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La-Z-Boy (NYSE:LZB)

F2Q08 Earnings Call

November 14, 1007 8:30 am ET

Executives

Kathy Liebmann - Director, Investor Relations and Corporate Communications

Kurt Darrow - Vice President, CEO

Mike Riccio - CFO

Analysts

Chad Bolen – Raymond James & Associates

Matt McCall – BB&T Capital Markets

John Baugh – Stifel Nicholas & Company

[John Kernen] – Morgan Keegan & Company

David Cohen – Midwood Capital Partners

Jan Billow – Lehman Brothers, Inc.

John Pinto – Brightleaf Capital

Operator

Greetings, and welcome to the La-Z-Boy, Inc. second quarter fiscal year 2008 conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference please press *0 on your telephone key pad. As a reminder this conference is being recorded. It is now my pleasure to introduce your host Ms. Kathy Liebmann Director, Investor Relations and Corporate Communications for La-Z-Boy, Inc. Thank you. Ms. [Liebman] you may now begin.

Kathy Liebmann

Thank you Jackie, Good morning everyone and thank you for joining us on this mornings call to discuss our fiscal 2008 second quarter results. Present on the call today are Kurt Darrow, La-Z-Boy’s President and CEO and Mike Riccio our CFO. Kurt will open today’s call with some prepared remarks on the quarter and will discuss the strategic direction of our business and Mike will speak about some of the more unusual items this quarter. We will then open the call to questions. As is our custom, the time allotted for this call is one hour. In order to allow everyone an opportunity to ask questions, please limit your questions to two and if you have follow up you may reenter the queue. A telephone replay of the call will be available for one week beginning this afternoon.

These regular quarterly investor conference calls are one of La-Z-Boy’s primary vehicles to provide guidance and to communicate with investors about the company’s current operations and future prospects. We will make forward looking statements during this call so I will repeat our usual safe harbor remarks. While these statements reflect the best judgments of management at the present time, they are subject to numerous future risks and uncertainties as detailed in our regular SEC filings, and they may differ materially from actual results due to a wide range of factors. We undertake no obligation to update any forward looking statements made during this call. With that, let me turn over the call to Kurt Darrow, La-Z-Boy’s President and CEO.

Kurt Darrow

Thank you Kathy. Good morning everyone and thank you for participating this morning. As Kathy mentioned I will begin with an update on our strategic initiatives and our performance for the quarter and then Mike will speak on several financial topics before I conclude with our prepared remarks and move to the question and answer period.

The credit crunch, the troubled housing market, lower consumer confidence, discretionary spending, you name it, they have all impacted the consumers desire to spend money on furniture purchases. With these issues beyond our control, coupled with the difficult retail environment, we as a company our focus on business drivers we can control to position La-Z-Boy for the time when the market recovers which it undoubtedly will. As I have highlighted in the past, La-Z-Boy, with its strong balance sheet and the most recognized brand in the industry, has the ability to weather the storm and I have every confidence we will emerge from this period as a stronger company, one that is strategically aligned to operate in a very different and new marketplace.

We will remain a competitive manufacturer and distributor of home furnishings and our proprietary store system will run as an integrated chain with all the efficiencies inherent in that model.

Before I go through our results for the quarter, I would like to give those of you who are new to our story and remind those of you who have been following us for some time, some perspective on how much our industry has changed over the last several years and concurrent changes we have made to the La-Z-Boy business model to compete successfully in this dynamic environment.

First, we have rationalized our portfolio of companies. Several years ago we had a group of 12 companies that were not providing the desired results and we went about a process of focusing our portfolio on what we believe are our core businesses for the future. We went through a process of first, investing ourselves in those companies that were not related to servicing the home and second, of evaluating the remainder of the portfolio using a filter of size, profitability and strategic long term fit to La-Z-Boy or our store systems. As a result we rationalized the 12 companies from three years ago to the three upholstery and three case good companies we currently have in addition to our retail business.

As we sit here today those six remaining wholesale companies are all profitable and each company addresses a specific segment of the market with very little overlap with products, price point and importantly the various customers served by each company.

