La-Z-Boy Inc (LZB) 2018 Q3 法說會逐字稿

Greetings, and welcome to the La-Z-Boy Third Quarter Fiscal 2018 Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Kathy Liebmann, Director of Investor Relations and Corporate Communications for La-Z-Boy. Kathy, please go ahead.

Thank you, Kevin. Good morning, everyone, and thank you for joining us to discuss our fiscal 2018 third 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 1 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-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 Chairman, President and Chief Executive Officer. Kurt?

Thank you, Kathy. Good morning, everyone. Our third quarter was certainly more complex than usual as we went through the extensive documentation related to tax reform, which Mike will speak about a little bit more in a few minutes as well as the previously announced legal settlement related to certain power units, both of which impacted our results.

Those 2 issues aside, we reported solid results for the fiscal 2018 third quarter. Sales increased 6.1% and all 3 of our business segments operated at a high level. The La-Z-Boy Furniture Galleries store network posted its fourth consecutive quarterly same-store sales increase, and the company generated $40 million in cash from operations. This positions us well as we continue to invest in our dual growth strategy to capture more share with our core customer and to expand our business through our e-commerce strategy to win a younger consumer, who exhibits different shopping characteristics. It also allows us to continue to make the necessary capital investments in our business to expand our vibrant retail footprint and strengthen our U.S. manufacturing platform, which is paramount to our ability to provide custom furniture quickly while bringing innovative products to the market. Additionally, we returned $21 million to shareholders through dividends and share repurchases, buying back 0.5 million shares during the quarter.

Now let me take you through a review of our 3 operating segments for the quarter. First, our upholstery segment. For the quarter, sales in the upholstery segment increased 6% to $321 million and the segment operating margin declined to 9.9% from 11.8% in last year's third quarter. The charge for the legal settlement regarding certain power units reduced operating margin in the segment by 1.3% in this year's quarter. Our operating margin for the segment was also impacted by higher raw material costs principally for our 3 core components of steel, foam and wood. We implemented a price increase that was effective on delivered sales beginning in January, which meant we absorbed these inflated costs for 2/3 of the quarter, but we do not anticipate a significant drag on our fourth quarter margin with the price increase in effect.

On the product side, the Duo collection is pacing very well and indeed it's exceeding our expectation after canvassing North America retail floors for just a few short months. At this point, it appears to be on track to annualize at about $25 million to $30 million in wholesale sales. While it is still too early to tell how much of the sales volume is incremental to our existing motion sales, there is ample evidence that the new consumers are coming into the stores looking specifically for the Duo product.

iClean, our stain-resistant fabric, also continues to be popular. In addition to leveraging that product in different markets around the world, we are featuring it on the updated Urban Attitudes collection that we are introducing at the April High Point Furniture Market.

Our new state-of-the-art innovation center at our Dayton, Tennessee campus is on schedule for completion this spring and will be integral to our ability to provide a steady cadence of bringing exciting and progressive products to the market as we strengthen our legacy in this area. With our heritage steeped innovation, our objective is to remain the most innovative manufacturer in the industry where we marry our R&D talent with that of our world-class supply chain.

Written same-store sales for the La-Z-Boy Furniture Galleries network increased 2.6% for the quarter. Again, this is the fourth consecutive quarterly increase and we are encouraged by this momentum, particularly as we move into the spring. Total written sales across the network for the quarter increased 4.3%. During the quarter, 2 stores were opened, 2 stores were remodeled and 2 were closed. We ended the period with 350 La-Z-Boy Furniture Galleries stores, of which a 129 were in the new design concept. For the fourth quarter, across the network, there are plans for 2 store openings, 2 relocations and 2 closures and we expect to end fiscal 2018 with 350 stores, which will include 3 net new stores. For the full year, we plan to execute some 22 projects, with 1/3 of the activity dedicated to closing or changing out old format stores for the new concept design.

For those of you who may be new to our story, let me provide a brief overview of our e-commerce strategy. La-Z-Boy has a dual strategy to reach 2 distinctive groups of consumers. The first, our core customer, who prefers to shop either in a La-Z-Boy Furniture Galleries store or at another retailer store carrying the La-Z-Boy brand. And the second, a younger customer who seems to prefer to shop online for furniture. We believe we can grow sales to both of these consumer groups simultaneously. Our three-pronged e-commerce strategy addresses both a younger market while providing a wealth of information, access and buying opportunities for the La-Z-Boy brand to all consumers.

