Table of Contents

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549-1004

 

FORM 10-Q

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

FOR QUARTERLY PERIOD ENDED OCTOBER 28, 2017

 

COMMISSION FILE NUMBER 1-9656

 

LA-Z-BOY INCORPORATED

(Exact name of registrant as specified in its charter)

 

MICHIGAN

 

38-0751137

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

One La-Z-Boy Drive, Monroe, Michigan

 

48162-5138

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code (734) 242-1444

 

None

(Former name, former address and former fiscal year, if changed since last report.)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

 

Yes x      No o

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).

 

Yes x      No o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company,  or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “emerging growth company,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Smaller reporting company o

Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes o      No x

 

The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

 

Outstanding at November 22, 2017

Common Shares, $1.00 par value

 

47,317,497

 

 

 

 

 

 



Table of Contents

 

LA-Z-BOY INCORPORATED
FORM 10-Q SECOND QUARTER OF FISCAL 2018

 

TABLE OF CONTENTS

 

 

 

 

 

Page
Number(s)

PART I Financial Information (Unaudited)

 

3

 

Item 1.

Financial Statements

 

3

 

 

Consolidated Statement of Income

 

3

 

 

Consolidated Statement of Comprehensive Income

 

5

 

 

Consolidated Balance Sheet

 

6

 

 

Consolidated Statement of Cash Flows

 

7

 

 

Consolidated Statement of Changes in Equity

 

8

 

 

Notes to Consolidated Financial Statements

 

9

 

 

Note 1. Basis of Presentation

 

9

 

 

Note 2. Acquisitions

 

9

 

 

Note 3. Restricted Cash

 

9

 

 

Note 4. Inventories

 

10

 

 

Note 5. Goodwill and Other Intangible Assets

 

10

 

 

Note 6. Investments

 

10

 

 

Note 7. Pension Plans

 

12

 

 

Note 8. Product Warranties

 

12

 

 

Note 9. Stock-Based Compensation

 

13

 

 

Note 10. Accumulated Other Comprehensive Loss

 

16

 

 

Note 11. Segment Information

 

18

 

 

Note 12. Income Taxes

 

19

 

 

Note 13. Earnings per Share

 

19

 

 

Note 14. Fair Value Measurements

 

20

 

 

Note 15. Recent Accounting Pronouncements

 

22

 

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

25

 

 

Cautionary Statement Concerning Forward-Looking Statements

 

25

 

 

Introduction

 

26

 

 

Results of Operations

 

28

 

 

Liquidity and Capital Resources

 

32

 

 

Critical Accounting Policies

 

35

 

 

Recent Accounting Pronouncements

 

35

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

36

 

Item 4.

Controls and Procedures

 

36

 

 

 

 

 

PART II Other Information

 

36

 

Item 1A.

Risk Factors

 

36

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

36

 

Item 6.

Exhibits

 

38

 

 

 

 

 

Signature Page

 

38

 

2



Table of Contents

 

PART I — FINANCIAL INFORMATION (UNAUDITED)

 

ITEM 1. FINANCIAL STATEMENTS

 

LA-Z-BOY INCORPORATED

CONSOLIDATED STATEMENT OF INCOME

 

 

 

Quarter Ended

 

(Unaudited, amounts in thousands, except per share data)

 

10/28/17

 

10/29/16

 

Sales

 

$

393,205

 

$

376,579

 

Cost of sales

 

238,253

 

227,195

 

Gross profit

 

154,952

 

149,384

 

Selling, general and administrative expense

 

120,683

 

115,526

 

Operating income

 

34,269

 

33,858

 

Interest expense

 

160

 

117

 

Interest income

 

376

 

234

 

Other income (expense), net

 

(926

)

(969

)

Income before income taxes

 

33,559

 

33,006

 

Income tax expense

 

10,353

 

11,901

 

Net income

 

23,206

 

21,105

 

Net income attributable to noncontrolling interests

 

(310

)

(272

)

Net income attributable to La-Z-Boy Incorporated

 

$

22,896

 

$

20,833

 

 

 

 

 

 

 

Basic weighted average common shares

 

47,964

 

49,153

 

Basic net income attributable to La-Z-Boy Incorporated per share

 

$

0.47

 

$

0.42

 

 

 

 

 

 

 

Diluted weighted average common shares

 

48,297

 

49,511

 

Diluted net income attributable to La-Z-Boy Incorporated per share

 

$

0.47

 

$

0.42

 

 

 

 

 

 

 

Dividends declared per share

 

$

0.11

 

$

0.10

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

3



Table of Contents

 

LA-Z-BOY INCORPORATED

CONSOLIDATED STATEMENT OF INCOME

 

 

 

Six Months Ended

 

(Unaudited, amounts in thousands, except per share data)

 

10/28/17

 

10/29/16

 

Sales

 

$

750,284

 

$

717,362

 

Cost of sales

 

456,229

 

433,757

 

Gross profit

 

294,055

 

283,605

 

Selling, general and administrative expense

 

243,488

 

227,289

 

Operating income

 

50,567

 

56,316

 

Interest expense

 

317

 

232

 

Interest income

 

719

 

438

 

Gain on conversion of investment

 

2,204

 

 

Other income (expense), net

 

(1,381

)

(1,731

)

Income before income taxes

 

51,792

 

54,791

 

Income tax expense

 

16,842

 

19,678

 

Net income

 

34,950

 

35,113

 

Net income attributable to noncontrolling interests

 

(403

)

(474

)

Net income attributable to La-Z-Boy Incorporated

 

$

34,547

 

$

34,639

 

 

 

 

 

 

 

Basic weighted average common shares

 

48,160

 

49,129

 

Basic net income attributable to La-Z-Boy Incorporated per share

 

$

0.71

 

$

0.70

 

 

 

 

 

 

 

Diluted weighted average common shares

 

48,537

 

49,554

 

Diluted net income attributable to La-Z-Boy Incorporated per share

 

$

0.71

 

$

0.70

 

 

 

 

 

 

 

Dividends declared per share

 

$

0.22

 

$

0.20

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

4



Table of Contents

 

LA-Z-BOY INCORPORATED

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

 

 

 

Quarter Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

Net income

 

$

23,206

 

$

21,105

 

Other comprehensive income (loss)

 

 

 

 

 

Currency translation adjustment

 

(147

)

(261

)

Change in fair value of cash flow hedges, net of tax

 

(741

)

139

 

Net unrealized gain (loss) on marketable securities, net of tax

 

208

 

(149

)

Net pension amortization, net of tax

 

517

 

509

 

Total other comprehensive income (loss)

 

(163

)

238

 

Total comprehensive income before allocation to noncontrolling interests

 

23,043

 

21,343

 

Comprehensive income attributable to noncontrolling interests

 

(410

)

(199

)

Comprehensive income attributable to La-Z-Boy Incorporated

 

$

22,633

 

$

21,144

 

 

 

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

Net income

 

$

34,950

 

$

35,113

 

Other comprehensive income (loss)

 

 

 

 

 

Currency translation adjustment

 

2,169

 

(329

)

Change in fair value of cash flow hedges, net of tax

 

(263

)

(336

)

Net unrealized gain (loss) on marketable securities, net of tax

 

(63

)

56

 

Net pension amortization, net of tax

 

1,034

 

1,018

 

Total other comprehensive income

 

2,877

 

409

 

Total comprehensive income before allocation to noncontrolling interests

 

37,827

 

35,522

 

Comprehensive income attributable to noncontrolling interests

 

(908

)

(373

)

Comprehensive income attributable to La-Z-Boy Incorporated

 

$

36,919

 

$

35,149

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

5



Table of Contents

 

LA-Z-BOY INCORPORATED

CONSOLIDATED BALANCE SHEET

 

(Unaudited, amounts in thousands, except par value)

 

10/28/17

 

4/29/17

 

Current assets

 

 

 

 

 

Cash and equivalents

 

$

122,345

 

$

141,860

 

Restricted cash

 

2,352

 

8,999

 

Receivables, net of allowance of $2,656 at 10/28/17 and $2,563 at 4/29/17

 

145,167

 

150,846

 

Inventories, net

 

180,050

 

175,114

 

Other current assets

 

46,201

 

40,603

 

Total current assets

 

496,115

 

517,422

 

Property, plant and equipment, net

 

171,510

 

169,132

 

Goodwill

 

74,646

 

74,245

 

Other intangible assets, net

 

17,984

 

18,489

 

Deferred income taxes — long-term

 

40,097

 

40,131

 

Other long-term assets, net

 

81,191

 

69,436

 

Total assets

 

$

881,543

 

$

888,855

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current portion of long-term debt

 

$

238

 

$

219

 

Accounts payable

 

53,426

 

51,282

 

Accrued expenses and other current liabilities

 

133,257

 

147,175

 

Total current liabilities

 

186,921

 

198,676

 

Long-term debt

 

314

 

296

 

Other long-term liabilities

 

89,950

 

88,778

 

Contingencies and commitments

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

Preferred shares — 5,000 authorized; none issued

 

