La-Z-Boy Inc (LZB) 2015 Q3 法說會逐字稿

Greetings. And welcome to the La-Z-Boy Incorporated third-quarter FY15 earnings call.

(Operator Instructions)

As a reminder this conference is being recorded. It's now my pleasure to introduce your host, Kathy Liebmann, Director of Investor Relations and Corporate Communications for La-Z-Boy. Thank you, Ms. Liebmann, you may begin.

Thank you, Kevin. Good morning and thank you for joining us to discuss our FY15 third-quarter results. With us today are Kurt Darrow, La-Z-Boy's Chairman, 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.

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 judgments 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 Kurt Darrow, La-Z-Boy's Chairman, President and Chief Executive Officer. Kurt?

Thank you, Kathy, and good morning everyone. Yesterday afternoon we reported third-quarter results for FY15. Fundamentally it was a solid quarter and I'm pleased with our ability to continue to balance several strategic initiatives, which include driving increased sales, investing in the business to provide ongoing long-term profitable growth, and returning value to the shareholders.

As we move into the fourth quarter, I am confident about our business and positioning within the marketplace. We have a strong growth strategy that is already delivering results with much more to come. We are making the right long-term strategic investments to strengthen the core of the enterprise while identifying additional opportunities for expansion. All in all La-Z-Boy has a solid future ahead of it. Our team is strong, innovation remains at our core, and we have a strategy to carry us forward and enable us to continue to expand our market share.

For the third quarter we achieved the following; we increased sales 3.3%, increased same-store written sales for the La-Z-Boy Furniture Gallery network by 6.5%, posted a 7.5% consolidated operating margin, achieved 11% operating margin in the upholstery segment, improved the performance of both our retail and casegoods segments, made progress in our 4-4-5 build-out strategy, generated $23 million in cash from operating activities, and paid $0.08 per share dividend and purchased 640,000 shares. We accomplished this all while managing a number of moving parts during the period.

Now let me take a few moments to go through a review of our three operating segments. First upholstery. For the quarter sales in our upholstery segment increased 2.2%. As I referenced a moment ago our written business was strong during the quarter, both for the entire network of La-Z-Boy Furniture Gallery stores in terms of same-store sales and for the wholesale upholstery business, up 6.5% and 10.3% respectively. Obviously there is a disconnect between the 10.3% increase we had in the written wholesale upholstery business versus the 2.2% delivered number for the quarter. I want to take a moment to make sure everyone is level set on this, as it is reflective of the timing differences associated with the two numbers.

As we moved through the quarter our business accelerated, and our written business for the month of January was robust. On average there is a four-to-six-week lag time between the time we receive an order in the wholesale business and when it is actually delivered, particularly if it is a custom order. With an efficient domestic manufacturing platform we have the ability to offer the consumer mass customization, which we believe is a competitive differentiator for us. For orders written early in a given quarter, either stock or custom, they are delivered within the same quarter. However, when orders are written later in the period, as they were in the third quarter, they tend to roll as a delivered sale into the following quarter, particularly if they are custom orders.

So all of January's orders are reflected in our written same-store sales number for the La-Z-Boy Furniture Gallery network, but not in our reported volume for the wholesale upholstery or Company-owned retail segments as those numbers reported represent delivered sales. This means we move into the fourth quarter with a stronger than usual backlog, which will be delivered out during the period. For those of you who have been following us for a while you will recall this phenomenon occurred twice in the last few years, and the underlying strength of the business has proven itself out in the subsequent quarters.

During the period we posted an 11% operating margin for the wholesale upholstery segment, a solid margin considering the moving parts within the segment. As we spoke about last quarter, we are in the midst of implementing a totally new website and e-commerce technology platform. This change is part of a broader plan to create a compelling digital customer experience which will enhance the ease with which consumers are able to get inspired and informed, shop for products, and connect with our stores wherever they connect with us digitally. We have some additional work to do and at this point plan to launch the site in August. Additionally we continue to move through the implementation process of our new ERP system throughout the La-Z-Boy branded facilities, and we will discuss this initiative in more detail in a few minutes.

With respect our marketing program and merchandising strategies, we continue to be pleased with our initiatives. On the marketing side our Live Life Comfortably campaign featuring Brooke Shields as our brand ambassador continues to be effective. This spring we plan to air a new set of commercials that will highlight the broad array of stylish furniture that we offer. The campaign's objective has been to widen our consumer base while increasing our share of the stationary upholstery market where we believe we have a big opportunity, even with the growth we've achieved in this category over the last several years.

