La-Z-Boy Inc (LZB) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the La-Z-Boy International second-quarter 2006 conference call.

At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Mark Stegeman. Thank you. Mr. Stegeman, you may begin.

Thank you, Diego. Good morning. I'm Mark Stegeman, Treasurer of La-Z-Boy. I would like to thank you all for joining us on this morning's call to discuss our fiscal 2006 second-quarter results.

Present on the call today are Kurt Darrow, La-Z-Boy's President and Chief Executive Officer, David Risley, our Chief Financial Officer, and Patrick Norton, our Chairman. Kurt will begin with a discussion of prepared remarks, and then we will open the call to questions. We would ask that you please limit yourself to one question at a time with a follow-up if necessary, so that everyone has an opportunity to ask questions.

A telephone replay of the call will be available for a week, beginning this afternoon.

These regular quarterly investor conference calls are one of La-Z-Boy's primary vehicles to provide guidance and to communicate with investors about the Company's current operations and future prospects.

We will make forward-looking statements during this call, so I repeat our usual Safe Harbor remark. 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.

With that, let me turn over the call to La-Z-Boy's President and Chief Executive Officer, Kurt Darrow. Kurt?

Thank you, Mark. Good morning, everyone, and thank you for joining us on our fiscal 2006 second-quarter conference call.

My remarks this morning will address our results and what we experienced during a very unusual quarter, our ongoing strategy, and what we see for the third quarter.

First, our second quarter -- it was marked by a series of unusual events. We faced an unprecedented industry-wide shortage of polyurethane foam, an unexpected slow pace at retail in a period that is usually robust, and damage to our Newton, Mississippi manufacturing facilities two separate times. The first time, the town of Newton sustained a serious amount of damage from Hurricane Katrina, and our plant was not operational for a few days due to lack of electricity and employees being unable to get to work. Then a tornado spawned from Hurricane Rita hit our plywood plant facility in Newton, causing significant amount of damage to the building. Unbelievably, our plant was the only building in all of the city of Newton to be hit by a tornado. We are, however, very fortunate and thankful that not one of our employees was hurt or injured.

If there's any irony to any of this, it's that, due to the short supply of poly, we didn't need to produce as many plywood parts. Additionally, with poly prices going up, the industry in total, both upholstery and bedding, took price increases simultaneously, as none of us had the margin to absorb the significantly higher cost of poly.

As we mentioned in our release, the quarter was really marked by a series of unlikely events. The good news is that we've done so much work to our cost structure over the past two years that even with our sales down over 66 million in the quarter prior to the restructuring charge, we still managed to operate at about a breakeven level. Now, as we enter our third quarter with higher backlogs in upholstery, I'm happy to report that, as of last week, we can obtain all the poly supply we need to operate at levels that demand dictates.

Before I discuss this quarter, I want to make a point that, because our quarter ended in October, the poly shortage impacted our results significantly as opposed to our peers, whose quarters ended in September. They have the opportunity to regain October's lost production during the months of November and December. Additionally, because upholstery is approximately 75% of our overall business, the effect on us was much greater than many of our competitors.

Now, let's turn to our results. Our sales were down significantly. This was principally the results of two factors. The first was shortage of poly for the entire month of October. In the first two weeks of October, we only received 50% of our allocation, which meant our production was off accordingly. This impacts our ability to make money, as it's impossible to run efficiently on such a significant drop in volume in a compressed time frame.

The second factor is that the retail environment was unusually weak. This is not typical, although we did see a pick-up in October. The environment is quite puzzling. Historically, when housing starts are strong and interest rates are low, furniture sales are also strong. This, however, has not been the case for the last few years. We hear a lot about pent-up demand as people must be living in houses with empty rooms, but nobody has been able to define "pent-up" and the length of time associated with it. Unfortunately, furniture is a postponable purchase and with consumer confidence dropping 20% in September to its lowest level in two years, it's clear that people are still concerned about the Fed's continuation of interest rate increases, the gas prices, and the prospects of heating their homes this winter.