Collectively the companies that we sold at their peak were providing almost $300 million in revenue, but producing negative earnings over this time period. We generated over $100 million in cash from selling these companies and along with selling some other vacant properties we used that cash to substantially pay down our debt. While we have decreased the size of the company, we now have a core business that we believe we can grow profitably.

Second, we transitioned our casegood business to be primarily an import model after the industry quickly moved overseas. At our peak we had more than 20 casegood manufacturing facilities in the US. As a result we also had more than a dozen quarters of double digit sales declines without earnings as we were unable to compete with Asian imports. In fiscal 2006 we rided the ship, today with two domestic plants and the highly variable cost structure associated with our import model we are making money again even on significantly lower volume in our casegood segment.

Third, during this time frame the textile industry in the US for all intent and purposes moved offshore. The second and third largest suppliers to the industry as well as to La-Z-Boy went bankrupt and a large portion of the textile industry now exists in Asia, specifically in China. While the Chinese manufacturers have come up to speed with respect to the manufacture of fabric, initially there were some hiccups that the technology expertise and availability of looms were not up to the caliber, the speed or the quality needed to service our domestic business.

Consequently there were many disruptions in the supply chain including fabric outages, obsolete, service disruptions that we needed to work through. Whether it was from the yarn manufacturers, to the weavers or the cut and sew facilities. All of this impacted our service levels and our earnings over the course of going through this change.

Additionally, during this transition period we went from sourcing a minimal amount of cut and sew kits to now sourcing over 50% of our fabric and leather in cut and sew form from China and other countries. Fortunately we believe the lion’s share of the fabric industry transition is behind us.

Fourth, with the changes in the distribution landscape and the increasing importance of brand prominence, we have turned our focus to proprietary distribution as we believe that is a primary channel through which to sell our products. With a need to have deeper penetration in the larger more vibrant markets, where demographic data indicates substantial growth opportunities we found ourselves the owners of a number of markets that were in dismal shape. Because of the scale of these markets it made no sense to vacate them, so we had to set ourselves on a course of getting them properly structured to become profitable.

We have spent the last two years working to fix them through opening additional stores or relocating and converting existing stores while consolidating back office operations. This has been a long and expensive process and quite frankly it is taking longer than we expected. Principally because the overall retail environment is impacting our volume levels impeding our ability to absorb fixed costs.

I will speak more about our retail operation in detail in just a few moments. I mention it up front as it is indeed an important pillar to this company’s future success and longevity.

To summarize, against the backdrop of the massive changes that have swept our industry over the past three years, we have; one rationalized our portfolio of companies; two transformed the business model of our casegoods segment and three alter the majority of our fabric and leather supply chain and finally we have moved to strengthen and improve our La-Z-Boy store system with more corporate involvement and oversight than any time in our company’s history. So as you can see we have faced challenges in each of our segments over the past few years and we have dealt with them effectively. We believe we can do the same with our retail business and considerably improve its performance from today’s levels.

Now against that backdrop let me turn our attention to the recent quarter in our segment.

First, upholstery, for the quarter sales in the upholstery segment was off 11.4% year over year. We improved our operating margin to 7.1% a 50 basis point improvement from last years second quarter. This is a direct result of our intense focus on controlling the costs and streamlining operations. At our La-Z-Boy branded facilities we are 70% the way through our conversion to sell your production and our on schedule to complete that project by the end of the fiscal year. In addition, we continue to analyze every facet of our upholstery operation to further improve our efficiencies and ensure that we remain a competitive domestic manufacturer and one that is committed to delivering custom furniture to the consumer quickly.

I trust by now most of your have seen our new television commercials with the tag line “Comfort Its What We Do”. The proprietary distribution of core focus for La-Z-Boy our new add campaign is designed to both communicate comfort as La-Z-Boy’s core brand equity while simultaneously driving traffic into the La-Z-Boy Furniture Gallery stores. While it is too early to measure the success of the campaign, preliminary feedback has been positive and we look forward to the continued roll out of these commercials highlighting comfort, our professional sales staff, our range of products and our inviting store environment.

