La-Z-Boy Inc (LZB) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the La-Z-Boy fiscal 2011 first quarter conference call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce Ms. Kathy Liebmann, Director of Investor Relations for La-Z-Boy Incorporated. Ms. Liebmann you may now begin.

Thank you, Everett. Good morning and thank you for joining us to discuss our fiscal 2011 first quarter results. Present on the call are Kurt Darrow, La-Z-Boy's President and Chief Executive Officer, and Mike Riccio, our Chief Financial Officer. Kurt will begin today's call and then Mike will speak about the financials before turning the call back to Kurt for his concluding remarks. We will then open the call to questions. As is our custom the time allotted for this call is one hour.

A telephone replay of the call will be available for one week beginning this afternoon. These regular quarterly investor conference calls are one of La-Z-Boy's primary vehicles 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 remarks. 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 Kurt Darrow, La-Z-Boy's President and Chief Executive Officer. Kurt.

Thank you, Kathy. Good morning everyone and thank you for joining us on our call. Yesterday afternoon we reported our first quarter results for fiscal 2011. For the quarter we broke even on essentially flat sales. As we outlined in our press release we faced unusually challenging conditions during this period. In addition to the normal seasonality factors that typically pressure sales and earnings in our first quarter which ended in July, we encountered a series of additional headwinds which included higher raw material costs, supply chains disruptions, a hurricane which affected shipping from our Mexican-based cut and sew operations to our US plants and inefficiencies in Mexico as we finalize the transition of all custom cut and sew products for our US operations.

As a result of the various supply-chain delays our plants did not operate as planned during July and we were unable to produce approximately $10 million of orders during the month requiring us to move that production to August. We've spoken a lot over the past year about the many changes we have made to our operating structure to be more efficient. Our upholstery segments results have clearly demonstrated the success of these efforts over the previous five quarters. At the same time we have also improved the structure and performance of our case goods and retail segments which together improved their operating performance last quarter by more than $2 million.

Importantly the challenges we face this quarter are not systemic to our operating structure and with most of the issues that reduced production levels behind us we do not believe the quarter to be indicative of what our performance will likely be for the remainder of the year. We will continue to manage the business aggressively, capitalizing on both the La-Z-Boy brand and our vast network of branded distribution outlets and will work to drive sales across all business segments to grow our enterprise profitably and return value to our shareholders. I will briefly review our operating segments before I turn the call over to Mike.

First, our upholstery segment. For the quarter, upholstery sales increase 2.7% to $202 million. Our operating margin of 5% was impacted by the factors I mentioned a moment ago but it's worth discussing them a bit in more detail. First, raw materials. While raw material pricing has eased from its peak in the May through July period, raw materials were at their highest range of the past 12 months yielding an unfavorable quarter over quarter comparison.

Second, our Mexican operation is not yet generating the manufacturing efficiences we expected as we finalize the transition of all custom order cut and sew kits from our US operations. The learning curve is intense in Mexico and our team is coming up to speed on the numerous frame styles and fabrics they are required to produce. Third, flooding in Mexico caused by hurricane Alex washed out roads and delayed shipments of cut and sew kits to our US plants.

Fourth, we've experienced cover delays from Asia due to production and quality issues as well as late and higher cost containers. The delay from both Asia and Mexico impeded our production levels during the period in what is an already challenging quarter from a seasonality and volume perspective. However, as I mentioned although raw material costs remain higher than last year, pricing has abated somewhat from peak levels. Our Mexican operations improving it's efficiencies and we anticipate a progressive rate of savings as we move through the year. Additionally we have made a number of moves to minimize other supply chain disruptions so that we are able to operate at more normal production levels with inherent efficiencies built into our operating structure.

And finally, as of August 1, we took a strategic targeted price increase across the La-Z-Boy branded business to counteract the higher cost of raw materials and containers coming from Asia. For the first quarter our same store written sales for the La-Z-Boy Furniture Gallery system decreased 3.9%. We believe this is reflective of continued macro economic headwinds most notably ongoing high unemployment and low consumer confidence. Although the environment remains challenging and uncertain we are committed to the continued marketing of our brand to drive traffic to the La-Z-Boy Furniture Gallery system as well as to our broad base of other dealers.

