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Executives

Rick Isaak – Vice President and Controller

Steve Rolls – Chief Financial Officer

Ralph Scozzafava – Chairman and CEO

Analysts

Brad Thomas – Keybanc Capital Markets

John Baugh – Stifel Nicolaus

Budd Bugatch – Raymond James

David Liu – Bernstein

Sean Matlock – Kennedy Capital Management

Furniture Brands International, Inc. (FBN) Q4 2011 Earnings Call February 9, 2012 8:30 AM ET

Operator

Good day, ladies and gentlemen. And welcome to the Fourth Quarter 2011 Furniture Brands Earnings Conference Call. My name is Lucy, and I’ll be your coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question-and-answer session towards the end of the presentation. (Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call Mr. Rick Isaak, Vice President and Controller. Please proceed.

Rick Isaak

Thank you. Good morning, everyone, and thanks for joining us today. Steve Rolls is in the room but due to strange vocal cords he is trying to avoid speaking, so I’ll read his prepared remarks. I want to take a moment to read the Safe Harbor statement before I go over the financial results of our fourth quarter and full year. Ralph Scozzafava, our Chairman and Chief Executive Officer will then follow with a discussion of the highlights of the quarter and year.

I need to remind you that certain comments made during this call may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Our actual results and future financial condition may differ materially from those expressed in any such forward-looking statements as a result of many factors that may be outside of our control.

Please refer to our SEC filings, including our Form 10-Qs and Form 10-Ks for discussion of the major risks and uncertainties that may affect our business. The forward-looking statements made today are as of the date of this call, and we do not undertake any obligation to update our forward-looking statements.

If you do not have a copy of today’s press release, you may obtain one, along with copies of the prior press releases and past SEC filings by linking through to the Investor Relations page of our website, furniturebrands.com.

Now on to our financial results. As reported in this morning’s press release, total sales were $255.5 million for the fourth quarter, a decrease of 7.4% over the same period last year. For the full year sales were $1.1 billion -- $1.11 billion, down 4.5% from the $1.16 billion in sales reported in 2010.

Gross profit for the fourth quarter of 2011 was $58.8 million and gross margin was 23%, up from $50.1 million in gross profit and 18.1% in gross margin in the fourth quarter of last year. The increase in fourth quarter 2011 gross margin was primarily due to $10.3 million of lower expenses related to restructuring activity, compensation and benefits, and a $6.2 million decrease in inventory charges, partially offset by higher raw material costs of almost $5 million.

For the full year, gross profit was $267.3 million and gross margin was 24.1%, as compared to $276.3 million in gross profit and 23.8% in gross margin in 2010. The increase in full year 2011 gross margin was primarily due to lower expenses of $15 million related to restructuring activities, compensation and benefits, partially offset by higher raw material costs of $14 million.

SG&A expenses totaled $69 million for the fourth quarter, compared to $94.5 million in the fourth quarter of 2010. The decrease in fourth quarter SG&A was primarily due to a $10.2 million reduction in expenses related to restructuring, compensation and benefits, a $7.8 million reduction in non-working marketing and sales expenses, a $3 million reduction in bad debt expense, and $3.1 million of higher gains on facility and asset sales.

On a full year basis SG&A totaled $302.9 million, as compared to $320.2 million in 2010. The decrease in SG&A on a full year basis was primarily due to a $14.6 million reduction in expenses related to restructuring, compensation and benefits, a $3.1 million reduction in non-working marketing and sales expenses, a $1.8 million reduction in bad debt expense, a $1.1 million reduction in vacant facility costs and $1.5 million of higher gains on facility and asset sales, partially offset by $4.4 million in favorable settlement of certain international tax and trade compliance matters that took place in 2010.

Last quarter we spoke to you about $30 million in new annualized cost savings, about 70% of which will be realized in the SG&A line. We realized only a partial benefit from the $30 million in savings in the fourth quarter of 2011, but beginning with the first quarter of 2012, we expect the quarterly base SG&A run rate of $73 million to $77 million to fully reflect the impact of these cost savings. This base SG&A run rate may increase or decrease depending on changes such as brand support activities and incentive compensation accruals.

