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Executives

Ralph Scozzafava – Chairman & Chief Executive Officer

Vance Johnston – Senior Vice President & Chief Financial Officer

Rick Isaak – Chief Accounting Officer & Investor Relations

Analysts

Brad Thomas – KeyBanc Capital Markets

Furniture Brands International, Inc. (FBN) Q1 2013 Earnings Call May 3, 2013 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2013 Furniture Brands Earnings Conference Call. My name is Jo and I will be your Operator for today. (Operator instructions.) As a reminder, this call is being recorded for replay purposes. I would like to now turn the call over to Rick Isaak, Chief Accounting Officer of Furniture Brands. Please proceed, sir.

Rick Isaac

Good morning everyone and thanks for joining us today. With me this morning is Ralph Scozzafava, our Chairman and Chief Executive Officer; and Vance Johnston, our Chief Financial Officer. I want to take a moment to read the Safe Harbor Statement before I hand it over to Vance to go over our financial results of Q1 2013. Ralph will then review the quarter and the progress we’re making on our transformation plan.

I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934. Our actual results and future financial condition may differ materially from those expressed in any such forward-looking statement as a result of many factors that may be outside of our control. Please refer to our SEC filings including our Form 10(q)s and Form 10(k)s for a discussion of the major risks and uncertainties that may affect our business.

The forward-looking statements made today are as of the date of this call and we do not undertake any obligation to update our forward-looking statements. If you do not have a copy of today’s press release you may obtain one, along with copies of prior press releases and past SEC filings by linking through to the Investor Relations page of our website, www.furniturebrands.com. I will now hand it over to Vance to discuss our financial results.

Vance Johnston

Thanks, Rick, and good morning everyone. As reported in this morning’s press release, total sales were $254.7 million for Q1, down 11.3% from the same quarter last year. Sales from the 46 Thomasville stores that we have operated for more than 15 months decreased 2.3% from Q1 2012.

Gross profit for Q1 2013 was $51.5 million and gross margin was 20.2%, which included $1.0 million in charges related to product rationalization as compared to $71.4 million in gross profit and 24.9% in gross margin in Q1 last year. The year over year change in gross margin excluding the aforementioned charge was primarily due to deleveraging the fixed manufacturing costs due to lower sales, product rework and additional inventory charges, increased freight costs and increased employee benefits costs.

As we have explained on prior calls we are refreshing our product portfolio at Lane which will take some time to work through. As we clear existing product and make room for the updated product we expect to have some level of discounting and gross margin pressure.

SG&A expenses totaled $69.1 million for Q1 2013 compared to $70 million in Q1 2012. SG&A for Q1 2013 includes $500,000 in charges related to dark stores. The decrease in Q1 SG&A excluding this charge was primarily due to lower compensation costs partially offset by an increase in advertising expense. We continue to focus aggressively on improving our cost structure and controlling costs.

The operating loss for Q1 2013 was $19.0 million as compared to operating income of $1.4 million in the prior year period. The current quarter operating loss includes $2.2 million of charges which consist of the aforementioned $1.5 million of product rationalization and dark store charges as well as $1.4 million of impairment charges related to assets held for sale.

Interest expense for Q1 2013 was $2.4 million as compared to $800,000 in the prior year quarter. The increase in interest expense was primarily due to increased interest rates on higher debt and amortization of debt issuance costs related to the debt refinancing in September, 2012.

Net loss for the quarter was $21.2 million or $0.38 per diluted share which includes a $2.9 million after-tax charge for the aforementioned items. This compares to net income in Q1 2012 of $400,000 or $0.01 per diluted share.

Inventory at the end of the quarter was $241.7 million, which is down from the year-ending inventory balance of $244.3 million but up from the [prior year Q1] ending inventory balance of $225.5 million.

Capital expenditures for Q1 were $1.8 million. In Q1 we contributed $1.3 million to our pension plan. Cash at the end of the quarter totaled $10.3 million and long-term debt was $116.8 million. Although net earnings were below plan we were able to effectively manage working capital and ended the quarter with cash in line with our internal plan.

We ended the quarter with total liquidity of $60.4 million comprised of a cash balance of $10.3 million and $50.1 million in excess borrowing availability under our credit facilities, which we believe provides us the flexibility we need going forward.

As you know, it is our practice not to provide guidance but we want to share a few points and enable you to understand the framework within which we are planning 2013. Our focus continues to be on generating positive EBITDA and free cash flow and I would like to provide some comments on the key components.

