Nov 6, 2008
Executives
Clarence H. Smith – President and Chief Executive Officer Dennis L.
Fink – Executive Vice President and Chief Financial Officer
Analysts
John Baugh – Stifel Nicolaus & Company, Inc. Todd Schwartzman – Sidoti & Company
Operator
Welcome to the Haverty Furniture third quarter 2008 earnings and release conference call on the 6th of November, 2008. For today’s recorded presentation, all participants will be in a listen-only mode.
After the presentation there will be an opportunity to ask questions. (Operator Instructions) I will now hand the conference over to Dennis Fink.
Dennis L. Fink
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. We 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 are more fully disclosed in the company’s reports filed with the SEC. Our President and CEO, Clarence Smith, will now give you his update.
Clarence H. Smith
Good morning. Thank you for joining us for our third quarter conference call.
Net sales for the quarter were down 12.5%. Gross margins were strong at 51.5, up 193 basis points.
Because of the low sales level, we were not able to reduce our expenses enough to make a profit. The loss for the third quarter was $1.5 million versus a profit of $0.6 million last year.
We continue to see very difficult selling conditions in all of our markets and expect to have challenging conditions for the near future. Over the past several years we have deliberately de-leveraged our balance sheet by bringing down our accounts receivables, outsourcing much of our new financing for customers, and tightly managing our inventories.
Additionally, we have slowed our store growth and have put cuts in our capital spending back dramatically. With the tough business conditions in our industry in the past two years, we have focused on managing for cash and protecting our balance sheet.
Our budgeted CapEx for 2009 is approximately half of the $11 million being spent for 2008. We are eliminating or postponing most any project that we can.
In October we paid off all of our long term debt and now have zero borrowings on our revolver as of yesterday. We believe that our conservative focus on reducing our debt and managing for cash these past quarters was the right strategy for surviving the brutal industry downturn and positioning for future profitability.
We have worked to better align our cost structure to fit the sales conditions and while serving the same number of stores have reduced our head count by 21% from the beginning of 2007 and by 13% since the beginning of 2008. SG&A expenses for the third quarter were $6.9 million less than last year.
But we are now seeing even tougher conditions and we are in the process of making deeper cuts in several areas of our operations. In some cases we are furloughing staff to allow for adjusting back to improved volume in the future.
While we are resizing some staff to adjust to conditions, we are continuing to increase and update our training programs both in content and in systems upgrades to take the training quickly to the individuals throughout the organization. We’ve expanded live web-based conferencing to eliminate most of our travel-related or regional training.
Most recently we began a web-based video training program with many hours of product training as well as product handling and installation training for our field associates. This is also a great medium to explain our philosophies through live and video online presentations to our staff on many levels.
We feel that our inventories are in very good shape. We have a better in stock position on our best sellers than we have had in several quarters.
The panic and scare about inflation of goods particularly in Asia has died. There’s plenty of supply.
The export rebates to Chinese manufacturers from the government have been increased as of November 1 and the pricing of commodities such as steel and fuel have come down significantly. We’ve seen some domestic production return in upholstery which is encouraging because it allows a much quicker response and better service levels.
We’re continuing to leverage our best sellers by adding different configurations in key selling items to our good collections. We’ve had good success with entertainment centers and home office.
We are pleased with our recently added premium upholstery collections with quick shift special order capabilities. We think this will help us pick up some of the better customers who may be trading down from some of the higher end lines.
Our average cost per SKU is slightly up for the third quarter which is due to our selling of better quality products. We will not chase down the bottom of the market to try to grow sales.
We believe that our merchandise mix and our better quality goods is the right positioning for Haverty’s. We continue to closely evaluate our advertising by individual markets to reach our target customers.
We believe that our advertising mix by media and our brand message is more efficient due to our detailed analysis of our message and our sell through statistics. We have further rebalanced our delivery of distribution schedules to maximize routes and efficiencies without hurting our sales.
This is through consolidating and reducing routes and adjusting staff where necessary. We are evaluating the number of drive teams by market, the number of delivery days by market, and eliminating trucks where possible.
With the recent decrease in fuel costs we expect to see some savings in distribution and delivery in the coming months if oil prices stay down. We are looking at every store and lease in our system.
We have a number of stores with lease renewals coming up in 2009 and 2010. We are approaching property owners for possible rent relief and may choose not to exercise options if concession is not given where appropriate.
We believe that we are in a strong position to lower some of our rent expense in several of our markets. We are working to have the flexibility to close certain stores if markets worsen.
