HOOKER FURNISHINGS Corp Q1 FY2020 Earnings Call

Greetings, ladies and gentlemen, and welcome to the Hooker Furniture Quarterly Investor Conference Call reporting its Operating Results for the Fiscal 2020 First Quarter and Year. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Paul Huckfeldt, Vice President, Finance, and Chief Financial Officer for Hooker Furniture Corporation.

Thank you, Ashley. Good afternoon, and welcome to our quarterly conference call to review our financial results for the fiscal 2020 first quarter, which ended May 5, 2019. We certainly appreciate your participation this afternoon. Paul Toms, our Chairman and CEO; and Lee Boone, Co-President of our Home Meridian division, will join me for our prepared remarks. For the question-and-answer portion of the call, several other business unit heads will be available to take questions, including Michael Delgatti, President of our Hooker Domestic Upholstery and Emerging Channels; Home Meridian Co-President, Doug Townsend; Jeremy Hoff, President of our Hooker Branded Segment; and Anne Jacobson, our Chief Administrative Officer. During our call, we may make forward-looking statements, which are subject to risks and uncertainties. A discussion of factors that could cause our actual results to differ materially from management's expectations is contained in our press release and SEC filing announcing our fiscal 2020 first quarter results. Any forward-looking statement speaks only as of today, and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances after today's call. This morning, we reported consolidated net sales of $135.5 million and net income of $2 million or $0.17 per diluted share for our fiscal 2020 first quarter ended May 5, 2019. Compared to last year, our net sales decreased 5.2% or $7.4 million, and net income decreased 72% or $5.2 million. Earnings per diluted share decreased from $0.61 a year ago. Paul Toms will comment on our fiscal 2020 first quarter results.

