Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
GENERAL:
The following analysis of the results of operations and financial condition of the Company should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this quarterly report on Form 10-Q.
CRITICAL ACCOUNTING POLICIES:
The discussion and analysis of the Companys consolidated financial statements and results of operations are based on consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these consolidated financial statements requires the use of estimates and judgments that affect the reported results. Ultimate results may differ from these estimates under different assumptions or conditions. The Company uses estimates based on the best information available in recording transactions and balances resulting from business operations. Estimates are used for such items as collectability of trade accounts receivable, inventory valuation, depreciable lives, self-insurance programs, warranty costs and income taxes. Ultimate results may differ from these estimates under different assumptions or conditions.
Allowance for doubtful accounts
the Company establishes an allowance for doubtful accounts through review of open accounts, and historical collection and allowances amounts. The allowance for doubtful accounts is intended to reduce trade accounts receivable to the amount that reasonably approximates their fair value due to their short-term nature. The amount ultimately realized from trade accounts receivable may differ from the amount estimated in the consolidated financial statements based on collection experience and actual returns and allowances.
Inventories
the Company values inventory at the lower of cost or market. A large portion of our finished goods inventory is made to order and many of our raw material parts are interchangeable between products. Historically inventory write-downs to market have been in fabric and sourced products purchased for inventory. On a quarterly basis, management assesses the inventory on hand versus estimated future usage and estimated selling prices and if necessary writes down the obsolete or excess inventory to market. Although, we believe that inventory valuations are reasonable, unexpected changes in sales volume due to economic or competitive conditions may impact inventory valuations. Raw steel, lumber and wood frame parts are valued on the last-in, first-out (LIFO) method. Other inventories are valued on the first-in, first-out (FIFO) method. Changes
in the market conditions could require a write down of inventory.
Valuation of long-lived assets
the Company periodically reviews the carrying value of long-lived assets and estimated depreciable or amortizable lives for continued appropriateness. This review is based upon projections of anticipated future cash flows and is performed whenever events or changes in circumstances indicate that asset carrying values may not be recoverable or that the estimated depreciable or amortizable lives may have changed. These evaluations could result in a change in estimated useful lives in future periods. There were no impairments taken during the three months ended September 30, 2007 or 2006.
Self-insurance programs
the Company is self-insured for health care and most workers compensation up to predetermined amounts above which third party insurance applies. The Company purchases specific stop-loss insurance for individual health care claims in excess of $150,000 per plan year, with a $1.0 million individual lifetime maximum. For workers compensation, the Company retains the first $350,000 per claim and purchases excess coverage up to the statutory limits for amounts in excess of the retention limit. The Company is contingently liable to insurance carriers under its comprehensive general, product, and vehicle liability policies, as well as some workers compensation. Losses are accrued based upon the Companys estimates of the aggregate liability of claims incurred using certain actuarial assumptions followed in the insurance industry and
based on Company experience. The actual claims experience could differ from the estimates made by the Company.
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Warranty
the Company has warranty coverages with respect to the original purchases of our products that range from three months to lifetime. To estimate the warranty liability, the Company completes an analysis of the amount of warranty claims on sold product that may be incurred. This analysis includes consideration of: claim trends from historical levels to current and projected levels, changes in product performance, historical and expected claim lag periods, changes in sales levels and changes in product mix. The actual warranty expense could differ from the estimates made by the Company based on product performance.
Income taxes
the Company accounts for income taxes in accordance with the provisions of FIN 48, Accounting for Uncertainty in Income Taxes and SFAS No. 109, Accounting for Income Taxes. In the preparation of the Companys consolidated financial statements, management calculates income taxes. This includes estimating the Companys current tax liability as well as assessing temporary differences resulting from different treatment of items for tax and book accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded on the balance sheet. These assets and liabilities are analyzed regularly and management assesses the likelihood that deferred tax assets will be realized from future taxable income. The Company adopted the provisions of FIN 48 on July 1, 2007. The impact of the adoption is discussed in note 7, income taxes.
Revenue recognition
is upon delivery of product to our customer. The Companys ordering process creates persuasive evidence of the sale arrangement and the sales amount is determined. The delivery of the goods to its customer completes the earnings process. Net sales consist of product sales and related delivery charge revenue, net of adjustments for returns and allowances. Shipping and handling costs are included in cost of goods sold.
Overview
The following table has been prepared as an aid in understanding the Companys results of operations on a comparative basis for the three months ended September 30, 2007 and 2006. Amounts presented are percentages of the Companys net sales.