Now let me make some brief remarks on our casegood operation. In the second quarter our sales were off more than 20% year over year. On such a significant drop in volume we were still able to close an operating margin of 6.1% for the quarter reflecting the high variable cost structure of our business now it is based primarily as an import model. Our casegood companies had increased attendance at the October high point market and several of our new product introductions received excellent review as well as written orders. Going forward we will remain focused on unique new product introductions in order to increase sales throughout our segment while working to grow our business with small to medium sized retailers who value the services we can provide for them in terms of inventory management, sales training and quality product.

Now let’s turn our attention to retail. In our company owned retail segment we posted a $9 million loss for this quarter and a 12% decrease in sales compared with last years second quarter. It is important to note that in last years second quarter we were still operating stores in Pittsburg, Pennsylvania and Rochester, New York, so a portion of our sales decline is attributable to our vacating these markets. While we continue to make progress in removing costs from the operations principally through the warehouse and IT consolidation as well as improving our gross margins it is difficult to absorb our fixed costs in this segment when we are achieving less volume with more stores.

As I mentioned last quarter we have additional occupancy costs per quarter for 14 new generation stores we have added in the company owned segment including nine new stores and five remodels or relocations. Expanding the store system is definitely the right strategy in order to achieve the penetration in the markets in which we operate but in this environment the expense of those stores coupled with decreased volume is impeding the progress we are making behind the scene.

Finally, once we complete the consolidation of our own warehouse and IT systems for our own retail division, we will expand this strategy and footprint throughout North America to service our entire base of stores. This is a sizeable opportunity for both the company and our retail system as a whole and we believe we can service our network of 338 stores with 10-12 strategically located distribution centers throughout North America. This new model compares to more than 85-100 individual warehouses being utilized throughout our system today. This change will assist our dealer base as it will allow them to focus on the front end of the business removing redundant costs while providing a better in stock position because of the size and scale of this framework. System wide it will lower our costs, make us more competitive and allow us to provide better service to the consumer. This initiative will begin in calendar year 08’ and will be finished over a three to five year period depending on each of our dealers’ individual situation regarding their current distribution arrangement.

As I said earlier in the call proprietary distribution whether through a company or dealer owned store, in our estimation will be one of the keys to La-Z-Boys future and we believe building a strong proprietary store system where we can nurture and enhance the brand will serve as a critical platform for us to sell furniture.

The second quarter we opened two new company owned stores and closed one. Of the 70 stores we own today, 50 or 71% are in the new format versus only 37 or 54% at this time last year. For the remainder of the year we will add eight new stores including relocations and remodels.

I will now turn the call over to Mike Riccio our CFO to go through our financials.

Mike Riccio

Thank you Kurt and good morning everyone. As you can see from our financials, our earnings per share for the quarter from continued operations before restructuring the right down of the good will and results of VIE’s were $.05. We had a $.01 restructuring change related to transition costs linked to the North Carolina closure. A $.07 unchangeable write-down related to the good will and South Eastern Florida market and a $.04 loss for our VIE’s.

On substantially less volume in our wholesale segment as Kurt said we were able to maintain fairly reasonable operating margins. Furthermore, even with the additional occupancy cost retail combined with the 12% volume reduction our retail losses were essentially the same as last year’s comparable quarter. Given the state of the housing market and overall business decline in Florida our store system in South Eastern Florida has suffered double digit declines in the past 12 months. These issues led us to defer our store build out plans in that market for the time being. As a result our valuation model was significantly affected and therefore good will was impaired which led us to write it off.

While we still believe the Florida market will be a good market in which to operate in in the future and it was when we entered it, we fell with the losses that we are sustaining currently we feel a delay in adding new stores in the Southern Florida area is a prudent thing to do at the moment.

We also completed the sale of both our Clayton Marcus and Pennsylvania House operations this quarter. The Clayton Marcus deal resulted in about a $5.8 million loss for the quarter of which $3.4 million of the pre-tax loss relates to intangible assets. The Pennsylvania House deal where we sold the trade name of the business for $1.7 million resulted in a loss of about $600,000 on the name itself.

While we expect liquidation of inventory from Pennsylvania House will result in additional $2-3 million cash, we did write down the inventory by $3 million during the quarter in marketing the inventory to market. More importantly though is that this process is behind us and management can now focus its time and resources on the core La-Z-Boy branded business, specifically the retail segment.

