La-Z-Boy Inc (LZB) 2005 Q3 法說會逐字稿

Good morning, my name is Brandy, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the third 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 Q&A period. (OPERATOR INSTRUCTIONS)

Mr. Stegeman, you may begin your conference.

Thank you, Brandy. Good morning. I’m Mark Stegeman, Treasurer of La-Z-Boy, Inc. Thank you for joining us on our fiscal 2005 third quarter conference call. Present on today’s call are Kurt Darrow, La-Z-Boy’s President and CEO; David Risley, our CFO; and Pat Norton, our Chairman.

Today’s subject is our third quarter operating results. Kurt will begin with some prepared remarks and then we’ll open it up for questions. Please, as a courtesy to everyone on the call, we would ask that you limit yourself to one question with a follow-up question, if necessary.

This call is being web cast live and a replay will be available on our web site 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’ll 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 CEO Kurt Darrow. Kurt.

Thanks, Mark, and good morning ladies and gentlemen. We appreciate you joining us today for our third quarter fiscal 2005 conference call. I’ll provide an overview of our operating results and update on business conditions and an outlook for the fourth quarter. I’ll also spend some time reviewing the progress being made on our longer-term strategic view and our rapidly-changing business model.

Let me start by spending a few minutes on our third quarter operating results. Though we are not satisfied with our profitability on a year-over-year basis, we are pleased with the progress we’ve made in a number of areas of our business and in our ability to meet and exceed the expectations we set last quarter.

Prior to updating you on the key elements of the foundational changes we’ve made to our business model and the substantial progress we’re making, let’s review our recent numbers.

Sales for the third quarter were up $26 million, or 5.3 percent, from last year’s quarter. VIEs were $15 million of this increase. So our organic sales increase was 2.3 percent and was achieved, even though we lost $5.5 million of volume, attributable to Brueners and Rhodes, from the third quarter. This is the fourth consecutive quarter in which we’ve seen growth in our overall corporate sales. This increase was in spite of a relatively weak retail climate for furniture.

In our Upholstery segment, third quarter sales were up 2 percent. Sales from our La-Z-Boy Branded business continued to run ahead of our Upholstery segment as a whole. Key drivers include continued same-store sales growth and the increasing number of stores in our La-Z-Boy Furniture Gallery System as well as increasing sales with our nonproprietary dealers. We believe this improvement in our general dealer distribution is due primarily to the growing strength of the La-Z-Boy brand as well as from us addressing key product areas with well-designed and competitive products in the Recliner and Leather categories. This is the fourth consecutive quarter of continued sales trend improvement in Upholstery and we believe we are continuing to gain market share, particularly in our La-Z-Boy Branded business each period.

Casegood sales dollars for the quarter were up 3.7 percent. While this by itself is not a significant increase for the segment, it is the first time in over three years that we have posted a year-over-year sales gain and speaks to the progress we are making in turning around this segment of our business. We look for that trend to continue as we refocus our business model, primarily on being a marketer, a distributor, and importer of casegoods products. In addition, our American of Martinsville subsidiary, which serves the hospitality business, experienced solid top-line growth this quarter and has a strong and growing backlog.

On the order front, while we’ve experienced some inconsistencies in recent weeks, we remain optimistic due to the continuing improvement in consumer confidence, which has a strong correlation with the willingness to purchase furniture. In our Upholstery segment, order dollars for the quarter were down in the low single digits. The quarter started off relatively soft in November and December, but trended more positively in January.

In Casegoods, order trends continue to be inconsistent and our ongoing business was down in the mid single digits for the quarter. But we’re gaining confidence from our retailers that our shift from a predominantly domestic casegood manufacturer to primarily an import platform is progressing well. Many Pennsylvania House dealers are waiting on the sidelines as we work through that transition.

Also, as I noted earlier, our Hospitality business continues to experience substantial order increases for the quarter and also for the year. Industry data for the Hospitality industry continues to be favorable and we’ll expect ongoing growth in this market segment.

Let’s now take a look at our earnings. Our guidance last November called for the earnings in the 11 to 14-cent range, including 3 cents for VIEs and 1 cent for restructuring. Our actual performance was 21 cents, including a penny of income from the recapture of previous losses from a VIE and 3 cents for restructuring. I’ll explain the reasons for this better-than-anticipated performance in a moment.

First, let me comment on our operating margins. Our overall operating margin for the quarter was 3.9 percent, down from 5.3 percent a year earlier, but up from last quarter. Both quarters had restructuring charges, which cost us 40 basis points this year and 30 basis points last year. Upholstery operating margin was 6.1 percent this quarter and we expect improvement moving forward with our price increases taking effect and with raw material prices remaining in check. Casegoods operating margins, without restructuring, improved to 1.9 percent from last quarter’s breakeven levels.