One, we continue to expect to contribute around $6.0 million to $6.5 million to our pension plan in 2013. Secondly, we expect to generate cash flow from working capital through the rest of 2013 primarily through lower inventory. This is a key focus area for us and we expect reduced inventory throughout the year. We expect DPO and DSO levels to remain relatively stable for the rest of the year. Thirdly, we now expect to spend around $15 million in CAPEX for 2013. Fourth, we expect to generate approximately $2.5 million in proceeds from asset sales in 2013. Fifth, we expect [DNAA] to be approximately $17 million to $19 million in 2013.

And lastly, I finally want to provide some qualitative color around the major income statement drivers. Ralph will discuss sales in more detail in a moment, but we expect sales declines to moderate throughout the rest of the year.

While we expect to continue to see gross margins impacted by our product refresh we have spoken about, we do not expect to see declines of the magnitude that we saw in Q1 for the following reasons: our Q1 margin decline included a number of items that we do not expect to reoccur. I called out the $1.0 million in product rationalization charges in Q1 – in addition, gross margin was also impacted by some isolated rework and additional inventory charges, some of which we have addressed.

We also expect improvements in our wholesale business due to actions being taken to improve product and our overall value proposition. And thirdly, we expect to realize the benefits of facilities consolidation and additional product manufacturing and overall cost improvement activities that will lower cost of sales. And as we benefit from the cost saving initiatives that we’ve already put in place and some of the additional initiatives yield results, we expect SG&A to decrease year-over-year in the mid-single digit range for the rest of the year.

I’ll now turn the call over to Ralph to provide more commentary on our results and specific transformation initiatives.

Ralph Scozzafava

Thanks, Vance, and good morning everyone. Let me just start by saying that this was obviously a difficult quarter for us to say the least in what was a volatile environment. I’ll discuss this in greater detail in a moment but I’d like to note up front that we continue to focus on our transformation plan to drive both revenue enhancements as well as cost reductions. And while the numbers don’t show it yet, we did make some tangible progress in a handful of key areas.

That said, and let me be clear, a quarter like this is unacceptable for all of us here and we’re making the significant efforts necessary to restore positive EBITDA and free cash flow generation. On today’s call I want to review our Q1 results including a discussion of sales performance at our largest business groups and provide an update on our plan for 2013 and beyond.

Starting with sales, Q1 sales decreased 11%. Shipment trends were choppy throughout the quarter with January and March being the weakest months. However, some of our key businesses like our Designer Brands and contract business did deliver solid performance throughout the quarter. We ended the quarter with our backlog levels down just slightly from the year ago period.

Now, for sales performance by business group starting with our dedicated retail business focused on Thomasville, comp store sales at Thomasville retail for Q1 2013 decreased 2% from the prior year period. However, we saw improved order trends in Q1 and were pleased with our written sales increase of 6%. The backlog for this business was up and we expect to deliver that associated backlog in Q2.

We’ve made significant progress over the last two years improving the relevancy of our styles by reflecting the updated and contemporary looks in our offerings, and we’re starting to see some traction from this. We’re also very focused on driving improved and consistent visual merchandising in our stores. We took numerous markdowns of old accessories and outdated fabrics in our stores in Q1 to enable to us to begin the flow of our updated accessories and new fabrics. We believe that these in-store enhancements will pay off in the future.

Our four new and remodeled Thomasville stores are performing very well, which is reflective of our improved store format. Both the new stores as well as the relocated stores outperformed chain averages for delivered as well as written sales by a very wide margin in Q1. We plan to continue to prudently refresh and remodel where we see the highest potential for improved results.

For our Wholesale Brands which consist of Lane and Broyhill, our sales performance was below our expectations. We’re very focused on driving key sales initiatives to positively impact our top line and drive gross profit improvements in this business. As we’ve said before, we’re in the process of dramatically reconfiguring the merchandise assortment across key categories for both Lane and Broyhill.

We plan to maintain our position in existing key product, style, and price segments while then increasing our share in higher-volume, lower price point segments with great product values to help drive an increase in sales and gross profit dollars. We believe that great products at the right prices, combined with Lane’s and Broyhill’s strong brand recognition will drive improved results.

We’re much further along in driving the strategy at Broyhill where we’ve seen improved performance in upholstery and some improvement in case goods. At Broyhill during Q1 we continued to see relatively strong results in our stationary upholstery business which is returning to a leadership position in the mid-priced upholstery segment. We recently introduced a new line of Motion upholstery at Broyhill that is transitional in look and feel and appeals to the customer that wants a more contemporary look.

We’re also pleased with the results we’re seeing from our case goods mixing program which continues to get favorable responses from our dealer network. We’ve now expanded our container direct case goods program with newer collections at market to enable our dealers to floor more Broyhill case goods and more easily flow full containers.

At Lane, we just introduced the new stationary line at the April Highpoint Market which included several new stationary sofa introductions which are targeted to meet $499 price points. There was significant industry volume in the stationary segment and we’re working on positioning ourselves to gain our share of this volume.