On a retail side of our business the 44 Thomasville stores we’ve operated for more than 15 months showed a same-store sales decrease of 4% this quarter, following a 15% same-store sales increase in the fourth quarter of 2010.

Retail sales at the 64 company-owned stores and showrooms were $34.6 million in the fourth quarter of 2011, as compared to $38.8 million in the fourth quarter of 2010, when company-owned stores and showrooms totaled 67.

Recall that we closed three Thomasville stores in Q4 of 2010 and had some large volume low margin inventory clearance sales at quarter. This compares to Q4 2011 where we have slightly lower sales but higher gross margin for our retail business, which improved to 41% from 37.6% in the fourth quarter of 2010.

For the full year the 48 Thomasville stores that we’ve operated for more than 15 months showed the same-store sales increase of 6.3%, following a 19% increase for the full year of 2010.

Inventory at quarter end was $228 million, a decrease of 8.6%, as compared to the $250 million we reported at the end of 2010.

Cash at year end totaled $25.4 million, up $4.2 million from the third quarter of 2011 and long-term debt remained consistent throughout the year at $77 million. We could borrow an additional $20.5 million under our ABL as of today. This amount is lower than at the third quarter, primarily due to the draw down of inventory at the end of 2011.

Capital expenditures for the year came in at $27.5 million. We continue to expect our capital expenditures for the full year of 2012 to be in the $16 million to $18 million, and we expect depreciation and amortization to be in the $22 million to $24 million range.

We contributed $3.1 million to our pension plan in 2011 and as we said on the last quarter’s call, we anticipate our 2012 contribution to be approximately $14 million. This is reflective of the higher liability calculation due to lower discount rates as is true for all companies with defined benefit pension plans. Overtime, as interest rates return to more normal levels, we will see our underfunded liability decrease and contribution requirements come down.

With respect to next year, assuming no deterioration in the macroeconomic from current levels, we expect to be free cash flow positive as we improve our operating results, CapEx comes down from the elevated levels of 2011 and we continue to improve our inventory position. Revenue growth, flat sales and even a sales decline in the low single-digit range in 2012 as compared to 2011 will all be scenarios in which we expect to achieve this goal.

CapEx in 2012 will be in the $16 million to $18 million range, down significantly from the $27.5 million we spent in 2011. Depreciation and amortization is expected to be in the $22 million to $24 million range in 2012, and we expect to make a $14 million cash contribution to our pension plan.

In addition to the $30 million an expected 2012 savings, we announced with our third quarter results there are other sources of savings that Ralph will recap in a moment.

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

Ralph Scozzafava

Thanks, Rick. As I look back at 2011, it’s been a year defined by continued progress on the costs and efficiency fronts, but importantly this past year we made key investments to strengthen our infrastructure and to improve our competitiveness for the long-term.

To recap the key highlights of our 2011 performance, we are now able to better leverage our sales into profitability than we have been in many, many years. We completed the four straight year of reported gross margin improvement and 24.1% gross margin in 2011 is the highest in many years at Furniture Brands.

We are now a much leaner company today than at any other time in our history. There has been $110 million in annual structural SG&A expense reductions over the last four years and the additional actions taken in the second half of last year will reduce cost even further in 2012.

Our balance sheet is healthier with a debt level of $77 million, which is more than $220 million below 2007 levels. This is a reduction that was achieved during the worst recession of our lifetimes.

To summarize our ongoing productivity efforts, the progress we’ve made in our supply chain operations due to the implementation of our lean initiatives has evolved into a lean culture that’s based on continuous improvement.

We have increased our planned efficiencies to improve our sourcing and distribution operations at the same time. The progress has been measurable and demonstrated in the highest product quality ratings that we’ve ever had. The best factory safety numbers in the history of our company and our service levels across our brands are higher than they’ve ever been. These metrics all have a tangible impact on the business.

Take improved safety levels as an example. Not only are these important for our people, they translate into less loss time, less reduced worker’s compensation and as another contributor to our reduced cost structure and improved efficiencies.