Our operating results in the third quarter were positively impacted versus our guidance by several factors. First, the price increases we announced last fall were realized in the quarter to a greater degree than we had forecasted due to a higher percentage of sold order business at retail. This helped partially offset the increased raw material costs in the quarter, which were about $8.5 million higher than last year’s quarter.

We have seen increases in hot rolled steel moderate this quarter, but they’re still up more than 100 percent over last year. We anticipate that our steel pricing will hold at roughly the level it is at now, though with consumption spikes in China we could see more increases. Plywood increases have also moderated some, but are still up around 9 percent since the first of our fiscal year. In the third quarter, steel costs impacted our cost of sales by 1.3 percent of net sales and plywood had an impact of .4 percent.

Second, we had slightly higher volume for the quarter than we anticipated, which added about 1 penny in additional profit. The third factor was that the progress in our transformation to primarily an import model in our Casegoods business is progress well and we are beginning to see margin improvement for the group. We are now on target to be approaching approximately 75 percent of our Residential Casegoods business being imported, as we head into next year.

The magnitude of this progress was masked, however, by the rather significant operating losses we incurred at Pennsylvania House during the closing of the facilities in Lewisburg. Restructuring also came in 2 cents higher than forecast. We paid a higher severance amount to employees and recorded higher inventory write-downs due to inventory evaluations being lower than original estimates, mainly in raw materials. We believe once we finish this transition in our business model that we will cease incurring operating losses, which would quickly move us toward the low side of our 4 to 6 percent operating margin target.

Additionally, although we made great progress on the revenue side in the Hospitality business, the impact on margins will not be evident for a few more quarters as we work through backlogs that were bid aggressively 9 to 12 months ago to win business. In spite of the near-term improvement in this area, we feel we still have substantial opportunity to increase margins and our profitability.

And the final factor was that we did not have the VIE pre-tax losses that we had forecast, which amounted to a swing of about 4 cents for the quarter. This was a result of the seasonality of the retail business, with the third quarter being the most profitable, and also the recovery of previous losses we incurred when the owner of one of our VIEs invested $2 million of additional capital. It is also the result of a reduction in the number of VIEs. We continue to be very proactive with addressing these VIEs and in a few minutes I’ll discuss the progress we are making in our goal of eliminating the underperforming VIEs over the balance of the fiscal year.

Although we are not satisfied with our current consolidated operating profit, given the magnitude of the raw material increases and the lag time we experience in passing those increases through to our customers, we are encouraged by the progression we have seen over the past several quarters. In the first quarter of this year, including restructuring, we had an operating loss of .8 percent. In the second quarter, we had an operating profit of 3 percent, the third quarter was 3.9 percent, and we project continuing improvement to about 5 percent in the fourth quarter of this fiscal year. We are focused on continuing to make steady progress.

Now let’s move on to SG&A, which for the quarter was 19.7 percent, down from 19.9 percent last quarter, though up from 16.7 percent compared to a year ago quarter. As we continue the evolution of our business model to a greater mix of proprietary retail ownership, we expect our SG&A percentage will rise and that we’ll also see a corresponding positive impact on our overall gross profit margins. Absent VIEs and the retail businesses which we own today, our SG&A for the quarter was up 5 basis points, or about $3.2 million. The prime drivers of this were increased brand advertising, warranty charges, and costs associated with Sarbanes-Oxley compliance.

Turning to our balance sheet, it remains solid and we used $25 million of cash this quarter to pay down debt in order to bring our debt-to-capitalization ratio to 31.6 percent and closer to our targeted range in the mid-20s. We did not repurchase any shares this quarter, but we still have 6.7 million shares available under our current authorization.

Our inventories are at a higher level than we expect them to be long-term, although we made some progress bringing them down almost $10 million this quarter and expect that we’ll make further headway by year-end. However, being in a better in-stock position during the holiday season allowed us to service all of our dealers more effectively last quarter and helped us grow the business as a result. We will bring down our inventories in the fourth quarter, consistent with seasonal trends. We are focused on improving our overall inventory turns as we move forward.

We generated about $38 million in cash from operations for the quarter and used that to pay down debt, which I noted earlier, and for CapEx of about $10 million, which included $2.2 million of CapEx from (technical difficulty). Also continuing to be a high priority for our free cash flow is our dividend, which was declared yesterday at 11 cents per share and yields over 3 percent.

I’d like to spend some time reviewing the three elements of our business model, transitional progress we’ve achieved during the quarter, and the related expectations we have for each segment. Then I’ll finish up with our guidance for the fourth quarter.