Now let me turn to our case goods segments. For the quarter sales increased 2.7% to $37 million in our operating margin was 4.3% an improvement from the year ago level of negative 0.3%. Our improved performance in the segment reflects the many changes we have made to our cost structure. This is the first quarter where we realized the full benefit of the consolidation of the manufacturing facilities and warehouses implemented in the back half of last year. While we still have work to do to further improve the efficiencies in our US base case good manufacturing operations we are pleased that the changes we have made to the business model are flowing through to the bottom line.

At the same time our team is maintaining its focus on marketing the core product categories from these operating companies while increasing service levels to our customers. We believe our blended model which includes both imports and a domestic manufacturing presence enabled us to service our customers better and in this environment service in addition to product innovation and value are of utmost importance to our dealer base. Finally, in our retail segment we continue to improve our performance and during the quarter reduced our lost from the prior year period on a 1.8% decline in sales.

Over the past 18 month period, we have completely changed our retail's operating cost structure in the new model along with new selling tools and pricing strategies are driving an improvement in our gross margin. That said, there is still work to be done to make this segment profitable and that is our number one priority. As I mentioned earlier we are confident that the ongoing momentum established with our advertising and marketing platform will improve traffic to our stores and our team is continuing to focus on improving its close ratios and increasing the average ticket per customer.

In the meantime our integrated retail strategy remains of paramount importance as we believe branded distribution, particularly in the largest markets in which our stores operate, is the best way for us to achieve our market penetration targets. Currently we are earning a profit on the product our upholstery segment sells into the retail group. Once the retail segment becomes profitable, the blended margin where we are earning a profit on both sides of the business will greatly enhance the performance of our overall enterprise. And now I'd like to turn the call over to Mike Riccio to discuss the financial highlights. Michael.

Thank you, Kurt. For the first quarter La-Z-Boy reported sales of $263 million which was flat compared with the last year's first quarter. And we were essentially break even for the period, compared with the earnings of $2 million or $0.04 per share in last year's first quarter. Last year's first quarter results did include a $0.01 per share restructuring charge primarily related to costs associated with consolidation of our case goods facilities and the store closures within our retail segment.

During the quarter we did deconsolidate one of our VIEs and now have only two VIE's that we are consolidating. The deconsolidation resulted in a $4 million decrease in our consolidated sales net of eliminations, compared with last year's first quarter. It also impacted our operating results as our remaining VIEs had an operating loss of $1 million in this year's first quarter compared with operating income of a $100,000 dollars in last year's first quarter for the three VIEs. Additionally, we feel that our ongoing effective rate for taxes will be in the mid- to upper 30% range but discrete items and timing differences will continue to affect our tax rate until we are no longer in a cumulative loss position and reverse our significant amount of our federal valuations reserves.

Now let's shift to the balance sheet. We continue to be focused on maintaining a strong balance sheet. The overall macro economic environment has not yet become stable and we want to ensure we have the wherewithal and necessary financial flexibility in the event of another severe downturn. At the end of the first quarter we had $93 million in cash and our total debt stood at $46 million. Leaving us with a net cash position of $47 million. We also decreased our debt to capital ratio to 11.7% from last quarter and had $79 million in availability under our revolving line of credit.

Capital expenditures for the quarter were $2.4 million and we expect CapEx for the year to be in the range of $14 million to $16 million relating principally to IT upgrades, transportation equipment and ongoing maintenance of our facilities. Depreciation and amortization is estimated to be in the $24 million to $26 million range for fiscal 2011. And finally, I'd like to give some further color on the comments I made on last quarter's conference call with respect to what would reasonably be to expect in terms of an incremental margin. Last quarter I noted that we believe for every additional sales dollar generated above fiscal year 2010 levels we will return 20% to 30% to our operating results. With the lower end of the conversion reflecting sales increases being more case goods oriented and the higher end of the range reflecting sales growth stemming from our retail segment.

I also noted that the range reflects our best estimate of the conversion on incremental revenue for the full year and that we are comfortable with the full-year number but that we would anticipate quarterly fluctuations in the rate of conversion. The current economic climate has made it difficult to convert at a constant rate. When we gave you the range of a conversion last quarter it was an attempt to define how incremental sales would convert at an operating profit line assuming all things remain equal in the current business environment. As you would expect all things have not remained equal. So here's a way to think about it when you go about your modeling.