On the merchandising side our Urban Attitudes collection is performing well and meeting our targets and expectation for sales. Coupled with our advertising marketing campaign, we believe the collection will continue to grow and perform well in the future. Additionally at the October High Point Furniture Market we introduced an enhanced mechanism on our iconic motion products that gives the consumer many more features and options, including enhanced layout, increased leg rest elevation, greater body extension, and the ability to add a power option. With power being a growing category in the industry overall, and particularly strong for us, we are now offering power on all of our motion product styles. The product with the new mechanism began to ship a couple of weeks ago and should reach all retail floors late in the fourth quarter.

Now let me turn to a brief discussion of our casegoods segment. Sales in the casegood segment were $26 million, up 1% compared with last year's third quarter. On relatively flat volume we more than doubled our operating margin to 3.3% reflecting the success of the shift to an all-import model. We have continued to move through our product refresh program at Kincaid and American Drew to offer more transitional and casual styles, and are seeing traction with a number of the new collections.

While our casegoods business is a smaller part of our overall business, it is strategically important to us in terms of our ability to merchandise the La-Z-Boy Furniture Gallery stores with occasional furniture and offer consumers expanded in-home services for their dining and bedroom. With the all-import model in place and a more relevant product offering, we believe moving forward we will begin to grow the business as well as operate it in the mid-single digit operating range. Now let's turn to retail.

Delivered sales in our retail segment increased 11.9% to almost $90 million in the third quarter compared with last year's comparable period. The core base of 92 stores included in the last year's period delivered sales on the segment were up 4.7%. The retail segment posted an operating margin of 4.7%, up from 3.8% at last year's third quarter. As we continue to increase sales in our core base of stores, we have the ability to leverage the high fixed cost structure associated with the retail business. In this particular quarter the additional volume helped us to offset the nearly $700,000 drag associated with start-up costs for some new stores.

As we begin the fourth quarter we acquired four stores in southern California from an independent dealer. This brings our Company-owned store count in that market to 19 locations, making it one of the two largest company-owned markets in the United States. Now that we have complete ownership of southern California, we have the potential to add new stores and expand our footprint. As the Company owned retail segment grows -- and we believe that as time moves on, and when 4-4-5 is complete, we will own a larger percentage of the 400 La-Z-Boy Furniture Gallery stores -- so, too, will be the ability to capitalize further on our integrated retail model where we have the ability to earn a blended wholesale/retail margin approaching the mid to high teens.

During the quarter we increased our ticket count, our units per ticket, and better conversion on flat traffic. We believe a more qualified customer is entering our stores as our web traffic continues to increase. Our belief is that the consumers are doing more and more online research and shopping fewer stores, so when she does enter our stores she is very knowledgeable about our product and service offering and more included to purchase.

I will now turn the call over to Mike to review our financial performance.

Thank you, Kurt. Consolidated sales for the FY15 third quarter were $358 million, up 3.3% compared with last year's third quarter of $347 million. As a reminder the operating results of Baja for Lea Industries are reported as discontinued operations.

For the quarter consolidated operating income was $26.9 million, compared with $25.9 million in the FY14 third quarter. The Company reported net income from continuing operations contributable to La-Z-Boy Incorporated of $17.8 million or $0.34 per diluted share. This included a $0.01 per share after-tax gain relating to restructuring. This compares with last year's third-quarter net income of $17.5 million, or $0.33 per diluted share. As noted in our press release, adjusted income from continuing operations attributable to La-Z-Boy Incorporated per share was $0.33 in the third quarter of FY15 versus $0.33 in the third quarter of FY14.

For the quarter our consolidated operating margin was flat against last year's third quarter at 7.5%. Our consolidated gross margin improved 1.1 percentage points in the third quarter versus last year's comparable quarter, and was attributable to a number of factors including the benefits of a legal settlement in our upholstery segment, improved performance in our casegoods segment as a result of the transition to an all-import model for wood, and the increased size of our retail segment, which carries a higher gross margin compared to our wholesale segment. As Kurt mentioned, partially offsetting these improvements were the disruptions experienced in our upholstery segment from the ERP implementation and higher promotional activity in our retail segment.

Now let me turn to SG&A. Selling, general and administrative expenses in the third quarter as a percent of sales increased by 1.1 percentage points compared with last year's third quarter. This was driven partly by a negative impact in our warranty expense. In last year's third quarter we recorded a favorable adjustment to our product warranty liability, and this year we experienced higher parts and labor cost of service warranty claims.

Additionally for the third quarter we had ongoing spending for investments in technology, including the continued implementation of the ERP system and the replacement of our website and e-Commerce platform. As we near the completion date of our new world headquarters, we also have some SG&A costs related to the building which are not part of CapEx. The higher weighting of our retail segment also increased our SG&A expense, or SG&A as a percent of sales.