As I outlined to you in the last quarter’s call, the three elements of our business model include, first, remain the industry’s leading marketer and manufacturer of upholstered product; second, being a marketer, distributor and importer of casegood products; and third, being the leading proprietary furniture retailer with a strong focus from a corporate ownership perspective on the Top 25 markets in North America. I’ll spend a few minutes on each of these three segments.

First, let’s look at Upholstery. We work from a very solid foundation in this segment for the best brand in furniture and one of the best in the home, combined with a powerful integrated marketing system, which we continue to strengthen, all of this flowing through the strongest distribution network in furniture. With that said, we certainly face some significant challenges as this segment evolves, primarily in relation to the continuing emergence of the Asian upholstery manufacturing base. While we don’t believe the dynamics are exactly the same as the Casegood business, I can assure you we are moving quickly to transform our manufacturing and sourcing process into a lean globally-integrated system which takes full advantage of both the cost opportunities presented in Asia and the speed-to-market advantages of a U.S. manufacturing base.

One example is our rapid integration of Cut-and-Sew product into our system starting with Leather. We’ve made significant progress in the last 18 months and we’re continuing to move aggressively forward. Cut-and-Sew sets now represent more than 15 percent of all of our upholstery sales in La-Z-Boy Residential, and we expect that number to climb to 25 to 30 percent range over the next 12 to 18 months. This transition is already having a significant impact on our Leather business, which has increased substantially on a year-over-year basis.

We now import about 75 percent of our Leather in the form of Cut-and-Sew sets, which are assembled domestically. We are expanding this program with the fabric products and expect similar benefits competitively with improved margins. Each month, we also continue having finished upholstered component level product costed in Asia to determine if there is an advantage to bringing in more fully assemblage products or kits. At this point, we are finding that at our price points the freight cost equalizes much of the overseas labor and other cost advantages. We’ll continue, however, to monitor this situation closely, and if there is a meaningful change, we will act accordingly and swiftly.

Due to our unique dual-marketing approach of both stock and custom order selling, we believe that a North America manufacturing base is, and can continue to be, a distinct advantage for us. The reality is that we need continuous improvement in our cost structure, speed, and reliability of our domestic manufacturing facilities to ensure that they are world-class and globally competitive. We have many initiatives in this area, including the creation of a continuous improvement culture throughout our organization. We recently announced the creation of a corporate process improvement role to spearhead our overall efforts in every operating division.

In short, we believe if raw material prices stabilize and when our pricing and process improvement efforts take hold, we are fully capable of returning to our historic operating margins of 8 to 10 percent in Upholstery. As a point of reference, without the retail impact from our Company-owned stores on this segment, we performed at a 6.6 percent operating profit in the third quarter.

Now let’s spend some time reviewing the steady progress we are making in our Casegoods business. We finished the closure of the manufacturing operations at our Lewisburg facilities at the end of December, although it was challenging. We built Finished Good inventory levels a little higher than normal to ensure we did not have any interruption in supply to our dealers as we transitioned to more sourced product. We still have some areas left to transition, such as warehousing and customer service, but the burden of one of our oldest and highest cost production facilities is behind us.

We also made a change in leadership to Pennsylvania House with the naming of Dave Sowinski as President. Dave has been on the operations side of the business and was responsible for La-Z-Boy Global, our sourcing organization. He has worked extensively in developing our casegood strategy and knows our customers very well. He is recruiting a strong team, including individuals with previous global experience with other major organizations. We have every confidence he will be successful in leading the transformation underway at Pennsylvania House.

We now only (technical difficulty) domestic casegood facilities, each serving a specific purpose. We have a facility serving the highly-customized hospitality market, which makes primarily casegoods but also some upholstery. A facility which manufactures youth bedroom product and again large portions of this business continue to be viably produced domestically. And finally, a solid wood facility producing only bedroom products for Kincaid.

In the third quarter, we operated these three facilities at a capacity utilization rate of over 80 percent. Several of our companies have already made the transition to our new model of marketing, distributing, and importing casegoods and are successfully and profitably growing their business. Today, we have a global sourcing organization with about 100 people with a little over half working on the ground in China. This has enabled us to gain efficiencies as we (technical difficulty) of our products and continue to expand our direct container capabilities. The plants we are using in China are first-tier suppliers and are many of the same facilities producing products for Ethan Allen, Furniture Brands, and other quality companies. Our Residential Casegoods business is on track to be about 75 percent import-driven by the end of our fiscal year.

