La-Z-Boy Incorporated (LZB) Q4 2019 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to your La-Z-Boy Fiscal 2019 Fourth Quarter and Full Year Results Conference Call. All lines have been placed in a listen-only mode and the floor will be open for your questions and comments following the presentation. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Kathy Liebmann. Ma'am, the floor is yours.

Thank you, Christy, and good morning and thank you for joining us to discuss our fiscal 2019 fourth quarter and full year results. With us this morning are Kurt Darrow, La-Z-Boy's Chairman, President, and Chief Executive Officer; and Melinda Whittington, Senior Vice President and Chief Financial Officer. Kurt will open and close the call, and Melinda will speak to the financials midway through. We'll then open the call to questions. Slides will accompany this presentation, and you may view them through our webcast link, which will be available for one year and a telephone replay of the call will be available for one week beginning this afternoon. Before we begin this presentation, I'd like to remind you that some statements made in today's call include forward-looking statements about La-Z-Boy's future performance. Although we believe these statements to be reasonable, our actual results could differ materially. The most significant risk factors that could affect our future results are described in our annual report on Form 10-K and in today's presentation slides. We encourage you to review those risk factors as well as other key information detailed in our SEC filings. Also, our earnings release is available under the news and events tab on the Investor Relations page of our website, and it includes reconciliations of certain non-GAAP measures. With that, I will now turn the call over to Kurt Darrow, La-Z-Boy's Chairman, President, and Chief Executive Officer. Kurt?

