Hooker Furnishings Corporation (HOFT) Q3 2013 Earnings Report, Transcript and Summary

Greetings, ladies and gentlemen, and welcome to Hooker Furniture's Quarterly Investor Conference Call reporting its operating results for the Fiscal Third Quarter. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Paul Huckfeldt, Vice President of Finance and CFO. Mr. Huckfeldt, you may begin.

Thank you, Tyrone. Good morning, and welcome to our conference call to review our sales and earnings for the fiscal 2013 third quarter and 9 months, which both ended on October 28, 2012. We certainly appreciate your participation this morning. Joining me is Paul Toms, our Chairman and CEO; and Alan Cole, President of Hooker Furniture. 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 third quarter 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. On Monday, we reported net sales of nearly $57 million for the fiscal third quarter, which is about $2.6 million, or 4.8%, higher than the same period last year. Net income for the quarter increased by about $175,000, slightly over $2.4 million from $2.3 million last year, due primarily to the increase in net sales due to lower discounting, improved domestic upholstery gross margins and lower selling and administrative costs, which offset lower case goods unit volumes and higher costs on some of our imported products. For the fiscal first 9 months, sales decreased 5.6%, to $158.7 million. However, net income improved to $4.9 million, representing an 11% increase compared to last year, reporting earnings per share of $0.23 in the fiscal 2013 quarter compared to $0.21 last year, and year-to-date EPS of $0.46 a share compared to $0.41 a share last year. Now I'll ask Paul Toms to comment on our results.

Thanks, Paul, and good morning, everybody. On a sequential and year-over-year basis, this was our best quarter of the year for both top and bottom lines. It was particularly gratifying to see orders and shipments increased over the prior year across every segment of our company. Consolidated orders and shipments were each up just under 5% compared to last year at this same time. To have improving sales and demand at Hooker Furniture case goods, Bradington-Young's domestic and import divisions and at Sam Moore is an important accomplishment that confirms we're gaining momentum and positioned to grow sales again. While our profitability is benefited from the elimination of non-value-added costs throughout the year, ultimately, the greatest positive impact on profitability will be our ability to drive more revenues to the top line. We also made progress this quarter in improving our service levels across the board, with better in-stock positions on many of our bestsellers and well received recent product introductions. We finally saw volume improve again in case goods as we made significant strides in shipping our backlog, which is now at more historical levels. For the fourth quarter, we should continue to do a better job flowing best-selling products as we continue to refine our product mix and further improve our in-stock position on best sellers. As some of our newer case goods products hit retail floors this quarter, we received very reports that they're performing well at retail and generating sales. We're able to ship some of our April 2012 furniture introductions a little quicker than usual to take advantage of the strong fall selling season. As these and other products reflecting our new merchandising direction continue to fill the pipeline and become established on retail floors, we expect to build on the modest sales gains of this quarter. In recent months, the upholstery business has been stronger, both for retailers and within our company. At this time, I'd like to call on Alan Cole, President of Hooker Furniture to give us a detailed overview of the upholstery divisions as we enter the final quarter of our fiscal year.

