollars for the Furniture Gallery system, including independent and Company-owned stores, were up 2.7 percent in the first 9 months of calendar 2004, while total Furniture Gallery system sales were up 6.6 percent. In the third quarter, same store sales dollars were flat, while total system sales were up 3.4 percent. We were pleased with our ability to maintain our growth rates, given the negative impact the hurricanes had in the Southeast during the quarter.

Our intense focus for the Furniture Gallery system continues to be store growth and conversion to the successful new generation format. In the second quarter of fiscal 2005, we opened 2 new generation Galleries, remodeled or relocated 11, and closed 3 older format stores, bringing our total to 90 stores in the new format out of our 324. That is up from 59 new generation stores a year ago. For the upcoming third quarter, we'll have 2 stores remodeled to the new format, 3 stores relocated, and an additional 7 new La-Z-Boy Furniture Gallery stores. We plan on having at least 25 more in the new format by the end of fiscal 2005, with a little more than half of those being new stores and the remainder being remodels or relocations of existing older format stores. We remain on pace to add well over our targeted goal of 40 new generation stores to our system in fiscal '05. Our projections are to have over 350 stores by this time next year, with over 140 of them in the new format, and expect to grow by the end of calendar year 2007, to over 400 stores in North America. As I said before, a key component of our business model is the role Company-owned stores will play within our furniture Gallery system. This is a significant growth area for us, and one where we'll be devoting substantial attention and resources, with a strategic focus on the top 25 retail markets. We continue to strengthen our infrastructure, and we recently named a new General Manager for this business, who has significant retail experience and success within our system.

As a Company, we currently own 38 stores in 5 primary markets. We'll be adding 4 stores in existing markets to the total over the next 12 months, not including any acquisitions, bringing our total of Company-owned stores to 42. We also intend to increase our total involvement from 5 large metro markets to 8 in the near future, which will take our store total to the 65 to 70 range. One of our immediate tasks, however, is to work through our money losing VIEs. Historically, we have made conscious decisions to extend credit to undercapitalized dealers, to help them build up markets using the strength of our balance sheet. In conjunction with these decisions, we have recorded appropriate bad debt reserves. I can give you many examples of how that strategy has worked very well for us, and many of those dealers we have helped in the past, run very successful stores and operations today. Due to the accounting rule changes with FIN 46, we now have to record the losses on some of these VIEs. We are in the process of making changes with those unprofitable dealers, which amount to 4 of the 6 VIEs we have. 2 of them are profitable, but we can't record their profits, since we don't own them.

The alternatives with these unprofitable, undercapitalized VIEs are to own them directly, sell them, transition the business to another dealer, or close the stores and vacate the market, which is our least preferable option. We have 4 dealers in this unprofitable situation, and have executed or will be executing a plan for each of them. In 2 of the markets, we are transitioning the business to another dealer. In another market, we could potentially own that market directly. We believe these transitions should most all be completed in the third quarter. As importantly, we'll now have the opportunity to increase our market penetration in these 4 markets and improve their operating performance. Bottom line, we will have all of our unprofitable VIEs resolved and behind us by the end of our fiscal year. We believe that once we have had the opportunity to reposition the effective markets with new management systems and new locations, we have the capability to produce operating margins in the range of 3 to 5 percent, in line with Ethan Allen, Havertys, and other success home furnishings retailers. In summary, given the current economic conditions and the industry dynamics as we see them today, our business expectations are as follows -- First, as our price increases are fully realized and/or our raw material costs moderate, combined with our improved manufacturing efficiencies, our upholstery business is fully capable of returning to historic levels of 8 to 10 percent operating margins. In our case goods business, once we are finished with our transition in being primarily an importer, marketer, and distributor, we believe we should be operating in the 4 to 6 percent range. And finally, our retail business, as I mentioned previously, when matured, should operate at a 3 to 5 percent level in most markets. We believe the combination of these 3, gives us a winning model to maximize our growth and profitability potential in this industry.

