Unassociated Document
 
 
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 the quarterly period ended January 24, 2009

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.)
     
1284 North Telegraph Road, Monroe, Michigan
 
48162-3390
(Address of principal executive offices)
 
(Zip Code)
 
Registrant's telephone number, including area code (734) 242-1444
 
N/A
(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.
 
þYes                                                 ¨ No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “large accelerated filer”, “accelerated filer”, “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
¨ Large accelerated filer       þAccelerated filer       ¨ Non-accelerated filer*      ¨ Smaller Reporting Company
 
(*Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
¨ Yes                                                þNo
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
At January 24, 2009, there were 51,477,935 shares, par value $1.00, outstanding.

 
 

 

LA-Z-BOY INCORPORATED
FORM 10-Q THIRD QUARTER OF FISCAL 2009
 
TABLE OF CONTENTS
     
Page
Number(s)
PART I Financial Information (Unaudited)
 
 
Item 1.
Financial Statements
 
   
Consolidated Statement of Operations
3-4
   
Consolidated Balance Sheet
5
   
Consolidated Statement of Cash Flows
6
   
Consolidated Statement of Changes in Shareholders’ Equity
7
   
Notes to Consolidated Financial Statements
 
   
Note 1. Basis of Presentation
8
   
Note 2. Interim Results
8
   
Note 3. Reclassification
8
   
Note 4. Inventories
8
   
Note 5. Long-Lived Assets
8-9
   
Note 6. Goodwill and Other Intangible Assets
9-10
   
Note 7. Investments
10
   
Note 8. Pension Plans
10
   
Note 9. Financial Guarantees and Product Warranties
10-11
   
Note 10. Stock-Based Compensation
11
   
Note 11. Segment Information
11-12
   
Note 12. Restructuring
13-14
   
Note 13. Income Taxes
14-15
   
Note 14. Variable Interest Entities
15-16
   
Note 15. Discontinued Operations
16-17
   
Note 16. Income from Continued Dumping and Subsidy Offset Act
17
   
Note 17. Earnings per Share
17
   
Note 18. Fair Value Measurements
18-19
   
Note 19. Hedging Activities
19
   
Note 20. Recent Accounting Pronouncements
19-21
     
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
   
Cautionary Statement Concerning Forward-Looking Statements
22
   
Introduction
23-25
   
Results of Operations
26-34
   
Liquidity and Capital Resources
34-37
   
Critical Accounting Policies
37
   
Valuation of Goodwill and Intangible Assets
38
   
Regulatory Developments
38-39
   
Recent Accounting Pronouncements
39
     
 
Item 3. 
Quantitative and Qualitative Disclosures About Market Risk
40
       
 
Item 4. 
Controls and Procedures
40
       
PART II Other Information
 
 
Item 1A.
Risk Factors
41
 
Item 6.
Exhibits
41
            Signature Page
42
 
 
 

 

PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
 
LA-Z-BOY INCORPORATED
CONSOLIDATED STATEMENT OF OPERATIONS
 
   
Third Quarter Ended
 
(Unaudited, amounts in thousands, except per share data)
 
01/24/09
   
01/26/08
 
Sales
  $ 288,576     $ 373,081  
Cost of sales
               
Cost of goods sold
    207,356       265,078  
Restructuring
    1,664       (632 )
Total cost of sales
    209,020       264,446  
Gross profit
    79,556       108,635  
Selling, general and administrative
    94,092       104,672  
Write-down of long-lived assets
    7,036        
Write-down of intangibles
    45,977        
Restructuring
    741       877  
Operating income (loss)
    (68,290 )     3,086  
Interest expense
    1,386       2,148  
Interest income
    323       1,134  
Income from Continued Dumping and Subsidy Offset Act, net
    8,124       7,147  
Other income (expense), net
    (7,433 )     3,785  
Income (loss) from continuing operations before income taxes
    (68,662 )     13,004  
Income tax (benefit) expense
    (4,280 )     3,876  
Income (loss) from continuing operations
    (64,382 )     9,128  
Income from discontinued operations (net of tax)
          384  
Net income (loss)
  $ (64,382 )   $ 9,512  
                 
Basic average shares
    51,475       51,417  
Basic income (loss) from continuing operations per share
  $ (1.25 )   $ 0.18  
Discontinued operations per share (net of tax)
          0.01  
Basic net income (loss) per share
  $ (1.25 )   $ 0.19  
                 
Diluted average shares
    51,475       51,590  
Diluted income (loss) from continuing operations per share
  $ (1.25 )   $ 0.18  
Discontinued operations per share (net of tax)
           
Diluted net income (loss) per share
  $ (1.25 )   $ 0.18  
Dividends paid per share
  $ 0.02     $ 0.12  
 
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 
3

 
 
LA-Z-BOY INCORPORATED
CONSOLIDATED STATEMENT OF OPERATIONS
 
   
Nine Months Ended
 
(Unaudited, amounts in thousands, except per share data)
 
01/24/09
   
01/26/08
 
Sales
  $ 942,176     $ 1,082,911  
Cost of sales
               
Cost of goods sold
    685,151       790,879  
Restructuring
    9,696       2,447  
Total cost of sales
    694,847       793,326  
Gross profit
    247,329       289,585  
Selling, general and administrative
    287,873       297,278  
Write-down of long-lived assets
    7,036        
Write-down of intangibles
    47,677       5,809  
Restructuring
    2,208       2,446  
Operating loss
    (97,465 )     (15,948 )
Interest expense
    4,532       6,365  
Interest income
    1,885       3,039  
Income from Continued Dumping and Subsidy Offset Act, net
    8,124       7,147  
Other income (expense), net
    (7,974 )     4,701  
Loss from continuing operations before income taxes
    (99,962 )     (7,426 )
Income tax expense (benefit)
    26,708       (4,359 )
Loss from continuing operations
    (126,670 )     (3,067 )
Loss from discontinued operations (net of tax)
          (6,050 )
Net loss
  $ (126,670 )   $ (9,117 )
                 
Basic average shares
    51,454       51,402  
Basic loss from continuing operations per share
  $ (2.46 )   $ (0.06 )
Discontinued operations per share (net of tax)
          (0.12 )
Basic net loss per share
  $ (2.46 )   $ (0.18 )
                 
Diluted average shares
    51,454       51,402  
Diluted loss from continuing operations per share
  $ (2.46 )   $ (0.06 )
Discontinued operations per share (net of tax)
          (0.12 )
Diluted net loss per share
  $ (2.46 )   $ (0.18 )
Dividends paid per share
  $ 0.10     $ 0.36  
 
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 
4

 

LA-Z-BOY INCORPORATED
CONSOLIDATED BALANCE SHEET

(Unaudited, amounts in thousands)
 
01/24/09
   
04/26/08
 
Current assets
           
Cash and equivalents
  $ 18,686     $ 14,982  
Receivables, net of allowance of $31,045 in 2009 and $17,942 in 2008
    153,401       200,422  
Inventories, net
    172,259       178,361  
Deferred income taxes—current
    3,397       12,398  
Other current assets
    25,458       21,325  
Total current assets
    373,201       427,488  
Property, plant and equipment, net
    156,341       171,001  
Deferred income taxes—long term
    1,292       26,922  
Goodwill
    5,097       47,233  
Trade names
    3,100       9,006  
Other long-term assets, net of allowance of $4,723 in 2009 and $2,801 in 2008
    66,912       87,220  
Total assets
  $ 605,943     $ 768,870  
                 