Thank you, Paul, and good morning. We expect that this year will end on a positive note in the upholstery division, and we're pleased at the strides that we've made throughout this year in a tough economy. Our outlook for calendar year 2013 is even better, as we consider the improvements in the economy; growing dealer optimism, as retail activity has picked up in the last several weeks; and our momentum. We have a sense of much more positive momentum heading into next year than we did at this time last year. Certainly, one of our greatest accomplishments so far this year was returning the upholstery segment to operating profitability in the fiscal first quarter after having reported operating losses since the fiscal 2009 second quarter. The upholstery segment reported operating profits of $567,000 and $669,000, respectively, for the 3-month and 9-month periods just ended. As we reported earlier this week in the press release, Bradington-Young's domestic manufacturing has achieved sustained profitability for several months as well as increased sales and order rates. Sam Moore came close to breakeven this quarter as we continue to work through a short-term profit challenge that relates to the most robust incoming order rate at Sam Moore in many years. We've had to significantly ramp up production in response to this brisk demand for our new fully upholstered sofa line, which has entailed higher labor rates and higher costs of goods sold. We do expect to have our income in order rates and production capacity much better aligned by the end of January or the end of our fiscal fourth quarter. When it comes to our upholstery operations, we evaluate them as 3 distinct business units, Bradington-Young's domestically produced leather line; Seven Seas imported leather, a division of Bradington-Young; and Sam Moore's domestically produced custom fabric upholstery. Taking them one by one, I'll begin with Sam Moore. Top line momentum is robust, as incoming orders were up year-over-year around 25%. Backlogs are up more than 50% and shipments were up 7.5% at the end of the quarter. So we have the orders, we have the backlogs, it's a matter of ramping up our production to meet the demand. We're making progress and we've expanded our workforce by about 5% to date and anticipate another 5% expansion in the coming months. It will take some time to increase our production efficiencies from those employees recently hired as well as to train the new employees. We have also invested in technology to increase our production speed and efficiency such as computerized fabric cutting and a frame router system that cuts our plywood frame parts. At Bradington-Young, shipments and orders were up during the third quarter for the domestically produced product line and for the Seven Seas imported leather line. Bradington-Young domestic orders were up nearly 7% and shipments were up 6% at the end of the quarter. Domestic product backlogs were up 54% over 1 year ago at the end of the quarter. From our Seven Seas imported leather line, orders were up also nearly 7% and shipments were up over 12%. Seven Seas' backlog was down in the single digits, which is a positive development, due to a stronger in-stock position and better shipments of Seven Seas products out of the Martinsville distribution center. After the leather raw material price increases we experienced last year and earlier this year, we continue to keep a watch on the leather hide market. Leather prices are still subject to fluctuations as demand in the leather market strengthens. Our margins could be challenged on the import side by overall price increases in China that may occur next year. Overall, we remain very optimistic about the sales momentum and profitability improvements in the upholstery division as we wind down this year and as we prepare for next. 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.

Thanks, Alan. Just looking at some of the drivers of our results. Consolidated net sales increased for the fiscal 2013 third quarter compared to the comparable prior-year period, principally due to higher average selling prices in both segments. The case goods segment sales increase was offset by reduced discounting and changes in product mix and was partially offset by a lower unit volume. Upholstery net sales increased compared to the same period last year due to increased average selling prices and increased sales volume. Gross profit margin for the quarter increased to about 24% of net sales compared to 23.5% 1 year ago, primarily due to improved gross margins in the upholstery division as a result of improving manufacturing costs in our domestic operation and the price increases noted earlier. Manufacturing costs in our domestic upholstery operations increased modestly in absolute terms due to higher sales, but decreased as a percentage of net sales due to the favorable impact of those higher sales in our fixed cost base and to the extensive cost-reduction initiatives we've been undertaking. In our case goods segment, margin improvements from lower discounting were offset by higher purchase prices on products imported for case goods. Our selling and administrative expenses were about $250,000 lower than the prior year quarter and decreased as a percent of net sales from 18.5% to slightly over 17%. The decreases were principally due to decreases in salary expense due to cost-reduction efforts undertaken in fiscal 2012, lower contribution expense due to lower levels of distressed inventory, lower depreciation expense due to accelerated depreciation we took last year in conjunction with our move to the new showrooms and lower bad debt expense as we continue to have favorable collections experience. And improvements were offset by higher advertising expense due to some additional advertising and marketing initiatives aimed at increasing sales, and due to bonus expenses due to accrual of some profit-sharing bonuses and payment of project-related performance bonuses as part of our ERP implementation. All these factors contributed to an increase in operating margin for the third quarter compared to the same quarter 1 year ago. Operating income improved from 5% of net sales to nearly 6.7% of net sales for this year's fiscal quarter. On the balance sheet side, the balance sheet continues to remain strong. At quarter end, we had cash of a little over $33 million, down $7.3 million from year-end, primarily due to inventory increases of about $5 million since the beginning of the fiscal year, which were intended to improve our ability to service our customers. And we've invested in property, plant and equipment, such as our ERP system, and remodel of our showroom earlier this year in addition to the normal maintenance modernization and efficiency projects that we typically invest in. For the remainder of the year, we expect to invest a little more in inventory and expect to spend between $1 million and $2 million on capital expenditures, primarily for the ERP system and for some projects to increase manufacturing capacity and efficiency. We continue to be debt-free and have over $13 million available on our revolving credit facility, which remains in place until July of 2013. Thanks to this cash -- to this balance sheet strength and our cash position and our long-term belief in the business model, we continue to maintain our quarterly dividend $0.10 a share, and we maintain a $12.5 million share repurchase authorization, which we announced back in the fiscal second quarter. Now I'll turn the discussion back to Paul Toms for the outlook.