The last area I would like to touch on is our guidance for the third quarter. We have seen order trends moderate, particularly in the upholstery segment, and we remain concerned about record high energy costs, and an unengaged consumer. Consumer confidence has fallen steadily over the past 3 months, though we are hopeful that with a definite resolution of the election behind us, they will begin to feel more confident. As a result, we currently expect our third quarter sales to be even or slightly ahead compared to the prior year. For the quarter, you can expect both upholstery and case goods to be basically flat with last year's prior third quarter. In this quarter, we factored in the potential loss of the Rhodes and Bruener's business, where we had about $8 million in volume in last year's third quarter. We anticipate reported earnings to be in the range of 11 to 14 cents per share for the the third quarter of fiscal '05. This would include up to 3 percent per share for potential losses from VIEs, and a penny for our previously announced restructuring, as we continue to wind down some operations. This would compare to the 29 cents we earned per diluted share in fiscal 2004's third quarter, which also included a penny restructuring charge. For the third quarter, margins will be impacted by the traditional holiday shutdowns, and the continued raw material cost increases, which will be somewhat offset during the quarter with our price increases.

For your modeling purposes we still expect capital expenditures for '05 will be approximately $30 million, and depreciation should -- depreciation should approximate at 28 to 30 million, and the tax rate should remain steady at 38 percent. In closing, we are aggressively transitioning to our new business model, though not without some pain. Our core strength, however, including our brand and our proprietary distribution system, give us confidence that we will reach our objectives in a reasonable time frame. I want to thank you for being on our call with us today. And with that, Mark, I'll turn it back to you.

Thank you, Kurt. Angela, if you could once again, just let everybody know what the instructions are for asking questions so everyone can participate, I would appreciate it.

Thank you. (OPERATOR INSTRUCTIONS) Susan McClary.

Can you give us a sense of what your capacity utilization is between upholstery and case goods? How that compares to what it's been over the last few quarters?

Yes, Susan, I can do that. In our upholstery segment, our capacity utilization, for the quarter, was at 84 percent. That was up about 10 percent to the prior year. Our case goods utilization was in the 65 percent range, and that was actually up slightly, but only because we have closed the -- a couple of plants since last year. Our overall utilization is in the 80 percent range, and that is also up over the previous year. I might add, that once we close the Pennsylvania House facility in Lewisburg, and now that we are out of our -- one of our 2 plants in the Kincaid business, our case goods utilization should be in the high 80s or low 90s as we start the new year.

Okay. Given then, that your upholstery utilization is up 10 percent, but yet your margins are down about 170 basis points year-over-year, can you quantify maybe how much of that is coming from things like the raw materials or other factors that are impacting it?

We mentioned in our call, Susan, that on the raw materials side, that we had, 7, $7.5 million worth of cost increases this quarter, primarily with steel and plywood. And we also had the $2.5 million of cost relative to the Pennsylvania House shutdown that impacted our margins this quarter.

Okay. So were those the biggest factors in there, would you say? Was there anything else that maybe is pulling them down some?

No, those were the 2 most significant ones.

Okay. And so then, looking forward, as you kind of get some price increases coming through and the utilization continues to increase, what -- what kind of improvement could we see in that margin?

Susan, I tried to lay out where we believe we can return our margins to, over a longer period of time. It's difficult for us to pick a point in time, given the volatility of raw materials. I mean we're being as prudent as we can, and as cautious as we can, but we don't have longer term insight on the volatility of the raw materials. And we have to go with the information as we see it today.

Laura Champine.

Did you give unit growth in the quarter? And what's built into your expectations for Q3?

Laura, we gave the -- on the upholstery side, we gave our unit growth was down on the order of 1 percent, and on overall sales up 1 percent. And that's as -- that's as far and to the clarity that we want to go, relative to units versus dollars.

Okay, but units were up 1 percent in upholstery, so you did get some pricing in the quarter, am I reading that right?

No, units were down 1 percent, and sales dollars were up 1 percent. But that -- but that has a lot to do with the changing mix of our business, as well.

Okay.

To a higher percentage of leather.

Okay. Can you talk about the level of price increase you expect to push through in Q3?

The level of price increases would vary within company, and given their competitive situation, and their ability to be competitive. I would say on average we have taken -- and certain of our businesses we have taken 2 or 3 price increases over the last 9 months, and they would range in the area of 1.5 to 2 percent. But each of our businesses are different. I think in total we would probably expect to have 3 to 4 percent in pricing over the whole year, once it is all fully fleshed out.

Todd Schwartzman.

Just to follow up, the capacity utilization during the quarter you said, I believe was 80 percent overall?

Yes.

Did you mention -- you said it was up a bit from last year. Did you give a number to that for last year?

It was up about 10 basis points over last year -- 10 percent, excuse me, over last year for the quarter. It's not up that much year-to-date, but for the quarter it was up about 10 percent. But it's -- I caution you that from the apples to apples comparison, we don't have as many facilities today -- as as many manufacturing plants in either case, goods or upholstery, as we had a year ago.

