Haverty Furniture Companies, Inc. (HVT) Q4 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Havertys' Q4 and Year-End 2011 Financial Results Conference Call. [Operator Instructions] This conference is being recorded today, Tuesday, the February 28, 2012. I would now like to hand the conference over to Dennis Fink, Chief Financial Officer. Please go ahead.

Good morning, everyone. During this conference, we'll make forward-looking statements, which are subject to risks and uncertainties. Actual results may differ materially from those made or implied in such statements, which speak only as of the date they are made and which we undertake no obligation to publicly update or revise. Factors that could cause actual results to differ include economic and competitive conditions and other uncertainties detailed in the company's reports filed with the SEC. Our President and CEO, Clarence Smith, will now give you an update.

Thank you for joining us on our 2011 Fourth Quarter and Full-Year Earnings Call. We're pleased to report that we finished the year with a strong fourth quarter, which pushed us positive in sales for the full year and produced fourth quarter pre-tax profits of $6.1 million. Earnings per share for the full year were $0.70 versus $0.38 for 2010. These results include a favorable one-time non-cash special item of $14.1 million for the release of almost all of the valuation allowance against the company's net deferred tax assets. 2012 quarter-to-date written sales are up about 5% over last year's comparable period due, in part, to a better in-stock position, a higher closing rate and a higher average ticket. Our traffic is slightly lower quarter-to-date. The ongoing investments in our stores and technology infrastructure, along with the upgrading of our design and products, has been an important combination, which help us grow our average ticket and our overall sales this past quarter. This year we will continue to improve our stores with 20 planned store remodeling and upgrades, in addition to 4 new stores. We are investing heavily in the latest technologies for better service, which include upgrading our website and our online access for our customers and our sales team. Additionally, we are making significant enhancements to our Wi-Fi access in our stores and DCs through major bandwidth improvements. Our merchandising, new marketing store presentation and all of our operating systems are focused on our goal of moving back to over $200 per square foot sales productivity. We believe that we can reach that productivity figure by as early as 2015. We ended 2011 right at $148 per square foot, exactly flat with 2010. We grew our square footage in 2011 for the first time in 3 years. We have plans to grow square footage over 2% in 2012 with 4 new stores, net of 3. The new stores are planned to open in the last half of 2012 and are focused on strengthening our position in our 3 largest markets at Atlanta, Metro DC Baltimore, Dallas-Fort Worth, as well as one additional Texas market. These include the relocation of our major South Atlanta store to a new building in McDonough, Georgia, a leading suburb, serving our customers in South Metro. We're expanding our reach in the DC Baltimore Metro market by adding a store in Towson, Maryland, the major shopping district of Baltimore. Late this year, we plan to open our major new store in Allen, Texas, our fast-growing northeast Dallas suburb. This will be our 12th store in the Dallas-Fort Worth Metro. And in the third quarter, we are opening a store in West Texas old country, in Midland, Texas, in the former Circuit City building. We're in the final stages of implementing our greatly improved accessory program, which includes lamps, tabletop accessories, rugs, botanicals, and top of bed categories. In the past, these classes were handled for the most part at the store level. Our new program is tightly coordinated with the product displays and standards established by our merchandising team. The majority of the products will be flowed through our distribution centers and will be shown and advertised on our website. And while we're starting from a very low level, we expect to be able to double our sales within 2 years in these accessories categories. These sales will not only be new profitable business, but we strongly believe that our coordinated program consistent from web photos to the store presentation throughout the company, will help inspire our customers and drive our overall business. We will be a player in accessories this year in our markets. For the past decade, we've been building the Havertys' brand as the better furniture store. We've set a new goal for all of our stores that the Havertys' customer experience longer -- warrants our being the inspiring furniture store. We are raising the bar on everything we do to better reach and engage our customers and to live up to those inspiring standards. We've seen some real traction with recent increases in sales, average ticket and in our closing rates. We're encouraged by the recent trends, enthusiastic about the many improvements planned and underway and we're excited about our future. I'll now turn the call over to Dennis Fink, CFO.

