La-Z-Boy Inc (LZB) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the La-Z-Boy, Incorporated, third 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, Treasurer of La-Z-Boy, Incorporated. 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 third quarter results. Present on the call today are Kurt Darrow, La-Z-Boy's President and CEO; David Risley, 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 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 will 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.

And 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, ladies and gentlemen, and thank you for joining us today.

My remarks this morning will address our results for the fiscal third quarter, our ongoing business strategy, and what we see for our fourth quarter. After what some termed a "perfect storm" last fall, with the hurricanes impacting our operations, the poly allocation and the subsequent significant increase in pricing, as well as the dampened demand resulting in a dip in consumer confidence following the hurricanes, we are pleased with the improvement in our operating performance this quarter, as it indicates that the execution of our strategy in each of our two largest businesses, upholstery and case goods, is progressing smoothly. Overall, we feel encouraged about the direction of our business and are confident we are well-positioned for the future with our retail strategy playing an important role long-term. We have done a significant amount of work to modify and improve our cost structure and business model, particularly on the case goods side.

In upholstery, we are making changes to our model, as we move to a greater percentage of cut-and-sew fabric kits and implement lean manufacturing techniques throughout all of our facilities. Providing business conditions remain somewhat normalized, we would expect to operate within our stated margin objectives in both our upholstery and case good businesses. Our retail segment still requires significant work, and we have a solid plan to make steady progress there. I will speak about that in more detail in just a bit.

Before getting into the specifics of the quarter, I would like to spend a moment to put the period into context. In mid-November, poly supply returned to 100%, although at a significantly higher cost. And the retail environment remained choppy. Sales were slow throughout most of December and then picked up immediately following the Christmas holiday. We continue to analyze business trends and macroeconomic statistics, and while furniture sales no longer correlate directly with new home sales and housing starts, they do appear to respond to changes in consumer confidence, which has rebounded nicely, even while the fed has continued to raise interest rates. And finally, the debate continues both within the industry and on Wall Street about pent-up furniture demand. Although no one seems to be able to define the timing of, quote, unquote, pent-up demand, we believe there are a lot of houses out there with unfurnished rooms. And there are also a number of second or vacation homes with empty rooms as well. While we do not know exactly when they will be furnished, as new and existing home sales slow, we are optimistic that people will begin redecorating their existing homes rather than considering a move.

Now, moving on to our results for the quarter, La-Z-Boy reported net sales of 502 million, down about 5 million or less than 1% compared with the prior-year period. We had earnings per share of $0.20, which includes an after-tax restructuring charge of $0.01 per share. For the nine-month period, net sales were 1.4 billion, a decrease of 74 million, or 5% compared with last year's comparable period. We've posted earnings per share of $0.14 per share to date, including restructuring charges of $0.11. We are pleased that even on slightly lower sales in both our upholstery and our case goods operations, we improved our margins significantly, both sequentially and year-over-year, which offers demonstrative validation that our business model and strategy are sound.

Now, turning to our upholstery operation, which is the lion's share of our business, sales were down 1.4% compared with last year, and our operating margin increased to 7.2% from 6.2% in the prior year period, and 3.9% in this year's second quarter. Our branded business, La-Z-Boy Residential, when combined with our store program, offers us the greatest growth opportunity of any of our companies. That division continued to post sales increases, although they were offset during the quarter by the performance at some of our smaller upholstery companies, as they continue to recover from the spate of retail bankruptcies and closures. Now, a note about poly. Prices remain over 50% above the level it was prior to the hurricanes, and there's no indication that it's coming down at any point soon, so we are converting our surcharges into a straight price increase this month. Going forward, we believe there are additional margin opportunities, as we realize the full benefit of both the capacity rationalization and the poly surcharge throughout an entire quarter. We closed our Waterloo facility in mid-December; and because the surcharge on poly was phased into production, it meant the lion's share of our output during the period did not carry the full surcharge. We also had some downtime at our production facilities during the quarter due to time off for holidays.

