Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

John Hastings - VP Communications, IR

Ralph Scozzafava - Chairman of the Board and CEO

Steve Rolls - SVP and CFO

Analysts

Brad Thomas - KeyBanc Capital Markets, Inc.

[Todd Slotman - Stability]

John Baugh - Stifel Nicolaus

Budd Bugatch - Raymond James

Sherman Chao - Impala Asset Management

Barry Vogel - Barry Vogel & Associates

[Tim Stabbles] - Private Investor

Furniture Brands International (FBN) Q4 2010 Earnings Call February 3, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2010 furniture brands earnings conference call. My name is [Katie] and I'll be your coordinator for today.

At this time, all participants will be in a listen-only mode. We will be conducting a question-and-answer session towards the end of the conference. (Operator Instructions).

I would like to now hand the call over to your host for today, Mr. John Hastings. Mr. Hastings, over to you, please.

John Hastings

Oh, good morning, and thank you, [Katie]. Welcome to our fourth quarter earnings conference call. With us today are Ralph Scozzafava, Chairman of the Board and Chief Executive Officer, and Steve Rolls, our 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.

Our Safe Harbor statement in the press release describes our current views with respect to future events and risks and uncertainties. We do not undertake or plan to update these forward-looking statements, even though our situation may change.

During today's call, management comments includes 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. I will now turn the call over to Ralph.

Ralph Scozzafava

Thanks, John, and good morning, everyone. We want to thank you for being with us again today.

As I begin another year-end call, I can't help but notice the strong progress that's been made on our business over the past few years. Our balance sheet is solid with net debt down for more than $180 million to $25 million today. We've eliminated much of the financial risk from our capital structure.

Gross margin is at its highest level that we've achieved since 2004. Our move to an operating company model has enabled us to eliminate more than $100 million in annual operating costs while improving our ability to develop product and serve our customers better.

Furniture Brands today has a cost structure that can leverage increased sales, and I'll discuss our plans to grow profitable sales across our brands later on in this call.

Now Steve will take us through the results. Steve?

Steve Rolls

Thanks, Ralph. Yesterday's press release showed sales for the quarter of $276.1 million compared to $285.6 million in the fourth quarter of 2009. The $9.5 million decline in sales is primarily attributable to the high level of sales of discontinued and slow-moving inventory in the fourth quarter of 2009 that generated favorable tax treatment.

Sales levels for the 2010 quarter also were negatively impacted by two customer bankruptcies and by the company's earlier decision to exit some lines of unprofitable ready-to-assemble business.

We've refreshed that product category with new collections that use better materials and our exclusive assemblies technology. We've placed these new collections on hundreds of store floors, and we expect to begin regaining those lost sales later in 2011 and beyond.

Gross margin for the quarter was 18.1% compared to 7.1% in 2009 quarter. Results for both quarters included selected items, as shown in the reconciliation table in the press release. Adjusting for these items, gross margin was 22.1% for the 2010 fourth quarter and 21.7% for the 2009 fourth quarter.

Gross margin for the 2010 quarter showed a sequential decline as a result of some promotional sales that we opted to bring to the market. For the full year of 2010, adjusted gross margin was 25.5% compared to 23.1% in 2009.

The increase in gross margin reflects efficiencies gained by our conversion to lean and cellular manufacturing. The lean culture is based on continuous improvement. So we'll keep driving improvements in operating efficiency.

The increase in gross margin was driven by operational improvements and not by the typical leverage that comes with sales growth. The selected items table in our press release details those costs in our reported results that we consider to be either non-recurring or will be eliminated or reduced over time through the execution of our strategic plan.

We've discussed these in past press releases and in conference calls, but I'll touch on a few to provide some additional clarity. The property disposition restructuring charges are primarily related to our planned closure of the case goods plant in Appomattox, Virginia in April of 2011.

We had forecasted total charges to close the plant at about $7 million, and we expect the closure and final disposition of this plant to produce annual savings of about $5 million. As I mentioned earlier, we are committed to the ready-to-assemble business that will source that product.

The contract product that came out of Appomattox will be produced at our other case goods plants in North Carolina. We've disclosed factory downtime for several years as a way to illustrate our capacity utilization. Downtime for the quarter totaled $2.2 million of which $1 million is related to the Appomattox plant that we are closing.

Adjusted SG&A for the quarter was $84.7 million compared to $85.5 million for the fourth quarter of 2009. For the full year, adjusted SG&A was $308 million in 2010 and $327.6 million in 2009. For modeling purposes, SG&A in both years concluded minimal incentive compensation expense. We would expect that normal expense for incentive compensation would total approximately $20 million annually.

Last quarter, we had indicated that a run rate for quarterly SG&A was approximately $78 million, not including the impact of any incremental brand support in activities.

SG&A for the fourth quarter of this year reflects increased marketing activities at Lane, Broyhill and Thomasville. Investing in our brands and supporting our dealers is an important piece of our growth strategy, and Ralph will go into more detail in these programs in his comments.

SG&A for the quarter also included startup expenses, such as personnel training and equipment testing for our Indonesian plant expansion.

On a comparable store basis, the 45 Thomasville stores we've operated for more than 15 months showed a same-store sales increase of 15% for the quarter of 2010 versus 2009. This is the fourth straight quarter of a 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.

Regarding our pension status, at the end of 2009, we had an under-funded status of $115.9 million on a GAAP basis. That amount declined to $84.7 million at year end 2010 because the value of our plant assets had risen with the overall market, and we made contributions in cash and stock of approximately $40 million during 2010.