Thank you, Clarence. Several points were made about the quarter's results and the outlook for 2012 in last night's press release. We will respond to any question about those in a few minutes after I comment on 3 specific items. The first one is our 2011 income taxes. Actual 2011 tax expense includes a reduction in our valuation allowance on deferred tax assets of $14.1 million. There is a table on Page 6 of the press release that summarizes the impact of various items on our tax expense. It indicates that the income tax expense for the full year of 2011 would have been $1,741,000 if computed its statutory rates applied to the $4.6 million pre-tax income. That equates to an effective tax rate of 38%. And maybe, more straightforward to use this figure in your models when coming up with a normalized way to view 2011's after-tax operating earnings. There are approximately $1.5 million of discrete tax expense items listed in that table that offset part of the $14.1 million deferred tax asset valuation release. For the year of 2011, the total tax benefit was $10.9 million. The second topic I'll touch on is a simple operating model for gauging Havertys' performance in 2012. We expanded our store base by 1 in the fourth quarter and we'll add 3 additional stores in the second half of 2012, while relocating another store to a newly constructed site. Our expanded retail footprint will require increases in several categories of fixed and discretionary type costs. Together with additional store remodelings and other budget expense increases, we expect our fixed and discretionary SG&A costs for 2012 will be approximately $213 million to $214 million, that's a 3% increase over those same kind of costs actually incurred in 2011. The variable SG&A expenses should continue to be in the 17% to 17.5% of sales range for 2012, very close to the actual 2011 rate. Our gross margin was 51.7% for 2011, almost all of which is variable with sales, and we have mentioned a similar result is expected this year. Using an average SG&A variable cost to 17.2% and deducting that from the gross margin results in a contribution marginal sales of about 34.5%. So for each additional $100 of sales, $34.50 is contributed towards fix and discretionary costs and then towards pre-tax profits. We approximate a break even sales level for 2012 to $213.5 million and expected non-variable costs can be divided by the 34.5% contribution margin to produce an annual figure in sales required of $619 million. That's the break even level. Providing out, or proving out that same figure, $619 million of sales times the 34% contribution margin, equals the $213.5 million of contribution dollars, which should completely cover the fixed and discretionary SG&A costs that are expected and result in a break even performance. We do not give sales guidance, but I will go through an example to demonstrate using the model in preparing your forecast. If you project annual sales to be $31 million, higher than the anticipated break even sales level, that's 5% lower than $619 million, a pre-tax profits of $10.7 million would be expected, and drive that by saying that $31 million over the break even level in sales times the 34.5% equals the $10.7 million expected pre-tax. As a further example, each additional 2% sales growth, that's $12.4 million in sales growth, beyond that, should increase pre-tax by increments of $4.2 million. Likewise, each 2% sales reduction will reduce pre-tax earnings by the same amount. The fixed and discretionary cost will be skewed somewhat to the back half of the year, as the advertising spend is usually higher then when all of the additional stores have begun operation. The quarterly average of this fixed and discretionary cost are expected to be $53.4 million. The first 2 quarters, should each run about $1 million below that average in the third and fourth quarter should each be about $1 million higher than that $53.4 million average. The third area I'll cover is cash flow. 2012 cash flow is expected to be neutral to modestly positive for the year. Higher planned capital expenditures of $21 million, with some additional growth now, are expected to be about $1.5 million more than depreciation. We anticipate earnings should generate enough cash to offset increases in working capital required together with the minor balance sheet, lease obligation, payments due and any dividends declared. In closing, I want to remind you that our book value at the end of 2011 is approximately $263 million or $12.10 a share. We regard this figure as conservative, since our LIFO inventory reserve is $18.1 million and we have no intangible assets, such as goodwill, recorded and also, we own 45 of 119 retail locations free and clear. Operator, at this time, we'll take questions from the audience.

[Operator Instructions] Our first question comes from the line of Budd Bugatch with Raymond James.