I would like to now take -- spend a couple minutes talking about our ERP project to give you a better understanding of the effect the system is having on the business. At the end of the quarter we had implemented the system in three plans, with the fourth plan going live on the system at the beginning of February. Since the ERP implementation essentially touches every system in our wholesale La-Z-Boy business, the complexity of the project is significant, and we continue to ensure that the pace of implementation minimizes the disruption to the business. That said, a certain amount of disruption is inherent in the process which is why we're implementing it one plant at a time.

To provide an topline view it is necessary to shut down production for a few days in advance of the actual implementation to prepare the plant. This is followed by the migration and install phases of the new system, if you will. Production is then brought back online in a systematic fashion to ensure everyone reconciles -- everything reconciles and interfaces properly with the other supporting systems. The downtime associated with this process coupled with our plant workers learning new procedures causes some temporary inefficiencies at the plants. This is in addition to the spend associated with the system.

The good news is that we are getting better and better at the implementation with each plant and the end is near, with the plant implementation plan to be completed in June when we move our last facility onto the new system. This last plant is our largest facility with multiple shift operations. Following that we'll move to the front end of the business to work on the sales order management system.

Offsetting the increased SG&A expense was a $2.3 million decrease in incentive compensation costs for the third quarter compared with the prior-year third quarter. The decrease in incentive compensation was driven by prior-year results that were stronger against the incentive-based targets from the current year. This was partially offset by a larger increase in our share price during third quarter of FY15 compared with the third quarter of FY14. Several of our share-based compensation awards are liability-based awards, and their cumulative expense to date is adjusted at the end of each quarter based on the share price from the last day of the reporting period.

Turning to the balance sheet. During the quarter as Kurt mentioned we generated $23 million in cash from operating activities, and ended the period with $98 million in cash and cash equivalents, $45 million in investments to enhance returns on our cash, and $10 million in restricted cash. For the period we spent $16 million in CapEx, saved $4.1 million in dividends representing $0.08 per share, and purchased 640,000 shares of stock in the open market for $16.1 million under our existing authorized share purchase program. This leaves 6.3 million shares in the program for repurchase, and we plan to continue to be opportunistic in the market with respect to buy back activity.

Of the $16 million in capital spending for the quarter about one-half of the spend relates to our new office building. We still anticipate CapEx for FY15 to be in the range of $70 million to $75 million, reflecting costs associated with our new world headquarters as well as for stores, transportation of equipment, and routine maintenance. Because we are in the implementation phase of our ERP system, at this time most of our costs associated with it will be expensed rather than capitalized. For FY15 we expect CapEx to return to a more normalized level of about $25 million to $30 million, roughly mirroring depreciation and amortization.

Lastly, our effective tax rate for continuing operations for the third quarter of FY15 was 34% compared to 33.3% for the third quarter of FY14. Our effective tax rate varies from the 35% statutory rate primarily due to state taxes less the benefit of the US manufacturing deduction, and foreign earnings in jurisdictions with lower tax rates than the US. We do not expect our effective tax rate to differ substantially in the fourth quarter from the current nine-month effective rate.

And now I'll turn the call back to Kurt for his concluding remarks.

Thank you, Mike. Before we close I'd like to talk about the great progress we are making with our 4-4-5 store build out program, the cornerstone of our growth strategy. At this time we are almost two years into our five-year plan.

For those of you new to the La-Z-Boy story, 4-4-5 is our moniker for expanding our store base throughout North America. Specifically it reflects our objective of building the La-Z-Boy Furniture Gallery network to include 400 stores, averaging $4 million in revenue per store, over a five-year time horizon. During the third quarter the network opened for new stores, relocated two, remodeled one, and closed three. We expect to end FY15 with 326 stores, reflecting 31 projects for the year including new stores, relocations, and remodels.

In addition to increasing our store base, much of the work being done by both the Company and our dealer network is also focused on upgrading the system as we convert old format stores through either a remodel or relocation into new design concept stores. There is clear evidence that our new formats, both the new concept design and new generation stores, are outperforming the older format. This is confirmed by our experience in converting old format stores to the new design concept format where we typically experienced a 10% to 15% lift in sales. As we continue to open additional stores to enhance our network, all new stores will be in the new design concept line.

We have received great feedback from our customers and store personnel, and believe it creates a stronger brand image, a better customer experience, and gives us more flexibility in how we merchandise our products. We have not yet fully tapped into this potential, but at this point we are observing that customers are spending 3% to 4% more per ticket in the new concept stores, and our percentage of custom orders is higher than the other stores as well. So as we change out the old stores, we will see an increase in performance for the entire network that extends beyond just new stores added to the system.