Current liabilities
               
Current portion of long-term debt
  $ 9,547     $ 4,792  
Accounts payable
    49,821       56,421  
Accrued expenses and other current liabilities
    89,263       102,700  
Total current liabilities
    148,631       163,913  
Long-term debt
    80,828       99,578  
Deferred income taxes—long term
    3,995        
Other long-term liabilities
    52,121       54,783  
Shareholders' equity
               
Common shares, $1 par value
    51,478       51,428  
Capital in excess of par value
    204,735       209,388  
Retained earnings
    65,693       190,215  
Accumulated other comprehensive loss
    (1,538 )     (435 )
Total shareholders' equity
    320,368       450,596  
Total liabilities and shareholders' equity
  $ 605,943     $ 768,870  
 
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 
5

 
 
LA-Z-BOY INCORPORATED
CONSOLIDATED STATEMENT OF CASH FLOWS

   
Third Quarter Ended
   
Nine Months Ended
 
(Unaudited, amounts in thousands)
 
01/24/09
   
01/26/08
   
01/24/09
   
01/26/08
 
Cash flows from operating activities
                       
Net income (loss)
  $ (64,382 )   $ 9,512     $ (126,670 )   $ (9,117 )
Adjustments to reconcile net income (loss) to cash provided by operating activities
                               
Gain on sale of assets
    (37 )           (2,707 )      
(Gain) loss on the sale of discontinued operations (net of tax)
          (96 )           3,894  
Write-down of businesses held for sale (net of tax)
                      2,159  
Write-down of long-lived assets
    7,036             7,036        
Write-down of intangibles
    45,977             47,677       5,809  
Write-down of investments
    5,140             5,140        
Restructuring
    2,405       245       11,904       4,893  
Provision for doubtful accounts
    9,439       2,754       18,439       6,373  
Depreciation and amortization
    5,827       6,193       17,770       18,506  
Stock-based compensation expense
    1,012       1,303       2,867       3,165  
Change in receivables
    31,405       53       23,314       9,241  
Change in inventories
    (3,463 )     8,645       7,380       17,897  
Change in payables
    (8,351 )     9,161       (6,424 )     (5,107 )
Change in other assets and liabilities
    640       147       (25,885 )     (18,650 )
Change in deferred taxes
    (4,658 )     3,676       38,180       (2,470 )
Total adjustments
    92,372       32,081       144,691       45,710  
Net cash provided by operating activities
    27,990       41,593       18,021       36,593  
                                 
Cash flows from investing activities
                               
Proceeds from disposals of assets
    45       456       7,831       7,738  
Proceeds from sale of discontinued operations
          150             4,169  
Capital expenditures
    (4,089 )     (5,239 )     (14,079 )     (20,838 )
Purchases of investments
    (1,630 )     (15,807 )     (10,595 )     (29,077 )
Proceeds from sales of investments
    10,854       15,649       21,881       30,242  
Change in other long-term assets
    (575 )     1,701       (346 )     2,086  
Net cash provided by (used for) investing activities
    4,605       (3,090 )     4,692       (5,680 )
                                 
Cash flows from financing activities
                               
Proceeds from debt
    15,992       574       55,458       1,391  
Payments on debt
    (43,752 )     (974 )     (69,039 )     (2,212 )
Stock issued/canceled for stock and employee benefit plans
          (13 )           (129 )
Dividends paid
    (1,037 )     (6,229 )     (5,188 )     (18,670 )
Net cash used for financing activities
    (28,797 )     (6,642 )     (18,769 )     (19,620 )
                                 
Effect of exchange rate changes on cash and equivalents
    (228 )     (1,378 )     (871 )     161  
Change in cash and equivalents
    3,570       30,483       3,073       11,454  
Cash acquired from consolidation of VIEs     631             631        
Cash and equivalents at beginning of period
    14,485       32,692       14,982       51,721  
Cash and equivalents at end of period
  $ 18,686     $ 63,175     $ 18,686     $ 63,175  
                                 
Cash paid (net of refunds) during period – income taxes
  $ (660 )   $ (4,336 )   $ (456 )   $ (443 )
Cash paid during period - interest
  $ 1,337     $ 2,652     $ 3,750     $ 6,057  
                                 
 
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 
6

 

LA-Z-BOY INCORPORATED
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited, amounts in thousands)
 
Common
Shares
   
Capital in 
Excess of 
Par Value
   
Retained 
Earnings
   
Accumulated 
Other Compre-
hensive 
Income(Loss)
   
Total
 
     At April 28, 2007
  $ 51,377     $ 208,283     $ 223,896     $ 1,792     $ 485,348  
                                         
Stock issued for stock and employee benefit plans, net of cancellations
    51       (3,422 )     3,102               (269 )
Stock option, performance-based and restricted stock expense
            4,527                       4,527  
Dividends paid
                    (20,746 )             (20,746 )
Comprehensive loss
                                       
 Net loss
                    (13,537 )                
Unrealized loss on marketable securities (net of tax of $0.1 million) arising during the period
                            (222 )        
Reclassification adjustment for gain on marketable securities (net of tax of $1.4 million) included in net loss
                            (2,420 )        
Translation adjustment
                            (117 )        
Net actuarial gain (net of tax of $0.2 million)
                            532          
Total comprehensive loss
                                    (15,764 )
    Impact of adoption of FIN 48
                    (2,500 )             (2,500 )
     At April 26, 2008
  $ 51,428     $ 209,388     $ 190,215     $ (435 )   $ 450,596  
                                         
Stock issued for stock and employee benefit plans, net of cancellations
    50       (7,520 )     7,336               (134 )
Stock option, performance-based and restricted stock expense
            2,867                       2,867  
Dividends paid
                    (5,188 )             (5,188 )
Comprehensive loss
                                       
Net loss
                    (126,670 )                
Unrealized loss on marketable securities arising during the period
                            (4,707 )        
Reclassification adjustment for loss on marketable securities included in net loss
                            4,767          
Translation adjustment
                            (356 )        
Change in fair value of cash flow hedges
                            (807 )        
Total comprehensive loss
                                    (127,773 )
At January 24, 2009
  $ 51,478     $ 204,735     $ 65,693     $ (1,538 )   $ 320,368  
 
The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
 
7

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 
Note 1: Basis of Presentation
 
The interim financial information is prepared in conformity with generally accepted accounting principles and such principles are applied on a basis consistent with those reflected in our fiscal 2008 Annual Report on Form 10-K, filed with the Securities and Exchange Commission, but does not include all the disclosures required by generally accepted accounting principles. In the opinion of management, the interim financial information includes all adjustments and accruals, consisting only of normal recurring adjustments, which are necessary for a fair presentation of results for the respective interim period.
 
During our first quarter of fiscal 2009, our largest division revised certain shipping agreements with third-party carriers such that risk of loss transfers to our customers upon shipment rather than upon delivery.  Accordingly, substantially all of our shipments with third-party carriers for this division are now recognized upon shipment of the product.
 
Note 2: Interim Results
 
The foregoing interim results are not necessarily indicative of the results of operations which will occur for the full fiscal year ending April 25, 2009.
 
Note 3: Reclassification
 
Certain prior year information has been reclassified to be comparable with the current year presentation.
 
Note 4: Inventories
 
A summary of inventory follows:
 
(Unaudited, amounts in thousands)
 
01/24/09
   
04/26/08
 
Raw materials
  $ 66,785     $ 71,346  
Work in process
    13,215       14,624  
Finished goods
    120,101       119,270  
FIFO inventories
    200,101       205,240  
Excess of FIFO over LIFO
    (27,842 )     (26,879 )
Inventories, net
  $ 172,259     $ 178,361  
 
Note 5: Long-Lived Assets
 
Fixed assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.  During the quarter ended January 24, 2009, economic conditions further deteriorated, which led to reduced volumes and continued operating losses. In addition, we experienced a significant decline in our stock price, resulting in a significant reduction in our market capitalization. Accordingly, we performed an assessment of our fixed assets to test for recoverability in accordance with SFAS No. 144.  The assessment of recoverability was based on management’s best estimates.  The fair value was determined by using quoted current market prices, as well as an analysis of the undiscounted cash flows by key asset group.  Our key asset groups consisted of our operating units in our Upholstery and Casegoods Group (La-Z-Boy, England, Bauhaus, Kincaid, Hammary, American Drew and Lea) and each of our retail stores.