In addition to the cost savings from Mexico we have additional cost savings programs in process throughout the Company. At the same time there are external pressures stemming from raw material price increases versus last year. Our goal is to have the cost savings exceed the raw material pricing pressures. And, the net between the various cost-saving initiatives and the raw material price increases will be incremental to the original range of 20% to 30%. So in other words, improvements we make operationally will be in addition to the 20% to 30% incremental margin range that we gave you last quarter. And as Kurt mentioned earlier in the call there's been an easing of raw material pricing.

During our conference call last quarter we said that if raw materials remained at the escalated levels at that time then we would anticipate approximately $18 million to $20 million in added raw material costs this year. But as raw materials have moderated if they remained at today's levels we would estimate the additional cost for fiscal 2011 versus fiscal 2010 to now be in the range of $16 million to $18 million. I'll now turn the call back to Kurt for some closing remarks.

Thank you, Mike. While we do indeed believe the industry has bounced back from the depths we saw in the fall 2008, the macro economic environment remains very uncertain with volume a wildcard. However the cost structure we established throughout our operations allows us to be profitable and we believe we are well positioned for sustained and improved profitability.

As I mentioned at the outset of the call, the challenge we encountered in the first quarter were not systemic to our operating structure and are largely behind us. We believe our results will improve as we move through fiscal 2011 particularly with cost savings accelerate as we progress throughout the year. Historically, our first quarter has not been an indicative of our potential for the full year. We are pleased with the work we've done to date and will continue to manage the business aggressively.

La-Z-Boy is the strongest brand in the furniture industry. Our network of branded distribution is vast and our operating structure is lean. Going forward our main focus is to increase the top line and to improve the results of all three of our business segments. We thank you for your interest in La-Z-Boy and for being on our call today. And with that I will now turn things back to Kathy.

Thanks, Kurt. We will begin the question and answer period now, Everett, please review the instructions for getting into the queue to ask questions.

Thank you, Ms. Liebmann. (Operator Instructions). Our first question today comes from the line of Budd Bugatch with Raymond James. Please proceed with your question.

Good morning, Kurt. Good morning, Mike. Let me just go right to the raw materials comment you made, Mike, at the end. If I read the queue properly, it looks like you've already experienced somewhere on the order of about $6 million of additional cost increases in the first quarter, if it's 2.9% of the upholstery sales, is that right?

That's reasonable, yes.

So that would leave $10 million to $12 million as yet to experience for the year?

Yes, sir.

Which would be $3 million to $4 million a quarter. How do you expect that to play out over the year? Is it more early on then later?

Budd, we expect it to be pretty much even out throughout the quarter now. The issue is, is comparably to last year it'll narrow its difference between the two years, so you won't see the differential as greatly. So if you're asking about the differential, it will probably be that much higher but since the third quarter started the higher cost, the differential will narrow. So if you're saying, will it be higher in the second quarter compared to last year, yes. Then the third quarter will be a little lower, than the fourth quarter will be lower.

Okay, so it's not evenly dispersed in terms of the differential for last year. It will be declining as the year progresses. So the impact on the operating margin should be lessened as the year progresses.

That is correct.

But Budd, I would caution you. That is our best guesstimate today, we do not have yearly contracts or any pricing firm out past this quarter, but from talking to our major suppliers, from doing the work, from studying what's been going on, that's our best belief right now.

Based on what prices are today.

Understood, and I appreciate the issue of the lack of contractual clarity on that. And where are the prices primarily? The last call I think you told us it was plywood that really was unsettling to you. Where are the major price increases at this point in time?

Budd, I would answer that in this term the three largest, outside of cover, the three largest commodities that we buy for upholstery are foam and wood and steel. And they are all-- the foam is the biggest cost component, but dollar-wise they're all significantly up from their low peak in the first quarter of a year ago, and they've all subsided a little bit, but there's not any one that I would say would stand out right now with differential.