As we mentioned last quarter, to support this import model we’re integrating a centralized 650,000 square-foot warehouse facility to support the logistical needs of an import model. We anticipate the facility will be up and running in the fourth quarter. It will support distribution from American Drew, Lea, and Pennsylvania House products and will reduce cycle time, increase our casegoods inventory turns and enhance the service we provide our (technical difficulty). Our customers are excited about our new ability to consolidate their orders from some of our casegood companies and thus reduce not only their delivery time, but also the cost and logistical issues they experience associated with receiving multiple smaller shipments. We are also reducing our warehousing costs by consolidating 8 smaller warehouses into this 1 efficient facility.

We are making progress with a strong sense of urgency in the casegoods business and have confronted the reality of our new environment. But we still have some distance to go to get to the 4 to 6 percent operating margin run rate we believe we can achieve as we head into the fall. Our import model, combined with a new focus on the top-line through new products, designs, SKU management, and effective sales and marketing programs make us confident we will get to our targets.

Now let’s move on to the final element of our business model – proprietary retailing. As I mentioned before, we have a great deal of experience in proprietary retailing, though we’re continually refining and accelerating the expansion of our model. We’re pleased with the performance of our La-Z-Boy Furniture Gallery System in the face of a tough retail environment, as we experience solid growth year-over-year. Same-store sales dollars for the Furniture Gallery System, including independent owners and company-owned stores, were up 2.9 percent for calendar year 2004. All total Furniture Gallery System sales were up 6.5 percent. In the fourth calendar quarter, same-store sales dollars were up 3.6 percent while total System sales were up 6.5 percent.

A key focus in retail is accelerating the opening of, and conversion to, our New Generation concept. To give you a perspective on that acceleration, in fiscal year ’04, we completed 22 conversions, relocations, or new store projects. In fiscal year ’05, we expect to complete 44 projects or a 100 percent increase over fiscal ’04. In fiscal ’06, we expect to complete over 50 projects. The reason we are so intent on moving to our New Generation concept quickly is that on average, New Gen stores are driving roughly 36 percent more traffic than our old format stores and are doing about 28 percent more dollars out of each store. Our New Generation stores are doing, on average, $4.2 million per store, while our older format stores are approximately at $3.3 million.

In the third quarter of fiscal ’05, we opened 4 New Generation stores and remodeled or relocated 4, bringing our total to 98 in the new format out of 328 stores. A year ago, we had 65 New Gen stores. For the last quarter of our fiscal year, we will have 6 stores remodeled or relocated to the new format and an additional 8 new Furniture Gallery locations. This will bring our total to 112 with a new format out of 336 stores by the end of fiscal ’05. A little more than half of the New Generation stores are new locations within the last three years, with the remainder being remodeled or relocations of existing older format stores. This is part of the reason that our progress has been somewhat slower than originally envisioned because many of our dealers have taken time to evaluate their current real estate and many have decided to move to better locations.

We will exceed our original targeted goal of 40 New Generation stores for fiscal ’05 by 4 additional projects or 10 percent. Our projections are to have over 360 stores by this time next year, with over 150 of them in the new format. We expect to grow by the end of calendar year 2007 to over 400 locations with at least 60 percent, or 250 in the new format.

In terms of corporate ownership, today we own 38 stores in 5 primary markets. We are in the process of adding 4 stores in these existing markets this calendar year, which will bring our total to 42 locations. We are also in the process of adding to our company-owned markets and expect to add several large metro markets by our fiscal year-end, which would bring our store total to the 60 to 65-store range.

We continue to work through our money-losing VIEs. These VIEs were created by conscious decisions to extend credit to undercapitalized dealers to help them build out markets using the strength of our balance sheet. In conjunction with these decisions, we recorded appropriate bad debt reserves. During the past quarter, of the 4 underperforming VIEs, we were able to transition the ownership of 2 of them to new independent owners. In fact, in one of these markets the new owner just opened a new store last week. The negative impact of these VIEs over the last three quarters has been 8 cents, an impact that will be largely behind us in fiscal year ’06. In the case of the remaining 2 underperforming markets, it appears likely we’ll become the owner. We will then increase our market penetration in these major areas and improve the operating performance. As we’ve said before, in situations where we take over poorly performing or under-stored markets, it will take us about 2 to 3 years to drive them to an acceptable level of profitability.

After the changes occur, as we have outlined for the fourth quarter, this will leave us with 3 remaining VIEs who are marginally profitable at the present time. We are comfortable having VIEs as long as they are profitable and achieving our market penetration targets.

Just to reiterate our strategy with company-owned stores, we believe that once we’ve had the opportunity to reposition the effective market with new management, new systems, and new locations, we have the capability to produce operating margins between 3 and 5 percent, in line with Ethan Allen, Havertys, and other successful public furniture retailers. In addition, our returns on investment capital should be consistent with the rest of our business, as the capital requirements of the retail business are less than the manufacturing model.