 

 

Common shares, $1 par value — 150,000 authorized; 47,540 outstanding at 10/28/17 and 48,472 outstanding at 4/29/17

 

47,540

 

48,472

 

Capital in excess of par value

 

295,891

 

289,632

 

Retained earnings

 

279,344

 

284,698

 

Accumulated other comprehensive loss

 

(30,511

)

(32,883

)

Total La-Z-Boy Incorporated shareholders’ equity

 

592,264

 

589,919

 

Noncontrolling interests

 

12,094

 

11,186

 

Total equity

 

604,358

 

601,105

 

Total liabilities and equity

 

$

881,543

 

$

888,855

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

6



Table of Contents

 

LA-Z-BOY INCORPORATED

CONSOLIDATED STATEMENT OF CASH FLOWS

 

 

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

34,950

 

$

35,113

 

Adjustments to reconcile net income to cash provided by (used for) operating activities

 

 

 

 

 

Gain on disposal of assets

 

(1,884

)

(62

)

Gain on conversion of investment

 

(2,204

)

 

Deferred income tax expense

 

(403

)

1,089

 

Provision for doubtful accounts

 

74

 

(18

)

Depreciation and amortization

 

15,869

 

13,999

 

Equity-based compensation expense

 

6,410

 

5,880

 

Pension plan contributions

 

(2,000

)

(2,300

)

Change in receivables

 

6,165

 

784

 

Change in inventories

 

(4,096

)

(3,747

)

Change in other assets

 

(7,935

)

(1,806

)

Change in payables

 

2,136

 

1,549

 

Change in other liabilities

 

4,142

 

3,622

 

Net cash provided by operating activities

 

51,224

 

54,103

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from disposals of assets

 

608

 

143

 

Proceeds from property insurance

 

1,485

 

 

Capital expenditures

 

(16,372

)

(10,226

)

Purchases of investments

 

(18,507

)

(17,814

)

Proceeds from sales of investments

 

11,529

 

9,757

 

Acquisitions, net of cash acquired

 

(15,879

)

(15,997

)

Net cash used for investing activities

 

(37,136

)

(34,137

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Payments on debt

 

(131

)

(156

)

Stock issued for stock and employee benefit plans, net of shares withheld for taxes

 

356

 

1,371

 

Excess tax benefit on stock option exercises

 

 

1,826

 

Purchases of common stock

 

(30,692

)

(19,766

)

Dividends paid

 

(10,648

)

(9,869

)

Net cash used for financing activities

 

(41,115

)

(26,594

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and equivalents

 

865

 

(149

)

Change in cash, cash equivalents and restricted cash

 

(26,162

)

(6,777

)

Cash, cash equivalents and restricted cash at beginning of period

 

150,859

 

121,335

 

Cash, cash equivalents and restricted cash at end of period

 

$

124,697

 

$

114,558

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing activities capital expenditures included in payables

 

$

1,631

 

$

681

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

7



Table of Contents

 

LA-Z-BOY INCORPORATED

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

 

(Unaudited, amounts in thousands)

 

Common
Shares

 

Capital in
Excess of
Par Value

 

Retained
Earnings

 

Accumulated
Other
Comprehensive
Loss

 

Non-
Controlling
Interests

 

Total

 

At April 30, 2016

 

$

49,331

 

$

279,339

 

$

252,472

 

$

(34,000

)

$

10,070

 

$

557,212

 

Net income

 

 

 

 

 

85,922

 

 

 

1,062

 

86,984

 

Other comprehensive income

 

 

 

 

 

 

 

1,117

 

54

 

1,171

 

Stock issued for stock and employee benefit plans, net of cancellations and withholding tax

 

504

 

2,992

 

(1,747

)

 

 

 

 

1,749

 

Purchases of 1,363 shares of common stock

 

(1,363

)

(3,300

)

(31,294

)

 

 

 

 

(35,957

)

Stock option and restricted stock expense

 

 

 

8,864

 

 

 

 

 

 

 

8,864

 

Tax benefit from exercise of options

 

 

 

1,737

 

 

 

 

 

 

 

1,737

 

Dividends paid

 

 

 

 

 

(20,655

)

 

 

 

 

(20,655

)

At April 29, 2017

 

48,472

 

289,632

 

284,698

 

(32,883

)

11,186

 

601,105

 

Net income

 

 

 

 

 

34,547

 

 

 

403

 

34,950

 

Other comprehensive income

 

 

 

 

 

 

 

2,372

 

505

 

2,877

 

Stock issued for stock and employee benefit plans, net of cancellations and withholding tax

 

186

 

1,481

 

(1,311

)

 

 

 

 

356

 

Purchases of 1,118 shares of common stock

 

(1,118

)

(1,632

)

(27,942

)

 

 

 

 

(30,692

)

Stock option and restricted stock expense

 

 

 

6,410

 

 

 

 

 

 

 

6,410

 

Dividends paid

 

 

 

 

 

(10,648

)

 

 

 

 

(10,648

)

At October 28, 2017

 

$

47,540

 

$

295,891

 

$

279,344

 

$

(30,511

)

$

12,094

 

$

604,358

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

8



Table of Contents

 

LA-Z-BOY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Note 1: Basis of Presentation

 

The accompanying consolidated financial statements include the consolidated accounts of La-Z-Boy Incorporated and our majority-owned subsidiaries. We derived the April 29, 2017, balance sheet from our audited financial statements. We prepared the interim financial information in conformity with generally accepted accounting principles, which we applied on a basis consistent with those reflected in our fiscal 2017 Annual Report on Form 10-K filed with the Securities and Exchange Commission, but the information does not include all of the disclosures required by generally accepted accounting principles. In management’s opinion, the interim financial information includes all adjustments and accruals, consisting only of normal recurring adjustments (except as otherwise disclosed), that are necessary for a fair statement of results for the respective interim periods. The interim results reflected in the accompanying financial statements are not necessarily indicative of the results of operations that will occur for the full fiscal year ending April 28, 2018.

 

At October 28, 2017, we owned preferred shares of two privately-held companies, and a warrant to purchase common shares of one of the companies, both of which are variable interest entities. We have not consolidated their results in our financial statements because we do not have the power to direct those activities that most significantly impact their economic performance and, therefore, are not the primary beneficiary.

 

During the first six months of fiscal 2017, we recorded a benefit related to legal settlements as part of cost of sales. The legal settlements increased gross margin by 0.1 percentage points and 0.4 percentage points in the second quarter and first six months of fiscal 2017, respectively.

 

In fiscal 2017, following a trial, a judgment was entered against us in a civil lawsuit over a contract that the other party claimed required us to pay royalties on certain powered motion furniture units. While we continue to appeal this judgment, we have fully reserved for all amounts currently due under the judgment. Under the judgment, we will continue to incur royalty charges against certain future sales. In addition to actively pursuing our appeal in this case, we continue to hold settlement discussions with the counter-party but to date have not reached a settlement.

 

Note 2: Acquisitions

 

As we previously reported in our fiscal 2017 Annual Report on Form 10-K, we acquired the La-Z-Boy wholesale business in the United Kingdom and Ireland in the third quarter of fiscal 2017. Per the terms of the purchase agreement, payment for the business was due 90 business days following the date of acquisition, and accordingly, we paid $15.9 million in the first quarter of fiscal 2018.

 

Note 3: Restricted Cash

 

We have cash on deposit with a bank as collateral for certain letters of credit. All of our letters of credit have maturity dates within the next twelve months, but we expect to renew some of these letters of credit when they mature.

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

Cash and cash equivalents

 

$

122,345

 

$

105,571

 

Restricted cash

 

2,352

 

8,987

 

Total cash, cash equivalents and restricted cash

 

$

124,697

 

$

114,558

 

 

9



Table of Contents

 

Note 4: Inventories

 

A summary of inventories is as follows:

 

(Unaudited, amounts in thousands)

 

10/28/17

 

4/29/17

 

Raw materials

 

$

78,370

 

$

83,371

 

Work in process

 

12,003

 

11,320

 

Finished goods

 

110,698

 

101,444

 

FIFO inventories

 

201,071

 

196,135

 

Excess of FIFO over LIFO

 

(21,021

)

(21,021

)

Total Inventories

 

$

180,050

 

$

175,114

 

 

Note 5: Goodwill and Other Intangible Assets

 

Our goodwill, reacquired rights, and other intangible assets on our consolidated balance sheet relate to our acquisitions of La-Z-Boy Furniture Galleries® stores over the past several fiscal years and our international business acquisition last fiscal year. Our other intangible assets also include a trade name for American Drew.