For the quarter, La-Z-Boy reported net sales of 454 million, down 66 million or 13% compared with the prior-year period. We also posted a $0.12 per share loss, which includes an after-tax restructuring charge of $0.10 related to the closure of our Waterloo, Ontario upholstery facility. Because we received more poly towards the end of October than we originally anticipated, we were able to improve our results beyond the loss of $0.17 to $0.21 that we had expected when we updated our guidance on October 18.

For the six-month period, net sales were down 70 million, or 7%, to 906 million. We posted a $0.06 per share loss for the six-month period, including our restructuring charges.

I'd like to spend some time talking about what we're doing in our upholstery division to operate more efficiently. First, we are adopting cellular (ph) concepts in certain of our operations, which have proven to run our plants leaner and more efficiently while increasing both quality and speed-to-market.

Second, we continue to import more cut and sewn product, which helps our value proposition and improves margins. We are importing approximately 60% of our leather in cut-and-sew kits and are increasing the number of imported fabric cut-and-sew product.

Third, we continue to rationalize our business and maximize our efficiencies, and we announced we would close our Canadian facility this December. The Waterloo plant is a high-cost facility and has been operating at less than optimal capacity. We were already shipping approximately 50% of Canada's product from the U.S. and determined we have enough capacity States-side to easily and completely service the entire Canadian market.

Fourth, we continue to reengineer various products to be more cost-effective without sacrificing quality or functionality.

With respect to poly, while we are receiving 100% of our needs today, we're paying 60 to 70% more for it than we did in August, and we took a variety of price increases and surcharges in an effort to stay cost-neutral. Our customers understand the rationale for these surcharges, as this is an industry-wide issue. At the consumer level, price increases probably won't show through until January. Also, it's important to note that the consumer was not impacted by the poly shortage during the quarter. We were able to ship sold orders on a regular basis, and our retailers worked down their inventories. Now, we will replenish those inventories and we move into the third quarter with a higher backlog in upholstery.

With respect to our backlog, unfortunately we can't catch up to our demand as quickly as it went away, as we do not have the human resources to make that happen. It will take into February to return to normal service levels, as we can only flex our production by about 10% per week. Upholstered product requires skilled labor, and it's not possible to take new people and hire them as temporary workers without proper training. That said, we will work extensive over-time, as our employees want to make up the hours they missed in October, so we will work longer and extra shifts this quarter, which otherwise would have been holidays.

The last point I would like to make is that we continue to carefully evaluate our business and focus on those that are core to our ongoing strategy. As such, we sold our Englander sleep products name and trademarks to a group of licensees for a gain in the quarter.

Now, turning the case goods, for the quarter, our sales were down 9% year-over-year while our margin improved to 2%, which compares favorably to 0.1% last year. We have worked hard to transition the business to be primarily a marketer, importer and distributor of case goods. Once we've fully worked through the transition of Pennsylvania House, which we expected to be completed by September but now will take us to the end of the calendar year, we will be well positioned to fully capitalize on our import and our distribution model, and all of our case goods businesses should contribute positively to the results.

On the hospitality side, American of Martinsville is gaining momentum and has built a backlog as the hotel business rebounds after several difficult years. We are confident that our residential case good cost model and value proposition is profitably structured, now that we're 70% import-driven, and believe that we can not only hit our 4 to 6% margin objective but, with additional volume, we can exceed it.

I'd like to spend some time talking about our Retail division and our strategy to position ourselves for the future, but first, some information about the segment's results for the quarter -- we posted a loss on sales of 49.2 million, due to the overall softness in retail, as well as problems and costs associated with the 21 stores we acquired in the fourth quarter of fiscal '05. As I said last quarter, there is a significant amount of work to be done with these stores, and they continue to impact our segment results. While turning the stores around is not an overnight process, we remain confident that acquiring them was the right strategic move. These markets have excellent demographics and long-term opportunity, after we move or renovate the stores, change over administrative systems and personnel, and build out the store system within each market to get our proper share of voice. Then these stores can generate returns in keeping with industry standards.