And you talked about, Kurt, the fact that you had taken a price increase effective the first of this month to counterbalance what we all see in terms of shipping and container issues from the Far East. I think in the last call I asked you as well would you take a price increase if you saw these cost increases persist, and you said if you saw them persist you would? So some of the price increase to cover some of these additional costs that you're seeing in raw materials?

That's correct, Budd, and again, we want to be very clear on this. They are comparative year-over-year is subsiding, but we're still looking at the $16 million to $18 million of net increase in these raw materials year-over-year. So, we did not take an across-the-board increase. We did not be overly aggressive, but we did what we thought was a prudent thing to do with our price increase.

And how should we think about the magnitude of that price increase to your product, and what percentage do you think you will ultimately realize of that?

You should think about it being very adequate and very good for us to keep our momentum going. For competitive reasons, Budd, I don't want to clarify exactly what it was and how it's going to play out, and you don't always realize everything you take in a price increase because of the changing and merchandising and all, but I'm really reluctant to give a number on that.

Okay. Let me go to another topic, and not continue to beat that one. You talked-- I think in the MD&A about a 3.8% improvement in retail gross margin, which is notable and hopefully sustainable, and I'd love your commentary on that as well, if you would.

Well, it's a good call-out, Budd, and our team has done a lot of work on their gross margins, on selling up, and again this is an improvement over a year ago, and going up through the year last year we had solid progress each quarter, probably more in the magnitude of a point or a point and a half as the last year went on. But the comparison to last year, and last Summer we were still dealing with more clearance merchandise than we have today. And so it's just a little bit smarter promotions, it's a little bit up-selling, our average ticket was up for the quarter quite substantially, and our retail team is just managing that whole process and being more intuitive in what they're doing when it comes to gross margin.

I think, Budd, you should see it like the raw materials all throughout the year, the differential quarter over quarter will narrow, but the number will stay at where we have it today.

Hopefully, Mike, maybe it will improve, and maybe Kurt could comment on this, and you all have, I think, pretty good clarity into the economics of your independent dealers, how do your gross margins corporately as Company-owned stores compared to what would be your best independent dealers' gross margin realization in your retail operations.

So Budd, I would answer that, that we have made solid improvement I think now with the results we had this quarter were at the level or slightly above the average of our dealer network, so we're in pretty good shape there. But I wouldn't expect to see another jump of that magnitude as we go forward because we have it at a level that we think we can sustain, we're a little bit worried about trying to push it a whole lot higher, and maybe become uncompetitive, but on a comparison to our independent dealer network, we're comfortable where we are.

Well, and then I'm going to take it to the next step then, Kurt, then if you look at that and that's in a range where, as an old retailer, and I think I am an old retailer in both senses of that phrase. That would make your operating expense ratio very eye-popping or very scary from that standpoint. Where are we in reducing those costs?

Our story there, Budd, has been very, very consistent. I think we-- again, if you want to use our network as a comparative, we are at or better than, because of our size and because of some of the efficiencies size gives you, we are at or as good as most of our independent dealers are today with one sizable exception, and that is our occupancy cost. And we have-- we went into a lot of the expensive markets at the peak of the real estate bubble. And our occupancy cost is much higher than a lot of our independent dealers who have been in the same locations for 20 years, who own their own real estate, who bought it at times when the real estate market was different, so that is the hurdle. Operating-wise, the business, we watch those metrics very closely and compare ourselves to best in class, but the occupancy cost and the percentage of sales that are occupancy costs represent is the bogey we have to overcome.

And could you put a number on the differential of that-- or is it a percentage of sales or give us some way to quantify or clarify that, and tell us if there's any light at the end of that tunnel.

There continues to be light. There's renegotiations going on in certain places as leases come up. The lease rates are going down, but obviously embedded in our operating loss is primarily the differential in the occupancy costs because our independent dealers who don't get any profit on the manufacturing side couldn't operate at these kinds of losses continually and stay in business, so you can look at that as the occupancy differential is the prime reason of our negative margin in retail.

We understand that. All right. Thank you, I will cede the floor, and let somebody else--.

Thank you, Budd.

Thank you. Ladies and gentlemen, our next question comes from the line of Matt McCall with BB&T Capital Markets. Please proceed with your question.

