Business Context and Reporting Period
Company: LA-Z-BOY INC
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Second quarter ended October 23, 1999 (Fiscal Year 2000)
Business Overview: The Company operates in Residential upholstery and Residential casegoods segments. The reporting period includes the full impact of the June 1, 1999 acquisition of Bauhaus USA, Inc. ($57 million cash). The Company also announced definitive agreements to acquire LADD Furniture, Inc. (stock-for-stock, ~$191 million) and Alexvale Furniture, Inc. (cash and stock) pending regulatory and shareholder approval.
Key Financial Metrics
| Metric | Q2 1999 | Q2 1998 | 6 Months 1999 | 6 Months 1998 |
|---|---|---|---|---|
| Sales | $387.7M | $334.8M | $709.4M | $603.7M |
| Gross Profit Margin | 26.1% | 26.8% | 25.6% | 25.4% |
| Operating Profit | $38.3M | $30.3M | $60.0M | $42.4M |
| Operating Margin | 9.9% | 9.0% | 8.5% | 7.0% |
| Net Income | $23.3M | $18.4M | $36.6M | $25.6M |
| Diluted EPS | $0.44 | $0.35 | $0.69 | $0.48 |
| Cash & Equivalents | $12.8M | $22.7M | $12.8M | $22.7M |
| Operating Cash Flow (6mo) | $20.5M (vs $30.2M prior year) | |||
| Current Ratio | 3.2 to 1 | |||
| Debt-to-Capital Ratio | 22% |
Material Changes vs. Prior Period
- Revenue Growth: Sales increased 16% in Q2 and 18% for the six months. Approximately half of the Q2 increase and 6% of the six-month increase were attributable to the Bauhaus acquisition. Organic growth was driven primarily by the upholstery segment.
- Profitability: Operating profit rose 27% in Q2 and 41% for the six months. Operating margins improved in both segments, with casegoods showing significant improvement (from 5.2% to 8.4% in Q2) due to reduced selling incentives and lower SG&A expenses.
- Margins: Gross profit margin declined slightly in Q2 (26.1% vs 26.8%) due to higher labor costs, plant layout improvements, and increased costs for plywood and cardboard packaging. These were partially offset by lower leather costs.
- Balance Sheet: Total assets increased 20% to $720.2M, driven by a 86% increase in goodwill ($89.3M) and a 20% increase in inventories ($119.6M). Long-term debt increased 89% to $119.6M, primarily due to financing the Bauhaus acquisition.
- Cash Flow: Operating cash flow for the six months decreased to $20.5M from $30.2M. Investing activities used $82.4M, largely due to the $58.7M net cash outflow for the Bauhaus acquisition and $22.0M in capital expenditures.
Guidance, Outlook, and Risks
- Outlook: Management expects third-quarter sales to increase over the prior year but at a slower rate than the second quarter, a trend expected to continue into the fourth quarter due to strong prior-year comparisons and slowing U.S. furniture sales growth.
- Acquisitions: The pending LADD and Alexvale acquisitions are expected to be consummated in the current quarter. LADD is a stock-for-stock merger; Alexvale involves cash and stock. These will substantially alter the Company's asset base and future results.
- Capital Expenditures: Excluding pending acquisitions, CapEx is expected to be $8M-$12M for the remainder of FY2000. Including LADD and Alexvale needs, the range is $14M-$18M for the remainder of FY2000.
- Liquidity: The Company has $113M in unused credit lines. It intends to refinance the Bauhaus debt and fund the Alexvale cash portion via credit lines or operations. The LADD acquisition will involve paying off LADD's $102M debt via a new $150M bridge loan.
- Year 2000 (Y2K) Risks: The Company estimates total Y2K costs between $11M-$12M ($10.5M spent to date). While 97% of IT systems handling sales are compliant, some testing remains. The primary risk is identified as business interruptions caused by third-party failures.
- Cost Pressures: Labor retention is difficult in a low-unemployment environment. Material costs for plywood and cardboard are rising; foam and fabric costs may rise in 2000 if oil prices increase.
Investor Verification Checklist
- Acquisition Integration: Verify the closing status and integration progress of the LADD and Alexvale acquisitions, and the impact on future debt levels.
- Margin Sustainability: Monitor whether gross margins can recover to prior levels as plant layout improvements stabilize and if material costs (plywood, cardboard, foam) continue to rise.
- Labor Costs: Assess the long-term impact of rising labor costs and training expenses in a tight labor market on operating profitability.
- Y2K Contingency: Confirm the completion of testing for the remaining 3% of IT systems and the effectiveness of contingency plans for critical third-party suppliers.
- Cash Flow Management: Track the Company's ability to fund pending acquisitions and capital expenditures while maintaining dividend payments and stock repurchases, given the seasonal cash flow dip in Q4.