LA-Z-BOY INCORPORATED - 10-Q Summary
Business Context and Reporting Period
This filing covers the second quarter and first six months of fiscal 2011, ended October 23, 2010. La-Z-Boy Incorporated manufactures, markets, and retails upholstered furniture and casegoods. The company operates through three segments: Upholstery Group, Casegoods Group, and Retail Group. Fiscal 2011 is a 53-week year. The reporting period includes the deconsolidation of a Toronto, Ontario Variable Interest Entity (VIE) effective April 25, 2010, due to changes in accounting guidance.
Key Financial Metrics
| Metric (in thousands) | Q2 2011 | Q2 2010 | 6 Mo 2011 | 6 Mo 2010 |
|---|---|---|---|---|
| Sales | $292,982 | $300,707 | $556,296 | $563,378 |
| Gross Profit | $85,106 | $94,442 | $157,940 | $174,264 |
| Operating Income | $5,339 | $9,303 | $3,689 | $10,908 |
| Net Income (Attributable to L-Z-B) | $3,945 | $5,966 | $3,729 | $7,543 |
| Diluted EPS | $0.07 | $0.11 | $0.07 | $0.14 |
| Cash and Equivalents | $83,656 | $59,043 | $83,656 | $59,043 |
| Total Debt (Current + Long-term) | $45,665 | $47,983 | $45,665 | $47,983 |
| Operating Cash Flow (6 Mo) | ($18,813) | $36,005 | ($18,813) | $36,005 |
Note: Debt figures derived from Balance Sheet current and long-term debt lines. Operating cash flow for the six months ended Oct 23, 2010, was negative due to working capital changes.
Material Changes vs. Prior Period
- Revenue Decline: Consolidated sales decreased 2.6% in Q2 and 1.3% for the six months. The deconsolidation of the Toronto VIE accounted for a $4.6 million (Q2) and $8.3 million (6 Mo) reduction in sales.
- Margin Compression: Operating margins declined to 1.8% in Q2 (from 3.1%) and 0.7% for six months (from 1.9%). Gross margins were pressured by a 2.1 percentage point increase in raw material costs and a shift in product mix toward lower-priced promotional items.
- Segment Performance:
- Upholstery Group: Sales down 3.4% (Q2); operating income down 32.7% due to raw material costs and pricing mix.
- Casegoods Group: Sales up 5.9% (Q2); operating income turned positive ($1.376M) from a loss, driven by restructuring efficiencies and a reversal of a prior product recall reserve.
- Retail Group: Sales up 3.2% (Q2); operating loss narrowed to $4.36M (from $5.30M) due to improved conversion rates, though margins remain negative.
- Cash Flow: Operating cash flow turned negative ($18.8M used) for the six months ended Oct 23, 2010, compared to $36.0M provided in the prior year, primarily due to accrued benefit payments, decreased accounts payable, and increased inventory levels.
Guidance, Outlook, Risks, and Unusual Items
- Accounting Corrections & VIEs: The company identified errors in inventory and lease expense accounting for consolidated VIEs. Adjustments totaling approximately $4.7 million ($2.7M inventory, $2.0M rent) were made. While deemed immaterial to prior periods, they required revisions to historical statements. Additionally, a tax rate correction increased net income by $0.2M for the current period.
- Material Weakness in Internal Controls: Management concluded that disclosure controls were not effective due to a material weakness in the oversight of VIEs. This weakness allowed for undetected errors in prior financial statements. Remediation is expected by the end of fiscal 2011.
- Restructuring: The company expects to incur approximately $0.5 million in additional pre-tax restructuring charges for the remainder of fiscal 2011 related to facility consolidations and contract terminations.
- Outlook: Management remains concerned about the macroeconomic environment, citing low consumer confidence and housing turnover. However, they are investing in marketing (featuring Brooke Shields) and operational improvements to capitalize on a potential upturn.
- Liquidity: The company maintains $83.7 million in cash and $97.2 million in excess availability under its credit facility. A reduction in the credit commitment to $175.0 million became effective post-quarter to lower fees, with no impact on borrowing capacity.
Investor Verification Checklist
- Internal Control Remediation: Verify the timeline and effectiveness of the plan to remediate the material weakness regarding VIE accounting oversight.
- Raw Material Costs: Monitor trends in raw material costs (fabric, leather, wood) and their impact on the Upholstery Group's gross margins.
- Working Capital Management: Assess the sustainability of the negative operating cash flow driven by inventory buildup and benefit payments.
- Retail Segment Turnaround: Evaluate whether the Retail Group can achieve positive operating margins given the high lease expense to sales volume ratio.
- VIE Exposure: Review the remaining exposure to the two consolidated VIEs and the three independent dealers with significant interests ($3.5 million exposure).