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U.S. Home Systems, Inc. (NASDAQ:USHS)

Q4 2007 Earnings Call

March 18, 2008 4:30 pm ET

Executives

Murray H. Gross, Chairman and Chief Executive Officer.

Peter T. Bulger, President and Chief Operating Officer.

Robert A. DeFronzo, Chief Financial Officer.

Analysts

Joel Havard - Hilliard Lyons

Chris Doucet - Doucet Asset Management

Rick Fetterman - Fetterman Investments

Operator

Good evening ladies and gentlemen and welcome to the US Home Systems Inc. Fourth Quarter 2007 Earnings Conference call. At this time, all participants are on a listen-only mode. Following today’s presentation, instructions will be given for the question and answer session. If anyone needs assistance at any time during the conference, please press * followed by 0. As a reminder, this conference is being recorded today, Tuesday, March 18, 2008. Now, I’ll turn the conference over to Brett Maas. Please go ahead sir.

Brett Maas

Good afternoon and thank you for joining the US Home Systems Inc. Investor Conference Call. Following management’s comments, we’ll open the line to answer your questions. This call is also being simulcast on the internet through our website at www.ushomesystems.com or through the Viavid broadcasting website at www.viavid.net. An audio replay of the call will be available on these websites for 14 days. Today’s presentation may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as a mandate and Section 21E of the Securities Exchange Act of 1934 as a mandate. Such forward-looking statements are based on a number of assumptions including expectations for continued market growth and anticipated revenue levels. Although the company believes these assumptions are reasonable no assurance can be given if they will prove correct. If the company’s performance differs materially from these assumptions or estimates, US Home Systems’ actual results could vary significantly from the estimated performance reflected in any forward looking statement. I now have the pleasure to introduce Murray Gross, Chairman and Chief Executive Officer, US Home Systems. Murray, the floor is yours.

Murray H. Gross

Thank you Brett, and good afternoon everyone. Joining me today is Peter Bulger, our President and Chief Operating Officer, and Robert DeFronzo, our Chief Financial Officer. Before we review the operating results for the fourth quarter and full year of 2007, I would like to give you an overview of some recent events.

In August 2007, our Board of Directors authorized a repurchase of up to $5 million of our outstanding common shares. At December 31, 2007, we had purchased 737,093 shares at a cost of approximately $4,985,000. This leaves us with approximately 7.6 million shares outstanding. However, I am pleased to announce today that our board has authorized a new program for the repurchase of up to $2 million of our outstanding common stock in the open market at such time and such prices as management may determine. Based on our current stock price, we believe repurchases of the company stock represents an excellent investment that will provide long-term value to our shareholders.

Last quarter I advised you that we had exited the consumer finance business. As a result of the sale for approximately 2.6 million of substantially all of the assets of First Consumer Credit, our finance subsidiary, in a buyout led by management of the consumer finance unit. As a result of the transaction, the financial operating results of FCC for all periods had been reclassified as discontinued operations in our consolidated statement of operations. Prior to the sale of FCC’s assets we had two reporting segments – the home improvement segment and consumer finance segment. As a result of the sale of FCC’s assets and the reclassification of FCC’s operating results as a discontinued operation, we have eliminated the previous separate segment reporting.

Now I would like to turn to our operating results and introduce Robert DeFronzo, our Chief Financial Officer, who will review the financial results with you.

Robert A. DeFronzo

Thank you, Murray. Thank you everyone for joining us this afternoon. As Murray said all of the financial results of our consumer finance business have been reclassified as a discontinued operation. So as we are going through the financial results today, when we refer to these results we will be talking about our continuing home improvement operation.

Let’s go ahead and begin with the fourth quarter results. In the fourth quarter, our new orders increased 17.1% to $31 million from $26.4 million in the fourth quarter of last year. Orders for kitchen products increased 19.1% to $26.4 million and orders for deck products increased 16.8% to $2.4 million. Orders for bath products were flat at 2.2 million. On a market comparable basis, our new orders increased 14.6% over the fourth quarter of 2006. We attribute this increase in new orders to our in-store marketing program which is a program we initiated in June 2007. We started the in-store marketing program to proactively approach and penetrate the marketplace. We simultaneously reduced our marketing media advertising as the response rate in those media was declining. The in-store marketing program consists primarily of staffing marketing promoters in various Home Depot stores during certain times of the week to generate customer interest in our product and to answer questions about our products and to schedule an in-home presentation. The in-store program has been principally directed to our kitchen and bath products. During the fourth quarter, the in-store program was operating at only 175 of the Home Depot stores that we operate our kitchen products in.