As we move ahead, we will continue to pare down non-essential costs and look for greater efficiencies in our upholstery production. As an example, in our branded business, we continue to integrate more cut-and-sew kits. In the first half of our fiscal year, cut-and-sew represented about 19% of our production; and we expect that rate to be approximately 30% in the back half of the year. Additionally, our plant productivity has increased, and in the third quarter, our number of units produced per man hour worked increased substantially. I would like to take this opportunity to express our sincere gratitude to our manufacturing employees who worked a significant amount of overtime this quarter to service our customers. Current order flow has our productions facilities working to our current staffing capacity, and it's important to note that we work two shifts at our branded manufacturing facilities. As I mentioned on last quarter's call, although we are currently receiving enough poly to satisfy our production needs, we can only flex our production capabilities by approximately 10% per week, so it will take until early spring to work off all the backlog we've built while on poly allocation in October and November.

I think it's important to take some time to talk about China's ability to become a player in the U.S. upholstery business because many of you have asked me about it repeatedly. Right now, as things stand today, China can be competitive in upholstery, but not compelling, and that is an important distinction. Let me explain what I mean. Yes, they can be competitive and they are -- and there are, indeed, some large retailers buying direct. However, most midsize retailers need a partner and/or manufacturer, and China's pricing is just not compelling in the way they were with case goods when they were 20 to 30% below the U.S. manufacturers and completely changed the dynamics of the industry. I'd like to point out three differences with respect to the upholstery business compared to the case good business from China, as these distinctions -- as the distinction between these two dictates why the Chinese are not impacting our upholstery today at our price points. First, customization. The female consumer wants a choice when she purchases upholstery, and the Chinese are primarily geared to mass manufacturing. Second, speed to market. Our customers who special order upholstery, which today accounts for some 40% of our business, want their orders quickly and we can deliver them for in four weeks or less. The Asian manufacturers cannot do that. And finally, number three, the cost-value relationship with respect to freight. Today's huge freight differential negates much of their labor advantage, and that's why their pricing today is not compelling. This is the situation as we see it today, but we know the marketplace is dynamic, so we are not putting our heads in the sand. We have some 80 people on the ground in China watching what's going on every single day, and should the playing field change, we will be there, too. We will not be late to the game in upholstery as we were with case goods, but we just don't see that happening today. Going forward, our basic fundamentals and position in the marketplace have not changed, so there's no reason, barring any unforeseen events, that we cannot perform in the 8 to 10% operating margin range for the upholstery segment.

On a case goods side of the business, we saw a substantial improvement in operating margins. For the quarter, our margin reached 6%, up sequentially from last quarter's margin of 2% and up from 1.9 in last year's comparable quarter. We have finally completed the transition of this business to primarily an import model, and our operating margin this quarter is the highest it has been in three and a half years. We worked through the issues at Pennsylvania House, and while we did not get all the upside from this in the third quarter, we expect that division to be a contributor going forward. At the same time, our American of Martinsville operation is enjoying the rebound in the hospitality sector, which we expect will continue in the near term. We still see opportunity to improve our cost structure in this segment, and we'll work to increase the value proposition and service to our customers to gain additional volume. Once we have proven we can sustain the current operating margin of 4 to 6%, we would expect to move beyond that level longer term.

Now I'd like to spend some time talking about our retail strategy, as that is where we have the most work to do. But first, let me review the segment's results for the period. We posted a loss on sales of 57 million. The loss related primarily to the stores in the markets we acquired late last year. Acquiring those markets was the right move, as they are in important markets, which for Company-owned stores is defined as the top 25 largest markets in North America. We were very underpenetrated in these markets and our previous dealers did not have the capital to build them out, and we as a Company need to have proper penetration in these vibrant and growing markets. Turning around these stores and markets is going take some time because we want to ensure we do it correctly. To reiterate the stores we acquired are in excellent markets. Markets with great demographics and buying power that support a sizable store system. However, the current stores need new systems, personnel changes, as well as the consolidation of many warehouses and store relocations. Most importantly, these markets need to be built out, as many of them have half the number number of stores they need to gain the proper share of voice and realize the efficiencies of distribution, administration and advertising. Experience in other market tells us without question that once critical mass is achieved, these markets ought to generate operating margins within our 3 to 5% range.