Based on the anticipated decrease in the under-funded status of our plant and with the benefit of recent federal pension relief, we may not be required to make a contribution to our plan in 2011. The plan's actuaries are reviewing the year-end financials. We'll have more clarity on the plan status at the first quarter call in May.

The press release reported that cash at the end of the quarter totaled $52 million with long-term debt of $77 million for a net debt position of $25 million. During 2010, working capital used $31 million in cash. We paid down $18 million in debt, and we increased capital expenditures to $22 million to fund our Indonesian expansion, our SAP implementation and launch our Mexican cut-and-sew operation.

I'll give some additional detail on how manufacturing and retail operations affected our cash flow. On the manufacturing [side], the RTA facility in Appomattox is the single largest source of our factory downtime.

In 2010, it was responsible for about $5.3 million of the $8.3 million in downtime that we reported in our selected items table. Factory downtime is primarily a cash cost and one that we expect to reduce significantly with the closure of Appomattox in the next 90 days. We cited a $5 million annual cost savings when we announced the Appomattox closure.

Furniture Brands continues to pay rent on closed retail stores. In 2010, those rent payments totaled about $9 million. In addition, we incurred non-rent costs, such as real estate taxes and common area costs for the closed stores that totaled approximately $2 million.

For 2011, closed store rent payments are expected to total approximately $8 million. These expenses will diminish as the leases expire and as we exit leases through either sub-lease or buyout. The 10-Qs show the runoff of the future lease cost in footnote two.

We have accrued for the portion of the remaining leases that is above market rates, and the remaining at-market lease obligation goes through the income statement. So from a P&L perspective, the future income statement impact will be lower than the cash impact.

Our open retail stores are currently operating a loss, although they use less cash by being open than if they were closed. Our retail segment results also do not reflect the contribution of the wholesale margin.

Like many furniture retailers, these stores are suffering losses because the rent could not be readily renegotiated to reflect the depressed consumer economy. Roughly half of the current Thomasville store leases expire by the end of 2014. Upon lease expiration, we have the option to either renegotiate the lease terms or relocate and resize the stores in question.

The new locations are likely to be smaller than the original store, have a lower lease rate and often will be in locations with better visibility and retail traffic. All those factors can meaningfully enhance store profitability.

Well that concludes my comments and financial results. Now I'll turn the call back over to Ralph.

Ralph Scozzafava

Thanks, Steve. I'll comment on our operating leverage and plans to grow the business, and then we can open up the line for questions.

We've achieved significant improvement in gross margin in SG&A expense over the last two years, creating leverage opportunities for our business. Growing gross margin by 580 basis points on a reported basis and 350 basis points on an adjusted basis while sales are declining can only happen through a vastly improved cost structure and the lean initiatives in our supply chain.

As Steve mentioned, we've also driven down administrative cost by more than $100 million annually. With more efficient manufacturing and a more scalable SG&A profile, we're driving the break-even point for our company lower and lower.

I'm often asked to quantify the earnings potential of an [extra] $1 in top-line sales for us. So I'll tell you that my rule of thumb is simple. It's that the gross margin contribution of an incremental dollar sales is about 700 basis points higher than the baseline gross margin. Now, of course, this assumes retail wholesale mix stays the same.

In addition, we have the benefit of approximately $75 million in net operating loss carry-forwards, which may provide future tax and earnings benefits. You can see the potential for meaningful improvement in our business and our earnings is significant.

While the math is impressive, the question is how do we get there. The answer is by doing more of what we did throughout 2010, but doing more of it and doing it better.

Last year, Lane kicked off a national TV and print ad campaign in the fourth quarter that's been a big hit with consumers and dealers. We're connecting Lane with sports fans through a best-seat-in-the-house campaign that use a 30-second TV ad that has run on major TV networks and on some marquis programming. The TV ad builds awareness of Lane with consumers, and the print ad uses snap tech technology to help smart phone users instantly find the closes Lane dealer.

During 2011, we'll launch an additional campaign for in-store displays and national print ads that focus on Laneology. That's what we call the bundle of features and benefits that really sets lane apart from a product quality perspective, making it a great value. You can check it out for yourself on the Lane website or the Laneology face page.

Broyhill has a great program to help dealers build visibility and drive traffic on a local level. Through our relationship with the Make-A-Wish Foundation, Broyhill and its dealers have completed 18 room makeovers for critically ill children.

Local media coverage of these events has been impressive. Our local dealers also benefit from the good will this program generates and gives them a way to stand out in a very competitive marketplace.

In addition to the Make-A-Wish program, Broyhill is back in national print advertising in major publications, magazines like Good Housekeeping, House Beautiful and Real Simple featuring three of Broyhill's newest bedroom groups.

Broyhill's making great strides in refreshing its product, both case goods and upholstery. We've introduced some fresh contemporary collections at price points that are very attractive to both dealers and consumers.

At Thomasville, we've made strong progress this year, as shown by the 19% improvement in same-store sales. We launched some great collections last fall at the high-point market and are shifting [these] early this year. We expect that trend to continue.

Like Lane, Thomasville is using TV advertising to build its brand with some great new spots. Look for those to begin airing this month.

Thomasville is also upgrading its digital presence with monthly updates to thomasville.com, daily postings to Facebook that engage our current future Thomasville customers. We've also added ratings and reviews for our product pages, too.

