Furniture Brands International CEO Discusses Q3 2010 Results - Earnings Call Transcript

Nov.12.10 | About: Furniture Brands (FBNIQ)

Furniture Brands International (FBN) Q3 2010 Earnings Call November 4, 2010 8:30 AM ET

Executives

John Hastings - VP, Communications

Ralph Scozzafava - Chairman of the Board, Chief Executive Officer

Steve Rolls - Senior Vice President, Chief Financial Officer

Analysts

Chad Bolen - Raymond James

Tim Madey - Primary Funds

Stanley Elliott - Stifel Nicolaus

Emerson Whitley - Harvest Capital

Operator

Good day, ladies and gentlemen, and welcome to the third quarter Furniture Brands earnings conference call. My name is [Stephanie] and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). I would now like to turn the conference over to your host for today, Mr. John Hastings. Please proceed.

John Hastings

Thank you, [Stephanie], and good morning, everyone. Welcome to our third quarter earnings conference call. With us today are Ralph Scozzafava, Chairman of the Board and Chief Executive Officer; and Steve Rolls, Senior Vice President and Chief Financial Officer.

During our prepared comments and the question-and-answer session that follows, we will be making statements expressing the beliefs and expectations of management regarding future performance. Any such statements are forward-looking statements, which reflect our current views with respect to future events and are based on assumptions and, therefore, are subject to risks and uncertainties.

These risks and uncertainties include, without limitation, the risk factors set forth in our Form 10Ks and 10Qs filed with the SEC and all of our subsequent SEC filings. We do not undertake or plan to update these forward-looking statements even though our situation may change.

During today’s call, management comments will use certain non-US GAAP financial measures to supplement our US GAAP disclosures. Whenever we disclose such non-US GAAP financial measures, we provide in the company’s earnings announcement a reconciliation of such measures to the most closely applicable US GAAP measure.

Thank you and I will now turn the call over to Ralph.

Ralph Scozzafava

Good morning, everyone. We appreciate you being with us again today. I'll make a few brief remarks about our performance for the quarter and then turn the call over to Steve to take you through some of our financials in more detail.

Yesterday's press release reported net sales of $272 million, a gross margin of 24.8%, and a net loss of $2.1 million or $0.04 per share. That compares to a loss of $23.5 million or $0.49 a share in the third quarter of '09 when we reported sales of $294 million and a gross margin of 23.1%.

Now, the third quarter is a historically weak sales period for us and the 2010 quarter's performance was further impacted by the timing of our week-long shutdown for July 4 in our domestic manufacturing operations. That shutdown occurred in the third quarter of 2010 versus the second quarter of '09.

Adjusting for the timing difference of the shutdown in our decision to exit some unprofitable ready-to-assemble business, our sales for Q3 in 2010 were essentially flat with the 2009 quarter. While the sluggish activity in the consumer spending area is affecting our top line, I'm very encouraged by our continued improvement in our gross margin and the consistent reduction in our administrative costs.

We've created a high degree of operating leverage by leaning out our manufacturing processes, by improving our retail store operations and by taking more costs and waste out of our business model. The fastest way to deliver that leverage to net income and to our shareholders is through top line sales growth. We know that. That's where I spend almost all of my time on a day-to-day basis and that’s where we're making significant investments in our brands.

Lane, Broyhill and Thomasville are three of the best known consumer brands in our industry. They all have dynamic marketing plans for the rest of 2010 and into 2011 that include exciting new products, national TV and print advertising, trade promotions, e-commerce initiatives and local PR events that will drive traffic to our dealer stores and to our own stores. I'll go into more detail on our efforts to drive sales in my closing comments.

At this point, I'll turn it over to Steve.

Steve Rolls

Thanks, Ralph. Yesterday's press release showed sales for the quarter of $272 million compared to $293.7 million in the third quarter of 2009. As Ralph mentioned, a comparison of the quarters is negatively effected by the timing of the plant shutdowns and our RTA business.

