La-Z-Boy Inc (LZB) 2017 Q2 法說會逐字稿

Greetings and welcome to the La-Z-Boy FY17 second-quarter results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to Kathy Liebmann, Director of Investor Relations and Corporate Communications. Thank you, Ms. Liebmann, you may now begin.

Thank you, Rob. Good morning and thank you for joining us to discuss our FY17 second-quarter results. With us this morning 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. Slides will accompany this presentation and are available for viewing through our webcast link. These regular quarterly investor conference calls are one of La-Z-Boys' 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.

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 our FY17 second-quarter results. For the period, on slightly down sales, we improved our consolidated operating margin, turned in a strong performance in our upholstery segment, increased earnings per share over last year's comparable period, and generated $18.3 million in cash from operating activities. And yesterday our Board of Directors voted to increase the quarterly dividend to shareholders by 10% to $0.11 per share.

During the quarter we also continued to invest in our business and acquired four La-Z-Boy Furniture Gallery stores in the Canadian market as we continue to grow our Company-owned retail base as part of our overall 4-4-5 store buildout strategy. And subsequent to quarter end we acquired an additional nine stores and signed an agreement to acquire the license from the La-Z-Boy brand in the UK and Ireland markets. I will speak about these acquisitions in more detail in a few minutes.

Most importantly, however, after moving through what I would characterize as a rather tepid summer and early fall, I'm pleased to say we have seen some positive indicators with respect to the tone of business. As we shared in our press release, our same-store sales results in October were better than the August/September period, and we believe our November results will be an improvement from October. As we move through the holiday selling season, which runs through President's day in February, our strategic plans with respect to advertising, merchandising and promotions remain intact as we gear up to capitalize on the strength of the period, as it is meaningful to the back half of our fiscal year in terms of sales and earnings.

Before talking about the second quarter, I will take a moment to put the first half of FY17 in perspective. For the first six months, sales were off 1% and we earned $0.03 more versus the comparable FY16 six-month period. While we are addressing things from a sales perspective, I am pleased with our operating performance as it demonstrates the efficiencies with which we continue to run the business.

It also highlights the strategic advantage inherent in our business model with multiple levers to pull, given our integrated business where we are a manufacturer, importer, and retailer. And as volume grows, we will be able to leverage this model and deliver improved operating performance.

I will now turn to a brief discussion of each of our operating segments. First, our two wholesale segments, upholstery and case goods.

Our upholstery operating margin of 12.7% was the strongest we've experienced in the second quarter since FY03. We've spoken a lot over the past year about our supply chain and the efficiencies it is delivering in terms of procurement and plant productivity. This, coupled with the benefits from our ERP system, which was implemented throughout our La-Z-Boy branded facilities about a year ago, is driving our operating performance.

With an improved inventory position, our workflow is more tightly managed, enabling us to enhance our speed to market proposition. As a result, we are shipping 96% of all of our orders in four weeks or less. This is great for both our dealer base and the ultimate consumer who is very happy to receive her custom furniture so quickly.

As a result of the weaker environment for home furnishings during the quarter, our wholesale upholstery sales were off 3.3% compared with the second quarter of last year. With that said, our team is implementing a number of initiatives to drive sales. For example, we have strengthened our opening price points and consumers are exposed to better-looking value-priced items from the La-Z-Boy assortment at all times, both in the stores and on our website.

With regard to the website itself, we are encouraged by the positive trends we are seeing in traffic, resulting from new marketing programs and the optimization of current programs. We are also making changes to the site to more fully engage the consumer and improve the user experience and are seeing consumers show strong interest in the design tools and customization options available on our site. We continue to believe that while most consumers prefer to purchase our products in the store, many utilize the Internet for research, so it is imperative that we provide them with a robust website that includes not only product information and pricing, but one with options for customization and one that highlights the many design services available from La-Z-Boy.

