Havertys Furniture Companies, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
Havertys is a single-segment retailer of residential furniture serving middle- to upper-middle-income customers through company-operated stores and its website. The unaudited filing covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $210.5 million | $207.6 million | $608.8 million | $604.9 million |
| Gross profit | $115.4 million | $112.1 million | $332.1 million | $328.7 million |
| Gross margin | 54.8% | 53.9% | 54.6% | 54.4% |
| SG&A expense | $103.2 million | $102.1 million | $302.9 million | $299.3 million |
| Income before interest and taxes | $11.5 million | $10.2 million | $29.3 million | $30.8 million |
| Net income | $8.4 million | $6.0 million | $20.9 million | $18.2 million |
| Diluted EPS, Common Stock | $0.39 | $0.28 | $0.98 | $0.84 |
| Operating cash flow | Not separately provided | Not separately provided | $62.5 million | $48.7 million |
Q3 net sales increased 1.4%, while nine-month sales increased 0.6%. Comparable-store sales increased 2.6% in Q3 and 0.9% for the first nine months. The average written ticket rose 5.9% in Q3 and 3.7% year to date; custom upholstery sales increased 10.6% and 9.6%, respectively.
Q3 SG&A declined to 49.0% of sales from 49.2%; nine-month SG&A increased to 49.8% from 49.5%. Management attributed higher costs primarily to wages, temporary labor, fuel, compensation, commissions, benefits and third-party financing costs.
At September 30, 2018, cash and cash equivalents were $96.3 million and restricted cash was $8.2 million. Total assets were $473.6 million, total liabilities were $181.2 million and stockholders’ equity was $292.4 million. The company reported no funded debt. Lease obligations totaled $51.8 million, including $3.9 million current.
The $60.0 million secured revolving credit facility had no borrowings or letters of credit outstanding and $48.4 million of net availability. Management stated that operating cash flow and available cash should fund working capital, dividends, share repurchases and planned capital projects.
Material changes versus the prior comparable period
- Net income increased 39.6% in Q3 and 15.0% for the first nine months, aided by higher sales, improved gross margins and a lower effective tax rate.
- The nine-month effective tax rate fell to 25.6% from 37.7%, primarily reflecting the lower U.S. statutory corporate tax rate under the Tax Cuts and Jobs Act.
- Nine-month operating cash flow increased $13.7 million to $62.5 million, principally from larger increases in accounts payable, accrued liabilities and other assets and liabilities.
- Investing cash use increased to $15.8 million from $14.3 million, including $18.2 million of capital expenditures versus $15.4 million.
- Financing cash use increased to $29.9 million from $11.0 million, primarily because of $14.5 million of common-stock repurchases and $11.3 million of dividends paid.
- Inventory increased $4.9 million from year-end 2017 to support expected demand and the fourth quarter. Net property and equipment declined $8.9 million as depreciation and disposals exceeded additions.
- The company adopted ASC Topic 606 and the restricted-cash cash-flow presentation standard on January 1, 2018. Management expects the revenue-standard adoption to have an immaterial ongoing effect on net income.
Guidance, outlook, risks and unusual items
- Management expected 2018 gross margin of approximately 54.5%, compared with 54.3% in 2017.
- Full-year fixed and discretionary SG&A was expected to be approximately $257 million to $259 million, versus $253.2 million in 2017. Variable SG&A was expected to be approximately 18.5% of sales, compared with 18.2% in 2017.
- 2018 capital expenditures were estimated at approximately $20.0 million. Store closures in Columbia, Sherman, North Richland Hills, Raleigh and Monroe were expected to reduce selling space by approximately 2.2%; a Chattanooga location was planned for Q4. Store closures were expected to be completed by year-end, with fill-in-market openings planned for 2019.
- The Western Distribution Center expansion was completed in Q3.
- Section 301 tariffs on certain China-origin furniture and components began at 10% on September 24, 2018 and were scheduled to increase to 25% on January 1, 2019. The company did not expect a material 2018 effect from the 10% tariff but stated that the 25% increase could pressure 2019 gross margins, operating profit, cash flows and demand.
- The company imported or purchased through suppliers approximately $100 million of China-manufactured inventory in 2017. It may be unable to fully pass tariff-related cost increases to customers or promptly secure alternative sources.
- Other unusual items included approximately $0.4 million of net real-estate-sale losses and $0.3 million of insurance-recovery gains in the first nine months of 2018, compared with $1.5 million of insurance-recovery gains in 2017.
- Undiscounted minimum commitments under noncancelable operating leases were approximately $136.3 million. Adoption of the new lease standard was expected in Q1 2019 and would place a substantial portion of these commitments on the balance sheet, without a significant expected effect on earnings or cash flows.
- The company disclosed ordinary-course claims and legal proceedings but did not expect them to have a material adverse effect. It reported no off-balance-sheet arrangements.
Investor verification priorities
- Verify the durability of comparable-store sales growth and the contribution from higher average tickets and custom upholstery.
- Assess whether tariff-related costs in 2019 can be offset through pricing, sourcing changes or product mix without weakening demand or gross margin.
- Monitor inventory growth, markdowns, LIFO adjustments and working-capital cash conversion.
- Reconcile the effects of store closures, planned 2019 openings and capital expenditures on selling capacity and future sales.
- Review the forthcoming lease-accounting adoption and its effect on reported assets, liabilities and leverage metrics.
- Confirm continued availability under the revolving credit facility and compliance with its covenants, including dividend-related limitations.
- Evaluate the sustainability of the lower effective tax rate and the effects of ongoing dividends and share repurchases on liquidity and share count.