To recap our previously announced savings initiatives with quantified benefits still to be realized, we’ve said that full realization of the savings associate with our Mexico and Indonesian operations will take place in 2014. It’s expected to be in the $12 -- the $10 million to $12 million range. Both plans currently represent a drag on earnings today as they’re ramping up. We’re expected to become positive contributors during the second half of next year.

A large portion of our company-operated Thomasville stores reached the end of their lease life in the 2013 to 2015 timeframe triggering either the closure, renegotiation, resizing, relocation of these stores with resolving benefits in the form of reduced rents or increased store volumes.

The $6 million annual cost from dark store leases will go to $5 million in 2012 and will start to drop off rapidly in 2014 as their terms mature or re-implement more buyouts.

And then finally there’s the $30 million an expected 2012 cost savings that we announced with our third quarter results. These are tangible, real and are happening right now.

In addition, as we mentioned last quarter we still have a number of closed manufacturing warehouse and office properties. We’ll be opportunistic with the sale of these over time with any sales contributing to our cash and reducing ongoing expenses.

Currently we have five significant properties for sale that cost us about $1.2 million in expenses annually. Their combined listing price is an excess of $14 million. We also have a leased warehouse on the West Coast that cost us about $4 million a year annually in expenses and we will exit that facility at the end of this year with $3 million in annual cost savings next year.

As important as our focus on efficiency has been and continuous to be we are now much more focused on improving our sales performance. With our well-recognized portfolio of brands, we’ll continue to seek the appropriate opportunities to gain floor space at our existing dealers, to penetrate new dealers and to be in the channels that we’ve not previously had a presence.

With our more vertical supply chain that includes Mexico and Indonesian operations, as well as our 13 domestic manufacturing facilities, we are able to produce lower priced product at acceptable margins today and bring new product offerings to the market, which enable us to hit high volume price points.

This is business that we didn’t previously have the ability to participate in profitability and we can now. The right product at the right price to the right retailers will help drive our sales performance. This is a huge pillar in our growth strategy.

On the product side, we’ve been focused on identifying the right consumer target for each brand and validating that we’re producing the product at the value that this consumer wants. We’ve worked hard to ensure we offer the right mix of styles, contemporary, updated traditional and traditional furniture across our product selections, so there’s something for every furniture shopper’s taste across our brand portfolio.

On the distribution side, we continue to serve our core furniture retailers, as well as department stores, big box retailers, of course our interior designers and international customers to name a few.

We also have 48 owned Thomasville stores, including the three stores we opened in 2011. We’re adding more Thomasville stores selectively and responsibly. These are fill-in locations that enable us to better leverage our existing infrastructure in geographies where we already have a presence.

With the right locations, store size and occupancy costs we believe there is strong potential to grow our Thomasville store space profitability and we’ll do so in a measured manner. This year we expect to open somewhere two and five Thomasville stores when we find the right locations.

As I look forward to 2012, our focus as an organization is firmly centered on one thing and that’s driving profitable sales. We’ve reduced our operating losses in each of the last three years and further progress in this area will continue.

We’ve achieved a lot of this by making some tough calls, decisions to align our cost structure better with our revenue base by improving the efficiency, our manufacturing operations and by exercising some discipline on the revenue front.

But now in 2012 driving our topline sales performance is what it’s all about, it’s priority number one across our entire company. We’ll deliver the right product at the right value to the right retailers to drive sales and we’ll continue to make progress on our path to profitability.

Well, that concludes our prepared comments for this morning. I want to thank everyone for being with us today and then open up the line for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question will come from the line of Brad Thomas with Keybanc Capital Markets. Please proceed.

Brad Thomas – Keybanc Capital Markets

Thanks. Good morning, Ralph. Good morning, Steve.

Ralph Scozzafava

Morning, Brad.

Steve Rolls

Morning, Brad.