We did do a good job managing our inventory during the quarter which is down compared to last years second quarter as well as this years first quarter. We generated cash from operations of $14 million during the quarter, primarily the result of reduction in this working capital. We did not repurchase any shares during the quarter and we still have authorization to purchase 5.4 million additional shares. The company will continue to evaluate the uses of this cash on a quarterly basis and will consider share repurchases depending on the overall sales environment as well as overall stock market conditions.

Our affected tax rate for the quarter was 46.6% and for purposes you should continue to use the range of 38-40% on continueing operations for the remainder of the year. Our Capex for the year is expected to be in the range of $25-28 million about the same as depreciation.

Finally, I would like to take a moment to speak about our bank agreement. The company received an amendment from its bank proof for one quarter adjustment to its fixed charge ratio requirements. While we were in compliance with the covenants for our private placement notes. Today we are working with our bank to renegotiate our agreements to refinance our debt with an asset based lending agreement. We think that longer term this new arrangement will afford us greater flexibility to make our company more profitable in the future. As we complete the processes, consolidate our distribution centers, expand our retail markets in the places where it makes sense to do so and continue to enhance our businesses at retail without being concerned about our quarterly costs covenant.

I thank you for your time this morning and I now turn the call back over to Kurt.

Kurt Darrow

Thank you Mike. Before we move to our guidance I would like to reiterate that we are aggressively managing our business and taking the necessary steps to grow our business profitably. Unfortunately the headwinds from the retail environment are making it difficult to see the fruits of our labor. There may be a long road ahead of us but we are confident we are positioning our company for the future. However, given the difficult environment and our lack of visibility and based on our performance for the first six months of this fiscal year our current annual guidance will not be attainable.

With the unusual items in the first half of the year, we are updating our guidance for the second half to give you better perspective for the remainder of the year. We expect sales for fiscal 2008 period to be down 4-8% and earnings per share to be in the range of $.06-$.14 per share compared with $.30 per share from continuing operations in the second half of 07’ which included an $.11 per share charge for restructuring a $.14 per share gain on property sales and a $.04 per share in income from anti-dumping monies. The 2008 second half range does not include any restructuring charges, potential income from anti-dumping or the sale of any discontinued operations.

We want to thank you for being on our call today and I will turn things back to Kathy to begin our question and answer period.

Kathy Liebmann

Thank you Kurt. We will begin the question and answer period now. Jackie, please review the instructions for getting into the queue for asking questions.

Operator

[Operator Instructions]

Question-and-Answer Session

Operator

Our first question is coming from Chad Bolen of Raymond James & Associates

Chad Bolen – Raymond James & Associates

Good morning Kurt, Kathy and Mike. This is Chad filling in for Budd, he is traveling this morning. In the past you guys discussed operating margin targets for the segments of I believe 7-9% for upholstery, 6-8% for cash based goods and 3-5% for retail. Are those targets still valid and when do you anticipate the retail division will break even?

Kurt Darrow

Good questions Chad. I think those targets are still valid but we, given the tough retail demand out there without more volume, I think it is going to be difficult for us to get in those ranges in the near term and that is pretty much the same answer on our retail position, we continue to take costs out but we have more costs we can take out but at the rate of decline in the consumer spending out there on furnishings without some lift to make some spread on additional volume, getting to those margin targets it will be a stretch for us in this environment.

Chad Bolen – Raymond James & Associates

Could you give us any color around the retail margin in the quarter and maybe a sense of a level of discounting and markdowns out there?

Kurt Darrow

It is a difficult environment out there Chad and we have had to do our share of being aggressive to make sure we get the consumers attention but frankly its not a margin issue for us we have been able frankly over last year increase our gross margins but it is a traffic issue, it’s a consumer pull back issue, it’s a lower average ticket issue so it’s just a tough environment and our people are working very hard to take care of every customer that comes into our stores but everybody is being a little cautious at this time.

Chad Bolen – Raymond James & Associates

Last question, then I will defer to others. As far as the renegotiation of the bank agreements, what do you anticipate the timing of that will be and do you anticipate any additional expense associated with that?