Thanks. Good morning, everybody.

Good morning, Matt.

So, just to clarify I think in some of the prepared remarks, you talked about plans to have your cost savings fully offset the raw materials. Did that cost savings comment include the benefit of the price increase you announced?

That did not.

And just to be sure everybody understands what we said. It is our plan to get more cost savings than raw materials. Whether we get it or not depends on how good we are on operations, it depends on what happens with volume, it depends on a lot of factors. But it's clear that we have, over the last three or four years and continuing now, been very relentless on driving cost out, and we're talking about costs outside of just Mexico that we intend to drive to the bottom line in this differential.

And those costs, we don't talk about, but every year if we give a raise or employment costs go up or any of those things, it's not just raw material costs, we have to always improve our efficiencies in order to cover any costs that we have that are increasing throughout the year.

Okay, that's a good segue, Mike, because I think last quarter, and you hit some of this, you had talked about the expected inflation essentially offsetting the expectations or the expected savings in Mexico, and then you talked about the case goods cost savings being offset by temporary costs. Sounds like maybe Mexico and cost savings in general are going to be above the inflation. What about that temporary cost differential versus case goods, is it still in that same offsetting, mid-single millions range?

If I understand your question right, Matt, our cost savings for doing the final conversion of getting out the expensive warehouse, and only going down to one plant. What, we think that we'll get the $4 million to $5 million a year out of that cost savings.

Our concern that we've been talking about there is where container costs are going to be, and how much can we sustain in that. Because it will stay high, probably at least through the November busy season of Christmas shipments and the Fall selling season, so if that subsides, that will help even more. That is the largest cost increase we've had there, other than the normal costs of China trying to right-size their costing over there to figure how to be competitive in their environment.

Okay, and then finally, I think you said this quarter was the first quarter, Kurt, I think you said that this quarter was the first quarter with the full benefit of the cost savings in the case goods arena. Remind us of the pace of the cost savings that you are going to recognize for the rest of the year. Is everything in right now, and we'll just see the volume benefit? What's-- remind me of that trajectory as we progress through --.

Good question, Matt. We made some changes in the second half of last fiscal year. So starting last November is when we started to consolidate the two plants. And obviously there's some start-up costs and some transition costs that happened in the third quarter, but as we combined the facilities and started to get some benefit from that, some of that benefit was in the last half of last year.

The big flip for this quarter, and what you saw happen on the P&L for the case goods segment was, in April we moved from the Statesville warehouse, which was leased, down to North Wilkesboro, a facility we own. And that money dropped off, and that will be a continued pick-up all through the year, but we got some of the $5 million last year we're getting a little more-- a big chunk of it this quarter. We'll probably show another decent chunk of it next quarter, and then the next half, the back half of last year will probably be more consistent.

Okay, and then the same question about Mexico.

So, we've been talking about the savings that we could have in Mexico, it is as we've continually talked about, it's volume related, it's how many sets per day they can produce. Our struggle right now is that they are not producing the number of sets per hour per manpower that we expected them to be at. So as that accelerates and if our volume goes up 15% to 20% as we go through the year, we would expect to garner the savings over the next nine to 12 months that we anticipated when we started.

So, we're behind where we thought we would be in the savings in Mexico after the first quarter. We believe we can catch up, we believe the savings there will start to show significantly in the next few quarters, but we did not accomplish what we had in our plan the first quarter.

Okay, thank you all.

Thank you, Matt.

Thank you. Our next question comes from the line of John Baugh with Stifel Nicolaus. Please proceed with your question.

Thank you. Good morning, Kurt and Mike.

Good morning, John.

If I look at the upholstery segment for the first quarter, and I took the $6 million of cost increase, which I believe, and correct me if I'm wrong, is related to upholstery and not case goods, and added that back because you get no pricing year-over-year in the first quarter. I get closer to an 8% EBIT margin. First of all, is that accurate?

Secondly, that's pretty close to, I think you did 8.3% in the year ago, and yet you had $10 million of production moved to August that you didn't capture. And you mentioned the storm issues and you mentioned that you're not producing in Mexico, so I guess that's a backhanded way of saying it seemed like a pretty good result just adjusting for the upholstery, or am I missing something or not seeing it correctly.