Although new orders increased in the fourth quarter, our installation completions were off particularly in December which resulted in a $1.7 million decline in our fourth quarter revenues as compared to the prior year. And although we are disappointed that we did not get the additional revenues, our backlog of uncompleted orders was $24 million at December 31, 2007, as compared to $19 million at December 31, 2006. Now the decline in revenues in the quarter resulted in a reduction of our gross profit of $1 million. In addition, our gross profit was adversely affected by the combination of higher material, manufacturing, and labor costs in our kitchen product line resulting principally from product enhancement and reduced deck product selling prices in our deck product line. We believe that the kitchen refacing product changes better meet consumers’ expectation and have resulted in increased customer satisfaction ratings as measured by the Home Depots’ customer survey. We made certain price adjustments on kitchen products in January 2008 to improve our kitchen product gross profit margin as we go forward.

In May 2007, we implemented new sales pricing for our deck products. The pricing was intended to stimulate sales of our deck products; however, we did not achieve the desired results and we are currently evaluating our deck pricing. In addition, during the quarter we incurred an operating loss of approximately $108,000 in markets we opened in June and July of 2007 - those being Nashville, Tennessee; Birmingham, Alabama; Harrisburg, Pennsylvania; and Rochester, New York. Although the volume of the new orders in these markets had been below our expectations, the startup losses in these markets were expected. Our backlog in these markets at December 31, 2007, was approximately $600,000. As a result of these factors, we incurred a loss in continuing operations of $434,000 or 5 cents per share in the fourth quarter of 2007 as compared to income of $1.2 million or 14 cents per share in the fourth quarter of 2006.

For the year ended December 31, 2007, in the aggregate, new orders were flat at approximately $128 million, but increased $5.3 million or 5.9% in our kitchen and counter-top products and $95.5 million in 2007 from $90.6 million in 2006. The increase is largely the result of the in-store marketing program. New orders for deck products reflected reduced demands declining $5.4 million or 19.7% to $22.1 million from $27.5 million in 2006. We believe that the sale of deck products is closely aligned with the housing and construction resale market and consequently we believe the decline in deck product demand reflects the softness in the general housing market. New orders for bath products were $10.2 million in 2007 as compared to $10.8 million in 2006. This slight decline in the bath products new orders was due to the decline in the number of markets in which we now offer our bath products in.

Our revenues in 2007 increased 2% to $123.3 million as compared to $120.8 million in the prior year. Approximately 70% of the increase or $1.7 million was realized in markets that were open prior to 2007 and the remaining 30% of the increase or about $729,000 resulted from sales and installation centers we opened in the second and third quarter of 2007. Our operating income for the year was approximately $3.9 million as compared to $6.9 million in 2006, and although we increased our revenues, the increase did not translate into increased operating income.

The principal factors resulting in the decline of our operating income are as follows: Our gross profit margin was adversely affected approximately $617,000 principally due to the combination of increased material costs in our kitchen refacing product line which had resulted from the product changes we made and downward selling price adjustments in our deck products. The second item is the effective rate of our marketing fees we paid to The Home Depot increased approximately $1.5 million as a result of sales product mix and certain program adjustments. Thirdly, we incurred an operating loss of approximately $612,000 in the four new sales and installation centers we opened in 2007. And lastly, we’ve increased spending in several areas that are designed to enhance our future operating and financial performance. More specifically, we’ve engaged consultants to assist us in our supply chain operations and in our information systems design which include developing new application and to assist us in complying with our requirements related to the management’s assessment of internal control. These increases in these costs were disproportionate to the increase in revenues we received in 2007.

For 2007, income from continuing operations was $2.4 million or 29 cents per share as compared to $4.1 million or 49 cents per share in 2006, and as we noted earlier, in the third quarter of 2007, we exited the consumer finance business. For the year including the loss on the sale of the assets of that unit, we had a loss on discontinued operations of $2.7 million or 33 cents per share. Including the discontinued operations, our consolidated loss of 2007 was $299,000 or 4 cents per share as compared to the net income of $4.2 million or 51 cents per share in 2006. That is the summary of our financial results. I would like now to turn the call over to Peter Bulger who will bring up the data on some of our larger corporate initiatives.