Thank you, Paul, and good afternoon everyone. Our disappointing earnings performance in the first quarter was driven primarily by several cost-related issues in our Home Meridian HMI Segment. Reduced demand and soft retail conditions across the home furnishings industry drove the consolidated 5% sales dip, which also weighed on our earnings for the quarter. Given the sales decline and the impact of a 10% tariff on furniture and furniture component parts imported from China, our Hooker Branded Segment and All Other performed reasonably well for the quarter. So, we have strategies for improvement in all of our businesses. The cost-related issues at Home Meridian included a large quality chargeback, higher freight, and demurrage costs as well as costs associated with our inventories. In addition, Home Meridian's margins were more affected by the 10% tariff on imports from China and our other business units due to the nature of HMI's customer base as many of its customers had large orders already in the pipeline at lower pre-tariff prices. However, increased pricing and sourcing strategies are in place. Our planned shift of production out of China to non-tariff countries is mostly on schedule. In fact, the shift is accelerating during the current quarter and is expected to be mostly complete by the end of the fiscal third quarter. As we reported in our fourth quarter earnings release in mid-April, orders and backlogs were down in February and March, and continue to be down throughout April. Reduced demand negatively impacted sales across all our business units and was experienced consistently across the industry according to the reporting of most public furniture companies and what we've heard from conversations with our retail customers. We've been encouraged, however, by the mid-single-digit uptick in orders during the fiscal May period in our Hooker Branded Segment. We believe Home Meridian's order rates remain below prior year due to many of their larger customers still delaying receipt of shipments and placement of reorders in response to the softer retail environment faced in the early part of the year. We expect to see Home Meridian orders start to improve during the fiscal 2020 second quarter, and for our second-half performance to be much better for this segment. Due primarily to the loss of margin in the HMI Segment, gross profit and operating income both decreased approximately $6.5 million in the quarter. The decreased operating profit in the Hooker Branded Segment was mainly attributable to lower net sales. We're addressing all these challenges with strategies to improve profitability in each of our businesses. While we do expect the challenges to persist throughout the summer, we're more optimistic about the fall selling season. We believe that many of these issues negatively impacting profitability at Home Meridian are unlikely to recur. These include the large quality-related chargeback, which was confined to a single customer and limited product, demurrage costs, excess freight costs at year-end, delayed implementation of tariff-prompted price increases, and postponed shipments to a few large retailers. While the majority of our operating units are in the residential furniture industry, it's noteworthy that both of our non-residential business units, Samuel Lawrence Hospitality and H Contract reported significant sales increases during the quarter. SLH sales more than doubled and ended the quarter with a backlog nearly 70% higher than during the same period last year, while H Contract had an approximate 40% sales increase along with improved gross margins and operating profits. Other business units that performed well in the quarter included Hooker Upholstery, which had a 3% sales increase and incoming orders 5% higher than a year ago. In the Home Meridian Segment, Accentrics Home, which is dedicated to emerging channels such as e-commerce, grew sales by nearly 20%. Turning now to the economy as a whole, the most significant macroeconomic development so far this year has been the increased tariff imposed on furniture and furniture components imported from China. Finished furniture and component parts shipped from China after May 10, 2019 became subject to an additional 15% tariff. The additional amount brings the total tariff on furniture imports from China to 25%. As of February 2019, Hooker Furniture Corporation imported over 40% of our product line from China. By segment, our strategies to address the increased tariffs include at Home Meridian, the company's PRI value-priced upholstery division is resourcing production away from China, projecting that 90% of production will be in non-tariff countries by the fall. Other divisions are moving production in non-tariff countries to a lesser degree. Home Meridian is also receiving vendor price concessions from many Chinese producers and raising prices to customers where possible. Hooker Casegoods and Hooker Upholstery are passing on most of the increased tariff costs beyond the amount offset by vendor concessions in the form of a surcharge that can be reversed if and when tariffs are dropped or reduced. Hooker Upholstery is moving a significant portion of their production outside of China in the coming six months. At Hooker Casegoods, our long-term relationship and the specialized craftsmanship of the company's main Chinese vendor makes moving entirely away from China a less desirable action. However, tariffs will be priced into all new items, and the vendor is opening a factory in Vietnam where some production can be shifted. The company is continuing to develop production in alternative countries and is receiving vendor price concessions from Chinese producers. Domestically produced upholstery divisions included in all other are enacting selected price increases and receiving vendor concessions to help mitigate the impact of tariffs on component parts imported from China. Taking a closer look at each of our segments, I'll begin with the Hooker Branded Segment. As mentioned, given the sales decline and the business disruptions from the initial 10% tariff, this segment performed well. Our net sales in this segment were down $3.2 million or 7.4%. This segment was still highly profitable with a 13% operating margin during the quarter, and upper single-digit sales increase in Hooker Casegoods was partially offset by Hooker Upholstery's 3% sales increase. All Other, which includes domestically produced upholstery divisions, Bradington-Young, Shenandoah, and Sam Moore, along with H Contract, reported a net sales decrease of $1.2 million, or 4.2%, from $29.5 million in last year's first quarter to $28.3 million in the current first quarter. Lower sales were driven by reduced shipments in our domestic upholstery manufacturing divisions, partially offset by continued growth at H Contract, which specializes in furnishings for senior living and retirement communities. Profitability performance in the segment was solid, with the segment reporting an operating income margin of approximately 10%. A new Sam Moore Division President joined the company shortly after the end of the quarter and will focus on growing the top line through helping Sam Moore transition into a more robust full-line upholstery resource with a broader selection and better selling programs. At this point, I'd like to turn the call over to Lee Boone to give more detail on the HMI segment this quarter.