We're confident we have a successful model for the La-Z-Boy store program. It's important to our company future and our company-owned stores will ultimately contribute to our bottom-line, although we have work to do in a number of markets. For example, of the 61 stores we own, only 23 of them are in the new generation format. In approximately 9 to 12, months 42 of them will be in the new format, and it will take another 9 months to a year to get good positioning with the rest of our locations. A big obstacle is finding the right real estate at affordable prices, and we won't settle for anything less than an 'A' location.

In terms of our total store system, we are aggressively opening stores and our objective is to have 400 stores by the end of calendar 2007 with corporate ownership of about 80 to 90. While we closed 8 stores this quarter and opened only 1, we're scheduled to open 25 new generation stores in the third quarter, 15 of those being brand-new locations and 10 being either relocations or remodels. Although a few stores have shifted from this quarter to next, our system still remains on track this fiscal year to open approximately 50 stores, 20 to 25 new locations, and 25 or so remodels and/or relocations.

I'd like to point out that, overall, the 329 total store system is healthy and growing but because it was necessary for us to acquire a number of underperforming stores, our company-owned store portfolio as a whole is not producing acceptable results. However, we have a core group of markets that are profitable and we will continue to address the issues of the stores that need to be improved.

When looking at our company-owned retail, one has to remember that we took in all the unhealthy stores and now we have to fix them and it will take some time. We acquired three markets, two of which were former VIEs, in a period of 60 days, and it was a lot to absorb at once. In a perfect world, we would have preferred to buy a poor-performing market, fix it, build it out, and move onto the next one -- but we didn't have the luxury of that and we did it all at one time.

The question is, how fast can we right-to-ship and what are we doing? Frankly, it is a market-by-market situation and we have developed a definitive plan to address the various issues. In some markets, we don't have enough stores; in others, we don't have stores located correctly, and we may in fact ultimately decide to exit a market. We're working on our basic infrastructure and are consolidating warehouses and streamlining advertising and administrative procedures so that we can leverage our infrastructure. We also need enough volume in each market to garner respectable share of voice through advertising and be heard.

Experience suggests that once a market achieves critical mass, our stores will generate the kinds of returns that are in keeping with our objectives. We estimate t will take us about six months to achieve the critical mass level in five of our markets, which includes Chicago and Washington, D.C., two of our largest markets that represent more than half of our company-owned stores. The remaining three markets that we own will require some additional time.

With respect to retailing, our mission is to capitalize on our brand. Retail is a natural extension of our brand and a good strategy which distinguishes us from most other manufacturers. With incredibly strong brand and a solid store program, it provides flexibility in being a marketer, distributor and retailer, which gives us a very strong business model. While we have a lot of work to do in this segment, it will put the building blocks in place for a brighter future.

In summary, we're going to compete effectively in this marketplace. We have a solid cost structure in place that should enable our three segments to provide good returns so that we grow our company profitably. We continue to improve our brand, finding innovative ways to make it more relevant and appeal to more audiences, which will position us well as the furniture business becomes more and more fragmented.

Before turning to our guidance, let me spend a brief moment on the balance sheet. For the quarter, cash flow used for operations was $1 million with a debt-to-cap ratio of 31.1%. Although our target for debt-to-cap is in the mid-20s, we were opportunistic during the quarter, given the weakness in our share price, and repurchased 260,000 shares. We have 5.9 million shares remaining in our repurchase program. Going forward, we will use a blended strategy of repurchasing shares and paying down debt as our cash flow allows.

Looking ahead to the third quarter for fiscal 2006, while this quarter was highly unusual, we have established solid fundamentals in each of our three business segments and expect a rebound from the series of events that impacted us in the second quarter. That said, we do remain concerned about the macroeconomic environment, as well as consumer confidence and are projecting flat year-over-year sales for the third quarter with earnings per share forecasted to be in the range of $0.13 to $0.17 per share.