Before providing some guidance regarding the fourth quarter, I want to reiterate our 9 to 12-month targets for each area of our business model. In Upholstery, we intend to return to the 8 to 10 percent operating profit range, assuming raw material costs stabilize and our pricing and process improvement initiatives take hold. In Casegoods, we are targeting operating margin levels between 4 and 6 percent, as we continue to utilize a higher degree of imported product. And finally, in retail, for those markets, which we’ve owned for more than 3 years, our objective is to achieve a 3 to 5 percent operating profit.

As we make progress towards these targets in the coming quarters, we are confident we can return the Company to its historical operating performance, which consistently ranked in the top quartile of our peer group.

Now let me touch on our guidance for the fourth quarter. Despite high energy prices, rising interest rates, constant geopolitical jitters, and a weakened dollar, consumer confidence has been slightly improving in the last several months. Our guidance takes into consideration the current direction of the economy, an extra week in our fiscal year calendar this year versus last year, and anticipates little or no further increase in our major raw material costs. With this as a backdrop, we expect our fourth fiscal quarter sales to be flat to slightly up compared to the prior year’s quarter. We also anticipate reported earnings for the fourth quarter to be in the range of 26 to 30 cents per diluted share, which includes restructuring charges of 1 cent and up to 2 cents per share potential loss in the consolidated VIEs.

For your modeling purposes for the quarter, and including the extra week, you can expect Upholstery sales to be flat to slightly up and Casegood sales up slightly compared to last year’s fourth quarter.

In our fourth quarter, margins should gradually improve throughout the quarter, as our price increases are phased in, and our volume will be approximately $40 to $50 million higher than the third quarter, absorbing more fixed overhead and SG&A costs. We’ll also experience a higher percentage of imported casegoods in our mix and again are anticipating raw material costs to remain at their current levels. We expect CapEx for the last quarter in ’05 to be about $7 million. Depreciation should approximate $7 million for the quarter. And the tax rate should remain at 38 percent.

In closing, we are confident that our new business model and the accompanying changes we are making will enable us to compete profitably in each area and position our Company with a strong foundation for the future. We have confronted the reality of our new environment and have made substantial progress in addressing that reality.

I want to thank you again for being with us today on our third quarter conference call. And with that, Mark, I’ll turn things back to you.

Okay, great. Thank you, Kurt. Brandy, could you just review the instructions for asking a question and then we’ll get started with the Q&A.

(OPERATOR INSTRUCTIONS) Charles Grom, JP Morgan

In your 10-Q, you commented that your order rates are down, and even in your comments order rates are down in the mid-single digits, yet you’re guiding 4Q sales to be flat to slightly up. Could you just walk us through the thought process there?

The primary thing, Chuck, is the fact that we have an extra week. So an extra week would normally give you, on a comparable basis, 7 percent sales lift (ph) for a quarter. And we have tempered that somewhat due to the order progress we’ve seen in the last few months. So, on a comparable basis, probably on a 13 instead of 14-week basis, our orders would be flat to slightly down if it wasn’t for the extra week.

Your sales, not your orders, right?

Our sales.

Okay. And then I guess a second question, if I could. Seems like you’re making a pretty big bet that raw material costs are not going to be rising and that’s surprising given the inflationary pressures we’ve seen. Could you just touch on why you feel comfortable putting in that kind of assumption out there?

Good question, Charles. I think the direction we have is pretty much today only for the quarter. And in various cases, we have some contracts. We have some pricing protection on it. And what we’ve seen in the last couple of months would indicate in the fourth quarter that we’re pretty confident that our material costs are going to be consistent with what they were in the third quarter. We’re not making a lot of judgments about materials beyond that, and that was one of the positions we’ve taken on a longer-term outlook that getting our margins back to a level that we’re comfortable with, are dependent upon raw materials stabilizing. But we’re not making any bet now of what they’re going to be 6 months from now.

Todd Schwartzman, Sidoti & Company

Talk a little bit about the average selling price increases. I wonder if you could just discuss what they were for the quarter, what you see going forward, and also maybe, if you could, maybe break it out by some of your best-selling products versus the rest, if there was any discrepancy there or if it’s across the board, pretty much the same average.