Brad Thomas – Keybanc Capital Markets

Wanted to follow-up on the outlook for cash flow to be positive in 2012 and just trying to understand some of the underlying assumptions or cornerstones that you’d need to achieve in order to get that. What would we need to see from a sales perspective and what would we need to see in terms of margins and raw materials? What goes into that forecast?

Steve Rolls

I apologize for my voice in advance. But basically there are a lot of pieces there and as we said, I think in the prepared remarks that plus or minus a little bit of where we ended up in 2011, we think that’s an achievable goal.

There are lot of things that took place in ‘11 that presumably won’t take place in ‘12 but we’ve already offset. So we’ve talked about cost reductions, we had, as everybody did, raw material cost increase spikes in sort of the mid-year last year. So we’ve taken actions of a broad variety to offset those, both productivity, some pricing actions.

So going into this year we should be better off there. Hard to tell what’ll happen with raw material pricings during this year, but we’ll see and we’ll do what we need to do along the way. We talked about the $30 million of cost reductions that we’ve done, all that is, not just income statement, that’s cash.

So there are lot of things that we’re doing. The ramping up of our two plants, our Indonesia and Mexico, while they’re still a bit of a drain as they reset sort of breakeven point, the second half of this year they’ll help.

We’ve talked before about the plant that we closed at the end of the first quarter of 2011 in Appomattox, Virginia. When we did that, we relocated that production capacity, some of it went outside to suppliers and some of it went to other plants of ours in the U.S. So as we ramped up that production again it’s not -- it doesn’t help as you ramp up.

I want you to reach that breakeven point which we have now, that will help in 2012 versus what the place in 2011. So, it’s a lot of moving pieces and obviously on the capital side we’re going to be spending quite a bit less on CapEx. It was a big investment here 2011, so we can bring our CapEx down in ‘12.

Brad Thomas – Keybanc Capital Markets

Thank you, Steve. We’ve talked a lot in the past about these investments and initiatives. If you could quantify the drag on earnings or expenses in 2011 and, versus what you’ll see in 2012 that would be very helpful, excluding the $30 million you’ve already talked about, what can you quantify in terms of the benefit of Mexico and Indonesia starting to ramp-up through the year?

Ralph Scozzafava

Yeah. I think, Brad, on those will in the second half of the year we’ll begin to see those return positively to our earnings. They’re going to be profitable at that point in time. We’re ramping now and Mexico is an example. We’re up to about 350 people in that facility where we really just started that up a year ago February and its running quite well, so that will be accretive by the second half.

Indonesia is ramping up as we speak. Now, again, the combined benefits to those things are $12 million roughly on an annual basis. We’ll see that in 2014, but we’re going to see some of that right now in this year.

Now, the thing that’s most important about those that is often lost when we talk about savings benefits. There’s a lot of commercial potential out of those plants. We can hit price points now on case goods in our better brands like Drexel Heritage, Thomasville that we couldn’t hit before when we had that production outside.

And I can tell you in upholstery where the Mexico cut-and-sew facilities supplies mainly Broyhill and Lane today, if you came to our showrooms at the Las Vegas market you’d have seen product that is very, very high quality product at price points that are lower than we’ve had them before that deliver the margin requirements that we have and we think that’s a big piece of our gross strategy. So it becomes a savings initiative. Yeah, it’s an enabler for topline and margin at the same time.

Brad Thomas – Keybanc Capital Markets

Okay. And just to follow-up on this SG&A, if we take your guidance for SG&A on a quarterly basis, if we took the low in the range we get $292 million that’d be about $6 million savings from what you posted in 2011.

I think in the prepared remarks you talked about 70% of that savings flowing through the SG&A line which should be about $21 million. Just trying to connect the dots here on how to think about the model for SG&A and if there are other things that are going to be going up to offset some of those savings?

Steve Rolls

Yeah. The biggest really offset, Brad, is incentive compensation accruals, as every company as they enter a new year has short-term and long-term incentives that cover blocks of employees. So you go into the year assuming that you’ll hit those targets and you accrue those at 100%. So that’s what we’re doing in 2012. If we overachieve that could go higher. If we underachieve that could go lower. So that’s about $20 million in that $73 to $77 number that we’ve given you. It’s not cash in the year, but it is expense in the year.