 

The following is a roll-forward of goodwill for the six months ended October 28, 2017:

 

(Unaudited, amounts in thousands)

 

Goodwill

 

Balance at April 29, 2017

 

$

74,245

 

Translation adjustment

 

401

 

Balance at October 28, 2017

 

$

74,646

 

 

The following is a roll-forward of our other intangible assets for the six months ended October 28, 2017:

 

(Unaudited, amounts in thousands)

 

Trade Names

 

Reacquired
Rights

 

Other
Intangible
Assets

 

Total Other
Intangible
Assets

 

Balance at April 29, 2017

 

$

1,155

 

$

13,747

 

$

3,587

 

$

18,489

 

Amortization

 

 

(528

)

(202

)

(730

)

Translation adjustment

 

 

176

 

49

 

225

 

Balance at October 28, 2017

 

$

1,155

 

$

13,395

 

$

3,434

 

$

17,984

 

 

Note 6: Investments

 

We have current and long-term investments intended to enhance returns on our cash as well as to fund future obligations of our non-qualified defined benefit retirement plan, our executive deferred compensation plan, and our performance compensation retirement plan. We also hold other investments, which at October 28, 2017, included cost-basis preferred shares of two privately-held companies, and at April 29, 2017, included an available-for-sale convertible debt security and cost-basis preferred shares of a privately-held company. Our short-term investments are included in other current assets and our long-term investments are included in other long-term assets on our consolidated balance sheet.

 

10



Table of Contents

 

The following summarizes our investments at October 28, 2017, and April 29, 2017:

 

(Unaudited, amounts in thousands)

 

10/28/17

 

4/29/17

 

Short-term investments:

 

 

 

 

 

Available-for-sale investments

 

$

11,966

 

$

15,040

 

Trading securities

 

17

 

6

 

Held-to-maturity investments

 

3,171

 

1,867

 

Total short-term investments

 

15,154

 

16,913

 

 

 

 

 

 

 

Long-term investments:

 

 

 

 

 

Available-for-sale investments

 

34,280

 

31,264

 

Cost basis investments

 

10,954

 

5,500

 

Total long-term investments

 

45,234

 

36,764

 

 

 

 

 

 

 

Total investments

 

$

60,388

 

$

53,677

 

 

 

 

 

 

 

Investments to enhance returns on cash

 

$

35,334

 

$

33,087

 

Investments to fund compensation/retirement plans

 

$

14,100

 

$

13,690

 

Other investments

 

$

10,954

 

$

6,900

 

 

The following is a summary of the unrealized gains, unrealized losses, and fair value by investment type at October 28, 2017, and April 29, 2017:

 

At October 28, 2017

 

(Unaudited, amounts in thousands)

 

Gross
Unrealized Gains

 

Gross
Unrealized Losses

 

Fair Value

 

Equity securities

 

$

2,303

 

$

(46

)

$

19,079

 

Fixed income

 

55

 

(115

)

37,236

 

Mutual funds

 

 

 

17

 

Other

 

64

 

 

4,056

 

Total securities

 

$

2,422

 

$

(161

)

$

60,388

 

 

 

 

 

 

 

 

 

At April 29, 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Unaudited, amounts in thousands)

 

Gross
Unrealized Gains

 

Gross
Unrealized Losses

 

Fair Value

 

Equity securities

 

$

1,796

 

$

(83

)

$

13,610

 

Fixed income

 

729

 

(72

)

37,580

 

Mutual funds

 

 

 

6

 

Other

 

1

 

(8

)

2,481

 

Total securities

 

$

2,526

 

$

(163

)

$

53,677

 

 

The following table summarizes sales of available-for-sale securities:

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Proceeds from sales

 

$

5,672

 

$

6,087

 

$

11,529

 

$

9,757

 

Gross realized gains

 

16

 

16

 

418

 

47

 

Gross realized losses

 

(7

)

(2

)

(228

)

(38

)

 

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The fair value of fixed income available-for-sale securities by contractual maturity was $12.1 million within one year, $23.4 million within two to five years, $1.3 million within six to ten years, and $0.4 million thereafter.

 

Note 7: Pension Plans

 

Net periodic pension costs were as follows:

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Service cost

 

$

329

 

$

319

 

$

658

 

$

638

 

Interest cost

 

1,147

 

1,170

 

2,294

 

2,340

 

Expected return on plan assets

 

(1,204

)

(1,245

)

(2,408

)

(2,490

)

Net amortization

 

780

 

764

 

1,560

 

1,528

 

Net periodic pension cost

 

$

1,052

 

$

1,008

 

$

2,104

 

$

2,016

 

 

The components of net periodic pension cost other than the service cost are included in other income (expense), net in our consolidated statement of income. Service cost is recorded in cost of sales in our consolidated statement of income.

 

Note 8: Product Warranties

 

We accrue an estimated liability for product warranties when we recognize revenue on the sale of warranted products. We estimate future warranty claims based on our claims experience and any additional anticipated future costs on previously sold products. We incorporate repair costs into our liability estimates, including materials, labor and overhead amounts necessary to perform repairs and any costs associated with delivering repaired product to our customers. Approximately 95% of our warranty liability relates to our Upholstery segment as we generally warrant our products against defects for one year on fabric and leather, from one to ten years on cushions and padding, and provide a limited lifetime warranty on certain mechanisms and frames. Our warranties cover labor costs relating to our parts for one year. Our warranty period begins when the consumer receives our product. We use considerable judgment in making our estimates, and we record differences between our actual and estimated costs when the differences are known.

 

A reconciliation of the changes in our product warranty liability is as follows:

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Balance as of the beginning of the period

 

$

21,882

 

$

20,908

 

$

21,870

 

$

20,511

 

Accruals during the period

 

4,648

 

4,719

 

9,501

 

9,854

 

Settlements during the period

 

(4,924

)

(4,725

)

(9,765

)

(9,463

)

Balance as of the end of the period

 

$

21,606

 

$

20,902

 

$

21,606

 

$

20,902

 

 

As of October 28, 2017, and April 29, 2017, we included $13.0 million and $13.2 million, respectively, of our product warranty liability in accrued expenses and other current liabilities on our consolidated balance sheet, and included the remainder in other long-term liabilities. We recorded accruals during the periods presented primarily to reflect charges that relate to warranties issued during the respective periods.

 

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Note 9: Stock-Based Compensation

 

The table below summarizes the total stock-based compensation expense we recognized for all outstanding grants in our consolidated statement of income:

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Equity-based awards expense

 

$

2,852

 

$

2,551

 

$

6,410

 

$

5,880

 

Liability-based awards (income) expense

 

(588

)

(1,229

)

308

 

270

 

Total stock-based compensation expense

 

$

2,264

 

$

1,322

 

$

6,718

 

$

6,150

 

 

Stock Options. We granted 573,591 stock options to employees during the first quarter of fiscal 2018, and we have stock options outstanding from previous grants. We account for stock options as equity-based awards because when they are exercised, they will be settled in common shares. We recognize compensation expense for stock options over the vesting period equal to the fair value on the date our compensation committee approved the awards. The vesting period for our stock options ranges from one to four years, with accelerated vesting upon retirement. We expense options granted to retirement-eligible employees immediately. We estimate forfeiture rates based on our employees’ forfeiture history and believe they will approximate future results. We estimate the fair value of the employee stock options at the date of grant using the Black-Scholes option-pricing model, which requires management to make certain assumptions. We estimate expected volatility based on the historical volatility of our common shares. We base the average expected life on the contractual term of the stock option and expected employee exercise trends. We base the risk-free rate on U.S. Treasury issues with a term equal to the expected life assumed at the date of the grant.

 

We calculated the fair value of stock options granted during the first quarter of fiscal 2018 using the following assumptions:

 

(Unaudited)

 

Fiscal 2018
grant

 

Risk-free interest rate

 

1.84

%

Dividend rate

 

1.61

%

Expected life in years

 

5.00

 

Stock price volatility

 

32.12

%

Fair value per share

 

$

7.16

 

 

Stock Appreciation Rights (“SARs”). We did not grant any SARs to employees during the first six months of fiscal 2018, but we have SARs outstanding from previous grants. SARs will be paid in cash upon exercise and, accordingly, we account for SARs as liability-based awards that we re-measure to reflect the fair value at the end of each reporting period. These awards vest at 25% per year, beginning one year from the grant date for a term of four years, with accelerated vesting upon retirement. We expense SARs granted to retirement-eligible employees immediately. We estimate the fair value of SARs at the end of each reporting period using the Black-Scholes option-pricing model, which requires management to make certain assumptions. We base the average expected life on the contractual term of the SARs and expected employee exercise trends (which is consistent with the expected life of our option awards). We base the risk-free rate on U.S. Treasury issues with a term equal to the expected life assumed at the end of the reporting period.

 

In fiscal 2013, we granted SARs as described in our Annual Report on Form 10-K for the fiscal year ended April 27, 2013. These awards have exceeded their expected life and are re-measured based on their intrinsic value, which is the market value of our common stock on the last day of the reporting period less the exercise

 

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price, until the earlier of the exercise date or the contractual term date. At October 28, 2017, the intrinsic value per share of these awards was $15.73.

