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Stanley Furniture Company Inc. (NASDAQ:STLY)

Q3 2009 Earnings Call

October 15, 2009; 09:00am ET

Executives

Albert Prillaman - Chairman & Chief Executive Officer

Glenn Prillaman - President & Chief Operating Officer

Douglas Payne - Executive Vice President

Analysts

John Baugh - Stifel Nicolaus

Budd Bugatch - Raymond James

Tucker Anderson - Cumberland Associates

Presentation

Operator

Greetings and welcome to the Stanley Furniture third quarter operating results. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

It is now my pleasure to introduce your host, Mr. Douglas Payne, Executive Vice President for Stanley Furniture. Thank you, Mr. Payne. You may begin.

Douglas Payne

Thank you, Rob. Good morning. Welcome to our quarterly conference call to review our third quarter 2009 operating results. We appreciate your participation. Joining me this morning is Albert Prillaman, our Chairman and CEO; and Glenn Prillaman, our President and Chief Operating Officer. Because of some sales meeting in the upcoming international home furnishings market in High Point, North Carolina, the three of us are in separate locations this morning.

During our call this morning we may make forward-looking statements which are subject to risks and uncertainties. A discussion of the factors that could cause actual results to differ materially from our expectations is contained in the company’s SEC filings and the Press Release, announcing our third quarter 2009 results. Any forward-looking statement speaks only as of today, and we undertake no obligation to update or revise any forward-looking statements to reflect events or circumstances after today’s call.

With that out of the way, I believe Albert has some opening comments.

Albert Prillaman

Thank you Doug. Good morning everyone. It was a difficult quarter and a disappointing quarter. After a sequential increase in sales in the second quarter, we were kind of optimistic for the fall selling season, but business drifted off again in the third quarter.

I remind you that we are in the, let’s call it the luxury market of the wood business. Our customer is the jumbo loan house buyer, and that market remains severely depressed, and that makes our business very difficult. The lower sales also made it more difficult in our manufacturing operations. Glenn will address that, and Doug will address our balance sheet, which as you can see from our press release, remains very strong.

So, Glenn let me turn it over to you first, and you make any comments about the operating results, marketing initiatives and so forth.

Glenn Prillaman

Okay, thank you. Let me also say that we are disappointed in the results. We recognize that our market segment continues to struggle, and we are currently acting on certain cost reduction efforts to lower our break-even point. A specific example of such is our offering an early retirement program, which will reduce our headcount as we move into next year.

In addition, although it’s too early to share details, we are looking at multiple options to better utilize our capacity. On the sales and marketing side, we are extremely optimistic about the repositioning of the Young America brand, as the brand you can trust, and we once again think we will create a niche in the marketplace for this product category that we can own.

What we are doing is costly and it creates some short-term interruption inside our factories and with our retail distribution. It has and will continue to contribute to operating income challenges, but we do believe we have made the right decision strategically for the future, for the product line and for the company’s profitability.

On the Stanley Furniture adult side of our product line, we continue to believe in a blended strategy of domestic production supplemented by overseas sourcing, and we are currently seeing some promising results from last market’s introduction, even though the overall marketplace is certainly lack-lustered.

Albert Prillaman

Thank you Glenn. Doug, why don’t you take us through the balance sheet, and any color on the financials that you think are appropriate?

Douglas Payne

Okay. As Albert indicated, our balance sheet remains in excellent shape. We ended the quarter with $42.4 million of cash on hand, and our total debt is $27.9 million. The $42.4 million of cash on hand is up about $1.7 million from the end of the second quarter. We began the year with $44 million of cash on hand, and we made a scheduled debt payment of $1.4 million during the second quarter. Excluding this payment our cash on hand at the end of the third quarter is about where we started the year.

Working capital excluding cash and current maturities and long-term debt decreased to $46.1 million at the end of the third quarter, which compares to $53.8 million a year ago and $54.5 million at year-end 2008. In response to the lower sales, we have quickly adjusted our inventory levels.

Inventories declined $12.2 million or 26% from the year ago quarter, and have declined $12 million since December 2008. Accounts receivable have declined 28% from a year ago, to the end of the third quarter at $18.1 million. While we’ve experienced some slower pay practices as you might expect due to the recessionary environment, our day sales outstanding and accounts receivable is within our normal historical range, and in keeping with our balance sheet management, we did not repurchase any stock or pay cash dividends during the quarter.

One other thing I might point out, the consolidation of our Lexington, North Carolina warehouse operation into other company-owned warehouse space is progressing slightly ahead of schedule, and we expect to be complete during the fourth quarter.

We did record a little over $1 million of accelerated depreciation in the third quarter related to this consolidation, and we expect to record about $700,000 of additional accelerated depreciation in the fourth quarter. This warehouse consolidation should lower our operating expenses by approximately $1.3 million a year, which will kick-in in the beginning of 2010.