On a net basis, the timing of the shutdown reduced the sales comp by approximately $11 million and the RTA business is down $7 million in the third quarter on a year-over-year basis. Gross margin for the quarter was 24.8% compared to 23.1% from the 2009 quarter. We've been able to maintain increased gross margin throughout 2010 even with the lower sales.

The improvements are primarily related to our transition to lean and cellular manufacturing. Today we have converted all of our high volume production lines to a cellular layout that uses our proprietary lean manufacturing method called Edge. The remaining lines are generally at our smaller operations that have a much higher degree of custom work.

Conversion of these lines has much more tailor to the specific operation. One thing to consider in the move to lean and cellular is that the transition typically results in a temporary decline in productivity as the teams acclimate to the new process. We look to maintain and improve our gross margin progress going forward.

The selected items table in the press release includes $3.8 million in future restructuring charges that are primarily associated with our plan to close a case goods plant in Appomattox, Virginia during the first quarter of 2011. This plant produces a composite and laminate product that has historically been used in our RTA business and with contract customers in the hospitality industry.

As we have exited unprofitable business and as sales have declined due to the weak economy, this plant became underutilized. In addition, demand for laminate-covered product is small as our RTA business today is focused on a wood venire product that incorporates innovative design and easy-to-assemble features that we currently source from outside vendors.

We expect the closure and this position of this plant to produce annual cost savings of approximately $5 million. The press release also discussed a reversal of $6.8 million and accruals for compensation. About $4.5 million of the accruals were in SG&A with the rest in cost of goods sold.

We view incentive compensation as a normal business expense, therefore, we don't list this as a selected item but we wanted to provide additional transparency into our operations.

Factory downtime for the quarter totaled $2.7 million and approximately $2 million of that is associated with the Appomattox plant that we're closing. Consolidating the contract work at that plant to existing operations in North Carolina will dramatically reduce our downtime exposure.

Our company-owned retail stores also continue to improve. Gross margin at our owned 70 stores and show rooms have improved 50 basis points to 38.7% and contributed an incremental 30 basis points to our overall gross margin improvement. It's worth nothing that our store count has stabilized on a year-over-year basis.

Our 70 stores in the 2010 third quarter generated 13% more revenue than the 71 stores that we had in the 2009 third quarter and SG&A as a percent of sales dropped from 65% in 2009 to 56% in the 2010 quarters. On a comp store basis, the 42 Thomasville stores we've operated for more than 15 months showed a same-store sales increase of 22% for the third quarter of 2010 versus 2009.

This is the third straight quarter of double-digit improvement in our core retail segment and it speaks to the progress our retail team is making and to the appeal of our Thomasville products.

SG&A for the quarter was $70.7 million compared to $89.2 million in the third quarter of 2009. Both quarters included selected items that are detailed it the press release. On an adjusted basis, SG&A totaled $68.7 million compared to $84.9 million in the 2009 third quarter. That’s a significant decline and is due to a number of factors that are part of our ongoing business.

I mentioned that compensation reduced SG&A this quarter by $4.5 million. Our other elements of payroll are payroll and benefits savings from lower headcount that total approximately $5.8 million, a $2.8 million decline in allowances for bad debt and a $1.8 million reduction in rent expense as we have consolidated warehousing capacity.

During the quarter, we addressed our pension funding status on two fronts. First, we contributed 4.1 million shares of FBN common stock to the plan in early September. We had previously estimated our 2011 pension funding target to be approximately $45 million at June 30, 2010. After the latest stock contribution, we now expect our contribution requirement to decrease to approximately $12 million subject to certain conditions.

Our 2010 stock contributions will generate approximately $7 million in net federal tax refunds that we expect to receive this quarter. We analyzed our pension funding options very carefully and we determined that funding with stock has several benefits. The ability to take advantage of any increase in share price was a very important factor and is supporting our liquidity and financial flexibility.

We also determined that addressing the targeted funding levels now is preferable to deferring our funding options to a future date given the tax refund opportunity. Our second pension-related activity was our agreement to our bank groups interest in extending a waiver in our credit agreement that moves the covenant for our funded status test from January 1, 2011 to January 1, 2012.