Given our large Motion business at Lane, our dealers will gain significant freight benefits when they buy and ship stationary together with Motion products from Lane. These new introductions were very well received at our market and we believe we’ll see improved results in this category.

Having the right product at the right price point is one of the key challenges at Lane and we’re in the process of addressing this. As mentioned on previous calls, making way for this new and improved product necessitates removal of older product at discounted prices – and that’s expected to continue to have an impact on our gross margins throughout 2013.

Turning over a large product portfolio to create better looking, more relevant product at great values to our dealers and end customers is not a quick or easy process. We have a plan in place to achieve this and we’re making solid progress against this plan. We’re pleased with the reception in the new stationary line as received and are hard at work at developing new products for Lane in the Motion line that will enable us to hit key lower price points with updated product styles. And we’ll be introducing these products this year.

At our Designer Brands business we continue to see positive results highlighted by strong performance at Henredon and Hickory Chair. At the recent Highpoint Market the showrooms of our Designer Brands saw very strong traffic as each business launched exciting new product assortments for the spring season. And in our Special Markets Business Group which houses our contract, ready-to-assemble, and licensing businesses we’re seeing continued improvement and solid performance across all of these businesses.

So now I want to spend a moment on the transformation plan we have in place to improve our results going forward. There are four key elements of our multi-year transformation plan. The first is developing and executing an integrated retail model. Further establishing Thomasville as a leading, multi-channel furniture retailer is key to our future success.

As I mentioned earlier, we’ve made progress revitalizing our product and are now focused on updating our accessories and refreshing the appearance of our stores, both inside and out; and strengthening the effectiveness of our marketing and promotional programs. While it’s early days with our new store prototype and the sample size is small, the improvement in the results that we’re seeing is dramatic.

Secondly, we have to drive distribution on our Wholesale Brands. We’re focused on revamping our product assortments to ensure that we have the right product at the right price points, including a strong and competitive offering at the higher-volume lower price point entry segments. The key here is addressing the Lane Motion business next which we’re aggressively focusing on. You can expect to see some exciting new products in the second half of the year on the Lane business.

The third piece is simplifying our structure and significantly reducing our costs. Our organizational structure, as we told you earlier this year, is being built around four primary business groups – Dedicated Retail, our Wholesale Brands, our Designer Brands, and Special Markets. This helps us to simplify our structure and also enables positive synergies in terms of how we operate these businesses which will benefit both our dealers and our end consumers.

In addition to the revenue driving benefits there are associated cost benefits. First, we expect to drive additional overhead cost savings of $5 million to $8 million primarily from impacting SG&A going forward. We took some actions and associated charges in 2012 and are well on our way to executing these plans in 2013 – and we’ll see some additional cost reductions that’ll go into 2014 and going forward from there.

Second, we have a supply chain network optimization program that we’re working through. We expect $10 million to $15 million in warehouse, plant, and freight consolidation by 2016 and have already begun the execution phase with our Q1 announcement of the consolidation of our Mount Airy plant into our Longview facility. The Longview project is on track and expected to be completed in Q3. We’ll keep you abreast of other activities as they unfold.

The third piece is some value engineering and some other very specific supply chain cost initiatives. We’ve targeted $2 million to $4 million in savings by 2014 and we’re going to get a number of these productivity initiatives across our supply chain. And lastly, we have some other facility costs that we can rationalize. These are vacant corporate real estate, vacant stores, and some other unused facilities. The old Broyhill facility that we recently sold is an example of this.

We expect $2 million to $4 million in annual run rate savings by the end of 2015 from the continued consolidation of nonmanufacturing facilities executing early terminations for store closings and executing subleases on closed stores and other properties. These cost reductions are in addition to the benefits we expect to receive from the normal roll-off of our dark store leases.

And then we’ve talked about before the fourth big piece of our plan, and that’s vertically integrating across more of our businesses. This encompasses two elements – forward integration through the disciplined expansion of our Thomasville stores as well as backward integration into offshore manufacturing in our high-grid supply chain structure.

We’ve accomplished most of what we set out to do recently in our supply chain, primarily through the building of our low-cost offshore capacity with our Indonesia case goods manufacturing plant and our Mexico cut-and-sew facility. Moving forward we’ll opportunistically expand these capabilities starting with Mexico.

In summary, I can tell you this – our results must improve, and we will not be satisfied until all the work we’re doing to execute our multi-year transformation plan delivers improved financial performance on a consistent basis.

While our brand portfolio is diverse the recipe for improvement is consistent, building the capacity and the capabilities to deliver compelling and relevant product at an attractive value with excellent service. Where we’ve done this we’ve seen the desired results. Where we have yet to implement the necessary changes we’ve seen underperformance.

