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Stanley Furniture (NASDAQ:STLY)

Q3 2013 Earnings Call

October 15, 2013 9:00 am ET

Executives

Micah S. Goldstein - Chief Financial Officer, Chief Operating Officer, Principal Accounting Officer, Secretary and Director

Glenn Charles Prillaman - Chief Executive Officer, President and Director

Analysts

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Barry George Haimes - Sage Asset Management, LLC

Steve Hale

Brad Hathaway

Operator

Greetings, and welcome to the Stanley Furniture Third Quarter Investor Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Micah Goldstein, Chief Operating Officer and Financial Officer for Stanley Furniture. Thank you, Mr. Goldstein, you may begin.

Micah S. Goldstein

Thanks, Rob. Good morning. Glenn and I appreciate you all taking the time to join us this morning, while we review the results of our third quarter.

During the call this morning, we may make some forward-looking statements that 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 our SEC filing and the press release announcing these results. Any forward-looking statement speaks only as of today, and we undertake no obligation to update or revise those forward-looking statements to reflect events or circumstances after this morning's call.

Glenn, I'll turn it over to you to kick us off.

Glenn Charles Prillaman

Good morning, everyone, and thank you for joining us. Our business showed important signs of improvement during the quarter. And after 3 years of strategic change necessary to position both our Stanley and Young America brands for growth, we are starting to see the benefits of our work.

I'd like to take you through a few of those. First, sales have stabilized, and we should begin growing in the near term. Second, service to customers improved through our domestic manufacturing model supporting our Young America brand, as our customer noticed better order fulfillment rates as the quarter ended. Third, the difficulties we experienced in Q2, after the launch of our new operating system in May, continued in Q3, and that did affect -- negatively affect sales, but it greatly dissipated as the quarter progressed. We entered Q4 with our customer well informed of order status, invoicing and acknowledging, stock availability and lead times for future production. Orders from earlier in the summer that were delayed due to the issues we experienced with the operating system were delivered to customers, allowing us to now focus only on fulfilling new orders. These are the improvements in the way day-to-day business is conducted that customers have needed to experience in order for us to begin growing. Fourth, our new customer care department in our new corporate office served our customer and our sales representatives in the field increasingly well as the quarter progressed. With refinements to our operating system not yet made at the beginning of the quarter, hold times, e-mail responses and our ability to speak with credibility regarding the information surrounding the sale of our products were issues, yet as we exited the period, customer satisfaction has greatly improved. Fifth, we -- as we got it, our cash use during the quarter declined significantly compared to prior quarters. Our balance sheet remains strong. And again, I want to remind you that our plan to become profitable does not hinge upon capital spending outside of protecting the value of the investments we've already made. Lastly, business in our segment remains difficult, and our read is that there is a fair amount of uncertainty in the retail sector at the moment. However, we, again, greet customers and introduce new product this week at High Point Market. The accomplishments I've mentioned are advancements in our business we and our customers can now see, financial results will follow.

I congratulate our team and thank our customers. And now, I'll turn the call back over to Micah to comment further on operations and the financials.

Micah S. Goldstein

Thanks, Glenn. The most substantial news from the past quarter has to do with the progress we made on our new enterprise system and how that progress has allowed our customers to begin experiencing how well our operations are performing. Specifically, during the quarter, we corrected the issues that were affecting the way we allocated inventory to customer orders. This was a big hurdle that hampered shipments and orders during the previous 2 quarters. We also solidified our demand planning processes and have improved the accuracy of product availability information to our customers. Our Robbinsville factory continues to gain efficiencies in spite of the low unit volume. The plant's maintaining its production schedule and has completely embraced the culture of continuous improvement. This transformation is showing in our metrics on quality, schedule attainment and labor efficiencies. The team is increasingly focused on attacking material waste in light of recent inflation on lumber.

With 4 markets per year now, our team supporting the Stanley brand remains busy developing and bringing new product to market, as well as keeping us in service on all existing groups. We have maintained the necessary inventory levels to provide good service and still believe our finishes and quality specifications represent a great value in the marketplace. So that's the operations summary.

Now as I recap the financials, I'll highlight the comparisons to prior year, which are what we discussed in the press release and 10-Q, but I also want to make some comments on sequential performance to highlight the improvements after the completion of our office/showroom consolidation and the new systems implementation.