Thank you, Kathy. Good morning everyone and thank you for joining us this morning. Last evening, we released our fiscal year 2019 and fourth quarter results, in line with our preannouncement that we released on June 5th. Fiscal 2019 was an exciting and productive year for La-Z-Boy Incorporated. We delivered excellent retail performance, nearly doubling our operating income, acquired the Arizona-based La-Z-Boy Furniture Galleries stores, the highest performing operation in the La-Z-Boy store network; solidified our position in the e-commerce space with our acquisition of Joybird, a premier direct-to-consumer retailer and manufacturer of upholstered furniture; further strengthened our well-established manufacturing platform; and set the stage for ongoing long-term growth. We closed fiscal 2019 achieving a 10% increase in sales to $1.75 billion, reflecting improvement across all core reporting segments and post a 7.4% consolidated operating margin, representing a strong performance within the home furnishings industry. The La-Z-Boy Furniture Gallery network performed well and the company-owned stores in our retail segment posted a delivered same-store sales increase of 5.7% for the full fiscal year. We generated $151 million in cash from operating activities and returned a combined total of $46 million to shareholders through an increased dividend and share purchases. And with a strong financial position, we are able to make strategic investments to drive growth across the enterprise, fuel new ventures to tap into new markets, and weather macroeconomic changes. Now, let's turn the discussion over to the fourth quarter. Consolidated sales for the quarter increased 8%, driven by excellent results for our company-owned retail segment, including both organic growth and acquisitions, including the North Dartmouth store in Massachusetts and nine Arizona stores. Joybird also fueled our sales performance. However, as indicated in the early June announcement, sales declined in the wholesale upholstery in Casegoods segment in the fourth quarter, consistent with the slow start to the calendar year across the North America retail home furnishings landscape, and with the lower volume translating to a direct impact to earnings given our fixed-cost structure. As noted in our pre-release, challenges in the Canadian market had a disproportionate impact to our sales for the quarter. Now, onto the wholesale business. In our Upholstery segment, while the full year showed positive growth, sales for the fourth quarter declined 1.2% versus last year's quarter, consistent with the declines we have seen across the industry. While our U.S. La-Z-Boy wholesale business was up slightly, we saw weakness in Canada as well as with other international and non-branded businesses. GAAP accounting for the quarter was 11.5% and non-GAAP operating margins was 11.6% versus 12.8% in the prior year. With the declines versus the prior year's quarter reflecting the change in product mix to more power products and our Duo line as well as the fixed-cost impact from the decrease in units. But all-in-all, we delivered a strong margin for the quarter, up sequentially from the third quarter even on lower sales. In the Casegoods segment, which also grew sales for the year, Q4 sales decreased 12.9% versus the prior year, consistent with industry trends. At 9.1%, we essentially held operating margin on down volume versus last year's quarter, highlighting our agile supply chain. Our Casegoods team continues to increase its presence on retail floors, positioning us to capture future opportunities. With respect to our brand platform, we are investing in the strong brand equity of La-Z-Boy to further solidify our standing in the marketplace. As you know, in May, we introduced Kristen Bell as our new brand ambassador and relaunched the Live Life Comfortably campaign across multiple channels, including TV, digital, print, La-Z-Boy social and web platforms, and through the La-Z-Boy Furniture Galleries stores. We are up spending on the brand platform in the first quarter along with our independent La-Z-Boy Furniture Gallery dealers who are contributing to this investment. We are delighted with the initial consumer response with Kristen bringing a new energy to La-Z-Boy with her vibrant personality, warmth, style, quick wit, and a focus on home and the family. With a robust social media following, particularly among younger consumers, Kristen is already bringing new eyes to the brand as she highlights the wide variety of comfortable, stylish and quality products and services offered by La-Z-Boy. On the product and innovation side, at the April High Point Market, we introduced a Wireless Hand Remote option for our power motion furniture. The remote includes two memory positions, a home button, a USB port, and a lock-out feature. It was very well received by our dealers and is representative of the fantastic work being done by the R&D team at our Dayton, Tennessee Innovation Center. Additionally, as consumers demonstrate increasing interest in and concern for the environment, we introduced an eco-friendly collection of fabrics called Conserve. These fabrics contain at least 30% of recycled plastic bottles that are spun into yarn, and on average, each sofa made with the Conserve fabric utilizes approximately 110 recycled plastic bottles. We also expanded our Urban Attitudes and Duo lines, both of which remain popular with consumers. Now, moving on to our retail segment. Our company-owned retail segment turned in an excellent fourth quarter with our team continued to execute at a high level. Sales increased 25% -- excuse me. Sales increased 24.9%, delivered same-store sales increased 8%, and operating income increased significantly. On a GAAP basis, operating margin improved to 8.4% from 6.6%, and non-GAAP operating margin increased to 8.5% from 6.6%. Excluding results from acquisitions, the core La-Z-Boy Retail business delivered healthy increases in sales and operating margin delivered by a higher ticket and increased design sales. Performance for the period was also driven by $22 million in sales from the 10 stores acquired, 9 of which are in Arizona. As noted previously, the Arizona stores have higher volume, experience a higher operating margin and have a lower SG&A as a percent of sales than the average across our remaining retail portfolio. Now across the complete La-Z-Boy Furniture Galleries network, written same-store sales for the 353 stores was positive at 0.8% for the quarter and up 1.8% for the full fiscal year. Excluding Canada, where business was challenged by weakening exchange rates and tariffs on finished goods coming from the U.S, written same-store sales across the 318 U.S. network stores increased 2.5% for the fourth quarter and 3.2% for the full 2019 year. On a positive note, the Canadian tariff on finished goods was listed in May and our Canadian La-Z-Boy Furniture Galleries stores experienced their first written same-store sales increase in eight months. And to provide some up-to-date color, we are pleased with the performance throughout the network over the Memorial Day weekend. We are continuing to invest in our La-Z-Boy Furniture Galleries store system, because that is where we're having the best opportunity to showcase the full array of our product offerings, while providing the consumer with an excellent shopping experience. The stores also afford us the opportunity to sell full-room groups, design services, which expand the average ticket. Across the network for fiscal 2019, we executed 19 projects, including new stores, remodels and relocations. And for fiscal 2020, we have more than 20 projects on tap and expect to end the year with 358 stores, including five net new stores. Now let's turn to Joybird, the e-commerce business we acquired last August. Just five years old, Joybird continues to exhibit rapid top line growth that is providing La-Z-Boy with new consumers through a new channel. For the quarter, Joybird delivered $22 million in sales. On the bottom line, we are making progress and driving to be slightly profitable in the back half of fiscal 2020 excluding purchase accounting adjustments. Leveraging our supply chain expertise has already unlocked pre-acquisition capability constraints at Joybird's Tijuana facility, almost doubling it. Additionally, we are now making and delivering several of Joybird's best-selling sofas at our Dayton, Tennessee plant to take advantage of our nationwide distribution capabilities to shorten delivery times and lower costs. While it's too early to determine how large Joybird will become, it is our fastest-growing business today, on pace to deliver more than $75 million in revenue in our first nine months of ownership. We have every confidence in its ability to become one of the leading online destinations for unique and beautifully crafted mid-century modern furniture and to deliver long-term value to the company. Now before turning the call over to Melinda, I will take a few minutes to address the recent changes to tariffs. As we mentioned early, the 10% retaliatory tariff on finished goods going into Canada was lifted on May 19. Good and encouraging news. However, we are still up against currency trends that are making goods coming from the U.S. more expensive in Canada. So it may take some time before we see that business completely regain its strong momentum. Also in May, the 10% tariff on goods coming from China increased to 25%. This continues to impact several items we source from our manufacturing operations. However, most of our cover for our -- including most of our cover for our upholstered products. As a reminder, however, for La-Z-Boy, two-thirds of our cover is converted into cut-and-sew kits in our Mexican-based facility and is therefore not subject to the Chinese tariff, leaving just one-third of kits subject to the tariff. We continue to be subject to the full 25% tariff on actuators, a component part used in our power product. Now recall at 10%, we were passing through the combined tariffs as a surcharge on our wholesale business that increased our price roughly 2% on the La-Z-Boy upholstery business and about 3% on upholstered units with power. With the supply chain working diligently with our global partners to minimize the impact of tariffs, the increased tariffs at 25% translate a pass-through surcharge as of June 1 of about 3.5% on non-powered upholstery and about 4% on power products. Since raising our prices in response to the initial round of Chinese tariffs, we have not seen a significant change in buying patterns. But at this point, it's too early to tell what will be the impact to demand elasticity from the recent increase to 25%. But with that said, we continue to believe we are more competitively positioned than many in the furniture industry based on our U.S. upholstery manufacturing footprint and the sourcing capabilities of our global supply chain. I will now turn over the call to Melinda to review our financial performance.