 
8

 

Based on the assessment of undiscounted projected future operating cash flows of our retail stores, the undiscounted cash flows did not exceed the net book value of leasehold improvements, furniture, fixtures, and office equipment at some stores, indicating that a permanent impairment had occurred.  As a result of our review we recorded an impairment charge of $7.0 million, relating to our Retail Group, in the third quarter of fiscal 2009.  Additionally, based on the results of the review it was determined that the fair value of the long-lived assets in our Upholstery and Casegoods Groups exceeded their carrying value and therefore no impairment existed.

Note 6: Goodwill and Other Intangible Assets
 
In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and trade names are tested at least annually for impairment by comparing their fair value to their carrying values. The fair value for each trade name is established based upon a royalty savings approach. Additionally, goodwill is tested for impairment by comparing the fair value of our operating units to their carrying values. The fair value for each operating unit is established based upon the discounted cash flows.  In situations where the fair value is less than the carrying value, indicating a potential impairment, a second comparison is performed using a calculation of implied fair value of goodwill to determine the monetary value of impairment.
 
Our business has been impacted by significant declines in consumer demand and in the last three months, our average market capitalization was below the book value of the company.  As a result of the low market capitalization, we reviewed the valuations of the goodwill for our Upholstery and Retail operating segments, in advance of our normal fourth quarter testing and we recorded an impairment charge of $40.4 million in the third quarter of fiscal 2009.
 
In the third quarter of fiscal 2009, we completed a valuation of the tax reserves relating to the acquisitions of the operating units in the Casegoods segment, and a reduction of the tax reserves was required.  This reduction was recorded as a reduction in trade names and totaled $0.4 million.  Additionally, as a result of the continued decline in consumer confidence and challenging economic environment, we reviewed the valuations of our trade names.  It was determined that the carrying value of trade names exceeded their fair value and an impairment loss of $5.5 million was recorded as a component of operating income.
 
During the second quarter of fiscal 2009, we committed to a plan to reorganize our Toronto, Ontario market which we consolidated as a VIE.  As a result of this plan, we recorded an impairment charge of $0.4 million which represented the entire goodwill amount of this market.
 
During the first quarter of fiscal 2009, we committed to a plan to close the operations of our La-Z-Boy U.K. subsidiary.  As a result of this plan, we recorded an impairment charge of $1.3 million which represented the entire goodwill amount of the operating unit.
 
9

 
The following table summarizes the changes to goodwill and trade names during the first nine months of fiscal 2009:
 
 
(Unaudited, amounts in thousands)
 
Balance as 
of 04/26/08
   
Impairments/
Other
   
Balance as 
of 01/24/09
 
Goodwill
                 
Upholstery Group
  $ 19,632     $ (19,632 )   $  
Retail Group
    22,096       (22,096 )      
Corporate and Other*
    5,505       (408 )     5,097  
Consolidated
  $ 47,233     $ (42,136 )   $ 5,097  
                         
Trade names
                       
Casegoods Group
  $ 9,006     $ (5,906 )   $ 3,100  
                         
* Corporate and Other includes goodwill from our VIEs.
 

Note 7:  Investments

Included in other long-term assets were investments of $21.1 million and $34.0 million at January 24, 2009 and April 26, 2008, respectively, of available-for-sale marketable securities to fund future obligations of one our non-qualified retirement plans and our captive insurance company. All unrealized gains or losses which have not been recognized as other than temporary losses are included in accumulated other comprehensive loss within Shareholders’ Equity.  The net unrealized loss was $0.6 million and $0.9 million at January 24, 2009 and April 26, 2008, respectively.  In the third quarter of fiscal 2009 we recognized $5.1 million of losses, recorded in Other income (expense), net,  related to the previously mentioned investments due to our intent to sell those assets in the near term and the losses being considered other than temporary.

Note 8: Pension Plans

Net periodic pension costs were as follows:
   
Third Quarter Ended
   
Nine Months Ended
 
 (Unaudited, amounts in thousands)
 
01/24/09
   
01/26/08
   
01/24/09
   
01/26/08
 
Service cost
  $ 328     $ 441     $ 984     $ 1,323  
Interest cost
    1,359       1,346       4,077       4,038  
Expected return on plan assets
    (1,728 )     (1,839 )     (5,184 )     (5,517 )
Net periodic pension cost (benefit)
  $ (41 )   $ (52 )   $ (123 )   $ (156 )
 
We did not make any contributions to the plans during the first nine months of fiscal 2009.  We are not required to make any contributions to the defined benefit plans in fiscal year 2009; however we may make contributions to meet future funding requirements as necessary. 
 
Note 9: Financial Guarantees and Product Warranties
 
We have provided financial guarantees relating to leases in connection with certain La-Z-Boy Furniture Galleries® stores which are not operated by the company.  The lease guarantees are generally for real estate leases and have remaining terms of one to three years. These lease guarantees enhance the credit of these dealers. The dealer is required to make periodic fee payments to compensate us for our guarantees. We have recognized liabilities for the fair values of the lease agreements that we have entered into, but they are not material to our financial position.
 
10

 
We would be required to perform under these agreements only if the dealer were to default on the lease. The maximum amount of potential future payments under lease guarantees was $2.1 million at the end of the third quarter of fiscal 2009.  During the third quarter of fiscal 2009, we assumed the lease obligation on two stores as a result of a change in the Michigan market.  Additionally, as a result of the change in the VIE for our Toronto market, we now include an additional Toronto store in our lease obligations.  These changes led to the $8.7 million decrease in our lease guarantees in the third quarter of fiscal 2009 and a corresponding increase in our lease obligations.
 
We have, from time-to-time, entered into agreements which resulted in indemnifying third parties against certain liabilities, mainly environmental obligations. We believe that judgments, if any, against us related to such agreements would not have a material effect on our business or financial condition.
 
Our accounting policy for product warranties is to accrue an estimated liability at the time the revenue is recognized. This estimate is based on historical claims and adjusted for currently known warranty issues.
 
A reconciliation of the changes in our product warranty liability is as follows:
 
   
Third Quarter Ended
   
Nine Months Ended
 
 (Unaudited, amounts in thousands)
 
01/24/09
   
01/26/08
   
01/24/09
   
01/26/08
 
Balance as of the beginning of the period
  $ 14,437     $ 14,258     $ 14,334     $ 14,283  
Accruals during the period
    3,491       4,620       11,588       12,999  
Settlements during the period
    (3,496 )     (4,411 )     (11,490 )     (12,815 )
Balance as of the end of the period
  $ 14,432     $ 14,467     $ 14,432     $ 14,467  

Note 10:  Stock-Based Compensation

Total compensation expense recognized in the Consolidated Statement of Operations for all equity based compensation was $1.0 million and $2.9 million, for the third quarter and first nine months of fiscal 2009, respectively.  For the third quarter and first nine months of fiscal 2008, we recorded total stock-based compensation expense of approximately $1.3 million and $3.2 million, respectively.
 
Note 11: Segment Information
 
Our reportable operating segments are the Upholstery Group, the Casegoods Group and the Retail Group. 
 