We know that there are going to be many potential store locations come available in the coming months ahead with the large number of big box bankruptcies in the news. A few may fit our profile at good lease terms in the markets we serve.
However, we will be very deliberate and critical in analyzing opportunities in these difficult times. If the location isn’t a home run, we won’t be interested.
This week we opened a relocated store in Mobile, Alabama replacing an expiring lease location. We are pleased with the repositioning of the strong Haverty’s market.
We will close an expiring lease location in the North Lake area of Atlanta by the end of the year. We will end the year with 122 stores, one less than last year.
Sales square footage for 2008 will be down by about 1%. We may have several store closings in 2009 related to lease expirations and expect to have a square footage decline in the low single digits.
Every day we read about failing furniture retailers due to extremely difficult conditions that have affected our industry for over two years. We are firmly focused on adjusting our costs to the conditions and keeping a strong balance sheet.
We believe that we’re gaining share because of the fallout of competitors in our local markets. However, our associates are much more concerned with serving our customers better by providing better quality merchandise at real values and delivering the best quality service.
This is what will make Haverty’s succeed through this industry shake out. Now I’d like to turn the call over to Dennis.
Dennis L. Fink
Thank you, Clarence. Following up on the comments about gross profit, we currently expect our gross profit margin for the fourth quarter of this year to be similar to the first nine months of the year which in fact would be an improvement over the level of last year’s fourth quarter gross margin.
Looking forward at our operating results at various sales levels, please be aware that almost 100% of the cost of goods sold for us is variable. There’s very little fixed cost in the cost of goods sold line.
SG&A on the other hand is roughly two-thirds fixed or discretionary items that includes store occupancy, warehousing, and also in the discretionary category is our advertising. The other one-third of our SG&A costs is mostly variable type expenses, so we’re focusing as Clarence said on managing SG&A by being as efficient as possible with the variable type costs and squeezing as much out of fixed costs as we can and that is about as difficult as can be imagined in this environment but as Clarence outlined, some of the areas that we’re looking at.
Cash flow for the nine months of 2008, cash provided by operating activities was $38.6 million. The largest source of the cash was about $32 million of decreases in accounts receivable from customers.
In this economic environment we’re pleased to have generated this cash and lowered our risk exposure by outsourcing more of the customer financing. Together with lower capital spending this year, which is roughly expected to be $10.5 million, we reduced our debt by $12 million for the nine months and at the end of the nine months we increased our cash balances by $18.6 million.
We actually used these cash balances during October to pay off all of our borrowings and it was ahead of schedule and without incurring any prepayment penalties. The only obligations that remain of a long term nature on our books are for a few capitalized leases that we have.
Further, accounts receivable reductions in the fourth quarter is expected to provide about $7 million more as a source of cash. As a reminder, our book value is approximately $12.75 per share.
Our inventory is valued at LIFO costs, so there’s a LIFO reserve on our books that’s about $17 million that reduces the percent of value you see. We also have no goodwill reported so the book value figure is all tangible.
At this time, Operator, we’ll take questions from the audience and would like to give everyone an opportunity to ask questions so please if you would limit yourselves to two questions and if you have follow up we would appreciate if you would re-enter the queue. Please go ahead, Operator.
Operator
(Operator Instructions) Your first question comes from Budd Bugatch from Raymond James.
Analyst for Budd Bugatch - Raymond James
This is actually TJ calling in for Budd who’s traveling right now. First I’d like to turn to the cost equation.
Clarence went through a number of details on the specific items that you guys were looking to maybe assess. I was just wondering if you might quantify of that one-third of the variable cost, realistically, what can we expect that could be trimmed out of that as far as the quantification?
Dennis L. Fink
The main thing I just wanted to do was point out that how these costs move up and down in relation to sales volume, but in the shorter term period, of course it’s hard to cut a lot out of fixed costs, but in the longer term you right size to the appropriate level and the answer is it just depends on how slow sales are and how much we can push out of the staffing and the whole scale of operations. We did cut costs as we mentioned in the press release and as Clarence confirmed, we got about $8 million out of SG&A versus the prior year and then we did have the sort of one time item.
Actually it was on the stores that had been closed in prior years reserving for possible sub-lease income issues and that was about a $1 million charge that we took in the quarter, so that increased our SG&A and that should not be a recurring type of expense. But the answer is we just have to push and we can’t really quantify it ahead of time very well.
You can see that we have squeezed quite a bit out of the costs. The one that’s the easiest to pick on and the one that you have to be the most careful about is of course advertising.