Now let me take some time to walk you through a few data points to give you some perspective in terms of where we are in our store system. I will start out with our three store types and their performance. As we begin calendar year 2015, a breakdown of our store formats was as follows. There are 59 new concept design stores, 225 new generation stores, and 42 old format stores. Collectively our system averaged slightly above $3.9 million in sales for all formats in 2014, which is close to the target we've set for the second pillar of 4-4-5.

In terms of our three formats, our sales performance for calendar 2014 was as follows. Our new design concept stores averaged $4.2 million in revenue per store, our new generation stores averaged $4.0 million per store, and our old format stores averaged $3.2 million. We also indicated when we reached the five-year milestone of 4-4-5 that we would ideally have 200 new concept stores and 200 new generation stores.

For calendar 2014 the revenue gap between new concept and new generation format declined slightly primarily for the following two reasons. First, in calendar 2014 we more than doubled the number of new concept design stores, and many of those stores opened this year are in some smaller markets like Bakersfield, California, Corpus Christi, Texas and Naples, Florida where the potential is not as great as some of the larger markets. Second, last year we only had 26 new concept design stores in the system and a large number of them were not open for the entire year. For these we projected full-year sales results based on a partial year of sales. This method overestimated the results on several stores. This year with a larger set to include we are only including stores with at least eight months of actual performance.

In addition to increasing the size of the La-Z-Boy Furniture Gallery network, the additional volume created through both the new stores and upgraded stores we'll flow through to our upholstery wholesale manufacturing facilities and will enable us to drive profitability as we leverage the fixed cost structure of our plans. As we have noted previously, we have the ability to manufacture some $250 million to $300 million more in wholesale volume throughout our existing manufacturing footprint without adding any brick or mortar, so we have a big opportunity to head our operating performance.

We are confident about our business prospects as we move into the fourth quarter. Selling season throughout the holiday period was strong, and we anticipate having a solid deliver fourth quarter. We are also pleased to report that we are moving into our new world headquarters within a month's time and look forward to being able to work in a more inspiring work environment that offers significant opportunity for increased collaboration. For the longer term we are making a number of moves to strengthen our business and drive profitable growth.

With a focus on branded distribution we are increasing the size of the La-Z-Boy Furniture Gallery network throughout North America and have a robust store build-out plan stated through the next several years -- slated for the next several years, excuse me. At the same time we are investing in our business across multiple areas to be more efficient and to continue to drive volume growth. This, coupled with an evolving product line, positions us well for the future as we look to expand the base of consumers attracted to the La-Z-Boy brand. Our future is bright, and I look forward to continuing to report on our strategic milestones as they are achieved.

We thank you for being on our call today, and I will turn things back over to Kathy. Thank you very much.

Thank you, Kurt. We will begin the question-and-answer period now. Kevin, please review the instructions for getting into the queue to ask questions.

(Operator Instructions)

Brad Thomas, KeyBanc Capital Markets.

I wanted to ask a question on sales and then a follow-up about margins, if I could. This was a very good quarter for written results.

I think this is the strongest in over a year for the written same-store sales. Kurt, I was hoping you could just talk a little bit more about the momentum that you had at the end of the quarter as you started to face easier comparisons, and perhaps how Presidents' Day fared when the weather across the country wasn't perhaps quite as good.

You were doing real well with that question, Brad, until you talked about Presidents' Day this year. Typically for us the period between after Thanksgiving and prior to Christmas is not the strongest few weeks in the furniture business.

But immediately after Christmas, the time between Christmas and New Year's and the month of January, is normally one of the strongest periods, and that's the pattern that we experienced this year. So we were really pleased with our piece of business from December 26, through the first couple of weeks of February. We just -- because the orders, as we mentioned, came in late in the quarter we didn't have the time to get them manufactured and out the door, but we will convert all that business in February and early March and recover to a normal -- to a normal cycle.

If you look at Presidents' Day weekend over a four-or-five-day period, the first couple of days we were pretty enthused about the prospects of another really strong increase to the holiday season. But obviously the weather the last two days dampened that a little bit. It wasn't terrible.

It just leveled out some of our expectations, and in total if you look at the five days it was still positive. But obviously we had higher expectations on Sunday and Monday that due to some of our markets even being closed starting Monday afternoon didn't pan out.

As we try to connect the dots between the written orders and the total sales, can you help us think about how many millions of dollars you perhaps could have delivered in the quarter if the orders had come earlier, perhaps what that backlog looks like that you have as a tailwind as we move into your fourth quarter here?