On the marketing side, we are evolving the Live Life Comfortably brand platform and produced two new commercials featuring Brooke Shields as our brand ambassador. The first commercial highlights the iClean stain-resistant fabric that we introduced at the April High Point Furniture Market. We expanded the line at the most recent market in October. And with it now on retail floors and the election season behind us, we began airing the iClean commercial two weeks ago.

The second commercial highlights our in-home design program and we expect to begin airing that one during the fourth quarter. The creative content of both commercials is compelling and we look forward to the attention they will capture for our brand and the vast offerings associated with it.

Subsequent to quarter end we signed an agreement to acquire the license for the La-Z-Boy brand in the United Kingdom and Ireland from our sales and distribution partner. We expect to close on that agreement in January. Annual wholesale revenue for this business, based on the current exchange rates, is approximately $42 million, and because of the licensing agreement in place today, we are already capturing about half of that sales volume.

The La-Z-Boy brand is a valuable asset with vast appeal around the world. Historically, the Company established license agreements or some type of partnerships in various locales outside of North America as it was a means to sell wholesale product without taking on the risk in the markets where we didn't have local on-the-ground experience. Over time, however, having learned more about other markets, and with a broader international team in place, we see the prospect to monetize the brand's value internationally.

For the second quarter, written same-store sales for the La-Z-Boy Furniture Gallery network declined 4.4% versus last year's comparable quarter. However, as the quarter progressed, we did see an improvement, with October down 1.9%. I would also point out that there was no one pocket of strength or overall weakness across the store system. Typically, we see that but in this case we saw the slight decline across the board.

In addition to the overall softness throughout the industry during the period, we believe approximately 1% of the decrease related to the cannibalization we spoke of last quarter. As we fill out existing markets where we already have stores, we are experiencing some of this cannibalization which affects same-store sales.

To reiterate what we said last quarter, there are a number of markets where we need more stores based on the demographics of that particular market. And when we add a store to satisfy that demand, sometimes the existing stores in the market may lose some sales. But net-net, the market overall is performing better and contributing to sales and profitability at both the wholesale and retail levels.

With respect to our 4-4-5 strategy, we, along with our independent dealers, are on pace to complete approximately 27 projects for FY17. These include new stores, remodels, and relocations, and we expect to end the year with 11 net new stores for a total of 349 La-Z-Boy Furniture Gallery stores, with 116 in the new concept design format.

During the second quarter the network opened three new stores, remodeled one, and closed two. For the third quarter of FY17, four new stores, one relocation, and three remodels are planned throughout the network.

Now let's turn our attention to case goods. With an 11% operating margin for the quarter, compared with 9.3% in last year's period, it is evident we have streamlined the business with a pure import model. Fueled by strong teams in the US and in Hong Kong we are flowing product well and have increased our service positions for our most popular groups. On average we are shipping product in about six days to our dealer base from the time of order.

At the fall Furniture Market we introduced some great new transitional collections at key price points which received a very positive response from retailers. Kincaid also launched a renewed effort to open Kincaid Gallery accounts by introducing new point-of-purchase displays, showcasing it's uncompromising commitment to quality solid wood construction. Kincaid upholstery also showcased a new program called Premier Colors which leverages our domestic finishing capabilities.

Importantly, after two years of refreshing our product line, we believe our case good portfolio is now well balanced with many transitional looks to appeal to today's consumer who tends to live less formally.

Now let's turn to a discussion of our retail segment. In our retail segment delivered sales increased 11.3% in the quarter versus last year's second quarter. We delivered sales for the core base of 111 stores included in last year's comparable period decreasing 5.5%.

Our 4-4-5 store buildout strategy is a key growth driver for the Company as we endeavor to fully penetrate the North American market with La-Z-Boy Furniture Gallery stores. Between the new stores the Company is opening and those we are acquiring, including 35 acquired since we started 4-4-5 three-and-a-half years ago, we believe the Company could potentially own almost half the store network by the time 4-4-5 is completed.