This is actually TJ McConville filling in for Budd. Congratulations on the strong performance in the fourth quarter. A couple of items from the release if I might. First, on the gross margin. Dennis, you mentioned that -- or I think, maybe Clarence, you mentioned that pricing and mix were the primary contributors to the benefit in the fourth quarter. Any way you can breakout the contribution of each of those buckets? And then on the mix side, is -- was that mix within categories or the mix of categories during the quarter?

TJ, I'm not sure I can give you a lot of clarity on that. Just in general, we had pricing discipline. It wasn't as much category mix as it was just in product of group mix, and we had some better sellers that have a little better margin. There's nothing major. It's more of a small and across-the-board improvement from our LIFO[ph].

That's fair enough and that answers the question. And then in 2012, we're aware now that you're going to be a player in accessories. How does that factor into your thinking on the flat gross margin?

Well accessories is not a big part of our overall business. We would like to make it more significant and that's our plan and we're in the process of making that happen. But it's -- last year, I think it was around 2.5% of our business. Now we were in the process of closing out a lot of our product on the floor to get out of the old program, and so we had very low margins in the category and we anticipate that. We strongly believe it's going to be a lot better margins in addition to sales this year. So that should help us. But even if it doubles to 5%, it's still not a huge part of our business. So it will help, though.

Okay. And on the remodels Clarence, any metrics that you care to share on may be some of the impacts you've seen early on, on some of the stores that you've touched already versus, maybe, a test group and what you might expect from the 20 that you're planning on doing in 2012?

Well when we started this program several years ago, we tested it and we showed some nice improvement Where we have spent most of our money and where the first remodelings were, were in our best stores, our biggest stores and our biggest markets. And we've had very nice reaction to that. So we're fully on board with this remodeling program. We're rolling it out as fast as we can. We know our stores look better. We know it's helping us engage our customers and help us with our business. So we feel very strongly about it and some of our biggest increases are from stores that we have recently remodeled. You have to get the customer in there to see that it's different and that -- it sometimes takes a little time, but we're very encouraged by it.

Very good. And then, finally, for me, a little bit bigger picture question here. We've gotten a few reports from some of the other furniture and now, you, today and other home goods retailers that indicate that customers are, at least, spending a little more on the home. We may not have gotten some -- any great data this morning, but how do you see the consumers' behavior out there, Clarence, in terms of willingness to invest in homes and what the outlook is for that going forward?

Well, I think what we're focusing on is the replacement market. We like to use the term of rejuvenation. I think that the -- well, the data that just came out today said Atlanta was one of the worst markets in the country. We have been leaning, historically, on new housings and new starts, but we're now focused more on the replacement market. And I think that, that customer is more willing to finally spend some money and we are seeing a little bit attraction there. So it's not as much housing driven as it is we've got an old-looking bedroom or a living room and we're in the mood to replace it, and we've got some new product, which is exciting, and they're reacting to it.

Our next question comes from the line of Todd Schwartzman with Sidoti & Company.

I'm wondering -- that was an interesting statement you just made, Clarence. I wonder if you could just elaborate a little bit on the replacement market and maybe talk about what you're doing on the merchandising, marketing perspective, product styling and such, to proactively court the replacement consumer?

Well, one of the ways we're trying to reach that customer, as you've known, we have a new agency, we have a new creative out there, we've realigned some of our mix to better reach that customer and we're spending more, not only on television, but on electronic, to reach that customer. But as far as the product is concerned, that replacement has been heavily focused on the family room, the television room, the entertainment area, the public room of the house. And a lot of the product we're selling, and some of our bestsellers are focused around that, include motion and leather, sectionals, all of the categories that the whole industry is doing pretty well there. And that -- I think that's where she focuses first and then also on bedding, which has been a good category for us, and as you well know, the industry. And that's helped our average ticket. These are beds that 20 years old and they're in the mood to replace it, that's part of that rejuvenation. And I think that has been a driver of our business, and I think, for the industry.