Upholstery Group.  The operating units in the Upholstery Group are Bauhaus, England, and La-Z-Boy. This group primarily manufactures and sells upholstered furniture to furniture retailers. Upholstered furniture includes recliners and motion furniture, sofas, loveseats, chairs, ottomans and sleeper sofas.
 
Casegoods Group. The operating units in the Casegoods Group are American Drew/Lea, Hammary and Kincaid. This group primarily sells manufactured or imported wood furniture to furniture retailers.  Casegoods product includes tables, chairs, entertainment centers, headboards, dressers, accent pieces and some upholstered furniture. 
 
Retail Group. The Retail Group consists of 69 company-owned La-Z-Boy Furniture Galleries® stores in eight primary markets.  The Retail Group sells mostly upholstered furniture to end consumers. 
 
11

 
   
Third Quarter Ended
   
Nine Months Ended
 
(Unaudited, amounts in thousands)
 
01/24/09
(13 weeks)
   
01/26/08
(13 weeks)
   
01/24/09
(39 weeks)
   
01/26/08
(39 weeks)
 
Sales
                       
Upholstery Group
  $ 199,200     $ 282,453     $ 684,252     $ 806,959  
Casegoods Group
    42,116       52,660       138,710       165,126  
Retail Group
    40,497       49,884       122,408       141,278  
VIEs/Eliminations
    6,763       (11,916 )     (3,194 )     (30,452 )
Consolidated
  $ 288,576     $ 373,081     $ 942,176     $ 1,082,911  
                                 
Operating income (loss)
                               
Upholstery Group
  $ (1,938 )   $ 19,467     $ 16,037     $ 47,370  
Casegoods Group
    (313 )     2,222       1,819       8,399  
Retail Group
    (7,108 )     (8,507 )     (27,509 )     (27,700 )
Corporate and Other*
    (3,513 )     (9,851 )     (21,195 )     (33,315 )
Long-lived asset write-down
    (7,036 )           (7,036 )      
Intangible write-down
    (45,977 )           (47,677 )     (5,809 )
Restructuring
    (2,405 )     (245 )     (11,904 )     (4,893 )
      Consolidated
  $ (68,290 )   $ 3,086     $ (97,465 )   $ (15,948 )
                                 

*Variable Interest Entities ("VIEs") are included in corporate and other.
 
The following table is provided to evaluate segment assets for the third quarter of fiscal 2009 and the end of the year for fiscal 2008.
 
(Unaudited, amounts in thousands)
 
01/24/09
   
04/26/08
 
Upholstery Group
  $ 348,261     $ 428,177  
Casegoods Group
    107,994       107,338  
Retail Group
    63,924       107,835  
Unallocated assets*
    85,764       125,520  
Consolidated
  $ 605,943     $ 768,870  
 
*The unallocated assets includes mainly the corporate assets and eliminations.
 
During the third quarter of fiscal 2009, the reporting of the retail warehouse operations was changed to the Upholstery Group from the Retail Group.  Since the warehouse operations were expanded to incorporate the warehousing, staging and delivery of independent La-Z-Boy Furniture Galleries® dealers’ products as well as for our Retail Group, the reporting of those warehouses was more appropriately included in our La-Z-Boy wholesale operating unit.  This reporting change affected the timing of inter-company revenue and profit recognition for the Upholstery Group.  This resulted in a reduction in inter-company sales for the Upholstery Group of $12.1 million and a decrease in inter-company profit of $3.3 million with a corresponding offset recorded in VIEs/Eliminations sales and Corporate and Other operating income.  The adjustments did not affect our consolidated operating results.
 
 
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Note 12: Restructuring
 
During the past several years, we have entered into various restructuring plans to rationalize our manufacturing facilities and to consolidate retail distribution centers and close underperforming retail facilities.  The majority of our restructuring charges related to our manufacturing and wholesale distribution facilities were reported as a component of Cost of Sales on our Consolidated Statement of Operations, while restructuring charges related to our retail operations were reported as a line item within our Selling, General and Administrative expenses section of our Consolidated Statement of Operations.  With these restructuring plans, we have written-down various fixed assets which were accounted for in accordance with SFAS No. 144.  Additionally, we recorded charges for severance and benefits, contract terminations and other transition costs related to relocating manufacturing and closing facilities, in accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities.

In the third quarter of fiscal 2009, we committed to a restructuring plan to close our plant in Sherman, Mississippi related to our Bauhaus operations.  The closure of this plant will be completed at the beginning of the fiscal 2009 fourth quarter.  In connection with this plant closure, we recorded pre-tax restructuring charges of $0.6 million in the third quarter of fiscal 2009, covering severance and benefits and the write-down of fixed assets.

In the third quarter of fiscal 2009, we announced a plan to reduce our company-wide employment to be more in line with today’s sales volume.  In connection with this plan, we recorded pre-tax restructuring charges of $1.1 million in the third quarter of fiscal 2009, covering severance and benefits.

In the first quarter of fiscal 2009, we committed to a restructuring plan to close the operations of our La-Z-Boy U.K. subsidiary due to a change in our strategic direction for this operation.  The closure of this operation occurred in the second quarter of fiscal 2009 and impacted about 17 employees.  In connection with this closure, we recorded pre-tax restructuring charges of about $0.1 million and $1.9 million, in the third quarter and first nine months of fiscal 2009, respectively, covering the write-down of inventory ($1.3 million), the write-down of fixed assets and other restructuring charges ($0.6 million).

During the fourth quarter of fiscal 2008, we committed to a restructuring plan to consolidate all of our North American cutting and sewing operations in Mexico and transfer production from our Tremonton, Utah plant, to our five remaining La-Z-Boy branded upholstery manufacturing facilities.  The transition of our cutting and sewing operations to Mexico will impact approximately 700 La-Z-Boy employees at the five remaining facilities.  Our Utah facility, which employed 630 people, ceased operations during the first quarter of fiscal 2009 and production was shifted to our remaining manufacturing facilities.  We began start up production at our Mexican facility in January 2009.  By the end of fiscal 2010 we expect 70% of our domestic cutting and sewing operations to be shifted to our Mexican facility, with the remainder in fiscal 2011.  In connection with these activities, we have incurred $10.3 million since the inception of this plan for severance and benefits, write-down of certain fixed assets, and other restructuring costs.  We expect to incur additional pre-tax restructuring charges of $5 to $7 million.   During the third quarter and first nine months of fiscal 2009, we had restructuring charges of $0.3 million and $7.7 million, respectively, covering severance and benefits ($3.1 million) and other restructuring costs ($4.6 million).  Other restructuring costs include transportation, freight surcharges and other transition costs as we move production to other plants.

In the fourth quarter of fiscal 2007, we committed to a restructuring plan which included the closures of two upholstery manufacturing facilities, the closure of a rough mill lumber operation, the consolidation of operations at a another upholstery operation and the elimination of a number of positions throughout the remainder of the organization. This plan impacted approximately 500 employees and occurred in the fourth quarter of fiscal 2007 and the first quarter of fiscal 2008.  During the first nine months of fiscal 2009, we had restructuring reversals of $0.5 million relating to these activities due to lower benefit costs than originally estimated.

 
13

 

During fiscal 2007 and 2008, several of our retail warehouses were consolidated into larger facilities and several underperforming stores were closed.  Approximately 130 jobs were eliminated as a result of these changes.  In the third quarter and first nine months of fiscal 2009, we had restructuring charges of $0.3 million and $1.1 million, respectively, due to contract terminations relating to these actions.
 
As of the end of the third quarter of fiscal 2009, we had a remaining restructuring liability of $3.5 million which is expected to be settled as follows: $1.3 million in the fourth quarter of fiscal 2009, $1.9 million in fiscal 2010, and $0.3 million thereafter.  Contract terminations resulting from the closure of several of our retail stores and warehouses result in our restructuring liability being paid out over an extended length of time.
 