Peter T. Bulger

Thanks Bob. Hello everyone. I wanted to update all of you today on some of our plans and initiatives. As previously reported, we and the Home Depot mutually agreed the phase out of our installed deck program under the Home Depot brand. We’ve already ceased marketing our deck products in the Mid West, Boston, Connecticut, Virginia Beach, and the Atlanta markets. We will complete the installation of all pending deck orders for the Home Depot customers and we will continue to honor our warranty service obligations. We expect that we will incur an impairment charge of approximately $54,000 after tax benefit in Q1 of 2008 related to the in-store deck displaced in these markets. We will continue to market, sell, and install on a non-exclusive basis our deck products under the Home Depot brand in the Northeastern markets including Northern Virginia, Maryland, Philadelphia, New Jersey, and New York until August 31, 2008. Concurrent with this phase-out of deck products in these markets, we will return to marketing our deck products under our own designer deck brand.

Prior to our relationship with the Home Depot, we successfully marketed our wood deck products under our own brand in Northern Virginia, Baltimore, and Washington D.C. area. We anticipate we will begin marketing deck products again under our own brand in Q2 2008. Additionally, we also plan to continue to enhance our deck product offering. First, we are currently working to broaden our deck product offering with additional selections of composite decking and railing materials. Due to the required maintenance of wood decks, we believe that more customers are considering composite materials to avoid the re-occurring stain and seal expenses. Secondly, we’re working with a third-party vendor to provide staining and sealing for our wood deck customers. We believe that home owners prefer to have their wood decks professionally stained and sealed to maintain its natural beauty, value, and long-term enjoyment.

And lastly, we’re extending our product offering of traditional on-site deck construction as an alternative to our designer deck modular system. We believe that the combination of materials and construction alternatives provide us with a greater competitive advantage and price point distribution to meet our customer’s need.

With regards to our kitchen refacing and counter-top platforms, we and the Home Depot agreed that effective April 1, 2008, we would begin rolling out our kitchen cabinet refacing products and counter-top products in the Ohio Valley markets including Cleveland, Columbus, Cincinnati, and Pittsburgh Pennsylvania encompassing approximately 96 The Home Depot stores. We believe the demographics of these markets suit our products and although we anticipate some initial start-up losses, we believe these markets will be free gift to earnings in the future. We will continue to offer our kitchen products exclusively in approximately 1500 The Home Depot stores and 33 Expo stores, and offer our bath products in approximately 525 The Home Depot stores. As a result of the addition of the Ohio Valley market, we are now the sole provider of kitchen cabinet refacing products and services to The Home Depot in the United States.

In March 2007, we launched a pilot program with The Home Depot for the introduction of counter-top products in the Boston market. This product offering consists of laminates and solid surface tops including Korean tile, stone, and granite. Since March 2007, we completed the roll-out of laminate counter-top products in all cabinet refacing markets and we introduced solid surface counter-top products in the Chicago, New York, California, and Florida markets. By the end of Q2 2008, we expect to complete the roll-out of all solid surface counter-top products in all of our kitchen refacing markets.

As previously reported, we and The Home Depot have mutually agreed to extend the termination date of our service provider agreement to February 28, 2011. I believe the extension of our service provider agreement with The Home Depot and our continued expansion of the kitchen cabinet refacing platform demonstrates the confidence that our partner has shown in us. We will continue to build our presence in these markets and we will strive to become the premiere provider for The Home Depot. As Bob mentioned earlier, we also are very excited about our in-store marketing program. The in-store lead generation program involves staffing marketing promoters in select Home Depot stores during peak traffic times. Marketing promoters generate interest in our products, answer questions, and schedule in-home presentations for potential customers. We started this pilot program in June in only a few stores and our results were very promising. We quickly implemented an expansion initiative with a third-party vendor and by the end of September we were operating the program in approximately 175 The Home Depot stores. Although our initial sale proficiencies were lower than other lead sources, we’ve seen a significant improvement in the fourth quarter of 2007 and in January and February of 2008. We will continue to monitor the results and expand the program into additional stores as appropriate.

And finally, last quarter we mentioned that we had launched our pilot program for storage solutions including closets, pantries, and garages. We believe that the closet and garage storage systems are preferable way for home owners to organize personal belongings, present a professional finished appearance, and add value to their homes. The preliminary results of this pilot program appear to be promising, and we will continue to evaluate the potential of this new platform.