Mike Riccio

Chad, I expect that we will be completed with everything in early January. It will take us a little bit of time to, since we are going to a more secured environment it takes a little time for everyone to do their due diligence and get that completed. We will have, which we have noted in there we think our make hold provision will be $2.5-3 million that is not obviously included in our guidance because it is a one off charge doing that. We think we will have that charge about the only significant charge, the rest of the fees will be, that we will have to pay to get into the bank agreement, will be amortized over an essential five year term that we are trying to negotiate.

Chad Bolen – Raymond James & Associates

Thank you very much

Operator

Thank you, our next question comes from Matt McCall from BB&T Capital Markets

Matt McCall – BB&T Capital Markets

Thank you, good morning everybody. Looking at the pre cash flow it looks like you did a good job generating some pre cash managed work in capital. As we look to the outlook for 08’ could you give me some idea what working capitals is going to look like in the back half and remind me of some seasonality impact there and really was the pre cash flow generation can look like in the back half of the year?

Mike Riccio

Matt if you look at our historical times, our third quarter is our highest generation of cash flow, historically for us because we build up our receivables during the second quarter and then as volumes decrease somewhat in the third, since our second, I guess worst quarter in line of how our quarter go, we usually generate pretty good cash in the third quarter then the fourth quarter is pretty much just a wash. We are just going to keep controlling our inventories, that is our major focus right now, is making sure that on the volumes we are currently selling at our inventories don’t get out of alignment so we don’t have to go into any discounting to then get rid of it.

Our receivables would be a function of what our sales end up being, but I think we will generate good cash in the third quarter the fourth quarter will be relatively flat.

Matt McCall – BB&T Capital Markets

Good cash, sensing a little stronger than your…

Mike Riccio

Q2 level? I’m just trying to give you a historical perspective. Historically our third quarter has been significantly better, cash flow wise, than our second.

Matt McCall – BB&T Capital Markets

One clarification the Capex number that you give is that X the benefit [inaudible] some inflow there is that number you gave X just a pure capex number for the outflow.

Mike Riccio

Yes

Matt McCall – BB&T Capital Markets

You may want to comment Kurt a minute ago you still have some costs you can take out I know you quantify in the past some of the cost savings you expect from any of these initiatives. What benefit if left and can you give us some idea of the timing of some of these non top line cost savings efforts.

Kurt Darrow

Matt, we have two major initiatives that are going to be completed in the second half of the year, one which has been a two and a half year project which has been transitioning our manufacturing facility to sell your manufacturing and we are on the downward slide of that but we do have 30% more of our factory space to transition over to [selliar] and we will get through that this fiscal year and the second part of that we are finishing our distribution rationalization of closing down multiple retail warehouses and getting down to four to service our network and also putting a common IT and point of sales system to all 70 stores and we expect that to be done by the fourth quarter as well. So those two projects, major initiatives that we have talked about in the past a couple of times we expect to get the further benefit of being through that as we roll out the end of the year.

Matt McCall – BB&T Capital Markets

And the benefit of those initiatives would be fully reflected on a run rate in the Q4 numbers that you have there. Show a little bit of a benefit on the margin lines.

Kurt Darrow

That’s correct, the run rate of them isn’t a big as we originally thought because of less volume and the conversion on less volume you don’t get totally the original expectations but I think the real benefit is going to be reflected in fiscal year 09’ when changing all the processes, running duplicate systems, having all the things going on, we will be fresh to go in 09’ with our manufacturing transition and our retail distribution transition behind us.

Matt McCall – BB&T Capital Markets

To follow up on that, the benefit is not going to be as much as you originally thought at the current run rate of business. You have broken out the levels of benefit that you expected from those, what level you can actually achieve next year at the current run rate of business maybe as a percent of the total you originally expected.

Kurt Darrow

I would think that as guidepost, if our business is down 10% the cost savings that we would get would probably be down 10%. It is proportionate, but the dollar numbers we put out there before won’t totally be realized if we don’t have the volume.

Matt McCall – BB&T Capital Markets

Thank you all.

