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Stanley Furniture

Q4 2007 Earnings Call

January 29, 2008 9:00 am ET

Executives

Douglas I. Payne - Executive Vice President, Finance & Administration and Secretary

Jeffrey R. Scheffer - Chairman, President and Chief Executive Officer

Analysts

Budd Bugatch - Raymond James

Todd Schwartzman - Sidoti

Jimmy Yu - Aristos Capital Management

John Baugh - Stifel Nicolaus

Charlie Carter – [inaudible]

Operator

Welcome to the Stanley Furniture 2007 operating results. (Operator Instructions)

It is now my pleasure to introduce your host, Mr. Douglas Payne, Executive Vice President for Stanley Furniture. Thank you, Mr. Payne, you may now begin.

Douglas I. Payne

Thank you, Jackie. Good morning and welcome to our quarterly conference call to review our 2007 operating results. We appreciate your participation. Joining me this morning is Jeff Scheffer, our Chairman, President, and CEO.

During our call this morning, we may make forward-looking statements which are subject to risks and uncertainties. The discussion of factors that could cause actual results to differ materially from our expectations are contained in the company’s SEC filings and the press release announcing our 2007 results.

Any forward-looking statement speaks only as of today, and we undertake no obligation to update or revise any forward-looking statements to reflect events or circumstances after today’s call.

At this time, Jeff has some opening comments.

Jeffrey R. Scheffer

Thanks, Doug and good morning, everyone. I’ll make a few comments on the year just ended, current business conditions, and our guidance going forward. Doug will then take you through the balance sheet, and after that we’ll open the call to your questions.

Obviously 2007 was a challenging year for both the furniture industry and Stanley. Knowing that many of you have moved on from ‘07 and are looking ahead to ’08 -- if not ’09 -- I am not going to rehash our ‘07 results contained in last evening’s press release.

However, I believe it is worth pointing out the considerable progress we made in the business last year. In 2007, we worked hard to better align our production levels with demand. During the first quarter we rationalized our Robbinsville, North Carolina production levels by reducing headcount there approximately 40%.

During the fourth quarter, we began the process of converting our Martinsville, Virginia production into our Stanley Town, Virginia plant and converting that Martinsville facility into a warehousing operation. In addition, we continued our use of lean business principles as part of our continuous improvement efforts.

During the year, we conducted 127 week-long rapid improvement events, involving 437, or nearly 22%, of our associates. Most of these events focus on the creation of manufacturing cells, establishing standard work and reducing machine time setup. These actions still leave us ample capacity to grow the business and position us to leverage operating improvements when business conditions improve.

Looking ahead to 2008, we have planned our year as if business conditions will range from current demand levels to a modestly worse environment. Very frankly, we have yet to see a bottom to this current cycle and would not expect to see any significant improvement in business conditions until housing turns up and unfortunately it appears that could be a while.

That said, our total year 2008 guidance is as follows -- and I would point out this guidance excludes any potential receipt of additional funds under the CDSOA.

Total year ‘08 net sales are expected to be in the range of $255 million to $268 million. That’s a 5% to 10% decrease range there compared to ‘07, the year just ended, where sales were $282.8 million. Operating income is expected to be in the range of $9 million to $12 million; that excludes a pre-tax charge to earnings of about $1 million for the manufacturing consolidation I mentioned a moment ago.

The company’s effective tax rate is expected to be in the range of 32% to 32.5%. In ‘08, earnings per share are expected to be in the range of $0.40 to $0.60 per share and that excludes a charge to earnings of about $0.06 for the manufacturing consolidation compared to $0.54 last year which I think you know excluded the pension plan termination, restructuring charge, and CDSOA funds.

For the first quarter of ‘08, our guidance is as follows: net sales are expected to be in the range of $62 million to $66 million compared to sales of $75.1 million in the first quarter of ’07. While year over year this is a significant reduction, I would point that sequentially this guidance is in line with our most recent quarter.