Touching on designer brands for a minute, in '09, they were the last segment to feel the recession effect and see a decline in sales. But their sales decline was also the steepest. We're seeing signs now that the high-end consumers are back in the market, and they want the quality and customization that our designer brands offer.

Designers know what they can expect from Henredon, Hickory Chair, Pearson, Laneventure and Maitland-Smith. The performance of these brands reflects this.

Finally, I'd like to make some comments around 2011. Well, first of all, with respect to Q1, in the month of January, I think we all know we battled some adverse weather conditions. Traffic at our dealers and our own stores was down early on, but rebounded nicely later in the month.

While it's still early in the quarter, we'll have to see how much of the early January loss business that we can make up completely in the current quarter. These things happen in our business, and we'll just manage through it with a lot of time left in the year.

In total, this will be a year where we invest in our brands and our company to build for the future. We're focused on driving sales, and we'll have numerous new product launches of consumer-tested products. We'll increase the support of our brands to drive consumer demand and traffic to our stores and our dealer stores as well.

We'll continue with our lean initiatives within our supply chain, manage our product cost and deliver good quality and service on our products. We'll continue to be good operators and manage our expenses down and our working capital, driving waste out of our company that's been a constant theme. We'll continue to find ways to be more effective and efficient with the operating expense piece of SG&A.

With regard to working capital, we expect this year to be with inventory levels flat to slightly down versus last year. We expect that cash flow will fluctuate quarter to quarter, but be somewhat neutral for the year as we continue with our investments in the company; our Indonesian plant expansion, investment in our new Mexico cut-and-sew facility and also our SAP implementation. On the flip side, we'll dispose of some surplus access throughout the year.

All that said, driving profitable sales growth remains our top priority. By increasing our investment to support our brands, introducing exciting new products this year, we intend to strengthen the market position of our industry-leading brands.

That concludes our prepared comments. I want to thank you all again for being with us. Now we'll open up the line to do the questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Brad Thomas - KeyBanc Capital Markets, Inc.

Brad Thomas - KeyBanc Capital Markets, Inc.

Ralph, I wanted to just follow up on some of your comments about the high-end consumer being back. You did mention that that was a segment of your business that slowed down later than everything else and with a little bit greater decline than everything else.

Could you just give us a little bit more color on what it is that you're seeing on higher end? How much of that is a function of perhaps just easier comparisons?

Then as you look back historically at the performance of the business coming out of recession, is this typical of what you see? When could we perhaps expect to see the middle end respond as well?

Ralph Scozzafava

Let me take a shot at that, Brad. I think what we're seeing now, and I think a lot of it is driven by seeing the financial markets come back to a degree and the higher-end consumer feeling a little bit freer and more apt to go ahead and spend dollars that they could have spent all along, but now it becomes a lot easier for them to do.

With our brands, what we're seeing and, particularly, brands like Hickory Chair or Pearson that are very customized is we're seeing designers now only with more projects, but with larger projects.

So where a year ago or a year and a half ago we may have seen an average designer working on two or three projects maybe a room at a time, we're seeing that same individual firm with six or seven projects two and three and four rooms at a time. I think that's really encouraging.

Are we back to '07 levels, '08 levels? Who knows? So there's a little bit of a comp factor in there. But the trends have been impressive.

Brad Thomas - KeyBanc Capital Markets, Inc.

As you look back historically, is there any pattern that has emerged through the data that you have in terms of the high end perhaps leading by a few quarters? Or does that really just remain to be seen?

Ralph Scozzafava

Yes, I think more remains to be seen. Overall, we saw that, the decline, when the financial markets really went through all the turmoil. We saw that segment, I won't say virtually stop, but it was really, really trailing the balance of the portfolio. So we'll find out together whether they lead us out. My intuition says they may.

Brad Thomas - KeyBanc Capital Markets, Inc.

I wanted to just follow up on the advertising. It sounds like you've been very pleased with the efforts around Lane during the end of 2010. I was hoping you could just quantify either in dollars or percentage of sales how you would expect the 2011 marketing and advertising to pan out versus what you spent in 2010.

Ralph Scozzafava

First of all, we're pleased with the campaign on Lane, and we really like the ability to tie the television into the national print to the digital. The snap tech technology is really kind of neat stuff.

The Facebook page and all of that is really interesting. It's a nice way to surround the consumer, not just with messaging, but also a lot of information on Laneology that talks to why Lane makes some of the very best reclining furniture anywhere. We just want to get that message across, and we'll spend to do it.

You're going to see a significant increase in our spending next year. We had a significant increase in Q4. We're going to carry it forward. This is one of these campaigns and typically when it's with television and a lot of print that has this cumulative effect.

So we haven't published externally how much it will increase. I can tell you it's a very large number on a percentage basis versus what we've historically done. We think we've got a large strong brand to do it with.

So you'll see more from us. Hopefully you've seen some of our commercials. Other people on the call have, I hope. We'll continue to do more of it this year.

Brad Thomas - KeyBanc Capital Markets, Inc.

Just lastly I wanted to follow up on the SAP implementation. Ralph, maybe if you can just give us an update on the timing of that and from a financial perspective and additional expenses or benefits that we might see in 2011.

Ralph Scozzafava

Let me ask Steve to handle that one. He's very, very close to it.

Steve Rolls

Yes, the SAP implementation start to finish is probably about a three-year timeframe. What we are in the process of completing right now is the blueprint phase, which for anybody who's gone through a major implementation of software, that's probably the most important part of your whole phase because you have to get it right looking at how you do things today and how you want them to be done tomorrow.

