Hooker Furnishings Corporation (HOFT) Q2 2013 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen, and welcome to the Hooker Furniture's Quarterly Investor Conference Call, reporting its operating results for fiscal 2013 second quarter. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Mr. Paul Huckfeldt, Vice President of Finance and Chief Financial Officer. You may begin, sir.

Thank you, Kevin. Good morning, and welcome to our conference call to review our sales and earnings for the fiscal 2013 second quarter and the first half, both of which ended on July 29, 2012. We certainly appreciate your participation this morning. Joining me today is Paul Toms, our Chairman and CEO; and Michael Delgatti, President of Hooker Upholstery. During our call today, we may make forward-looking statements which are subject to risks and uncertainties. A discussion of factors that could cause our actual results to differ materially from management's expectations is contained in our SEC filings and the press release announcing our 2013 second quarter results. Any forward-looking statements speaks only as of today, and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances after today's call. On Tuesday, we -- on Wednesday, we reported net sales of over $50 million for the fiscal second quarter, which was about $5.5 million or 9.7% lower than the same period last year. Net income for the quarter held up better than sales, decreasing about $172,000 to $1.5 million from $1.6 million last year, due primarily to the decline in sales, partially offset by decreased product discounting, lower selling and administrative costs and lower domestic manufacturing costs. For the fiscal first half, sales decreased 10.6% to $102 million, and net income was $2.5 million, representing a 15% increase compared to last year. We reported earnings per share of $0.14 in the fiscal 2013 quarter compared to $0.15 last year, and year-to-date EPS of $0.23 a share compared to $0.20 last year. Now I'll ask Paul Toms to comment on our results.

Thanks, Paul, and good morning, everyone. Our consolidated sales performance so far this year has been disappointing. We are gratified, however, that we've been able to achieve comparable profitability on lower sales for both casegoods and upholstery. We've maintained profitability by improving our domestic upholstery manufacturing operations and managing costs throughout the organization. I'll discuss more details on both of these factors later in the call. Lower freight rates and reduced discounting also contributed to our ability to be profitable on lower sales. On a consolidated basis, product discounting as a percentage of net sales decreased 362 basis points in the second quarter compared to last year's second quarter. For the first half, discounting decreased nearly 370 basis points year-over-year. So we believe we have now returned to more normal levels of discounting. More importantly, we believe we are now positioned to stabilize and begin growing sales again. After being under inventoried on bestsellers and newer product introductions for much of this year, we are now nearly restocked on best-selling products. The worst of the transition period in shipping delays we experienced due to vendor shifts from China to Vietnam and Indonesia is behind us. All these key barriers to success have been removed. On a positive side, we are now beginning to ship bestsellers again and preparing to ship several new, well-received product collections that will debut on retail floors during what has been, historically, the strongest selling season. Two of the most successful introductions we've had in recent years, our upscale whole home Rhapsody casegoods and upholstery collection and our new fully upholstered sofa line at Sam Moore, will be rolling out on retail floors in September and October. Rhapsody is very consistent, with the kind of product that has contributed so much for our sales and profits recently, premium, higher-margin collections such as Sanctuary, Grandover, and fashion-forward occasional products like Mélange accents. We expect the sofa program at Sam Moore to contribute significant incremental business and help establish Sam Moore as a complete upholstery resource, expanding beyond its long-time niche as a chair specialist. As these and other products begin to fill the pipeline and become established on retail floors, we'll be in good position to regain momentum and grow again. Our ability to flow products better and be in-stock on bestsellers should also help us regain momentum. As I mentioned earlier, we believe our operations have stabilized in Asia after about 18 months of adjustments and a learning curve as we shifted much of our production in China to other Asian source countries and factories. We believe our organization in Asia is as strong as it has ever been, and expect ongoing improvement in vendor performance and alignment along with improved product quality and delivery times. We've narrowed our supply base, and now are deploying a fine-tuning and becoming more important to fewer vendors. At the same time we're moving through these transitions and positioning for growth on the casegoods side of our business. We are also encouraged with the significant improvement in our upholstery profitability throughout this year and the prospects for us to improve even further. I'd like to call on Mike Delgatti, President of Hooker Upholstery, to elaborate further on the upholstery picture as we enter the fall selling season. Mike?