The press release reported that cash at the end of the quarter totaled $70.2 million with long-term debt of $77 million for a net debt position of $6.8 million. This was a decline from our net cash position at June 30 as we increased inventories of key raw materials and finished goods. We increased these inventories as we are entering a stronger selling season and we want to maintain our highly competitive delivery and customer service levels by mitigating any risk in the Asia portion of our supply chain.

The raw materials and finished goods are associated primarily with our new product introductions and our best selling collections, so we anticipate being able to turn this inventory on a normal schedule.

That concludes my comments on financial results and now I'll turn the call back over to Ralph.

Ralph Scozzafava

Thanks, Steve. I'll make a few closing comments before we open up the line for your questions. The big key to success in our industry is pretty straightforward: have great product. Having product consumers want is absolutely essential to our success.

We use a very creative yet structured process to bring new products to market. All of our product concepts have to pass through multiple stage gates successfully before they can be introduced to our dealers and in the marketplace. The stages help ensure that the product is the right fit for the brand in terms of style and price point, has a compelling design, features, design trend, that it appeals to a large sample of real consumers as well as our dealer base and can deliver an appropriate financial return.

We've made a significant investment over the past few years in our product development process. At last month's high point market, virtually all new collections introduced by Lane, Broyhill, Thomasville and Drexel Heritage utilized our process.

Now let me walk you through some programs that we have in place right now to drive sales at in three largest brands. I think you'll find them to be fairly exciting.

Lane had a great two-year run with its award-winning mobile showroom tour and we're getting ready to bring an even more exciting campaign to the marketplace. Lane has positioned itself as the leader in family home entertainment furniture and we're capturing the growing trend of sports fans opting to see the action at home instead of at a stadium.

Next month, Lane kicks off its national Best Seat At the Game campaign with 30-second TV spots during major sporting events, in big games, on ESPN, on the major networks and lots more. The spots will highlight participating dealers and will be supplemented with national print ads that will use snap tag technology to help smart phone users instantly find the closest Lane dealer, pretty neat.

We'll carry the momentum into January with similar TV spots during some MFC games, the Daytona 500 and many more. That's exciting for Lane and it's ground breaking for that brand.

At Broyhill, we have a new and strong relationship with the Make a Wish foundation and will grant room makeovers to 50 families of children with life-threatening illnesses. We've completed 10 of these switches so far and the local media coverage has created more than $11 million consumer impressions of the Broyhill brand and, I will tell you, 10 very happy kids who needed new bedrooms.

Our local dealers benefit from this good will as this program generates for them very, very strong differentiation in the marketplace and allows them another way to be competitive and to serve their community.

In addition to the Make a Wish program, Broyhill is back in national print advertising in major publications. This month's Good Housekeeping magazine is a good example featuring three of Broyhill's newest bedroom groups.

We're also helping our dealers create cost effective local advertising with our Broyhill ad builder website that lets our dealers create print-ready advertising with their store information using our library of images and copy. We offer the same concept with local TV spots where our dealers can customize a 30-second spot using our film and highlighting themselves using dealer specific information. For Broyhill, it's all about driving traffic to our dealers and helping them sell more with their consumers.

At Thomasville, we continue with our national TV advertising in the fourth quarter, which is a great way to build on our brand awareness and to drive store traffic. Thomasville is also upgrading its digital presence with monthly updates to Thomasville.com, daily postings to facebook that engage our current and future Thomasville consumers.

We've also added ratings and reviews to our product page and, I'll tell you, the initial feedback that we've got on Thomasville really help illustrate and confirm that Thomasville is a terrific furniture brand.

Because Thomasville has a dedicated retail store footprint, we're engaging in more and more training of our store managers to help improve on the in-store shopping experience. This is crucial to our success, the success of any retailer, for that matter, and the performance we've shown and the growth in our company-owned stores speaks to the strong progress that our team is making.

Well, that concludes our prepared comments for this morning. Now, we'd like to open up the lines and take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question comes from the line of Budd Bugatch – Raymond James.

