La-Z-Boy Incorporated — Fiscal 2016 Second-Quarter Form 10-Q
Business Context and Reporting Period
La-Z-Boy manufactures, imports, distributes and retails upholstered furniture, casegoods and accessories through its Upholstery, Casegoods and Retail segments. The filing covers the quarter and six months ended October 24, 2015, compared with October 25, 2014. Fiscal 2016 is a 53-week year. The interim financial statements are unaudited.
The company operated 123 company-owned La-Z-Boy Furniture Galleries stores at the reporting date. During the first six months, the company-owned network increased by 13 stores, including 10 acquired stores and three new stores.
Key Financial Metrics
| Metric | Quarter Ended Oct. 24, 2015 | Quarter Ended Oct. 25, 2014 | Six Months Ended Oct. 24, 2015 | Six Months Ended Oct. 25, 2014 |
|---|---|---|---|---|
| Sales | $382.9 million | $365.6 million | $724.3 million | $692.6 million |
| Gross profit | $145.8 million | $129.9 million | $270.0 million | $241.4 million |
| Gross margin | 38.1% | 35.5% | 37.3% | 34.8% |
| Operating income | $33.4 million | $30.2 million | $53.4 million | $46.7 million |
| Operating margin | 8.7% | 8.3% | 7.4% | 6.7% |
| Net income attributable to La-Z-Boy | $21.0 million | $19.5 million | $34.6 million | $32.6 million |
| Diluted EPS | $0.41 | $0.37 | $0.67 | $0.62 |
| Cash flow from operations | Not provided for the quarter | Not provided for the quarter | $21.7 million | $31.8 million |
Interest expense was $0.1 million for the quarter and $0.2 million for the six-month period. Effective tax rates were 36.2% for the quarter and 36.1% for the six months, compared with 35.3% in the prior-year periods.
At October 24, 2015, cash and equivalents were $74.6 million, restricted cash was $9.0 million, and investments totaled $45.7 million. The company had $4.0 million outstanding under its revolving credit facility, with $139.4 million of excess availability under the $150.0 million commitment. Total debt, including current and long-term portions, was approximately $5.0 million.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 4.7% and six-month sales increased 4.6%, driven by higher Upholstery and Retail sales.
- Quarterly operating income increased 10.6%; six-month operating income increased 14.3%. Operating margin improved 0.4 percentage point for the quarter and 0.7 percentage point for the six months.
- Gross margin improved 2.6 percentage points in the quarter and 2.4 percentage points for the six months. Benefits included favorable product mix, supply-chain efficiencies, greater Retail sales mix and approximately 0.5 percentage point from legal settlements.
- SG&A as a percentage of sales increased 2.2 percentage points in the quarter and 1.7 percentage points for the six months. Higher incentive compensation, advertising, warranty costs, professional fees, ERP and e-commerce spending, and new-headquarters costs were significant factors.
- Upholstery sales increased 2.9% for the quarter and 3.3% for the six months; operating margin increased to 12.1% and 10.7%, respectively.
- Casegoods sales declined 2.3% for the quarter and 10.7% for the six months, principally because the hospitality product line was eliminated. Second-quarter margin also faced a comparison against a prior-year $2.0 million LIFO-reserve reduction.
- Retail sales increased 14.1% for the quarter and 16.3% for the six months. Retail operating margin improved to 5.9% and 5.7%, respectively, supported by custom orders, in-home design services, powered units and fixed-cost leverage.
- Net income comparisons benefited from the absence of prior-year discontinued-operation income, including a $2.4 million after-tax benefit in the first six months of fiscal 2015 related to a former subsidiary. Fiscal 2016 results contain no discontinued-operation income.
- Cash from operations declined to $21.7 million from $31.8 million, primarily because of a $21.5 million inventory increase and a $7.0 million pension contribution.
- The company repurchased $18.5 million of common stock during the first six months and paid $8.1 million of dividends. Approximately 5.0 million shares remained authorized for repurchase at October 24, 2015.
Outlook, Commentary, Risks and Unusual Items
Management remained optimistic about growth based on the brand, marketing initiatives and product offering. Its strategy focuses on the 4-4-5 store build-out initiative, acquisitions of independent Furniture Galleries stores, expansion through multichannel distribution, and increasing market share in stationary upholstery. Fiscal 2016 capital expenditures were expected to be $25 million to $30 million.
During the quarter, the company acquired 10 Furniture Galleries stores from three independent operators for $21.6 million, including $19.2 million of cash. The acquisition added $18.3 million of goodwill and a $2.5 million indefinite-lived reacquired-rights intangible asset; management stated that the effect on current results was not material.
Restructuring expense was $0.2 million for the quarter and $0.4 million for the six months. The remaining restructuring liability was $0.4 million, expected to be settled by the end of fiscal 2016. Product warranty liability was $18.1 million at October 24, 2015, reflecting higher replacement-part and labor costs associated with more complex products.
Key risks include consumer and housing-market conditions, commodity and energy costs, import logistics, labor or supply disruptions, currency and interest-rate changes, product defects and warranty claims, litigation, store expansion and lease risks, restructuring execution, goodwill or intangible impairment, information-technology failures, and ERP implementation. The sales-order-management portion of the ERP implementation was expected to be completed in summer 2016. Management reported no material changes to previously disclosed risk factors, contractual obligations or market-risk information.
The company expects regular quarterly dividends to continue but noted that the board may discontinue them at any time. It also stated that liquidity was adequate for operations, debt service, dividends, capital expenditures and growth plans. A $0.9 million net liability for uncertain tax positions was not expected to change significantly over the next 12 months.
Investor Verification Items
- Verify the sustainability of gross-margin improvement, particularly the benefit from legal settlements and favorable product mix.
- Assess whether higher SG&A, warranty, ERP, e-commerce and headquarters costs could offset continued sales growth.
- Monitor inventory growth, operating cash conversion and the effect of the $7.0 million pension contribution.
- Evaluate integration results and impairment risk associated with the 10-store acquisition and newly recognized goodwill.
- Track Casegoods performance as the business completes its all-import transition and absorbs the discontinued hospitality product line.
- Confirm the pace and economics of the 4-4-5 store expansion and future independent-dealer acquisitions.
- Review the impact of share repurchases and dividends on liquidity and outstanding shares.
- Follow ERP implementation progress and potential effects on internal controls and operating execution.