In addition to opening new Company-owned stores, we need to refurbish and/or relocate a number of these stores. Our new generation stores, which are in a different format and are typically larger, consistently generate greater sales per square foot. We have a lot of work to do, and because we will only consider A-1 real estate locations, it will take some time. Of our 64 Company-owned stores, only 26 are in the new generation format; and we plan to double that number by this time next year. The remaining stores will then be relocated, depending upon when leases expire and when alternative locations become available. We expect our Company-owned retail performance to begin to show improvement as we move into next year and to be profitable in fiscal 2008. Although we are currently operating our retail business at a loss, it is important to look at its synergistic value to our wholesale business, as we are making solid margins on the wholesale side and once our retail segment improves, it will significantly change the earnings power of the Company. Overall, our total store system is healthy and growing; and we are moving toward our objective of 400 stores by 2007 calendar year-end. In the third quarter, we opened 11 new stores, remodeled and/or relocated 8 stores, and closed 4, bringing our system-wide store count to 336.

When we think about the future of La-Z-Boy, retail plays an important role. And as an extension of our brand, it is the key component of our overall strategy. And we continue to be mindful that much of American manufacturing, be it automobiles, appliances or furniture, is slowly moving offshore. While we do not necessarily see that in upholstery today, should the landscape change down the road, we still have a significant and solid business. Additionally, operating within the retail segment gets us closer to our customers so that we can better understand them. That will, in turn, help us further strengthen the entire La-Z-Boy store system. In summary, we believe the bulk of the macro changes in the furniture industry are behind us, and now it's a matter of execution. We are going to compete effectively in this environment and believe the strength of our brand, our store program, and our business model positions us well for the future.

Before turning to our guidance for the fourth quarter, let me spend a brief moment on the balance sheet. For the quarter, cash flow from operations was 33 million, as we continued to focus on leaner supply chain management, thereby achieving a $21 million reduction in inventories during the quarter. Our total debt to cap ratio decreased to 29.2%. Our objective is to get the number to the mid-20s and we will use a blended strategy going forward, based on our cash flow of paying down debt and buying back shares. We did not repurchase shares this quarter, and we have 5 million shares remaining in our repurchase authorization. Now, looking ahead to our fourth quarter of fiscal 2006, which will have 13 weeks against last year's 14 weeks. We are pleased we rebounded from the second quarter and are confident our business model will bring us into the fourth quarter on solid footing. Although we are mindful that consumer confidence and the macroeconomic environment remain somewhat volatile. On a comparable 13-week quarter versus last year, we forecasted our sales to be flat. We reported earnings for the fiscal 2000 [sic] fourth quarter to be in the range of $0.26 to $0.32 per share.

We appreciate you being with us on our call this morning, and I'll turn things back to Mark for our question-and-answer period.

Great, thanks, Kurt. Diego, if you would again review the instructions for asking questions and getting into the queue that, would be helpful. Thank you.

[OPERATOR INSTRUCTIONS]. Todd Schwartzman, Sidoti & Co.

Good morning. Roughly how much of Pennsylvania House's production is now overseas?

Todd, as we went through the -- finished out the third quarter, as we headed into the new year, 100% of Pennsylvania House's product is coming from Asia.

That's what the press release seemed to imply. I just wanted to get clear on that.

Now, Todd, that's on the case goods side. We still make Pennsylvania's upholstery program here in the states, which is a lower part of their volume than the case goods, but all of the case goods are coming from Asia today.

Right, and on the case goods side -- so, that was by December that was the case, 100% sourced?

Well, to put it in context, actually we haven't manufactured anything here in the states since last spring, but it's taken us time to transition out of the inventory, get a new suppliers, do all the things, but, yes, 100% is -- when we were fully in stock on all of our groups in November and December and that transition is complete.