Chad Bolen - Raymond James

This is actually Chad pinch hitting for Budd. A couple of things -- I mean, the Thomasville delivered comp was very nice at up 22%. We have heard kind of through the channel that conditions at retail have gotten more challenging. Can you give us a sense of what -- I guess the written comp or maybe a better feel of kind of real-time order trends at retail?

Ralph Scozzafava

Yes, let me take a quick shot at it. Chad, we haven't disclosed a lot of that but I want to give you a sense for it. We're tracking a little bit behind he delivered number. We're still up in the double-digit range from a written perspective. Keep in mind Thomasville and our retail operations are 14%, 15% of our business but the momentum at Thomasville has been pretty good. That said, we all know that the market is a little bit softer today than it was, call it, in Q1 and our numbers reflect that.

Chad Bolen - Raymond James

Could you guys give us the -- what's the number of dealer-owned Thomasville stores right now or at quarter end?

Ralph Scozzafava

We've got a total of I'd say -- it really goes between galleries and our own stores but the number is 71 and there are a couple of stores that -- or galleries that are classified as stores and vice versa. But the number that we track is 71.

Chad Bolen - Raymond James

In terms of inventory, could you give us the breakdown of inventory by finished goods, work in progress and raw materials? Do you have a specific target in mind for the end of the year in terms of either the absolute dollars or days cost of sales?

Ralph Scozzafava

Why don't I talk a little bit to the inventory build and then Steve can give you the breakout? What we decided to do and it's really right around Q1, we noticed -- and I think a lot of those folks in the industry -- that the supply chain from Asia was challenged, Chinese New Year being an element of that. Another complication was really ocean freight.

We wanted to get ahead of really the issue and make sure that we could service our dealers and we had cash. So we invested in what we call very strategic fast-moving inventory. So we took our inventory levels up. They won't stay at these levels forever but we want to take our inventory through Q4, Q1.

It'll come down over that period and we'll settle at a point somewhere in the $240 million, $230 million range. We'll continue to refine that. Steve can give you a breakout though.

Steve Rolls

Yes, finished goods -- I'm just going to give you round numbers here. Exact numbers -- around $180 million and raw materials around $80 million and the difference there is WIP and a lot of our -- not a lot -- but a chunk of raw materials are cut and sew kits that we would order in advance from Asia.

Chad Bolen - Raymond James

To clarify what you said, Ralph, the $230 million to $240 million, is that the end of Q1 kind of timeframe?

Ralph Scozzafava

Yes, we want to make sure that we get through really the higher demand periods of the year, Q1, Q4 for us that we can service orders. Our customer service levels for now the third quarter are the highest they've been. We just want to make sure we can service everybody.

Chad Bolen - Raymond James

It sounded like from your comments that you feel pretty good about the items that are in inventory at some of your better selling, better velocity stuff. So I would presume you don't anticipate a lot of discounting necessary to turn that. Should we expect maybe a bit of a drag sequentially from under production if you're reducing inventory a bit?

Ralph Scozzafava

I don't see any of that.

Steve Rolls

I think you're well aware of our consumer testing process, so while we've worked on a lot of slow moving inventory over the last, call it, year or two, going forward we expect to have less and less of that to deal with because we'll be producing product that consumers really want to buy.

Ralph Scozzafava

If you look at our inventory from an aging point of view it's the healthiest it's been.

Operator

(Operator Instructions).

Ralph Scozzafava

Well, that was quick and I want to thank everybody for -- oh, we have one more.

Operator

Your next question comes from the line of Tim Madey - Primary Funds.

Tim Madey - Primary Funds

I wanted to ask you about the assets that you sold and the impact that that had on sales in the quarter, that these two unprofitable lines are ready-to-assemble business?

Ralph Scozzafava

The Appomattox -- Tim, let me start with the read-to-assemble and then we can -- I want to clarify the question on the other piece. The ready-to-assemble business for us, we've had some profitable business that we were into over probably 2008 and 2009 and at some point you either keep doing it or you exit it or improve it.