Okay.

But the capacity is up from 70 percent to 80 percent for the quarter.

And on the raw materials side, could you quantify maybe with a percentage, how much of the higher steel and plywood costs you think you will recoup in the second half of the year?

Todd, I'm going to be very cautious on that because, candidly last quarter we were optimistic that we would recoup a high percentage of it. And after we did our modeling, we got more increases on the materials. So it would be less than prudent for me to say we think we're going to do X or Y, and then in December have some commodities change their pricing.

Assuming no change, would you say 50 percent or more?

50 percent more -- ?

50 percent of the incremental costs will be recovered by your price increases?

I think on an overall basis, we would be higher than that. But it -- but it won't really show its maturation, probably until the fourth quarter.

Joel Havard.

Kurt, I appreciated your comments at the -- in the introduction about the challenges you faced. Of course, the line I was most pleased with was that you're committed in not delaying executing tough decisions. I'm paraphrasing here. If you would remind us the steps taken to date, that we've talked about, that you all have talked about, that we've run into down at High Point. Pennsylvania House, being shut down over the course of Q3, that volume being folded into a combination of imports, and I guess the Hudson facility. Bauhaus getting a new lease on life under Mr. England's management, we're glad to hear that. Other units on the bubble, I think that's the execution story that a lot of investors are waiting to hear about. Without naming names, without tipping your cards on what those tough decisions may be, could you run through some sort of scenario analysis with us?

That's a tough question, Joel.

Yes, it is.

I have been quite reluctant to speak publicly about some of the thoughts and changes that we are contemplating privately, because they involve people's lives. They involve humans and I'm -- and I'm not comfortable in putting a stake in the ground yet publicly, about which of our companies may have a long-term future, and which may not with us. But suffice it to say, we've made some internal decisions on some directions, and the thing we're trying to do with all of our businesses is get them back in a -- into a mode where there is some opportunity to consider other options, if they present themselves. So I think it would be irresponsible of us to provide any more color to that or get any more detail. Suffice it to say, that we're not going to sit here with a pat hand, and if our portfolio as a whole does not make sense, we're prepared to make those moves.

I appreciate what you're telling us there. Again, without trying to get specific to any particular division, I think a lot of us on the street are just looking for assurance that management has made its mind up, that you are not going to simply wait for the tide to turn for the industry as a whole, and that you are willing, and have given some thought and analysis to moves that may need to be taken.

You can rest assured we have done that. We have a pretty comprehensive game plan, and we're going to be moving aggressively in that direction.

Well, I will leave that alone then. On the VIE side, is your -- your press release indicates you do see some carry over, spillover into Q3. Your remarks indicated that by year end, these remaining, I guess 4 of the 6, apparently you have dealt with 2 of these folks. You see these other 4 being cleaned up. Can you give us any assurance that there's not another, you know, deal or 2 on the bubble that may slip into this pot? And if so, how do you address that, and get this, you know -- this wound healed over the course of ' 05, so that we get a cleaner look at '06?

Let me answer part of that, and I'll let Dave answer the one from the financial standpoint. Joel, we have 6 dealers out of 127 owners of the La-Z-Boy stores, that fell into the VIE category. Of those 6, 2 are profitable. But we have -- we have done some things from a real estate standpoint and an equity standpoint, where we have helped them expand in the markets. But they are -- but they're operating profitable, we are very comfortable with the management, we think they have a great long-term future. The way the accounting pronouncements read, we are not able to take any of their earnings into our earnings.

I understand.

Just the losses.

Right.

As far as the 4 that are unprofitable at this time, when I mentioned the end of the year, I was referring to the end of our fiscal year.

Right.

Which is next April, and we believe all 4 of them can be, and will be, dealt with by then. At the same time, we're trying to do it in a gentlemanly manner. We are trying to do it professional. We're trying not to disrupt business in those markets, and disappoint consumers. So a few of theses have taken a little longer than we would have liked. But we are moving aggressively to get these behind us, and we want a clean start on that as we head into next year.

All right, so if I've got my time frame right, I think at Q1, you had 4 dealers that were problematic. Now it is 6, but 2 of the 6 have moved back into the profitable area. Was that based on moves you all took with them, or was that them turning their business internally, or what combination? And -- ?