That runs 6% to 7% of sales. As I said, it’s mostly discretionary, so you have to decide really how much effort in media spending you’re going to put forward and it does have an impact on sales itself because the less you spend the less tension you draw and awareness you create so we’ve been cutting back in that area and we just have to make that judgment three or four months at a time.
Analyst for Budd Bugatch - Raymond James
My second question deals with the outsourcing of the credit. I was wondering if you guys had seen any pushback from those third party providers whereas maybe if you had the credit in house, would you have gotten the customers approved and now they’re not being approved, or is it pretty similar to what your credit standards have been?
Dennis L. Fink
They’re very consistent on the outside and we have found their credit standards are very similar to ours. So we haven’t seen a big change in approval rates at this point in time.
I think you can expect that would happen over time depending on how deep and long this recession is, but the corporate credit has shrunk much more quickly and is much more challenging than the consumer credit is right now for things other than mortgages. The mortgage market obviously is extremely tight for consumers but the credit card lending and lines, you hear about that being squeezed.
We haven’t seen it significantly yet in our business so I think that we always have the option of offering longer terms and taking more inside but at this point in time we’re more likely to be concerned or be focused on generating cash rather than adding credit sales.
Operator
Your next question comes from John Baugh from Stifel Nicolaus.
John Baugh – Stifel Nicolaus & Company, Inc.
Let’s start with the stores. 122...
If we can just go into some detail again on how many are owned, how many are leased, if how many are coming up for lease renewal in the next year or two. You mentioned I think a sale lease back that you were doing.
What are the opportunities there, and I guess is it possible for you to give me a number, I know about what kind of rent expense you might save, but give us a feel for what rent expense is as a percentage of revenues and some ballpark of what you think you might be able to cut and what I guess was a fixed expense but maybe now will be a little more variable.
Clarence H. Smith
Well it’s really a market by market deal. We have about a dozen stores that the leases come up in the next couple of years that we’re going to be discussing in the next year because we have to give notice and so we’ll be looking at every one of these, talking to or landlords, trying to see whether it makes sense to renew the lease or leave the markets.
These would mostly be in smaller markets and it would depend on how we’re doing in each individual store. Many times we’re able to get leases with kick outs.
That’s another thing we’re trying to look at just to give us more flexibility. In some cases we’ve been able to reduce the rents in half for a period of time and these are the kinds of things that we’ll continue to do.
I think we own about a third of our stores. I’m not sure exactly what we expect to save as a percentage but it’s really making the markets more viable and helping to make them more profitable.
Dennis L. Fink
The total rent expense for the company is about $32 million a year.
John Baugh – Stifel Nicolaus & Company, Inc.
You mentioned a sale of lease back I think in the release. What are the plans there?
Dennis L. Fink
We have one under contract and that market is not very fluid right now so that’s a longer term strategy would be additional sale lease backs but probably not that many likely in the next say six months or so. We view sale in leasebacks from time to time.
We did 11 store sale lease back about 6 years ago and I believe this is the second one we’ve done since that time. That’s a good source of cash in the right kind of market.
Right now that market is tight.
Clarence H. Smith
John Baugh – Stifel Nicolaus & Company, Inc.
What is your of the credit you’ve underwritten that’s notional or dollar amount, what is the total outstanding, how are you handling the provision, is it kind of overfund? Just kind of walk us through the credit in house.
Dennis L. Fink
We’ve got about I think it was $36 million outstanding in accounts receivable. We have a part of it classified as long term.
Most of it is expected to be paid off in the next year. Actually, let me correct that, it’s about $34 million.
That is down from $67 million at year end last year and is about $75 million one year ago and in terms of the choice, what we do is the... It’s where the more aggressive credit offer is.
We offer longer term no interest through the third party and the shorter term is offered internally. Right now the biggest program is 12 months no interest, 12 equal payments, the internal program.
People have it there to choose. There is a size minimum purchase to get the more expensive or the more desirable credit programs, longer term free interest.
It takes a bigger purchase to get that so the financing side, you can have a small purchase and on the outside you get the better programs, you have to have a bigger purchase. We let the customer choose.
Our credit quality is very good from the customers that come in, that have reason to [inaudible] and so because of that, we’ve had approval rates over 85% over the years. We haven’t seen much of a change in that.
It’s come down some, a few points. In terms of coming up with a provision, we look at delinquency and the biggest factor is the status of the accounts, if they’re delinquent or if they have any problems that are on their credit files, we’ll reserve against it.