In summary, we’re very excited about these initiatives and believe that they’ll produce positive results in 2008. Now let me turn it back over to Murray.

Murray H. Gross

Thank you, Peter. As Peter said, we are excited about these initiatives and our continuing relationship with The Home Depot. I’m encouraged by our new order input trends over the last 5 months. For the months of January and February 2008, our new orders were up 22% over the same 2-month period of 2007. I believe that the fundamentals of our business remain strong. However, we are living in times of great economic uncertainty and market variability. We remain cautious about growth prospects as tighter credit standards, increasing fuel costs, rising unemployment, and falling consumer confidence are a reality that we must deal with. Even so, as I stated in June last year, in my experience I expect consumer demand for kitchen and bath products to recover at a faster rate than the general housing market and the increasing numbers of potential home sellers will undertake economical remodeling expenditures to spruce up their homes to stand out against competition while many other home owners will choose to incur remodeling investments to upgrade their existing house.

That belief is supported by the most recent issue of Kitchen and Bath Design magazine where the magazine quotes Ed Pell, Manager of Market Research for the National Kitchen and Bath Association, “In general, the kitchen and bath market will continue in 2008 to be supported by a strong foundation for resiliency if not growth. Dipping home values and prices act as a spur to kitchen and bath remodeling. Since consumers trying to sell tend to improve their homes in the hope of attracting buyers and home owners staying put improve their homes for enhanced lifestyle and increased home value.” The article continues on to say that cocooning, the phenomenon of people retreating into their homes, remains a major market factor and is likely to intensify as the economy worsens, spurring the desire for a better kitchen and bathroom.

In conclusion, I believe that the fundamentals of our business remain strong. The company remains strategically well positioned within this market. The first quarter of the year has historically been a seasonally slow quarter for us and one in which we’ve incurred operating losses. Depending on the volume of March installations we expect our first quarter bottom-line results to range between a 2-cent per share loss and a 2-cent per share gain. I will also remind shareholders that the second and third calendar quarters represent what have historically been our strongest quarters each year. We continue to maintain a strong financial position with nearly $11 million in cash at December 31, 2007, and approximately $60 million in working capital.

Finally, I would like to encourage everyone to review our filing on Form 10-K which has additional information about our 2007 results. Now in order to get everyone’s questions, let’s open the line.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) Our first question is from the line of Joel Havard with Hilliard Lyons. Please go ahead.

Joel Havard - Hilliard Lyons

Thank you. Good afternoon everybody. I wanted to get a little bit more in-depth tutorial if you will on the Ohio Valley, the countertop, and the storage programs. I realize a lot of this is still information, but having been away from the store, I could really use a little bit more thorough update. I don’t want you to waste the whole call on it, but you said Cleveland, Cincinnati – what were the other markets that will be included in that?

Murray Gross

Columbus and Pittsburgh.

Joel Havard - Hilliard Lyons

Columbus and Pittsburgh, alright. This is kitchen only? Kitchen and bath?

Murray Gross

Kitchen only and countertops.

Joel Havard - Hilliard Lyons

Okay, kitchen with counter. That’s a good point. I want to come back to that. The followup I had on that – I think Peter said it, you are now the sole provider nationally – did I hear that right?

Murray Gross

That’s correct.

Joel Havard - Hilliard Lyons

I’m going to give you chance to brag maybe a little bit, Murray, here. It’s sort of not in keeping with Home Depot’s style or policy to have sole providers. What are you guys delivering to them that’s getting them over that?

Murray Gross

Our revenues have been very good from a standpoint of just what we’re delivering in performance. Our performance overall on a market basis far exceeded what they were getting from another provider, and probably more importantly our voice of the customer scores, VOC scores as Home Depot refers to them, were very good, and so we’re delivering the right kind of revenue at the quality that Home Depot expects, and that is really their first consideration.

Joel Havard - Hilliard Lyons

The VOC thing, let me make sure I understand it, is that a customer feedback measure that Home Depot uses internally?

Murray Gross

Yes, every customer receives a survey asking probably 30 questions in various categories of their experience.

Joel Havard - Hilliard Lyons

And you guys are scoring above expectations there as well. Congratulation! On the countertop side, laminates – should I think of that in terms of 4 or 5 bucks a linear foot? Is that probably about right where solids would be more like 10?

Murray Gross

It’s more on a square foot basis, but you can think about it in terms of the job. A laminate countertop on average is about $2000 or maybe a little less, and a granite or stone countertop on average is $4000 plus.