Well, our backlog, Brad, is only about a four-to-six-week period. So it's not an entire quarter. But we're pleased with where it is. Our backlog is up higher than what our written sales for the quarter was in the third quarter. So it's a significant amount of business.

But, there is some of this that happens every year because Christmas always falls on the same date, so there's some comparative there. But if you go back in the last few years and in the first quarter of 2014 and the fourth quarter of 2012, similar things happened when we outsold but did not deliver the backlog out. And then when the following quarter comes on it proves the underlying strength of the business and then the orders get delivered out.

So I don't want to give you -- I don't want to give you a number on it because it would be misleading that that would continue for the whole quarter and that probably won't in that kind of a pace. But there is a large amount -- we do have a large increase in our backlog year over year.

Great. And if I could just ask maybe one question on the margin side here then. If we dissect the drivers in the upholstery segment specifically, it looked like you had a nice legal benefit, the supply chain efficiencies were I think a bigger tailwind than what you'd seen last quarter.

On the flip side it looks like ERP and raw materials were a bigger drag. Any more color you could provide about those and how those may play out in the next quarter or two?

No, I think you identified them pretty well. In our press release we try to always tell you some of the things that are a little bit unusual to our normal business cycle.

We're in a fluid business and every quarter we have things that happen that are planned and unplanned, and we just try to give you some basis for what we see. But this simply was a quarter where we didn't get the delivered sales to match the investments we're making to improve our business.

And had we had $10 million or $15 million more sales in the quarter, these things wouldn't be significant. But on close to flat sales they do pop their head up.

So nothing out of the ordinary. Our business is still running very well.

And I think the other thing is the -- and there's a [grant] down of this, but we're moving into our headquarters next month, the E1 implementation in the plants will be done in the first quarter, and we'll be launching our website in August. So all that spending that's been going on, in some cases for the last couple of years, all that is winding down.

That doesn't mean that we might have a couple of other things that we need to invest in going forward. But these have been three very large projects for us that have taken a lot of CapEx, a lot of time, and some expense that have crept into our numbers that are not ongoing forever.

So you'll see some of that. And we'll give you some more color on that in June, as far as what we expect that to do in our 2016 forecast.

Budd Bugatch from Raymond James.

Good morning Kurt, Mike, and Kathy, this is actually Bobby filling in for Budd. Thank you for taking my questions, and Kurt, thanks for the additional store information on calendar year 2014 revenue. That's very helpful.

First off, in the press release you referenced the four-to-six-week lead time. Is that longer than normal?

No, it's not longer than normal. That's not the manufacturing time either.

That's the time from when we receive the order until we get it to the dealer and then he gets it to the customer. That's the cycle of our revenue and production cycle.

So, that's pretty consistent. Now that doesn't mean that when an item is sold out of stock at a local retail store, it's probably available to the customer within that week. But when it's a special order or when our dealers are projecting their needs for stock into the future, our normal production cycle is in that range.

All right, perfect. Thank you. And then you guys referenced the pace of business accelerating in the second half of the quarter versus the first half.

Can you maybe point to anything in particular that might have caused that? Was the promotional cadence different in the second half or was the marketing strategy a little bit different?

I wish we could take credit for that, but it's the way the holidays fall. It's just the cycle of the business, and there's a peak at Thanksgiving, there's a valley before Christmas, and then there's the big peak of the year after Christmas in January business.

But nothing changed in terms of the promotional environment on a -- year-over-year type data stayed roughly the same I would guess?

Yes. Everything -- we tweak everything a little bit year over year but nothing that I can call out. It's just that the peak after the holiday season was stronger than in previous years.

All right. Thank you. And lastly should we expect a similar amount of store startup cost here in the fiscal fourth quarter as we saw here in the fiscal third quarter?

I think that's a safe assumption. But it won't be necessarily the same drag that it is. Because this year it was accelerated over 2014 and so that was off trend.

So we will mirror the expenses we had this year but we probably won't have more than them. So they are already embedded in our numbers for comparison sake.

Okay. Thank you. I appreciate you guys taking my questions and best of luck going forward.

Matt McCall from BB&T Capital Markets.

Let's see, just to make sure the ERP pressure, Mike you went through kind of what's going on and I just want to make sure I heard you right. That was not -- there was no pressure that was associated with any kind of issue, this was just a normal process of closing facilities and the inefficiencies that follow, correct?

Right. I was just trying to give some more color on what we perceive as being the inefficiencies. This was one of our larger plants during the quarter, the third, and it had a two-shift operation.