We believe we have solid plans in place to address the areas where we are underperforming and this organization is focused on making significant strides to improve our product, value, service levels and cost structure as we work forward, driving to our positive EBITDA and free cash flow.

This concludes our prepared remarks for this morning and now we’ll hand the call over to the Operator to start the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) Your first question comes from the line of Brad Thomas from KeyBanc Capital Markets. Please proceed.

Brad Thomas – KeyBanc Capital Markets

Thanks, good morning guys. I wanted to first just ask a bit more about the sales trends during the quarter. Obviously the numbers are a little bit disappointing relative to what we had been looking for. Can you just share a little bit more color around how the color played out by month? And obviously you highlighted written orders in the Thomasville that looked better but what are you seeing out there? This is obviously a challenging quarter for the consumer in general – I’d just be interested in any more details that you could share.

Ralph Scozzafava

Sure. I think a couple things, Brad – I think we mentioned it’s choppy, and for us, just to give you a little bit more color and more data than we typically do, we finished last year, our total sales were down 3%. And in our Q4 our sales were up 3%. And really it was back loaded. We had a December where our sales were up year on year 13% and it brought us into a January where sales were down. We saw a February where sales were relatively flat, down in March and we just closed in April where our sales are up slightly. So it’s very, very, very choppy.

So as we look at it over a longer period of time, some of the trends that we’re seeing are fairly consistent. Our Designer Brands have performed extremely well, our Special Markets business has performed well. So brands like Drexel Heritage and Henredon and Hickory Chair, all doing fairly well; and the bulk of our challenge has been in our wholesale businesses, Broyhill and Lane. And that’s why you’re hearing and seeing about all the activity we have in making sure that we have relevant product, making sure we hit the right price points.

We’re very pleased with the progress made in Broyhill upholstery – probably one of the better businesses in our company. And I know you’ve followed us closely – our case goods mixing program at Broyhill, which we started shipping in June and July last year is gaining traction. And we just had a big stationary introduction for Lane at Highpoint Market and there’ll be more to come there, certainly on Motion and our reclining chair business.

So we’re attacking the pieces that need help but I will say on a macro level – pretty choppy. Months up, months down, and this is a quarter we’re clearly not pleased with.

Brad Thomas – KeyBanc Capital Markets

And so just to follow up from a doors and floor space perspective, Ralph, it seems to be an exciting time for the furniture industry where housing’s coming back, replacement cycles are kicking in. Retailers obviously want more exposure to home-related products, but by the same token many of them can go directly to Asia and buy from factories there. What’s the outlook for you from a doors and floor space perspective?

Ralph Scozzafava

Yeah, I think the key to this for us is we’ve got to get more slots on floors, right? And net doors have to increase – that’s the biggest thing that we’re driving on our wholesale businesses. And that’s an everyday, in the trenches kind of a focus. And I think to get there you’ve got to have excellent product, and you’ve got to bring value and you’ve got to bring service.

So just a case in point, I think the stationary introductions that we’ve made in Broyhill over the past two years are exactly the kinds of products that our dealers want. These are excellent products that have great looks, tremendous I think fabric-to-frame application; and I think the service levels and quick ship is really, really compelling.

That’s how we’re going to get on the floor and be able to compete, you mentioned with offshore people. We’ve got to be able to do that – offer value, offer looks, offer service. And then we do it with great brands which some of our competitors don’t have.

Brad Thomas – KeyBanc Capital Markets

Great. And then just a housekeeping item on the inventory – it sounds like there’s a good opportunity to reduce that to drive working capital improvements. Where would you feel comfortable bringing your inventory by the end of the year?

Ralph Scozzafava

Yeah, I think that’s a number that internally we’re going to have a lower target than anything we would tell you externally, but we closed I think it was 2011 somewhere around $225 million. We’d like to think we can do better than that but we’ve got some internal targets and we’re going to go ahead and get after them.

Brad Thomas – KeyBanc Capital Markets

So another $15 million to $20 million for this year.

Ralph Scozzafava

Yep, every quarter we’re going to take it down, and the key to it is to maintain service levels.

Brad Thomas – KeyBanc Capital Markets

Great. Thanks for all the color and good luck.

Ralph Scozzafava

Great, thanks Brad. Good to hear from you.

Operator

Thank you. Sir, you have no further questions at this time. (Operator instructions.) We have no further questions. I would like to hand it back to Rick.

Ralph Scozzafava

Okay, thank you Operator, this is Ralph. Thank you everyone for joining us today. We will certainly work hard over the next quarter and we look forward to speaking to everyone in August. If you have any questions for us please contact us here at Furniture Brands. Rick, Vance, and myself will be available. Take care, everyone.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect, good day.

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