At this point, for us, it was better to exit it. All in, it's about $11 million, $10 million on a quarterly basis from a top line point of view but it is accretive to gross margin once we discontinue it. So we got out of that business.

It does affect our top line but you can see what our gross margins are doing because of that and frankly many other things. So we'll lap that as we get into 2011, so what you see in 2010 will be real comps and then 2011 will be a real true number to comp against 2010.

I want to clarify your question. Is it about Appomattox?

Tim Madey - Primary Funds

I just was -- I saw the year-over-year sales comparison. I was just trying to make a fair comparison with last year and what amount had actually been pulled out of the revenue line as a result of those two lines of business that you exited?

Ralph Scozzafava

One thing we do here is we try and obviously look across not just one quarter but the quarters and year-to-date. You had a couple of complicating factors. One is our shutdown in July 4 that was in one quarter last year, a different quarter this year, kind of makes the comps a little bit uneven.

If you just take Q2 and Q3 a year ago to this year and you comp them out, the difference in sales is about 99% the ready-to-assemble business and everything comps out as flat.

Tim Madey - Primary Funds

Can you talk about -- or take a few moments to talk about any top line initiatives that you're looking at now? I'm familiar with the consumer facing issue, but I'm wonder if there are any partnerships or any new initiatives that you can discuss?

Ralph Scozzafava

I think there are a few and if you think about the bigger brands I think, number one, new product that’s come into market and we've been really, really aggressive. Some companies may pull back at a time like this. We've brought more new product that's being consumer tested, so I think that's important.

We've got probably what I would call the most aggressive TV and print campaigns that we've had on our biggest brands, Lane, in particular, and Thomasville. I'm excited about that. The spending has increased. You'll see us on air for those brands and you'll see Broyhill broadly in print and we're excited about those pieces.

We've got some partnerships with some dealers that we've taken to another level. We typically don't mention them by name but we've got a couple north of the border that we're excited about and those will be kicking off for us at the close of this year and beginning in 2011.

Then I think the other piece of this as it relates to Thomasville, some store growth with company-owned stores. We haven't announced all locations yet. We'll do that in the not-so-distant future. We like the footprint. We like what we're able to do. We like the ability to leverage the scale of Thomasville and with the improvements the management team's making. It's a good bet for us. You'll see some expansion there as well.

Operator

Your next question comes from the line of Stanley Elliott - Stifel Nicolaus.

Stanley Elliott - Stifel Nicolaus

A quick question on the retail segment -- the comp sales are very impressive in the Thomasville. What do you guys do or how do you think about trying to improve gross margins from here? I know that you've made a number of changes to the business, but I just want to see how that's going to look going forward.

Steve Rolls

So there are kind of two elements when you think about gross margins. What's true in anybody in retail is with a weak economy you kind of get a little deleveraged at a retail level because you've got a lot of costs associated with that. So I think we'll continue to see margins improve as sales improve with the economy.

The other piece that you may recall is a lot of our stores we took back from dealers that we had lease guarantees with and those lease guarantees we decide whether to keep the store open or not. With Thomasville, almost in every case, we know we can improve the results to operate it differently and so we do keep it open and do better. As you see, we keep making improvements.

The challenge is a lot of time those stores were located by those dealers in the wrong part of the market or they were the wrong size. So as those leases mature you'll see us in most cases move those stores, change the size so that they can operate much more profitably.

In some cases they may already be in the right place and the right size and we'll just get a lower lease rate obviously given the current economy. So we'd love to turn that switch overnight. It's not going to happen. So I think you'll continue to see some losses there for some time but we expect to continue to improve.

Stanley Elliott - Stifel Nicolaus

On those new formats, are you talking or thinking about larger size stores or smaller size stores or how do you think about that?

Ralph Scozzafava

Well, the format won't change dramatically. We've got some model and concept stores that we like. We think we have the formula down. Our footprint is about 12,000 square feet, so that's what we see, that's what we target and we're looking for A locations and we know we can put Thomasville in the right location with the right adjacencies and the right kind of traffic flow in the right area, that we can have a very good store and that's what you'll see from us going forward. I think our locations will improve dramatically.