Then we also have a general reserve that’s based on a 1, 2, and 3 year look back of write offs as a percent of AR and that has been going up some and so we have increased our allowance for that reason but because the absolute dollar receivables has come down, our allowance for doubtful accounts on the balance sheet is actually a little lower than it was a year ago.
John Baugh – Stifel Nicolaus & Company, Inc.
Just refresh me, combining the outside credit and your credit, what typically is that as a percentage of your sales?
Dennis L. Fink
It was running in the 50% range and it has come back down in the quarter just ended. It was about 43% and that 43% is made up of about 8% inside and 35% outside of total sales.
Just in the year ago quarter, it was about 51% and the biggest decrease has come inside as I said before. One of the reasons we are more aggressive with credit offers last summer, we had a little longer terms available.
We were doing no interest until 2010 and 2011 so that was 42 months roughly or 30 months, one of those two programs, and we’re also allowing no down payments during that time period and back off of the minimum so that was a pretty liberal time credit wise. In terms of qualifying from the purchase standpoint, not from the credit quality, but it has come down.
People are... I could just make a generalization.
People who don’t have the money aren’t spending it, which sounds like [inaudible] but they’re not as quick to want to add debt.
John Baugh – Stifel Nicolaus & Company, Inc.
Clarence, quickly, any comment on the regional performance of the business?
Clarence H. Smith
Every region is weak right now. Texas is better than most and I don’t know if that’s going to hold.
I’m sure it was affected at some point by the increase in oil but we have weakness across our company.
John Baugh – Stifel Nicolaus & Company, Inc.
I’ve heard some people say in Florida in parts is showing signs of bottoming. Do you see that or is it still deteriorating?
Clarence H. Smith
I like that thought but let’s hope that’s what’s happening. It is very tough in Florida.
Operator
Your next question comes from Todd Schwartzman from Sidoti and Company.
Todd Schwartzman – Sidoti & Company
Clarence, you mentioned that you’re happy with the entertainment and home office sales during the quarter. Can you maybe speak to how bedroom has been trending and specifically maybe talk about youth versus adult bedroom?
Clarence H. Smith
Our bedroom category has always been strong and it continues to be. We’re happy with our program.
I would say that we want to improve our youth program and we will be adding to that. But we’ve had some challenges in the last several quarters in keeping in stock some of our better sellers.
We had to move some of the production from countries to different factories and we’re now back in stock on our best sellers as I mentioned. I feel good about our bedroom sales for the fourth quarter.
It’s a strong category for us.
Todd Schwartzman – Sidoti & Company
It sounds like adult might be faring a little better for the production region that you mentioned?
Clarence H. Smith
I would say right now it probably is just because we’re better in stock with it yes.
Todd Schwartzman – Sidoti & Company
Also in terms of Florida, do you have any sense now of the mix of sales in Florida or in your Florida stores or for delivery to Florida mix between consumers that are furnishing primary versus secondary or even part time residences?
Clarence H. Smith
I don’t think I have a good figure about part time versus full time residences there but I would say that they’re a lot fewer. In both cases we don’t give our particular percentages by region and I know in the past we’ve said we have about 25% of our stores and I think that’s about the same number right now but we haven’t given our percentages by region out.
Todd Schwartzman – Sidoti & Company
Do you track out of town sales to within various territories, various markets? For out of state deliver, specifically again, just trying to get a feel for how building is maybe bottoming in Florida versus --
Clarence H. Smith
We could get those numbers but that’s not something we normally track. I don’t think that’s a usual something analysis that we have.
Dennis L. Fink
We definitely know it because we know the billing address and the delivery address.
Clarence H. Smith
It’s a good question. I know where you’re heading there.
We’re all trying to find out when this thing is going to bottom in Florida.
Todd Schwartzman – Sidoti & Company
What I’m getting at of course is I would expect, and you probably I would think expect to see a little bit of an upturn in your shipments within Florida potentially before there’s any type of low single digit type increase in home sales down there because of the presence of the out of town consumer.
Clarence H. Smith
We’re moving into our season in Florida. This is historically the season, now through early spring, so we hope to see some better uptick and we’ll probably have a better feel in the next several months.
Operator
There appear to be no further questions, sir. Are there any other points you wish to raise?
Clarence H. Smith
No, I don’t, I just want to thank those for participating in our call and we appreciate your interest in having us. Thank you.
Operator
Ladies and gentlemen, this concludes the Haverty Furniture third quarter 2008 earnings release conference call. Thank you for participating.
You may now disconnect.