Operating income is expected to be in the range of $2.3 million to $3 million, excluding a pre-tax charge to earnings of about $400,000 for the manufacturing consolidation.

Earnings per share are expected to be in the range of $0.10 to $0.15. That excludes a restructuring charge of about $0.03 compared to $0.15 in the year-ago quarter.

Obviously, these remain very challenging times for our industry, and we are not sure how much deeper and longer this cycle will go. As such, we will continue to manage the business prudently. Our financial position remains strong and I’m confident we have an enthusiastic and engaged management team that is preparing the business for the eventual upturn.

Douglas I. Payne

Thank you, Jeff. Disciplined allocation of capital remains a high priority. As a result of our strong cash flow, our excellent financial position and positive long-term outlook, we continue to invest in the future of the business and use significant amounts of cash to repurchase our stock and pay cash dividends.

We have used nearly $150 million in the past 12 years to repurchase our stock and thereby increase the shareholders’ proportionate ownership of the company by 83%, which is net of new shares issued in connection with our stock compensation plans.

Since initiating a cash dividend in 2003, we have increased the per share amount fourfold, including a 25% increase in 2007. We took advantage of attractive borrowing terms in early 2007 to add $25 million of long-term debt to our balance sheet and we ended 2007 with total debt of $30.7 million and cash on hand of $31.6 million.

During 2007, strong cash flow from operations and $25 million in proceeds from additional borrowings were used to re-purchase 639,000 shares of the company’s common stock for $13.6 million, pay cash dividends of $4.2 million, make scheduled debt payments of $2.9 million, invest $4 million in capital improvements, and increase cash on hand by $25.4 million.

Working capital, excluding cash and current maturities of long-term debt, decreased $7 million, or 10.2%, primarily due to a decrease in accounts receivable and inventories reflecting lower sales. Approximately $19 million is currently authorized by our board of directors to repurchase stock. We curtailed our share repurchases in the latter portion of 2007. We believe now is the time to be more conservative and maintain a very strong financial position in these uncertain times.

Jeffrey R. Scheffer

Thanks, Doug. Jackie, we will open the call now to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Budd Bugatch - Raymond James.

Budd Bugatch - Raymond James

Your guidance for the first quarter assumes revenues down 12% to 17.5% which I know while sequentially the top end of that meets what was done in the fourth quarter, it sort of implies that maybe you have seen a continued worsening even in the fourth quarter and maybe in the first part of the first quarter?

Jeffrey R. Scheffer

Budd, I think your math is right there on the down 12% to roughly 17%. I would say this to you: this downturn began -- or at least we saw it begin -- in late ’05. It showed signs of abating early last year. Our first quarter, and I haven’t looked hard at Q2, but I think our second quarter last year, the first couple of months there, April and May, were actually quite good. It was still down over the prior year, but it was giving us a little hope that maybe things were starting to bottom a bit and that turned out to be a false bottom, I suppose. We don’t see anything a whole lot different right now than what we experienced in Q4.

Budd Bugatch - Raymond James

Your language was pretty instructive, I thought, in the release when you said modestly worsening, framing your guidance. I wanted you to characterize that if you would or put some numbers around that if you could. I think at the top end it is probably fairly flat and at the bottom end it is worse.

Jeffrey R. Scheffer

I think at the top end it’s down about 5%; at the bottom end it’s down 10%.

Budd Bugatch - Raymond James

That’s for the full year?

Jeffrey R. Scheffer

Right.

Budd Bugatch - Raymond James

I congratulate you on a least appropriately trying to frame that.

Jeffrey R. Scheffer

The 5% down would be somewhere around current demand levels.

Budd Bugatch - Raymond James

Your crystal ball is probably better than mine --

Jeffrey R. Scheffer

No, Doug likes to say that the only thing true about a forecast is that it’s always wrong; you just never know which way and to what extent. What we’ve given you here is our best shot today and if things change either way, we’ll certainly let you know.