Thank you, Paul. Good morning, everyone. We feel very good about how the upholstery division is positioned as we head into the fall. For the remainder of the year, we anticipate that our domestic upholstery operations will operate at breakeven or better, and that our Seven Seas imported leather upholstery line will continue to be profitable. On the sales side, upholstery backlogs and incoming orders are up over last year this time, which bodes well for the fall selling season if retail activity picks up as it historically does at this time of the year. As you may recall from our fiscal quarter reporting, we returned upholstery to profitability last quarter after reporting operating losses since the fiscal 2009 second quarter. In the current quarter, the upholstery division hit a small operating loss but remains profitable on an operating profit basis for the first half. Year-to-date, upholstery has had operating income of $102,000 compared to an operating loss of $1.3 million in last year's first half. I do want to point out the favorable comparison to last year was impacted significantly by our consolidation of Bradington-Young's manufacturing and administrative headquarters during last year's first half. This transfer from an older, inefficient plant in Cherryville, North Carolina to a more efficient and newer plant in Hickory, North Carolina was costly and also involves some workforce reductions and severance. But that improvement in our operations and capacity utilization has helped to put us in our current position for sustained profitability. When we evaluate our upholstery operations, we really look at them as 3 distinct business units: Bradington-Young's domestically-produced leather line, the Seven Seas imported leather division of Bradington-Young, and then, Sam Moore's domestically-produced custom fabric upholstery. Taking them one by one, I'll start with the Seven Seas imported leather line. This line has contributed positively to our overall upholstery financial performance by being profitable for some time. Revenue growth has also been robust, as the line has essentially doubled in size over the last couple of years. In the current quarter, orders were up approximately 22%, and during August, orders were very strong as well. Given our in-stock position, this puts us on pace for a small revenue increase in the Seven Seas line for the year. Bradington-Young domestic was essentially a breakeven for the quarter. Orders were up in the mid-single digits and backlogs are up 36% year-over-year. We feel confident, with the anticipated fall pickup in business, we will continue to operate at breakeven or better. As I mentioned in our call last quarter, we believe Bradington-Young's domestic line has made great strides this year in adjusting to the leather raw material price increase and the saturation of the retail market with lower-priced leather substitutes. Through strategies such as our Comfort@Home store display program, Bradington-Young has been able to stabilize sales and set a solid path forward. After 5 consecutive quarters of sales growth at Sam Moore, we had a slight 2% sales dip there this quarter, as well as an operating loss of approximately $250,000. We view this as a temporary situation resulting from our expansion into the fully upholstered sofa category at the April market. Adding sofa production to our Bedford, Virginia factory has involved costs associated with ramping up our overall capacity and the hiring and training of new employees. Currently, our incoming orders are outpacing production, and backlogs are up 27% year-over-year. Once we are fully ramped up at Sam Moore, so that our production and shipments match our order rate demand, we will be back on track for sales growth. We are quite optimistic about Sam Moore's continued sales momentum. We believe we are aligned with the right dealers and are hitting at all cylinders in terms of the expansion of our line, with new products we have introduced in recent seasons such as the new sofa program, the Accommodations modular seating line, and a new assortment of reclining chairs and swivel gliders. A few dealers have already received shipments of our new sofa line, and the initial reports are positive. For the October market, we plan to further expand our sofa offerings and expect to gain additional placements with initial dealers and new placements with other dealers. And now, I'm going to turn the call back over to Paul Huckfeldt who has some detailed comments on our results and an update on our balance sheet. Thank you.