During the quarter the Company opened two stores, acquired four in the Canadian market, and closed one. Subsequent to quarter end, we acquired nine stores in northeastern Pennsylvania market with seven in that state, one in Dover, New Jersey and one in Middletown, New York. We acquired these stores from a retiring independent dealer, a husband and wife team.

We expect the nine stores to contribute approximately $35 million in sales on an annual basis to the Company's retail segment. These stores are profitable, have been quickly integrated into our retail segment, and will be immediately accretive to the segment's profitability.

I would like to take this opportunity to thank Alyssa and Frank Hager for their unwavering dedication and support to La-Z-Boy Incorporated over their almost 20-year tenure with the Company. They have been great partners and we wish them all the best in their much deserved retirement.

As the Company-owned retail segment continues to grow, we will be able to further capitalize on the combined wholesale, retail margin associated with our integrated retail strategy, which continues to deliver results.

For the quarter, our operating margin declined at 2.8%, primarily the result of lower delivered sales for our core stores and the inability to absorb the high fixed costs associated with the retail business. Additionally, during the quarter we increased our marketing spend and spent to a higher anticipated sales plan without achieving the expected results.

At the same time, we continue to run tests in a number of targeted markets, as we did last quarter. And while the up-spend in these nine DMAs was indeed successful, it was not enough to make the difference in our profitability for the period.

For the quarter, on lower traffic, our conversion was positive and we experienced an increase in the average ticket driven by our in-home design sales and an increase in custom orders. We have also seen an expansion of our in-home program, with our designers working with consumers to decorate their bedrooms and dining rooms, following living rooms and family room projects. While this has also benefited our case goods group, importantly, we have a more satisfied consumer who will be more inclined to shop with us again.

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

Thank you, Kurt. Consolidated sales for the FY17 second quarter were $377 million, down 1.6% compared with last year's second quarter. For the period, the consolidated operating margin increased to 8.8% from 8.7%. The Company reported earnings per diluted share attributable to La-Z-Boy Incorporated of $0.42 compared with $0.41 per diluted share in last year's second quarter.

With respect to earnings per share, our results came in higher than the range we anticipated reporting when we preannounced in October. In addition to converting better than we expected, our compensation costs came in under our estimate, driven primarily by a lower stock price.

Our consolidated gross margin improved 1.4 percentage points in the quarter, compared with last year's second quarter, with most of it a result of changes in our consolidated sales mix due to the increased weighting of our retail segment, which carries a higher gross margin than our wholesale businesses. Our gross margin in upholstery segment improved due to supply chain efficiencies and changes in product mix. And in our case goods segment lower freight costs were primarily responsible for the increase versus the prior-year period.

Partially offsetting these improvements was a lower benefit from a legal settlement of 0.4 percentage points compared with last year's second quarter in the upholstery segment. In our retail segment our results were impacted due to an inventory sell-through associated with the Canadian acquisition which related to the inventory being recorded at fair value on the acquisition date. Therefore we realized a lower gross margin when it is sold. The negative impact on our gross margin as a result of the Canadian inventory should lessen over the next several quarters as we work through it.

Selling, general and administrative expenses as a percent of sales increased 1.3 percentage points in the FY17 second quarter compared with the same period a year ago. Here too, the increasing size of our retail segment is contributing to the increase, with 1.4 percentage points of the quarter's increase stemming from the growth of our retail business. This reflects the higher percentage of sales for SG&A at retail compared to the wholesale segments.

As Kurt discussed earlier, we increased our advertising spend across all markets and ran tests in select markets, resulting in our advertising expense as a percent of sales being 0.7 percentage points higher for the quarter versus last year's second quarter. Partially offsetting the increase was incentive compensation cost as a percent of sales that were 0.8 percentage points lower in the quarter compared with the same period a year ago.

Incentive comp costs were lower primarily due to a $6.97 decline in our share price during the period compared with a $3.52 increase in our stock price in last year's second quarter. Several of our share-based compensation awards are liability based and their cumulative expense is adjusted at the end of each quarter based on the stock price on the last day of the reporting quarter. Also during the period legal fees were 0.4 percentage points lower as a percent of sales compared with last year's second quarter.