John, I think your math is fairly correct, although the $10 million, from our standpoint, doesn't really come into your equation because you are comparing like volume to like volume without the $10 million. So, a couple of issues there. We have more cost increase than just the raw materials. We have some other inflationary pressures with wages and things of that nature, so that is outside of the $6 million. But all the cost benefits that we garnered last year, compared to what we have in this first quarter, our overall operating platform costs have come down, so that has counteracted that, and that's how we perform at the same rate we would have last year had we not had the disruptions.

Okay.

So, you've got both things going, you have a little more cost than you said in your model, but you have a lot more cost savings that were structural to the business as we went through fiscal 2010 that are now showing up in the first quarter that weren't in first quarter 2010.

Got it. And then help me with container costs going forward. When are you going to largely phase out of bringing covers from China. I understand you will still have container in case goods, but the margins there were pretty good, and I assume included the higher container costs.

So help me understand a little bit where we are in transitioning out of China with cotton, so is there any inventory that is going to come down. I was quite pleased with your inventory number given the fact that sales production moved $10 million, and the next quarter we had inflative raw materials I assume in inventory. And I assume you had some kind of dual stuff coming in from China as well as stuff you're making in Mexico, stuff being cut and sewn. Some color around that transition out of China and inventories would be helpful.

Let me start, John, with our inventory. Our inventory was actually slightly higher than we wanted it to be, but we received a lot of material late in the quarter and couldn't consume it this quarter, and we will consume that in August. And the increase we have in inventory will probably flow through in the quarter.

But on the container issue, let's be clear about a couple of things. One, prices with containers are up anywhere from 20% to 30% on average, some lanes are more expensive, some lanes are less. And that's all going to be driven by how much more capacity the shipping companies put back on line, but I'm not sure they're going to be eager to do that real fast. So the case goods is importing about 75% of its goods, and they all come in containers.

But we have two other components of our strategy with Asia, and with containers that I think needs to be clarified. Number one, we get almost all of the raw fabric, the fabric wools and the leather hides from Asia today. So, even if we were cutting everything in Mexico, we would have a lot a container costs on getting material over here. But that misses the point. When we originally communicated and designed our Mexican strategy, it was for them to do all of our custom order business. So they're doing the decorative colors, the lower volumes, and so they are not doing 100% of our kit needs. So, Mexico will do 40% or 50% of our needs, but we will still buy substantial amount of kits from China on our more commercial goods.

So the amount of containers we have is directly proportionate to the amount of kits we buy, the amount of fabric we buy, the amount of case goods we buy. So we'll have a substantial cost on containers for the foreseeable future.

Okay, that's very helpful. And is there on the custom piece, are we running dual cost structures still current, or have we really transitioned that out, and it's just a matter of getting Mexico more productive?

So we have erred, as I've said numerous times on these calls, we have erred on the side of service to our customers to make sure there's not too many hiccups in this transition. And we thought by now we would be 100% in Mexico. I would say we still have about 10% of the employees that we had in our cut and sew assignments two years ago still in the US, and until we get better efficiencies and more productivity out of Mexico, that's going to remain. Longer term, we would not be doing anything here in the US, but right now we have about 10% of our production in that, still in the US.

Okay. And then last question is, just sort of the tone of business, you mention 3.9% I think decline in written in the July quarter. Does it look like the next six months we're going to be down on the retail side year-over-year on same-store given the macro outlay. I realize it's a forecast, and you don't do forecasts, but just curious, we've gone from a fairly nice positive to a fairly meaningful negative in a short period of time. Thanks.

Was that last statement a question, a statement, or did you want a forecast?

I'm asking you to forecast.

John, our crystal ball is not better than anybody else's. We definitely saw a slowdown begin in May, and again, we report our numbers are through July, most of the other companies that report have been through June. I think July was more challenging. We're not ready to say this is a trend for the next year, but customer traffic was down slightly-- the customer is being a little cautious.