Operator

Thank you; our next question is from, John Baugh from Stifel Nicholas & Company

John Baugh – Stifel Nicholas & Company

Thank you, good morning. Cash proceeds from the sales of Clayton Marcus in Pennsylvania, what have they been to date and any more inventory wind down, I think you mentioned $2-3 million going forward. Is there anything in Clayton Marcus?

Mike Riccio

Clayton Marcus we sold and we gave that number, I think in the cash flow we’ve got a little over $4 million from the sale in discontinued operations. Since we just sold Pennsylvania House’s name, we will collect the receivables on it then we will sell the rest of the inventory off. Of course now that we have sold the company, we are liquidating the inventory we have to take some reserve against the inventory because on an ongoing basis the inventory is worth a lot more and you say you are not going to replace it ongoing on it. I think you will see we are done selling the companies, the proceeds we have some small receivables out there about $500,000 that were held back until we did some final working capital adjustments. But other than that, other than collecting the additional inventory and receivables there will be no cash generated from the sale of those companies going forward.

John Baugh – Stifel Nicholas & Company

Kurt are you comfortable with what you mentioned your down 6, 12, is that where you want to be, is that it?

Kurt Darrow

Good question John, that is it, obviously for the time being, we certainly feel very good about where we are at as I mentioned in my prepared remarks, all the companies are profitable, our wholesale companies are doing a good job of keeping up respectable margins given the down volume they are doing, they are working hard every day to control their costs. My comment on the future would be we still have the same size profitability and strategic fit issues and should one of our companies fall into that area in the future we would have to evaluate it but they all met our strategic rigor testing at this point and we are very comfortable where we ended up with our six wholesale companies.

John Baugh – Stifel Nicholas & Company

On the retail, it looks like you are running $180 million annual run rate revenues; to me it looks like it could get a little worse before it gets better cyclically. Is the strategy, you mentioned some cutting of costs still coming from the finishing of the distribution IT sales systems, it strikes me as though the savings from that aren’t going to be massive or significant, if the volumes are down that is why you are losing $8-9 million even a quarter. If you would assume that we are going to stay in a very difficult retail environment for the next 12-24 months, is there a different strategy you are looking at employing or are you just going to allow the wholesales business essentially offset the retail and right through the cycles or however long it takes.

Kurt Darrow

That is a very good observation. We are looking at all types of alternatives and I think the way that we look at this and the way the investment community ought to look at this is we are looking at it as integrated retail, operation and system and we think that there’s a margin expansion opportunities on the host sales side. By being involved in a proprietary distribution system there is also the associated risks and it is apparent that you have to look at the operating profit generated on the wholesales side negated against the loses on the retail side but we are looking at options. We are looking at underperforming stores, stores that don’t cash flow positive. We are looking at all kinds of options, none that I really want to reveal today, but it isn’t our intent to sit here and ride it out. We’ve got some other things that we are investigating and looking at but obviously it is the biggest challenge the company has going forward and one we are prepared to address.

John Baugh – Stifel Nicholas & Company

I guess my perspective is obviously cyclical, you can’t do much I guess another way to phrase the question is are you confident you’ve got the right size box with the right structure? I know you referenced how you are making money I think in the DC area before the cycle went bad and I’m sure you sort of used that formula elsewhere and I’m wondering how easy or difficult it is for you to delineate the issues or strictly cyclical we just stick to the format, sales staff and everything you do. Maybe the box doesn’t work the same in this area versus that area. Any thoughts there?

Kurt Darrow

Your observation of how much is us and how much is the market, if you have any clarity on that we would enjoy hearing that because we would look at that continually. We are not positive we have the perfect box, we are not positive we are offering everything that the consumer wants to see when she comes into the store and we are going to be doing some test stores at the first of the year on some different size and different product assortments, some things that aren’t totally fully developed, but I think whether times were good or bad I don’t think retail is a stagnant business and we always have to be looking at perhaps what is the next format what can we do a little different how do we make ourselves different than the other retailers selling home furnishings. That is something else that we are in the planning stages for and we will have some test stores out there in the first half of 08’.

John Baugh – Stifel Nicholas & Company

Will it be smaller stores?