Stanley Elliott - Stifel Nicolaus

On the promotional front with kind of the slowing data points that we've seen come out, how do we think about the promotional activity at this juncture?

Ralph Scozzafava

Well, I think one of the earlier callers asked about discounting. I think, first of all, as it relates to our inventory and discontinued product and all of that, I think that we've done a better job of reducing that, so the rules around here are we want to make sure that we sell our product at the appropriate price.

I think that we've seen the market become more promotional overall. I think we've seen a little bit of that but on the flip side of that we're also seeing the high end of the market come back and I can tell you that our designer brands that are targeted to the more affluent consumer are performing very well. So we want to be careful with discounts. It's a slippery slope and you can create a very unprofitable environment for yourself if you're not careful.

Stanley Elliott - Stifel Nicolaus

Last question, the $5 million cost savings, fully realized next year?

Steve Rolls

No, I mean, our announcement said we'd be closing that plant kind of in the latter part of March, so we'll keep having some losses up until then. There will be some additional costs associated with exiting the facility kind of as we go along. So call it beginning in April or May we'll start to see the improvement and savings.

Ralph Scozzafava

If I were modeling I'd take half of the annual. I think that would be a good rule of thumb for you.

Stanley Elliott - Stifel Nicolaus

With all these cost savings that you guys have implemented, how do we think about contribution margin going forward for the business?

Ralph Scozzafava

It's the source of much debate and here I can tell you that. My rule of thumb has been 600 to 800 basis points depending on which part of the business we're talking about. So that would be incremental gross margin. You have some sales commissions that come out the other way, so 29, 30.

Operator

Your next question comes from the line of Emerson Whitley - Harvest Capital.

Emerson Whitley - Harvest Capital

I just had a couple of questions. On the advertising spend going forward, how much should we expect that to -- I guess what are you expecting to be up on a year-over-year basis and how should we be thinking about that from a modeling perspective?

Ralph Scozzafava

Yes, that one is going to be a little bit tougher, not because we don't know the numbers. It's hard to communicate externally. I would tell you this. As you're thinking about SG&A, our objective is to take out ways to take out administrative costs. When we get those costs out, to take that funding and to put it behind our brands. So you're going to see SG&A move around just a little bit. Know that it's not going to be structural. It's going to be spend against the brands.

We've got -- I think we talked on the last call of a run rate somewhere around $78 million on the quarter. We may exceed that some quarters. We may go below that other quarters and the toggle will be completely brand support driven.

Emerson Whitley - Harvest Capital

So that's still a pretty good run rate on a quarterly basis?

Ralph Scozzafava

Yes.

Emerson Whitley - Harvest Capital

Then the metrics for the reversal of the comp accrual, what metrics are you guys using for the where that gets impacted or where that gets shifted around?

Steve Rolls

We have different metrics depending on the term of our compensation. We have a short-term plan, long-term plan, so in some we measure sales and income and others we measure return on invested capital.

Emerson Whitley - Harvest Capital

Is the short -- which is which on that? Is that the sales and income is the -- ?

Steve Rolls

Typically. Right, that's right.

Emerson Whitley - Harvest Capital

The short term?

Ralph Scozzafava

The return on invested capital is a three-year program.

Operator

We have no further questions in queue. I would like to turn the call over to the management for any closing remarks. Please proceed.

Ralph Scozzafava

All right, well, thank you. Once again, we appreciate everybody being with us. We've got a lot to do. I can tell you internally our objective is to get better every single day, to make our company better, make our business better, make our performance better every single day and if we can do that we'll have better weeks, months, quarters and years and that's really what we're trying to do.

So every time you look at our results and you comp us to a year ago we want you to do that and we're going to fight like heck to continue to improve. So we've got a Q4 in front of us that we want to finish strong. We're planning now for a good 2011. We can't control the external factors but we can control what we do and we're making great strides. So thanks for being with us and we'll talk to you all again next quarter. Take care.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.

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