Our first objective is to increase online sales of La-Z-Boy furnitures through la-z-boy.com and other digital companies such as Wayfair, where we have been selling for a couple of years and have enjoyed a steady increase in sales on their platform. We have also completed test orders with Amazon and expect to be selling on their site this spring.

The second objective is to leverage the strength of our world-class global supply chain to support other e-commerce brands, which we are already doing. And the third is to invest in new online companies. And as of today, we have invested almost $9 million in 2 companies. We will continue to provide updates to you on how these initiatives are evolving as we are committed to growing our business in this dynamic marketplace and leveraging the strength of our brand and supply chain.

Before turning to case goods, let me take a moment to provide an update about our investment in our New Tazewell, Tennessee campus, home to our England upholstery subsidiary. Yesterday, in conjunction with the state of Tennessee, we held a groundbreaking ceremony to celebrate the 2 projects we formally announced last week, stating that we would invest $10 million in these 2 projects. The first is to expand our manufacturing facility by some 87,000 square feet or 20% due to increased demand. And the second is to construct a new corporate office building to replace the one that was destroyed in a fire this past May. The state of Tennessee is contributing money towards the 2 projects. Construction is set to begin immediately, with expectations for the additional capacity at the plant to be ready for operations by January of 2019 and the office building to be completed in the spring of '19. As with our world headquarters and our innovation center that is under construction, we intend to construct a LEED-certified corporate office building. England has been an excellent performer over the years with consistent increases in sales and profitability. Increasing their capacity at the New Tazewell facility will allow us to answer existing demand and continue to expand the England business.

Now let's discuss case goods. Sales in our case goods segment for fiscal 2018 third quarter were $27.2 million, an increase of 17% from last year's third quarter, and the operating margin for the segment increased to 10.3% from 6.8% in the comparable period of fiscal 2017. The case goods business is in the best shape that it's been in years. The product portfolio features well-priced, on-trend collections that appeal to today's consumers on the way they live. This, coupled with a proven track record of providing excellent service to its dealers, namely being in-stock and providing quick ship times, has allowed the group to expand its business with larger retailers. The entire team has done an excellent job in righting the ship, and I believe this business is poised for continued success.

Now moving on to retail. Sales for the fiscal 2018 third quarter increased 3% to $125.8 million. The operating margin increased to 5.6% from 5.2% in the prior year period. On the core base of 138 stores included in the last year's quarter, delivered sales declined 1.1% versus the prior year, mainly due to a decrease in traffic, which was somewhat offset by an improvement in the average ticket driven by increased design services, custom orders and higher conversion. With respect to the slight sales decline for the core stores, we did observe a negative trend related to weather in a number of the company-owned markets, particularly in the Midwest and Northeast, when we analyzed the traffic and sales patterns compared to the stores in our non-related weather markets.

During the quarter, the company opened 1 new La-Z-Boy Furniture Galleries store in Mechanicsburg, Pennsylvania and acquired 1 store in Grand Rapids, Michigan, bringing the company-owned store count to 147 of the 350 stores in the network.

I will now turn the call over to Mike to review our numbers for the quarter in much more detail. Michael?

Thanks, Kurt. Consolidated sales for the fiscal 2018 third quarter were $414 million, up 6.1% from $390 million in last year's third quarter. Consolidated operating income for the quarter was $33.1 million versus $33.6 million in the fiscal 2017 third quarter, and the consolidated operating margin was 8% in the current period versus 8.6% in last year's quarter. This year's third quarter consolidated operating margin was reduced by 1% as a result of the charge for the legal -- for the lawsuit regarding certain power products.

The company reported net income attributable to the La-Z-Boy Incorporated of $12.1 million or $0.25 per diluted share, which included a $0.20 per share net charge related to the 2017 Tax Cuts and Jobs Act or tax reform, and a $0.06 per share charge related to the legal settlement. This compares with $23.3 million or $0.47 per diluted share, which included a $0.03 per share discrete tax benefit in the fiscal 2017 third quarter. I will discuss tax reform in a little more detail in a moment.

Our consolidated gross margin decreased 0.9 percentage points in the third quarter compared with last year's comparable period. This was primarily the result of a decline in the gross margin in our upholstery segment due to the increases in raw material prices that Kurt mentioned earlier.

SG&A as a percent of sales was 0.3 percentage points lower in the third quarter of fiscal 2018 compared with the same period of fiscal 2017, primarily due to improved absorption of fixed SG&A cost on the higher sales dollars and a reduction in discretionary SG&A spending compared with the year ago period. However, partially offsetting these improvements was the legal settlement, which increased our SG&A expense as a percent of sales in the fiscal 2018 third quarter by 1 percentage point.