Can you talk a little bit about the quality production issues, any improvement that you're seeing over that timeframe at Pennsylvania House?

Well, I think in a general comment, we see continued improvement in the quality and the execution of product coming from China. We don't have any particular issues at Pennsylvania House or any of our other companies, and we don't see quality being a -- an issue for us going forward. We do have our own QC people in China, in our -- in the main factories we use every day assisting with things, but quality is not a huge concern for us at this point.

And as far as AOM, I know you don't give out any numbers, but could you talk a little bit about the relative performance -- the level of improvement that you saw in Q3 vis-a-vis the recent quarters, and just kind of give a -- give us a sense as to how far back AOM has made it from its pre2001-2002 levels?

Well, Todd, you were right on a couple of things. Number one, you've already gone over the one question rule. Number two, we don't give out specific information, but AOM has rebounded in sync with what's happened in the hospitality business. And if the hospitality -- if the hospitality business and that sector is going to be up, say, 20% this year, AOM would follow that curve. So if you want to look at the dynamics of that segment, you can pretty much parallel what AOM's performance improvement has been, but, again, we don't want to give specifics on that.

Okay. Terrific. Thanks.

Thank you, Todd.

Budd Bugatch, Raymond James.

Good morning, gentlemen. This is Chris Thornsberry on behalf of Budd. Quick question for you on the transition of stores to the new generation format. Specifically, the Company-owned stores. You said you had 26 in that format now. You want to double that by this time next year. I'd like to get a feel, if you could go over what kind of costs do you incur when you transition a store to the new generation format, both indirect and direct, because I imagine there's going to be some capital use spend on remodeling the store, but then there's also some indirect costs of maybe loss of productivity in that particular store.

Well, Chris, from a capital standpoint, because we're primarily dealing with leases, it's not a -- it's not overly capital intensive and the timing of the moves are as leases are running out and we're getting things opened. You have some signage expense and some inventory expense as you have a new store, but, again, it is not significant. It's less than -- even with the inventory, it's less than $0.5 million a store, and we don't -- we don't see that having a significant impact on what we're doing with our CapEx or our planning for next year.

Okay. And in terms of the indirect costs, do you lose much in terms of store productivity in the transition period?

No. Unfortunately, in the transition, the best two times to be in the furniture business is when you open a store and when you close a store, so we try to time that so the transition works, and we -- we don't really lose that much momentum as we make the transition.

Ivy Zelman, Credit Suisse.

Good morning, guys. Good quarter. Few questions. But if I'm not allowed, just cut me off. But one relates to your comments about the Chinese in upholstery -- your three reasons why you don't see it as a major head wind. The first, I guess, is just to understand the cost advantages of being overseas. If you look at the cut-and-sew, what percent of cost of goods sold is fabric, and how much do you really save by doing cut-and-sew, I guess is first part of that one question.

Well, Ivy, on the cut-and-sew, without getting into specifics because of the different prices of fabric and all, but we can get cut-and-sew fabrics here today from China delivered to our factory door for less money than we can buy the roll goods in this country. So there is a significant amount of savings, but it is a limiting, from a merchandising standpoint, it's limited in the flexibility and the color pallets and things of that nature, but the fact that they've shared part of that savings with us already in the cut-and-sew process helps us be even more competitive with the prices they can offer in China.

Okay. But if you just took fabric as a percent of costs of goods sold, what would that be roughly?

Oh, 25, 27%.

Okay. And as you are doing the cut-and-sew, roughly the savings you think that you would realize from it doing -- or what percent is cut-and-sew? Better question.

I'm not sure I understand your question, Ivy.

What percent of your business in upholstery are you doing with cut-and-sew today?

In leather and fabric --

No. Forget leather for first -- if you could, please.

Well, we're probably doing in the range of 20% of our units.

Okay.

Joel Havard, BB&T Capital Markets.

Thank you. Good morning, guys.

