La-Z-Boy Incorporated: Fiscal 2017 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended January 28, 2017, compared with January 23, 2016. The filing identifies this as the third quarter of fiscal 2017, although the request metadata references 2016 Q3. Fiscal 2017 has 52 weeks versus 53 weeks in fiscal 2016.
Business Context
La-Z-Boy manufactures, imports, distributes and retails upholstered furniture, casegoods and related accessories. Reportable segments are Upholstery, Casegoods and Retail. The company owned 142 La-Z-Boy Furniture Galleries stores at quarter-end and continued expanding its company-owned retail network through acquisitions.
Financial Results and Key Metrics
| Metric | Q3 FY2017 | Q3 FY2016 | Change |
|---|---|---|---|
| Sales | $390.0 million | $384.0 million | 1.6% |
| Gross profit | $156.1 million | $148.0 million | 5.5% |
| Gross margin | 40.0% | 38.5% | Up 1.5 percentage points |
| Operating income | $32.9 million | $34.8 million | (5.5%) |
| Operating margin | 8.4% | 9.1% | Down 0.7 percentage points |
| Net income attributable to La-Z-Boy | $23.3 million | $21.9 million | 6.3% |
| Diluted EPS | $0.47 | $0.43 | 9.3% |
| Dividends declared per share | $0.11 | $0.10 | 10.0% |
| Metric | Nine months FY2017 | Nine months FY2016 | Change |
|---|---|---|---|
| Sales | $1.107 billion | $1.108 billion | (0.1%) |
| Operating income | $87.8 million | $88.1 million | (0.4%) |
| Operating margin | 7.9% | 8.0% | Down 0.1 percentage points |
| Net income attributable to La-Z-Boy | $57.9 million | $56.5 million | 2.5% |
| Diluted EPS | $1.16 | $1.11 | 4.5% |
Cash flow and liquidity: Nine-month operating cash flow was $91.3 million, up from $69.7 million. Investing cash flow was negative $58.0 million, including $35.9 million of acquisitions and $15.5 million of capital expenditures. Financing cash flow was negative $35.1 million, including $25.1 million of share repurchases and $15.3 million of dividends. Cash and equivalents were $110.3 million at January 28, 2017, supplemented by $29.9 million of investments held to enhance cash returns.
Debt and credit availability: Total reported debt was approximately $0.6 million, consisting of $0.2 million current and $0.3 million long-term debt. The company had no borrowings under its $150.0 million revolving credit facility and $140.2 million of excess availability.
Balance sheet: Total assets were $864.6 million, including $193.7 million of inventories. Total equity was $586.9 million. Goodwill and other intangible assets increased materially following fiscal 2017 acquisitions.
Material Changes Versus the Prior Comparable Period
- Consolidated third-quarter sales increased modestly, while nine-month sales were essentially flat because of weaker demand in the home furnishings sector.
- Gross margin improved from product mix, supply-chain efficiencies and lower promotional activity in certain categories. However, SG&A increased as a percentage of sales because of retail expansion, fixed store costs, advertising and higher incentive compensation.
- Retail sales increased 10.9% in both the quarter and nine-month period, driven by new and acquired stores. Retail operating margin declined to 5.2% from 8.0% in the quarter and to 3.5% from 6.6% for nine months, reflecting lower comparable-store traffic, promotional activity, acquired inventory valuation effects and higher fixed costs.
- Upholstery operating margin improved to 11.5% from 10.9% in the quarter and to 11.8% from 10.7% for nine months, despite lower nine-month sales and increased promotional activity on products being phased out.
- Casegoods sales declined 5.5% in the quarter and 2.7% for nine months, primarily from lower volume. Nine-month operating margin improved, but quarterly margin declined because fixed SG&A costs were spread over lower sales.
- Weighted average diluted shares declined to 49.4 million from 50.5 million in the quarter and to 49.5 million from 50.9 million for nine months, reflecting share repurchases.
Guidance, Outlook, Risks and Unusual Items
- Management characterized the home-furnishings retail environment as challenging but continued to expect its brand, proprietary distribution network, independent dealer base and operating platform to support long-term profitable growth.
- The company expects the fiscal 2017 fourth quarter to contain 13 weeks versus 14 weeks in the prior-year fourth quarter, creating a comparability headwind.
- Fiscal 2017 capital expenditures were expected to be approximately $30 million. Construction of a new Innovation Center and Dayton campus upgrades was expected to begin in the fourth quarter, with an estimated project cost of approximately $26 million and construction continuing through fiscal 2020.
- Fiscal 2017 acquisitions included the La-Z-Boy brand license for the United Kingdom and Ireland and acquisitions of company-owned Furniture Galleries stores, including nine stores in Pennsylvania, New York and New Jersey. The acquisitions added approximately $46.9 million of goodwill and intangible assets and included a $16.6 million purchase-price liability for the U.K. and Ireland license.
- A court ruled against the company on its affirmative defenses in a contract dispute concerning alleged royalties on certain power units. The company recorded $0.4 million of related interest expense in the quarter; the filing does not provide a clear total remaining exposure.
- The effective tax rate declined to 29.4% from 36.2% in the quarter and to 33.4% from 36.1% for nine months. State tax credits and releases of valuation allowances reduced the current-period rate; discrete items lowered the quarterly rate by 5.0 percentage points.
- Management identified risks involving consumer demand, recessionary conditions, foreign sourcing, tariffs and trade policy, currency, logistics, labor and supply disruptions, product defects and warranties, litigation, store expansion, goodwill impairment and information technology systems.
- The company had a $21.2 million product warranty liability at January 28, 2017, approximately 95% of which related to the Upholstery segment.
- The company was implementing an ERP system in its largest operating unit and expected to complete the sales-order-management component by the end of fiscal 2018. Management stated that disclosure controls were effective.
Important Facts for Investors to Verify
- Assess whether weaker comparable-store traffic and the 40.3% nine-month decline in Retail operating income are temporary or indicate a sustained profitability issue.
- Review the contract royalty litigation, including the amount awarded, potential future royalties, interest and any appeal or settlement developments.
- Evaluate the earnings contribution, purchase accounting and integration risks associated with the U.K. and Ireland license and acquired retail stores.
- Monitor gross-margin benefits from product mix and supply-chain improvements against promotional pressure and potential sourcing, tariff and freight costs.
- Verify the timing and approximately $26 million cost of the Innovation Center and Dayton campus project, as well as the broader capital-expenditure plan.
- Consider the effect of the shorter fiscal 2017 fourth quarter on year-over-year sales and earnings comparisons.
- Review future tax rates without the current-period state-credit and valuation-allowance benefits.
- Monitor share repurchases, with 3.1 million shares remaining authorized at January 28, 2017, and the effect of buybacks on per-share results and liquidity.