Now let me turn to the balance sheet. For the quarter we generated $18 million in cash from operating activities. We ended the period with $106 million in cash and cash equivalents, $31 million in investments to enhance returns on our cash, and $9 million in restricted cash.

During the quarter the Company invested almost $11 million acquiring four La-Z-Boy Furniture Gallery stores, spent $5 million in capital expenditures, paid $4.9 million in dividends, and spent $6.2 million to purchase approximately 250,000 shares of stock on the open market, which leaves 3.3 million shares available for purchase in our program.

Our cash needs over the next two quarters will include funding our two recently announced acquisitions. In November we acquired the nine retail stores in Pennsylvania, and we expect to acquire the license for the La-Z-Boy brand in the United Kingdom and Ireland. The license acquisition is scheduled to close in January, with the cash funding taking place 90 days later per the terms of our agreement.

Based on the current exchange rates, we expect to invest about $37 million on both these acquisitions. We don't expect the UK acquisition to add much in sales in the third quarter due to the proposed closing date which is slated for late in the quarter.

We expect our CapEx for the full FY17 year to be in the $30 million to $35 million range. Given these uses for cash, our operating cash flows, stock market conditions, and other opportunities that may come up to invest in the business to drive growth, we will be opportunistic with respect to our share repurchase program.

And, lastly, our effective tax rate for the quarter was 36.1% compared with 36.2% for the second quarter in FY16. Our effective tax rate varies from the 35% federal 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.

Also, as a reminder, last year's fourth quarter had 14 weeks compared with this year's fourth quarter which will have 13 weeks.

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

Thank you, Mike. Looking ahead, we are optimistic about our business prospects. In addition to being the most recognized brand in the industry, we believe the combination of being a manufacturer, retailer and importer with a multi-channel distribution model gives us a competitive edge in the marketplace.

At the same time, our operations are lean and efficient, positioning us well to drive profitability with increased volume. As we move forward, I believe these factors, combined with great product and marketing strategies, will carry us into the future as we develop and expand our business. We look forward to updating you on our strategy as they evolve. And thank you for your support of La-Z-Boy Incorporated.

I will now turn the call back to Kathy to start the Q&A.

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

(Operator Instructions)

Our first question is coming from the line of Bradley Thomas with KeyBanc. Please proceed with your questions.

Good morning, Kurt, Mike and Kathy.

I wanted to ask about margins in the upholstery segments, which were up nicely despite the volume decline. Obviously in your Q you referenced supply chain initiatives. I was hoping you could just talk a bit more about what it is that's driving the margin improvement within the segment, and maybe the opportunity that you see going forward there.

I think the largest thing that is helping our margin is the ability to flow our materials and our supply chain to our workers on the floor without interruption. It makes a lot of sense that if people continue to stay engaged throughout the day without gaps and waiting for materials to come to the sales, that their productivity will be better.

We have a combination of some great work by our supply chain team to lower the input costs with our purchasing power, and then record productivity in our plants about the number of you units that are made per hour. Those things are getting better as we continue throughout the year. We would expect them to stay in that range.

Our challenge with improvement or consistency with this kind of performance is primarily based on volume, Brad, and also raw materials. So, if those two things stay in a positive tone, there was nothing unusual this quarter about our productivity or our earnings in our upholstery segment that benefited us. It's just a matter of those two things continuing at this level.

Got you. And as you all look at raw materials and input prices and how those have been trending of late, what's your latest thinking on the outlook for raw materials and potential needs to do price increases going forward?

Our bias as we sit here today would be that raw materials will probably tick up some in the second half of the year. To what degree we're not positive yet but we've got more bias that they will go up rather than go down. Not enough to affect anything that we've got planned for the second half, but if that trend continues as we head into calendar 2017 we would make whatever pricing adjustments we had to at the April market.