Good morning, Joel.

I wanted to stay with our one theme of questions here, and I'll ask a few small parts within retail. Kurt, you reviewed the -- the Q3 store breakout as far as new builds, remodels. Could you start to think about the pace of '07? You said doubling the new gens. That's the Company-owned new generations?

Yes.

Okay. And is that by year-end fiscal '07 or over the next 12 months? It's nearly the same, but.

Right. There are two components, as you know, Joel, to our store program. One is our independent dealers, which is the bulk of our business and then there's the portion that we are owning. We are going to -- as I think we detailed in our press release, we're going to open 49 new format stores this year with about half of those being new stores and about half of that being either remodels or relocations. We would expect to be on a similar pace in fiscal '07. So the 49, 50 stores, when you combined remodeling and relocations with the new stores, we would expect to duplicate that number again next year.

Okay. And at Q3, in -- what was the total number of new generation stores, including the independents?

147, I think.

I think that number is 147 out of the 336. Just a minute. We're looking that up.

146. Sorry.

Yes, 146 of the 337. 336, excuse me.

Margaret Whelan, UBS.

Good morning, guys.

Good morning.

Nice quarter.

Thank you.

And just kind of going back to your -- both, Kurt, about -- the upholstery with Asia. I mean, if you think back a couple of years ago, all of -- yourself and your peers in the U.S. were arguing that case goods would never really saturate the U.S. market, and clearly we were wrong there. When I was in China last week meeting with upholsterers, it seemed like a lot of them wanted to partner with some of the branded names in the U.S. I'm wondering, would you consider that, partnering with one or two of them, they buy you, you buy them, or kind of committing their manufacturing space to your franchise?

Well, Margaret on a -- on an overall basis, I would say that we will -- we would consider anything that we have to consider to remain competitive. We have to provide a product assortment that has our stores being able to compete effectively in the marketplace. And if we can't provide that from here, or if we have to combine that with a combination of anything else, we will do that. So we're not ruling out anything, and we're not saying that the dynamics in China won't change a year from now. We're trying to state what we believe to be the condition today, and we got our eyes wide open to what the future could or couldn't be.

All right, and the second question I have is then, at what point do you see the retail group getting -- turning profitable, sustainably?

Well, we stated in our remarks that we think we're going to make substantial progress during the 2007 fiscal year, and we think it'll be profitable as we enter into 2008.

John Baugh, Stifel Nicolaus.

Good morning. I guess just going back to the cut-and-sew numbers, I think you indicated -- and I assume this was a comment to fabric only, that you'd be doing 30% in the second half. Any sense of -- is that the limit -- you said 40% of your business is customization. Obviously, that can't go cut-and-sew. Where do you think the limit is, and how much savings additionally -- obviously, you're going to make a jump from 18 to 30. I'm wondering, can you go beyond that or will you go beyond that and are there further savings beyond that?

John, I will try to answer all 12 of your questions with one answer here. I think the issue for us is -- and just so you have the numbers, we're going to be above 30% combined with both leather and fabric cut-and-sew at our current run rate. So that's the number we're dealing with. But I think this is a moving target, and I think the biggest factor in what is going to be available to us long-term is what happens to the U.S. fabric manufacturers here, what's available here, how much roll goods can be merchandised into our line here to remain competitive. And ours is not necessarily just a cost savings. We have to be able to offer a merchandise program and a diversity of look and color and texture to the lady when she walks in the stores so that she's motivated and excited to buy. And typically to date, unfortunately, the majority of cut-and-sew in both leather and fabric is what shade of brown do you want to have and a whole store of brown fabrics doesn't excite very many women. So there's two factors at work here. There's the cost side, which we're very conscious of. But there's also what's a properly merchandised store look like, and how do we offer some degree of selection and customization so that our edge of difference in the marketplace can be sustained.

Laura Champine, Morgan Keegan.