Yes you did call out the entertainment -- the family room as a source of strength. I'm just wondering, you really cited a lot of upholstery products, in addition to that, are you seeing strength -- relative strength in entertainment center or other case goods for that same room or is it mostly centered on upholstery right now?

Well, as far as the growth, it's been mostly upholstery. But we're doing a better job with products that were developed, that we developed and have designed and sourcing play at the higher price points. And we had that come in late last year, on the fourth quarter last year and we've done well with that, which includes some formal dining room, includes bedroom, casual dining, and that's been good, particularly, casual dining which is part of that family room function. So we've had some good reaction to the new product that we have brought in.

Can I get you to, maybe, quantify some of those metrics, ticket, traffic, close ratio and such?

Well, I think, I mentioned, our traffic has been down slightly. Our business has been up because of the average ticket and because of the close rate, which is a few percentage points higher in our closing rate and our average ticket is up several percent, too. So we're a big ticket. Average sale is in the $1,600 range and it has been moving up. So we continue to have that to be a goal and in some markets, it's over $2,000. So that will continue to be something we're focused on and we're getting pretty good reaction to the new products. We're doing more special order product, more Custom Choice, I mentioned that in the press release and that's focused mostly around Upholstery.

The closing rate you said was up several percentage points?

Yes.

On a year-over-year basis?

Well, no, I'm talking about the most recently -- this most recent quarter, actually, this quarter. So last year, it was pretty -- it was up slightly. But the recent trend of the 5% up is related to those 2 categories of average sale and closing rate.

Okay. And on the improvement in average ticket, can you speak, maybe, in terms of the pecking order to what you attribute that to? The number of items per purchase? How much of that -- is accessories kicking in?

No. It's not accessories because that would bring down the average ticket. I think it's just -- it's average price per SKU that -- we're selling items that are more expensive, which may include leathers sectionals, it would be a larger dining room in price point, less promotional bedroom, more of the better goods there. So it's all the way down to the higher price per SKU.

And that $1,600 number was -- is relative to what at the end of, say, Q4 2010?

We're not giving those exact percentages there. It's up slightly.

Okay. And I think lastly, to what extent does the -- your better results, your better metrics stem from you, proactively seeking a potential [indiscernible] amount, maybe a slightly higher income consumer. Are you -- have you changed your target demo or is it just simply a function of the price points to some of the newer products that you've launched that some wealthier consumers have migrated to?

Todd, I think it's a matter of focus. We're focused very closely on this customer. We know who she is. We deliver to her. We've done a lot of analysis in the last 6 to 7 months as to where she lives, how she listens to the advertising, what kind of advertising and we're focusing on serving her better. And we have broadened the product that I think is appealing to her better. So it's really a matter of focus, as opposed to trying to be a promotional house, which -- we do some of that, but we're not -- we're trying to separate from the real promotional players and focus on serving that customer better.

And is all of this a direct early result of your new advertising consulting relationship?

Well, that just started, frankly. The new creative just started in February. So, no, I think it's an overall focus of everything we're doing about the technology, the service center, the web, our presence, of the way our stores look, the investment in our stores, our systems, everything we're doing. And I think that we're getting a little traction there, which is encouraging to see.

Great. And I said it was my last question, I lied. One more on real estate. Any comments on big-box opportunities going forward?

Well, we mentioned the -- before this year, they're tougher to find at the values we like them to be. And we are really focusing now on making sure that what we have is producing up to that $200 level or higher and strengthening our position on our current markets. So we don't have any plans to grow outside of our footprint for sure. And any new stores would probably be strengthening existing markets or relocations.

[Operator Instructions] Our next question comes from the line of David Berman with Berman Capital.

It looks like most of the questions are already asked. But I was just curious if you could comment on the competitive environment please?

Well, it's a tough place to be trying to sell furniture, David. We compete against some very strong players, who advertise very aggressively including Ashley, Rooms To Go, American Signature, Ethan Allen and almost everyone of our markets and then there's strong independence in most -- everyone of our markets. And some of the department stores have gotten aggressive too, specifically, Macy's. But it's a very competitive market and I don't think it's really changed significantly in the last year. There've been, certainly, players who've fallen out, but the players that are there now are investing heavily and advertising aggressively. And it is certainly a tough environment.