Net sales for the quarter were $24 million and basically flat with both the prior year and the sequential quarter. Orders during the early part of the quarter, as Glenn referenced, were depressed as we work through the challenges associated with our system. They have since improved, and we did exit Q3 with healthy backlogs on both brands. As expected and as guided on the last call, gross margins improved by about 260 basis points over the sequential quarter to 11.6% of net sales. Lower discounting and improved operating performance drove most of that improvement. The unfavorable margin comparison to the prior year is the result of inflation on both sides of the business and, to a lesser extent, the final shipments of the floor sample promotion we offered in Q2.

Not much to discuss on SG&A. It remains consistent. We still believe a number just shy of $5 million is the best to use as you try and model or forecast what our business is going to look like.

And our operating loss for the quarter was $1.9 million. On a sequential basis, the improvement is attributed to what I just spoke about with regards to gross margin. And compared to the prior year, the increased loss was also driven by inflation in the floor sample promotion and slightly higher SG&A spending.

As Glenn mentioned in his opening remarks, our balance sheet remains healthy. Our team worked very hard to minimize the use of cash, and you should expect this discipline and trend to continue into the future.

With that, let's open the line for questions, Rob.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Budd Bugatch of Raymond James.

Unknown Analyst

This is Bobby filling in for Budd. I just had a couple quick questions. One, being on the backlog, what -- kind of how are the margins in the backlog? Is that -- is there -- there's no discounting less -- and is the price increase accounted for in the backlog and the margin's healthy?

Micah S. Goldstein

Yes, I think that's a fair depiction, Bobby. Our price increase is now fully implemented. The price increase that we did was only on the Stanley side of our business, so the Young America backlog has not been impacted by that at all. And as I mentioned earlier, we have seen inflation on both sides of the business. So that obviously, on Young America, any time we see inflation, and we haven't raised price, that has potential to impact margins. And we're working hard to offset that through efficiency gains in the factory.

Unknown Analyst

All right. And then to touch on inflation, that was going to be my next question. Is that -- do you see that as kind of a temporary issue or something that could be -- could come into something more longer term?

Micah S. Goldstein

So let's split it out and talk about it by business. So on the Stanley side, we saw inflation related to a government-mandated wage increase for workers in Indonesia, and we took pricing action to offset that inflation. The timing of that price increase was pushed back, as you recall, because we delayed the launch of our operating system. And that's why we really took a little bit more of a margin hit on the Stanley side than we had originally anticipated taking. On the Young America side, the inflation that we're seeing right now is mostly related to lumber. And it's pretty typical, lumber prices fluctuate throughout the year. This year has been a lot wetter than normal, we had a really wet summer, and so we've had to go further from our factory to procure lumber. And so that increases transportation costs. And when the loggers have a hard time getting into the woods, they -- the supply and demand gets out of balance, and the loggers make a little bit more money. So we expect that to come back down, it usually does. No way for us to predict when that's going to happen, although dry weather helps.

Operator

Our next question is from the line of John Baugh with Stifel.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

A couple things. So help with the order number. You mentioned it was depressed at the beginning of the quarter, and I guess you emerged from the quarter stronger. Were the orders year-over-year for the entire quarter flat, up, down?

Glenn Charles Prillaman

John, I think what we saw more so progressing as the quarter went on is our service to customers. What I spoke of is our customer care department was armed with better information, and therefore, they could serve the customer and the sales rep in the field as the quarter went on because of the fixes in our operating system. And then, certainly, the customer could use our online web portal, and so on and so forth, as the quarter. So as far as how that affects orders, I think that's exactly what we're betting on moving forward. There has been a little softness as we exited the third quarter and into the fourth. Things are really difficult right now at retail, and there's a lot of uncertainty out there, in our opinion and from what we hear.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Okay. So your guess would be that during the third quarter, your order activity improved and likely improved as your service or your ability to process the order improved. And then subsequent to the quarter end, now that you're in a great position to take orders, maybe retail traffic is a little slower, and the orders are showing a little weakness again. Would that be a fair summary?

