It was back to the future for Motley Fool Hidden Gems recommendation Hooker Furniture
Optimism over the firm's new business model -- importing furniture made by others -- and the high-margin sales it offered gave way to disappointment when those margins failed to make an appearance in the first quarter of a new and improved fiscal 2008.
Sales declined 15% to $77.3 million for the quarter. Operating margins fell 230 basis points to 8%, and net profits fared even worse, dropping 26%. And while the company acknowledged that the top line would be difficult to improve in the recently sluggish retail environment, it looks as if the bottom line ended up providing the biggest challenge to management, as it tumbled more than 33%.
According to management, several factors contributed to the lower-than-expected profitability. First and foremost, when a manufacturer with a large manufacturing base (and make no mistake -- Hooker still has factories here in the U.S.) reduces its sales, it cannot use its fixed assets to full capacity. The resulting inability to use fixed assets in the most efficient manner almost by definition causes lower profitability. Exacerbating the situation, Hooker was unable to cut its advertising, warehousing, and distribution costs fast enough to keep up with declining sales. As a result, although absolute costs declined, costs as a percentage of sales increased -- hurting operating margins.
The good news
The good news last week was that, as I predicted, Hooker was able to keep selling down its inventories, freeing up working capital and transforming it into free cash flow. Inventories fell 34% year over year -- much faster than sales declined. This liquidated inventory helped Hooker generate nearly $20 million in cash from operations during the quarter. With capital expenditures falling (the more factories Hooker closes, the fewer investments it must make to keep factories in working order), the firm ended the quarter with free cash flow totaling $18.9 million.
The future
CEO Paul Toms described the furniture biz as still "sluggish" and predicted a continuation "at least through the summer months." That said, Hooker has completed its purchase of upholstered-furniture business Sam Moore from La-Z-Boy
But there is danger here: With a new business come new fixed assets. It seems to this Fool that absent a revival of the furniture market in general, Sam Moore's factories could suffer from underutilization fully as much as Hooker's own upholstered-furniture factories. I just don't see how adding manufacturing capacity in a weak sales environment will remedy matters. Tune in three months from now for the next installment.
Check out how Hooker did during its transitional quarter back in March:
Fool contributor Rich Smith does not own shares of any company named above. The Fool has a disclosure policy.