There hasn't been a changed at all?

No.

I mean, it's been tough for the last few years. But is there a change?

No. I don't see there's been a change. I just think that the players -- there may be fewer of them, but they're more aggressive. And everybody is trying to defend their turf and grow their business. And the people I mentioned are all strong and all of them would be there, and we're not expecting to have any major players fall out anytime.

I mean, it seemed, based on your numbers -- I'm looking at the numbers, seems like things are fairly stable? Is that a fair statement?

I'm sorry. Did you say, you felt like...

It seems like it's a fairly stable environment just by looking at your numbers and your margins and your inventories.

Well, it's been flat for a while. It was great to see a positive. We've been getting positive through the last day of the year of 2011. So it's been a -- we've been down most of the last 5 or 6 quarters, down 1.5% to 2%. So if you call that stable, I think that's stable. It's nice to see a positive here and we're hoping to be able to hold that number.

Our next question comes from the line of the Bob Fetch with Lord, Abbett.

Could you elaborate and fill us in, in terms of how you determine where you're going to open your new stores, in Towson and the one in Midland?

Well, I mentioned that we're strengthening our best markets. I mean both -- Dallas, Atlanta and D.C. were our best markets, our biggest markets. So these are opportunities to strengthen in areas that we are not serving now and/or that are growing faster and we want to reach more of those customers. So we're just reinvesting in our best markets.

Do you feel the markets are underserved as well?

Well, not underserved. It's just that we're not in those areas. We're not in the heart of Baltimore, for instance. Towson is the first real city, real store in the actual city. We were in Columbia before or in Columbia. Allen, Texas is the fastest growing part of Dallas and we wanted to move there. So -- and then South Atlanta is a relocation into a better location. So it's just strengthening us in our current markets. That's our main focus.

And was there a lease-up in Atlanta as well?

Yes. That's a store that we -- the lease will be up when we leave it.

Can you comment on what you see as your labor costs going forward and what they were last year in terms of wage costs?

Well, when count everything, including commissions, they're over 20%. And it's -- slightly, that's the level -- it's going to be up except to the extent that there's kind of the administrative level or the so-called fixed cost level that we'd like to leverage by getting a lot more sales without increasing headcount in administrative functions.

Yes. So excluding commissions, what rate of increase might there be year-to-year on your wage and benefits?

Well, wage and benefits, together, it's 2% to 3%.

And any commentary on -- further on product costs where you're seeing pressure either on goods or upholstery side?

Well, I think the biggest issue with everyone is really petroleum prices. If they have -- teach them some other ways -- and of course, transportation, that's in another ingredient and different products. So that would be the main one, I think at, this point. There are not a lot of significant pressures, but we're just on the look out for them and certainly, we have to price that in.

How about your container costs, are they down this year with some of the excess capacity that's out there?

They were down earlier in the year and then were back up a little with the fuel very lately. But the capacity issue has kind of been equalized. That was a big deal back in 2009 when we had a big drop in inbound container cost. So I would say that is a little more stable situation too.

And lastly, if you could just talk about the variability of performance amongst your store base. Is it -- has it been narrowing? And the degree, to which, what percent of your stores may not be profitable currently?

I'd say that's narrowing. We've closed, over the last several years, our weaker performers. We'll have some leases come up in the next couple of years that we'll be watching closely and there's some that are certainly being watched. But I think that the variability is tightening. I think since 2006, we've gone through a lot: closed some stores, eliminated weak ones, cut staff, put in systems. I think we're pretty comfortable with our current base. And if we could get back to the average $200 number, we'd be making a lot of money.

And there are no further questions in the queue. Please proceed.

Well, I'd like to thank you for joining us on our conference call and thank you for your interest in Havertys.

Ladies and gentlemen, this concludes Havertys' Q4 and Year-End 2011 Financial Results Conference Call. Thank you for your participation. You may now disconnect.