So we should be complete with the blueprint phase [in call] the next couple of months. Then we would go onto our first phase of implementation where we'll be implementing the product in two of our brands as well as in our corporate area for financials. We'll have another phase where we'll bring in more of the brands and then a final phase to finish off that.

In terms of quantification, we really haven't been doing that. Suffice it to say, it will more than pay for itself over time. We'll be able to get some of the costs out in this first phase and then more of them as we go forward.

Easily we'll save enough money to make this worthwhile. But it also really helps in how you manage the business. It gives you much more information, relevant information, much faster to manage the business better. So we certainly look forward to that.

Operator

Your next question comes from the line of [Todd Slotman - Stability]. Please proceed.

[Todd Slotman - Stability]

On that implementation of SAP, is it safe to say that if there were to be any glitches, we'll call it? Would those be more likely upon that first phase of implementation as opposed to the blueprint stage?

Steve Rolls

Yes. I would say, again, doing blueprint right helps you minimize glitches. I've never heard of an implementation of SAP or PeopleSoft or anything else where you don't have some challenges. I mean, we know we'll have those, but the key is to try to anticipate those to be able to react very quickly to them and minimize those impacts.

So we'll be focused on that. We'll be very focused on change management, help people get trained and kind of handle the new systems better.

Ralph Scozzafava

Yes, we, Todd, won't have a go-live date until 2012. So the blueprinting is just maybe a fancy word for lots of planning.

[Todd Slotman - Stability]

With the $75 million and NOL carry-forwards in mind, how should we be thinking about the tax rate for this year?

Steve Rolls

Well, so if you look at our taxes, we do show some taxes because we have some foreign taxes that we pay, we have some state taxes that we pay. But a lot of state and, certainly, our federal taxes are cushioned by our tax losses from the past.

I would say, in terms of tax rate, it might be flat to possibly a little bit up. But it's not what you'd model as a 40% or 36% kind of tax rate because while we had to reserve our tax losses, they're still there and we'll still get the cash benefit from those as we generate profit.

[Todd Slotman - Stability]

Just revisiting the media spend for the year, the comment of a sharp year-over-year increase, did that pertain just to the Lane brand? Or is that total spend?

[Steve Rolls]

You'll see more spending on Lane. You'll see more spending on Thomasville, more on Broyhill. So I don't want to say across the board, but we've had to prioritize on some big brands. That's what we've done.

[Todd Slotman - Stability]

Are there any substantive decreases at any of the brands?

[Ralph Scozzafava]

No, we're up on all brands and up quite significantly on those three.

[Todd Slotman - Stability]

As far as the operational improvement evident in the fourth quarter gross margin, how should we think about continuation of that into Q1? What are the puts and takes that would be useful? I mean, aside from the non-recurring items.

Ralph Scozzafava

Yes, I think the gross margin for us is in a bright spot. We've got a terrific supply chain team, and the improvements that we put in and have been reflected in our gross margin this past year are structural.

The lean culture that we're driving in our factories, some of the consolidations that we've made across and into our facilities, really have stock and are part of our cost structure now.

To Steve's comment in his prepared remarks, this is a journey for us, and it's one that we'll continue to be on. So we're maniacally focused every single day on how we get waste out of our system, how we get more efficient and effective.

We have not modeled in any benefits for our Indonesia facility yet, for Mexico cut-and-sew, which a year from now I expect to be seeing benefits from. These are things that we'll just continue to do as we embark and continue on the Lane journey.

So the gross margin we'll keep working against. I expect to see continued improvement over time.

[Todd Slotman - Stability]

In near term, say one to two quarters continuation of a normalized mid-20s kind of gross margin?

Ralph Scozzafava

We're going to look at where we are. We've made some discounts in the fourth quarter to drive distribution. Those are choices that we made. We are not going to continue those forever.

So from a quarter-to-quarter basis, you'll have a quarter that will be up more, maybe one that won't. But, over time, if you draw a line, you will see an upward slope.

Operator

Your next question comes from the line of John Baugh - Stifel Nicolaus.

John Baugh - Stifel Nicolaus

A couple of things year; on the SG&A number, it was a sizable ramp in the fourth quarter. You threw out the number of $78 million. I think you reported $94.5 million. Then if you add back the property dispositions, it's closer to $91 million or so.

So that's $13 million odd. I [don't] add back the other things, historical expense and receivables. So I don't know if you do in your $78 million guidance.

But I'm wondering. Is that GAAP all the marketing spend that we're talking about? If so, is that going to be the number we're looking at in '11 quarterly as well?

Ralph Scozzafava

Yes, let me try and take a shot, and then I can turn it over to Steve, John. Yes, we talked about the number of about $78 million in kind of an average run rate. Then I think at the time we were communicating it could go up or down, depending on brand support. So, yes, there was increased brand support. If I'm modeling, I add that onto the number.

We also had some expenses in the fourth quarter that fall into SG&A, oddly enough, from some of the new plant expansion work that we're doing in Indonesia and Mexico and from an accounting standpoint. Until those plants are producing product for sale, the guys here have to book that into those expenses into SG&A. So you do see a little bit of that at the same time.

The theme here has been continue to take out what we call operating expenses -- that, of course, is SG&A -- and get tighter and tighter and smart and smarter and eliminate the waste and then use those funds to build our brands. You saw a little bit of that in Q4.

