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Haverty Furniture Companies Inc. (NYSE:HVT)
Q3 2019 Earnings Call
Oct 31, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good day, and welcome to Haverty's third-quarter 2019 financial results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Richard Hare. Please go ahead, sir.

Richard Hare -- Executive Vice President & Chief Financial Officer

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

Our President, CEO and Chairman Clarence Smith will now give you an update on our results and provide commentary about our business.

Clarence Smith -- Chief Executive Officer and Chairman

Good morning. Thank you for joining our third-quarter conference call. Our sales were slightly down from last year. However, we were pleased to have positive written sales up 1.6%.

Our sales continue to be driven by the increasing average ticket, up 4.7% and the solid double-digit growth in custom upholstery. Traffic is down low single digits with a level closing percentage, while our comparative store sales decreased 0.4%. This is an improvement from the last three quarters' performance. The timing and impact of Hurricane Dorian threatening Florida and the Atlantic coastal stores over Labor Day week was particularly unfortunate.

Labor Day week is our largest and most important sales event of the year, leading into the fall selling season. We were impacted due to the unknown but constant threat of landfall from Southeast Florida to Virginia for almost two weeks. While we don't like to give weather reports, we'll point out that this disruption did impact our written and delivered sales for the third quarter. Over the Labor Day weekend, Dorian affected 11 markets from West Palm Beach to Norfolk, forcing us to close 25 stores from one to three days.

Due to the storm being a Category 5, it affected our business five -- or three to five days before the storm passed each market due to the necessary storm preparations. We experienced no damage to our stores due to the storm. We believe that we'll catch up much of the ground in the fourth quarter. We've built a backlog of undelivered sales up 17% due to several factors.

The factory disruptions related to the 25% Chinese tariff have impacted us more than we expected. The disruptions related to relocating the factories coming out of the ground, primarily in Vietnam, hiring and training new workers and working with the less developed infrastructure impacted key products and important categories more than our suppliers or we expected. We had to move production to other countries and redesign products to adapt to different factories. Several factories chose to stop production of best-selling products in China due to the tariff.

Our sourcing and merchandising teams have been working closely with our suppliers and expect that most of this disruption related to the tariff and its impact on in-stock and deliveries will be behind us by year-end or early first quarter. We had a decline in our gross margins of 130 basis points due to several different pressure points, the pricing burden from the 25% China tariff, along with the pressure to close out the dropped products due to the tariffs, combined with increasing freight charges, were the primary reasons for the drop in gross margins. We were more aggressive in some of our promotions this past quarter and in several of our categories, which did have an impact. We feel that we're in much better position to improve our gross margins going forward.

We have a great deal of new merchandise arriving in the next weeks and months. We partnered with the strongest U.S., Chinese and Vietnamese factories, and our team feels we have the best lineup of better quality furniture that we've ever had. We're developing new products quicker to react to our customers' taste. We've added important lines to our rapidly growing special order programs and work with all of those suppliers to ship in weeks rather than months.

We've been aggressively working to reduce our discontinued and off-price goods. In the last two years, we've reduced this category by over half by better inventory management and by running these products through clearance centers. Because of these improved effectiveness, we are in the process of closing our largest dedicated outlet in Atlanta at the end of the year. We've identified several stores to handle the discontinued product going forward, and we feel that we'll be able to reduce our markdowns and the cost of handling and managing closeouts with less operating costs going forward.

Our capex plans for this year and 2020 are heavily weighted toward additional investments in IT and operating systems to better understand, reach and serve our target customer. All our teams are committed to providing the finest customer experience from engagement on our website, in-store presentations, each designed to the final delivery and service. Every contact with our customer is a Haverty's team member because we believe controlling the entire customer journey is critical to building the Haverty's brand. We're pleased with the two stores that we opened in the third quarter, our reentry into St.

Louis after 93 years and a new store in Newnan, Georgia, a fast-growing market southwest of Atlanta. We'll have a relocation of our Baton Rouge store late this quarter. We expect to end the year with 121 stores, one over last year. For 2020, we expect to add a few new stores in our existing distribution footprint.