Glenn Charles Prillaman

Yes, that's right. That's right, John. Obviously, I don't like to guess on orders in the third quarter. What I would -- what we did in the third quarter is stabilized. And now what should happen, barring any macro factor outside of our control, is we should see growth now that we've got the business where we wanted it. And it's not like it's been a 1- or 2-quarter journey here. This is -- the system's implementation and getting our people armed with the right information and then the factory allocating orders correctly all through that new system, that was, as we've said, that last hurdle that we needed to jump in our 3-year plan here to transform this company to where it can grow again and compete and differentiate in the marketplace. So it is disheartening a bit to see the government shutdown and uncertainty out there in the consumer marketplace and have the -- not have a ton of momentum going on at retail or upper-end cased goods, but I think that's temporary. And I think there's market share for us to gain, so that's what we look forward to.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Yes, and I wanted to -- on that latter point, any -- can you give us any color around your shelf space battle or market share battle perspectively? Now that you're in a position to service orders, what's the strategy? What will you be doing here at High Point? Give us some kind of rearview as well in the last 12 months of your shelf space changes, if they've been losses, where likelihood of getting back any of those losses and gaining shelf space going forward?

Glenn Charles Prillaman

John, I think that the Stanley -- let's take it in 2 parts, and let's look at the Stanley side of our business first. I think over the past number of years, there have been so many different manufacturers that, because of importing, they're coming into to the business. It's a constant battle for floor space, no doubt about it. We -- when we got the Stanley line in service like we wanted to as we entered this year, we went to April market and took some aggressive, aggressive action to get floor samples placed, and we're starting to see some benefits from that. But it's just -- this is an introduce and closeout business, the Stanley business. And new product is very, very important, and we're now bringing it at every market we attend, which means both Vegas and High Point twice a year, so 4 times a year. That business is about bringing new product and just gaining as much floor space as possible. The discounts that we gave at April market, that was a onetime deal, and I don't expect us to do that, that heavily in the future, unless there is an opportunity to gain market share through a new customer or what have you. So the idea there is create great designs at great values and have the product in service, and that's where we are. Then you switch to Young America, and certainly, new product is important there as well. But because our Young America service was more so impacted through the launch of our -- or due to the launch of our new operating system, it's not that we have an issue necessarily with shelf space, it's more of the confidence of the retail sales associates. And now that our retail sales associate can call to our office or call their sales representative or check their iPhone for stock availability or future production dates, that we believe we can get that mindshare back and now turn shelf space that we have. Are there new customers out there? I think so. And the company's multiple channel distribution strategy should definitely serve us well. As things may be shaking up. They may or may not be shaking up a bit, we're certain -- in certain areas with floor space, but it's really just about us executing our model now that we've stabilized the business.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Glenn, is the clearance of all the former or old Young America product, is that essentially done by the end of Q3 or is there more of that bleeding into Q4?

Glenn Charles Prillaman

That's essentially done, John. There's always going to be -- there are always going to be some products that are discontinued because as we introduce one, we'll tend to drop another, but nothing out of the ordinary going forward.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

And I assume that there's still a profitable adult business and a negative EBIT youth businesses. Is that correct, first of all? And then, what is -- is it strictly a matter of volume at this point for the youth business to get to at least breakeven or profit?

Glenn Charles Prillaman

Yes and yes. And the second one is absolutely yes.

Operator

Our next question is from the line of Barry Haimes of Sage Asset Management.

Barry George Haimes - Sage Asset Management, LLC

I have a couple questions. One is just following up on the order commentary and the pattern of orders through the quarter that you've already talked about, would you say those trends were similar between Stanley and Young America or were there any differences as you trended through the quarter? Second question is you've been thinking through -- you've talked about some ways to possibly better load Robbinsville, maybe doing some manufacturing for others or what have you. Any update on what your thoughts are around that?

Glenn Charles Prillaman

Thanks, Barry. No, Barry, no update on -- if you're speaking about private label or OEM projects in Robbinsville. What I've said in the past, and I'll say it again, is that when you have a domestic manufacturing facility and you have short lead times, there are a lot of people experiencing issues with delays from overseas. And so we do talk to people about that, but the private label business and the OEM business, that's tough business to make money on. We're going to definitely pursue any opportunities, but no update to give you there. As far as orders are concerned, the best I can tell you is I don't think there's anything too much to read into this because what matters is what happens from here, and it's tough to predict, but we think we're going to grow because of where we've positioned the company. But if you look back at Q3, Young America has been fairly stable. And Stanley, which is a little more cyclical, we actually saw orders start to build in the beginning and through the mid part of the quarter. And then as we got into September, we saw some softness.

Operator

Our next question is coming from the line of Steve Hale of Hale Partnership.

Steve Hale

A question for you. I saw on the court dockets, the favorable ruling from the Court of Appeals on the CDOSA (sic) [CDSOA]. I haven't seen an 8-K, and I didn't see any details in your Q. I was just wondering what the plan was for kind of more broadly sharing that with your stakeholders.