 

In fiscal 2014, we granted SARs as described in our Annual Report on Form 10-K for the fiscal year ended April 26, 2014. At October 28, 2017, we measured the fair value of these SARs using the following assumptions:

 

(Unaudited)

 

Fiscal 2014
grant

 

Risk-free interest rate

 

1.28

%

Dividend rate

 

1.59

%

Expected life in years

 

0.63

 

Stock price volatility

 

45.68

%

Fair value per share

 

$

9.17

 

 

Restricted Stock. We granted 102,662 shares of restricted stock to employees during the first quarter of fiscal 2018. We also have shares of restricted stock outstanding from previous grants. We issue restricted stock at no cost to the employees, and the shares are held in an escrow account until the vesting period ends. If a recipient’s employment ends during the escrow period (other than through death or disability), the shares are returned at no cost to the company. We account for restricted stock awards as equity-based awards because when they vest, they will be settled in common shares. The fair value of the restricted stock awarded in the first quarter of fiscal 2018 was $27.25 per share, the market value of our common shares on the date of grant. We estimate forfeiture rates based on our employees’ forfeiture history and believe they will approximate future results. We recognize compensation expense for restricted stock over the vesting period equal to the fair value on the date our compensation committee approved the awards. Restricted stock awards vest at 25% per year, beginning one year from the grant date for a term of four years.

 

Restricted Stock Units. During the second quarter of fiscal 2018, we granted 29,520 restricted stock units to our non-employee directors. These restricted stock units vest when the director leaves the board. We account for these restricted stock units as equity-based awards because when they vest, they will be settled in shares of our common stock. We measure and recognize compensation expense for these awards based on the market price of our common shares on the date of grant, which was $23.85.

 

Performance Shares. During the first quarter of fiscal 2018, we granted 177,805 performance-based shares. We also have performance-based share awards outstanding from previous grants. Payout of these grants depends on our financial performance (80%) and a market-based condition based on the total return our shareholders receive on their investment in our stock relative to returns earned through investments in other public companies (20%). The performance share opportunity ranges from 50% of the employee’s target award if minimum performance requirements are met to a maximum of 200% of the target award based on the attainment of certain financial and shareholder-return goals over a specific performance period, which is generally three fiscal years.

 

We account for performance-based shares as equity-based awards because when they vest, they will be settled in common shares. We estimate forfeiture rates based on our employees’ forfeiture history and believe they will approximate future results. For shares that vest based on our results relative to the performance goals, we expense as compensation cost the fair value of the shares as of the day we granted the awards recognized over the performance period, taking into account the probability that we will satisfy the performance goals. The fair value of each share of the awards we granted in fiscal 2018 that vest based on attaining performance goals was $25.93, the market value of our common shares on the date we granted the awards less the dividends we expect

 

14



Table of Contents

 

to pay before the shares vest. For shares that vest based on market conditions, we use a Monte Carlo valuation model to estimate each share’s fair value as of the date of grant, and, similar to the way in which we expense awards of stock options, we expense compensation cost over the vesting period regardless of the value that award recipients ultimately receive. Based on the Monte Carlo model, the fair value as of the grant date of the fiscal 2018 grant of shares that vest based on market conditions was $36.24.

 

15


 


Table of Contents

 

Note 10: Accumulated Other Comprehensive Loss

 

The activity in accumulated other comprehensive loss for the quarter ended October 28, 2017, and October 29, 2016, is as follows:

 

(Unaudited, amounts in thousands)

 

Translation
adjustment

 

Change in
fair value
of cash
flow hedge

 

Unrealized
gain on
marketable
securities

 

Net pension
amortization
and net
actuarial
loss

 

Accumulated
other
comprehensive
loss

 

Balance at July 29, 2017

 

$

984

 

$

552

 

$

1,481

 

$

(33,265

)

$

(30,248

)

Changes before reclassifications

 

(247

)

(1,094

)

344

 

 

(997

)

Amounts reclassified to net income

 

 

(103

)

(8

)

836

 

725

 

Tax effect

 

 

456

 

(128

)

(319

)

9

 

Other comprehensive income (loss) attributable to La-Z- Boy Incorporated

 

(247

)

(741

)

208

 

517

 

(263

)

Balance at October 28, 2017

 

$

737

 

$

(189

)

$

1,689

 

$

(32,748

)

$

(30,511

)

 

 

 

 

 

 

 

 

 

 

 

 

(Unaudited, amounts in thousands)

 

Translation
adjustment

 

Change in
fair value
of cash
flow hedge

 

Unrealized
gain on
marketable
securities

 

Net pension
amortization
and net
actuarial
loss

 

Accumulated
other
comprehensive
loss

 

Balance at July 30, 2016

 

$

(485

)

$

(761

)

$

1,263

 

$

(33,818

)

$

(33,801

)

Changes before reclassifications

 

(188

)

(200

)

(226

)

 

(614

)

Amounts reclassified to net income

 

 

424

 

(14

)

823

 

1,233

 

Tax effect

 

 

(85

)

91

 

(314

)

(308

)

Other comprehensive income (loss) attributable to La-Z- Boy Incorporated

 

(188

)

139

 

(149

)

509

 

311

 

Balance at October 29, 2016

 

$

(673

)

$

(622

)

$

1,114

 

$

(33,309

)

$

(33,490

)

 

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Table of Contents

 

The activity in accumulated other comprehensive loss for the six months ended October 28, 2017, and October 29, 2016, is as follows:

 

(Unaudited, amounts in thousands)

 

Translation
adjustment

 

Change in
fair value
of cash
flow hedge

 

Unrealized
gain on
marketable
securities

 

Net pension
amortization
and net
actuarial
loss

 

Accumulated
other
comprehensive
loss

 

Balance at April 29, 2017

 

$

(927

)

$

74

 

$

1,752

 

$

(33,782

)

$

(32,883

)

Changes before reclassifications

 

1,664

 

(239

)

738

 

 

2,163

 

Amounts reclassified to net income

 

 

(186

)

(840

)

1,671

 

645

 

Tax effect

 

 

162

 

39

 

(637

)

(436

)

Other comprehensive income (loss) attributable to La-Z- Boy Incorporated

 

1,664

 

(263

)

(63

)

1,034

 

2,372

 

Balance at October 28, 2017

 

$

737

 

$

(189

)

$

1,689

 

$

(32,748

)

$

(30,511

)

 

 

 

 

 

 

 

 

 

 

 

 

(Unaudited, amounts in thousands)

 

Translation
adjustment

 

Change in
fair value
of cash
flow hedge

 

Unrealized
gain on
marketable
securities

 

Net pension
amortization
and net
actuarial
loss

 

Accumulated
other
comprehensive
loss

 

Balance at April 30, 2016

 

$

(445

)

$

(286

)

$

1,058

 

$

(34,327

)

$

(34,000

)

Changes before reclassifications

 

(228

)

(1,479

)

100

 

 

(1,607

)

Amounts reclassified to net income

 

 

936

 

(9

)

1,645

 

2,572

 

Tax effect

 

 

207

 

(35

)

(627

)

(455

)

Other comprehensive income (loss) attributable to La-Z- Boy Incorporated

 

(228

)

(336

)

56

 

1,018

 

510

 

Balance at October 29, 2016

 

$

(673

)

$

(622

)

$

1,114

 

$

(33,309

)

$

(33,490

)

 

In our consolidated statement of income, we reclassified the unrealized gain on marketable securities from accumulated other comprehensive loss to net income through other income (expense), net, reclassified the change in fair value of cash flow hedges to net income through cost of sales, and reclassified the net pension amortization to net income through other income (expense), net.

 

The components of non-controlling interest for the quarter and six months ended October 28, 2017, and October 29, 2016, were as follows:

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Balance as of the beginning of the period

 

$

11,684

 

$

10,244

 

$

11,186

 

$

10,070

 

Net income

 

310

 

272

 

403

 

474

 

Other comprehensive income (loss)

 

100

 

(73

)

505

 

(101

)

Balance as of the end of the period

 

$

12,094

 

$

10,443

 

$

12,094

 

$

10,443

 

 

17



Table of Contents

 

Note 11: Segment Information

 

Our reportable operating segments are the Upholstery segment, the Casegoods segment and the Retail segment.

 

Upholstery Segment. Our Upholstery segment is our largest business segment and consists primarily of two operating units: La-Z-Boy, our largest operating unit, and our England subsidiary. The Upholstery segment also includes our international wholesale businesses. Our Upholstery segment manufactures and imports upholstered furniture such as recliners and motion furniture, sofas, loveseats, chairs, sectionals, modulars, ottomans and sleeper sofas. The Upholstery segment sells directly to La-Z-Boy Furniture Galleries® stores, operators of La-Z-Boy Comfort Studio® locations and England Custom Comfort Center locations, major dealers, and a wide cross-section of other independent retailers.

 

Casegoods Segment. Our Casegoods segment consists of three brands: American Drew, Hammary, and Kincaid. The Casegoods segment sells directly to major dealers, as well as La-Z-Boy Furniture Galleries® stores, and a wide cross-section of other independent retailers. Our Casegoods segment is an importer, marketer, and distributor of casegoods/wood furniture such as bedroom sets, dining room sets, entertainment centers and occasional pieces, and also manufactures some coordinated upholstered furniture.