Thanks, Kurt, and good morning, everyone. To start, let me remind you that we are presenting our results on both a GAAP and non-GAAP basis, which excludes purchase accounting adjustments for our acquisitions and the non-cash charge for the fourth quarter termination of the company's defined benefit pension plan. We believe this non-GAAP presentation better reflects underlying trends and performance of the business. Throughout fiscal 2019, we recorded $7.5 million or $0.12 per share in purchase accounting charges, the majority of which related to the acquisition of Joybird, which is reflected in corporate and other and the 10 La-Z-Boy Furniture Gallery stores, which are reflected in our Retail segment. For consistency, we have presented prior periods similarly for the impact of prior acquisitions. The termination of the pension plan resulted in a onetime non-cash charge of $32.7 million or $0.58 per diluted share. And as always, a full reconciliation of GAAP to non-GAAP is included in our press release. The tables are also included in the appendix section at the end of our conference call slides. And now, I'll briefly review our consolidated fourth quarter results, before moving to a discussion of the full year. As Kurt noted, sales increased 8% versus the prior year quarter to $454 million, reflecting strong growth in retail in Joybird, but challenges to our wholesale businesses consistent with the industry. GAAP consolidated operating income was $37 million for the quarter. And excluding purchase accounting charges, non-GAAP consolidated operating income was $39 million versus $46 million in last year's quarter. Consolidated operating margin on a GAAP basis was 8.2% versus 10.9% last year. And non-GAAP consolidated operating margin was 8.6% versus 10.9% last year. Given our fixed-cost structure, volume declines experienced by our wholesale business translated to a negative margin impact on these businesses. In addition, as discussed last quarter, changes to our consolidated business mix with the acquisition of Joybird and the growth of our Retail segment impacted quarter-over-quarter comparisons. This created an expected 120 basis point drag to operating margin, the combination of 310 basis points higher SG&A, partially offset by an improvement in gross margin from this mix. In addition, incentives -- increased incentive compensation cost were 170 basis points higher than prior year and changes in employee benefits policies increased costs 40 basis points during the Q4 transition period. GAAP earnings per diluted share for fiscal 2019 fourth quarter was $0.03 versus $0.72 in the prior year period. Non-GAAP EPS was $0.64 per diluted share in the current quarter versus $0.72 in last year's fourth quarter. Non-GAAP results exclude a $0.03 per share charge for purchase accounting as well as the non-cash charge of $0.58 per share for the termination of the defined benefit pension plan. Also affecting comparability, the fourth quarter includes the increased incentive comp cost of $0.13, a $0.03 per share charge for changes in employee benefits as well. And conversely, last year's fourth quarter included a $0.06 per share benefit related to tax reform. Turning to a discussion of our fiscal 2019 full year results. Sales increased 10% or $161 million to $1.75 billion, driven both by growth in our core businesses and from recent acquisitions. Consolidated operating income on a GAAP basis increased to $131 million and on a non-GAAP basis, to $137 million. GAAP consolidated operating margin declined to 7.4% from 8.2% last year. And this year's non-GAAP operating margin was 7.8% compared to 8.2%. GAAP earnings per share were $1.44 versus $1.67 in prior year. Non-GAAP EPS for this fiscal year was $2.14 versus $1.68 in the prior fiscal. Again, this year's non-GAAP results exclude the non-cash pension termination charge of $0.58 and the charge for purchase accounting of $0.12 on the year. Fiscal 2018 non-GAAP results exclude a similar charge for purchase accounting of $0.01 per share. For the full fiscal year, our consolidated GAAP gross margin increased 90 basis points and non-GAAP gross margin increased 110 basis points. Again, the majority of the gross margin increase was due to changes in our consolidated business mix, driven by the growth in retail and the contribution from Joybird, both of which carry the higher gross margins in our wholesale business. Fiscal 2019 GAAP results also include the purchase accounting charges related to our acquisition that were 20 basis points higher than the prior fiscal. Looking at gross margin percentages by segment, we experienced a decline in upholstery, due to higher supply chain cost and changes to our product mix, which were offset somewhat by higher selling prices. Gross margin improved in our Casegoods segment for the year, primarily driven by increased volumes and a shift in product mix to new higher margin collections. Our Retail segment's gross margin increased primarily due to the increased design services and custom sales as well as the benefit of acquired stores that have higher margins than our average stores. Moving on to SG&A for the year. GAAP SG&A as a percent of sales increased 170 basis points in fiscal 2019 compared to fiscal 2018. Non-GAAP SG&A increased 150 basis points adjusted for acquisition-related costs for Joybird. Changes in our consolidated business mix increased SG&A by 200 basis points for the year, reflecting the growth of Joybird and Retail for the roughly three-quarters of the year that we own them. In addition, incentive compensation costs as a percentage of sales were 80 basis points higher for fiscal 2019, due to our improved financial performance against incentive targets. Partially offsetting higher SG&A was the improved leverage of fixed cost on higher sales dollars. Our effective tax rate for fiscal 2019 was 26.4% compared with 36.7% in fiscal 2018. Both periods reflect the impact of tax reform, but the statutory rate for each year differed due to our April year-end as tax reform was phased in during our fiscal 2018 year. Absent discrete items, the effective tax rate in fiscal 2019 would have been 25.1%. For fiscal 2020, looking forward, absent discrete