Hooker Furniture Corporation — Q2 FY2012 Form 10-Q
Reporting period: Thirteen weeks ended July 31, 2011 (quarter began May 2, 2011); first half was the 26 weeks ended July 31, 2011. Comparatives are the quarter and first half ended August 1, 2010. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and performance
The company markets residential casegoods and upholstered furniture, including imported products and domestically manufactured upholstery. It reported one operating segment and provided additional casegoods and upholstery detail. Management described the home furnishings market as weak, citing low consumer confidence, high unemployment, and difficult housing and mortgage conditions. The quarter marked the fifth consecutive year-over-year quarterly sales increase; management attributed growth partly to market-share gains.
Key financial metrics
| Metric | Q2 FY2012 | Q2 FY2011 | First half FY2012 | First half FY2011 |
|---|---|---|---|---|
| Net sales | $55.6m | $53.4m | $114.0m | $104.7m |
| Gross profit / margin | $12.2m / 21.9% | $12.0m / 22.4% | $23.2m / 20.4% | $23.7m / 22.7% |
| Operating income / margin | $2.5m / 4.5% | $1.6m / 2.9% | $3.2m / 2.8% | $3.3m / 3.1% |
| Net income | $1.6m | $1.2m | $2.2m | $2.3m |
| Diluted EPS | $0.15 | $0.11 | $0.20 | $0.21 |
- Cash flow: First-half operating cash flow was $18.3m, versus cash used of $5.6m in the prior-year first half. Cash increased $13.8m to $30.4m. Investing activities used $2.3m, including $1.9m of capital expenditures; dividends paid were $2.2m.
- Balance sheet and liquidity: At July 31, 2011, current assets were $104.0m and current liabilities $15.6m; working capital was $88.4m and the current ratio 6.7:1. Total assets were $148.8m and shareholders’ equity $126.7m.
- Debt and facilities: No revolving-credit borrowings were outstanding. The $15.0m revolver had $13.1m available, with $1.9m of standby letters of credit outstanding; maturity for any principal borrowed was July 31, 2013. The company also reported up to $15.5m available to borrow against life-insurance cash surrender value. It was in compliance with credit covenants.
- Dividends: $0.10 per share declared for the quarter. A further $0.10-per-share dividend was declared September 6, payable November 25, 2011.
Material changes versus comparable periods
- Quarterly sales increased 4.1%; first-half sales increased 8.8%. Higher unit volume drove growth, while average selling prices declined about 1.0% in the quarter and 2.5% in the first half, mainly from discounting and sales mix.
- Quarterly gross margin fell 0.5 percentage point; first-half margin fell 2.3 points. Management cited greater discounting to clear excess inventory, increased returns and allowances, and, for the first half, higher healthcare costs. First-half discounting was $12.2m (10.7% of sales), versus $8.4m (8.0%); returns and allowances were $2.7m (2.4%), versus $1.8m (1.7%).
- Quarterly operating income improved on lower selling and administrative expenses. First-half operating income declined slightly, as lower overhead did not offset weaker gross margin. First-half net income and EPS also declined year over year.
- Casegoods sales rose nearly 6% in the quarter and nearly 14% in the first half; upholstery sales were essentially flat in both comparisons. Upholstery gross margin improved, but the division remained loss-making at the operating level in the first half.
- First-half 2010 results included a $0.5m casualty-loss charge and $1.7m insurance recovery; the prior-year first-half cash flow also included $1.4m in casualty insurance proceeds. Comparisons therefore include these prior-period items.
Outlook, risks, and unusual items
- Management was cautiously optimistic that sales would continue to grow year over year through market-share gains and improving consumer demand, but provided no specific numerical sales or earnings guidance.
- Management expected margins to face pressure for the remainder of FY2012 from elevated discounting, especially in Q3, to rationalize products and reduce excess inventory; higher Asian import costs related to Chinese wage inflation and currency strength; and higher domestic raw-material costs, including leather, cotton, and steel.
- Other identified risks included weak consumer confidence and housing conditions, intense price competition, currency and imported-goods costs, supply and shipping disruptions, domestic manufacturing costs, product quality and safety, and execution costs or disruption from the ERP-system implementation. The company does not use derivatives to manage its foreign-exchange exposure.
- The domestic upholstery business has relatively high fixed costs and continued to struggle to return to profitability. Management said further cost reductions would be challenging and focused on efficiency, overhead control, and expanding product offerings and sales.
- During Q2 the company exited its poorest-quality Chinese factory and increased quality audits at other Asian suppliers. A $0.610m company-owned life-insurance gain in Q1 reduced first-half salary-related expense.
- After quarter-end, an accidental sprinkler operation flooded part of a leased Martinsville warehouse. Repairs were essentially complete; estimated costs were approximately $0.250m, expected to be recorded as a Q3 FY2012 casualty loss.
- Management said it believed available resources were sufficient for foreseeable business needs and expected $0.75m–$1.5m of capital expenditures during the remainder of FY2012.
Investor verification priorities
- Verify whether sales growth and order rates persist, particularly for casegoods, and whether consumer demand improves as management expects.
- Track discounting, returns and allowances, inventory reduction, and gross-margin recovery against management’s stated cost pressures.
- Assess whether the upholstery division improves from its first-half operating loss and whether fixed costs can be aligned with sales.
- Monitor cash conversion and working-capital movements, including whether inventory reduction is sustainable without impairing product availability.
- Confirm the recorded cost and insurance treatment of the warehouse flood, and the effects of Asian sourcing, currency movements, and ERP implementation on costs and operations.