So just trying to give -- nothing, there was no issues with the system or that we all of a sudden encountered some problems. We keep getting more and more on the system and working through it and more people have to learn the system. Was just trying to give some understanding of some of the inefficiencies and where they come from, but nothing unusual this quarter than any other quarter.

Okay. Just pulling that apart. On the 4-4-5 strategy, Kurt you said -- so I guess the question is sort of around -- first part of the question is around southern California. You've got your 400-store goal. Did that include -- did that include, the initial goal include southern California, the acquired stores, and any potential stores that you are going to add?

Well, the 400 stores include the base stores that we had when we started at 315. So those four stores are in that base. It's just the transfer of who owns it, it doesn't change our store counts at all.

The opportunity I referred to is there's probably two or three other places we can put some stores in the area of responsibility that we assume from our previous dealer. So that will increase our store count.

But in the overall number the four stores don't make any difference. They were part of the 326 before we bought them and they are still part of that now.

Okay, maybe I should have asked about the owned stores, but I understand what you're saying. But I guess is there -- the question is has there been any change as you move through the first two years, any change to the plan?

You've still got 400 out there, you've still got $4 million out there. You're approaching the $3.9 million per store you got there last year. So any alterations to the plan, tweaks to the plan as you crawl through the first two years?

I don't believe so at this point. We have a pretty good backlog of projects for next year. We should be in that same 30 to 35 project range.

We will probably close less stores next year, so the net will go up. So no, right now -- obviously the last 20 stores will be harder to get on time and schedule in in the first couple of years when we have a bigger area of opportunity. But we're not seeing anything right now that would make us change our targets.

Okay. Even though you're closing in on the $4 million target in the first quarter?

Right.

Okay. All right. Then I think you said -- you gave some kind of targeted margins.

It sounded like updated targeted margins to the mid-single digit, and take us -- again the delay I think you said the blended margin could reach the mid-to-high teens or the upholstery business. Can you talk about the assumptions behind retail, behind wholesale that gets you to maybe the high end of that range, and what it takes to get to the high end versus the low end and the timing to achieve that range?

That is one question?

It's three parts. (laughter)

No, I think we're a little -- maybe we didn't communicate right here. So our operating targets from the beginning of last year that we have not changed yet was the upholstery wholesale business making high-single, low-double digit operating performance.

So the 9%, 10%, 11% range, that's what we expect. Our casegoods business, we had had the target out there at mid-single digits.

We've done that a few years and a few years we didn't. We feel more confident in the consistency of that business and the capabilities of making a mid-single digit operating profit now that we have an import model.

Then in our retail business that is also challenged to make the mid-single digit range, operating margin and they crept up on it this quarter. Those still are double digit, mid-single digit in the other two segments, those are still where we're operating.

Our comment on the Company-owned integrated model, if we would reach the higher point of those targets, so if we would make 11% or 12% in the quarter in upholstery, or we would make 5% or 6% in a quarter in retail, you start getting a blended mid-teen operating margin in the combined segments through everything we sell through one of our Company-owned stores. But we are not raising our targets on upholstery to mid-double digits. It's the combined margin capture of the wholesale and retail business.

Okay. And does it assume the completion of 4-4-5, you get on that to get to the level where that's the ongoing trend?

Well that certainly will help. But the biggest driver we have in our wholesale business to improve our margin is absorption.

So the more volume we can put through it, whether comes from our independent dealers or our network of stores, our plans are agnostic to where the volume comes through. They just want to expand, making more product into the facility.

One thing I'd also like to mention, Matt, is that we did not have many disruptions in the third quarter with the port slowdown in LA. Our team did a pretty good job of advanced planning, of ordering some upfront, of diverting some containers.

We have a little bit of advantage is that a lot of our fabrics go straight to our facility in Mexico and avoid the LA port. But if a port would go on strike and there would be a shutdown or a service interruption, that will start to show itself in the industry and it will be more costly to divert.

It'll be more of a challenge to get things on time. And so we're watching that with a mindful eye, and I just wanted everybody to be aware of it.

But no impact in Q3.

Minimal.

Okay. Thank you, Kurt.

John Baugh, Stifel.

Good morning, Kurt. Good morning, Kathy. Just quickly, was curious in the backlog, which is quite strong.

You mentioned I think some more promotional activity in the retail side. I was curious is the backlog margin if you will when it shifts appreciably different, or unrelated to that promotional comment?

The margin on the backlog is -- there's substantially no change, John. We may have had a slight decrease in our gross margin in retail for the quarter. Nothing significant.