Again, we want to thank you for joining us on our call today. I will turn things back over to Mark to begin the question-and-answer period.

Thanks a lot, Kurt. We will have the operator review the instructions for queuing up to ask questions, but again, if you could just as one and one follow-up, that would be appreciated. Go ahead, Diego.

Thank you. Ladies and gentlemen, at this time, we will be conducting our question-and-answer session. (OPERATOR INSTRUCTIONS). Joel Havard with BB&T Capital Markets.

Thank you. Good morning, everybody. Kurt, you used the "core" word again. I wonder if you could talk to us about the way management and the Board are thinking about the big, remaining, noncore operation. Obviously, we're talking about American of Martinsville. As it gets healthier, is it time to think about what reasonable market price is acceptable versus holding out for a top pick?

Well, I will give you credit for one thing, Joel; you sure are consistent with your questions! (LAUGHTER).

I don't think it would be proper for us to comment directly on some of our longer-term positions and things of that nature, but I think you can tell from our past history here the last year and a half that we have a plan in place; we know what's core to us. We've been active in selling our office seating business, our bedding business, and we will continue to do what we think is prudent to put us in a position to be more competitive.

I will take that as mild confirmation or reassurance.

The follow-up to that is, as you look at any additional opportunities on noncore divestitures, where do you see the balance of cash realized from that shifting between some further debt reduction, if that's still an important goal or as important a goal, versus working capital use, especially on the retail development side versus share repurchase activity?

Well, I think, Joel, we've been very consistent in our message about our uses of free cash flow. We believe we can generate enough cash to take care of any internal capital needs that we have, including anything we need to do with the stores. I would remind you that we lease the majority of our stores and the capital required to build them out is not significant. Then, as additional cash flow is available over and beyond that, we will use a blended strategy of paying down debt and share repurchase.

All right. Thanks, gentlemen.

Ivy Zelman with Credit Suisse First Boston.

I appreciate the opportunity to ask a few questions. I know one, but I'll take a shot at this one. Excluding the underperforming stores that you acquired, can you give us a sense of what retail margins would be?

We don't give specific margins on our various segments, Ivy, but in the retail business, in order to be successful, you have to have margins in the mid to upper 40s -- gross margins -- to be able to successfully run a profitable business. That's certainly the range we would have to operate in.

Lastly, just a quick one on capital. Realizing that it sounds like the 260,000 shares that you bought in the quarter, it looks as if you were borrowing to buy stock. Is that something that you would continue to do? I guess where do you think I guess the intrinsic value is in the stock to continue to buy it here?

Well, I don't think we did any necessarily borrowing to buy stock. Without any earnings this quarter, we did a little bit of borrowing to fund the business but most of that stock was bought at the beginning of the quarter before we came into the problems with the poly and the supply issues. So, I don't think you'll be seeing us lever up to buy more stock, but as I mentioned earlier to Joel, we will use a blended strategy with our free cash flow on both stock repurchase and debt reduction.

Scott Heleniac (ph) with Ferris Baker Watts.

The new stores you bought over the past few quarters, you plan to relocate all of those over time, or just I guess the majority of them? What is the plan there?

That was a good question. As I said earlier, we have 61 stores and only 21 of them are in the new format. We evaluate each location; we evaluate its acceptance in the marketplace. There will be a number of stores that we will remodel, because we think they are properly positioned and have a rent structure that allows us to earn the returns we need with a remodel. There are a number of other ones that we will move, and there are certain ones that we will just out right close the market has moved away from it. So, we have a plan in each market; we have a plan for each store. We are handicapped a little bit by some lease situations that we inherited and finding affordable real estate. I think you can tell from our comments this morning we are being very aggressive on moving forward with real estate positioning in our retail markets and believe, in 18 months, our picture will be much different than it is today as far as our physical store program going forward.

