La-Z-Boy Incorporated: Fiscal 2019 Second-Quarter 10-Q Summary
Business Context and Reporting Period
La-Z-Boy manufactures, imports, distributes, and retails upholstered and casegoods furniture through its Upholstery, Casegoods, Retail, and Corporate and Other activities. The filing covers the quarter and six months ended October 27, 2018, compared with October 28, 2017. Results are unaudited.
The company operated 157 company-owned La-Z-Boy Furniture Galleries stores within a broader network of 353 Galleries stores and 543 Comfort Studio locations. During the quarter, La-Z-Boy acquired Joybird, an online upholstered-furniture retailer and manufacturer, and acquired two independent Furniture Galleries operators.
Financial Performance and Key Metrics
| Metric | Q2 FY2019 | Q2 FY2018 | Change |
|---|---|---|---|
| Sales | $439.3 million | $393.2 million | +11.7% |
| Gross profit | $174.4 million | $155.0 million | +12.6% |
| Gross margin | 39.7% | 39.4% | +30 bps |
| Operating income | $28.5 million | $34.3 million | -16.8% |
| Operating margin | 6.5% | 8.7% | -220 bps |
| Net income attributable to La-Z-Boy | $20.0 million | $22.9 million | -12.6% |
| Diluted EPS | $0.42 | $0.47 | -10.6% |
| Metric | Six Months FY2019 | Six Months FY2018 | Change |
|---|---|---|---|
| Sales | $824.0 million | $750.3 million | +9.8% |
| Operating income | $51.7 million | $50.6 million | +2.2% |
| Operating margin | 6.3% | 6.7% | -40 bps |
| Net income attributable to La-Z-Boy | $38.3 million | $34.5 million | +10.9% |
| Diluted EPS | $0.81 | $0.71 | +14.1% |
The quarter’s effective tax rate was 22.9%, versus 30.8% in the prior-year quarter. Management stated that the rate would have been 24.7% absent discrete adjustments. Dividends declared increased to $0.12 per share from $0.11.
Segment Results
- Upholstery: Sales rose 4.0% to $317.1 million, while operating income declined 3.8% to $32.2 million. The margin fell to 10.1% from 11.0%, primarily because of supply-chain inflation and unfavorable product mix, partly offset by price increases.
- Casegoods: Sales increased 11.8% to $31.4 million and operating income increased 13.9% to $3.8 million. The margin improved to 12.0% from 11.8%, despite higher imported-product freight costs.
- Retail: Sales increased 19.7% to $139.7 million and operating income increased 68.2% to $6.6 million. Growth reflected acquired stores, 4.0% delivered same-store sales growth, new stores, and improved cost leverage. Results included $1.1 million of incremental purchase-accounting inventory expense.
- Corporate and Other: Sales increased to $22.4 million, principally from Joybird, but the operating loss widened to $14.0 million from $6.4 million. Higher incentive compensation, Joybird operating and purchase-accounting costs, and the absence of a prior-year insurance gain contributed to the deterioration.
Cash Flow, Liquidity, Debt, and Capital Allocation
- Six-month operating cash flow was $46.1 million, down from $51.2 million. Cash generation was reduced by a $7.0 million discretionary pension contribution, $7.5 million of prepaid Joybird compensation, and increased inventories and other assets.
- Investing cash use was $102.1 million, including $78.1 million for acquisitions and $26.9 million of capital expenditures.
- Financing cash flow was $16.0 million, primarily reflecting $35.0 million borrowed under the credit facility, partly offset by $11.6 million of share repurchases and $11.3 million of dividends paid.
- Cash, cash equivalents, and restricted cash totaled $95.9 million at October 27, 2018, versus $136.9 million at April 28, 2018. Investments intended to enhance cash returns totaled $29.8 million.
- The revolving credit facility has a $150.0 million commitment, matures December 19, 2022, and had $35.0 million outstanding and $113.1 million of excess availability at quarter-end. The company was not subject to the facility’s fixed-charge coverage requirement.
- Management expected fiscal 2019 capital expenditures of $45 million to $50 million, primarily for the Innovation Center, manufacturing and plant upgrades, an England facility and office, and distribution-center relocation.
- During the first six months, the company repurchased approximately 0.4 million shares for $11.6 million. Approximately 6.3 million shares remained available under the repurchase authorization.
Material Changes, Acquisitions, and Accounting Items
- Joybird was acquired in July 2018 for guaranteed payments of $75 million, subject to working-capital adjustments, with additional contingent consideration. The filing recorded approximately $75.8 million of goodwill, a $6.4 million trade name, and a $3.3 million provisional earn-out liability. The undiscounted earn-out range was zero to $65 million.
- Two Furniture Galleries operators were acquired for aggregate consideration of $42.8 million, including $38.9 million of cash and $32.0 million of goodwill.
- Total goodwill increased from $75.3 million at fiscal year-end to $182.1 million, largely because of the acquisitions.
- The company adopted ASC 606 revenue recognition guidance using the modified-retrospective method. Adoption did not materially affect the amount or timing of revenue but changed presentation and disclosures.
- The company adopted investment-accounting guidance and reclassified a net $1.6 million cumulative adjustment from accumulated other comprehensive income to retained earnings.
- The company expects adoption of the new operating-lease standard in fiscal 2020 to materially affect the consolidated balance sheet because of its significant operating leases.
Outlook, Commentary, Risks, and Contingencies
Management emphasized profitable sales growth through expansion of company-owned stores, proprietary distribution, product innovation, digital marketing, e-commerce, and the Joybird platform. The Innovation Center was expected to be completed by the end of fiscal 2019. Management also expected to continue regular quarterly dividends and opportunistic share repurchases, subject to board approval and cash generation.
Key risks include consumer confidence and recessionary conditions, housing and credit markets, raw-material, labor, freight, logistics, tariff and trade-policy inflation, foreign-exchange movements, supply disruptions, product defects and warranty costs, information-technology failures, litigation, store expansion and lease terms, e-commerce execution, and potential goodwill or intangible-asset impairments.
Contractual obligations totaled $574.7 million, including $408.8 million of operating leases, $97.4 million of purchase obligations, $35.0 million of short-term debt, $23.8 million of future guaranteed payments, $3.6 million of contingent consideration, and $3.2 million of legal liabilities. The filing states that most purchase orders are generally cancellable before production begins.
The filing identifies no material changes to previously disclosed risk factors. Management reported effective disclosure controls and procedures; acquired Joybird and the Arizona store operations were being integrated and were excluded from management’s fiscal year-end internal-control assessment under applicable SEC guidance.
Important Facts for Investors to Verify
- Whether Joybird and the acquired stores can generate sufficient growth and profitability to offset their operating, advertising, retention, and purchase-accounting costs.
- The durability of consolidated margins amid supply-chain inflation, freight costs, tariffs, labor pressures, and product-mix changes.
- The amount and timing of Joybird earn-out payments, future guaranteed payments, and any changes to provisional acquisition accounting.
- Whether operating cash flow can support the planned $45 million to $50 million of capital expenditures, dividends, acquisitions, and share repurchases while maintaining liquidity.
- The utilization and covenant headroom of the revolving credit facility, particularly if cash needs or working-capital requirements increase.
- The impact of the anticipated operating-lease accounting adoption and the company’s significant lease obligations.
- Potential goodwill and intangible-asset impairment exposure following the increase in goodwill to $182.1 million.
- The final effects of the Tax Cuts and Jobs Act and any resulting changes to the effective tax rate.