Thanks, Paul. Home Meridian sales decreased $3 million or 4.2% compared to last year's first quarter, and we reported a $5 million operating loss in the quarter. Higher than expected non-recurring quality-related charges in the quarter negatively impacted sales by $2.1 million or 3%, and accounted for about 40% of the segment's quarterly operating loss. Home Meridian's profitability was also negatively impacted by import tariffs that were not fully recovered in selling prices; excessive freight costs and business disruptions from the resourcing of production away from China. Divergence and per diem cost due to port congestion and delays by us and some customers on receipt of inventory also contributed to high cost of goods sold for the quarter. Management is implementing numerous countermeasures to improve top line and bottom line results. Top line initiatives include new product and licensing initiatives with mega accounts, as well as a new container mixing warehouse in Vietnam, operational this month, which will enable retailers to mix products from multiple factories on individual shipping containers. Countermeasures to improve profitability include sourcing moves away from China and underperforming factories, pricing improvements with select retail customers, elimination of certain low margin products, and focused spending reductions. Unfortunately, the recently increased tariff rate of 25% on China-sourced goods will continue to impact results into Q2, hopefully to a lesser degree, as we continue to move production to other countries. Our countermeasures to mitigate tariffs are well underway. We have adjusted pricing on all goods remaining in China to make up margin losses, and we're making good progress resourcing production to Vietnam and Malaysia. Approximately 50% of our PRI upholstery production will be produced in Vietnam by the end of Q2, and roughly 90% is scheduled to move by this fall. Not only will these moves solidify our new upholstery base outside of China, they will deliver higher margins on the transferred products. In addition to motion upholstery, we are shifting production of other merchandise categories away from China, including hospitality furnishings, kitchen cabinets, accident case goods, and upholstered headboards. Last year, 35% of Home Meridian production came from China. By year-end, we expect that number to be less than 15%. Sluggish furniture retail conditions industry-wide in Q1 resulted in reduced orders, customers requested shipping delays, and corresponding lower sales. The biggest shortfall was in our clubs business where we did not receive a reorder of a major upholstery purchase from last year. In addition, a few of our largest retailers experienced significantly lower sales in Q1 which combined with long supply chain lead times and the recent tariff increase caused them to delay and cancel orders in Q1 as well as Q2. Q1 results were also negatively impacted across all business units by unusually high freight and container expenses resulting from logistical backups, retailer warehouses, and Home Meridian's stateside warehouses. These issues are costly, but temporary problems and we're working with each individual customer and warehouse location for a quick resolution. We expect significant improvements in Q2 and beyond. The combination of all these issues occurring on top of lower sales volume in Q1 led to the operating loss for the quarter. In addition to the remedial actions outlined above, Home Meridian is conducting a thorough profitability review to improve feature results. Additional margin improvements will come from re-pricing merchandise of certain mega accounts, the elimination of low margin products, and targeted spending reductions across the company. On a more positive note, Home Meridian launched a new mass channel division in Q1 that is dedicated to developing business with mass retailers. The core product line of the new mass merchant's division is ready to assemble or RTA furniture, a new category for HMI, representing significant incremental sales and profit growth opportunity. Two experienced leaders have been hired from the industry, who will develop the business this year, for shipments that are targeted for Q4. Fortunately, we are beginning to see some strengthening in our incoming orders as strong Memorial Day sales delivered better results. We are well-positioned to benefit from improving retail conditions as they develop. We've not lost space at retail, and in fact stand to gain placements with many of our largest customers with a wave of over 30 new product programs that are scheduled for shipment in Q2 and Q3. Despite the poor performance in Q1 and the remedial actions underway, Home Meridian management is convinced our overall strategy is sound and will deliver long-term results as well as enhance shareholder value.

Thank you, Lee. Consolidated average selling prices increased 4.9%, mostly due to favorable product mix from our customer base, but that was not sufficient to offset the unit volume decrease of 8.7%, which resulted from decreased order volumes in both our reporting segments and in all other. Unit volumes are down high single-digit to low double digits across all of our segments. Consolidated gross profit decreased $6.4 million to $25.5 million for the fiscal 2020 first quarter, and decreased from 22.4% to 18.8% as a percent of net sales. Hooker branded gross profit decreased both in absolute terms and as a percent of net sales due to lower Hooker case goods sales, and to a lesser extent increased product costs, partially offset by the increased sales and higher gross margin in our Hooker upholstery division, which is benefiting from well-placed product introductions last year. Gross profit significantly declined in absolute terms and as a percentage of net sales in the Home Meridian segment. As we've already discussed, the margin was negatively impacted by quality chargebacks, unrecovered tariffs and freight charges, and some lower margin sales programs that we've been working to improve, as well as increased warehousing and distribution costs. Gross margin decreased slightly in absolute terms, but increased as a percent of net sales in all other, primarily due to increased sales and profitability in contract and moderately lower material costs in our domestic upholstery units, partially offset by higher direct labor and overhead as a percent of sales, which is attributable to the lower volumes. Consolidated selling, general, and administrative expenses stayed essentially flat, but increased as a percentage of sales due to the lower sales in the quarter. Higher employee compensation and benefits costs were offset by lower selling expenses on the lower sales volume. Recognition of a deferred gain of about $275,000 related to the sale of a former distribution facility partially offset the absence of a $1 million gain on company-owned life insurance, which was recorded in this quarter last year. For these reasons, operating income from fiscal 2020 first quarter decreased $6.5 million to $2.9 million. Operating margin decreased from 6.6% to 2.1%. On the balance sheet, our cash balance increased $16.8 million from the fiscal year 2019 year-end to $28.3 million. We generated $20.3 million in cash from operating activities, much of it from the collection of accounts receivable that was outstanding at the end of the fiscal fourth quarter, and $1.4 million in proceeds from the sale of that former distribution facility, which we had owner-financed. I should also note that we adopted ASC 842, the new leased accounting standard this quarter, which put about $44 million of new assets and a similar liability on our balance sheets. At the end of the fiscal 2020 first quarter, we had access to $27.7 million on our revolving line of credit and $24.5 million of cash surrender value of our company-owned life insurance, which gives us considerable financial flexibility. Now I'll turn the call back to Paul Toms for some closing comments and his outlook.