Great. And then, lastly, if I could, exciting opportunity for you all to do the deal within the UK and Ireland. Kurt, I was hoping you could just talk maybe a little bit more broadly about how the leadership team thinks about international as an opportunity as you look forward.

We tried to lay that out in our call notes, Brad, that our history has been that we've had a lot of partners around the world, and La-Z-Boy didn't really want to take much risk and didn't have a lot to add in those local markets. But we had wholesale distributors that we could sell to. I think La-Z-Boy is represented today by various partners in 40-plus countries. So we've always had a presence.

But as we've gotten more experience, gotten to know our customers worldwide, some of them, frankly, are in the same position as our La-Z-Boy store owners and they're looking to monetize their work and they're looking towards retirement. We have more of an interest today in certain of those places that we think we can continue to advance our business there and move forward. So it's a fluid situation.

It's a little bit like the La-Z-Boy stores. I can't give a lot of guidance on when or how these things could or could not be acquired because it takes two parties on either side and we don't control all the timing. But if another opportunity presented itself that we thought was similar to what we have in the UK, we would take a very active interest.

Great. I'll turn it over to others. Thank you, Kurt, and looking forward to seeing you at our conference next week.

Our next question comes from the line of Budd Bugatch with Raymond James. Please proceed with your questions.

Good morning. I feel like I probably should begin this by saying this is Budd for Bobby.

(laughter) That's good, Budd.

Kurt, congratulations on the quarter and to your team, as well. And you did note, Mike, there was a difference between what you guided or what you outlined in your release just before the October market and what you were able to deliver, and much of that seems to have come from the stock comp. But you also talked about improved conversion to where you thought it was going to be. Could you pars it out? The stock comp differential looked to me likely between $0.03 to $0.04, depending how you calculate tax rate and the differential. Can you help us figure out what caused that difference and how much of it might be permanent?

It's probably about half and half of the additional earnings per share that we received on comp. Because we obviously knew we had some comp benefit throughout the quarter, but when we released, the stock price obviously went down a couple dollars from there and we didn't have that included in our estimate. So I'd say half was that.

And then half -- we looked at some spending and tried to cut some things off by the end of the quarter to make our conversion better when we saw that we were missing numbers. So, we just were able to do more than we anticipated by the end of the quarter. So it's about half and half.

I don't think we'll spend that money in the second half of the year that we saved on the first half. And some of it was just better productivity in the plant that we anticipated, as well, on the lower volume.

We expect to continue to get productivity out of the plant. And we expect, if our sales volume's down, to continue to try and look at all of our costs to make sure that we're being comparative in our sales versus our expense ratios.

And is there any way for us, for folks out in the hinterlands, to get a feel for how to handle the stock comp? That does have some volatility to it particularly because of that liability-based plan.

Is there any way for us to get a better handle on it? Or are we just at the vagary of whatever the price is at the end of the quarter?

I think your latter statement is the truth. The stock differential of $10 in a quarter is pretty significant in how we do the calculation. Then I would say that, given what's happened in the market overall and our price coming back, we'll have it going the other way in the third quarter if the third quarter would end today.

It's just the ebb and flow of that. So we can't predict it or give you any more advice, Budd, than what we have.

Every year some of these share-based compensation plans, when people cash in those shares, we lose some of the volatility. But it's still going to take us probably another three or four years to cycle through most of those before they expire. So we're stuck in this for a little while longer.

We'll try and see if we can give some better clarity on that as we move through this. But the stock market is about as unpredictable with anything I've seen. So, we're struggling with giving better guidance on that ourselves.

You surprise me by saying that, Mike. The next question I have is on tax rate. Your taxes are pretty benign and relatively vanilla as we look at them.

But can you give us a feel for cash tax versus whatever you show on the provision on the statements? Is there much difference that we should be aware of?

We have obviously differences in our depreciation expense as we try and accelerate depreciation and try and reduce that down, I would say. But we have things going the other way, as well.