 

Retail Segment. Our Retail segment consists of 147 company-owned La-Z-Boy Furniture Galleries® stores. The Retail segment primarily sells upholstered furniture, in addition to some casegoods and other accessories, to end consumers through these stores.

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Sales

 

 

 

 

 

 

 

 

 

Upholstery segment:

 

 

 

 

 

 

 

 

 

Sales to external customers

 

$

251,741

 

$

244,898

 

$

476,555

 

$

468,707

 

Intersegment sales

 

53,020

 

50,891

 

102,613

 

94,498

 

Upholstery segment sales

 

304,761

 

295,789

 

579,168

 

563,205

 

 

 

 

 

 

 

 

 

 

 

Casegoods segment:

 

 

 

 

 

 

 

 

 

Sales to external customers

 

23,915

 

23,567

 

44,934

 

44,152

 

Intersegment sales

 

4,150

 

2,321

 

8,641

 

6,774

 

Casegoods segment sales

 

28,065

 

25,888

 

53,575

 

50,926

 

 

 

 

 

 

 

 

 

 

 

Retail segment sales

 

116,737

 

107,365

 

227,253

 

203,085

 

 

 

 

 

 

 

 

 

 

 

Corporate and Other:

 

 

 

 

 

 

 

 

 

Sales to external customers

 

812

 

749

 

1,542

 

1,418

 

Intersegment sales

 

2,091

 

1,563

 

4,021

 

2,773

 

Corporate and Other sales

 

2,903

 

2,312

 

5,563

 

4,191

 

 

 

 

 

 

 

 

 

 

 

Eliminations

 

(59,261

)

(54,775

)

(115,275

)

(104,045

)

Consolidated sales

 

$

393,205

 

$

376,579

 

$

750,284

 

$

717,362

 

 

18



Table of Contents

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Operating Income (Loss)

 

 

 

 

 

 

 

 

 

Upholstery segment

 

$

33,424

 

$

38,220

 

$

56,723

 

$

68,719

 

Casegoods segment

 

3,302

 

2,847

 

6,041

 

4,994

 

Retail segment

 

3,903

 

3,007

 

5,670

 

5,190

 

Corporate and Other

 

(6,360

)

(10,216

)

(17,867

)

(22,587

)

Consolidated operating income

 

34,269

 

33,858

 

50,567

 

56,316

 

Interest expense

 

160

 

117

 

317

 

232

 

Interest income

 

376

 

234

 

719

 

438

 

Gain on conversion of investment

 

 

 

2,204

 

 

Other income (expense), net

 

(926

)

(969

)

(1,381

)

(1,731

)

Income before income taxes

 

$

33,559

 

$

33,006

 

$

51,792

 

$

54,791

 

 

Note 12: Income Taxes

 

Our effective tax rate for the second quarter and six months ended October 28, 2017, was 30.8% and 32.5%, respectively. For the second quarter and six months ended October 29, 2016, our effective tax rate was 36.1% and 35.9%, respectively. Our effective tax rate varies from the 35% statutory rate primarily due to state taxes, less the benefit of the U.S. manufacturing deduction and foreign earnings in jurisdictions with lower tax rates than the U.S. Additionally, our effective tax rate for the second quarter and first six months of fiscal 2018 was lower primarily due to certain discrete tax items related to research and development tax credits of $1.3 million attributable to fiscal years prior to fiscal 2018 for which we intend to file amended tax returns.

 

Our consolidated balance sheet at the end of the second quarter of fiscal 2018 reflected a $0.9 million net liability for uncertain income tax positions. We do not expect this net liability to change significantly in the next 12 months. We will either pay or release the liability for uncertain income tax positions as tax audits are completed or settled, statutes of limitation expire or other new information becomes available.

 

Note 13: Earnings per Share

 

Certain share-based compensation awards that entitle their holders to receive non-forfeitable dividends prior to vesting are considered participating securities. We grant restricted stock awards that contain non-forfeitable rights to dividends on unvested shares, and we are required to include these participating securities in calculating our basic earnings per common share, using the two-class method.

 

19



Table of Contents

 

The following is a reconciliation of the numerators and denominators we used in our computations of basic and diluted earnings per share:

 

 

 

Quarter Ended

 

Six Months Ended

 

(Unaudited, amounts in thousands)

 

10/28/17

 

10/29/16

 

10/28/17

 

10/29/16

 

Numerator (basic and diluted):

 

 

 

 

 

 

 

 

 

Net income attributable to La-Z-Boy Incorporated

 

$

22,896

 

$

20,833

 

$

34,547

 

$

34,639

 

Income allocated to participating securities

 

(117

)

(103

)

(172

)

(172

)

Net income available to common shareholders

 

$

22,779

 

$

20,730

 

$

34,375

 

$

34,467

 

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

47,964

 

49,153

 

48,160

 

49,129

 

Add:

 

 

 

 

 

 

 

 

 

Contingent common shares

 

96

 

100

 

99

 

100

 

Stock option dilution

 

237

 

258

 

278

 

325

 

Diluted weighted average common shares outstanding

 

48,297

 

49,511

 

48,537

 

49,554

 

 

The above values for contingent common shares reflect the dilutive effect of common shares that we would have issued to employees under the terms of performance-based share awards if the relevant performance period for the award had been the reporting period.

 

We did not exclude any outstanding options from the diluted share calculation for the quarter and six months ended October 28, 2017, or for the quarter and six months ended October 29, 2016.

 

Note 14: Fair Value Measurements

 

Accounting standards require that we put financial assets and liabilities into one of three categories based on the inputs we use to value them:

 

·                  Level 1 — Financial assets and liabilities the values of which are based on unadjusted quoted market prices for identical assets and liabilities in an active market that we have the ability to access.

 

·                  Level 2 — Financial assets and liabilities the values of which are based on quoted prices in markets that are not active or on model inputs that are observable for substantially the full term of the asset or liability.

 

·                  Level 3 — Financial assets and liabilities the values of which are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.

 

Accounting standards require that in making fair value measurements, we use observable market data when available. When inputs used to measure fair value fall within different levels of the hierarchy, we categorize the fair value measurement as being in the lowest level that is significant to the measurement. We recognize transfers between levels of the fair value hierarchy at the end of the reporting period in which they occur.

 

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In addition to assets and liabilities that we record at fair value on a recurring basis, we are required to record assets and liabilities at fair value on a non-recurring basis. We measure non-financial assets such as other intangible assets, goodwill, and other long-lived assets at fair value when there is an indicator of impairment, and we record them at fair value only when we recognize an impairment loss.

 

The following table presents the fair value hierarchy for those assets we measured at fair value on a recurring basis at October 28, 2017, and April 29, 2017:

 

At October 28, 2017

 

 

 

Fair Value Measurements

 

(Unaudited, amounts in thousands)

 

Level 1 (a)

 

Level 2 (a)

 

Level 3 (b)

 

Assets

 

 

 

 

 

 

 

Available-for-sale investments

 

$

1,352

 

$

37,916

 

$

 

Trading securities

 

 

17

 

 

Held-to-maturity investments

 

3,171

 

 

 

Cost basis investments

 

 

 

10,954

 

Total assets

 

$

4,523

 

$

37,933

 

$

10,954

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Contingent consideration liability

 

$

 

$

 

$

1,050

 

 

(a)         There were no transfers between Level 1 and Level 2 during the first six months of fiscal 2018.

(b)         There were no transfers into or out of Level 3 during the first six months of fiscal 2018.

 

At April 29, 2017

 

 

 

Fair Value Measurements

 

(Unaudited, amounts in thousands)

 

Level 1 (c)

 

Level 2 (c)

 

Level 3 (d)

 

Assets

 

 

 

 

 

 

 

Available-for-sale investments

 

$

1,217

 

$

36,638

 

$

1,400

 

Trading securities

 

 

6

 

 

Held-to-maturity investments

 

1,866

 

 

 

Cost basis investment

 

 

 

5,500

 

Total assets

 

$

3,083

 

$

36,644

 

$

6,900

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

Contingent consideration liability

 

$

 

$

 

$

1,248

 

 

(c)          There were no transfers between Level 1 and Level 2 during fiscal 2017.

(d)         There were no transfers into or out of Level 3 during fiscal 2017.

 

At October 28, 2017, and April 29, 2017, we held available-for-sale marketable securities intended to enhance returns on our cash and to fund future obligations of our non-qualified defined benefit retirement plan, as well as trading securities to fund future obligations of our executive deferred compensation plan and our performance compensation retirement plan. We also held other fixed income and cost basis investments.