Other things, you’ll have a little bit of inflationary pressure on things like wages and healthcare, so there’s a little bit of that in there. You’ve got some advertising in there that can go up or down and that’s reasonably controllable by us and then obviously sales commission on the SG&A would fluctuate with the sales line.

Operator

And our next question will come from the line of John Baugh with Stifel Nicolaus. Please proceed.

John Baugh – Stifel Nicolaus

Good morning. Just, Ralph, I was wondering if you would be willing to discuss in some level of detail the revenue performance across your brands or product lines and would you be willing on this call to tell investors, what timeframe they should expect to see consolidated revenues stop going down and preferably go up? It’s certainly my impression that the overall market while soft is not weakening further. So I’m curious if we’ve got a flattish hopefully up industry environment, when Furniture Brands, its shareholders might expect to see consolidated revenues go up? Thank you.

Ralph Scozzafava

Yeah. Hey, John. I think that’s the pivotal question, right? If you go anywhere in our company you can go on our factory floors, you can walk into any office, you can talk to the guys that are stapling upholstery this morning and everyone will tell you the same thing. Our number one priority is to drive our topline at this point.

Through the last couple of years and you guys know and John you followed us for a long time. We’ve been a little different place than other companies. We’ve had a lot of revenue that we’ve had to be disciplined about to take out of our system that just wasn’t profitable and I can go through a longer list of what those things were. And I think we’re at a point now where we’re at a base level and I think the economy is recovering.

So our intention is to drive our topline and the way we’re going to do it is to have product at the right value, the right looks at the right price in the right dealers is going to be the answer. We’ve been able to do it in our Thomasville stores and I’ve mentioned on past calls that our Designer brands are outperforming.

The rest of the brands are in our portfolio, the high-end consumers in the marketplace. We expect that to continue. And what we’ve now go to do is hit price points at what I call our good level brands that will enable us to drive our topline.

We haven’t given forward guidance on the topline. I’d love to be able to do it. But I can tell you this. We declined about 4.5% last year and about the same the year before. We don’t like declining it for at 4.5%. So everything we’re doing is to go ahead and drive growth.

One of the reasons Steve wanted to talk to you about and Rick went through the numbers on positive cash flow in various scenarios. We’ve done some analysis around plus 5%, minus 6% for cash flow. But there’s no question that topline is this company’s number one priority.

John Baugh – Stifel Nicolaus

So, Ralph, are you seeing positive growth in Henredon, Drexel, Maitland-Smith or are those flat? Any color on what’s growing and then maybe what’s suffering even worse than the average?

Ralph Scozzafava

Yeah. I think, John, just to be really specific on that and I’ll tell you that our higher end brands, the brands and you know what they are at the higher price points, have performed well. We have brands that were up last year, okay. And we’ve had some brands, obviously, that were down and we ended up down 4.5%.

We carry a good backlog into 2012. We were -- our orders were only down 3.5% last year. It’s certainly not a victory. We want to be up. But, yeah, you do have a little bit of wiggle from quarter-to-quarter, month-to-month. What we’re focused on now is getting product on the floor, product that will retail and drive our topline.

John Baugh – Stifel Nicolaus

And any color on January, the weather has been terrific. Consumers seem to be slightly better mood and any re-through to the first four, five, six weeks of this year?

Ralph Scozzafava

All I can tell you is our backlog is in better shape than it was a year ago. We haven’t given a lot of through the quarter information. I mean, we’re literally five weeks into this thing. So it’s the early innings. We’ll obviously have numbers for you in May. But we like our backlog. But we’ve got a lot of work to do, every day we drive sales.

Operator

And our next question will come from the line of Budd Bugatch with Raymond James. Please proceed.

Budd Bugatch – Raymond James

Good morning, Ralph. Good morning, Steve. Good morning, Rick.

Ralph Scozzafava

Good morning, Budd.

Steve Rolls

Good morning, Budd.