But you've already started -- have you actually moved, relocated any of those stores?

Yes, we have, and we have a number of projects. We have about 20 projects underway over the next 18 months that are going to make a significant difference in our performance.

Budd Bugatch with Raymond James.

Good morning, Kurt. Waterloo -- you're going to close that in December. I guess my rough math says maybe the capacity there was about US$50 million. Is that about right?

That's a good, round number.

At what kind of margin differential would that have operated to your U.S. facilities? Would it be 4 or 500 basis points below?

Well, that's a difficult question to quantify because it would depend at times on the currency and the difference with currency exchange and what we were charging and what the dealers were paying, and so that number floated a little bit. But, it was an old facility; it was on multiple floors; it wasn't as efficient as our other facilities. It made, essentially, the same product that we make here in the States, so it's an easy transition for us to move that production.

What I'm trying to get too is the payback of the charge. How long will it take to pay that back as you did the math or sharpened your pencil and made the decision to exit the facility?

I would say the payback will probably be about 18 months.

So, 18 months -- a year and a half payback?

Yes.

If I could just get one more question in, on a foam issue and the dislocation that caused, are you seeing now pricing starts to crack bit as well, now that supply has gotten more stable? Did you -- in the quarter, as you look at the quarter results, you couldn't get all the pricing you wanted to be cost-neutral, so you had an impact. Can you quantify that? What does it look like for the next couple of quarters?

Okay, to answer one of your five questions, Budd, I will start with we have not seen any back-up in pricing as of yet. Our information is that if any of that is coming, it probably won't be until after the first of the year. It is amazing that, as the prices went up and up, the quicker they went up, the more the supply became available, but that's for another conversation.

We have quite a bit of supply coming in right now to catch up. The only thing that is in the quarter, in the third quarter, that isn't being carried by some type of surcharge or price is the business that we had to transfer out of our October backlog into November and early December because of our allocation and because of our short production in that month. The balance of our business, all of the sold quarters that have come in since the middle of October, all carry a surcharge. So we think we're going to be hurt a little bit in November by the mix of product that has the surcharge on it and the product that doesn't. That will improve in December, and then we actually have more surcharge that went in the first of November that will manifest itself into January. So I think, for the quarter, we think we will be okay but it's a building process as we go through the next 90 days.

In this quarter, did you quantify the impact of that delta in pricing on this quarter, not only the inefficiencies it caused but how much -- what kind of basis points did it cost you in margin for the quarter just reported?

The quarter just reported? We didn't have -- the quarter just reported was more one of volume, not price on poly. In most of our companies, we didn't start paying the higher price until very late, late in the quarter and it is not a very big number. It's more volume-driven for the quarter than it is the price of poly -- for the second quarter.

Understood. Thank you very much.

(OPERATOR INSTRUCTIONS). Margaret Whelan with UBS.

It's actually Susan for Margaret. Can we focus a little bit on your sales guidance? It looks like, if we subtract that $24 million or so of backlog that you have in there, you're looking for a sequential increase of about 6% in your sales from Q2 to Q3. Can you just walk us through maybe what you've seen in November, in terms of demand, and then how you're thinking about December and January?

Well, Susan, that's a very tough question to answer because the demand curve is up and down in any given week, and some weeks, we can't tell why it's up and some weeks, we can't tell why it's down. One of the reasons we are a little more confident on our volume for this quarter is we do have some additional backlog in a couple of our businesses, particularly the upholstery business and the hospitality business, compared to where we were a year ago. So, we think that's going to be beneficial. But to make any comments on what we think the consumer is going to be doing in December and January -- very tough for us to do that. We see a choppy environment out there; we see a cautious consumer. So without the additional backlog that's carrying over from the second quarter, we probably wouldn't have been quite as bullish about our sales for the quarter because it's still a very tough environment out there.