Budd Bugatch - Raymond James

Receivables, it looks like in days sales you really curtailed that and I’m kind of worried about the health of retailers out there. I think there was a notable retailer -- I’m not going to mention the name -- that has put some squeeze on the manufacturers very recently. What can you tell us? Is that calculation right that you have actually curtailed days sales outstanding based upon the most recent run rate?

Douglas I. Payne

Budd, your calculation is correct. Our days sales outstanding were down at the end of the year. I don’t have the calculation right in front of me but I know it was down fairly significantly.

I think a lot of it just simply has to do with the timing and where sales were towards the end of the fourth quarter, and in December in particular. What I can tell you about the health of our retailers is that not a lot has changed to date. We are certainly very cognizant of the concerns that I know you have and probably many others share that the longer and the deeper this downturn continues obviously the more people that could get into financial difficulty.

Our bad debt expense for 2007 was actually down compared to 2006 because we had a couple of relatively larger customers for us that went out of business in 2006.

Budd Bugatch - Raymond James

What was the reserve at the end of the year?

Douglas I. Payne

Our total receivable reserves were about $1.4 million, I believe.

Budd Bugatch - Raymond James

At the end of the year?

Douglas I. Payne

Yes.

Jeffrey R. Scheffer

Budd, I would only add to that, just to maybe refresh that we are very well distributed; we don’t have a customer that accounts for more than 3%, 4% of our business.

Budd Bugatch - Raymond James

That is a change from really one of the last cycles we have been through?

Jeffrey R. Scheffer

For us it is, yes.

Budd Bugatch - Raymond James

I was surprised that you didn’t buy any stock in the quarter given what had happened to the share price and some CDSOA funds. Your balance sheet has never been, in my memory, stronger than it is today. I know you commented that you say it pays to be conservative, but there is conservative and then there is overly conservative, I guess.

Jeffrey R. Scheffer

Well, as we both indicated in our opening comments, these are very uncertain times, uncharted waters, and we just think if there is a time to be over conservative, it would be this time right now.

Budd Bugatch - Raymond James

Can you give us a CapEx expectation for the year?

Douglas I. Payne

We are budgeting right around $3 million and we expect to be probably somewhere between $3 million and $4 million at the high side.

Operator

Your next question comes from Todd Schwartzman - Sidoti.

Todd Schwartzman - Sidoti

In light of your annual guidance which sounds somewhat of a relatively cautious tone, your industry outlook is cautious, the guidance range is wide and understandably so; can you walk us through maybe reconciling the profit that you did post in Q4 when you guys had guided to a loss for the quarter? Although albeit it was lower guidance, but you were profitable. What went right on a relative basis in Q4?

Douglas I. Payne

Todd, the things that went right was first of all, we were slightly above the sales guidance that we had offered for the fourth quarter. As you know, it all starts with sales, so that was the first thing that went right relative to the guidance.

The second thing was basically the operation of our domestic facility. We actually had better manufacturing or operating results in the fourth quarter than we had anticipated when we put that guidance together.

Todd Schwartzman - Sidoti

Why was the top line a little stronger than the top end of what you were looking for?

Douglas I. Payne

I’ll let Jeff add to this if he would like. I think it is just the inherent difficultly in forecasting revenues in these uncertain times, Todd.

Jeffrey R. Scheffer

No question about it. Bear in mind Todd that we operate typically with a backlog that’s sometimes measured in hours because we shift so quickly, we’ve really only got about 14 days’ visibility at any given time.

Todd Schwartzman - Sidoti

That being the case, if you could look into that crystal ball, look out ten years perhaps, are you still committed to maintaining the current number of domestic plants?

Jeffrey R. Scheffer

Ten years is quite a horizon. What I would say to you is that honestly, I can’t tell you ten years out. What I would say to you is that the reason we continue to operate these three domestic facilities is that we believe it gives us the absolute best chance of consistently executing the promise of our mission.