There are a lot of moving parts to that question, Todd, and I’m worried that perhaps our competition is listening and I don’t want to give them the exact pricing on all of our individual products. But suffice to say that we have 13 or 14 different divisions, different companies, different product lines in our portfolio and all of them are in a different relative competitive position in their respective categories. To give you a blanket number on our pricing across the whole board would be very difficult. And the amount of the pricing that has stuck on the various companies depends on their place in the market. And also, one of the things that always happens when you take price increases is that you can have a change in your mix. Some of our companies, we have seen some change in mix, which, in some cases, helps your pricing, in other cases, hurts your pricing. So our overall averages have been going up each quarter. We’re going to see some more pricing come through in the fourth quarter that was taken last October. But to get any more clarity on that, we don’t want to provide that at this time.

Are the increases in line with your historical heights, or are they growing somewhat?

Well, I would say our increases are slightly higher than historical heights because of the magnitude of the raw materials. So we have had to (technical difficulty) a little bit higher and more frequent increases in the past 12 months than we would do on a normal (technical difficulty).

And customer acceptance outside of proprietary?

We’re in the furniture business and customers never like a price increase, but the fact of the matter is the material costs are no different for us than anybody else and the industry, in general, has had to do some price adjustments to make up for the differential. It is a little more difficult, has been a little more difficult, for our Company given the fact that we are primarily an upholstery company which uses more steel and also because of a higher percentage of our upholstery being motion, our problems have been magnified. So I think the impact (technical difficulty) has had a greater impact on us than probably any other major public company.

Joel Havard, BB&T Capital

I wanted to talk about specific Q3 operating margins of 6.1 in Upholstery. We understand you all got a few initiatives going on in both the manufacturing sourcing and logistics fronts. Could you quantify the impact that these things in the aggregate may have had in Q3 and how you can see any relief going into Q4 or next fiscal year?

My answer to that question, Joel, would be that again there is a lot of different elements (technical difficulty) businesses. The Cut-and-Sew piece that I spoke about, increasing the significance of that to our overall, the pricing changes that we have made at the various companies, and the pickup in volume that we’re anticipating going forward all will contribute to some improved margins. But I’m not sure that we can give you the specificity of the things that you ask for in your question.

Oh sure, I mean I would love to have it down to the (technical difficulty) what the impact was. Would it be generally true to say that there was some transition cost impact in operating margins within the Upholstery segment from these various initiatives that will start to moderate, if not by Q4, then over the course of ’06?

I would say that there was not a lot of transition cost in Upholstery during the quarter. The transition cost that really affected our third quarter was primarily related to Pennsylvania House, both in larger-than-expected operating losses and larger-than-expected restructuring. That’s where the majority of our transitional costs -- and probably a little bit of cost in transferring into our new warehouse facility for our Casegoods Group and the expense of moving the product around and getting it consolidated. But those two are the larger, significant transitional costs that we’re experiencing at the present time.

Sure, sure, and I don’t want to drag it out. I’m losing my train of thought. Let me get back in line, guys. Thanks.

Carlos Ribeiro, CSFB

Your finished inventory was up 33 percent year-over-year, how much of that is attributed to casegood buildup?

A portion is attributed to it, particularly with Pennsylvania House. You have to remember that we stopped production at Christmastime in Pennsylvania House. We will not receive much foreign product until late March/early April. So we had to build enough product to satisfy the demand for 8 to 10 weeks, which is what we did. We also are bringing in more imported casegood products than before, which has a buildup. And we also had a buildup in our Residential Group with us being in an in-stock position on our Leather products and getting the flow of the Cut-and-Sew set in a manner where we can service our dealers appropriately. But now that we have got ourselves up the adequate run rate, we believe we can moderate our inventories in the fourth quarter some and bring them back down closer to year-over-year levels.

And, Kurt, if you kind of back out the hospitality business, what would be the casegoods increase on a year-over-year basis?

Well, if you’re going to back out the hospitality business, we would probably back out the transitional issues that we’ve had with Pennsylvania House. Our year-over-year rate would be in the low to single digit levels to flat on our remaining casegood companies. So we’ve had 1 company really struggling, 1 company really doing well, and the other 4 are kind of in the middle of the pack.

Bud Begatch (ph), Raymond James

Actually, this is Chris Thornsran on behalf of Bud. Just a quick question following up on the sales guidance, did you have the consolidation of VIEs in the fourth quarter of last year?

No.

You didn’t. Okay. So this guidance for flat to slightly up includes additional revenues from VIEs. I was trying to get a handle on kind of the core revenues from upholstery and casegoods that you’re looking at, and also excluding the extra week.

Well, as I answered earlier, our core sales, without the extra week, will probably be slightly down to flat. We’re being cautious on the top side given recent order trends. Our problem with estimating the sales increase of the VIEs is that we are planning on -- the remaining 2 underperforming VIEs, we’re planning on taking them into company ownership and we’re not sure when that’s going to happen. So it’s a little bit of a moving target for us to make an appropriate judgment on the amount of volume the VIEs will produce in the quarter.