But the furniture business and the degree of the seasonality and all is such that I don't want to call this a trend yet, but definitely if you would have asked me six months ago, did I think this slip in business would have happened, and we would be at the levels we were in the summer of 2009, I would have said no. So this is a little bit below our expectations, but we are--- we want to get through the Summer, we want to get into the Fall selling season, which is typically better. And we're adjusting some things, and being more promotional in some areas to make sure that we stay as aggressive as possible, but I'm not sure I would tell you that it's doom and gloom yet, it's just been choppy.

Okay. My last quick question is, has there been any competitor reaction positively or negatively to your announced price increase in upholstery.

I'm not aware of anything. I would tell you, John, from our intelligence, most of our competitors took some price increases at the April market. And typically that's when we do take our price increases, and we were betting on raw materials not going up as much, we were betting on doing more volume, we were betting on cost savings in Mexico running through. And so we delayed our price increase as long as we could, but I know a number of our competitors and a number of people in the industry took some increases in the market because of the cost pressures that they were facing.

Thank you. Good luck.

Thank you, John.

Thank you. Ladies and gentlemen, our next question comes from the line of Todd Schwartzman with Sidoti and Company. Please proceed with your question.

Hi. Good morning, folks. First question on the level of production in Mexico. Kurt, you had mentioned the number of sets per man hour being produced a little below plan. Can I get you to quantify how much below that is?

Well, I think you can deduce from what I said earlier, Todd, that if we have 10% of the people still here in the US, if we were running where we should be, that wouldn't be the situation, so that's really the range of where we're not-- where we thought we would be today compared to where we are.

So it's purely a function of the number of personnel.

No, no. It's the amount of output per person-- you can continue to add people, but then you're not as efficient, so there's a balance between the number of people and the efficiencies you get per person per hour.

Okay. Because you had I think alluded in your opening remarks to the intensity of the learning curve in Mexico, I was just wondering if that was factoring into the equation?

It is, and we had it in our plan. And I would say that we're in a much better position in August than we were in May when our quarter started about the efficiencies and the amount of production we're getting out of Mexico, so we are making month-to-month sequential progress, but it's still behind our expectations when we started the year.

Okay. Are there any other steps that you're taking to reduce the supply chain disruptions that you haven't already detailed for us that you might want to elaborate on.

There's really no other silver bullet or something of that nature. We're going to probably carry a little bit more inventory so we have a cushion on our bestsellers. We're going to probably work tighter with our suppliers to see if they can do likewise. But it's a difficult business model doing business that far away, and I know for a fact that we're not the only furniture company experiencing supply chain delays, and when we have to get the majority of our fabric and leather from China, it's a constant thing we work on daily.

And is that price increase on the case goods side in the cards? If so, if not what would you need to see to change your thinking?

So if I understand your question, Todd, what we would see with case goods typically is, when you go to do new collections and new product, that's where you get the price increases. It is rare to get a lot of increases on in-line goods, but as you go to develop new collections, that's where the pricing changes, and also then the container cost in case goods that have gone through. So our team is, I think, one of our case good companies did, earlier in the quarter or maybe at market, takes some selective price increases. So we're watching this and trying to be as competitive as possible without giving up all of our margins, so it's a constant view we have of what's going on in the industry.

With the branded product in the upholstery business, that is across-the-board, is it not?

I'm not sure I understand your question.

The price increase for the La-Z-Boy branded products, that encompasses the full product line-up, does it not?

We did not take an X% increase on everything in the line. They're certain items that we felt that we were able to do that, there were certain items that have to be more competitive, and so as I mentioned in my comments, we took a strategic targeted price increase to get us the yield we thought we needed without disrupting our volume.

Right, by across-the-board, I didn't mean a constant percentage, rather an increase of some size affected each and every product in the line-up?

That's not what we did. There are some items that had no price increase at all, and there's some items that had more than average. It's called a merchandised price increase.

Okay, finally, maybe if you could detail the retail demand relative strength or weakness by geographic market or region.

Todd, you've asked that question before on previous calls, we called out the problems with, a year ago, with California and Florida and some other places that were hardest hit. They seem to have suffered the most here in the second wave. Those our still very challenging markets that we have, and consistent with what we've said before, our best performing area of North America is still Canada, and they continue to do quite well for us. But outside of that, we don't see a lot of regional differences within our business. Everybody is struggling with a lot of the same issues. This lack of consumer confidence and unemployment is a nationwide issue, and so calling out California and Nevada and Florida and Michigan for different reasons is probably as far as we see any inconsistencies with the rest of the country.