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Three Months Ended
September 30,
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2007
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|
2006
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|
Net sales
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100.0
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%
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100.0
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%
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Cost of goods sold
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|
(80.4
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)
|
(81.8
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)
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Gross margin
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|
19.6
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18.2
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Selling, general and administrative
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(17.4
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)
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(17.1
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)
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Operating income
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|
2.2
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|
1.1
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|
Other expense, net
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|
(0.3
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)
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(0.2
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)
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Income before income taxes
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|
1.9
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|
0.9
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|
Income tax expense
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|
(0.7
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)
|
(0.3
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)
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Net income
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|
1.2
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%
|
0.6
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%
|
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Results of Operations for the Quarter Ended September 30, 2007 vs. 2006
Net sales for the quarter ended September 30, 2007 were $100.9 million, comparable to the prior year quarter of $101.3 million. Residential net sales were $62.7 million, an increase of 2% from the prior year quarter net sales of $61.8 million. Recreational vehicle net sales were $15.7 million, compared to $15.9 million, a decrease of 1% from the prior year quarter. Commercial net sales were $22.5 million, compared to $23.6 million in the prior year quarter, a decrease of 5%. The decrease in commercial net sales is primarily due to a slowdown of orders for our hospitality products.
Gross margin for the quarter ended September 30, 2007 was 19.6% compared to 18.2% in the prior year quarter. The gross margin improvement is primarily due, in comparable parts, to the impact of changes in product mix and increased cost control.
Selling, general and administrative expenses increased by approximately $0.3 million in comparison to the prior year quarter, representing 17.4% and 17.1% of net sales for the quarters ended September 30, 2007 and 2006, respectively.
Operating income for the current quarter was $2.2 million compared to $1.1 million in the prior year quarter reflecting the aforementioned factors
.
The effective income tax rate was 36.9% in the current and prior year fiscal quarters. The Company anticipates its effective income tax rate for the fiscal year to be approximately 37.0%. The primary difference between the federal statutory rate and the expected effective rate is the result of state taxes.
The above factors resulted in current quarter net income of $1.2 million or $0.18 per share, compared to the prior year quarter of $0.6 million or $0.09 per share.
All earnings per share amounts are on a diluted basis.
Liquidity and Capital Resources
Operating Activities:
Working Capital (current assets less current liabilities) at September 30, 2007 was $100.9 million. Net cash used in operating activities was $0.9 million for the three months ended September 30, 2007. Significant changes in working capital from June 30, 2007 to September 30, 2007 included decreased accounts receivable of $8.7 million, increased inventory of $8.3 million and decreased accounts payable of $1.7 million. The decrease in receivables is related to timing of shipments to customers and the related payment terms. The increase in purchased finished goods inventory is due primarily to timing of inventory purchases to meet our forecasted customer requirements and new product introductions. The decrease in accounts payable is due to the timing of inventory purchases from suppliers, the related payment terms and the timing of payments. The Company expects that due to the nature of our operations that there
will be continuing fluctuations in accounts receivable, inventory, accounts payable, and cash flows from operations due to the following: we purchase inventory from overseas suppliers with long lead times and depending on the timing of the delivery of those orders inventory levels can be greatly impacted, we have various customers that purchase large quantities of inventory periodically and the timing of those purchases can significantly impact inventory levels, accounts receivable, accounts payable and short-term borrowings. As discussed below, the Company believes it has adequate financing arrangements and access to capital to absorb these fluctuations in operating cash flow.
Investing Activities:
Capital expenditures were $0.4 million for the quarter ended September 30, 2007. Depreciation and amortization expense was $1.2 million and $ 1.4 million for the fiscal quarters ended September 30, 2007 and 2006, respectively. The Company expects that capital expenditures will be approximately $2.5 million for the remainder of the 2008 fiscal year.
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Financing Activities:
Net cash provided by financing activities was $1.4 million during the quarter ended September 30, 2007. Short-term borrowings increased by $2.4 million in the quarter ended September 30, 2007 primarily due to the increase in inventory. Net cash used in financing activities was $3.0 million during the quarter ended September 30, 2006. Short-term borrowings decreased by $2.0 million in the quarter ended September 30, 2006 primarily due to the decrease in accounts receivable.
Management believes that the Company has adequate cash, cash equivalents, and credit arrangements to meet its operating and capital requirements for fiscal 2008. In the opinion of management, the Companys liquidity and credit resources provide it with the ability to react to opportunities as they arise, the ability to pay quarterly dividends to its shareholders, and ensures that productive capital assets that enhance safety and improve operations are purchased as needed.
Outlook
Although industry-wide trends indicate a soft market environment for residential products, orders for the Companys residential products have remained constant throughout the first fiscal quarter. The Company expects order levels to remain comparable to the prior year levels throughout fiscal year 2008. However, further industry-wide declines could result in lower order levels for the Company. Orders for recreational vehicle products continue to be down, and we expect this to continue through our third fiscal quarter ending March 31, 2008, at which time we will be able to better evaluate the spring and summer selling season. Our orders for products into commercial hospitality applications slowed significantly in the first quarter of the 2008 fiscal year as compared to the relatively high levels experienced in the first quarter of fiscal year 2007, and we expect orders to be lower than the prior year
period into the second half of fiscal year 2008. The Company anticipates continued modest increases in commercial office orders and shipments through the balance of fiscal year 2008.