Steve Rolls

The only thing I'd add there, I think, is that we did have a couple of customers go bankrupt, which I don't think anybody who dealt with them in the industry were really expecting.

So I can't say we won't have -- we'll always have some AR charges along the way. But I would hope that we're getting to the end or the thin end of retailers going out of business with the economy.

John Baugh - Stifel Nicolaus

So, Steve, if I added back the bad debt and the disposition and then some kind of number for the Indonesian plan expansion, the marketing spend might be more in the $5 million increase range or something as opposed to on the surface, like $10 million or $12 million.

Steve Rolls

Yes.

John Baugh - Stifel Nicolaus

Then on the Thomasville numbers, which you break out, you did have a sales gain there. Yet the margin, gross margin, deteriorated pretty noticeably, I think, 360 basis points. Is there something going on there that you can provide some color as to why that margin deteriorated on such a nice gain in sales?

Steve Rolls

Yes, promotions; kind of straight forward.

John Baugh - Stifel Nicolaus

Then what are we looking at across the business in terms of raw material cost ramp? Did we experience any of that in the fourth quarter? I assume we'll start to experience it more heavily going forward. Is there any pricing implementation to offset any of that being discussed or actually announced?

Ralph Scozzafava

Let me take that in reversed order. We haven't announced any pricing actions of any kind of consequence, John. We do see on the horizon that we are [e-hearing] from vendors and we're seeing in commodity costs that there are going to be some increases that we're going to have to deal with, certainly fuel is one that we'll have to deal with in the fabric area.

We've seen costs go up and then come down. We've been able to buy in bridge across a lot of that little bit of a hill but there's always going to be commodity pressure and I think in 2011 we'll see more of it.

Our job is to be more productive. We've got a global supply chain team and we're aggregating our spends with select partners. We want to be a bigger player with our vendors and help them get through it as well as us but do it in a cost effective way.

All that said, will there be pressure next year? Yes and our job is to have productivity gains to offset it and that's really where it stands today.

John Baugh - Stifel Nicolaus

So that would probably be a margin pressure point in '11. I assume pricing in this environment is still very challenging.

Ralph Scozzafava

That's our feel today.

John Baugh - Stifel Nicolaus

Lastly, on inventories, they're way down from where they were in years prior but -- and I don't remember precisely what happened a year ago fourth quarter. Maybe that was an unusually low point, $226 million, but they're up substantially year-over-year on a decline in sales during the year.

Is that number where you want it? Is it too high? If so, why? What would be the guidance or thought process for inventories? I guess you have to have some line of sight on sales and I'd love to hear any comment you have about where you think sales will go this year in light of your increased marketing spend and all the other things.

Ralph Scozzafava

I think from an inventory standpoint, I think we were pretty low, down in the 220s a year ago. I think $250 million is a little bit high for us, so I anticipate that our inventories -- it'll fluctuate a little bit quarter to quarter but should go down throughout the year and end the year in a better position, lower in my mind than it is today.

As far as sales is concerned, we would love to be in a position to give sales guidance. I think the economy is still in a situation where we see fits and starts. If I was to give you sales guidance a year ago it would have been up. Then, of course, we know what happened in the back half of the year. So we'll stay away from that.

I think the biggest thing that we can do every single day is be smart about trying to maximize profitable sales, take costs out of the business, manage our cash. Again, in 2011, it's about investing back in the business, back in the brands, brand support, new product introductions and I think over time, economy permitting, we'll see the sales growth.

John Baugh - Stifel Nicolaus

If I could just follow up, the comment about the designer brands seeing improvement, I assume that doesn't translate to Drexel or Thomasville. You were just talking about the high-end brands you mentioned, number one, and so am I correct on that?

Number two, what do you mean? Projects aren't revenues I don’t think. Have you seen a sequential improvement in revenues, a year-over-year improvement in revenues there or any color?

Ralph Scozzafava

I think the one thing I would take away without going through brand by brand is that the higher-end consumer, the more affluent consumer, where we excel, what I would call our better best, and that's from Thomasville, Drexel on up. We're seeing more momentum.

I think the work that we're doing and the marketing that we're doing to help the general multi-brand furniture retailer to drive their business is really important. So if we can support Lane and support Broyhill, drive consumers, shoppers and traffic to our retail partners, that's what's going to help our business the most. It's going to help our dealers the most and that's really at the core of our strategy.

So when they win, we win and we've got to get the good price point segment to really move. Once we do that then we'll see good sales momentum.

Operator

Your next question comes from the line of Budd Bugatch - Raymond James.

Budd Bugatch - Raymond James

I'm trying to understand a couple of things. Sequentially, it looks to me like gross margins fell in the fourth quarter versus the third quarter on the wholesale side by about 500 basis points on an adjusted basis, adjusting for everything but the factory downtime. Can you help me understand what did happen there? You actually had sales up a little bit, by $2 million, and yet the gross margin fell by that much.

Ralph Scozzafava

Yes, I think the simple answer is we got a little bit more promotional in the fourth quarter on some of our brands to drive floor placements. We think the economy is going to recover at some point. I think we all do. We all know that. The question is when.

We made some investments with current dealers. We made some investments to get into some new doors. Of course, when you do that you're going to spend a little bit and that's really what drove that.

Budd Bugatch - Raymond James

Ralph, that actually understated the results in the third versus the fourth because in that adjustment you took a $6.7 million charge for inventory that I backed out. I thought that that would -- last year you had taken a $30 something million charge in the fourth quarter and I thought the inventories were fairly clean and we might have seen the last of that. So what was that all about?