Good morning. There seems to be a little bit of a disconnect with your upholstery plants running overtime and not even able to fill backlog, but sales are down year-over-year, which makes me wonder if you've -- I know you've shut down some upholstery plants in the last few quarters. Are you in a situation with your fixed cost structure reduced to the point that even if sales are down, you've got to run your plants at overtime?

Good question. I think what everybody needs understand is there's a limit to how much capacity you have that's constrained by staffing, not by the size of your plants, and during the quarter, we increased our production even with one less plant here in the U.S. So we are at maximum capacity for us, giving the staffing that we have. We if were 100% confident that business was going to take off and run at high levels this year, we certainly have the ability to staff up, but it takes a while to train people. It takes a while to get proficient, and right now, if we would do that, we would have them proficient at a time when seasonally the business normally goes down a little bit. So we did not work off a whole lot of the backlog in the third quarter that was built up because of the reasons we've mentioned before, but most upholstery manufacturers with overtime can flex their production 10, 15%. That's as much -- that's as much as you can do. You can't -- just because you have the business, you can't overnight increase your production 50% because the making of upholstery still takes skilled workers and that's the constraint, not the order book.

Okay. I'm confused because you mentioned just now that production was up, but sales were down 1%, and you've indicated -- maybe in the Q that you took maybe 2% in pricing so that would indicate that your production in units was actually down 3%. Am I missing something there?

Well, I think you have to separate our upholstery business; and we've said, Laura, that our production and our branded business was up and our business in our non-branded was down. Many of our smaller upholstery companies did significant business with Rhodes and Breuners and people of that nature, and they have not recovered from the loss of that. So we have a tale of two different business models here for the quarter, and that's causing the discrepancy.

[OPERATOR INSTRUCTIONS]. Budd Bugatch, Raymond James.

Hi, Chris Thornsberry again. Just a quick follow-up. On the other income line, had you $1.4 million of income. What was in that this quarter?

That's a lot of miscellaneous items in addition to -- I don't think there's anything --

It was a number of different things. There wasn't any one thing significant. We had a gain on -- sale of an investment and some other things, but no one item that significantly stands out, Chris.

Okay. I was just curious, because that was a little higher than you guys have shown in the past couple of years, so I wondering if there was one thing, but it's just a miscellany of different things?

That's correct.

Okay. Thank you.

Thank you.

Ivy Zelman, Credit Suisse.

Can you guys tell us within case goods, with the margin improvement that you enjoyed, how much of that was related to the -- the hospitality business? And if you can break out, sort of understanding with all that backlog, you had -- I think you said it was 40 million worth of backlog in hospitality, which we know is higher margin -- if you truly saw margin improvement ex the hospitality segment?

Well, just to clarify, Ivy, I don't think we said we had 40 million in backlog in hospitality. We do have a longer backlog in that business than our other businesses and we have about a three-, three-and-a-half month backlog at times, but the 40 million is not -- I don't think is a number that we've ever mentioned. But the improvement in case goods was across all of our business, and was not driven solely by American of Martinsville. We had some other companies who had just as significant amount improvement as we did AOM, and the balance of all of our companies showed -- participated this quarter in the improving margin that we have in the segment.

Joel Havard, BB&T Capital Markets.

Thanks, again. Guys, what was the same-store sales, and please give us, again, your definition of it as far as which stores and what time?

Well, the same-store sales that we referred to, Joel, when we talk about same-store sales publicly in our press release, it includes all 336 stores, less the new ones, and if they don't have a 12-month comparative year-over-year, we take them out. But when we talk about same-store sales, we talk about both the independents and what the Company owns, and the same-store sales in the fourth calendar quarter, which is a quarter lag from our fiscal quarter, but in the fourth calendar quarter, they were down 3.5% on same-store and down 0.5% with all stores.

Thank you. Ladies and gentlemen, there are no further questions at this time. To access a digital replay of this conference, please dial 877-660-6853. For international dialers, you can dial 201-612-7415. Use account number 286, and conference ID number 192544. This concludes today's conference. Thank you, all, for your participation. All parties may disconnect now.