Thanks, Paul. While we were glad to see mid-single-digit improvement in orders in the Hooker branded segments so far in the second quarter, the order activity is inconsistent across divisions. Overall, the residential furniture industry is experiencing deflated demand and somewhat sluggish retail conditions. We expect the newly enacted 25% tariff on Chinese imports to cause some additional business disruptions in the industry throughout the next several months. We're more optimistic about the second half of the year and expect demand to increase to normal or above-average levels beginning around Labor Day, and continuing into the fall, which is traditionally the strongest season of the year for furniture sales. We also expect that some of our large retail customers will have completed their rebalancing of inventories and be in a better position to receive new products. Both short-term and long-term, we're addressing all of our challenges, and in almost every division, we have active strategies to expand our business beyond the current product line and customer base. We remain confident in our business model and strategies, and in our strategic execution, and are making the necessary investments both capital and human to perform at a very high level. This ends the formal part of our discussion, and at this time, I'll turn the call back over to our operator Ashley for questions. Thank you.

Thank you. Your line is open.

Yes, good afternoon, and thank you for taking the questions. So I wanted to get just a better understanding as far as HMI, the larger loss, just in terms of what was kind of non-recurring versus recurring. I know you guys gave some details as far as the quality-related chargeback of 2.1 million, just wanted to get a better sense of the magnitude of cost related to the higher freight and demurrage costs as well as the higher costs related to inventories?

Freight costs related to the return from the fourth quarter filled up the warehouses, which required us to use temporary warehouses. This situation resulted in additional per diem and demurrage charges that extended into the first quarter, and we will see a bit of this in the second quarter as well. However, these issues will resolve by the third and fourth quarters. The return charge and the quality charge were one-time events that we do not expect to recur.

Got it. Okay, all right. And then, so back in the fourth quarter, there was also a product quality issue from an agent vendor, so is this related to that, or is this just a spillover from the fourth quarter, or this is a separate issue?

The freight charges and the extra warehouses are related to that return. We actually didn't get the returns until Q1, and so that's when the freight charges came, but we had to accrue for it and talked about it in Q4.

Thank you for that information; it's helpful. As you're moving product sourcing away from China, can you provide us with your expectations for the percentage of sales or imports from China by the end of the fiscal year?

This is Lee, Anthony. By year-end, we anticipate having 90% to 95% of the China production moved out of China that we intend to move, not 100% will be moved out, because there are not appropriate places to move a small part of it, but 90% to 95% will be moved by the end of this year...

Right, but is that specifically for Home Meridian, or is that for the company as a whole?

That's for Home Meridian.

Home Meridian, but my question was just in terms of Hooker Furniture Corporation as a whole?

If our reliance on China was 40% at the end of last year, I would think by the end of this year it would be closer to 20%.

Got it. Okay, that's very helpful. Okay…

I do think we have strategies in place between concessions by vendors and price increases to mitigate most of the impact of the 25% tariff on the products that remain in China.