Thanks, Mike. Our quarterly results were driven by several factors. I'll review them by income statement category. Sales volume decreased due to out-of-stock positions on several best-selling casegoods collections, as reported last quarter, due to shifts from China to Vietnam and Indonesia, which resulted in delayed shipments of several well-placed new casegoods products. Consolidated unit volume decreased nearly 23%. Both segments showed volume decreases compared to the prior-year quarter, with casegoods down 26% compared to the prior-year quarter. But note that sales in the prior quarter were driven by heavy discounting, which had an adverse effect on profitability. Casegoods average selling prices increased 18%, offsetting some of the impact of those lost sales. In the upholstery segment, unit volume decreased for leather upholstery by nearly 18% and by almost 7% for upholstered fabric seating. And average selling prices were both up about 9% due to selling price increases on the domestic products and the elimination of heavy discounting that impacted the imported upholstery much like it did casegoods last year. Gross profit margin for the quarter increased to 22.5% of net sales compared to about 22% a year ago, primarily due to lower discounting we mentioned earlier, as well as lower cost of goods sold due to the moderation in freight costs on imported inventory and lower domestic manufacturing costs in our upholstery segment. These were partially offset by the cost of a prepaid freight program and the impact of the fixed operations-related costs on the lower sales volumes that we've had this year. Our selling and administrative expenses were about $726,000 lower than the prior quarter, but increased as a percent of net sales from 17.4% to slightly under 18% due to the lower sales volume. The absolute decrease in spending was principally due to lower commissions on the lower sales volume, lower charitable contributions of excess inventory due to the reduction in slow-moving and obsolete inventory since last year, lower accrued bonus expense. Favorable items were offset partially by higher bad debt expense net of recoveries and higher professional services due to additional consulting fees related to several corporate initiatives. All these factors contributed to a slight increase in operating margin in the second quarter compared to the same quarter a year ago. Our balance sheet remains strong and continues to help cushion us from some of the impact of these challenges to our profitability. At quarter end, we had cash of a little over $43 million, up $3 million from year-end, even though we've increased inventory about $1.5 million since then. The higher cash balance is due primarily to lower accounts receivable and higher accounts payable. During the remainder of the year, we expect to invest $2 million to $4 million of working capital to increase our inventories back to levels more appropriate to our current sales volumes and to support the receivables on the expected sales rebound as we get back into stock on key products. And we expect to spend $1.5 million to $2.5 million in capital expenditures, about 1/2 of which will be spent on systems enhancement. We continue to be debt-free and have over $13 million available under our revolving credit facility, which remains in place until July 2013. Thanks to our cash position and our long-term belief in the business model, we continue to maintain our quarterly dividend at $0.10 per share and continue to make share repurchases under our $12.5 million share repurchase authorization, which we announced in the fiscal second quarter. Now I'll turn the discussion back to Paul Toms for his outlook.

Thanks, Paul. Through the end of August, there has been no significant upturn in the retail furniture business, but we're hopeful that demand will improve as we enter what is typically the strongest selling season of the year. While consumer confidence and housing activity are still below historically healthy levels, housing starts, sales of existing and new homes and housing prices have all improved recently. Housing affordability is the best in 9 years. Consumer confidence, one of the indicators we follow closely, dipped recently. We believe this is due to uncertainty around the pending national elections, expiring tax breaks and the unresolved debt crisis. On the positive side, we've heard some reports of improvement at retail over Labor Day weekend and promotions that were at a lot of our customers related to the Labor Day weekend. Demand for casegoods remain subdued, with incoming orders decreasing in the high single-digit range during the second quarter, but up modestly in August compared to the same period last year. We are pleased the incoming order rates for upholstery were up 12% year-over-year on the second quarter. In addition to the increased upholstery backlogs Mike referred to, casegoods backlogs were up $3.5 million or about 25% at the end of the fiscal 2013 second quarter compared to the same date last year. And we expect to draw benefits during the third quarter from shipping bestsellers we have restocked in inventory, as well as shipping the first cuttings of new collections that we launched in April that we expect will hit retail floors in September and October. In the area of external factors that impact our business, I want to mention here that we are closely monitoring the possibility of a strike by the International Longshoremen's Association on October 1, 2012, which is likely if an agreement is not reached between the ILA and the United States Maritime Alliance before September 30. We increased ordering 5 months ago in order to mitigate the potential impact of a strike and expect to receive about twice the normal amount of inventory for the 6 weeks leading up to October 1. We're hopeful that the 2 parties can reach an agreement before the deadline. On the internal operation side of our business, our Enterprise Resource Planning system, the ERP system, became operational this past weekend for our casegoods segment, after nearly 2 years of design, planning, conversion and training efforts by our associates and implementation partner. At this point, it appears that our operations are stable and everything is proceeding according to plan. This ends our formal remarks. At this point, I'll turn the call back over to Kevin, our operator, for questions. Thank you.