Micah S. Goldstein

Yes, so, Steve, I mean, it's still very much a legislative matter, and so we're letting the lawyers talk about it. Our Q that we filed this morning has the CDSOA disclosure and that it is the most current information that we can give you at this time. It is updated from the last quarter, if you haven't read it in detail yet. I mean...

Steve Hale

No, no, well, yes, I read it, but it didn't say anything about the rulings and the easing out in the Ashley Furniture that came down from that court, right? So I understand that you guys got to kind of...

Micah S. Goldstein

Yes, it does reference that ruling and the subsequent...

Steve Hale

The one from August.

Micah S. Goldstein

and those people to have it reheard.

Steve Hale

So it references the August 2013 rule?

Micah S. Goldstein

Yes, it is August.

Glenn Charles Prillaman

Yes, the August 19 ruling.

Micah S. Goldstein

And then it references there their petition to have it reheard en banc on October 3. So yes, it's current.

Steve Hale

And so is there any -- are you guys still viewing that as continued? I was wondering, given kind of that second affirmation from a higher-level court, if that was impacting your guys' view on uses of the excess cash, and if you might explain to everyone what you're thinking about with that.

Micah S. Goldstein

We booked it in income and felt like the chances of having it clawed back were remote to start with, obviously, this latest ruling confirms that thinking. But as I said, it's still very much a legislative matter. And until it's all worked through the system, we think we've done everything that we need to do. Our thoughts on the way we managed excess cash have not changed. We discuss it with the board on a monthly basis. Our focus right now is on not burning cash through operations. We don't need any more capital spending to reach profitability from here other than minor maintenance capital spending to take care of the assets that we got and keep our factory and our systems running. And I think if we return to growth as we hope will happen in the near term, we'll be in a position where we're cash neutral or generating cash, and then can have a more intelligent conversation about capital allocation.

Steve Hale

And to that end, on the adult business, which you guys have said is profitable, have you guys considered any type of inventory financing for that side of the house?

Micah S. Goldstein

We always think about the best way to use cash and leverage, Steve. And I think the challenge for us, and we've looked at it several times in the last few quarters, people don't like to lend money to people that are losing money. And so the rates that we're offered to think about that are not attractive. And our investment options for the cash we have are not good enough to offset that increased expense from borrowings. So I think that being our own bank in the short run until we return to profitability, makes the most sense.

Operator

[Operator Instructions] Our next question is from the line of Brad Hathaway of Far View Capital.

Brad Hathaway

So actually, just quickly following up on something Steve brought up. Is -- so when you approach the banks, you have them look at Young America and Stanley as separate companies or you approach them as one consolidated company?

Micah S. Goldstein

Yes, Brad, we do everything as one consolidated company. That's how we view our business, and that's how we look at things, and that's how we report, and that's how people evaluate us. And as I said, our conversations with banks that want to lend us money tend to be very short conversations. All of our filings are public information, and the rates are not attractive to consider doing that, and we don't think we need to do that. We talk about it with our board on a regular basis, and it would be nice to need capital for growth in the future, and we'd look forward to that opportunity. Right now, we're focused on returning the business to growth so that we can do that. And quite frankly, our inventories are both in great shape and could support growth without financing, at least as of now.

Brad Hathaway

Okay. I mean, I'd actually like to say that I kind of -- I disagree that the market views you as one company, at least from my perspective, and this is just purely speaking for me, but also some people I've spoken with. There's a view of the company as a profitable, sustainable adult business, and then an option on the recovery of the youth business. And so I guess what I wonder about is how you can't use that, the fact that you have a profitable, sustainable, standalone Stanley brand as, perhaps, more of an advantage in these kind of negotiations.

Micah S. Goldstein

Yes, again, I mean, I think if we were in a position where we needed to use cash, I can appreciate your comments and understand why you would say what you say. We've got a healthy balance sheet. We just spend all the money we need to spend to return the business -- to position the business to be able to grow from here, and we really don't need to put debt on the balance sheet right now. At least that's our perspective, and obviously, that's one that you may differ in your belief on.

Brad Hathaway

Okay, because I just wonder what the cost of capital would be for inventory financing for a profitable brand like Stanley compared to the cost of capital being implied by the current discounted share price and whether -- I guess what we're all wondering here is, yes, you have a great balance sheet with a lot of cash. You're also potentially at a turning point in your business. I mean, I think it sounds like you're more optimistic now than you have been in prior quarters. So the ability to add extra value to shareholders by taking advantage of the fact that the market is not as optimistic as you are, and move and use kind of creative financing to increase your ability to take advantage there is something that I think shareholders might be very interested in.