 
Restructuring liabilities along with charges to expense, cash payments or asset write-downs for all of our restructuring actions were as follows:
 

         
Fiscal 2009
       
(Unaudited, amounts in thousands)
 
04/26/08
Balance
   
Charges to
Expense *
   
Cash
Payments
or Asset
Write-Offs
   
01/24/09
Balance
 
Severance and benefit-related costs
  $ 2,842     $ 4,230     $ (4,226 )   $ 2,846  
Fixed asset write-downs, net of gains
          398       (398 )      
Contract termination costs
    939       1,126       (1,427 )     638  
Other
          6,150       (6,150 )      
Total restructuring
  $ 3,781     $ 11,904     $ (12,201 )   $ 3,484  

* Charges to expense include $1.9 million of non-cash charges for contract termination costs, fixed asset and inventory write-downs.

         
Fiscal 2008
       
(Unaudited, amounts in thousands)
 
04/28/07
Balance
   
Charges to
Expense **
   
Cash
Payments
or Asset
Write-Offs
   
04/26/08
Balance
 
Severance and benefit-related costs
  $ 2,177     $ 3,253     $ (2,588 )   $ 2,842  
Fixed asset write-downs, net of gains
          364       (364 )      
Contract termination costs
    1,257       2,019       (2,337 )     939  
Other
          2,499       (2,499 )      
Total restructuring
  $ 3,434     $ 8,135     $ (7,788 )   $ 3,781  

** Charges to expense include $1.1 million of non-cash charges for contract termination costs, fixed asset and inventory write-downs.

Note 13:  Income Taxes

In accordance with SFAS No. 109, Accounting for Income Taxes, we evaluate our deferred taxes to determine if a valuation allowance is required.  SFAS No. 109 requires that companies assess whether a valuation allowance should be established based on the consideration of all available evidence using a “more likely than not” standard with significant weight being given to evidence that can be objectively verified.  Our current and prior year losses present the most significant negative evidence as to whether we need to record a valuation allowance against our net deferred tax assets. Given the current economic climate and the losses that we have sustained, we have recorded a valuation allowance against the deferred tax assets of the U.S. operations.

 
14

 

At January 24, 2009 and April 26, 2008, we had deferred tax assets of $65.6 million and $51.4 million, respectively, offset by valuation allowances of $64.9 million and $12.1 million, respectively.  The accounting for deferred taxes is based upon an estimate of future results. Differences between the anticipated and actual outcome of these future tax consequences could have a material impact on our consolidated results of operations or financial position. Changes in existing tax laws could also affect actual tax results and the valuation of deferred tax assets over time.

Our income tax benefit for the third quarter of fiscal 2009 was $4.3 million, compared with a provision for income tax expense of $3.9 million in the corresponding prior year period. Our effective income tax rate was approximately 6.2% for the quarter ended January 24, 2009, compared to an effective income tax rate of 29.8% for the quarter ended January 26, 2008. The difference in our effective tax rate primarily results from the recording of valuation allowances against the majority of our U.S. deferred tax assets beginning in the second quarter of fiscal year 2009.  The current period tax benefit results primarily from the reversal of deferred tax liabilities associated with trade names and goodwill that were written off during the current quarter which exceeded the income tax expense on certain operations with taxable income conducted in certain U.S. states.  At January 24, 2009, we had a federal income tax receivable of $11.8 million relating to a net operating loss carry-back from fiscal year 2009.  We expect to receive this amount in the form of a refund when we file, early in fiscal 2010, our fiscal 2009 tax return and claim the tax loss against taxable income in fiscal 2007.
 
Note 14: Variable Interest Entities
 
Financial Accounting Standards Board Interpretation No. 46R, Consolidation of Variable Interest Entities (“FIN 46”), requires the “primary beneficiary” of a VIE to include the VIE’s assets, liabilities and operating results in its consolidated financial statements.   In general, a VIE is a corporation, partnership, limited-liability company, trust or any other legal structure used to conduct activities or hold assets that either (a) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (b) has a group of equity owners that are unable to make significant decisions about its activities, or (c) has a group of equity owners that do not have the obligation to absorb losses or the right to receive returns generated by its operations.

La-Z-Boy Furniture Galleries® stores that are not operated by us are operated by independent dealers. These stores sell La-Z-Boy manufactured products as well as various accessories purchased from approved La-Z-Boy vendors.  Most of these independent dealers have sufficient equity to carry out their principal operating activities without subordinated financial support.  However, there are certain independent dealers that we have determined may not have sufficient equity.  In some cases we have extended credit beyond normal trade terms to the independent dealers, made direct loans, entered into leases and/or guaranteed certain loans or leases.

We evaluate our transactions and relationships with our La-Z-Boy Furniture Galleries® dealers on a quarterly basis to determine if any of our independent dealers qualify as a variable interest entity and additionally whether we are primary beneficiary for any of the dealers who do qualify as a variable interest entity.

 
15

 

Based on the criteria for consolidation of VIEs, we have consolidated several dealers where we were the primary beneficiary based on the fair value of our variable interests.  All of our consolidated VIEs were recorded at fair value on the date we became the primary beneficiary.  Because these entities are accounted for as if the entities were consolidated based on voting interests, we absorb all net losses of the VIEs in excess of their equity.  We recognize all net earnings of these VIEs to the extent of recouping the losses previously recorded.  Earnings in excess of our losses are attributed to equity owners of the dealers and are recorded as minority interest.  During the third quarter of fiscal 2009, we terminated our relationship with our Toronto VIE.  However, four of the stores operated by the former dealer were assumed by another dealer in the Toronto market and one was closed.  As a result this dealer became a VIE.  With this change in ownership, the total markets remain the same; however the store count did increase by three.  We had four consolidated VIEs for fiscal 2009 representing 37 stores and four VIEs for fiscal 2008 representing 34 stores.

The table below shows the impact the VIEs had on our financial statements during the third quarter and first nine months of fiscal 2009 and fiscal 2008:

   
Third Quarter Ended
 
(Unaudited, amounts in thousands)
 
01/24/09
   
04/26/08
 
             
Current assets
  $ 18,234     $ 21,202  
Non-current assets
    19,994       17,591  
Total assets
  $ 38,228     $ 38,793  
                 
Current liabilities
  $ 6,673     $ 9,705  
Non-current liabilities
    5,381       3,408  
Total liabilities
  $ 12,054     $ 13,113  
 
   
Third Quarter Ended
   
Nine Months Ended
 
(Unaudited, amounts in thousands )
 
01/24/09
   
01/26/08
   
01/24/09
   
01/26/08
 
                         
Net sales, net of inter-company eliminations
  $ 13,430     $ 14,874     $ 39,301     $ 38,896  
Pre-tax loss
  $ (3,932 )   $ (1,928 )   $ (7,435 )   $ (7,529 )
 
As of the end of the third quarter of fiscal 2009, we had significant interests in four independent La-Z-Boy Furniture Galleries® dealers for which we were not the primary beneficiary.  Our total exposure to losses related to these dealers was $1.5 million which consists of past due accounts receivable as well as notes receivable, net of reserves and collateral on inventory and real estate.  We do not have any obligations or commitments to provide additional financial support to these dealers for the remainder of the fiscal year.
 
Note 15: Discontinued Operations
 
During the second quarter of fiscal 2008, we completed the sale of our Clayton Marcus operating unit and our Pennsylvania House trade name.  These dispositions were accounted for as discontinued operations.