Albert Prillaman

Okay, thank you Doug. Now Operator, I’d like to open it up for any questions.

Questions-and-Answers Session

Operator

(Operator Instructions) Your first question comes from John Baugh - Stifel Nicolaus.

John Baugh - Stifel Nicolaus

I guess my first question is for Glenn, on the marketing push with Young America. What specifically are you doing in dollars? I understand the manufacturing shift and the disruption, but you seem to indicate there’s some impact on the marketing side or to your customers, and I’m wondering if you could just sort of elaborate a little more on the manufacturing disruption piece versus the marketing disruption piece.

Glenn Prillaman

Sure John. The major disruption in the factory is just making new products. They are not products that we haven’t made before, but as we began to source overseas certain products that were more labor intensive, more material intensive, ‘99, 2000, like beds, bunk beds, cribs, things like that, we really focused our factories on making cases.

So now that we bring those cribs and bunk beds, beds back here, we’ve just got some challenges in making those new products, but nothing that we haven’t had engineered before and made before.

John Baugh - Stifel Nicolaus

Then on the marketing side, what specifically are you doing? Are you increasing marketing dollars? What’s the impact to any of this to your dealers? Maybe carry a little more inventory, finished goods, bringing the sourced stuff in first before you make the stuff here, etc.

Glenn Prillaman

We are not planning on increasing the marketing dollars. We are going to keep our costs in line there as far as our fixed selling. Our main mission on the marketing side is to get across to the consumer at the retail level.

This idea of a market leadership position in color and choice, and the indoor air quality of a nursery in creating a safety level of our product that’s far and way above what is called compliance or the law; and then just because we control the production now, the quality and service, we definitely think we can improve on that. So no, not any kind of increase in marketing costs to get this across.

Albert Prillaman

Hey John, just to add to that, what we’ve really done between what we started now and will complete in the first quarter, and keep in mind, Young America is nearly half of our business. We have reinvented the entire product line, and with finish options, safety options, safety requirements, that really can’t be a match in the industry. Now the consumers may have to pay a premium for it, but she was already paying a premium for our product. But now we give her a reason to pay the premium.

John Baugh - Stifel Nicolaus

Sure. Then just a broader kind of strategic question, anybody can answer this. I’m not going to pin you down on the initiatives across reductions that you’re working on and numbers, but philosophically, how do you think about your revenue? Where do you drive your break-even point to?

I guess where I am coming from is; you can sustain a level of EBIT loss for quite some time, given your balance sheet, your cash flow, and the CDSOA money coming in. So I am curious how you and the Board think about what level of capacity do we want to leave open and absorb some losses. In other words, keep our capacity maybe only lower the break-even at $180 million in revenues, or do we need to go to $160 million to $150 million to break even now? I am just curious as to the puts and takes of a strategic thinking on that.

Albert Prillaman

Well, let me take a stab at that, since I’m supposed to be paid for being a strategical guy. The difficulty is determining. As I said earlier, we are in a luxury market, and that market is just really dead right now and people are out of the market. You’ve got to determine what’s going to be the size of that market two years from now, three years from now, four years from now. We don’t see it returning to its former size. We are not counting on that.

So in the meantime, you always leave some protective capacity, but in this business or any manufacturing business, unless you are north of maybe 80% plus in capacity utilization, it doesn’t make sense. It’s easy to go back and add the capacity quite frankly. So we are not going to hold onto excess capacity forever, and by the same token, we are not going to totally mortgage our future either, but what we refer to as a 21st century furniture company as we come out of this thing.

We really think it’s going be different; it’s going to look different. So we are thinking about our factories in a totally different way, and we are not there yet, not ready to share anything, but we don’t see anything going back to the old days, so to speak, and distribution channels are going to continue to change, that’s another factor.

So we want to come out of this thing, whenever we do come out of it, as really a new kind of company with market niches that we can defend, and not just be totally subject to knocked off at a lower price all the time. We are going to give people things they can’t get from lower cost operations.

Now having said that, because you can’t on a product-per-product basis like product, you can’t compete with what offshore and Asia can give you, but if you can satisfy different marketing niches, and like the Young America decision was a market driven issue, in order to satisfy our marketing initiatives you have to bring it back inside. On the adult side, in fact we might even expand sourcing, that is yet to be determined.

So we are not satisfied at all at saying “We are going to maintain operating losses for a period of time.” As we go into next year, we want to get leaner and leaner and leaner. We are treating our business like we don’t have any cash John, to be honest with you.

John Baugh - Stifel Nicolaus

So you said before, your break-even was around $200 million.

Albert Prillaman

We’re going to take it well below that.

John Baugh - Stifel Nicolaus

You’re running at $160 million. So do you care to stab at a number? Are you targeting $160 million or you just don’t want to go there right now.

Albert Prillaman

I don’t want to go there right now. We’re going to do what we have to do though.