Kurt Darrow

Not necessarily, we have stores throughout our system that range from about 11,000-16,000 feet and given the cost of real estate in some of the more expensive markets you have to go with smaller square feet but I don’t think for the size of our program and to be a legitimate competitor I don’t think we can go much below the 10,000 feet and really offer a compelling experience for the consumer.

John Baugh – Stifel Nicholas & Company

Great, thanks for answering the questions.

Mike Riccio

John, the only think I wanted to clarify was that you made an annualization comment about our sales. Just for reference point, over the past years our first and second quarter retail are usually our weakest quarters and our third and fourth quarters are usually stronger quarters for sales. I just didn’t want to leave that annualization out there.

Operator

Thank you our next question is coming from John Kernen or Morgan Keegan & Company

[John Kernen] – Morgan Keegan & Company

This is John Kernen of Morgan Keegan calling in for Laura Champine. Can you explain how total written sales were below same store written sales?

Mike Riccio

We shut more stores down than we opened up. On a total store basis our sales were down. On total stores you are normally looking saying that we added more stores but we have actually closed more underperforming stores than we opened up so our total sales were down because of that.

[John Kernen] – Morgan Keegan & Company

Okay, that explains it, thank you.

Operator

Thank you, our next question is coming from David Cullen from Midwood Capital Partners

David Cohen – Midwood Capital Partners

Hi everyone. I had some questions about in the past there have been a series of costs savings targets and you already answered one lowered improvement from cellular conversion. I think you mentioned for example in March there was restructuring that was targeted to save $11 million. There was retail consolidation as a system $9 million, retail gross margin improvement of $7 million. It goes across that set of specific actions what is the current thinking on the level of savings that comes from those actions.

Kurt Darrow

I think those savings are still within the ranges that we would be looking at with the caveat of the down volumes. As I said earlier, the wholesale margins on approximately $50 million less volume this quarter were essentially the same as last year, so obviously the costs are coming out and some efficiencies are improvements are happening. We are still confident about our three large initiatives, higher capacities, utilization because of the plant closings the benefits from [cellar] the benefits of retail distribution alignment. Again, they are not fully realized if you keep having double digit sales decreases.

David Cohen – Midwood Capital Partners

You think about the retail business. Ultimately what kind of target margins do you think you can get in that or what kind of return can you get? It seems to me there aren’t benchmarks to look at the possibility of that strategy in Ethan Allen and they look like they still make all their money and have all their return on capital, coming from their wholesale business. I understand the strategy element of controlling your distribution, what is the financial return in a better environment like Ethan?

Kurt Darrow

I would answer that question even though Ethan Allen is not showing huge margins in their retail business it allows them to make an above average margin in their wholesale business and you have to look at the two blended and you still get a pretty good return. That is certainly how we are looking at it as well. The extra volume provided and the margin opportunity provided by having a proprietary distribution system is all part and parcel to the strategic reason behind it and looking at them stand alone, it is a little more difficult to do because there are so many interdependencies but I think the overall operating margin even with essentially a break even retail business like Ethan Allen has today is still pretty respectable in this industry given the tough times.

David Cohen – Midwood Capital Partners

Thanks guys.

Operator

Thank you, our next question is coming from Jan Dellow of Lehman Brothers Inc.

Jan Billow – Lehman Brothers, Inc.

I have a couple of questions. I wanted to ask first about the availability under the bank line right now and I know you are renegotiating it?

Mike Riccio

In our 10-Q we put in there it is $48 million approximately right now. On the amendment, an asset test as we are renegotiating to be able to maintain. We have nothing borrowed on it right now. Then we are allowed $5 million of additional debt besides that.

Jan Billow – Lehman Brothers, Inc.

So the size of it is basically premised on your asset base?

Mike Riccio

The current availability has no basis for what our availability on a new line. That is just a transition debt over the period. It will be based on our eligible inventory and our eligible receivables and how we do that going forward.

Jan Billow – Lehman Brothers, Inc.

Are you targeting a certain amount?

Mike Riccio

I’m not prepared to discuss that right now. We will be putting something out probably in January where we stand on that.

Jan Billow – Lehman Brothers, Inc.

Are you expecting to use your bank line for the 2008 maturity for private places that is coming due or is that something that you think you will be paying out of cash?