[Operator Instructions] Our first question comes from Todd Schwartzman, Sidoti and Company.

First question is on the demand. I certainly get that the -- industry-wide, the demand for casegoods is still sluggish. But I wonder if you could speak to the second quarter decline in your upholstery business. Is that really solely attributed to the shift, the transition underway at Sam Moore?

Mike, I'll let you address upholstery and the decline in shipments for the quarter.

Sure. As far as shipments for the quarter, most of the impact was a result of the startup of the new sofa line and the fact that we have hired a number of people, many of which are going through a rather steep learning curve, are currently in training. But we view that as a very temporary situation and feel that we will be back on track in the very near-term, as mentioned in my comments. The good news is that our order rate has outpaced our production rate and our backlogs are strong, and we believe we'll be more matched with our order rate from a production perspective in the relatively near-term.

That's encouraging to hear, Mike. I certainly understand the profitability impact of the startup, the training element and hiring. Are you suggesting that it was almost equally -- affected the top line almost equally?

Yes, sir.

Some of this, remember, last year in both of our imported product line, casegoods and Seven Seas, we had a pretty heavy sale -- selling of discounted overstocks. So some of the comparison from last year on the imported part of the upholstery segment is, in fact, we had strong sales without the same profitability last year, just like casegoods experienced.

Okay. And Paul Toms, without asking for you to give any type of forecast per se, I wonder if you could just expound upon the stabilization and the hope to stabilizing the stock, growing sales and maybe some type of timeline. I'm with the understanding that certainly there is a lot of uncertainty due to the election and other forces that you enumerated. But are we looking at maybe stabilization being the name of the game in Q3 and in growth in Q4? Or just internally, how are you thinking about the recovery at this point?

I think, Todd, we said in our Q1 call that we felt like the challenge with inventory restocking and late shipment of some of our new introductions would impact us through the second quarter, but we expected it to dissipate after that. And I think that's exactly where we are. We're receiving product now at about double of normal daily rate, and we think it will continue that way. We know it will because of what's on the order for the next 5 or 6 weeks. So I think the inventory availability issues are behind us. Our new collections, we actually have our major new collection in Virginia, in the warehouse from the April market, which is better performance than we've had in several years. So it's really just an issue at this point of retail demand. And honestly, I haven't seen much pickup in retail demand since March. It's been a long 5 months, and we're always hopeful entering the fall that business will pick up. It traditionally does. And we've talked with maybe a handful of retailers about their Labor Day results, and most of them were encouraged. There's maybe one that was -- didn't really think it met expectations, but I would say the majority of them felt pretty good about Labor Day. So it's just how are things going to be in the fall at retail. I think if the business is there, we've got the inventory, I think we've got products that are sellable. We've got to regain a little bit of floorspace we lost. But, yes, we expect that sales have bottomed down in the second quarter for casegoods. And upholstery, I think as Mike said, a lot of that has just been capacity, which we're addressing. And backlogs are really up over 20% in 3 out of our 4 businesses. I think they're about flat for imported upholstery, but they're up 20%-plus in Sam Moore, at Bradington-Young domestic leather and in casegoods.

Do you think that over the last 6 to 9 or maybe 12 months that you've been at somewhat of a competitive disadvantage for not being a vertically-integrated manufacturer retailer?

No, I don't. I believe that one of our core strength is the broad distribution that we have, in 26 different channels of distribution from traditional retail stores to department stores to Internet retailers to interior designers and catalogs, it's -- I think if you're vertically integrated, you can't do that. You're typically -- you're wed to your own stores. And if you're talking about vertically integrated all the way through to the retail side, I don't think so. And on the sourcing side, if you're on one of your own plants, yes, you have more control over them, and probably lead times are less. You don't go through some of the transitions. But I think there's a whole different set of problems you have as a domestic manufacturer of casegoods. And that's the whole structure around you that supplies parts, component parts, and -- has kind of gone away or it's much, much smaller than it was. It also limits your ability. We can offer a lot broader selection of products and sell a lot broader selection of customers because of it than we could if we owned our plants. Even if we were to try to own plants or be joint partners, in Asia, things are constantly moving. And so we really don't want to have a stake in the ground as far as the joint venture on the sourcing side.