We're pleased with the store locations we have in our markets, focusing on higher-quality furniture and fashion, and we're positioned to grow our business and build profitable market share. I'm going to turn it back over to Richard.

Richard Hare -- Executive Vice President & Chief Financial Officer

Thank you, Clarence, and good morning. In the third quarter of 2019, sales were $209.3 million, a 0.6% decrease over the prior-year quarter. Our comparable store sales were down 0.4% for the quarter. Our gross margin, our gross profit margin, decreased 130 basis points to 53.5% due to merchandise pricing and mix as we had slightly more aggressive promotions, coupled with higher product and freight costs during the quarter.

In addition, tariffs and increased product costs generated a higher LIFO reserve. Selling, general and administrative expenses increased $976,000 to $104.2 million. This increase was largely driven by increased healthcare costs over the prior-year period. Other income was de minimis during the third quarter.

However, in the prior-year quarter, we recorded a loss on the disposal of some property that had been used as a drop site, which resulted in a total of slightly over $700,000 of expense. We recorded net interest income of $292,000 in the third quarter of 2019. We recorded net interest expense of $260,000 in the third quarter of 2018, resulting in a variance of $552,000 over the prior-year period. This variance is the result of the adoption of the new lease accounting standard we adopted in the first quarter of 2019.

Income before income taxes decreased $3 million to $8.2 million in the third quarter of 2019 versus $11.2 million in the same quarter last year. Our tax expense was $2.1 million during the third quarter of 2019, which resulted in an effective tax rate of 25.4%. In the prior-year period, tax expense was $2.9 million, which resulted in a tax rate of 25.5%. The primary difference in the effective tax rate and the statutory rate is due to the state income taxes and the tax impact associated with vested stock awards.

Net income for the third quarter of 2019 was $6,097,000 or $0.31 per diluted share on our common stock, compared to net income of $8,352,000 or $0.39 per share in the comparable quarter last year. Now turning to our balance sheet. At the end of the third quarter, our inventories were $99.9 million, which was down $8.4 million over the prior year's third-quarter balance and down $5.9 million over the fourth quarter of 2018. We ended the quarter with $89.5 million of cash and cash equivalents, and our $60 million revolving credit facility remains untapped.

And as a reminder, the company has no funded debt. In September of 2019, we amended and extended our $60 million revolving credit agreement. The maturity date was extended out five years and will now mature in September of 2024. The terms and conditions are basically the same.

We did get some slight enhancements of relief on some of the mechanical aspects of certain covenants. For additional information, please refer to the exhibits contained in our third-quarter 2019 Form 10-Q, which will be filed tomorrow. Looking at some of our uses of cash flow, capital expenditures were $4.7 million for the third quarter of 2019. We also paid $3.9 million in regular quarterly dividends, representing $0.20 per common share.

We purchased $1.5 million of common stock, which equates to 83,348 shares during the third quarter of this year, and we have $16.9 million remaining under current authorization in our buyback program. As previously disclosed last quarter, on January 1, we adopted the new lease accounting standard that requires companies to capitalize their lease obligations on their balance sheet along with additional qualitative and quantitative disclosures. Further details regarding our implementation of this standard are included in the notes included with the financial statements and our Q3 2019 earnings press release. In addition, our earnings release list out several additional forward-looking statements, including our future expectations of certain financial metrics.

I will highlight a few, but please refer to our press release for additional commentary. In 2019, we continue to expect our gross profit margin for the full year to be approximately 54.1%. Fixed and discretionary type expenses within SG&A are expected to be in the $257 million to $258 million range for 2019. Variable SG&A costs for 2019 are expected to be 18.4% as a percentage of sales.

Our planned capital expenditures for 2019 is $18.5 million, which includes the opening of three locations. We expect our overall effective tax rate in 2019 to be 25%, excluding any impact from the vesting of stock-based compensation awards. Our federal tax rate is expected to be between 1%, and state and local taxes make up the remaining difference. This completes our commentary on the third-quarter financial results.