Operator

(Operator Instructions) Your next question comes from Budd Bugatch - Raymond James.

Budd Bugatch - Raymond James

Let me try to just piggyback on where John was going. Can you give us at least some color as to the difference in performance between adult and youth?

Albert Prillaman

We have more excess capacity in adult than we do in youth.

Budd Bugatch - Raymond James

So does that mean that youth then had a lower Op loss or…

Albert Prillaman

I’m not going to go there, but you can reach your own conclusion. Youth is moving toward better capacity utilization than the adult business.

Budd Bugatch - Raymond James

And the youth conversion, that will be finished in the first quarter?

Glenn Prillaman

Yes. Well Budd, I would say yes in terms from the marketing standpoint. Yes in service as well, but not from a profitability.

Budd Bugatch - Raymond James

How about sourcing and manufacturing? Is your sourcing complete now overseas, so you’ll now be all produced inside?

Glenn Prillaman

Yes, Budd.

Budd Bugatch - Raymond James

That will be complete in the first quarter, Glenn?

Glenn Prillaman

Yes, and we‘ll be rotating through the line, through the different patterns in the line in the first quarter, but our retailer will be in service with the new story, the new goods in the first quarter.

Budd Bugatch - Raymond James

Service levels today, how are they?

Albert Prillaman

Service levels are very good on the Young America side of the business and the adult as well. The demand level right now really does have us in any position where we are extremely concerned about service interruptions.

Budd Bugatch - Raymond James

Okay. You note inefficiencies; are the inefficiencies basically on absorption and also learning costs of making. How do you parse between the two of those?

Douglas Payne

The issue with our financial performance is by and large a volume driven issue. There is ground noise as I would call it, with the transition on the products that we brought back in through our factories that we were sourcing previously, and that has certainly added to the manufacturing inefficiencies that we’ve incurred, but by far the larger factor is just overhead absorption or under absorption.

Budd Bugatch - Raymond James

And you drew down inventories I think by $5 million. I don’t believe the Q is out. I haven’t been able to find it if it is. Is most of that draw down in finished?

Douglas Payne

Yes.

Budd Bugatch - Raymond James

So that would lead you to believe that we were drawing down inventories at the same time, trying to get in front of the capacity utilization issue?

Douglas Payne

Yes.

Budd Bugatch - Raymond James

Okay. On to the CDSOA issue, I understand there may have been some developments in the legal community on some challenges, is that true or do we have any clarification on that?

Albert Prillaman

Yes. Budd I would answer that as, the legal proceedings are still ongoing, and nothing really has changed that would cause us to adjust or change the ranges of what we might receive depending upon the final resolution of all of those legal issues.

Budd Bugatch - Raymond James

But hasn’t their appeal been turned down to go on banc? I thought that I heard that.

Albert Prillaman

Yes, it has.

Budd Bugatch - Raymond James

So it has to go to the Supreme Court now if it’s going to be heard anywhere?

Albert Prillaman

Yes.

Operator

(Operator Instructions) Your next question comes from Tucker Anderson - Cumberland Associates.

Tucker Anderson - Cumberland Associates

Yes Albert, you said that in a lot of ways you’re assuming that we are going to be in a new world, new paradigm, whatever you want, both in terms of the strength of your market, but another way that it looks like we may be in a new world is with pretty continual pressure on the ballot for awhile, and other economies growing a lot faster than ours, perhaps the Asian markets and things like that.

I was wondering, if you think through the sourcing and trade issues and those sort of things, if that’s part of your thinking, how you’re going to size the business, how you’re going to source it, that sort of thing?

Albert Prillaman

Not really Tucker, because your Asian sources are tied to the dollar anyway. So it doesn’t impact. What’s happening to the dollar is not impacting what’s happening out of sourcing in Asia.

Tucker Anderson - Cumberland Associates

You don’t think it would on a continuing basis? I understand that’s true on a short-term basis.

Albert Prillaman

Lots more of the people have to address that regarding, does China ever float their currency, and does that inequity ever go away. It would lead you to believe that they’re going to long-term have more cost pressures than we do, but on our adult side, most of what we source, literally everything that we source, and Glenn you addressed this, is more or less design driven and very labor-intensive type of techniques, whether it be carving or finishes or things like that or materials.

You can just get that at a much lower cost overseas than you can here, primarily from Asia, and it’s not just China, it’s also Indonesia and to some extent Vietnam, but we are not doing anything in Vietnam at this point. Is that right Glenn, its all Indonesia primarily?

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Albert Prillaman

Thank you very much. We appreciate you joining us this morning. We are just going to continue to work through this. We are constantly looking at how do we make our product line better, moving to the future versus looking backwards too, and also our operating efficiencies, but we are going to do what it takes if this market just stays at this level for some time. We are committed to getting back to profitability. In the meantime, you can count on a very strong balance sheet management.

That concludes our comments, and thanks again for joining us. Good-bye.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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