items, we estimate our effective tax rate will continue to be in the range of 25% to 26%. Regarding our significant non-cash pension termination charge, recall that as part of the redesign of our employee benefits plan, we terminated our defined benefit pension plan for eligible factory hourly employees during the fourth quarter of fiscal 2019. We settled all future obligations under the plan through a combination of lump-sum payments to eligible participants, who elected to receive them and transferred the remaining benefit obligations to a highly rated insurance company. In connection with this, we recognized a non-cash pre-tax charge of $33 million on our consolidated statement of income, which equated to $0.58 per share. We did not have to contribute any additional operating cash into the plan to settle the obligation. Both the cash usage and the non-cash P&L charge were significantly lower than we initially expected due to favorable developments in the risk premiums we were able to secure and the number of individuals electing lump-sum payments. Terminating the plan, transfers the administration costs and risks of plan funding going forward and allows us to fund more meaningful benefit programs for our employees. Turning to the balance sheet. In fiscal 2019, we generated $151 million in cash from operating activities. We ended the year with $131 million – $130 million in cash and cash equivalents, $31 million in investments to enhance returns on cash, and $2 million in restricted cash. During fiscal 2019, we invested $48 million in capital expenditures, primarily related to our new innovation center in Dayton, Tennessee, upgrades to our Dayton manufacturing facility and construction of a new corporate office building for our England subsidiary. For the full fiscal year, we paid $23 million in dividends and spent $23 million purchasing 800,000 shares of stock in the open market under our existing authorized share repurchase program, which leaves 5.9 million shares of purchase availability under that authorization. We also repaid the remaining $20 million of borrowings outstanding under our revolving credit line in the fourth quarter. Our capital allocation priorities remain to invest in the business to drive growth, and then provide return to shareholders with our dividends and discretionary share buyback. And finally, turning to our fiscal 2020 year, let me highlight several important items. Regarding leases, beginning with our first quarter of fiscal 2020, we will adopt the new accounting standard on leases and will record all lease debt and related right-of-use assets on our balance sheet. We estimate we will record amounts in the range of $300 million to $325 million on the balance sheet, and we do not anticipate any material impact to our income statement. Regarding capital expenditures, for fiscal 2020, we expect CapEx to be in the range of $50 million to $60 million, including plant upgrades and improvements to several of our retail stores. Regarding tariffs, the environment remains volatile. As noted earlier, we expect to continue to pass-through tariffs as a surcharge, resulting in higher selling prices. And we believe with our supply chain structure, we are competitively well positioned against our peers. However, with the broader industry having a negative start to calendar 2019, we may see an impact on demand elasticity with the increased tariffs. Regarding seasonality, our first quarter is typically the weakest in terms of sales and earning's across our businesses, due to a general slowdown throughout the furniture industry related to the summer period. As a result, the majority of our manufacturing facilities closed for a week in July for vacation and maintenance. And with lower volume during that period, in addition to the one week without production and shipment, we historically convert at a lower rate during the first quarter. Further into the year, our change in consolidated sales mix may also affect seasonality of the consolidated company. For our Retail segment and Joybird, the third quarter is typically the highest volume sales quarter, while the fourth quarter is typically our strongest on our wholesale upholstery businesses. As the Retail and Joybird businesses grow as a percentage of our consolidated sales, third quarter sales could outpace or be level with fourth quarter for the consolidated company in future years. Regarding SG&A cost trends, in addition to normal inflationary pressures, we would again note the impact of changes on our consolidated business mix with Retail growing and the acquisition of Joybird, which will again drive an approximate 200 to 250 basis point increase in SG&A for the first quarter versus fiscal year's – versus last year's fiscal first quarter, when we did not yet own Joybird or the Arizona retail businesses. We estimate this mix impact to the full year to be an SG&A increase in the range of 100 to 150 basis points. While in the topic of SG&A, I would note that we have more heavily front loaded advertising investments in the year to support the first quarter launch of our campaign featuring Kristen Bell in fiscal 2020. And on quarterly results, more broadly, I would remind you that we anticipate Joybird becoming slightly profitable in the back half of fiscal 2020, excluding purchase accounting adjustments. For comparability, let me note that in fiscal 2019, first quarter results included a $0.03 per share benefit from currency and employee benefits charge changes resulted in one-time $0.07 per share benefit to Q3, offset partially with a $0.03 additional charge in Q4; all of these items being in 2019 and one-time in nature. And finally, we will continue with our non-GAAP presentation as we go into 2020, excluding purchase accounting adjustments. For acquisitions to date, adjustments are anticipated to be in the range of $0.08 to $0.10 per share for the fiscal year, plus any effect from revaluation of the contingent consideration liability for future earn-outs on Joybird. As a reminder, this earn-out could range from zero to $65 million as we've discussed extensively in previous quarters. And now, I will turn the call back to Kurt for concluding remarks.