So, there's not a significant difference right now in our cash taxes versus our provided taxes. We may have a little bit here and there. But if I see something I'll let you all know, but I'm not aware of any significant timing difference that's making a big difference in the two.

Okay. And lastly from me, on the acquisitions, can we get a feel of maybe some of the profit impact? I know you talked about the revenue impact. What do you think the accretion impact is of the stores?

And how will we see or where's the geography of what we would see on the UK licensing deal? How is that going to show up in the financials?

I believe the UK business will show up in the upholstery segment. And I would say that both of our acquisitions are at or above the segment level's performance in the retail segment, with the Hager acquisition and the UK acquisition in the upholstery segment. So, both are very profitable businesses.

There's probably a little more risk to the UK, given what's going on there with Brexit and all. But we think we can maintain and over time enhance the sales and profitability of both of those businesses.

And the UK acquisition, are you selling product into the UK for them? How is that working? Are they manufacturing? How is that?

Our partners are a company called Furnico. They've had a business under that name and they have a manufacturing plant in the UK that they will continue with. They've been our distributor of La-Z-Boy products in the UK and Ireland for eight or nine years and have built up a pretty substantial business.

We supply them La-Z-Boy product, which they resell to customers, and that's the majority of their business, Budd. There's a small portion that we license the La-Z-Boy name on the Furnico product that they make actually in the UK, primarily for the High Street customers. I think it's 85% the product that we make overseas and import and 15% the Furnico product.

This is product coming out of your Thailand operation goes to the UK and that's --?

It comes out of Thailand. It also comes out of a partner we have in China that makes product for other of our international licensee under the La-Z-Boy name.

And you're not buying the Furnico manufacturing facility?

We are not.

Okay. Thank you very much. Great quarter. Good luck on the balance of the year.

(Operator Instructions)

The next question is from the line of Anthony Lebiedzinski with Sidoti & Company. Please proceed with your questions.

Good morning. Thank you for taking the questions. I was actually a little bit pleasantly surprised about the October trends improving versus August and September even with all the pre-election jitters and so on.

Can you tell us if the trends that you've seen in October and November, have those been consistent in both upholstery and case goods, or is upholstery doing significantly better than case goods? Any color on that, that would be appreciated.

I think our position today on things is we really can't explain the improvement in October. We were glad to see it but there wasn't anything in the market that signaled that things were changing in that direction. But there has obviously been a pick-up in our industry across the board in the consumer being out shopping more for furniture since the election has been over.

For us, it started with a pretty strong Veterans week and weekend and it continued right through the Thanksgiving holiday. There's a little better pace to business, obviously, than we saw in the summer. We are not yet ready to make a bet that it's going to continue for six months, but it is a welcome surprise that the consumer feels a little more confident about buying big ticket items.

Got it. Okay. Just switching back to the quarter, can you share any metrics for traffic versus ticket for the retail segment?

We don't give exact numbers but as this is a trend that we've been on, like most retailers our traffic is down from the previous year, not substantially, but it's down. We're getting increases by a better conversion rate and a higher ticket driven primarily by our in-home and our customization. We continue to work on that because we believe the traffic is going to stay down, given the changing research patterns of consumers not visiting as many stores but doing all her work on the Internet to determine the couple places she may shop for furniture.

Got it. Lastly, in your 10-Q you mentioned that the upholstery segment had some issues -- well, it wasn't issues, but you were phasing out frames and fabrics. Where are you with that process now?

I think our call there is we were perhaps a little more aggressive this quarter with making sure we dealt with obsolescence and things of that nature. It's a common occurrence in our business as we have line changeovers and all that. We just are taking a little more aggressive stance of moving things through and not letting it accumulate.

Thank you very much.

Thank you. At this time I will turn the floor back to Kathy Liebmann.

Thank you everyone for participating on our call this morning. Should you have any follow-up questions, please give me a call. I will be available later today. Have a great day.

Thank you.

This concludes today's conference. Thank you for your participation. You may now disconnect your lines at this time.