Budd Bugatch – Raymond James

I think, Rick, you said that the availability to borrow was $20.5 million at the end of the year. Is that over the $42 million weekly dominion and cash liquidity threshold? Is that the way to understand that number?

Rick Isaak

It’s actually the amount above the $35 million threshold.

Budd Bugatch – Raymond James

So it’s above the $35 million threshold. So that means that above the weekly dominion threshold then it’s like $13 million?

Rick Isaak

Correct.

Budd Bugatch – Raymond James

Okay. Just wanted to make sure we have that correct. Okay. That’s helpful. Thank you very much. Ralph, when you look at inventory, I think you’ve said in the past that you think the inventory is still too high. What would be appropriate inventory goal? Where would you have liked inventories to come in this year? Where would you have thought they would have been appropriate for you to sized?

Ralph Scozzafava

Yeah. I think to answer that but we hit our number on inventory this year. Our internal number was $229 so that was good. I think inventory seasonally will go up a little bit in Q1. That’s our biggest demand quarter. Q2 has been better even with Q1 the last couple of years, so I expect our first half inventories to go up a little bit and then I think we’ll take inventories back down, and we’re going to close this year with inventory below the $228 that you’re looking at right now.

Budd Bugatch – Raymond James

And any size level of it that’s below $228, is it $10 million, 5%, 10%?

Ralph Scozzafava

It’ll be a small. It’ll be a small number.

Budd Bugatch – Raymond James

Okay. I think you have five plants, I think you said, five properties available for sale.

Ralph Scozzafava

Yeah.

Budd Bugatch – Raymond James

Any sizing on the assets, size of that, what do you think the, I don’t know where those assets show on the balance sheet, I don’t think we have an assets held for sale?

Rick Isaak

They’re in the other asset section on the balance sheet.

Budd Bugatch – Raymond James

Is that other assets that’s $50 some million, how much of that represents the…

Rick Isaak

We had said in the call that there’s about $14 million, $15 million in asset value in that area.

Budd Bugatch – Raymond James

Okay. And any idea when you think you can realize that, there anything under contract?

Ralph Scozzafava

What -- we have one that’s right now leased to buy and we’ll see how that works out. The others are listed and I can tell you we have people touring them, but we’re going to be disciplined, we’re not going to give properties away. But I’d anticipate over the next couple of years we’ll clear our way through those.

Budd Bugatch – Raymond James

Okay. And just to be sure I’m clear, the cash flow, the positive cash flow is, does not include any asset sales. It’s basically cash from operations minus capital expenditures excluding asset sales. Is that the way you’re defining free cash?

Rick Isaak

Yeah. Exactly.

Ralph Scozzafava

There is -- so if we sell a property, that’s incremental to what we’re talking about and what we’ve given you as an estimate today.

Budd Bugatch – Raymond James

Okay. And in the CapEx for this year, is there SAP still included in that?

Ralph Scozzafava

Yeah.

Rick Isaak

Yeah.

Budd Bugatch – Raymond James

Okay. And I think, let me try and get to the sales question if I can, another way. I think over the last couple of years you’ve had some very good performance with the U.S. government. I think maybe a year or so ago was $60 million in sales. What’s the outlook for that business, because that’s obviously an issue that we’re facing with a number of companies that sell product to the U.S. government?

Ralph Scozzafava

Yeah. I think the issue of that business is we’ve had it for quite a long time. We service them very well. We’ll have it longer and other than that, we really don’t talk about any specific customer just given the size, it’s just not something we’re required to do.

Budd Bugatch – Raymond James

Okay. And so then, my last question on sales, trying to get there. What would be a victory this year, you say, it wasn’t a victory with orders down modestly single-digit. What would be a victory for 2012?

Ralph Scozzafava

Well, I think a victory is always when your sales are up. That’s always a victory. So that’s our intention. But we’ve got a plan internally. We haven’t given guidance on revenue but I’d love to be able to do it.

Budd Bugatch – Raymond James

I don’t want to stop you, Ralph, I don’t want to...

Ralph Scozzafava

There will be a day when we’ll do it. I will promise that. It just won’t be today.