We think everything starts with product, you have got to have something she wants at a price she is willing to pay for it; that does not necessarily mean it’s always got to be the lowest price in the market but you have got to give her something she wants at a price she is willing to pay.

We then look to differentiate our company from the competition and how quickly we ship. We are still shipping these 3,500 SKUs now on average in about 14 or 15 days. When she gets the product, we don’t want her to have any problem with it.

To think that we could just shut these facilities down and outsource everything we do, I don’t think we stand a snowball’s chance in consistently executing that mission. So for us it starts with the mission; it then comes down to okay, how are you going to best execute it. That is why we have these facilities.

I would say this to you also is that China does not appear to be getting any cheaper so we have weathered quite a storm, we have taken quite a punch. Prices in China are not getting any lower. So I like our look.

Todd Schwartzman - Sidoti

If you were to consider an acquisition down the road, would you necessarily look only at case goods transactions?

Jeffrey R. Scheffer

We are not acquisitive minded, we would probably start there. I don’t know if it were upholstery, would we take a look at it? We might but it would strategically have to make an awful lot of sense. I would point out we’ve been in the upholstery business once before and that didn’t work out too well.

Todd Schwartzman - Sidoti

The last question is regarding the CDSOA; can you give us a timetable on expected payments, maybe quantify what you know now, best guesstimate and when the payments might stop?

Jeffrey R. Scheffer

I will let Doug answer that, but this may be your ten-year horizon, I don’t know.

Douglas I. Payne

I will try to frame this up as best I can and share with you and with our other listeners what we know about the situation at the present time.

As of October 1, 2007, the U.S. Customs and Border Protection had disclosed that there was approximately $178 million in duty that either been secured by cash deposits or bonds on unliquidated entries and that amount is potentially available for distribution under CDSOA.

In addition to that, there is approximately $41 million of funds that are available for distribution that were set aside by the government over the past two years for a group of domestic producers that have requested CDSOA funds that are not eligible to receive the funds based on the CDSOA and the government’s historical administration of the law.

The government set aside those funds in connection with two lower court cases that were decided against the government on constitutional grounds that have subsequently been appealed. The resolution of those legal appeals is likely to have a significant impact on the amount of additional CDSOA funds that we receive.

Now there are a number of factors that can affect how much additional CDSOA funds that we receive and those factors include the annual administrative review process which can retroactively increase or decrease the actual duties owed on entries secured by the cash deposits and bonds; our percentage allocation, which is based on our qualifying expenditures in relation to the qualifying expenditures of other eligible domestic producers requesting distribution for the relevant time periods under CDSOA; the ultimate resolution of the legal appeals that I just mentioned to you; and there are other administrative and legal challenges that very well may be instituted.

With all that as a caveat, if you assume that our percentage allocation in future years is the same as it was for the 2007 payment, which was approximately 25% of the funds actually distributed; and that the amount of $178 million that was collected by the government as of October 1, 2007 does not change as a result of the annual administrative review processes or otherwise; and that the government loses the pending appeals based on the constitutional issues, which would reduce our percentage allocation by approximately 50%, based on the amount of funds that were held back for the pending litigation in 2007; we could potentially receive approximately $22 million in additional CDSOA funds.

Now if the government ultimately prevails on the pending constitutional legal challenges, and all the other assumptions remain the same, we could potentially receive approximately $32 million more in funds for a total of approximately $55 million in additional CDSOA funds.

Now due to the uncertainty of the various legal and administrative processes, we can’t provide any assurances as to the amount of additional CDSOA funds that ultimately will be received -- if any -- and we really can’t predict when we may receive any such additional funds.

I hope that’s helpful; you probably wish you hadn’t asked the question by now.

Operator

Your next question comes from Jimmy Yu - Aristos Capital Management.