Thanks, Paul. As our service levels and in-stock position improved this quarter, we realize the kinds of top line benefits we expect will continue from better flow of best-selling products and recent well-received introductions. Our improved in-stock position should also drive higher sales from special orders at retail, which has always been an important part of our business. We're also pleased that the Rhapsody collection we introduced last spring has been performing very well at retail since it began shipping in early September. And other collections and product lines were also retailing well. Demand is positive in every segment of our business with our consolidated incoming order rate up just under 5% for the third quarter versus the same period last year. We're more bullish in our outlook when we look forward to the second quarter of our next fiscal year and beyond and in the shorter term. Longer term, there are many positive signs from the housing sector, with increased housing activity, home prices increasing in many markets, reduced inventory of homes and the highest homebuilder confidence level in 6 years. Consumer confidence is also improving to more historically healthy levels, driven by improvements in housing and gains in the stock market this year. All this bodes well for our industry longer term. In the shorter term, we believe the uncertainty around negotiations in Washington, D.C., regarding the so-called fiscal cliff had created enough uncertainty for consumers to postpone big ticket purchases temporarily. We're bullish enough about the future to continue investing in people, systems, our manufacturing facilities and long-term strategies for growth. On the internal side of our business, we had a successful implementation of Phase 1 of our Enterprise Resource Planning System over Labor Day weekend. While we're still working through numerous issues, we were pleased to have had a normal shipping month in September, given the magnitude and scope of the project. We plan to begin Phase 2 in our upholstery division in January, with full implementation scheduled for late in the fourth quarter of fiscal 2014. This ends our formal remarks, and at this time, I'll turn the call back over to our operator for questions. Thank you.

[Operator Instructions] We have a question from Todd Schwartzman of Sidoti & Company.

First question is for Paul Huckfeldt. Salaries were down year-over-year in the third quarter. That's going to ramp up a bit, as you discussed, with the headcount change expected in Sam Moore. There are other moving parts and in SG&A, as well, in the third quarter, the bonuses, advertising expense. I'm just wondering if you could give us the puts and takes as far as modeling the SG&A line for the next few quarters?

From the baseline of the third quarter, we're going to be adding some salaries for some new initiatives that we're talking about. I would expect depreciation is going to increase modestly due to our ERP implementation. Beyond that, I think it's pretty stable.

What would you say in dollars is the fixed component of OpEx?

In dollars?

Or will be, more importantly, in, let's say, in the next 2 to 3 quarters?

You're going to hear some papers flipping. Just a second, sorry. Fixed component is going to be $9 million.

Okay. All right. Alan, is it too soon to talk about whether the new Sam Moore sofa line is having an effect on increasing transaction size, maybe resulting in more consumer purchases of more items per transaction or perhaps more of a whole-room type of purchase?

That's a great question. And I think the -- it's got several effects. First of all, what we found is with each of our sofa placements, we generally get at least 2 chair placements out of the Sam Moore core line. So the sofa line not only brings the plus business from the sofas themselves but it also brings more of the core Sam Moore product along. Our average unit cost or unit selling price has gone up about 10% across the whole line, a good portion of that is the higher average unit cost of our sofas. So I think in answer to your question, it's going to impact us in several ways, but your insight is good about the fact that it will put us in the whole-room business, if you will, rather than accent pieces alone in upholstery. It's a -- long-term, I think it bodes very well for the continued growth of Sam Moore's chair line as the sofa line grows.