Mike Riccio

I expect that I’ll be replacing my private placement with this new line when I get it in place.

Jan Billow – Lehman Brothers, Inc.

I just wanted to make sure that understood correctly the conversation about the proceeds from the asset sale. Proceeds from all the asset sales are to be in the neighborhood of $4 million and the majority is already on the balance sheet, am I understanding that correctly?

Mike Riccio

I think what I would say just to be clear we sold the companies in the quarter and collected the cash. The assets that are still left on the books and are discontinued operations are the items that we didn’t sell as part of the deal. The Pennsylvania House we just sold the trade name, we kept the inventory and receivables, we will collect the receivables and inventory that will be in the range of anywhere from $3-5 million additional from what we have on the books. After that we will have nothing left in discontinued operations.

Jan Billow – Lehman Brothers, Inc.

So, another $3-5 million from basically working capital run off.

Mike Riccio

Yes, but it won’t be for the sale of discontinued ops, it’ll just be collection of their working capital.

Jan Billow – Lehman Brothers, Inc.

I guess the other question that I had was about covenants, you’ve got no waiver, you are talking to your bank, but usually places have far off the bank covenant. I guess I am wondering are there discussions ongoing with the private placement people as well?

Mike Riccio

Yes, but as we said in our 10-Q we will get this loan completed in the third quarter and then if and when we determine we are not going to make the covenants going forward then we will discuss with our private placements about making them whole and paying them off as we have provided in our agreement that we are allowed to do.

Jan Billow – Lehman Brothers, Inc.

Great, thank you

Operator

Our next question is coming from John Pinto from Brightleaf Capital.

John Pinto – Brightleaf Capital

Kurt, if you could talk a little more about the retail side and looking at what Ethan Allen has done so well in terms of sales training on the floor and then maybe also looking at your assortment or aggressive products versus theirs, is there anything can you walk us through what you are doing on the sales side in terms of your own company stores and dealer stores as well as maybe looking at either products to bring in or the brand.

Kurt Darrow

I think Ethan Allen certainly has been at this longer than we have and we have great admiration for what they have been able to do, we have a retail division that is very focused on hiring quality people, getting them trained. We too have an in home design program that we are utilizing throughout a lot of our own stores but it is a difficult environment for sales people. There is a tendency to want to look around for other opportunities and I don’t believe we are as good as we can be with all of our sales processes and working with the customers to the degree that we should but certainly we understand where some of the gaps are. We do some mystery shopping to make sure we know what is going on at retail. We have fairly robust training programs and detailed selling processes that we go through. I don’t think you are ever satisfied with how you are doing in that area and I’m sure we have some improvement that we can make.

John Pinto – Brightleaf Capital

The environment is not going to get better until sometime middle or late, who knows when, is there some sort of event that happens that makes you start to pull back your retail exposure? I know you have closed some stores but you are repositioning more than anything. Is there something you are going to say too much fixed cost here I need to pull back just like you have done in the manufacturing and sourcing side but now in this other area where you’ve got fixed costs?

Kurt Darrow

That’s a good question as well. I think last year we vacated both the Pittsburg and the Rochester market because we didn’t think they had the size or scale that we wanted long term and I answered previously we are looking at all at this point. We have a network of 338 stores out there and a lot of them are doing fairly well right now even in a tough environment and we could do some repositioning, but we are very committed to our store program. It is something we have had for over 25 years and we think is a key strategy for us. We are not going to put our head in the sand, as one of the other questions was asked about just riding it out. I think there are lots of things we can do to improve but could we vacate a few stores, could we look at a certain number of markets, absolutely, but we’ve got three or four markets where we’ve got nine, ten, twelve stores operating right now. We wouldn’t consider at this point pulling back from that we think we are positioned well for the long term.

John Pinto – Brightleaf Capital

Okay, great, thank you.

Operator

Thank you; there are no further questions at this time. I’d like to hand the floor back over to management for any closing comments.

Kathy Liebmann

Thank you everybody for participating this morning. I will be available for the remainder of the day should anybody have any follow up questions. Have a good day.

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Source: La-Z-Boy F2Q08 (Qtr End 10/27/07) Earnings Call Transcript
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