We just had some different offers at retail that caused that to happen, and they were intentional. But it isn't significant enough to be concerned about.

Great. Thank you. And then as we look at the February [molief] of Presidents' Day, obviously you talked about that, but from December 26 through mid February I remember weather was a bit of an issue last year.

You talked about the second half for the quarter being stronger in orders, but that's always the case. So that presumably is a year-over-year similarity.

Is the strength you're seeing in your view the easy weather comparison? Or do you really sense that customers are coming in at a greater rate?

Your ads are more effective? Your product offering working? Any color there?

Well, that's a good question. You could add in lower gas prices and rising consumer confidence.

We do see -- we did see from that period we referred to the customer more willing to buy, more willing to trade up some. That's I think a condition of the economy right now.

We may have had some benefit during this time, because we're talking about the wholesale business, which is all of North America. We may have had 1% or so of benefit from the bad weather last year in that run up period.

We probably gained some of that back at Presidents' Day, the Sunday and Monday. I don't really want to use weather as a benefit or an excuse because we seem to get it every winter. But it's not significant enough to say there wasn't a pattern going on of increased buying by our customers.

Great. Thank you. Just lastly quickly, the stores you bought in southern Cal, is there a rough revenue contribution to the quarter? Were they profitable, neutral, really profitable, losing money? And then also any thoughts about raw materials moving forward? Thanks.

So, the stores in southern California are profitable. They are slightly below the average of the stores, and there is a couple of stores that are fairly old that need to be moved that we're going to do as soon as possible. But they'll be a net contributor to our store network.

Right now, we'll give you a lot more detail in June. But right now we are not seeing going forward a lot of pressure on raw materials.

There's always some minor categories that will have some increase. We did have some this quarter that affected our performance. But we don't see a big run up in raw materials in our planning for next year.

Kristine Koerber from Barrington Research Associates.

A couple of questions. First, as we look at the investment spending that you've been doing over the last couple of years how much of that -- how much of the major investment spending has flowed through the P&L at this point?

We talked about it in our MD&A that we had probably about, between the technology costs and -- it's probably been around 0.3, 0.4 percentage points of our sales that we could -- net cost there. We do feel confident, though, that as we go through this year and we compare it to next year as we -- and as Kurt said we'll give some more color on this during our June call of projects that we're going to do, not do, and what that impact is on us.

But we don't see this being an ongoing problem now that we're [intergoshering] these costs next year. Probably in that level.

I was looking at kind of the total number just trying to get some idea of how much you've spent over the last couple of years. In total, not just this recent quarter.

We'd have to do some research on that to answer that adequately. In total when you take the entire E1 project, our headquarters, and our spend on e-Com, it's going to push $90 million to $100 million and most of that is capital, but some percentage of that is expense as well.

Okay. Mike, you had indicated that if the next project is front end, implementation front-end systems, you talked about the timing of that and I'm assuming that's relatively minor and we shouldn't expect any disruption. Is that correct?

A couple of different things on that. The sales order management system will not be shutting the plants down on as we go live, but it is going to touch every part of ERP as it's the order entry system, it's how all the invoicing is done, it's a major part of the consumer interface or the dealer interface with our system.

So it will cost us some money to go live on that. Some will be capital and some will be expensed. We've been working on that all along.

The time that we've been working on the rest of the system, but we wanted to get all the plants on first before we started installing different parts of that system. So we will have some expenses over the fall and into next calendar year.

But we're hoping that it won't be as disruptive on the plants, but as we go live this will be -- we can't really go live in distant parts of that. It's going to turn the system on all at one time in the fourth quarter of next year.

So we're working through that and making sure that we test it properly. I can't say that it won't be as costly. It will be more capital because we're designing that part of the system and then when we implement it -- we'll be giving some more flavor on that as we go through the summer.

Okay, that's helpful. Thanks.

Then geographically, any change in trends geographically? The markets, or is it pretty consistent across the country?

I would say it was pretty consistent across the Company. We didn't see a big variation between the highs and the lows, and there really were no way underperforming regions. So we were pretty pleased at the broad-based participation in the increased sales for the quarter.

Okay, great. And then just lastly, any update on Urban Attitudes? I don't know what you're seeing there.

Sure. I think we reported last quarter that it was performing at slightly above 30% of our overall upholstery business, and it's still in that range. We think as time goes on and people understand they can shop that type of product category in our stores we think it's going to continue to go up.

Certainly we didn't ever intend it to be 50% or 60% of our business, but we intended it to serve both the more fashion-forward customer and the customer who has needs for smaller products. So, I think it's been a huge success for us and will continue to mature.

Great. Thank you.