Turning to the balance sheet. During the quarter, we generated $40 million in cash from operating activities. We ended the quarter with $135.3 million in cash and cash equivalents, $35.4 million in investments to enhance returns on our cash and $2.4 million in restricted cash. During the third quarter of fiscal 2018, we spent $7.8 million in capital expenditures, paid $5.7 million in dividends and spent $15.4 million purchasing almost 525,000 shares of stock in the open market under our existing share purchase program. This leaves us with 7 million shares available for purchase in the program. Based on cash flows and other capital needs to invest in the business to drive growth, we plan to continue to be opportunistic in the market with respect to buyback activity. Our current estimate for total CapEx spend for the year is in the range of $45 million to $50 million.

Our effective tax rate for the third quarter and 9 months of fiscal 2018 was 62% and 43.9%, respectively. For the third quarter and 9 months of fiscal 2017, our effective tax rate was 29.4% and 33.4%, respectively. As I mentioned during our call last quarter, the fiscal 2017 third quarter included a $0.03 per share benefit from discrete items relating to Tennessee job credits and reduction of valuation allowances related to state deferred taxes. Our effective tax rate varies from the federal statutory rate, primarily due to state taxes, plus the benefit of U.S. manufacturing deduction and foreign earnings in jurisdictions with lower tax rates than the U.S.

As we mentioned in our filing last night, on December 22, 2017, the 2017 Tax Cuts and Jobs Act was enacted into law. And except for certain provisions, it's effective for tax years beginning on or after January 1, 2018. As a fiscal year U.S. tax payer, the majority of the provisions will apply to our fiscal 2019, such as eliminating the domestic manufacturing deduction, creating new taxes on certain foreign-sourced income and introducing new limitations on certain business deductions. For fiscal 2018, the most significant impacts include: lowering of the U.S. federal corporate income tax rate, remeasuring certain net deferred taxes and requiring the transition tax on the deemed repatriation of certain foreign earnings. The phase in of the lower federal income tax rate resulted in a blended federal rate of 30.4% for fiscal 2018 as compared with the previous 35%. The federal tax rate will be reduced to 21% in subsequent fiscal years. The total effect of tax reform was a charge of $9.5 million in the third quarter of fiscal 2018. This included a $9.8 million charge for the provisional remeasurement of certain deferred taxes and related amounts, a provisional $1.9 million of income tax expense for the estimated effects of the transition tax and a benefit of $2.2 million primarily related to the lower blended federal tax rate.

Based on our current interpretation of the new tax laws, we made reasonable estimates to report provisional adjustments during the third quarter of fiscal 2018, as I just outlined. Since we're still accumulating and processing data to finalize the underlying calculations and expect regulators to issue further guidance, among other things, we believe our estimates may change during fiscal 2018 and potentially into fiscal 2019. We are also analyzing other provisions of the new tax laws to determine if they will impact our effective tax rate in fiscal 2018 or in the future. We will continue to refine such amounts within the measurement period allowed, which is not to extend beyond 1 year of the enactment date.

We are currently estimating our fiscal 2018 effective tax rate to be about 32%, absent any discrete adjustments. Our effective tax rate for fiscal 2019 is currently estimated to be in the range of 25% to 26%. Our effective tax rate differs from the U.S. federal income tax rate of 21%, primarily due to state taxes.

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

Thank you, Mike. We are optimistic about our business. We have all the elements in place to continuing to evolve, grow and prosper in a dynamic marketplace. Our brand is strong, we have a world-class global supply chain, our distribution network is vast, including the solid and growing La-Z-Boy Furniture Galleries store network, and we are nimble as we develop new go-to-market strategies, including our e-commerce initiative to reach existing and new customers. At the same time, we continue to make strategic investments in our business to strengthen our operations and grow in new areas and with the new consumer groups to solidify our long-term positioning within the industry.

We want to thank you for your interest in La-Z-Boy Incorporated. And we'll turn over the call to Kathy to provide some instructions for getting into the queue for questions. Kathy?

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) Our first question is coming from Bobby Griffin from Raymond James.

My first question is, is there -- around some of the commentary given in the 10-Q, a product mix shift was referenced as part of the upholstery growth with a shift towards power and leather. And I know the shift towards power has been going on for some time. But I guess, when you sit back and look at it, where do you see that going? And do you see that benefit continuing in the future? And kind of what -- maybe if you can give us any color on what type of mix we're at today and -- or to help us frame that type of benefit going forward?