 

The fair value measurements for our Level 1 and Level 2 securities are based on quoted prices in active markets, as well as through broker quotes and independent valuation providers, multiplied by the number of shares owned exclusive of any transaction costs. At October 28, 2017, our Level 3 investments included preferred shares of two privately-held companies, and a warrant to purchase common shares of one of these privately-held companies. We initially valued our Level 3 investments at their cost basis as of the date of purchase, because the cost basis was the best estimate of their fair value on the date of acquisition. During fiscal

 

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2017, we recorded a $0.7 million unrealized gain in other comprehensive income related to a change in the fair value of the available-for-sale convertible debt security. During the first quarter of fiscal 2018, the available-for-sale convertible debt security converted to $3.0 million of cost-basis preferred shares of a privately-held company, and we recorded a gain of $2.2 million in other income (expense), net in our consolidated statement of income related to the conversion. We also invested another $2.5 million in the same privately-held company during the first quarter of fiscal 2018. Our Level 3 liability is a contingent consideration liability, and we estimate the fair value of this liability based on the present value of the probability-weighted future cash flows, which are unobservable inputs that are not supported by market activity. During the second quarter of fiscal 2018, we reversed a portion of the contingent consideration liability, and recorded the benefit as a component of selling, general, and administrative expense in our consolidated statement of income, because we determined it was not probable that the contingent consideration would be earned.

 

The following table is a reconciliation of our Level 3 assets and liabilities recorded at fair value using significant unobservable inputs:

 

(Unaudited, amounts in thousands)

 

Level 3

 

Assets

 

 

 

Balance at April 29, 2017

 

$

6,900

 

Purchases

 

2,500

 

Realized gain

 

2,204

 

Unrealized gain reclassified to net income

 

(650

)

Balance at October 28, 2017

 

$

10,954

 

 

 

 

 

(Unaudited, amounts in thousands)

 

Level 3

 

Liabilities

 

 

 

Balance at April 29, 2017

 

$

1,248

 

Fair value adjustment

 

(213

)

Translation adjustment

 

15

 

Balance at October 28, 2017

 

$

1,050

 

 

Our asset leveling presented above does not include certain available-for-sale investments that are measured at fair value using net asset value per share under the practical expedient methodology. These investments are still included in the total fair value column of the table in our investment footnote (see Note 6). The fair value of the investments measured using net asset value at October 28, 2017, and April 29, 2017, was $7.0 million and $7.1 million, respectively.

 

Note 15: Recent Accounting Pronouncements

 

Accounting pronouncements adopted in fiscal 2018

 

In March 2016, the FASB issued a new accounting standard focused on simplifying the accounting for share-based payments, including accounting for income taxes, estimating forfeitures, and classifying certain share-based transactions in the consolidated statement of cash flows. We adopted this standard in the first quarter of fiscal 2018. Our adoption of this standard did not have a material impact on our consolidated financial statements. We did not record a cumulative-effect adjustment as we had no unrecognized excess tax benefits as of the end of fiscal 2017. We elected to continue estimating forfeiture rates on our share-based awards. We

 

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adjusted the consolidated statement of cash flows for the first six months of fiscal 2017 to conform to the current fiscal year presentation by reclassifying $1.7 million of cash paid related to shares swapped for taxes from a financing activity to an operating activity.

 

In August 2016, the FASB issued a new accounting standard that provides guidance on the classification of eight cash receipts and cash payments issues on the statement of cash flows. The intent of this standard was to help reduce diversity in practice regarding cash flow presentation. We early adopted this standard in fiscal 2018. Adoption of this standard did not have a material impact on our consolidated statement of cash flows and although the guidance requires retrospective treatment, we did not have any cash receipts or payments during the prior year that needed to be reclassified.

 

In November 2016, the FASB issued a new accounting standard that requires the statement of cash flows to explain the change during the period in the total cash, cash equivalents, and amounts generally described as restricted cash. Amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. We early adopted this standard in fiscal 2018 with retrospective application. For the six months ended October 29, 2016, this change resulted in a $9.0 million increase in cash, cash equivalents and restricted cash at both the beginning and end of the period on our consolidated statement of cash flows. In addition, removing the change in restricted cash from the consolidated statement of cash flows resulted in a decrease of less than $0.1 million in our net cash used for investing activities for the six months ended October 29, 2016.

 

In March 2017, the FASB issued a new accounting standard that changes the presentation of pension costs in our consolidated statement of income. We elected to early adopt this standard in fiscal 2018, and it requires retrospective application. All components of pension costs other than service costs will now be presented in other income (expense), net rather than operating income in our consolidated statement of income. Adoption of this standard did not have a material impact on our consolidated statement of income for any periods presented. For the second quarter and first six months of fiscal 2017, we reclassified pension costs of $0.7 million and $1.4 million, respectively, from operating income to other income (expense), net to conform to the current-year presentation.

 

Accounting pronouncements not yet adopted

 

In May 2014, the FASB issued a new accounting standard that requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The new standard supersedes virtually all existing authoritative accounting guidance on revenue recognition and requires additional disclosures and greater use of estimates and judgments. During July 2015, the FASB deferred the effective date of the revenue recognition standard by one year, thus making the new accounting standard effective for our fiscal 2019. We have reviewed substantially all of our contracts and other revenue streams and currently believe that the application of the new standard will not have a material change in the amount of or timing for recognizing revenue. At this time, we believe we will choose the modified retrospective approach to implementing the new standard when it becomes effective for our fiscal 2019. We are still assessing the impact this standard will have on our financial statement disclosures.

 

In January 2016, the FASB issued a new accounting standard that requires equity investments to be measured at fair value with the fair value changes to be recognized through net income. This standard does not apply to investments that are accounted for under the equity method of accounting, or that result in consolidation of the invested entity. We currently hold equity investments that are measured at fair value at the end of each reporting period, and we recognize the fair value changes through other comprehensive income (loss) as unrealized gains (losses). Based on the fair value of our net unrealized gain as of October 28, 2017, adoption of this standard

 

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would be immaterial to our consolidated financial statements. Adoption of this standard will be required for our fiscal 2019 financial statements.

 

In February 2016, the FASB issued a new accounting standard requiring all operating leases that a lessee enters into to be recorded on their balance sheet. Under this new standard, the lessee is required to record an asset for the right to use the underlying asset for the lease term and a corresponding liability for the contractual lease payments. This standard is effective for our fiscal 2020. We are currently reviewing our leases and gathering the necessary information and tools to adopt this standard when it becomes effective for our fiscal 2020. We anticipate that adoption of this standard will have a significant impact on our consolidated balance sheet as we have a significant number of operating leases.

 

In June 2016, the FASB issued a new accounting standard that amends current guidance on other-than-temporary impairments of available-for-sale debt securities. This amended standard requires the use of an allowance to record estimated credit losses on these assets when the fair value is below the amortized cost of the asset. This standard also removes the evaluation of the length of time that a security has been in a loss position to avoid recording a credit loss. We are required to adopt this standard for our fiscal 2021 and apply it through a cumulative-effect adjustment to retained earnings. We are still assessing the impact this standard will have on our consolidated financial statements and related disclosures.

 

In October 2016, the FASB issued a new accounting standard that requires entities to recognize the income tax consequences of an intra-entity transfer of assets other than inventory when the transfer occurs. This standard will be applicable for our fiscal 2019. We are still assessing the impact this standard will have on our consolidated financial statements and related disclosures.

 

In January 2017, the FASB issued a new accounting standard clarifying the definition of a business with the objective of adding guidance to entities evaluating whether a transaction should be accounted for as an acquisition. This standard will be applicable for our fiscal 2019. We are still assessing the impact this standard will have on our consolidated financial statements and related disclosures.

 

In January 2017, the FASB issued a new accounting standard simplifying the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. An entity should now perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. This standard will be applicable for our fiscal 2021. We are still assessing the impact this standard will have on our consolidated financial statements and related disclosures.

 

In August 2017, the FASB issued a new accounting standard designed to improve and simplify the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. This standard is intended to better align the recognition and presentation of the effects of hedging instruments with the hedged item in the financial statements, and requires additional disclosures on hedging instruments. This standard will be effective for our fiscal 2020. Based on our current hedging activity, we do not expect this standard to have a material impact on our consolidated financial statements or disclosures.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

We have prepared this Management’s Discussion and Analysis as an aid to understanding our financial results. It should be read in conjunction with the accompanying Consolidated Financial Statements and related Notes to Consolidated Financial Statements. After a cautionary note about forward-looking statements, we begin with an introduction to our key businesses and then provide discussions of our results of operations, liquidity and capital resources, and critical accounting policies.