Todd Schwartzman from Sidoti & Company.

Wanted to ask you if you could talk about the landscape in southern Cal with regard to format, design format, how the19 stores shaped out? And also if you're going to own all the stores in that market what's the right number there? How many do you expect to add to that, and what's your time frame for getting there?

Good question. All the -- the 15 that the Company had previously owned are either all new gen or new concept. And the four we purchased only one of them is a new gen and the other three are old concept. So they will be immediately either remodeled or relocated.

I think we probably -- if we can find the right location at the right cost I think we have the potential to eventually have as many as 25 stores in southern California. So it would be $100 million-plus market for us if it performs like it is now and we get that store count in there. So we're pretty bullish on that market.

Are there any other markets currently you think you are either equally underpenetrated or more so, perhaps?

Well, I think we've been very transparent, Todd, about our struggles in greater New England, Boston [specific], Miami, and greater New York. We know we're not penetrating those markets to the same degree as we are in Baltimore, Washington, Chicago, southeastern Michigan.

So those have our attention and have some focus. They've been intentionally left towards the end because they are more expensive, they are more challenging.

But we're going to find ways to address those and try to get their performance more on par with the rest of the country. But those three stand out as places that we have room for improvement.

Great. Thanks for that.

On the mix of motion versus upholstery, where did the Q3 delivered number shake out? What difference, if any, was there with regard to Urban Attitudes versus the non-Urban Attitudes mix of upholstery -- stationary versus motion?

Todd, the Urban Attitudes percentage of the whole didn't change significantly. So that was not material.

Probably the difference in the third quarter to our mix was that we are in the middle of a changeover from one of our motion sofa mechanisms to a new one. A lot of the old mechanisms are being sold off the floor and they're waiting for the new mechanism to be delivered.

Depending on when our customers made that decision, there might have been a gap year of available -- and it's not our entire motion line, it's half of it. But the changeover probably affected the amount of motion sofas we delivered during the quarter, and that should straighten itself out in the fourth quarter. So our upholstery sales as a mix were up slightly in the quarter compared to motion, but we think with this new mechanism that we'll get back to our standard percentages.

But in terms of the orders you've received thus far from the Urban Attitudes consumer, are they embracing motion, are they ordering motion in greater numbers as a percentage of the mix of total orders, vis-a-vis your non-Urban Attitudes business?

Our Urban Attitudes business, Todd, is strictly stationary.

It is strictly stationary. Okay, got it.

A particular sofa, the occasional chairs, and an accessory package that goes with it. It has no effect on our motion business.

Is there any intention to branch out?

Well, we're always looking to try to have more stylish motion and try to make mechanism changes that would enhance that. But that's not easy to do.

So I wouldn't see in the near term a significant change in that. But it's something that we continue to work out to broaden that appeal.

As far as the mix of custom orders, do you foresee the time, if you do what you hope to achieve in having the designers penetrate consumers homes, to a greater extent, do you foresee a day when that will be the norm, custom upholstery that is, where you won't even speak in terms of what the mix was of custom to non?

Well, I think it's going to increase because it is a competitive advantage for us. But-- and it varies by category.

So our highest customer order category is stationary upholstery, and it is more decorative. We do have a lot of people that want to pick their own fabrics. It's something they can't find everyplace else, so that's very good for us.

But then we still sell a lot of recliners, and the custom percentage on recliners in changing fabrics and colors is not nearly as great as it is on sofas and motion sofas. So it may change and accelerate in certain categories, but as long as we're selling chairs, which in the foreseeable future we have no indication that we're going to change that, our overall percentage is not going to change dramatically.

Got you. On the casegoods side, I'm aware of the transition underway toward the new collections.

But if you could maybe speak to the flattish delivered number for the quarter? Is the weather there -- is anything else going on there? Is that pretty much explaining the lion's share of that somewhat depressed demand for casegoods?

No, there's nothing unusual there. We did have some hospitality business that are in the numbers of last year because it wasn't a standalone segment like Lee.

So I don't have the actual number. But we will be running up against that for another quarter or two. So actually without hospitality their business was up more than the financials show, but we'll work our way through that.

We have to get these new groups on all the retail floors, we have to get some traction on them. We have to service them better and we have to finish this product line refresh.

We're coming the end of all that. So we would expect in calendar 2015 to see some growth and start making some traction in that category.

Great. Thanks, Mike. Thanks, Kurt.

Thank you. You've reached the end of our question-and-answer session. I like to turn the floor back over to Management for any further closing comments.

Thank you for participating on our call this morning. Should you have any additional questions please give me a call. Have a great day.

Thank you. That does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.