Okay. How much of the gross margin kickoff year-over-year was due to the discounting situation? How much of that was the inventory position, the price mix? I mean, how would you rank those factors?

I think the largest impact on gross margins in this quarter has been the improvement in our domestic upholstery operations. Really, our casegoods business is pretty stabilized. Discounting really ended, for the most part, Q2, Q3 last year. Freight rates have been fairly stable, bumped up a few hundred dollars per container but not really anything of significance. So most of the improvement in our gross margins is more related to upholstery manufacturing.

Okay. And on the ERP installation, is there another phase to come?

Yes, there is.

What is that phase?

It's domestic upholstery manufacturing. We intentionally did casegoods first. And our import leather business is pretty similar. And a lot of that was done in Phase 1. But Phase 2 is more around Bradington-Young and Sam Moore's domestic upholstery business.

So how much of that spending on the upholstery side, how does that play out? How does that ramp?

I think we believe it will take us about a year to implement ERP in our domestic upholstery operations. And the spending that we forecast for the year, which, I think, was around $4 million in CapEx, and what do we say, maybe another $1 million, $1.25 million this year on ERP. I think next year is probably not too different than this year in terms of CapEx and ERP spending.

And do you expect that to dissipate after the end of next year?

Yes.

Okay. In the second quarter, how much stock did you repurchase?

I think it was just about 20,000 shares. The plan just didn't go in until -- at some time -- I forgot exactly when it started. It seemed like we didn't have the entire quarter.

It went in at the end of the winter, so it's the end of the first month.

Okay.

And we're only buying opportunistically. So we only purchased 22,000 shares in the quarter. The plan was just getting ramped up.

Okay. And last question. On the youth business in casegoods, can you comment on what the outlook is for capturing share going forward?

The youth business is stable. It's profitable. It's not a huge part of our business. It's 2%, 3% of our total. I think we can grow that. But honestly, we're fairly measured in what we do in youth. It's not one of the areas that we're counting on for a significant growth. I think it's fairly inventory-intensive. We've been through some sourcing changes there, but they haven't been as disruptive as in some of the other casegoods product lines. But again, 2% to 3% of our volume and probably similar growth to what we would have overall, less than we would expect in upholstery.

Okay. And on the expansion of the Sam Moore line into sofas, is everything going to be branded Sam Moore?

This is Mike. Yes, it will. The program is being marketed under the Sam Moore brand like our other businesses within this business.

I'll also mention, with the sofa program, just the pull-through on the chairs.

Yes. And that's one of the exciting aspects of this program, in that what were happening is, for every sofa we sell, we're selling at least 1 or 2 chairs. So in the end, the sofa business is helping us grow our chair business as well.

And when it's fully up and running, is this going to be both motion and stationary? Or just stationary?

Just stationary. In the motion category, we also have a recliner program that's doing quite well. Recliners that correlate to our sofas and also our freestanding, and displayed by many retailers in their recliner departments.

And we're doing promotions on sofas through Bradington-Young.

Our next question comes from Matt McCall from BB&T Capital Markets.

I just want to clarify a couple of the previous comments and some of the comments that you made earlier. You talked about -- I guess to start with, the domestic manufacturing savings, you referenced in one of the previous questions, you said that lower discounting, lower domestic manufacturing costs and then, I guess, SG&A expense management helped your margin. Just trying to make that domestic manufacturing cost reduction make sense in -- when comparing to some of the things that Mike said about the transition. Just trying to understand how were -- I guess, I'm mixed up on the 2, the puts and takes there. You saw some transition costs and inefficiencies, yet you're citing that as an improvement. So help me understand that better?

All right. Well let me clarify one thing. When Paul Huckfeldt talked about less discounting in upholstery, that was on the import leather upholstery business. A year ago, we had higher discounting, just like we did in casegoods, to move some excess and obsolete inventory. And then, I'm going to let either Mike or Paul Huckfeldt jump in on the domestic upholstery manufacturing, but I think our -- we are more efficient. We have better gross margins for domestic manufactured upholstery than we did a year ago, and that's on similar volume, I guess, to second quarter last year.

Yes, I think, both of those coexist, is that we would've done better. There were significant improvements in domestic manufacturing. However, those improvements were curtailed just a little bit by additional costs incurred in the sofa startup.