Ralph Scozzafava

That's an SG&A number. We'd have to go reconcile that with you, Budd.

Budd Bugatch - Raymond James

That's not in the cost of goods sold.

Steve Rolls

No, it is in the cost of goods sold. We continually look at our inventories and where we need to take charges we do. So I'm not sure if your question is why do we have the charges.

Budd Bugatch - Raymond James

Yes, I thought the inventory was relatively clean after that or had we built some obsolete inventory again that you had to then charge out? That 500 basis points didn't include that 400 basis points more for that issue. I was just trying to understand. Are we going to see that every year in the fourth quarter, I guess is the real question.

Steve Rolls

Well, you've got a couple of things there, Budd. Some of that is related to the promotions that Ralph talked about. Some of that is related to the Appomattox plant closure. You've got raw materials, for example, that you probably don't have use for elsewhere. So it's a few different things. But I think if you looked at those they're indicative.

Budd Bugatch - Raymond James

I'm not sure I totally understand that. I thought that we had wrapped the Appomattox into another number. The other thing that confounds me a little bit is understanding where the -- in the wholesale segment it looks to me like the SG&A did rise on adjusted basis by about $15 million from the third quarter to the fourth quarter.

Now, the third quarter looked abnormally low at $48 million adjusted but the fourth quarter looks higher than any of the other preceding two quarters and it's very similar to the fourth quarter of last year. So what was going on there?

Steve Rolls

Again, as I think Ralph said in the past, we think about that $78 million as a normalized run rate. In addition to that, we had the advertising in the fourth quarter. We had expenses related to the education plant expansion, some other things. We had some sales force reorganization and different things.

Budd Bugatch - Raymond James

So if $78 million, Steve, is the normalized run rate, you have about a $21 million run rate on an adjusted basis, excluding closure costs, for retail. So then are we talking about a $59 million to $60 million run rate or a $57 million run rate for the wholesale side of the business? That would be the math, right?

Steve Rolls

On a static basis that would be the math.

Budd Bugatch - Raymond James

Well, your retail SG&A has been about $21 million to $22 million adjusted for every quarter for the last eight.

Steve Rolls

Again, as I said in my comments, that didn't have expenses for short and long-term incentive compensation accruals that we'd be adding to this year.

Budd Bugatch - Raymond James

Are you going to start accruing at $5 million a quarter then for the incentive compensation?

Steve Rolls

That's correct.

Budd Bugatch - Raymond James

You are? So the $78 million includes $5 million, so it's really $73 million.

Steve Rolls

No, you would add that on.

Budd Bugatch - Raymond James

Oh, so you're going to have $83 million as a reported number.

Steve Rolls

That's right.

Budd Bugatch - Raymond James

So $78 million is the operating number and then $83 million on a quarterly run rate including the $5 million.

Steve Rolls

Right, plus any additional advertising promotion that we might do.

Budd Bugatch - Raymond James

Then I think you quantified that for John as an incremental $5 million a year.

Steve Rolls

That's what we added in the fourth quarter of 2010.

Budd Bugatch - Raymond James

So the $5 million was a fourth quarter add. Will that repeat quarter by quarter?

Ralph Scozzafava

We don't know.

Budd Bugatch - Raymond James

Last question for me is CapEx for next year.

Steve Rolls

Yes, we haven't given that out either, Budd, but we are in investment mode. We are investing in Indonesia. We're investing in Mexico. We're investing in SAP.

Budd Bugatch - Raymond James

So that's not something that we should be interested in?

Steve Rolls

Sure you should. No, I'm just saying we're stepping up our investments from what we did in 2010.

Budd Bugatch - Raymond James

Can you help us quantify that at all or what you might need -- have you ever quantified -- I think you have quantified what Indonesia would cost. Wasn't it $10 million to $20 million?

Steve Rolls

Yes, that was the range we gave some time ago.

Budd Bugatch - Raymond James

How much has already been invested?

Ralph Scozzafava

The bulk of it. We've got -- .

Steve Rolls

Well, by the end of this quarter.

Ralph Scozzafava

Yes, by the end of this quarter, the bulk of it is in.

Budd Bugatch - Raymond James

By the end of which quarter, the first quarter or the fourth quarter?

Steve Rolls

The first quarter of 2011.

Budd Bugatch - Raymond James

First quarter of '11, so then after the first quarter of '11 you'll have been done investing in Indonesia?

Steve Rolls

Mostly.

Ralph Scozzafava

In the big parts, yes. It'll be small odds and ends and then you'll see the Mexico investment made through the balance of the year. Then, of course, SAP goes on through this year and over the next two beyond.

Budd Bugatch - Raymond James

So will you be in a position to give us a CapEx estimate for the year at the end of the first quarter?

Ralph Scozzafava

We probably can. Let us go back and just make sure that we're going to pull out what's going to go into 2012, what we've already spent and we'll reconcile it for you. I don't have a problem giving you a CapEx model at all. You'll need it to model.

Operator

Your next question comes from the line of Sherman Chao - Impala Asset Management.

Sherman Chao - Impala Asset Management

I just wanted to ask about the context of the fourth quarter business environment where it sounds like you and the industry went through a period of promotions partly, I guess call it, offensive and part of you all [decline] it as defensive where the business environment was a lot weaker the second half of the year than the beginning of the year.