Joel Havard - Hilliard Lyons

Are you all doing granite? When you said solids, I thought you mentioned…

Murray Gross

We’re doing granite. We haven’t rolled out to the markets in Chicago, New York, California, and Florida, so in California and Florida, that represents about 8 markets in those states, and New York and Chicago, so you have about 10 markets. We’re in the process now of rolling solid surface out in the remainder of the markets.

Joel Havard - Hilliard Lyons

Of your remaining kitchen market?

Murray Gross

Remaining kitchen market. We only sell countertops in connection with the cabinet refacing, but the most important aspect of that business is that we are selling I think because of the economical nature of what we sell as an alternative to full kitchen remodeling. The magazine I referred to just said that the average kitchen remodel today is running about $44,000. Now, that includes appliances and a lot of other things, but Kitchen and Bath Design magazine just published that in this outlook for next year, and our average ticket with the countertop is running about $8000.

Joel Havard - Hilliard Lyons

Okay, well you anticipated my next question. So that 2 to 4 is in the context of the 8 without countertop?

Murray Gross

No, with countertop.

Joel Havard - Hilliard Lyons

Okay, that’s 8 with countertop, of which 2 to 4 is kind of the range for you all.

Murray Gross

Yes, but our seal of laminate countertops has far exceeded our expectation, and I think what we learned out of that is when the customer is looking for an economical alternative, they are doing that in both the cabinetry and the countertop.

Joel Havard - Hilliard Lyons

Good. Alright, make sure I understand this. You’ve got the laminate rolled out to all your kitchen markets nationally – 1400 some stores, and solids will be…

Murray Gross

That’s correct. Really 1400 stores.

Joel Havard - Hilliard Lyons

And solids will be rolled out over the rest of the year?

Murray Gross

Well, this quarter.

Joel Havard - Hilliard Lyons

This quarter?

Murray Gross

Next quarter, I mean. By the end of Q2.

Joel Havard - Hilliard Lyons

Alright, got it. That’s excellent. Finally, the storage, how many markets are that being tested in currently?

Murray Gross

It’s only being tested really a third of the market. We’re only doing it in 14 stores in south Florida, so it’s really just at its infancy, Joel. Can’t give you a lot of good insight because it’s a very small test, but satisfactory.

Joel Havard - Hilliard Lyons

You all started that out a quarter or two ago?

Murray Gross

In November.

Joel Havard - Hilliard Lyons

November, alright. I was going to say, short timeframe and Florida for goodness’ sake - that’s probably a pretty tough environment to be testing anything in now that’s housing related. Is that…?

Murray Gross

Interestingly enough, our kitchen business has remained very strong there, unlike California where it’s been impacted much greater than it has in Florida.

Joel Havard - Hilliard Lyons

So, what you want to say is this is probably still in test mode over the course of ’08 - don’t start trying to muscle that in yet.

Murray Gross

Yeah, I wouldn’t do anything with it.

Joel Havard - Hilliard Lyons

Alright, I understand. Guys, thanks for your handholding on this. I don’t want to dominate the call, so I’ll jump back in line.

Murray Gross

Okay, nice talking to you Joe.

Operator

Thank you. Our next question is from the line from the line of David Cowen with Midwood Capital. Please go ahead.

David Cowen - Midwood Capital

Hi, everybody. You provided a number around the operating loss from the 4 new sales centers in ’07. First of all, on those, what’s your expectation about when those markets can achieve operating profit breakeven?

Murray Gross

Well, we expected them to do that of course toward the end of the year, and they have not. They are still losing money. I think we lost about $100,000 in those markets in Q4. I would expect them to begin to breakeven in Q2.

David Cowen - Midwood Capital

Given the investment required for new markets, how do you size the impact of the 4 Ohio Valley and Pittsburgh markets?

Murray Gross

I would say this should all look very much alike. Operating expenses in those markets are pretty similar, and I would expect in the first 3 months of operation, we will typically lose $125,000 to $150,000 in the new markets, so they are not all going to open at the same time, but I think my best guess is we’ll probably lose half a million dollars from those openings in Q2.

David Cowen - Midwood Capital

Given the significant transition going on in the deck business, are there some actions that you guys are have taken or looking to take in terms of leading to rightsize the sales and installation infrastructure there because you won’t have the same volume of your main products in these markets eventually?