Okay. That $24 million that you've got in the backlog, especially on the upholstery side, how long do you expect that it will take you to run through that? Is that what you are referring to when you say February?

Yes. That depends on obviously demand as we go through this period, and we always take care of customer-sold orders first and give that the highest priority. We, by working over time and working some holidays, we can flex our production 10 to 15% higher than a normal week. But in those first couple of weeks of October, we were losing production at a rate of 50% a week, so it's going to take us the balance of this quarter and maybe early into February, maybe the first two weeks, to be at a level that gets us back to a three or four-week service level on our backlog and back to where we were in September timeframe.

Now, if demand would fall off precipitously, then we would be quicker than that to be at a normal service level, but I don't think that will happen and we are planning to be back to normal scheduling as we head into February.

Okay, thank you.

Brian Nelson (ph) with Legg Mason.

Good morning, sitting in for John Baugh. I just wanted to have you talk about casegoods a little bit. Revenues were down 9% in the quarter. You talk about relatively good performance in the AOM division. This implies pretty bad performance everywhere else. Is this all Pennsylvania House-driven, or is this kind of across-the-board weakness in all your other casegood divisions?

Good question, and I think you read the tea leaves pretty accurately. While we had good performance at the hospitality business, it wasn't great and it wasn't as good as we see for the upcoming quarter, but the progress that has been made in all of our casegoods businesses, with the exception of the Pennsylvania House, has been very positive and they are all the trending to meet the expectations we have for them.

Pennsylvania House is the problem right now. It's under a lot of pressure, and it is negating a lot of the gains we're getting in other places of our casegoods business. So, this is not a segment-issue problem for us; it's a specific company problem. As I said in my prepared remarks, we felt that we were going to have all the new product from China in the States being sold in time for the Christmas season and in good shape by September. That process has taken us about 60 to 75 days longer and we won't get the benefit of those changes until the third quarter. But the problem -- not that -- we are pleased with everything going on in our entire casegoods business but the progress is being made as we expected in the other companies with the exception of Pennsylvania House being the one that's not performing up to expectations whatsoever.

Laura Champine with Morgan Keegan.

How did your October High Point market price increases compare to that competitors passed through at the same time?

You know, I don't know exactly what our competitors have done. They don't share that with me, and certainly, we get anecdotal information from customers and all but we overall, with various of our companies, took different strategies. Some of them were outright price increases; some of them were surcharges. In some companies, we've had numerous surcharges. But, I would think that, in general, most upholstery companies are in the range of 4, 5, 6% up in price depending on their mix of sofas and recliners. I'm told that the bedding companies are in the double digits, and some of them are in the midteens on their pricing. So, the fact of the matter is, to the best of our knowledge, none of the manufacturers have enough margin to absorb this kind of significant change in the cost structure, and the whole tide has been risen by the price increases across the board. We're going to have to assess how the consumer reacts to that when they start being realized at retail.

Did the La-Z-Boy-branded business pass through that 4 to 6% that you mentioned for the upholstery industry at the High Point market?

Well, between a series of surcharges and price increases that will go into effect after the first of the year, that's pretty much the range we ended up at; yes, it is.

Okay, so if that hits after the first of the year, and the poly prices have just started to hit you in November, will you cover your -- how we will those price increases help you cover your increased costs, not just for that but for fuel and some other components, in the January quarter?

Well, there's two components to our pricing (indiscernible). One, we were going to take a price increase in October prior to the poly issue for the things you mentioned, for fabric surcharges, for freight increases, for things of that nature. That was already planned. We took, additionally, a surcharge beginning October 1 for poly, and that went into effect immediately. So, we don't think there will be a huge drag on our earnings during the third quarter, based on the actions we've taken to remain cost-neutral on poly.

Ladies and gentlemen, there are no further questions at this time. If you would like to access a replay of this conference, please dial 877-660-6853. Use account number 286 and conference ID number 177140. A replay will be available from November 23, 2005.

This concludes today's conference. Thank you for your participation.