The results of the discontinued operations for Clayton Marcus and Pennsylvania House for the third quarter and first nine months of fiscal 2008 were as follows:

 
16

 

   
Third Quarter
Ended
   
Nine Months
Ended
 
(Unaudited, amounts in thousands)
 
01/26/08
   
01/26/08
 
Net sales
  $ 1,563     $ 22,622  
Income (loss) from discontinued operations, net of tax
  $ 384     $ (1,916 )
Loss on the sale of discontinued operations, net of tax
  $     $ (4,134 )

In the Consolidated Statement of Cash Flows, the activity of these operating units was included along with the activity from our continuing operations.

Note 16: Income from Continued Dumping and Subsidy Offset Act

We recorded $8.1 million and $7.1 million as Income from the Continued Dumping and Subsidy Offset Act, net of legal expenses, during the third quarter of fiscal 2009 and fiscal 2008, respectively, from the receipt of funds under the Continued Dumping and Subsidy Act (“CDSOA”) of 2000 in connection with the case involving wooden bedroom furniture from China.  The CDSOA provides for distribution of monies collected by U.S. Customs and Border Protection from anti-dumping cases to domestic producers that supported the anti-dumping petition.

Note 17: Earnings per Share
 
Basic net income (loss) per share is computed using the weighted average number of shares outstanding during the period. Diluted net income (loss) per share uses the weighted average number of shares outstanding during the period plus the additional common shares that would be outstanding if the dilutive potential common shares issuable under employee stock options and unvested restricted stock were issued.
 
A reconciliation of basic and diluted weighted average common shares outstanding follows:
 
   
Third Quarter Ended
   
Nine Months Ended
 
 (Unaudited, amounts in thousands)
 
01/24/09
   
01/26/08
   
01/24/09
   
01/26/08
 
Weighted average common shares outstanding (basic)
    51,475       51,417       51,454       51,402  
Effect of options and unvested restricted stock
          173              
Weighted average common shares outstanding (diluted)
    51,475       51,590       51,454       51,402  

The weighted average common shares outstanding (diluted) for third quarter of fiscal 2009 exclude outstanding stock options of 0.6 million because the net loss in third quarter ended January 24, 2009 would cause the effect of options to be anti-dilutive.  The weighted average common shares outstanding (diluted) for the nine months ended January 24, 2009 and January 26, 2008 exclude outstanding stock options of 0.5 million and 0.2 million, respectively, because the net loss in the first nine months of fiscal 2009 and fiscal 2008, respectively, would cause the effect of options to be anti-dilutive.

The effect of options to purchase 2.5 million and 2.7 million shares for the quarters ended January 24, 2009 and January 26, 2008 with a weighted average exercise price of $15.46 and $15.50 respectively, were excluded from the diluted share calculation because the exercise prices of these options were higher than the weighted average share price for the quarters and would have been anti-dilutive. 

 
17

 

Note 18: Fair Value Measurements

We adopted FASB Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”), Fair Value Measurements, effective April 27, 2008 for our financial assets and liabilities.  Adoption of SFAS No. 157 did not have a material effect on our financial position, results of operations or cash flows.

In February 2008, the Financial Accounting Standards Board issued FASB Staff Position FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13 (“FSP 157-1”). FSP FAS 157-1 amended SFAS No. 157 to exclude from its scope SFAS No. 13, Accounting for Leases, and its related interpretive accounting pronouncements that address leasing transactions. Also in February 2008, the FASB issued FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157 (“FSP 157-2”). FSP 157-2 amended SFAS No. 157 to defer the effective date of SFAS No. 157 until fiscal years beginning after November 15, 2008 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis, at least annually. We are currently assessing the impact of SFAS No. 157 on our non-financial assets and non-financial liabilities measured at fair value on a nonrecurring basis.
 
SFAS No. 157 requires the categorization of financial assets and liabilities, based on the inputs to the valuation technique, into a three-level fair value hierarchy. The fair value hierarchy gives the highest priority to the quoted prices in active markets for identical assets and liabilities and lowest priority to unobservable inputs. The various levels of the SFAS No. 157 fair value hierarchy are described as follows:

 
·
Level 1 — Financial assets and liabilities whose values are based on unadjusted quoted market prices for identical assets and liabilities in an active market that the company has the ability to access.
 
·
Level 2 — Financial assets and liabilities whose values are based on quoted prices in markets that are not active or model inputs that are observable for substantially the full term of the asset or liability.
 
 
·
Level 3 — Financial assets and liabilities whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. 
 
SFAS No. 157 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.

 
18

 

The following table presents the fair value hierarchy for those assets measured at fair value on a recurring basis as of January 24, 2009:

   
Fair Value Measurements
 
(Unaudited, amounts in thousands)
 
Level 1
   
Level 2
   
Level 3
 
Assets
                 
Available-for-sale securities
  $ 8,932     $ 12,119     $  
Liabilities
                       
Interest rate swap
          (807 )      
Total
  $ 8,932     $ 11,312     $  

We hold available-for-sale marketable securities to fund future obligations of one of our non-qualified retirement plans and our captive insurance company.  The fair value measurements for these securities are based upon 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 and without any adjustments to reflect discounts that may be applied to selling a large block of the securities at one time.

We entered into a three year interest rate swap agreement in order to fix a portion of our floating rate debt.  The fair value of the swap agreement was measured as the present value of all expected future cash flows based on the LIBOR-based swap yield curve as of the date of the valuation and considered counterparty non-performance risk. These assumptions can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Note 19:  Hedging Activities

During the first quarter of fiscal 2009, we entered into an interest rate swap agreement which we accounted for as a cash flow hedge.  This swap hedges the interest on $20 million of floating rate debt.  Under the swap, we are required to pay 3.33% through May 16, 2011 and we receive three month LIBOR from the counterparty. This offsets the three month LIBOR component of interest which we are required to pay under $20 million of floating rate debt.  Interest under this debt as of January 24, 2009 was three month LIBOR plus 2.0%.
 
Note 20:  Recent Accounting Pronouncements
 
FASB Statement of Financial Accounting Standards No. 159

The FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which allows a company to choose to measure selected financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.

We adopted SFAS No. 159 on April 27, 2008 and have not elected the permitted fair value measurement provisions of this statement.

 
19

 

FASB Statement of Financial Accounting Standards No. 160

The FASB issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 (“SFAS No. 160”).  It is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.  Earlier application is prohibited. SFAS No. 160 requires that accounting and reporting for minority interests will be re-characterized as non-controlling interests and classified as a component of equity.  SFAS No. 160 also establishes reporting requirements that provide disclosures that clearly identify and distinguish between the interests of the parent and the interests of the non-controlling owners.

We are currently evaluating the impact SFAS No. 160 will have on our financial statements.  This statement will be effective for interim periods beginning in fiscal 2010.

FASB Statement of Financial Accounting Standards No. 141(R)

The FASB issued Statement of Financial Accounting Standards No. 141 (Revised 2007), Business Combinations, (“SFAS No. 141(R)”), which replaces FASB Statement No. 141.  SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. SFAS No. 141(R) is effective for business combinations that occur during or after fiscal years that begin after December 15, 2008.

We are currently evaluating the impact SFAS No. 141(R) will have on our financial statements.  This statement will be effective in fiscal 2010.

FASB Statement of Financial Accounting Standards No. 161
 
The FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities, (“SFAS No. 161”). It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early adoption encouraged.  The objective of this statement is to require enhanced disclosures about an entity’s derivative and hedging activities and to improve the transparency of financial reporting. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows requires disclosure of the fair values of derivative instruments and their gains and losses in tabular format and derivative features that are credit risk related.
 
This statement will be effective for the fourth quarter of fiscal 2009 and it will require expanded disclosure of our hedging activities.
 