Murray Gross

I think, David, what we’re going to be doing is the markets that we cut out are markets that we didn’t manufacture the product in. We bought it externally, and unless the market surprises us, we scaled back our expectations just because of our experience last year and what we think we’re facing this year and trying to be Ms. Cleo and determining what that is. What we’re going to begin doing is in addition to the Home Depot business, we going to be in our marketing program in Northern Virginia, the home of that business, and we think between both the Depot business and the non-Depot business, we ought to be able to maintain our revenues at the same level we saw in those markets before, but we will probably cut back everything that we’re able to to rightsize the business this year. The key to it is can we generate the sales in our own model as we use because that’s kind of the unknown. We think the Depot business will be what the Depot business is or has been and blend of the businesses will be hanging for the balance of the year.

David Cowen - Midwood Capital

Okay, and indulging in two more questions—the margin issues that you highlighted as being a drag – net pricing, materials cost, and the kitchen size – did those continue in Q1, are those behind you, or will they even continue further than Q1.

Murray Gross

David, as you know, we have a cycle to our product. From date of sale, date of completion is about 60 days, so we really didn’t get the price changes in place until the middle of January, so we will see some of the benefit of that. We actually have one item of price change that went in place a little bit earlier, with a just a tiny bit of that price change come through in the quarter, but by and large, most of the price effect will not hit us till Q2.

David Cowen - Midwood Capital

Okay, and how about raw materials?

Murray Gross

Well, that’s really a pricing question. We make product changes enhancing our product line. I think one of the good things about it is it really seems to consumers’ expectations, but the real question there is that the material changes have caused out materials cost to increase and we’ll see the pricing increases that counteract that.

David Cowen - Midwood Capital

Okay, last question – you talked since the third quarter about the effectiveness of the in-store lead generation, and that was only in a small number of stores, but how should we look at the cost of order generation incorporated with the expansion of that effort?

Murray Gross

Well, we saw increased marketing costs from that in Q4 and we saw it in January, and I can’t fully talk about it, but I can tell you that the Depot has given us some assistance in the cost of their participation in the cost of that program.

David Cowen - Midwood Capital

Okay. Thanks guys.

Company

Thank you.

Operator

Once again, ladies and gentlemen, if there are any additional questions at this time, please press * followed by 1 on your touchtone phone. As a reminder, if you are using speaker phone, you will need to lift the handset before pressing the numbers. Once again, *1 for any questions.

Our next question is from the line of Chris Doucet with Doucet Asset Management. Please go ahead.

Chris Doucet - Doucet Asset Management

Hi guys

Murray Gross

Hi Chris

Chris Doucet - Doucet Asset Management

Just three quick questions. Actually the first one maybe not that quick. Murray, I know you’ve run this business for a long long time, and just kind of a quick macro question. Does this particular time remind you of any other time in the history of you running this company?

Murray Gross

Not in running this company, Chris. I think I said in one of the conference calls that the environment reminds me of the ‘70s which you may or may not remember, but in ’73-’74, we had still the war, high energy prices, gas lines, recession, all kinds of negative things. The things we didn’t have, as I recall, were energy prices at the level they are now, the subprime mortgage prices, and just the grave consumer confidence issues and rising unemployment. So, are they exactly alike? No, but are there some days you allude to them? Yes. Once we came out of that and we got through that ’73-’74 period, the next 4 years of business were really outstanding. We had our business though the late ‘70s go inflation got nuts and Carter shut everything down in 1980. There was no consumer 3148, so are there similarities? Yes. Are there other things? There just seemed to be so many of them. It’s like I wish we were though the recession, that the news acknowledged it, and the newscasters started talking about coming out of it instead of being in it, but I think looking at the history of the business so we talk about it since the industry has started to be tracked, it’s an industry that’s grown every year since 1980, and I refer to an article that this year remodeling may off in the 2% to 3% range, if you read that whole article in that magazine. I am encouraged by January and February. Do I walk around losing some sleep on what might be around the corner? Yes, but looking at what’s happening, I don’t want to tell you that January and February will continue all year because I am looking at the business day by day and sometimes minute by minute rather than a month at a time at the moment, so I don’t know if that answers your question.

Chris Doucet - Doucet Asset Management

Yeah, thank you by the way. Just out of curiosity – with the increase in marketing costs and fees paid to Home Depot, could you guys give us a breakdown of that?

Murray Gross

The $1.5 million for the year?

Chris Doucet - Doucet Asset Management

Correct.