All right, thank you very much.

Thank you, Todd.

Thank you. (Operator Instructions). Our next question comes from the line of Budd Bugatch with Raymond James. Please proceed with your question.

How about a quick follow up. Also in the MD&A, you talked about an advertising to sales ratio increased for retail of about 100 basis points or 1%. Can you talk about what you did there, and why, and maybe if that's going to persist as well?

You've really done your homework this Q, haven't you, Budd? So, how we plan and I think how most retailers plan, Budd, is that you base your advertising spend on what you think you're going to write. And so we spent for the quarter and for the Memorial Day and Fourth of July, at a level that we didn't quite write. On the other hand, we report our sales on delivered. And with some of the supply chain issues we had, we didn't deliver all we should have in the quarter.

So I think it's hard on just a one quarter basis to take a snapshot. We are not planning on an annual basis to significantly increase our percentage of advertising to sales, but it could fluctuate from quarter on quarter based on our budget toward written, and what we actually get delivered, which is what the P&L compares it to.

I'm aware of all of that, I just wondered whether or not there was any specific increase that was just endemic, but you're just saying this was--.

No. It was a timing issue

Normal flow of the business.

Yes.

Two areas that we haven't addressed, CDSOA, in the queue I think you demurred from giving us any numbers except the past numbers. What's the changes there, any new issues on that over the last three months?

From our standpoint, Budd, we have not heard anything different. We've heard very little. There was something that came out last week about some rates on certain of the Chinese manufacturers that were pretty substantial, but the government has been fairly quiet on what their next move is based on the Supreme Court decision in the Spring, and so we're in a wait/see game in trying to determine what might be coming next.

So no clarification from the CBP as to what their plans are in terms of release of those funds, or have there been any additional challenges going up to any of the courts.

Budd, not to my knowledge. To the best of my knowledge, we haven't heard anything from the government, best of my knowledge there is no challenge of that right now. If nothing would happen, there would be a normal payout at the end of the year, which is a declining balance of cleaning up previous years. That is going to be made here regardless of a decision is made on all of the money that's held back.

But we don't know if that's a hold back yet.

We do not have clarity on that.

Okay, and you were able to deconsolidate the Canadian VIE for the accounting change at the end of the year. You have two left, you I think reduced it from the beginning of that whole escapade of six VIEs, if I remember right What are the prospects for these two VIEs going forward?

Budd, as you are going to see, they lost money during the quarter, and they produce their losses over the years, so we'll have to continue to monitor that. Our hope, hope is not a good strategy, but right now we don't see any other potential VIEs that we'll have to consolidate in the near future, but it depends on the business conditions and what changes there. But we'll monitor the two that we have, and they're making changes like we are to try and right size the ship, and get their costs to where their volumes are, and I just don't see a change in that in the near future of what we're doing now.

And, Budd, just for clarity, we have two VIEs left, one in the Southern California market and one in the Atlanta market. And we think our partners there are very aggressive, are doing a good job given the state of the economy, and where they operate. We meet with them regularly, we monitor what they do compared to what we're doing in our own retail business, and we're just continuing to try to strengthen that situation.

But they can't consistently continue to lose money either, as you said a few minutes ago, so how do we ensure their continued viability?

It's no different than-- a lot of it's no different than, the company's point of view on that is that they have lease commitments, and some of them they can't get out of, and so they have a fixed cost structure that is higher than their volume is indicating. And we have to look at it globally, we also make money on the wholesale side selling into them, and we look at the net contribution from what we earn to what we lose, and we're looking at that but it is a top of mind awareness for us, and something that we deal with every quarter.

Thanks, Kurt. Good luck on the quarter and the balance of this calendar year.

Thank you, Budd

Thank you, ladies and gentlemen, we have no further questions at this time. I'd like to turn the floor back to management for any closing remarks.

Thank you, everyone, for joining us this morning. Should you have any follow-up questions, I am available today, so please give a call. Have a good day.

Ladies and gentlemen, this concludes today's teleconference, and you may disconnect your lines at this time. Thank you for your participation.