FASB Staff Position EITF 03-6-1: Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities

In June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities, (“FSP EITF 03-6-1”). FSP EITF 03-6-1 requires that unvested share-based payment awards containing non-forfeited rights to dividends be included in the computation of earnings per common share. The adoption of FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008 and interim periods within those years, retrospective application is required.

 
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This statement will be effective beginning with our first quarter of fiscal 2010 and will require us to include unvested shares of our share-based payment awards into our calculation of earnings per share.   This is expected to increase our basic shares outstanding by about 0.6 million and 0.2 million for the periods ending January 24, 2009 and January 26, 2008, respectively.

FASB Staff Position FAS 140-4 and FIN 46(R)-8: Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities

In December 2008, the FASB issued FASB Staff Position ("FSP") FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities. This document increases disclosure requirements for public companies and is effective for reporting periods (interim and annual) that end after December 15, 2008. The purpose of this FSP is to promptly improve disclosures by public entities and enterprises until the pending amendments to FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, are finalized and approved by the Board. The FSP amends Statement 140 to require public entities to provide additional disclosures about transferors' continuing involvements with transferred financial assets. It also amends Interpretation 46(R) to require public enterprises, including sponsors that have a variable interest in a variable interest entity, to provide additional disclosures about their involvement with variable interest entities.

We have implemented the requirements of FSP FAS 140-4 and FIN 46(R)-8 for this reporting period.  As the requirements of this literature only impact our disclosures, there was no impact to our financial results.

FASB Staff Position FAS 132R-1: Employers’ Disclosures about Postretirement Benefit Plan Assets
 
In December 2008, FASB issued FASB Staff Position (“FSP”) FAS 132R-1, Employers’ Disclosures about Postretirement Benefit Plan Assets.  This document expands the disclosures related to postretirement benefit plan assets to include disclosures concerning a company’s investment policies for benefit plan assets and categories of plan assets.  This document further expands the disclosure requirements to include fair value of plan assets, including the levels within the fair value hierarchy and other related disclosures under SFAS No. 157, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, and any concentrations of risk related to the plan assets.
 
This statement is effective for our fiscal 2010 year end.  We are currently determining the impact, if any, this statement will have on our consolidated financial statements and disclosures.
 
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
 
AND RESULTS OF OPERATIONS
 
Our Management’s Discussion and Analysis is an integral part of understanding our financial results. This Management’s Discussion and Analysis should be read in conjunction with the accompanying Consolidated Financial Statements and related Notes to Consolidated Financial Statements. We begin the Management’s Discussion and Analysis with an introduction to La-Z-Boy Incorporated’s key businesses, strategies and significant operational events in fiscal 2009. We then provide a discussion of our results of operations, liquidity and capital resources, quantitative and qualitative disclosures about market risk, and critical accounting policies.
 
Cautionary Statement Concerning Forward-Looking Statements
 
We are making forward-looking statements in this report. Generally, forward-looking statements include information concerning possible or assumed future actions, events or results of operations. More specifically, forward-looking statements include the information in this document regarding:

future income, margins and cash flows
 
future economic performance
future growth
 
industry and importing trends
adequacy and cost of financial resources
 
management plans

Forward-looking statements also include those preceded or followed by the words "anticipates," "believes," "estimates," "hopes," "plans," "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 anticipated or projected due to a number of factors. These factors include, but are not limited to: (a) changes in consumer confidence; (b) changes in demographics; (c) further changes in residential housing and commercial real estate market; (d) the impact of terrorism or war; (e) continued energy and other commodity price changes; (f) the impact of logistics on imports; (g) the impact of interest rate changes; (h) changes in currency exchange rates; (i) competitive factors; (j) operating factors, such as supply, labor or distribution disruptions including changes in operating conditions or costs; (k) effects of restructuring actions; (l) changes in the domestic or international regulatory environment; (m) ability to implement global sourcing organization strategies; (n) continued economic recession and decline in the equity market; (o) the impact of adopting new accounting principles; (p) the impact from natural events such as hurricanes, earthquakes and tornadoes; (q) the ability to procure fabric rolls and leather hides or cut and sewn fabric and leather sets domestically or abroad; (r) continued decline in the credit market and potential impacts on our customers and suppliers; (s) unanticipated labor/industrial actions; (t) those matters discussed in Item 1A of our fiscal 2008 Annual Report and factors relating to acquisitions 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, either to reflect new developments or for any other reason.

 
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Introduction

La-Z-Boy Incorporated manufactures, markets, imports, distributes and retails upholstery products and casegoods (wood) furniture products. Our La-Z-Boy brand is the most recognized brand in the furniture industry, and we are the leading global producer of reclining chairs. We own 69 La-Z-Boy Furniture Galleries® stores, which are retail locations dedicated to marketing our La-Z-Boy branded product. These 69 stores are part of the larger store network of La-Z-Boy Furniture Galleries® stores which includes a total of 328 stores, the balance of which are independently owned and operated. The network constitutes the industry’s largest single-branded upholstered furniture retailer in North America. These stores combine the style, comfort and quality of La-Z-Boy furniture with our in-home design service to help consumers furnish certain rooms in their homes.

In addition to our company-owned stores, we consolidate certain of our independent dealers who did not have sufficient equity to carry out their principal business activities without our financial support. These dealers are referred to as Variable Interest Entities (“VIEs”). During the third quarter of fiscal 2009 we had four VIEs, operating 37 stores consolidated into our Statement of Operations.  During the third quarter of fiscal 2009, we terminated our relationship with our Toronto VIE.  However, four of the stores operated by the former dealer were assumed by another dealer in the Toronto market and one was closed.  As a result this dealer became a VIE.  With this change in ownership, the total markets remain the same; however the store count did increase by three.  At the end of the fiscal 2008 third quarter, we had four VIEs, operating 34 stores, in our Consolidated Statement of Operations.

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

Upholstery Group.  In terms of revenue, our largest segment is the Upholstery Group, which includes La-Z-Boy, our largest operating unit. Also included in the Upholstery Group are the operating units Bauhaus and England.  This group primarily manufactures and sells upholstered furniture to proprietary stores and other furniture retailers.  Upholstered furniture includes recliners and motion furniture, sofas, loveseats, chairs, ottomans and sleeper sofas.

Casegoods Group.  Our Casegoods Group today is primarily an importer, marketer and distributor of casegoods (wood) furniture.  It also operates two manufacturing facilities in North Carolina.  The operating units in the Casegoods Group are American Drew/Lea, Hammary and Kincaid.  Casegoods product includes tables, chairs, entertainment centers, headboards, dressers, accent pieces and some coordinated upholstered furniture. 

Retail Group.  The Retail Group consists of 69 company-owned La-Z-Boy Furniture Galleries® stores located in eight markets.  These markets range from the Midwest to the East Coast of the United States and also include Southeastern Florida.  The Retail Group sells mostly upholstered furniture to end consumers through the retail network.

The chart below shows the current structure of the La-Z-Boy Furniture Galleries® store network.

 
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During the first quarter of fiscal 2008, we began rolling out a new proprietary distribution model referred to as Comfort Studios.  Comfort Studios are typically smaller and more adaptable than the former in-store gallery model.  At the end of the third quarter of fiscal 2009, we had 449 Comfort Studios, of which some were new studios and the rest were conversions of former in-store galleries and general dealers.  We expect to open or convert approximately 35 more Comfort Studios during the remainder of fiscal 2009.  Kincaid, England and Lea also have in-store gallery programs.