Well, Joel that's a moving target, and the seasonality of the furniture business is such that one quarter they could lose a little, and the next quarter they could -- they could make it back. So even the 2 that are profitable on an annual basis, there could be times within the year that there's an ebb and flow. And I will let David respond to your question about --

Okay.

-- any other potential and what the accounting rules read in this -- in this new challenge for us.

Okay.

Yes, Joel, in our footnotes in our 10-Q, you will find that there's a disclosure in there that we have other dealers who are technically VIEs, but for which we are not the primary beneficiary. Essentially that means they are -- generally speaking, their banks are the primary. The total for those is 17.5 million in terms of accounts and notes receivable. That's the exposure that you have. So you can tell probably from that, that we're not talking about, you know, a whole slew of people out there. We certainly monitor that situation. We've -- you know, as Kurt said, the current VIEs go back a long period of time in development. And our -- the rest of our dealers are in much better shape.

Charles Grom.

Hi, guys, this is Paul Trussel on behalf of Charles Grom. How are you doing?

Good morning, Paul.

Most of my questions have been answered. I just have a few follow-up questions.

Paul, we're have a little difficulty hearing you.

Can you hear me better now?

Much better.

Okay. Great. Yeah, guys just a few follow-up questions. One just kind of a tack on to the VIEs. You mentioned that there were 6 dealers, 4 unprofitable. Could you give us a sense of how many stores those dealers own?

In total, we have -- in total we have about 32 to 35 stores in the VIE situation. The dealers that have the largest number of stores, actually are the profitable ones. And so I think we're talking in the range of -- oh, we're talking in the range of 15 to 18 stores of the 4 dealers that are unprofitable at this point.

Okay. Great. Great. Thanks for the clarification. And then, just in terms of your case good brands. Could you possibly rank those brands in terms of sales contribution? And profitability, between, like, Pennsylvania House, Martinsville, Drew, Kincaid?

We look at our business on a segment basis, and we put them all into 1 bucket, and we've decided not to go any further into detail about the individual performance of the individual companies. We believe with our segment breakout, the way we're giving information on both of our case goods and upholstery segment, that we're giving quite a bit of information for people to make judgments on those various businesses, as a complete segment.

Okay. And then Todd Oldham. Could you talk, just speak briefly about those sales, and how the Todd Oldham brand has been acting for you guys, and if you can give a percentage of sales in this last quarter?

The Todd Oldham brand has been fantastic for us. It has helped us achieve 1 of our marketing objectives with the La-Z-Boy brand, which is to appeal to a younger customer. We're having many instances that customers who wouldn't normally have come into 1 of our retail outlets, are coming in, in search of a Todd Oldham design. And at times, while they may not buy the Todd Oldham design, they buy other products within our offering. So from a positioning standpoint, from a marketing standpoint, it has done exactly what we expected it to do. And on the sales side, it has continued to grow every month. We knew it was a long-term proposition for us. But at the present time, it is meeting the expectations we have for the line. Again, similar to my comments on the case goods, we don't want to get down into the level of detail and break out specific categories within our different businesses.

Great. And lastly, guys, any -- any more further word on just how trends have been into the November month?

Well, we're very early --

Just basically over the last few weeks.

We're very early into the November month, and I think we need to get beyond the election a little bit to give any kind of qualified opinion on whether consumer confidence is going to head north, and we see a pickup, or things are going to stay like they have been since Labor Day. So I don't think we have a big enough of a sampling here, to make any qualified judgment on direction.

Carlos Ribeiro.

Just a quick question on your price increases. Did you guys get any pushback at all at the furniture show with respect to the new higher prices that you were implementing?

We wouldn't be in the furniture industry if we didn't get pushbacks. Again, my answer on that would be that, depending on the strength of the various companies, how they were positioned prior to the market, how they were -- how they rate up to their competition, certain of our companies have more pricing power than others. But all of our companies were faced with the raw material situation, and so all of them took varying degrees of increases. And to the degree that 100 percent of that will all stick, we'll -- we won't know until sometime probably after Christmas. But certainly, we'll make some improvement across all facets of our business, headed into next year.

Okay. And second question, knowing that you guys don't like to comment on specific businesses in the case goods business, would it be safe to say that your hospitality business, in terms of sales, that it was up maybe double-digits in the quarter? Can you comment on that, rather than specifically -- qualitatively rather than quantitative?

My answer to that would be that we -- certainly the sales, the revenue gainer of the case goods group for the quarter was AOM. But, again we don't want to give any more detail on that than what we've provided so far.