We appreciate your participation in today's call. Operator, now, we would like to open up the call for questions.

Questions & Answers:


Operator

[Operator instructions] Our first question will come from Bobby Griffin with Raymond James.

Alessandra Jimenez -- Raymond James -- Analyst

Good morning. This is Alessandra Jimenez on for Bobby Griffin. Thank you for taking my question. First, I wanted to dive a little into the production flow issue.

Can we get a sense of what your China exposure is now?

Clarence Smith -- Chief Executive Officer and Chairman

We think it's somewhere around $70 million. That's down from, well, it's down almost -- from $125 million or so. Richard, is that right?

Richard Hare -- Executive Vice President & Chief Financial Officer

Yeah, we've gone down from 30% of our raw materials coming from China down to about a little under 20% -- about 18%. So -- and you've seen a corresponding increase in our Vietnam exposure.

Alessandra Jimenez -- Raymond James -- Analyst

OK. And then what number do you think we could get that down to?

Clarence Smith -- Chief Executive Officer and Chairman

Well, I don't think we know exactly. There's a lot in flux now about the tariff. We do have a number of significant important Chinese suppliers who we don't think can move the product or will move the product and -- that we're still buying from. So it will be reduced from where it is, but I don't know how much down.

Alessandra Jimenez -- Raymond James -- Analyst

OK. And then from a gross margin perspective, can you quantify the puts and takes of gross margin decline in the quarter? And how you view those impacts moving forward into the fourth quarter?

Clarence Smith -- Chief Executive Officer and Chairman

Yeah. I'd say, we've declined 130 basis points. For the year, our guidance remains the same, as we mentioned last quarter. But this particular quarter, about a third of it was tariff related, either product prices or LIFO, and then two-thirds was our more aggressive promotions during the quarter and our increased freight.

Alessandra Jimenez -- Raymond James -- Analyst

OK. And then lastly, can you give us the breakout of fixed and variable SG&A for the quarter for our model?

Richard Hare -- Executive Vice President & Chief Financial Officer

Sure. For -- variable for the quarter was $38,104,000 million or 18.2%, and fixed and discretionary was $66,057,000 or 31.6% of net sales.

Alessandra Jimenez -- Raymond James -- Analyst

OK. Thank you, and best of luck on the fourth quarter.

Operator

Thank you. Our next question will come from Brad Thomas with KeyBanc Capital Markets.

Brad Thomas -- KeyBanc Capital Markets -- Analyst

Hi, good morning, Clarence. Good morning, Richard. I wanted to focus on what I thought was a real bright spot in the business, the written comps and the strong custom orders. And I guess, I was hoping we could maybe piece it a little bit and you could give us a little context for -- do you have any sense for how much of a headwind to those written orders you think the hurricane was?

Clarence Smith -- Chief Executive Officer and Chairman

Wow. Richard, do you want to give any guess on that one?

Richard Hare -- Executive Vice President & Chief Financial Officer

Well, it's -- Brad, it's a great question. It's hard to quantify, but let me just give you some background on our written business during the quarter. So starting in July, we had really strong written business in the mid-single digits. And in August, it was up about 9%.

And then in September, we basically gave August back. It was down about the same, a little bit more. So you can kind of see that Labor Day, the issues that were there, among other things, kind of created that. We basically gave up August and September with our written business.

Overall, we're up 1.6% for the quarter. And as Clarence mentioned in his prepared remarks, we have a really strong backlog of undelivered sales up about 17%.

Brad Thomas -- KeyBanc Capital Markets -- Analyst

That's great. That was going to be my follow-up. As you -- I mean, we can see the customer deposits from the outside, it looks like that's up about 14%. As we think about sales in the fourth quarter, any degree to which you can help us think about quantifying what sort of a lift you might get, either in dollars or in percentage terms as you work to deliver some of that strong backlog?

Clarence Smith -- Chief Executive Officer and Chairman

Well, we typically avoid any kind of sales type guidance. Obviously, we feel good about going into the quarter with our backlog up 70%. And we'll just kind of have to see how it plays out.