Thank you, Melinda. In the shorter term, we are facing several hurdles with the fluid tariff environment, geopolitical uncertainty and the negative growth posted by the furniture industry for the first calendar quarter. But with that said, with our strong brand, multi-channel distribution network and predominantly domestic manufacturing footprint, we believe we are competitively well-positioned in the marketplace. Additionally, our balance sheet is strong, which will allow us to weather a possible economic downturn. I'm so proud of the work the La-Z-Boy team has accomplished this year. We are playing offense and implementing creative solutions to optimize our portfolio of powerhouse brands, maximize the reach and efficiencies of our supply chain and capture new and different consumers. We are excited about the future narrative of La-Z-Boy and believe the best is yet to come. We appreciate your interest in La-Z-Boy Incorporated, and now we'll turn over the call to Kathy to provide the instructions for getting into the queue.

Thank you, Kurt. We'll begin the question-and-answer period now. Christy, will you please review the instructions for getting into the queue to ask questions?

Absolutely. Thank you. The floor is now open for questions. [Operator Instructions] And we'll take our first question from Bradley Thomas with KeyBanc Capital Markets. Please go ahead.

Hey, good morning, Kurt, Melinda, and Kathy. Let's see, I wanted to focus on the sales trends and just follow-up on the slowdown that you all experienced in the quarter in the upholstery and Casegoods segments. And Kurt, if you could just give us an update about how you're thinking about the health of those two segments going forward, particularly when you contrast it against what's been very strong same-store sales and strong merchandise and exciting new advertising campaign that's been helping your retail segment?

Well, I would have a couple of comments on that, Brad. Number one, we reminded people earlier that we are in the furniture business, and everybody that reported numbers in the first four, five months of the year showed a slowdown. And we weren't immune to that. But our U.S. business is fairly healthy. But then you take the effects -- for the La-Z-Boy brands. Then you take the effects of -- we've got a significant business in Canada, which we've talked about in the call; we've got a business in the U.K. and with what's going on there. And when things get a little tougher, sometimes our non-branded companies don't do quite as well as the La-Z-Boy brand. So it's a mixture of things there that we're dealing with. And similarly, we talked in February about we were pleased with Presidents' Day weekend, and things got softer after that. We were very pleased with the Memorial Day weekend, but that's no prediction that the trend is going to continue. So we don't think there is anything systemically wrong. I think you see with our store performance that the core La-Z-Boy brand is holding up real well. But we've got some other parts of that business that have normally been consistent with the La-Z-Boy brand, and for the last few months, that hasn't been the case.

And then with respect to the price increases that you are putting through, can you just give us an update as of today, how much your price is up maybe year-over-year? And as you look forward the next couple of quarters, do we need to put through more price increases given the timing of raw materials are coming in and goods are coming in that are hit with the tariff? How should we think about that?

I think we outlined that, Brad, pretty well in the call. We took a 2% and 3% increase on the first round of tariffs, which was some time ago, and this next time around, it's…

We're up to -- with the Chinese tariffs on our portfolio, we're up to about 4% across the portfolio. It depends on if you're power or non-power on the Chinese tariffs. Of course, everything is volatile. That's what the adjustment -- the first round of Chinese tariffs, we took that first round. We're up to, call it, across the blended portfolio just under 5% on Chinese tariffs. Mexico came and went in the last couple of weeks, which would have created another round of pricing. Canada has come off. So at this point, we are -- with just pricing that's come out in like two, three weeks ago, we are whole in what we're trying to pass through. What we don't know is how elasticity will be impacted on that pricing or what else will come along in the next round of tariffs, which again, we would still try to pass through. But at some point, you're just hitting an elasticity point that could be troubling. Particularly on the back of -- recall, over the last two years, the industry has seen some pretty significant upticks in raw material charges that we're starting to see become a tailwind instead of a headwind. But overall, furniture prices have certainly taken an uptick over the last two years.

Yeah. And I think we saw that the combination of all those things really hit the wall in Canada when you add on the currency. So, I think some of the furniture coming from America in Canada is 30%, 40% more expensive now given the currency. So there could come a time, Brad, when the effect on volume and not running our plant at the level we want to is better than passing on more tariff. But we don't believe we've reached that point yet, but we'll keep a watchful eye on it.