Micah S. Goldstein

That's good feedback, and I appreciate it.

Glenn Charles Prillaman

Brad, this is Glenn, I wanted to thank you for reading my optimism correctly. Thank you.

Brad Hathaway

Now switching gears kind of to the business again. I mean, obviously, it's good to hear that you're confident about kind of this is where you're going to start growing from here. I guess what I'd love to understand a little more is the potential to materially grow the business. I mean, what needs to happen for this not to grow 5%, but for this to grow much more significant number? I mean, what -- is it something at Stanley, Young America, retail? What do you need to do from here?

Glenn Charles Prillaman

Okay, Brad, this is Glenn, and I don't know if you heard me, but yes, I am. I'm very optimistic about it because we spent the last 3 years positioning each part of the business to get to this point. I think what needs to happen is not magic. I mean, we have not serviced our customers well, take that, over the last couple years because of all the change in the business. So what needs to happen is that the change needs to end. It has. The business needs to stabilize itself. We need to become a more predictable company for our customer to do business with and much easier for them to do business with. And we are. So that should bring growth. New product, we have spent a tremendous amount of effort over the past several years bringing new product that really speaks to the part of the market that we're targeting, that premium part of the market. It's not the ultra high end, it's certainly not the middle part of the market, but it's the premium upper-end segment. And that new product, obviously, needs to take hold in the marketplace. We're starting to see that. And as more new product is brought to market and floored and accepted by the interior design trade as well, that should bring growth. Systems, we have to have systems that put accurate, transparent, timely information in the hands of our salespeople, our customer care representatives and our customer. And we've invested in that pretty much down to the level where we're just refining those things. And those stakeholders have that information in their hands. That should bring a level of comfort with the brands and growth. So it's just stability means a lot to our customer base, and we are a stable company. And while it's difficult that you have to go through this and kind of disclose everything as you go through this transformation, our customer now sees firsthand the benefits of some of the investments we've made. And that should bring growth. So what we can't control is something at the macro level, and that's what would prohibit growth. And that's not an excuse, it's just a statement that we can't control things at that level. Everything we can control, we think we've got it in a much improved position, and that should render growth.

Brad Hathaway

Okay. I mean, I guess, maybe you said this another way. I mean, most of your shareholders, I think, are not looking for -- to move from $100 million of revenue to $110 million of revenue. They're looking for kind of the longer term, obviously, but move back to $150 million of revenue plus. So are there -- what -- are there any kind of bottlenecks or things that would prevent you from being able to make that move or -- and what needs to happen at retail for you to be able to make kind of that more sizable jump back to being a kind of much more -- a much larger and more sustainable company?

Glenn Charles Prillaman

The obvious answer, Brad, is time. Time is definitely not something that we think of being on our side. We're as anxious as you are. I think the thing that -- one thing to remember is that we were over a $300 million company. We're now 1/3 of that size. Most companies are probably somewhere -- at least in our view, somewhere about 1/2 their size. And so we think that, sure, we've lost some market share because we decided to go through this transition and kind of really reinvent our company over the past several years, and that's cost us some market share, so we think we have some market share to gain back. And if you want to pick $150 million as your number, I can't tell you when we're going to get there. Do I think we're going to get there? Yes, I think the opportunity is there. But as far as what has to happen, it's not any -- I don't think there's any event that I can bring to the table that has to happen, that I can create a rally cry around. It's really been about doing what we've done and to stabilize the business, and now telling our customer here's what we're going to do and then doing it. It's just execution.

Brad Hathaway

Okay. If the demand and the quality of product and whatnot was there, could the company add $30 million of revenue in a year? Is that possible or is that just too rapid in terms of growth?

Glenn Charles Prillaman

That's possible. We don't have capacity constraints to grow at that pace. And as Micah said, and I don't know off the top of my head, do we have enough inventory to grow at that pace, obviously, we wouldn't service customers if we grew that fast, so that would be a nice problem to have. And again, volume being the only issue with profitability, if we needed a credit facility of any type when we're making money, that's not going to be a problem.

Operator

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

Glenn Charles Prillaman

Thank you, Rob. Thanks again for everybody on the call. I do want to thank again our sales representatives, our customers, our customer care department. This is the point from which we grow, and we're excited about it, and we'll see you all at this week's High Point Market.

Operator

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

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