So I think, we probably would see power to continually grow over time. A lot of it depends on continued innovation. It depends on how big of a percentage of our business Duo becomes. And so I don't really see -- not only with us but in the whole industry, I don't see power slowing down. People want the extra features. They -- there's always new things coming out. So that is going to be a continuing growth story for us. Leather sometimes fluctuates, Bobby, based on the price of leather, but that's still a growth area. And I think, for us, the way we position the brand and our stores, we have pretty strong capabilities of selling better product. And certainly, leather and the power products carry additional pricing, but our customer is not afraid of it, and we offer a good value even though it's more expensive. So I don't have any numbers in front of me about what percentage of our business is leather or power or anything like that, but both are growing and we would anticipate that continuing.

Have you seen the power mix -- the favorable mix accelerate recently? Has there, kind of, just been kind of a gradual increase over time?

It's more gradual. It's -- you have to do a lot of business to significantly change our percentage of sale, our balance of sale, but we're pleased with the direction it's heading.

Okay. I appreciate the color. And then I was hoping, can you maybe provide a little update on the international side of things? It's been a couple of quarters since the U.K. and Ireland acquisition. Any early learnings? Or maybe what some additional -- if you -- if any new additional opportunities in international that you're thinking about?

No. We're very bullish about our international opportunities and extremely pleased with the first year of owning the business in the U.K. Our team went in there and took over from our previous distributor, who was doing a great job, but they started from scratch, put a team together, put systems in, did everything and we didn't miss a beat. So we're pleased with that opportunity. We think we have more growth opportunities in Europe. We just signed on a manufacturing partner in Poland to help us be more competitive in Europe. So we're continuing to work that angle pretty hard and still having great success with Kuka in China. They continue to open more and more La-Z-Boy stores and that's going well. So we have real pockets of strengths in parts of the world and we'll continue to be opportunistic as those opportunities become available or need additional help to grow in their markets.

Okay. And I guess, lastly for me. I just want to touch quickly on the company-owned stores, the delivered sales during the quarter. Is there any -- can you provide any commentary of how big you think the impact was from weather? Was that pretty much the majority of the decline? Or is it too hard to parse it in that much detail?

No. I mean -- it's a good question, Bobby. You know the company owns the majority of the stores on -- in the Northeast, on the East Coast and in the Midwest. The balance of our dealers are all in the warm weather states. So obviously, they are smarter than us. But if you just recall what's happened in December and January about weather, it was pretty difficult at times. Thankfully, it didn't happen on a big holiday or anything like that, but there was enough of a difference that -- our stores that we have in California and Las Vegas and Florida outperformed the stores that were weather-related by 2 or 3 points. So it -- I don't want to call it significant because every year, you have weather and we don't like to use weather as an excuse, but I was just trying to highlight the differential of -- we run the same type of business nationwide, we run the same promotions at our stores and the difference in performance this quarter was a result of weather.

Our next question today is coming from Anthony Lebiedzinski from Sidoti & Company.

I was just curious, as far as the retail segment, was there any notable impact of cannibalization?

That's a good question, Anthony. We've reported out the cannibalization for some time. It's held in there pretty steadily at about 0.3% of sales for the company-owned stores. And remember, we've commented a couple of times that because we get the benefit also of the integrated margin, because we make the profit on selling to ourselves, we would have a tendency to put stores a little closer together in the larger markets than our independent dealers, and we would accept a little more cannibalization because the overall profitability of the market is enhanced. So I don't think that cannibalization number is as high with our independent dealers, but that's what we've been experiencing for the last couple of years.

Okay. Thank you for that clarification. And also, just wondering how has February shaped up, including the Presidents' Day weekend?

It's kind of early for us to really give you a broader view on how all of our customers did. We wouldn't have that data immediately. What we're hearing is positive. And most telling data point that we have is what our own stores did over the 5-day holiday and we were satisfied with how we performed during that time. So this is the last big holiday. The next one probably isn't until Memorial Day weekend. So it always is one of the top 3 holidays of the year for us and we were pleased with our performance.

Got it. Got it. Okay. And also in your 10-Q, you mentioned that you are targeting 400 La-Z-Boy stores, 600 Comfort Studio locations. What's the expected timeframe? If you could give us like a ballpark estimate when you think you can achieve those targets?