So the incremental business then, it sounds, is more prospective than something you've already started to see?

Yes, it's both. I think we've started to see it. We tried to ramp-up in an intelligent way. You notice that we've added 5% to our employee count. Most of those employees are what we call direct labor. So as they become fully productive, their cost moves right along with the sales. And we're adding another 5% to our employee base. So it's a good gradual ramp-up. I think it's being done very intelligently. You may remember about 2 years ago, we started in the stationary upholstery business with a line of modular products we call Accommodations. And that product line has matured nicely now. The sofa line adds to that. So the major upholstery, as I call it, component of the Sam Moore's line continues to gain percentage of the overall sales.

And the new workers, how many in total are we talking about after that second 5% piece?

10% of our sales force or our workforce, excuse me, at Sam Moore would be about 20 people. We have about 200 employees, maybe slightly over, today, 200 employees at Sam Moore. But I do want to emphasize, again, those people for the most part are what we call direct labor as opposed to being spread across our organization. So what it helps us do is leverage all of our costs both indirect and our fixed costs as we grow the volume.

Great. Okay. Wanted to just talk a little bit about the port strikes under way in Southern California and as well as the prospects for the eastern seaboard?

Todd, this is Paul Toms. And you've probably read this morning that it looks like the port strike in Long Beach is over. They've still got to vote, but I think everybody is back at work today. That had minimal impact on us. We don't bring a lot of product in through West Coast ports. The prospect of East Coast ports and Gulf Coast ports striking at the end of December would have an impact on our business. However, we're confident that if there is a strike, we believe it will be very short in duration. And we also are in very good inventory positions. We've been receiving a lot of inventory through the third quarter, even since the end of the third quarter. I think a strike of a short duration would have a minimal impact on our ability to service our customers. Probably a larger concern for us is that the shipping lines are always trying to find additional surcharges, and they've recently talked about one that is a port congestion surcharge that will go into effect if there is a strike. And so I think we could see some increases to container costs for a short period of time around an East Coast/Gulf Coast strike.

Okay. And what do your customers, Paul, in the Northeast tell you about any impact they may have seen the Superstorm Sandy on their businesses?

I have not received a lot of feedback from customers or our sales representatives in that area about a significant impact on business. Intuitively, you would think it's got to impact the business in the areas that were most directly impacted. But I can't say that I've seen a significant downturn in business in that region.

All right. On your in-stock position, you have made, I think, a little faster progress than what I was looking for. How much -- if you maybe put on a percentage terms, 100% you're all the way there, where you want to be -- what is left, if anything, in this fourth quarter as far as additional margin improvement?

I don't know that there's going to be tremendous margin improvement because I think it's more a matter of, at this point, the inventory levels are very close to target. The inventory mix is not at target yet and by that I mean we would like to have even more of our best sellers in a heavier inventory position than we do. So we've made a lot of progress, but there's -- I think we can continue to tweak the mix of products that we're carrying. The component of inventories that is discontinued-, pre-discontinued-, inactive-type inventory is very small, almost 1/4 of what it was early last year. And so I think in terms of discounts and things, I don't believe discount are going to be a significant impact on our business, but it's just really it will drive more top line growth if we continue to get in a better stock position on our best sellers.

And the international business, any update, anything notable going on there? And maybe tell us what percentage of sales in the quarter were overseas.

No, I don't have the percentage of sales for the quarter in international as a percent of our total business. I can tell you, international, this is going to be a year that I think we're relatively flat in our international business. We've had a little bit of a restructuring of some business in Asia, where we've changed retailers that we're doing business with that's had a negative impact on our volume in that region. Other areas that are important to us like the Middle East are stable or growing slightly, and we had a few credit concerns with some -- 1 or 2 large customers, international customers. So I think this year we're probably -- are going to be flatter in international. So as a percent of our total, it probably doesn't change much.

Got it. And lastly, but just a little bit on the ERP, Phase 2 is going to be implemented in January initially. In terms of costs related to that, on an incremental basis, so beyond Q3, is there anything more or have we seen that fully expensed?