Budd Bugatch – Raymond James

And just, let’s just try one last way, to make your $20 million to $20 some million of compensation benefits, what kind of revenue increase do you need to do that?

Ralph Scozzafava

We’ll take the [fifth] on that, we’ve got a lot of work to do, Budd, here and I’ll tell you it’s a combination of topline. It’s a combination of bottom line. But I think what you’re hearing from us today and I think if you’ve been around our company inside and I know you’re pretty well-connected to a lot of our people and how we’re thinking about the business, everywhere you go in this company, everybody has got the same goal and that’s to grow our topline profitably, and the emphasis is on growth. And that’s what we have to do. That is job one in this company today and it will be for a long time.

Budd Bugatch – Raymond James

All right. Thank you very much.

Ralph Scozzafava

Sure.

Operator

And our next question will come from the line of [David Liu] with Bernstein. Please proceed.

David Liu – Bernstein

Good morning. Can I clarify a couple of things? One thing that $300 million annualized, I’m anchoring on $75 million quarterly SG&A. Are you suggesting about $20 million would be non-cash compensation in that because the last two years looking at the cash flow statement, it’s been only $2.5 million each.

Steve Rolls

Yeah. That’s accruing to 100% targets for payouts that would -- the payouts wouldn’t occur until 2013 if they’re achieved, but that’s the 100% target, the $20 million.

David Liu – Bernstein

Right. So it would be -- $20 million would be non-cash, you’re suggesting versus $2.5 million in each of the last two years.

Steve Rolls

That’s correct.

David Liu – Bernstein

Okay. So if we stick with about $280 million in annualized SG&A and the net outflow from the pensions and CapEx net of D&A is approximately $8 million, so we call about $290 in SG&A, so you need, let’s say, roughly about $300 million in gross margins in order to generate a profit and assuming nothing happens in that working capital, you would need an operating profit in order to generate positive free cash flow?

So $300 million in gross margins either translates to a 10% increase in sales as the current or at the 2011 gross margin rate or about a 300 basis points gross margin improvement assuming sales are flat to ‘11. What are you thinking about there?

Rick Isaak

David, there are some big numbers that you want to include in that calculation. Depreciation and amortization is a big part of it.

David Liu – Bernstein

I’ve netted that out already in the CapEx. I’m thinking about just cash expenses here.

Rick Isaak

Okay. So, yeah, you offset the CapEx and the depreciation and amortization, which…

David Liu – Bernstein

Yeah. I’ve already netted that out.

Rick Isaak

Okay. So that would actually be a benefit to our SG&A.

David Liu – Bernstein

Yeah. It offset by the pension contribution and net outflow for all those three items is $8 million assumed, so it’s not a big deal. I’m talking about numbers. I’m just again trying to get out from a numeric standpoint of, I just want to understand that are you thinking more that the opportunity is for margin improvement or sales improvement, right.

You think you can skin the cat in a number of ways and I kind of think of as you eight need a gross margin level that you -- that the company had not achieved since 2004 as flat sales or 10% sales increase for…

Ralph Scozzafava

Yeah.

David Liu – Bernstein

… a positive cash flow or you’re thinking or maybe we’re missing something and you’re thinking that there are further opportunities in that working capital. I’m not -- I just wanted to understand that?

Ralph Scozzafava

Working capital is a small element of it. You got to remember, we got $30 million in savings, two-thirds of that, roughly 70%, I should say, is going to be in SG&A, so you...

David Liu – Bernstein

If that’s in that number, that $280 number, we just worked out, it was supposed to be $300, but we took out the $20 that’s non-cash. So I think we all -- we’ve included all those things, right? I’m just trying to summarize everything you’ve said and put it into when I scratch out the numbers, I come out with you had have a $1.2 billion in sales and a 25% gross margin rate or basically a 27% gross margin rate at $1.1 billion in order to achieve an operating -- a cash operating profit?