All right. And one further question. In the Pennsylvania House segment, recently, I think it was early January, you had the announcement where you were discontinuing the Southern Routes line. I just wanted to know what were your kind of plans in terms of revenues and potential earnings that are going to be gone from, for lack of a better word, from not producing this collection and when do you get that back? What are you kind of putting in place of the Southern Routes collection?

Good question. I’m glad you asked that. We think the publicity on the dropping of the Southern Routes Group has been a little bit overblown. It is not uncommon at all in the casegoods business to not cut certain groups that were introduced at a market. That’s pretty much common industry’s practice. In this particular case, we had a little bit of a difficult veneer process to replicate. And we had sold less than $1 million of the group prior to making a decision. We talked with a number of the dealers about the decision, the risk involved. All of our major dealers were very supportive of the decision.

And what we didn’t want to have happen is we didn’t want to have a black eye in our transferring product to Asia on the entire Pennsylvania line on the back of one potential problem that could happen if we didn’t execute the Southern Routes veneer process correctly. So we decided that to get off to a good start with the product coming in from overseas for Pennsylvania House to make sure our dealers went through the transition in a good format and had confidence in the quality that we didn’t want to have something that was a marginal seller taint the applecart at all. So we made the decision to call it back. We have a full product array of new things planned for the April market and we don’t think it was a meaningful sales or earnings hit relative to Pennsylvania House.

Okay. So you had less than $1 million worth of orders from the time it was entered at market to the time you pulled it?

That’s correct.

Okay. That’s helpful. Appreciate it.

(OPERATOR INSTRUCTIONS) Susan McClary, UBS

Can you talk a little bit about your uses of cash? I know that you paid down some debt this quarter and that you’ve got a 20 percent kind of debt-to-cap ratio as a goal. But can you talk a little bit about the decision process in paying down debt versus maybe repurchasing shares or doing other things with it?

Susan, I’ll let David speak to that question.

Yes, Susan. We have designed our capital structure to be such that our Board is comfortable with us being in the mid-20 percent range of debt to total cap. Because of the write-offs and the restructuring that we’ve incurred, the non-cash charges in the last 12 months, obviously our equity has come down, which has pushed our number up. So even though the tangible relationship is not much different than it was before, the absolute ratio is out of line with our targeted range. We would expect to bring that down again this next quarter and once we’re back within range you might want to assume that we’ll continue to look at stock repurchases.

Okay. Can you give us a sense of what is the average cost of the debt? What is the average kind of rate that you’re paying on it? And does any of it come due (technical difficulty) a month or so?

No. There is two major (indiscernible) of placement debt. One that was done about four years ago and one was done a year-and-a-half ago. (Technical difficulty) $80 (ph$) million a year-and-a-half ago. And that rate --

5.25.

5.25.

And then there is a little piece that’s less than that. And then there’s just under 6.5 percent on $35 million.

There is a full schedule. If you want to go back to our 10-Q, excuse me, 10-K, and you’ll find it in the footnotes there.

Yes, and I will be happy to go over that with you, if you need to.

And also a table in the MBA (ph).

Anon Christian, Morgan Keegan

My question relates to distribution. I’m trying to get a sense of your estimates for the industry-wide retail square footage on the growth in the last year and your expectations for next year. And also, I’m trying to find out if the growth that manufacturers want at stores and discounters and specialty retailers are more than offsetting bankruptcies of independents. And if so, how does that shift in the channel affect La-Z-Boy?

Let me try to answer your question in reverse. La-Z-Boy has been in the store program for a long time. We are not new to this and we are approaching our 30th year of having some format of La-Z-Boy stores throughout North America. I think another difference with the La-Z-Boy program, in most instances, we do not change our distribution when we open stores. Our stores have, for years, lived compatibly with general distribution and we think given the holler (ph) of our brand and the breadth of our product that we need to have our line distributed at both independent dealers and the La-Z-Boy stores alike.

To give you a number on square footage, we would have to get back to you on that. We can tell you that our average new store is averaging somewhere between 15,000 and 17,000 feet of selling space, and if we’re going to open 20 to 25 new ones, you can do the math on the square footage and growth. But what we haven’t netted out is any closures that we might have during a year. And I don’t have that readily available, but certainly we’ll get back to you with that answer.

So the growth of the discounters and specialty retail channels, vis-à-vis the independents, would that have any impact at all going forward?