Great. And if I could add one more on Joybird, it's really been experiencing some exciting growth. Can you help us think about how much you think Joybird could be up this coming year? Just, obviously, I know -- I'll tend to not tie it on sales, but obviously, it can create a lot of variability given how fast it's been growing historically. For example, how much was the $22 million up year-over-year in 4Q? And again, how are you thinking about it going forward?

Well, we're not going to give you the exact. But I would say, honestly, we don't know because we are slightly behind in the integration plan we have. But we're very pleased that we are making their product now in Dayton, Tennessee. We are -- we have filled our regional distribution centers with their products, so they can get -- consumers can get product in a week or less. Having half the line made on the East Coast, cuts down the time and the transportation cost. But if you just run out a progression, Brad, we bought them when they were on a $50 million to $55 million pace. And now after owning them for less than nine months, we believe they're on a $70 million to $80 million pace. And we would expect that to be a higher pace all next year if everything we have comes together. Now another worry there is if the Mexican tariffs ever come back into play, they would be affected on that with the full tariff burden on finished goods, which would be significantly more price or profit than we anticipated. But everything -- from our standpoint, everything is going as planned. It's not just going as fast as we want. But the teams are working hard on getting everything integrated. And the big takeaway here though, for our company, this gives us a new customer and a new channel that we're not attracting with the La-Z-Boy brand or in the La-Z-Boy stores. And it's very accretive to everything we're trying to do from a growth standpoint.

It’s very helpful. Thank you so much.

Thank you, Brad.

[Operator Instructions] And our next question comes from Anthony Lebiedzinski with Sidoti & Company. Please go ahead.

Yes, good morning. And thank you for taking the question. So just wanted to follow-up about Mexico. So obviously, there was a recent threat of potential tariffs that went away. But longer-term, are you perhaps rethinking your supply chain? Or is it just too early at this point? How are you guys thinking about that?

I think the broader answer to that, Anthony, and good morning to you too. I think we rethink our supply chain all the time. So we're flexible. We're nimble. There's been a big move to Vietnam in the industry with products out of China. We still think Mexico is advantageous to us from a speed standpoint. And for us, to deliver the custom-order promise in four weeks or less, it would be hard to do that. We might be able to save a little bit of money, but it would destroy one of the competitive advantages we have is doing custom. And today, in the La-Z-Boy Furniture Galleries stores, nearly 50% of all our business is either in-home design or custom. So, there's more factors than just cost. And we also don't want to make one bet in any one country outside of the United States or one currency. So we're flexible on how much of a given commodity or anything that we do in these various countries. So it's ever changing. There is no road map, because these things are just fluid right now and get announced, and you have to react. But we've got a number of contingency plans should something change permanently that we can react to.

All right. That's good to hear. So, moving on to a different topic. So in your 10-K, you talked about your expectation for higher costs in fiscal 2020 for raw materials, transportation, which includes ocean freight, costs and some other things. So, can you perhaps give us some more detail as to what you guys expect from a cost perspective?

Yes. Just to clarify, raw material inputs have actually become a tailwind. So some of those, so steel, poly and some of our wood input costs that were at all-time highs, call it, six months to 12 months ago, have actually become a tailwind consistent with the rest of the industry, but it's the rest of our input costs that continue to see increases. And so that was really -- the point of that comment is to make the point that it's a balance. While we appreciate being able to leverage the tailwinds with some of those raw material costs that we priced for over the last two years, we are seeing other input costs. And as you know, transportation being one of them that are definitely up year-over-year, and we don't see those trends easing similar with just employee costs, including insurances, health insurances and those types of benefits.

Got it. Okay. Thanks for that explanation and clarification. So, yeah, as far as the Retail segment, obviously, another good quarter there. You mentioned that you do have a higher ticket driving that same -- delivered same-store sales increase. Can you give us a sense as to the magnitude? I just wanted to get a better understanding of traffic versus ticket as to what's driving the performance there. And whether -- and also, while we're at that subject, your thoughts on the sustainability of that going forward?

Well, let me talk about the mix between average ticket and traffic. It changes monthly. It's not a consistent number. Our traffic has kind of leveled out at a degree that is good for us. We're not seeing the 6%, 8%, 10% down traffic anymore. So it's stabilized. It’s -- frankly, in the last four months, some months, traffic has been slightly up and slightly down. So that's a positive sign. We anticipate the traffic to get a bump with our increased investment in Kristen Bell and the brand platform. And so -- but it's just -- it's all a matter of our core salespeople, our retail consultants, our designers, connecting with the customers, making them aware of everything La-Z-Boy has to offer and talking about being able to do your whole room or a series of rooms rather than selling individual items. And that's really been the story that we've -- the journey we've been on for the last number of years. And unless we would see a pretty substantial economic slowdown, which is not in our plan for this year, I would not see a degradation to the ticket in the new horizon and think the same-store growth is -- continue to go up.