Ralph Scozzafava

We understand your math. The point I’m trying to make to you is there’s a gross margin element to the $30 million. It’s probably somewhere between $9 million and $10 million, so that’s part of the calculation. Steve will give you a couple of other numbers that will fill in the blanks and if we can’t solve it on this call with you, you can give us a call afterwards. Go ahead, Steve.

Steve Rolls

Let me try to have you think about it maybe in a different way. So if you look at 2011, we used about $26 million of cash from end of 2010 to 2011. CapEx will be down in 2012, pension contributions will be up, pretty much offset, so throw those aside.

If we’re going to take $30 million of cost out in both SG&A and as Ralph said, some of that hits gross margin, that piece alone would offset the cash burn if we performed exactly the same in 2012 as we did in 2011. So, obviously, there are going to be things going in different directions from year-to-year, but that maybe is a little more simplistic way to think about it.

David Liu – Bernstein

But, Steve, you had a $26 million in benefit in net working capital reduction to the cash in 2011...

Steve Rolls

Yeah.

David Liu – Bernstein

So you would have burned more cash excluding that. Are you anticipating the same level of net working capital benefit in 2012?

Steve Rolls

We also have some one timers in 2011. We had between $2.5 million and $3 million of ABL refinancing costs when we extended that. We had $7 million to $8 million of severance payments, so there are a lot of different elements in there...

David Liu – Bernstein

Okay.

Steve Rolls

That we wouldn’t expect to repeat in 2012...

David Liu – Bernstein

Well, I’m just trying to relate it back to again the P&L, so what you are suggesting is that you think that gross margins will be higher, right, because you’re going to have cost savings from the gross margin line?

Steve Rolls

Yeah. That’s true. So $9 million of the $30 million hits gross profit. The plants that we’ve talked about in Indonesia and Mexico will improve. The Appomattox closure will be behind us and that will improve. So there’s so many moving pieces here, unfortunately. But, yeah, that’s and hopefully we won’t have the same kind of raw material pressures in 2012 we had in 2011.

David Liu – Bernstein

Yeah. That’s why I was question that, I wasn’t sure how much visibility really there was in that positive free cash flow forecasted this time. There’s a lot of things that still to some degree unknown and to some extent uncontrollable by you?

Steve Rolls

Yeah. There are a lot of big pieces.

David Liu – Bernstein

Yeah. Okay. Thank you very much.

Steve Rolls

You’re welcome.

Operator

(Operator Instructions) And our next question will come from the line of Sean Matlock with Kennedy Capital Management. Please proceed.

Sean Matlock – Kennedy Capital Management

Good morning, guys. How are you guys doing?

Ralph Scozzafava

Doing well. Thanks, Sean.

Steve Rolls

Hi.

Sean Matlock – Kennedy Capital Management

Hey. I had most of my questions kind of answered. It’d be nice to get a little more visibility on sales, but I understand how you don’t really have it right now. So I’ll talk to you guys soon. Thank you.

Ralph Scozzafava

All right.

Steve Rolls

All right.

Operator

Ladies and gentlemen, this concludes our question-and-answer portion for today’s call. I will now turn the call back over to Chairman and Chief Executive Officer, Ralph Scozzafava for any closing comments.

Ralph Scozzafava

I want to close with this. I hope everyone has taken away a couple of key points from this morning’s call. I think the first and foremost, and it really is representative of the questions that were asked and they’re good ones.

Our job is to grow our topline. Everybody in our company knows that. It’s about product. It’s about getting product to retail and making sure that it turns and we’re going to continue to do that, and we’re doing to drive that this year.

The second big piece that I think is important is our ability to drive cash flow and to make sure that we can have a company that’s going to be healthy for many years to come. We’ve made some long-term decisions in 2011 to put some capabilities in place, particularly two new factories that we think are going to be a big help to our ability to drive topline and our ability to drive our bottom line.

So, a lot of work to do, we’re going to get back to it. We want to thank everybody and I want to thank you for your interest in our company for being on this call and we’ll talk to everyone again in May. If we didn’t answer your question, please feel free to call Steve Rolls and he’ll certainly be able to help you there. Take care, everyone.

Operator

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

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