Got it, okay. Thank you for that. And also, as far as your inventories, where would you expect those to be at the end of the fiscal year?

I’m not sure what the model reflects, Anthony, but it’s likely similar to our current situation. A part of our business, which includes inventories particularly in e-commerce for Home Meridian and Hooker, as well as the interior design sector and smaller foundational accounts, is expected to grow overall, meaning we will require more inventory to support higher levels. Currently, we have around $10 million to $12 million more inventory than necessary, with half of that relating to returns from the fourth quarter and the other half due to inventory build-up as business slowed, despite having placed orders anticipating higher demand. So, while the inventory levels may remain similar to now, the composition will likely change and should align better with future demand.

Thank you for that information. Regarding HMI, you mentioned some top line initiatives with major accounts. Was that a reference to the RTA, or is there anything else included in those top line initiatives?

So, the RTA initiative is primarily a fiscal year 2021 start. We might get shipments in Q4 this year, but it won't help this year a lot. The top line initiatives are more sales programs of existing product categories with our mega accounts and our newer licensing initiatives that will be launching at the October market.

Got it. Okay, so thank you for that. And you also talked about your non-residential sales doing well. So what percentage of your total sales is that now?

7%, 8% of HMI sales, and that's probably $40 million combined between SLH, so 7%, something like that.

Got it. Okay. Okay, got it. And then, lastly, do you have any updated thoughts on your capital allocation plans, just overall how are you thinking about cash flow priorities now?

I think right now we're going to manage the business in the short term. Given the uncertainty about tariffs, we need some cash cushion. This approach has served us well in the past, allowing us to avoid decisions based solely on cash generation. Therefore, in the short term, our capital allocation will remain steady. We continue to believe that strategic acquisitions are the best long-term use of cash to further diversify the company and enhance our presence in underrepresented niches. We are also maintaining our dividend, having recently declared the same $0.15 dividend as before, and we plan to continue that. The current goal is to conserve capital and see how the rest of this year unfolds, while also looking to make strategic acquisitions once things stabilize.

Got it. Okay. So, would you need the tariff issues to go away before you would consider making any acquisitions?

I don't think 'go away,' but I think just get them under control.

Got it. Okay. All right, well, thank you so much.

Thank you. And our next question comes from the line of Todd Lechtenberger with Amalfi Fund. Your line is now open.

Thank you, gentlemen. Just quickly, in a broader context, you mentioned in the press release and your comments that you expect demand to return to normal or exceed average levels starting around Labor Day. Can you elaborate on that expectation, especially considering the recent softness? What leads you to have that belief?

Okay. This is Paul Toms, and I believe there are several points to consider. First, we've observed improvements in business in May, particularly around Memorial Day, compared to most of the first quarter. This positive trend isn't uniform across all divisions, but it's evident in multiple areas. The first half of the year was marked by a lot of uncertainty due to tariffs, the government shutdown, and a very volatile stock market at the end of December. We feel that those challenges are behind us. While additional tariffs remain, we have strategies to manage those, and I hope others do as well. As we move through the summer, the housing sector looks more promising right now with declining interest rates, moderating home prices, and increasing inventories, indicating improvement in that sector. I can't identify a single reason for the earlier downturn in business, but overall, things seem to be getting better, as I've mentioned. Large customers appear to impact our business more than we impact theirs, as they started this period with more inventory than necessary. Consequently, they have paused and indicated that they don't need the products they initially ordered, and might be reconsidering those orders. This has delayed both their reorder placements for current merchandise and new orders for additional products. However, I believe that as their business improves, which it seems to be doing modestly following Memorial Day, they will begin to adjust their inventory levels. Lastly, I anticipate that the fall will be the strongest selling season, beginning with Labor Day, and I expect that trend to continue this year.

Okay, thank you very much.

Sure.

Thank you, ladies and gentlemen this concludes today's Q&A session. I would now like to turn the call back over to Paul Toms for any closing remarks.

Well, don't have any additional remarks, but we appreciate you joining us for the call. We hope to have better results to report in September, and thank you for joining us today. Good day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude today's program, and you may all disconnect. Everyone have a wonderful day.