I think you have to look back over the last four or five years, beginning in 2000, and the fact that we have lost about $5 billion worth of retail business across this country with the bankruptcies or closings of Heilig Meyers, Home Life, Montgomery Ward, Breuners. The list goes on and on. And I think all of the people that you’ve mentioned and a lot of people like Crate & Barrel, Pottery Barn, Wal-Mart, those people in the mid to late 90s weren’t involved in the furniture business. So I think the business that was conducted by the people who have gone out of business has been fragmented out to some new segments, to the traditional dealers that have been in the market, and to the growing number of manufacturer stores that are opening up across the country. I think a piece of all of that had been given to all of the various different segments of the distribution channel.

Sure, I understand. But from a margin standpoint, is the shift going to be -- make a meaningful impact to La-Z-Boy’s financials?

Well, you have to look at it as two different businesses. There’s an expectation of margins on the manufacturing side of our business and there is an expectation for margins on the retail side of our business. We think there’s some synergy between the two and we think that growing our retail business, both ourselves and with our independent dealers, can drive more business through our current facilities and help improve our manufacturing margins. We don’t anticipate making the same kind of margins on our retail business that we do in manufacturing, but we think the aggregate will be an acceptable level and will position our Company well for the future.

John Baugh, Legg Mason

Question relating to upholstery and imports. Can you refresh me on how many upholstery plants do you (technical difficulty) and whether the shift to Cut-and-Sew will require or maybe provide an opportunity to consolidate anything. And then maybe a guess as to where you think, as an industry, obviously you don’t seem, your price points, to think that reporting finished goods, upholstery makes sense, fabric at least. But a guess as to what you might see the rest of the industry do, and how that, again, may over time impact the necessity of closing any of your domestic upholstered factories in the U.S.

John, I will try to answer that question in reverse. From what we’re seeing and the people we’re talking to, the retailers that we have close contacts with, upholstery products less than $1,000, less than $999 retail for sofas, we’re not seeing a lot of finished good products coming in in that range. At over $1,000, at sofas from $1,400 to $1,900, with a lot of exposed wood, yes, there is product coming in in that range. But that seems to be the break point now where there’s a differential between finished goods coming in and not.

The other issue that’s real important in our business is the custom order capability. And that’s again a model that hasn’t been replicated successfully yet in China. And giving a lady of the choice of buying 1,500 fabrics in one location is a little more difficult to do than some people think.

I need to make a comment. To answer your question directly, we have 25 upholstery plants in our Company, but as we’ve acquired companies and put them together, we have upholstery plants that do less than $40 million and we have upholstery plants that do over $200 million in the La-Z-Boy system. So for us to call each plant similar would be a misnomer for us. We could have some gained efficiencies by more Cut-and-Sew. Although at the present time, one of the problems we have in certain of our locations is finding enough qualified sewers and people who want to work on sewing machines all day. And so we think that a little more Cut-and-Sew right now would be a relief to us.

We’re not anticipating in the near-term, we’re hoping that the volume that we can pick up as we grow the business to the store program and have more competitively priced product through Cut-and-Sew will give us the opportunity to use the freed-up floor space for more growth. But we monitor that on a regular basis and if we see that we’re able to take out some more capacity we certainly would not be opposed to doing that.

And how about on the Leather side, Kurt. I assume you’re on average above the $999 price point, but you’re primarily assembling, if not exclusively, assembling that here and just doing the Cut-and-Sew and then Leather. Will that be the case going forward as well, or do you anticipate bringing finished goods there and possibly, again, consolidating production, the assembly part of that here.

Good question, John. The Leather piece is all over the board. It’s hard for us to fathom today that some places you can get leather sofas cheaper than you can fabric sofas, which doesn’t make a whole lot of merchandising sense. But we’re not seeing the pressure on our leather products to the same degree. We think that our program is competitively priced. It’s still growing. Again, one of the things that we offer, and why we want to keep that selection story going, even on the frames that we offer that are Cut-and-Sew today, there’s options to step off of those and get custom orders with our domestic manufacturing and a wider choice of colors. So I’m not sure that the customer wants such a limited choice of two shades of brown for a leather sofa and we’re trying to mix the two to be competitive on the opening price points with Cut-and-Sew but still have the upside to do custom orders at a step up with our domestic production.

What is your percentage of La-Z-Boy-branded upholstery growth fabric and leather that is custom ordered?

Well, La-Z-Boy stores today are selling 46 to 48 percent of their business custom order. I would say our overall average is probably in the low 40s of what’s coming through our total distribution chain.

At this time, there are no further questions.

Thank you very much, Brandy, and thank you for attending today’s call everyone.

Thank you for participating in today’s third quarter operating results conference call. This call will be available for replay beginning at 11:30 AM EST today through 11:59 PM EST on Saturday, February 19, 2005. The conference ID number for the replay is 3063032. The number to dial for the replay is 1-800-642-1687 or 706-645-9291.