So can you talk to the things that led to the -- A, would you agree with that general characterization and then, B, if you could provide some more insights into the decisions and the things that led to the more offensive versus defensive promotional activity?

Ralph Scozzafava

You've characterized it well. The first half of the year -- and really the GDP number confirm it -- what you saw in Q4 of '09 and Q1 of 2010 was some good, strong economic numbers and, of course, we, like a lot of other companies, had a better first quarter and a better second quarter and then we saw demand pail off and particularly in our categories.

Over that time, what happened, Sherman, I think -- and we were among the companies. We had an internal project here called Uptick where we thought we're seeing some form of an economic upturn. Let's make sure we have inventory available. Of course, when you have a long lead time supply chain particularly on case goods from Asia, cut and sew kits from Asia, you tend to order higher quantities.

Then when demand does slow down, all of your inventory arrives and you find yourself in a relatively high inventory position. I don't think we were the only one there. You couple that with this idea that we want to not only stimulate demand but we want to be there on the floor with more distribution, with more doors, with more product in each door that we're in and just build our floor space and you start to want to invest a little bit.

So I think those factors combine to have us be a little bit more promotional to focus on driving floor placements and I think they're reflected in the gross margin numbers in the fourth quarter. We hope to come out of the fourth quarter with better distribution and better position -- we certainly are from an inventory standpoint -- but better positioned commercially to sell.

Sherman Chao - Impala Asset Management

Do you get a sense that the industry, the promotional activities -- how much more is left to go to clean out the inventories or has the retail trade been conditioned now to say we've now stepped down to a different level of pricing that we need to adjust to or is it sort of understood that that was a tactical necessity that may not necessarily be required in '11?

Ralph Scozzafava

I think the latter really is the right attitude and is the one that will allow, I think, our industry and the people in it to sustain businesses over the long term. I don’t think that we can be promotional forever. I do think we have to have a promotional element to our mix. There's no question about that.

But over time we've got to sell brands. We've got to sell value and I think if we're able to do that we'll be able to generate margin and then that's both for our retail stores and it's for our dealers. It's for us as a manufacturer at the same time.

So I think that we're dealing with a rough economy and we're just trying to all manage through it and that's just part of it.

Sherman Chao - Impala Asset Management

I guess one final question on material costs, whatnot. Can you help me understand just what the impact of -- what kind of pricing is needed for the material cost increases that may be taking place either on the case goods side or upholstery?

Ralph Scozzafava

Right now we're evaluating with those input cost increases could look like. We don't see them across the board. I think there was probably more pressure a couple of months ago. But we do know that costs in Asia are increasing. We know that for sure.

We know that oil, gas, petroleum, we're going to see some increases there and we're going to have to understand the magnitude and deal with them. We would like to offset with productivity gains. I think that's first for us in the environment that we're in. The luxury of lots of price increases, I don't think we have a lot of that today.

Operator

Your next question comes from the line of Barry Vogel - Barry Vogel & Associates.

Barry Vogel - Barry Vogel & Associates

There's been a lot of commentary and a lot of questions and a lot of answers, so some of my questions have been answered. I just want to key in on two or three things. The first thing is that it was obviously a disappointing sequential quarter in terms of sales and it was obviously disappointing if we look at an adjusted gross margin in the third quarter on -- I think the third quarter was $272 million revenues and I make these adjustments just like everybody else and some of them I use and some of them I don't.

But I show in my numbers a 25.3% gross margin in the third quarter and here on your numbers you have an adjusted gross margin, if we took away all of those items, of 22.1% on sales of $270 million -- what was it -- $270 something million. So could you key in on the main culprit of the sales drop sequentially, the main culprits, and the gross margin culprits? I know you mentioned the RPA situation a couple of times and I don't know if that is one of the main culprits.

Ralph Scozzafava

I'll talk to the sales number and then Steve can talk a little bit more to the gross margin, Barry. If I look at the sales number on the year, our business is down 5%. A little more than half of that is a ready to assemble business that we've exited. So on balance it's about a 2% decline over the course of a very difficult year.

So as I look at that, are we pleased? No. Do we want to grow? Absolutely. If you see where we control our stores, at Thomasville, our same-store sales are up 19%. We're seeing some really buoyancy in our real high-end brands and what we've got to do now, our charge is to help our dealers and the retail stores where we have distributional along with other products in a multi-brand environment.

We've got to help drive traffic to those stores. We've got to help build floor space and we've got to help sell our products through it. So we're not pleased with where sales are but we do understand and we've made some conscious choices to grow gross margin and, of course, you're going to have a little top line that you're going to sacrifice when you do that.

On the gross margin piece -- and I'll hand this to Steve in a second -- to grow 200 and 300 basis points in a year when you're volume is essentially flat I think is a pretty good performance. We've done some things in the fourth quarter consciously and we've done them to gain some floor space.

We think it's the right investment in our business and then I think what you'll see us over time do -- and not a lot of time -- is return to more what are now normative levels of gross margin.

Barry Vogel - Barry Vogel & Associates

What would that be?

Steve Rolls

In terms of normative gross margin, Barry, we haven't really put that out. As you see, we've been able to improve year over year and, as Ralph said earlier, the fourth quarter really just reflects a lot of promotional activity. So not saying there won't be any of that in the first quarter but we're continuing to focus on improvement of gross margins.

Things that will help that would be less promotional activity than we did in the fourth quarter, when we ultimately closed the Appomattox plant. In the second quarter we'll have less drag from that. So we'll just keep finding ways to improve our plant productivity and our products.

