La-Z-Boy Incorporated: Fiscal 2018 Third-Quarter Form 10-Q
Business context and reporting period
La-Z-Boy manufactures, imports, distributes and retails upholstered and casegoods furniture through wholesale channels, company-owned La-Z-Boy Furniture Galleries stores, independent dealers and e-commerce. The filing covers the quarter and nine months ended January 27, 2018, compared with January 28, 2017. Although the request identifies 2017 Q3, the filing is the third quarter of fiscal 2018.
- Reportable segments: Upholstery, Casegoods and Retail.
- Retail operated 147 company-owned La-Z-Boy Furniture Galleries stores.
- Shares outstanding at February 13, 2018: 46.99 million.
Financial performance and liquidity
| Metric | Quarter ended Jan. 27, 2018 | Prior year quarter | Nine months ended Jan. 27, 2018 | Prior year nine months |
|---|---|---|---|---|
| Sales | $413.6 million | $390.0 million | $1,163.9 million | $1,107.4 million |
| Operating income | $33.1 million | $33.6 million | $83.7 million | $89.9 million |
| Operating margin | 8.0% | 8.6% | 7.2% | 8.1% |
| Net income attributable to La-Z-Boy | $12.1 million | $23.3 million | $46.7 million | $57.9 million |
| Diluted EPS | $0.25 | $0.47 | $0.96 | $1.16 |
- Quarterly gross profit was $162.5 million, implying a 39.3% gross margin versus 40.2% in the prior-year quarter. Nine-month gross profit was $456.6 million, implying a 39.2% margin versus 39.8%.
- Quarterly income tax expense was $20.0 million and the effective tax rate was 62.0%; the nine-month rate was 43.9%, versus 29.4% and 33.4%, respectively, in the comparable periods.
- Nine-month operating cash flow was $91.2 million versus $93.0 million. Capital expenditures were $24.1 million versus $15.5 million.
- Nine-month investing cash outflow was $45.2 million and financing cash outflow was $61.4 million. Share repurchases totaled $46.1 million and dividends paid totaled $16.3 million.
- Cash, cash equivalents and restricted cash were $137.6 million at January 27, 2018, compared with $150.9 million at April 29, 2017. Investments to enhance cash returns totaled $35.4 million.
- Total debt was approximately $0.5 million. The company had no borrowings under its $150.0 million revolving credit facility and $148.1 million of excess availability; the facility maturity was extended to December 19, 2022.
- Total assets were $893.5 million and shareholders’ equity was $602.8 million at January 27, 2018.
Material changes versus the prior comparable period
- Sales increased 6.1% in the quarter and 5.1% for the nine months, with growth in all three operating segments.
- Operating income declined 1.4% in the quarter and 6.9% for the nine months. Margin pressure primarily reflected higher steel, polyurethane foam and wood costs, lower manufacturing-volume absorption and a $4.1 million third-quarter charge related to a civil litigation settlement.
- Upholstery sales increased 6.0% in the quarter and 3.9% for the nine months, but operating income declined 11.1% and 15.3%, respectively. The United Kingdom and Ireland wholesale acquisition contributed $8.2 million of quarterly sales and $20.2 million of nine-month sales.
- Casegoods sales increased 17.0% in the quarter and 8.9% for the nine months; operating income increased 75.3% and 34.1%, respectively, due to higher volume, improved product mix and lower SG&A leverage.
- Retail sales increased 3.0% in the quarter and 8.6% for the nine months; operating income increased 11.9% and 10.7%. Comparable-store sales declined 1.1% in the quarter and 0.8% for the nine months, primarily due to lower traffic.
- Net income and EPS were significantly reduced by the Tax Cuts and Jobs Act. The company recorded a provisional $9.5 million net tax charge, including deferred-tax remeasurement and transition-tax expense, partly offset by the lower blended federal tax rate.
- The company paid $13.5 million to settle a civil dispute involving power-unit royalties and related obligations. The settlement resolved past and future claims without admission of liability.
- Share repurchases increased to 1.6 million shares for $46.1 million in the first nine months, versus 1.4 million shares for $25.1 million in the prior-year period.
Guidance, outlook, risks and unusual items
- Management expected fiscal 2018 capital expenditures of $45 million to $50 million, including approximately $15 million for the new Innovation Center and approximately $2 million for the England corporate office and manufacturing expansion.
- Management stated that the second-quarter price increase was expected to offset raw-material inflation as the company entered the fourth quarter.
- The company’s long-term strategy emphasizes expanding proprietary distribution to a target of 400 Furniture Galleries stores and 600 Comfort Studio locations, increasing e-commerce activity, developing new products and improving digital marketing.
- Tax Act amounts were provisional and could be revised through the permitted measurement period as additional data and regulatory guidance become available.
- Key risks include consumer demand and recessionary conditions, commodity and freight costs, supply-chain and labor disruptions, currency and tax changes, tariffs or trade-policy changes, product defects and warranty claims, litigation, information-technology failures, store expansion and lease risks, e-commerce execution, and potential goodwill or intangible-asset impairment.
- The company anticipated a material balance-sheet effect when operating-lease accounting becomes effective in fiscal 2020. No material change to previously disclosed contractual obligations was reported.
- The final phase of the ERP implementation was scheduled for deployment in the fourth quarter of fiscal 2018 and would require control-effectiveness testing.
Investor verification points
- Verify the final impact of the Tax Cuts and Jobs Act and any revisions to the provisional $9.5 million tax charge.
- Assess whether price increases offset continuing steel, foam and wood inflation and restore Upholstery margins.
- Monitor comparable-store traffic and sales, particularly in the company-owned Retail segment.
- Reconcile cash usage from share repurchases, dividends, acquisitions and planned capital expenditures with future liquidity.
- Review the financial and operational effects of the United Kingdom and Ireland acquisition, the England facility projects and the Innovation Center.
- Track the outcome of ERP control testing and the eventual impact of operating-lease capitalization.
- Evaluate exposure to warranty claims, product defects, currency movements, import costs, litigation and other contingencies.