Got it. Okay. Thanks for that. And lastly, as far as the up spending on advertising that you previously mentioned, can you give us a sense as to the magnitude of that up spend?

Yes. We don't call out specific numbers, but obviously, given that we've made an investment in Kristen, we want to make sure we get a -- the maximum bang for our buck there, I guess, I would say. So, we definitely are investing a bit more into marketing this year in conjunction with our licensee partners, so across the entire Furniture Galleries network. And that is more heavily skewed than would normally be the case into the front half of the year, particularly the first quarter with the launch.

Got it. All right. Thank you and best of luck.

Thank you, Anthony.

Thank you.

And our next question comes from Bobby Griffin with Raymond James. Please go ahead.

Good morning, everybody. Appreciate you taking my questions.

Good morning, Bobby.

Kurt, I wanted to go back to your comments about the furniture prices in Canada with currency, raw materials and tariffs. They were upwards of up 30%, 40% year-over-year. When did -- at what price level did you start to see the deterioration in unit volumes? Was it 15% or 20%? Just probably we can get a flavor of what might be the tipping point here in the U.S. on prices?

Yes. That's a hard -- I don't have that data right here in front of me, Bobby. And then I would go back to a statement Melinda made. The tariffs and all were on top of the raw material increases that happened within the last two years, too. So it's not any one of those things individually. Those could have all been dealt with. It's the cumulative effect of raw materials for that hitting the all-time high, transportation costs all that. Then the U.S. tariffs, the Chinese tariffs, the retaliatory tariffs. And then the double whammy for Canada is the currency. So all I can tell you is that as the things escalated in our fiscal 2019, each quarter last year, our business in Canada continued on a downward slope. And it was very refreshing to see a change in that direction in May. One quarter doesn't make the year or one month doesn't make the year, but we saw that the GAAP to the U.S. performance on our Canada business, both wholesale and retail, every quarter in 2019 go down and down and down each quarter, percentage-wise.

Okay. And the one thing that changed in May was just the removal of the retaliatory tariff?

Well, that's the biggest thing. I'm not -- I don't have it in front of me. I don't know what the currency did off the top of my head. And that came down a little bit, too, but certainly, the tariff coming off was a relief. And I don't have fresh intelligence on what our retail partners are doing. How much of that they're passing on? How much they're eating themselves? How they're merchandising that? But obviously, that was a bit of very good news. And there has to be some correlation between that and the change of direction of the pace of the business.

And always keep in mind, while the Chinese tariffs are on component parts, so 25% equates to 4% kind of increase in what we're passing through. That Canadian tariff was 10% on finished goods, so that going away is a really dramatic impact and immediate.

Okay. I appreciate that. And then secondly from me, if you look on, I guess, in your non-branded wholesale business, the slowdown that happened, call it, year-to-date with some of the weather, was there any meaningful change in the kind of level of products people were ordering or purchasing like a trade down instead of buying a $2,000 sofa, you saw more common of $1,200 sofa. Just to get a sense if your non-branded retail partners are seeing something different out of their consumers.

My sense is that with the marketing and the effort behind our brand and our stores and all the things that we do, we are not the first level of distribution that sees this impact. But a lot of what our non-branded businesses appeal to are smaller dealers, dealers in rural communities, dealers who need a distributor supplier to help them. And I think typical to past slowdowns, we started seeing some of our smaller dealers suffer earlier or faster than the majors. They just don't have as many options given the benefit of scale that some of the rest of our -- the big customers have. So we didn't see it at any one geography area, any one customer segment. But, I think, there is some indication that some of the smaller dealers may be feeling the effects of all this conversation about the world going on, affecting their customers a little more.

Okay. I appreciate that. And then, when we look at the first half of next fiscal year and comp with a higher advertising, the traditional 1Q slowdown, maybe some of the inflationary pressures and a little bit of uncertainty here, should we assume for first half operating income to be down year-over-year? Or any color there to help us, maybe, right-size the model versus last year? And this is on a non-GAAP basis, I'm sorry.

Yes. I'm hesitant to get into anything that feels like guidance per se. But certainly, there are challenges to our summer months.

And Bobby, the hesitance of us to answer that question. So it was announced yesterday, I guess, that our President and the Chinese Premier are going to meet. And so, what if they leave from there and there's a big change. Then obviously, we would all be more optimistic. I'm not optimistic necessarily that's going to happen. But the predictability of what is going to happen in the next six months, given what happened in the last six months and the -- you don't get a lot of time to plan for these things that get announced overnight. So it's a -- you just go through a litany of things; if the interest rates are cut, if this or that. So you make your models for a lot of companies, you're probably as good at it right now as we are. But we don't have a crystal ball. We have a crystal ball of what we're planning to do and how we're executing and where we think our pinch points are and all that. But as far as the broader economy and all the things that are going on, it's not easy to predict.

Okay. And, I guess, I'll try to sneak one more in here. Melinda, can you maybe just update us on capital allocation? How do you view the leases in terms of a total debt? Do you have a total adjusted debt target or net debt target that you look at now with the leases? And share buyback was down a little bit this year. Your stocks kind of pulled back here a little bit. How should we think about share buybacks going forward?