Well, I will say a little bit and then I think Paul Huckfeldt can chime in as well. But we're probably 2/3 of the way through the ERP project. The last big component, though, is the manufacturing component for our domestic upholstery, and we'll start that in January. We actually won't implement until probably fourth quarter of next year or first quarter of fiscal year 2015. So we've still got a fair amount of expense. I would say probably 40% of the total spend that we'll use for ERP is still outstanding. And we expect our CapEx for next year, including ERP, to be similar to what it was this year.

A big chunk of that will be capitalized and we'll -- it's a major system, so it will be depreciated over a relatively long period of time. And it's just sort of a part of our infrastructure.

[Operator Instructions] Next question is from Bob Sullivan of Satuit Capital Management.

A couple of questions, kind of bigger picture, I guess, how you're looking at the housing market at this point. Kind of internally, do you get the sense from some of the internal things that you're looking at and for some of your customers that -- is -- are we still bouncing along the bottom in -- as far as their planning goes and your planning, or are we actually starting to see some real acceleration? And does that affect your planning for the second half of calendar 2013 in anyway?

Well, I don't know that I can answer for many of our retailers. But I think from our standpoint, we believe that housing, the progress we've seen this year is really the first significant progress in the last 5 years. And it couldn't come soon enough. I think what we're seeing is that housing definitely has bottomed out. Prices are stabilized, accelerating, I think I saw last night 6% over the same period last month in some markets. Inventories are down. Affordability is the best in 10 years. Housing starts are up. And we're still talking about from very low levels, and if you were to look at them against historical healthy levels, we're probably just starting to get in the lower range of what you would consider healthy. But I do think it's all trending in the right direction. And for us, it would influence our sales forecasts for next year, and I feel like it will continue to improve as we progress through 2014.

Does it give you any sense or any desire for some more new product introductions out there as you look out?

No, we're pretty aggressive in bringing out new products even through the downturn. So I don't know that it changes our product introductory plans that much. I just -- I think we just believe that it will have a positive impact on our sector. Also, I think this time around, you'll see a closer correlation between housing and furniture sales. I think the last time in the 2000-2005 period, much of the housing was speculative and a lot of homes were not bought with the idea of moving into them, so they were never furnished. We also had people that were able to get financing and I think they've stretched absolutely as thin as they could to get the most house and there wasn't a lot of income left for discretionary purchases like furniture. We also had furniture declining in price through those -- that same period. So I think all of those things are really not in play this time. The housing that is going to be sold, I think, is generally to more qualified buyers and I believe there'll be discretionary income and I don't think there's a lot of speculation in the housing market now.

Fortunately, right?

Fortunately.

Last kind of question, kind of getting a little bit closer to the ground I guess. The -- your operating margin, very robust, looks like it went up to about 6.7%, I think, and that's versus 5%. And do you see that level as kind of where you want to be? Or what would be the goal, I guess? And then, given that we are seeing some spend, ERP, manufacturing, headcount, et cetera, et cetera, does that -- is that 6.7%, does that kind of stay stable or can we see that moving up above 7% over time as the next year progresses?

I think some of the investments we're making could have a very short-term impact on margins, like 6.7% is underneath what we would expect to produce in a better sales environment, and as we continue to make progress in our domestic upholstery manufacturing operations. Our historical margins in imported case goods have been high single-digits, and I think our import upholstery business is a similar business to import case goods. Domestic upholstery manufacturing, maybe it's more mid single-digits, but I think 7% or even north of that is very attainable in just a -- with a little bit of boost in sales in the coming year.

Pretty good leverage on import sales, in particular. We're not going to add a lot of costs to ramp up sales.

This ends the Q&A portion of today's conference. I'd like to turn the call over to management for any closing remark.

Okay. Well, we don't have a lot to add to what we've already said today, but we appreciate everybody joining us for the call. We are pleased with the quarter and yet we think there's plenty of opportunity for additional improvement. So we look forward to reporting the results of our fourth quarter in about another 4 months. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.