Okay. Would that comment also hold true for your orders in the quarter?

Yes, it would.

Okay. Another question here. Can you quantify the incremental benefit on a -- the cut and sewn fabric kits that you guys are going to be implementing, relative to what you -- your traditional manufacturing process on the upholstery side? You guys have been doing leather -- .

We've been doing leather and we haven't -- we're just starting upholstery in January.

Okay.

And to give you an exact number that we have, there's a combination of savings between the cost of the fabric, and the labor content that you get with cut and sewn. There's also some decisions that we have to make on the merchandising side, of how much more competitive we become with that item and how much more margin we want to pick up in our deliberations. The other issue for us is that we are trying very hard to be primarily in the branded business, a line where the consumer has a choice. So we are blending our margins on certain of the patterns where we would get a couple colors cut and sewn over in China, but we would buy the other fabrics of the pattern here, and make them for special orders in this country. So the blended effect of that, Carlos, you are going to have to let us have a couple of months of experience, before we tell you what our results.

Okay. If you kind of look out 12 months, what percentage of your upholstered product would have kind of this blended strategy?

Well, I think in the -- again in the branded business, we're at about 14 percent today, with the predominance being leather. I can see that moving into the low to mid-20s fairly rapidly, and probably a year's time.

Okay. Great. And just lastly, can you quantify at all, or give us any indication in terms of how much these new retail partnerships that you commented in your -- earlier in the call, would benefit sales? Any -- can you give us any sense in terms of what they're going to contribute to the top line?

Well, there are -- what the -- there are 2 portions of our retail business. The new stores that we're opening, and the VIEs that we may or may not own going forward. I'm not sure which you were referring to, Carlos.

Well, I guess, initially, just the one, the San Diego retailer you were referring to, as well as the Canadian retailer.

Again, that's -- that's information that we don't want to reveal. But we think it's very significant and they are large presentations of our product, they are very well positioned retailers in their markets, and we think it is a -- we think it is a significant number in total, when you put all 3 of those customers together.

Once again, in order to ask a question, please press star, and the number 1, on your telephone keypad. Bud Bugatch.

Actually this is Chris Thornsberry on behalf of Bud. Good morning, guys.

Good morning, Chris.

Just had a quick question for you. Regarding the Pennsylvania House and the consolidation in the case goods segment, you said that was about $2.5 million in incremental costs in this quarter. Does that include just the restructuring, and also the -- does that also include inefficiencies involved with that, and where do you see that kind of playing out in Q1 and beyond?

Actually, it was 2.7 for the quarter, and it was -- did not include the restructuring.

So it was just all inefficiencies relating to the consolidation?

That's correct. We will have -- we plan to have the plant shut down by the end of December. That was our original plan, so we will still have inefficiency issues for the months of November and December, and then the bulk of the severance costs will occur in either December or January.

So we should we expect something similar to the 2.7 you guys had?

We hope it's not quite that bad.

Okay.

It will be -- it will be a negative drain on us.

Okay. And one last question on the debt. You mentioned your debt-to-cap is about 34 percent. Some of that was as a result of VIEs's consolidated into the balance sheet, which I think added about 3.4 percentage points. Is that correct?

It's in that range, yes.

Okay. Bringing the debt-to-cap down to the mid-20s, I'm just curious. Is that going to be mostly paying down debt as it matures or are you going to pay down debt early? And how much do you expect to bet back when you transfer, for instance, you mentioned 2 of those dealers that are VIEs, you would you transition to other owners. Kind of how does that play out and where do you see that debt-to-cap at the end of next fiscal year, for instance?

Well, the debt-to-cap is going to be a function of cash generation, obviously. You know, the debt-to-cap moved up basically because of the change in the net worth, as a result of the write-off of goodwill and intangibles in the last couple of years. The absolute level of debt is up slightly, but not that significantly. The real movement is because of the change in the equity. Our board is -- and management are more comfortable with a debt-to-cap in the mid-20s. We'll be doing that through the paying off of debt, the short-term debt, as cash flows allow. And then we'll reevaluate other uses of cash, once we get back into that target range.

Do you have any significant maturities of debt in the next 12 months?

No.

No, okay. All right, thank you.

At this time, there are no further questions. Mr. Stegeman, do you have any closing remarks?

Thank you for joining us today, and we'll talk with you soon.

This concludes today's second quarter earnings call. You may now disconnect.