Yes. I mean, broadly, the lease accounting change is a paper accounting change, right? So that really doesn't change how we think about debt or overall managing our balance sheet. As you know, we've been pretty conservative in recent years on how we manage the balance sheet. We have essentially no debt right now other than the leases. And, I guess, the second piece to that is relative to cash usage in the year. We had two things this year: paying off those two -- at this past year, paying off those two acquisitions, as well as we expected to need to put a healthy sum of money into terminating the pension. And so, we did back off a bit on share buyback for that reason, knowing we had some unusual uses in the year. In general, we've always said that, sure, first, we'll invest in our business, and then we'll give money back to the shareholders through dividends and share repurchase. At minimum, we would always offset any dilution. But this past year was a bit of an abnormality in how much share buyback we did, because of the other uses in the year.

Okay. I appreciate you guys taking all my questions. Best of luck going forward in the summer and some of this uncertainty in front of us.

Makes it fun.

And we have a final question from Dillard Watt from Stifel. Please go ahead.

Thanks. Good morning. Melinda, I wanted to talk a little bit about CapEx. It was up in 2019, I think, primarily due to the new innovation center in Dayton and then, I think, as well as some, I guess, some ongoing improvements in the manufacturing. And we're now moving up, again, $50 million to $60 million this year. Could you help, kind of, bridge the difference between, maybe, moving from fiscal 2018 to 2019 and now into 2020? And maybe how much of that is just the timing of store projects? And, sort of, what's maybe a longer-term go-forward rate we can think about?

Sure. Well, I think we've been more, as you said, in the 30 to 40 range historically. We definitely have -- are in the process of making investments to modernize some of our plants, and we've talked a lot about those buildings, the Dayton Innovation Center, as well as making updates to our Dayton, Tennessee plants. I think we started 2019 calling CapEx more in the $60 million to $70 million range. I may be off on that a little bit. But what we actually ended up spending in 2019 actually came down a bit. Simply, as we finished up all those Dayton, Tennessee projects, the plant project is -- a bit of that spend has slid into our 2020 numbers. So that's why you see us right now calling a number in the $50 million to $60 million range for 2020. That carries – is the carryover of some of those final projects in Dayton, another plant update and so forth. I do think after that I would anticipate, in the out years, starting to see that, maybe not revert all the way down to the $30 million to $40 million you saw in the past. But these are definitely big investment years, as we finish out some of the plant work we want to do, on top of the ongoing projects, as you mentioned, always on store renovations. And, of course, investments in our own infrastructure as well, IT projects and those types of things.

And Dillard, I would add, this is not a new phenomenon. What we've been doing in the last seven or eight years is, we went through a long period of time, the recession, prior to that, when we made some ill-fated acquisitions and all. But we didn't have any capital to invest. So we went a long time without keeping our facilities in the manner that we should. So we've been playing catch-up with our IT systems. And five years ago, or four years ago, we built the new headquarters. We spent a lot of money in Dayton. Our distribution centers have all been moved and upgraded. Our last big project is going to kick off this year, and that is in our Neosho, Missouri plant. And if you think about the Dayton plant that we're just finishing up on and Neosho, they manufacture nearly 70% of all the furniture we sell in the U.S. So it's critical that those facilities are up-to-date, have new technology in them, are pleasant places to work for our people. Because every place we have a business, we're in a talent war to keep our people and give them some amenities. So this is the last really big facility that we have to -- but given 150 stores that we own and six plants and all the store models and everything, this business needs capital investment every year or you get far behind and you have to play catch-up. We're trying to get to a point where, hopefully, in a year or two, we can give you a normal CapEx maintenance part of our CapEx that you can count on. And hopefully, after this year, we'll be in a position to start being more forthright about what we think that will take.

Understood. That's helpful. And then maybe, Melinda, just any sort of help you might provide on what you expect working capital to do this year? Understanding that, certainly, it potentially depends on sales, which is a little bit uncertain. But if there's anything that you know will push that one way or another, that'll be great.

Yes. I mean as you said, it's all dependent on the business growth, right? But I would point out that, I mean, if you look at our Q4 cash flow delivery, we had a particularly good year in 2019 of managing our working capital relative to the business. So, certainly, our intention would be to continue to do that, but that's always a challenge. I don't see -- we don't have anything on tap where we're planning to make some big move on terms or anything, to see something dramatic, again, other than, I'd call out, we've put a lot of focus on working capital this year and drove some quite good results here in the fourth quarter.

Understood. Thank you.

Thank you, Dillard.

And that concludes our Q&A session for today. I'll turn it back over to Kathy, Kurt and Melinda for closing remarks.

Thank you, everyone, for joining us on our call this morning. If you have follow-up questions, please give me a call, and I will get in touch with you. Have a great day. Bye-bye.

And that does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time, and have a great day.