Murray Gross

Well, we pay Home Depot an 18% fee on kitchens, and it doesn’t quite come out to that on a net basis, but as the mix of kitchens, you had a decrease $5 million in the debt business, on which we pay a 10% fee and we had an increase of over $5 million or so on the kitchen business, so if they were exactly equal, we would have paid $400,000 more just on that shift in business. So that’s primarily what that increase was the result was. The other thing that happened is that we spend money on this in-store marketing program, and that increased our lead costs. Now, we’ve addressed that issue, and we see how it’s helping our business, and we’ve addressed the issue, and so therefore there will be some reduction as the year goes on in the percentage of overall in that marketing thing.

Chris Doucet - Doucet Asset Management

Okay, and my next question that price increase that you instituted here in January I guess – is that going to get your gross margins back to where they were in the second quarter?

Murray Gross

We believe so. You will see improvement in the gross margin in Q1 over Q4.

Chris Doucet - Doucet Asset Management

Just one last question, and I’ll step back in the queue. Why only $2 million on the stock repurchase authorization? You did $5 million this summer when the stock was obviously significantly higher. Now that the stock price has been cut in half, you do 40% of the amount. Why only two million bucks?

Murray Gross

That is what the board felt was appropriate at this time.

Chris Doucet - Doucet Asset Management

Bye guys. Good luck with the quarter. Thank you.

Murray Gross

You are welcome. Thank you.

Operator

Once again, ladies and gentlemen, if there are any additional questions at this time, please press * followed by 1. As a reminder, if you are using speaker equipment, you will need to lift the handset before pressing the numbers.

And our next question is from the line of Rick Fetterman with Fetterman Investments. Please go ahead.

Rick Fetterman - Fetterman Investments

Hi, good afternoon.

Murray Gross

Hey Rick. How are you?

Rick Fetterman - Fetterman Investments

Murray, what percentage of kitchen refacing traditionally result in countertop sales and what are you experiencing thus far?

Murray Gross

Normally, what our experience in the past was we sold countertops to about 60% of the people we sold kitchens to, and I would tell you I won’t have the numbers till the end of this month for the first quarter, but it looks as though we are now approaching close to the 50% number. That’s the information I have at the moment.

Rick Fetterman - Fetterman Investments

Would you expect as the solid surface countertops roll out across the rest of the country for that to pick up some or no way to really measure that?

Murray Gross

It’s sort of market by market. We haven’t been able to figure it out. The solid surface is not as I guess strong as we expected it to be; however, the laminate countertop business has far exceeded what we expected. The good news in that is that our margins on laminate countertops are much better than on stone countertops.

Rick Fetterman - Fetterman Investments

Are they in the low 50% range or the refacing business normally is?

Murray Gross

Now, it’s lower - a few margin points lower than that, but it’s good gross margin.

Rick Fetterman - Fetterman Investments

Regarding the closets, in terms of time, when would you expect some indication for yourself internally how the business is running and then how long would it take Home Depot to make a decision as to whether it’s something they want to pursue with you and their stores?

Murray Gross

If I knew the answer to that, I’d be able to tell you what the stock market would do

Rick Fetterman - Fetterman Investments

What about the first half of the question then?

Murray Gross

The test is small. Everything has gone well. We’ve sold it, we’ve installed it. Hopefully, we’ll have some kind of an answer for you shortly. It’s a discussion point to take place in the not too distant future, so I’ll be able to, definitely by our next call, give you a realistic update on it.

Rick Fetterman - Fetterman Investments

Okay, final question is at one point you had offered the thought that there might be market in garage organization. Is that part and parcel of the closet business or is that something different?

Murray Gross

Well, it’s both. It’s home organization in the broad category as Depot thinks about it; however, we’re looking at the business apart from the closet business. We have identified a product line that is very unique, and we’re looking at that business right now as a category that can stand on its own, and we’re doing some analysis and stuff that’s premature, but I don’t put it in the same bucket as closets. Okay, we’ll just wait and see how that unfolds.

Rick Fetterman - Fetterman Investments

Thanks a lot, and good luck on the quarter.

Murray Gross

Thanks Rick.

Operator

Thank you. Mr. gross, there are no further questions. I’ll turn it back to you.

Murray Gross

Well, gentlemen, thank you very much for your time and participation, and we look forward to our next call. Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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Source: U.S. Home Systems, Inc. Q4 2007 Earnings Call Transcript

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