 

Cautionary Statement Concerning Forward-Looking Statements

 

La-Z-Boy Incorporated and its subsidiaries (individually and collectively, “we,” “our” or the “Company”) make forward-looking statements in this report, and its representatives may make oral forward-looking statements from time to time. Generally, forward-looking statements include information concerning possible or assumed future actions, events or results of operations. More specifically, forward-looking statements may include information regarding:

 

·  future income, margins and cash flows

 

·  future economic performance

·  future sales

 

·  industry and importing trends

·  adequacy and cost of financial resources

 

·  management plans and strategic initiatives

 

Forward-looking statements also include those preceded or followed by the words “anticipates,” “believes,” “estimates,” “hopes,” “plans,” “could,” “intends” and “expects” or similar expressions. With respect to all forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 

Actual results could differ materially from those we anticipate or project due to a number of factors, including: (a) changes in consumer confidence and demographics; (b) the possibility of a recession; (c) changes in the real estate and credit markets and their effects on our customers, consumers and suppliers; (d) international political unrest, terrorism or war; (e) volatility in energy and other commodities prices; (f) the impact of logistics on imports and exports; (g) tax rate, interest rate, and currency exchange rate changes; (h) operating factors, such as supply, labor or distribution disruptions (e.g. port strikes); (i) changes in legislation, including the tax code, or changes in the domestic or international regulatory environment  (including new or increased duties); (j) adoption of new accounting principles; (k) fires, severe weather or other natural events such as hurricanes, earthquakes, flooding, tornadoes and tsunamis; (l) our ability to procure or transport fabric rolls, leather hides or cut-and-sewn fabric and leather sets domestically or abroad; (m) information technology conversions or system failures and our ability to recover from a system failure; (n) effects of our brand awareness and marketing programs; (o) the discovery of defects in our products resulting in delays in manufacturing, recall campaigns, reputational damage, or increased warranty costs; (p) litigation arising out of alleged defects in our products; (q) unusual or significant litigation; (r) our ability to locate new La-Z-Boy Furniture Galleries® stores (or store owners) and negotiate favorable lease terms for new or existing locations; (s) the ability to increase volume through our e-commerce initiatives; (t) the impact of potential goodwill or intangible asset impairments; and (u) those matters discussed in Item 1A of our fiscal 2017 Annual Report on Form 10-K and other factors identified from time to time in our reports filed with the Securities and Exchange Commission. We undertake no obligation to update or revise any forward-looking statements, whether to reflect new information or new developments or for any other reason.

 

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Introduction

 

Our Business

 

We manufacture, market, import, export, distribute and retail upholstery furniture products. In addition, we import, distribute and retail accessories and casegoods (wood) furniture products. We are the leading global producer of reclining chairs and the second largest manufacturer/distributor of residential furniture in the United States. The La-Z-Boy Furniture Galleries® stores retail network is the third largest retailer of single-branded furniture in the United States. We have seven major manufacturing locations and six regional distribution centers in the United States and one facility in Mexico to support our speed-to-market and customization strategy. We also participate in a joint venture that operates a manufacturing facility in Thailand that supports our international business. Additionally, we have contracts with several suppliers in Asia to produce products that support our pure import model for casegoods.

 

We sell our products to furniture retailers or distributors in the United States, Canada, and approximately 60 other countries, directly to consumers through stores that we own and operate, and through our website, la-z-boy.com. The centerpiece of our retail distribution strategy is our network of 350 La-Z-Boy Furniture Galleries® stores and 547 La-Z-Boy Comfort Studio® locations, each dedicated to marketing our La-Z-Boy branded products. We consider this dedicated space to be “proprietary.” We own 147 of the La-Z-Boy Furniture Galleries® stores. The remainder of the La-Z-Boy Furniture Galleries® stores, as well as all 547 La-Z-Boy Comfort Studio® locations, are independently owned and operated. La-Z-Boy Furniture Galleries® stores help consumers furnish their homes by combining the style, comfort, and quality of La-Z-Boy furniture with our available design services. La-Z-Boy Comfort Studio® locations are defined spaces within larger independent retailers that are dedicated to displaying and selling La-Z-Boy branded products. Our other brands, England, American Drew, Hammary, and Kincaid enjoy distribution through many of the same outlets, with approximately half of Hammary’s sales originating through the La-Z-Boy Furniture Galleries® store network. Kincaid and England have their own dedicated proprietary in-store programs with 532 outlets and almost 1.7 million square feet of proprietary floor space. In total, our proprietary floor space includes approximately 9.5 million square feet.

 

Our goal is to deliver value to our shareholders with improved sales and earnings over the long term through executing our strategic initiatives. The foundation of our strategic initiatives is driving profitable sales growth in all areas of our business, but most importantly in our flagship La-Z-Boy brand. We are planning for this growth in several ways:

 

·                  We are expanding our branded distribution channels, which include the La-Z-Boy Furniture Galleries® store network and the La-Z-Boy Comfort Studio® locations, our store-within-a-store format. Our target is 1,000 proprietary locations, composed of 400 La-Z-Boy Furniture Galleries® stores and 600 La-Z-Boy Comfort Studio® locations. We expect this initiative to generate growth in our Retail segment through an increased company-owned store count, and to generate growth in our wholesale Upholstery segment as our proprietary distribution network expands.

·                  We are growing the size of our company-owned retail business by opening new La-Z-Boy Furniture Galleries® stores, primarily in markets that can be serviced through our regional distribution centers, where we see opportunity for growth, or where we believe we have opportunities for further market penetration.

·                  We are attempting to responsibly increase our market share by taking advantage of our unique multi-channel distribution network. In addition to our branded distribution channels, over 1,800 other dealers sell La-Z-Boy products, providing us the benefit of multi-channel distribution. These outlets include some of the best known names in the industry, including Art Van, Nebraska Furniture Mart, and

 

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Slumberland. Our other brands, England, American Drew, Hammary, and Kincaid, enjoy distribution through many of the same outlets. We believe there is significant growth potential for our brands through these retail channels.

·                  We also aim to increase our market share in stationary upholstered furniture through a combination of our Live Life Comfortably® marketing campaign, featuring Brooke Shields as our brand ambassador, and our innovative and on-trend product. While we are known for our iconic recliners, they account for less than half of our sales in dollars, and we believe we have the potential to expand sales of our other products. To stimulate growth, we focus on expanding our digital marketing and e-commerce capabilities to build traffic across our multiple digital and physical properties. We are driving change throughout our digital platforms to improve the user experience, with a specific focus on the ease by which customers browse through our broad assortment, customize products to their liking, find stores to make a purchase, or purchase at la-z-boy.com.

·                  We are bringing innovative products to market, including stain-resistant iCleanTM fabric and our power products, some of which include dual mechanisms and articulating headrests. Most recently we introduced duoTM, a revolutionary new product line that features the look of stationary furniture with the power to recline at the push of a button. We are committed to innovation throughout our business, and to support these efforts we are building a new state-of-the-art Innovation Center at our Dayton, Tennessee campus. The Innovation Center is expected to be completed by the end of fiscal 2018.

 

In addition to the strategies above, we recognize that online furniture sales are growing rapidly. In response to this changing landscape, we are developing a multi-faceted strategy to participate in and leverage this growth opportunity. This strategy has three components: increase online sales of La-Z-Boy furniture through la-z-boy.com and other digital players, such as Wayfair and Amazon; leverage the strength of our world-class global supply chain to support other e-commerce brands; and invest in new online companies. We believe these three opportunities will position us for growth in the ever-changing online selling environment, and we will continue developing these strategies throughout the fiscal year.

 

Our reportable operating segments are the Upholstery segment, the Casegoods segment and the Retail segment.

 

·                  Upholstery Segment. Our Upholstery segment is our largest business segment and consists primarily of two operating units: La-Z-Boy, our largest operating unit, and our England subsidiary. The Upholstery segment also includes our international wholesale businesses. Our Upholstery segment manufactures and imports upholstered furniture such as recliners and motion furniture, sofas, loveseats, chairs, sectionals, modulars, ottomans and sleeper sofas. The Upholstery segment sells directly to La-Z-Boy Furniture Galleries® stores, operators of La-Z-Boy Comfort Studio® locations and England Custom Comfort Center locations, major dealers, and a wide cross-section of other independent retailers.

·                  Casegoods Segment. Our Casegoods segment is an importer, marketer, and distributor of casegoods/wood furniture such as bedroom sets, dining room sets, entertainment centers and occasional pieces, and also manufactures some coordinated upholstered furniture. The Casegoods segment consists of three brands: American Drew, Hammary, and Kincaid. The Casegoods segment sells directly to major dealers, as well as La-Z-Boy Furniture Galleries® stores, and a wide cross-section of other independent retailers.

·                  Retail Segment. Our Retail segment consists of 147 company-owned La-Z-Boy Furniture Galleries® stores. The Retail segment primarily sells upholstered furniture, in addition to some casegoods and other accessories, to the end consumer through these stores.

 

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Results of Operations

Fiscal 2018 Second Quarter and Six Months Compared with Fiscal 2017 Comparable Periods

 

La-Z-Boy Incorporated

 

(Unaudited, amounts
in thousands,
except percentages)

 

Quarter
Ended
10/28/17

 

Quarter
Ended
10/29/16

 

%
Change

 

Six Months
Ended
10/28/17

 

Six Months
Ended
10/29/16

 

%
Change

 

Sales

 

$

393,205

 

$

376,579

 

4.4

%

$

750,284

 

$

717,362

 

4.6

%

Operating income

 

34,269

 

33,858

 

1.2

%

50,567

 

56,316

 

(10.2

)%

Operating margin

 

8.7

%

9.0

%

 

 

6.7

%

7.9

%

 

 

 

Sales

 

Our consolidated sales increased $16.6 million and $32.9 million in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago. This increase was driven by sales growth in all three of our operating segments. Our Upholstery and Retail segments benefited from acquisitions completed in fiscal 2017. In addition, we increased sales in our Upholstery segment due to a favorable change in our product mix and increased our Casegoods segment sales by expanding our floor space with existing retailers, resulting in higher volume.