We still -- as you know, we've gotten out of a lot of unprofitable products over the years and we've made a lot of improvement there but I'd say we have more we can do over time as our product line rolls to new product from old product. So we have some product today that isn't at the margins it needs to be.

It's not something we're going to cut immediately like we have some but it will roll off over time. So we intend to just keep working at improving our gross margins.

Barry Vogel - Barry Vogel & Associates

One other question, Steve, as far as the operating tax loss carry forwards and any tax refunds receivable, as of December 31 -- I wrote down and I don't know if I wrote it down correctly because I was writing a lot of things -- that you had a $75 million operating tax loss carryforward. Is that correct?

Steve Rolls

Yes, it's right about that. So as we start to generate profit we can apply that.

Barry Vogel - Barry Vogel & Associates

So it's not a tax refund receivable on that.

Steve Rolls

No.

Barry Vogel - Barry Vogel & Associates

You must generate profits to use your NOL.

Steve Rolls

That's right.

Operator

Your next question comes from the line of [Tim Stabbles] - Private Investor.

[Tim Stabbles] - Private Investor

Do we have a figure for year-end net debt, roughly unchanged or not sure?

Steve Rolls

For 2010?

[Tim Stabbles] - Private Investor

2011 projected.

Steve Rolls

Oh, no, we haven't done that and I think in Ralph's comments he said that we expect to be roughly flat on cash flow for the year, give or take. It's hard to project at this point but that's what we're thinking. So given that, unless we change our debt level, that wouldn't change either.

[Tim Stabbles] - Private Investor

Did we get any reward from the marketing spend in Q4 or should we fundamentally look at that as a startup cost but investment in the future?

Steve Rolls

I think a little bit of both. The benefit I would say is we've gotten some increased placements. Those will flow into the market and be up and running this quarter, next quarter, just more of a cumulative effect.

The thing that we all have to understand here ourselves is that when we start this consumer marketing, there is a cumulative effect. There is a little bit of a ramp up period and consumers won't just view and ad and run to the store. But over time we get into their consideration set and then we're able to affect their purchase behavior.

[Tim Stabbles] - Private Investor

Suffice it to say, it would be really problematic if we're ramping up a marketing expense and we didn't get sales growth in 2011. That would be a problem.

Steve Rolls

I think in general it would be.

[Tim Stabbles] - Private Investor

At what point in time does the company start looking at -- we've got Ethan Allen that was up 21% on sales for the quarter they just reported. At what point -- this company in my view is very -- these brands are very valuable, management knows that and a lot of the shareholder base knows it.

The stock is down compared to your peers on one of the worst bases from its peak. At what point do we look at saying, well, this company is worth more to somebody else and we've got to look after our shareholders because at $4 and change, these brands are being valued quite cheaply.

Ralph Scozzafava

Yes, I would tend to agree that they're valued cheaply. I think that's first and foremost and with that the whole effort that we have here, the board, management, myself, how do we drive value for our shareholders. That's critical. We've been through a pretty significant turnaround of a business that three years ago lost $400 million and last year lost $170 million at the operating line.

We're in a turnaround and we're doing that. To have the gross margin growth that we've had, to have the SG&A lower than it's ever been in the history of the company, to have the debt where it stands today -- I can remember entering the company three years ago and we owed $300 million in debt and we had $27 million on the balance sheet.

So there's a lot of progress made, not fast enough for me or anybody else and certainly as we make that progress we expect the marketplace to value the company appropriately and that's our effort every day.

Steve Rolls

Tim, you highlighted Ethan Allen's increase and really it's not comparable to Furniture Brands in total. You really have to look at what we've talked about whether Thomasville -- because Thomasville is very similar to Ethan Allen and its price point, its product, its go to market strategy, Ethan has a more -- a longer, more established retail presence than Thomasville has but you look at our same-store sales and it's right there.

So you can't really make that as a comparison that the full -- .

[Tim Stabbles] - Private Investor

Let me ask one final question then. I do want to acknowledge I was around in this company a couple years ago and the balance sheet and things looked a lot scarier. Things have, as far as the financial security and whatnot, there has been a remaking of the company and that's very heartening. It's the sales growth that's a concern, of course.

So my follow-up question is the stock seems very undervalued. We can't do a buyback, right, or we could?

Steve Rolls

No, we can't.

[Tim Stabbles] - Private Investor

Can you speak to whether management is going to be coming in here -- I don't know if we're going to drop here or what's going to happen; I haven't seen where to open -- but whether we'll see some support from management for -- it was buying back a year to two ago I think in the low $4s and what not. Is management going to put its money where its mouth is and show some faith in the value of these brands in the future of Furniture Brands?

Ralph Scozzafava

I think it's a great question and one of the core values we talk about here a lot is ownership. Tim, you probably know I bought a whole lot of stock. I'm our largest individual shareholder. My goal is to continue to be that. We encourage every bit of our management team, every person, to be an owner in the company. Unfortunately, I can't publically say whether I'm going to buy tomorrow or ever. I think you know that. But my money is up.

I think we're set. I don't think there are any more callers. So I want to thank everybody for being with us today. We've got more work to do, as it typically the case, and we're going to get after it and we look forward to talking to everybody on our next conference call. Have a great day.

Operator

Ladies and gentlemen, thank you very much for your participation in today's conference cal. You may now disconnect. Have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Furniture Brands CEO Discusses Q4 2010 Results - Earnings Conference Call
This Transcript
All Transcripts