Jimmy Yu - Aristos Capital Management

Could you talk about your strategic plans to get out of these uncertain times? How do you plan to increase production in the future?

Jeffrey R. Scheffer

The question was a strategic plan to increase production in these uncertain times. There is not a whole lot, if anything frankly, we can do to stimulate demand. What we will continue to work on will be our products and making sure that we put the best product out there; shipping it faster than anyone else; and making it the highest-quality product that we can produce; that is where we are going to spend our time.

To a large degree, business is going to be what it is going to be. If consumers aren’t walking through doors of furniture stores, there is not a lot of that Jeff, Doug and Stanley Furniture can do about it. But we are spending our times on those things that we can affect.

I will say this to you, because we are one of the last producers standing here in this country I think it is fair to say we will be able to respond to that upturn, perhaps more quickly than our competition. The longer this thing goes on, it’s been said Jimmy that the demand for furniture never changes; what changes from time to time is people’s willingness to spend for it. So the longer this current cycle goes on, we think the harder and stronger it will come back and we think we are well-poised and positioned to be able to respond to that demand when it happens.

Jimmy Yu - Aristos Capital Management

So given your current number of facilities, do you feel the capacity will increase over time?

Jeffrey R. Scheffer

Yes, we do.

Jimmy Yu - Aristos Capital Management

Can you talk a little about the SG&A cost, material costs? It seems like gross profit that was down. I’m trying to get a better sense of why so high? Why not more like previous quarters?

Douglas I. Payne

I’ll take a swing at that. Most of the gross profit decline in 2007 was really attributable to the volume levels and the decrease in sales, and the corresponding reduction in production and output levels.

Also what you have going on as we commented on in the release is higher raw material and compensation costs. We are seeing some moderation in lumber prices. Outside of that, virtually all other raw materials that we utilized are remaining at elevated levels and we are not seeing any abatement in those price levels.

Jimmy Yu - Aristos Capital Management

I remember last quarter you mentioned something similar> If you are guiding next quarter with numbers from this quarter, wouldn’t you say that this pressure on margins will continue?

Jeffrey R. Scheffer

If you filter through the guidance we are projecting a little improvement, perhaps, depending on exactly where revenues end up and the first quarter of ‘08 and as we continue through out’08. That is primarily a function of the cost control initiatives that we have instituted in 2007 starting back in the early part of ‘07, as we downsized our production and output levels out of one of our factories in North Carolina and then continuing on into the fourth quarter of the year as we took our Martinsville, Virginia facility and are in the process of converting that from a manufacturing to a warehousing operation.

Jimmy Yu - Aristos Capital Management

I just wanted to get an idea about the facility that you just closed. Can you give me an idea about the number of people laid off and how it affected SG&A?

Douglas I. Payne

That impact is really all in cost of goods sold and gross profit. There is very little impact in SG&A.

Jeffrey R. Scheffer

Yes, we both are trying to remember the exact number of people.

Douglas I. Payne

It’s about 250 associates.

Jeffrey R. Scheffer

SG&A for the year last year, this is from memory, but I think it was right at about 14%, which I think was true of the fourth quarter as well which in a declining sales environment, I think we’ve done a nice job controlling those expenses. That’s close to where we’ve been historically; somewhere between 13% and 14%.

Operator

Your next question comes from John Baugh - Stifel Nicolaus.

John Baugh - Stifel Nicolaus

The fourth quarter EBIT, when you cut through all the charges and gains, was that about $1.2 million, Doug?

Douglas I. Payne

It sounds right, hold on a second, I will tell you.

John Baugh - Stifel Nicolaus

The question is, if that’s the right number and you are looking at revenues in the first quarter of a similar level yet you are guiding EBIT to $2.3 million to $3.0 million walk us through the two or three keys? I assume it is restructuring but could you help us to understand that improvement?