So this would be -- in April would be the end of our 5-year period on 4-4-5. So we wanted to have 400 stores, averaging $4 million in 5 years. And we got to -- about 2 or 2.5 years in, we got to the $4 million average per store, which is where we still are. But as I mentioned a number of times, the reason we did not have more stores in our overall count is the cost of real estate in certain markets, which is beginning to change because there's more real estate available. But we have a limit on what we believe we should pay for real estate to be able to have a profitable store and we're just going to be more prudent about that. The benefit, on the other hand, is our dealers and ourselves remodeled more stores and put more stores in the new design concept than we anticipated. So we've got a more up-to-date footprint out in the market. And I'm still of the opinion that we will get to the 400 stores, but I'm not going to put a timeline on it because the last 10 or 15 stores will probably be the hardest, but there certainly is room for another 40 to 50 La-Z-Boy stores in North America.

Got it. And then the 600 Comfort Studio locations, is that similar as far as the timeframe where...

Yes.

Okay. Got it.

Yes. Let me -- the thousand number, Anthony, was an aspirational goal, and one that we are -- still have in our sights. But there is room for that. And we think we can partner with a lot of great retailers and have the La-Z-Boy gallery space within their store be one of the more productive dollars per square foot areas that they have. And we're continuing to add new in-store galleries quite a bit.

(Operator Instructions) Our next question is coming from Brad Thomas from KeyBanc Capital Markets.

This is Sameet Desai on for Brad. It's great to see that written trends have continued to accelerate quarter-over-quarter. Could you comment on transaction and ticket trends and your ability to continue performing at this level?

Well, we've stayed on a pretty consistent glide path of our traffic being down, and not significantly, but trending down probably for the last 3 years. But the effort on close rate, the effort on average ticket, the percentage of in-home business we're doing, where there's a much higher ticket, have been able to compensate for that. And we don't -- we do not see traffic going down as much as we did 3 years ago. So I think we're reaching a plateau. But the average ticket and getting a higher share of wallet by selling the customer multiple products and accessories and tables has continued to move forward. So that will be key to us to keeping the stores' volume up there is that trend to continue. And our belief is that consumers, instead of shopping 3 or 4 stores for furniture today, do all their research online. They eliminate a couple of their options and only go to the places they're really intending to buy. So we have research that indicates they're a little more predisposed to buy when they come in. So the results we're seeing should happen given the change of where the customer gets their information.

Okay. Could you talk a bit about the trends you're seeing across your various distribution channels? And any differences in trends between your major and minor independent dealers? And also are you seeing any success gaining more floorspace or exposure with the Duo line there?

So we're -- I'll answer the last half of your question. We're very pleased with our Duo line and the placements, where it was, and I would believe that just about every one of our major customers put that product on the floor and is having success. But I would also say with all the effort that we've put on the stores and the extra stores that we have build out, we've build out 50 new stores in the last 4 years. Surprisingly, as a percentage of our overall business, our stores are about the same as they were 5 years ago. So that means our other independent dealers and major accounts and small rural dealers have continued to grow their La-Z-Boy business at the same time, which I think is very healthy for the company. So we like our dual-distribution strategy, we like having representation in the -- all the markets across North America. And there's no discernible difference. It's not significant, but probably there's more smaller family retailers going out of business as the world becomes more digital and people's shopping patterns change. But other than that, we haven't seen a major shift in where our business is coming from.

Okay. Thanks for the color there. And lastly, on price increases. You mentioned in your prepared remarks that you feel pretty good on the price increase that you just took offsetting the raw material increases into 4Q. I'm hoping you could walk us through that a little bit given we've seen raw material prices continue to increase over the last several months. And presumably, the price increase that you just put through was planned at a lower level. Just curious how that works out? And what that means going forward?

So just to correct one thing. We were not pleased with our price increase, but it was a necessary evil. We just had the belief that we do not try to take price increases on -- for any other reason but raw materials. We think we should be more efficient, we think we should save money with inside the operations and cover our own increases like health care and wages. But raw materials are just something that you can't overcome. So we took at the time what we thought was the correct number. We introduced that at the October market. And since we have a 30- to 45-day backlog, your price increase doesn't go into effect right away. And so the only month in this past quarter that we had the full benefit of the price increase was January. So all of our business in November, December was at the old price. The fourth quarter will be the first quarter with the price increase for the whole quarter. So we are hearing some noise about foam prices, steel prices. We're watching them. We have typically contracts with some of our vendors that extend out over maybe when they would take an increase commercially with other people. It doesn't mean we don't get it, but we don't get it necessarily on certain timing. So -- and you were correct in your other statement that we didn't plan for a second round of price increases 4 months after the first ones came along. So we'll have to watch that. We believe we're, perhaps, covered here for the fourth quarter. But if those happen, we'll have to think about how we go to market in April and what it may mean in the first quarter for our dynamics. But inflation is alive in the furniture business.

Thank you. We've reached end of our question-and-answer session. And that does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.