And the sofa startup would just have impacted us at Sam Moore. There's no impact to Bradington-Young.

Okay. All right. Well, that helps. And when you talk about the backlog strength, you also talked I think about regaining some floors. I'm trying to understand the impact of the delayed product on both your backlogs. So how much of the backlog build is just due to not having the product to ship? And then what was the impact on your floor count, if you will, or sort of in another way, how many orders were actually canceled or business was lost because of it?

You know, Matt, that's -- I'm not trying to be evasive, but it's really hard to quantify because I don't know that -- the loss business. I think a lot of it, we never even know about. It's people that are in a retail store looking at -- selecting a product. And if they went to our line, our catalog, and saw that it's 60, 90 days before they can get it, they just go to some -- to a different vendor. And so that's business we lost. It's really hard to measure. The backlog is partly up because of delayed delivery on our major introduction from the October 2011 market, which has been shipped just in the last month. And it's up because of some delays on in-line bestsellers that are now getting back in stock. But I think we said a quarter ago that we'll get back in stock quicker than we'll regain some of the lost floorspace. And I think our customers are pretty loyal, but if they took something off the floor because they couldn't get delivery, then we've got to earn our way back onto the floor. And it's oftentimes involve somebody else slipping up or a retailer moving out of our product and having space again on the floor. So we've got a little bit of work still to do in recapturing some of that. Having said all of that, I do think our sales kind of troughed in the second quarter, and we expect sales to improve through the balance of the year.

We didn't experience a lot of cancellations.

No. I don't think we had cancellations. It's just not being able to measure how much was never placed.

Okay. And you mentioned your 26 channels. I'm curious if you've seen any visible transition to or from any channel or channels. Do you see any themes that you're seeing among those different channels that you utilize? And if it's telling you any -- giving you any indication of a broader issue or issues that the industry may be facing?

You know what, I think what we're seeing is just a continuation of what's been going on over the last 10 years, that the independent full-line furniture stores are losing market share to the big box retailers and to some other channels of distribution. Internet retailing is growing. Specialty stores, probably still growing. But I think department stores and full-line furniture stores have lost market share, and that's continued up until the present. We are -- I think we're addressing that. We're trying -- we've got several initiatives which we're not really ready to talk about, but we're trying to partner with the strongest retailers in the full-line furniture store channel and then we are looking at ways to grow our business with the large top 100 retailers through efforts of a dedicated national accounts manager that we announced hiring back in the spring. And then we're looking at a couple of other initiatives, which we are not ready to talk about quite yet, to try to address growing channels.

And then the final one, if you look at mix, both from a geographic perspective and then from a casegoods versus upholstery perspective, what's your outlook? What can international be as a percent of the total -- you pick it, is it 3 years from now? And then what do you expect upholstery to grow to as a percent of the total while assuming that some of these initiatives are going to cause it to grow at a faster pace?

International, when we hired a dedicated executive to call and develop that business for us -- and we'd look at international kind of peculiar, I guess. We don't include Canada in our international business. It's always been just like the U.S. But outside of the U.S. and Canada, our goal was to have that represent 10% of our volume. We're not there yet. We're probably at the 4% on those 2. Maybe 6%, if you threw Canada in there. We are now looking at, if we want it to grow beyond that. And our time frame initially was maybe 5 years. We are now saying it looked out further than 2 or 3 more years, and how do we grow it beyond that initial target. And we're looking at -- we've hired reps, we've put reps in place in Turkey, in the Middle East, in Mexico. We're looking to add a rep in China. So we're starting to expand our sales organization for international growth. And the target, move it beyond 10% of our revenue. Upholstery, I think, does have better growth prospects. And some of the initiatives we're working on are actually more around upholstery than casegoods. Today that business runs anywhere from 30% to 35% of our total. And I think down the road, we would expect it to be maybe 40% to 45%.

[Operator Instructions] I'm not showing any further questions at this time. I'd like to turn the conference back over to our host for closing comments.

All right. Thank you. And we really have no additional comments. We appreciate everybody participating today and taking the time to hear what we have to say. We're already well into the third quarter and hopeful we can deliver better results yet end of Q3. Thanks again for your time.

Ladies and gentlemen, that concludes today's presentation. You may now disconnect. And have a wonderful day.