Douglas I. Payne

First of all, your $1.2 million adjusted EBIT number for the fourth quarter is correct and your assumption on the difference in the guidance going from Q4 to Q1 is also correct. Now a big part of that is the cost that we are taking out in the conversion of the Martinsville facility and so forth and the elimination of a lot of those costs.

John Baugh - Stifel Nicolaus

Inventory levels, I think, were really low at the end of last year.

Douglas I. Payne

That’s correct.

John Baugh - Stifel Nicolaus

So they are more or less where you want them, so it does not imply a production pullback?

Douglas I. Payne

We prefer they were lower, John, obviously, but you are absolutely right. They were a little light entering last year, and we are not uncomfortable with that level at this point. I think the good thing is there are no huge pockets of inventory we don’t want.

John Baugh - Stifel Nicolaus

Follow up on Budd’s question about buyback, I too was a little surprised that there was no activity. Obviously, things change and I don’t want to hold you to anything, but how should we think about buybacks in ‘08? If your assumptions are more or less correct, we will get additional CDSOA money somewhere, I would hope in the year, but even if we didn’t, we will have positive cash flow and you are essentially debt free today;

Would you assume that you would be buying back some stock, less than last year? Any kind of help.

Douglas I. Payne

John, that’s why you get paid the big bucks.

Jeffrey R. Scheffer

Let’s just put it this way. I think our track record speaks for itself. As Doug indicated in his opening remarks, we have for the last 12 years declared $150 million to buy stock, and we view allocation of capital as a long-term strategy. Let’s just leave it there.

John Baugh - Stifel Nicolaus

Thanks for the review on the CDSOA, that was great. Am I right in assuming that 178, that has all been collected at this point, there won’t be additional money going into the gross?

Douglas I. Payne

One thing I should have commented on at the beginning, John, related to that is the duties will remain in effect after September 30, 2007 but the CDSOA provision that allows for those funds to be distributed to the interdomestic producers, that expires for merchandise that enters the U.S. after September 30, 2007. So that amount of the $178 million as has been disclosed by the government has either been secured by cash deposits or bonds.

Operator

Your next question comes from Charlie Carter - [inaudible].

Charlie Carter - [inaudible]

We’re all well aware of just how deep and tough this housing recession has been. You alluded to being one of the last people standing in the industry; obviously, we are learning that imports from China are going higher because of freight/fuel costs and their own input costs over there.

If you are not going to be buying back stock, what else can you be doing strategically at this point in the cycle, because we know that there is going to be a recovery at some point and you seem to be pretty well-positioned to be opportunistic.

Can we talk a little bit about that> If you all are not going to step up the buybacks at these levels?

Jeffrey R. Scheffer

Charlie, I don’t think we said we weren’t in the future going to step up and buy. I think what we said was that our track record should speak for itself and anything more than that I’m just not going to speculate.

Charlie Carter - [inaudible]

But is there anything else strategically that would make sense in the industry? You’ve already answered and said that you have sufficient capacity for volume rebound, but is there anything else that you see in the industry that would kind of make sense to look at to buy at these levels, because I’m assuming a lot of your competitors are in distress.

Jeffrey R. Scheffer

Yes, not at the present time. If you are talking about our competitors, most of them have closed up shop and now buy their product primarily with the Far East and resell it here. So there is nothing out there that we see at the present time. As we said earlier, we are going to continue to work on making this business as we know it today better.

Operator

Your next question comes from Jimmy Yu - Aristos Capital.

Jimmy Yu - Aristos Capital Management

Along the lines of this share buyback, can you talk about the dividend and are you guys are looking at that in any way?

Douglas I. Payne

Jimmy, as I commented in my opening comments, we instituted a cash dividend back in 2003. We’ve actually grown that fourfold, including a 25% increase in ‘07 and that’s something that we and our Board continually evaluate and look at and would expect them to continue to do so as we go forward.

Operator

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

Douglas I. Payne

Thank you, everyone for your participation on this morning’s call. We look forward to talking to you again in April. Thank you.

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