The Company continues to explore cost control opportunities in all facets of its business. The Company believes it has the necessary inventories, product offerings and marketing strategies in place to take advantage of opportunities for expansion of market share in certain markets, such as commercial office and hospitality. The Company anticipates continuing its strategy of providing furniture from a wide selection of domestically manufactured and imported product lines.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
General
Market risk represents the risk of changes in value of a financial instrument, derivative or non-derivative, caused by fluctuations in interest rates, foreign exchange rates and equity prices. As discussed below, management of the Company does not believe that changes in these factors could cause material fluctuations in the Companys results of operations or cash flows. The ability to import furniture products can be adversely affected by political issues in the countries where suppliers are located, disruptions associated with shipping distances and negotiations with port employees. Other risks related to furniture product importation include government imposition of regulations and/or quotas; duties and taxes on imports; and significant fluctuation in the value of the U. S. dollar against foreign currencies. Any of these factors could interrupt supply,
increase costs and decrease earnings.
Impairment of long-lived assets
Accounting rules require that long-lived assets be evaluated for impairment whenever events or changes in circumstances indicate that its carrying value may not be recoverable. We have substantial long-lived assets, consisting mainly of property, plant and equipment, which based upon such events or changes in circumstances, there could be a write-down of all or a portion of these assets and a corresponding reduction in our earnings and net worth. At September 30, 2007, no impairment of long-lived assets has been identified.
Foreign Currency Risk
During the three-months ended September 30, 2007 and 2006, the Company did not have sales, purchases, or other expenses denominated in foreign currencies. As such, the Company is not exposed to material market risk associated with currency exchange rates and prices.
Interest Rate Risk
The Companys primary market risk exposure with regard to financial instruments is changes in interest rates. At September 30, 2007, a hypothetical 100 basis point increase in short-term interest rates would decrease annual pre-tax earnings by approximately $140,000, assuming no change in the volume or composition of debt. On September 30, 2007, the Company had effectively fixed the interest rates at 4.5% on approximately $15.3 million of its long-term debt through the use of interest rate swaps. As of September 30, 2007, the cumulative fair value of the swaps is a liability of approximately $0.1 million and is included in other current liabilities.
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Tariffs
The Company has exposure to actions by governments, including tariffs. Tariffs are a possibility on any imported or exported products.
Inflation
Increased operating costs are reflected in product or services pricing with any limitations on price increases determined by the marketplace. The impact of inflation on the Company has not been significant during the past three years because of the relatively low rates of inflation experienced in the United States. Raw material costs, labor costs and interest rates are important components of costs for the Company. Inflation or other pricing pressures could impact any or all of these components, with a possible adverse effect on our profitability, especially where increases in these costs exceed price increases on finished products. In recent years, the Company has faced strong inflationary and other pricing pressures with respect to steel, fuel and health care costs, which have been partially mitigated by pricing adjustments.
Item 4. Controls and Procedures
(a)
Evaluation of disclosure controls and procedures.
Based on their evaluation as of the end of the period covered by this quarterly report on Form 10-Q, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective as of the date of such evaluation.
(b)
Changes in internal control over financial reporting.
During the quarter ended September 30, 2007, there were no significant changes in the Companys internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended) that has materially affected, or is reasonably likely to materially affect the Companys internal control over financial reporting.
Cautionary Statement Relevant to Forward-Looking Information for the Purpose of Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995
The Company and its representatives may from time to time make written or oral forward-looking statements with respect to long-term goals or anticipated results of the Company, including statements contained in the Companys filings with the Securities and Exchange Commission and in its reports to stockholders.
Statements, including those in this quarterly report on Form 10-Q, which are not historical or current facts, are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. There are certain important factors that could cause our results to differ materially from those anticipated by some of the statements made in this press release. Investors are cautioned that all forward-looking statements involve risk and uncertainty. Some of the factors that could affect results are the cyclical nature of the furniture industry, the effectiveness of new product introductions and distribution channels, the product mix of sales, pricing pressures, the cost of raw materials and fuel, foreign currency valuations, actions by governments including taxes and tariffs, the amount of sales generated and the profit margins thereon, competition (both
foreign and domestic), changes in interest rates, credit exposure with customers and general economic conditions. For further information regarding these risks and uncertainties, see the Risk Factors section in Item 1A of the Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2007.
We specifically decline to undertake any obligation to publicly revise any forward-looking statements that have been made to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
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