Brad Thomas -- KeyBanc Capital Markets -- Analyst

Gotcha. And -- but just directionally, do you feel like you're in a good position from an operations standpoint to work down that backlog and to get a benefit to your sales in the fourth quarter from that?

Clarence Smith -- Chief Executive Officer and Chairman

Yeah, we do. I mean, we expect that backlog to come down significantly by the end of the quarter. How much is still to be determined because a lot of the stuff is in flux. I mean, it's on the water.

We certainly hope to be able to take advantage of it, but it's just -- there are still unknowns about how that's going to play out.

Brad Thomas -- KeyBanc Capital Markets -- Analyst

And then just big picture, Clarence, I mean, as we think about the disruptions that you all in the industry have faced this year from tariffs. Do you feel like that is starting to work its way through the system that you can see where maybe end insight might come that your supplier relationships are going to be a bit more sticky with what you have set up at this point? I guess, said another way, is there a point where you think that this will get a little bit more back to normal?

Clarence Smith -- Chief Executive Officer and Chairman

Well, that's what we're expecting back to normal, both this quarter and into the first quarter because we do have a lot of goods that we know are coming, we expect to get in by the end of the year. Some of it will carry over. There's just a lot of pressure on these factories. As you know, everybody is trying to go to Vietnam at the same time, getting the product out and getting it on time has really been a struggle.

And I think that is being fleshed out and worked out. There'll still be problems. You can't move that much product into brand-new factories and expect it to get out exactly the way you want it from the start. So we do feel a lot better about it.

We met with our team this morning. Again, they feel that by end of the year and certainly, end of the first quarter, that should be eliminated.

Brad Thomas -- KeyBanc Capital Markets -- Analyst

Great. Thank you so much for the details, and good luck.

Operator

Thank you. [Operator instructions] Our next one will come from the Anthony Lebiedzinski with Sidoti.

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

Thank you, and good morning, fellas. So thank you for taking the questions. Just wondering how are you guys thinking about overall your promotional strategy and the third-party credit as well? Will you be looking to do more of the same? Or perhaps maybe dial up the promotions, just kind of wanted to get some better kind of clarity about that? How are you thinking about that?

Clarence Smith -- Chief Executive Officer and Chairman

We were pretty aggressive in the third quarter, primarily around Labor Day and the follow-up after that to try to gain back some business. I don't see us as getting more aggressive than that. And I think it is expensive to promote credit. We will be doing it.

We'll be doing it a little more focused. I don't see that we'll be more promotional going forward. I think it's going to be well planned, tighter and I think more effective going forward including this quarter.

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

Got it. And then as far as your penetration of your H Design program, where are you now? And where do you think that will ultimately go to?

Clarence Smith -- Chief Executive Officer and Chairman

It's still increasing. It's in the mid-20 percentage, and I think it will continue to go up. I don't see it going up rapidly. I think probably into the high 20% would be the objective and where we'd see it leveling off.

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

Got it. OK. And lastly, you guys talked about opening a few new stores next year. Kind of wondering as far as the timing of that? And also, do you anticipate any store closings next year?

Clarence Smith -- Chief Executive Officer and Chairman

I think we'll net a couple of stores next year, several, two or three. They're in process. Leases are not finalized, and we don't announce those until they are, and that takes some time. So it will be late in the year probably when those come online.

In the second half anyway.

Operator

Thank you. [Operator instructions] I am showing there are no further questions in the queue at this time.

Clarence Smith -- Chief Executive Officer and Chairman

Well, thank you for your participation in today's call. We look forward to talking with you in the future when we release our fourth-quarter results.

Operator

[Operator signoff]

Duration: 24 minutes

Call participants:

Richard Hare -- Executive Vice President & Chief Financial Officer

Clarence Smith -- Chief Executive Officer and Chairman

Alessandra Jimenez -- Raymond James -- Analyst

Brad Thomas -- KeyBanc Capital Markets -- Analyst

Anthony Lebiedzinski -- Sidoti and Company -- Analyst

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