 

Operating Margin

 

Our operating margin decreased 0.3 percentage points and 1.2 percentage points in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago.

 

·                  Our gross margin decreased 0.3 percentage points in both the second quarter and first six months of fiscal 2018 compared with the same periods a year ago.

·                  The decreases were primarily the result of a decline in our Upholstery segment’s gross margin due to increased raw material prices for our three core raw material components of steel, polyurethane foam and wood.

·                  Additionally, favorable legal settlements in the second quarter and first six months of fiscal 2017 negatively impacted the comparison of our gross margin by 0.1 percentage point and 0.4 percentage points, respectively.

·                  Lastly, partially offsetting these items was a benefit of 0.3 percentage points and 0.6 percentage points in the second quarter and first six months, respectively, because of changes in our consolidated sales mix, reflecting the growth of our Retail segment, which has a higher gross margin than our wholesale segments.

·                  Our selling, general, and administrative (“SG&A”) expenses as a percentage of sales were flat in the second quarter of fiscal 2018 compared to the same period a year ago. SG&A expense as a percentage of sales increased 0.9 percentage points in the first six months of fiscal 2018 compared with the same period a year ago.

·                  Our SG&A expense as a percentage of sales increased 0.5 percentage points and 0.8 percentage points in the second quarter and first six months, respectively, due to the growth of our Retail segment, as a percentage of our total sales, which has a higher level of SG&A expense as a percentage of sales than our wholesale segments.

·                  Partially offsetting this increase was a $1.7 million insurance gain we recorded during the second quarter of fiscal 2018. The gain occurred because the insurance proceeds we expect to receive as a result of a fire in our England subsidiary’s corporate office building during the first quarter of fiscal 2018 exceed the building’s net book value.  This gain decreased our

 

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SG&A expense as a percentage of sales by 0.4 percentage points and 0.2 percentage points in the second quarter and first six months, respectively.

 

We explain these items further when we discuss each segment’s results later in this Management’s Discussion and Analysis.

 

Upholstery Segment

 

(Unaudited, amounts
in thousands,
except percentages)

 

Quarter
Ended
10/28/17

 

Quarter
Ended
10/29/16

 

%
Change

 

Six Months
Ended
10/28/17

 

Six
Months
Ended
10/29/16

 

%
Change

 

Sales

 

$

304,761

 

$

295,789

 

3.0

%

$

579,168

 

$

563,205

 

2.8

%

Operating income

 

33,424

 

38,220

 

(12.5

)%

56,723

 

68,719

 

(17.5

)%

Operating margin

 

11.0

%

12.9

%

 

 

9.8

%

12.2

%

 

 

 

Sales

 

Our Upholstery segment’s sales increased $9.0 million and $16.0 million in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago. These increases were primarily due to our acquisition of the La-Z-Boy wholesale business in the United Kingdom and Ireland, which contributed sales of $4.6 million and $12.0 million in the second quarter and first six months of fiscal 2018, respectively. Changes in our product mix resulted in an additional 1.9% increase in sales in both the second quarter and first six months of fiscal 2018 compared with the same periods in the prior year. Our product mix in the second quarter and first six months of fiscal 2018 shifted from non-powered fabric units to more leather units with power that have a higher average selling price. These increases were somewhat offset by lower overall unit volume, which resulted in a 1.3% decrease and a 2.4% decrease in sales when compared with the second quarter and first six months of fiscal 2017, respectively.

 

Operating Margin

 

Our Upholstery segment’s operating margin decreased 1.9 percentage points and 2.4 percentage points in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago.

 

·                  The segment’s gross margin decreased 1.3 percentage points and 1.6 percentage points during the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago.

·                  Increased raw material prices, primarily for our three core raw material components of steel, polyurethane foam and wood, decreased the segment’s gross margin by 0.7 percentage points and 0.6 percentage points in the second quarter and first six months of fiscal 2018, respectively. The inflationary pressure we experienced from these raw materials was higher than expected, and during the second quarter we implemented a price increase that we expect will offset the negative impact on our margins as we move into the fourth quarter of our fiscal year. We expect that product delivered late in the third quarter of fiscal 2018 will include the price increase.

·                  Lower absorption of fixed costs in our manufacturing facilities, driven primarily by a decline in production volume, decreased the segment’s gross margin by 0.5 percentage points and 0.7 percentage points in the second quarter and first six months of fiscal 2018, respectively.

 

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·                  Favorable legal settlements in the second quarter and first six months of fiscal 2017 negatively impacted the comparison of the segment’s gross margin by 0.1 percentage point and 0.5 percentage points, respectively.

·                  The segment’s SG&A expense as a percentage of sales increased 0.6 percentage points and 0.8 percentage points during the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago.

·                  The increase in SG&A expense as a percentage of sales was due to higher depreciation on technology investments in our ERP system and software maintenance and other costs associated with our investments in our web e-commerce platform.

 

Casegoods Segment

 

(Unaudited, amounts in
thousands,
except percentages)

 

Quarter
Ended
10/28/17

 

Quarter
Ended
10/29/16

 

%
Change

 

Six Months
Ended
10/28/17

 

Six Months
Ended
10/29/16

 

%
Change

 

Sales

 

$

28,065

 

$

25,888

 

8.4

%

$

53,575

 

$

50,926

 

5.2

%

Operating income

 

3,302

 

2,847

 

16.0

%

6,041

 

4,994

 

21.0

%

Operating margin

 

11.8

%

11.0

%

 

 

11.3

%

9.8

%

 

 

 

Sales

 

Our Casegoods segment’s sales increased $2.2 million and $2.6 million in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago, primarily due to higher volume achieved through a better in-stock position, improved product styling, and expanding our floor space with existing retailers.

 

Operating Margin

 

Our Casegoods segment’s operating margin improved 0.8 percentage points and 1.5 percentage points in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago.

 

·                  The segment’s gross margin decreased 0.9 percentage points in the second quarter of fiscal 2018 compared with the same period a year ago due to increased freight expense on imported product, which was somewhat offset by increased volume and a shift in our product mix to newer, higher margin collections. The segment’s gross margin increased 0.2 percentage points in the first six months of fiscal 2018 compared with the same period a year ago because of increased volume and a shift in our product mix to newer, higher margin collections, which was somewhat offset by increased freight expense on imported product.

·                  The segment’s SG&A expense as a percentage of sales decreased 1.7 percentage points and 1.3 percentage points during the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago, due primarily to our improved absorption of fixed SG&A costs on the higher sales volume, and a reduction in discretionary SG&A spending.

 

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Table of Contents

 

Retail Segment

 

(Unaudited, amounts
in thousands,
except percentages)

 

Quarter
Ended
10/28/17

 

Quarter
Ended
10/29/16

 

%
Change

 

Six Months
Ended
10/28/17

 

Six Months
Ended
10/29/16

 

%
Change

 

Sales

 

$

116,737

 

$

107,365

 

8.7

%

$

227,253

 

$

203,085

 

11.9

%

Operating income

 

3,903

 

3,007

 

29.8

%

5,670

 

5,190

 

9.2

%

Operating margin

 

3.3

%

2.8

%

 

 

2.5

%

2.6

%

 

 

 

Sales

 

Our Retail segment’s sales increased $9.4 million and $24.2 million in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago. In the second quarter and first six months of fiscal 2018, we increased the segment’s sales from our acquired stores by $6.9 million and $20.0 million, respectively, and added $3.9 million and $6.8 million, respectively, from new stores that were not open in the prior-year period. Partially offsetting these items was a $1.4 million and a $2.6 million decrease, respectively, in sales from stores that have been open for at least 12 months, a decline of 1.3% and 1.4%, respectively. This decrease was primarily driven by lower store traffic, the impact of which was somewhat offset by an increase in average ticket that resulted from increased design services, custom orders and improved conversion.

 

Operating Margin

 

Our Retail segment’s operating margin increased 0.5 percentage points in the second quarter of fiscal 2018 and decreased 0.1 percentage point in the first six months of fiscal 2018 compared with the same periods a year ago.

 

·                  The segment’s gross margin increased 0.8 percentage points and 0.5 percentage points in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago due to an increase in design services and custom orders.

·                  The segment’s SG&A expense as a percentage of sales increased 0.3 percentage points and 0.6 percentage points in the second quarter and first six months of fiscal 2018, respectively, compared with the same periods a year ago. SG&A expense was higher as a percentage of sales, primarily because our sales at stores that have been open for a minimum of 12 months declined and we were not able to leverage our fixed costs (primarily occupancy and administrative costs) to the same extent as in the prior year period.