Impact of Current Market Conditions

Towards the end of the fiscal 2009 second quarter, we realized significant declines in consumer demand brought on by a weak job market, declining home prices and tightening consumer credit which were factors in the failure of several prominent financial institutions.  These events intensified concerns about credit and liquidity risks in the financial markets and had a major impact on the economy and our business.  The collapse of the credit markets, the related tightening of access to capital and the ensuing write-downs of troubled loans by financial institutions had a significant impact on the decline in consumer confidence and the discretionary spending on home furnishing purchases. As a direct result of the recessionary economic climate, we took the following actions to align our operating structure with the resulting level of business:

 
·
We reduced employment by about 24% or 2,500 employees across all levels of the company since the third quarter of fiscal 2008.

 
·
We reduced our exposure to the overall tightening of the financial markets by our decision to withdraw credit support to certain independent dealers. As a result we anticipate the closure of about 15 to 20 primarily dealer owned, La-Z-Boy Furniture Galleries® stores in calendar 2009.

 
·
We significantly reduced our planned fiscal 2009 capital expenditures from approximately $27 million to approximately $18 million to $20 million.

 
·
We suspended our bonus and profit sharing plan, as well as suspending the company match portion of our 401(k) plan.

 
·
We will close a plant in Sherman, Mississippi during February 2009, which will reduce our capacity and increase our efficiencies for our Bauhaus operations.

 
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In addition to these initiatives we plan to aggressively reduce overall operating expenses and inventories to be in alignment with today’s volumes.  We believe the reduction in employment alone will result in savings of $25 million to $30 million annually.  We continue to focus on cash flow and liquidity to ensure that our balance sheet remains strong enough to withstand this current recession.  We plan to reduce our inventory balances by 10% during the fourth quarter as we have significantly reduced our overseas purchases.

As a result of our fiscal 2009 losses, the impact of the restructuring actions we have taken over the past two years, the significant decline in current and projected demand for consumer domestic furniture purchases and resulting uncertainty in the economic climate, we reassessed the likelihood that we will be able to realize the benefit of our deferred tax assets.   As a result, we recorded a valuation allowance of $38.2 million against the deferred tax assets, or $0.74 per share in the 2009 fiscal second quarter.  In the third quarter of fiscal 2009, a valuation allowance of $14.6 million was recorded against the current quarter’s tax benefit due to the pre-tax losses incurred.

Over the past four months, our stock price has declined nearly 90%, negatively impacting our market capitalization which is now significantly below our company’s book value.  As a result, we have had to analyze the overall valuation of the company, our fixed assets and our intangible assets.  Although we tested the valuation of our Retail segment’s goodwill during the second quarter, the major decline in the stock market and the freezing of money in the capital markets resulted in an increase in our weighted average cost of capital from 11% at the end of the second quarter of fiscal 2009 to 16% at the end of the third quarter of fiscal 2009.  This increase in the weighted average cost of capital had the effect of reducing our fair value estimates and resulted in significant write-downs in our intangible assets.  We recorded a non-cash impairment charge of $40.4 million relating to the goodwill in our Retail and Upholstery segments and a non-cash impairment charge of $5.5 million relating to the trade names of operating units in our Casegoods segment.

 
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Results of Operations
Analysis of Operations: Quarter Ended January 24, 2009
(Third Quarter 2009 compared with 2008)

   
Quarter Ended
     
(Amounts in thousands, except per share amounts and percentages)
 
01/24/09
   
01/26/08
   
Percent
change
Upholstery sales
  $ 199,200     $ 282,453       (29.5 )%
Casegoods sales
    42,116       52,660       (20.0 )%
Retail sales
    40,497       49,884       (18.8 )%
Other/eliminations*
    6,763       (11,916 )     156.7 %
Consolidated sales
  $ 288,576     $ 373,081       (22.7 )%
                         
Consolidated gross profit
  $ 79,556     $ 108,635       (26.8 )%
Consolidated gross margin
    27.6 %     29.1 %        
                         
Consolidated S,G&A
  $ 94,092     $ 104,672       (10.1 )%
S,G&A as a percent of sales
    32.6 %     28.1 %        
                         
Upholstery operating income
  $ (1,938 )   $ 19,467       (110.0 )%
Casegoods operating income
    (313 )     2,222       (114.1 )%
Retail operating loss
    (7,108 )     (8,507 )     16.4 %
Corporate and other
    (3,513 )     (9,851 )     64.3 %
Long-lived asset write-down
    (7,036 )           N/M  
Intangible write-down
    (45,977 )           N/M  
Restructuring
    (2,405 )     (245 )     (881.6 )%
Consolidated operating income (loss)
  $ (68,290 )   $ 3,086       N/M  
                         
Upholstery operating margin
    (1.0 )%     6.9 %        
Casegoods operating margin
    (0.7 )%     4.2 %        
Retail operating margin
    (17.6 )%     (17.1 )%        
Consolidated operating margin
    (23.7 )%     0.8 %        
                         
Income (loss) from continuing operations
  $ (64,382 )   $ 9,128          
                         
Income (loss) from discontinued operations
  $     $ 384          
Diluted income (loss) per share from continuing operations
  $ (1.25 )   $ 0.18          
* Includes sales from our VIEs.
N/M = non meaningful

 
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Sales

Consolidated sales were down 22.7% or $84.5 million when compared with the third quarter of fiscal 2008 due in large part to the challenging economic conditions including the weak retail environment, record low consumer confidence, an uncertain housing market and a deteriorating consumer credit environment.

Upholstery Group sales were down 29.5% or $83.3 million compared with the third quarter of fiscal 2008. Sales price increases resulted in a 2.9% increase in sales; however this was offset by a decrease in sales volume due to the challenging economic conditions.  Additionally, the change in reporting of the Retail distribution centers to the Upholstery Group affected the timing of inter-company sales resulting in a reduction in inter-company sales for the Upholstery Group of $12.1 million when compared to the third quarter of the prior year.

Casegoods Group sales decreased 20.0% or $10.5 million compared with the third quarter of fiscal 2008. The decrease in sales volume occurred across all of our Casegoods operating units and directly related to the challenging economic conditions.

Retail Group sales decreased 18.8% or $9.4 million when compared with the third quarter of fiscal 2008.  The decrease in sales was related to the challenging economic conditions, which had an extremely negative effect on the home furnishings market.

Included in Other/eliminations are the sales by our VIEs and the elimination of sales from our Upholstery and Casegoods Groups to our Retail Group.  Due to the previously mentioned change in reporting of the Retail distribution centers, this elimination was adjusted by $12.1 million during the quarter, which decreased the eliminations for this quarter.  In addition, the decrease in the sales between our Upholstery Group and Retail Group reduced our elimination of sales by $7.3 million. The addition of the three stores in our Toronto market did not occur until the end of the third quarter of fiscal 2009 and therefore did not have an impact on the third quarter sales.

Gross Margin

Gross margin decreased 1.5 percentage points in the third quarter of fiscal 2009 in comparison to the third quarter of fiscal 2008.  Gross margin was positively impacted by selling price increases, net of discounts, which increased our gross margin by 3.1 percentage points.  Raw material cost increases had a 2.5 percentage point negative impact on gross margin.   Additionally, restructuring costs negatively impacted gross margin by 0.6 percentage points.  The remainder of the decrease in gross margin during the quarter related to under absorption of overhead costs due to the reduction in sales volume as a result of the current economic environment.

Selling, General and Administrative Expenses

Selling, general and administrative expenses (S,G&A) decreased $10.6 million when compared to the prior year’s third quarter, but increased as a percent of sales by 4.5 percentage points due to the decline in our overall sales volume.  During fiscal 2009, the Florida, Michigan, and the West Coast markets were impacted to a greater extent by the weak retail environment than other markets.  Accordingly we revised our estimates of amounts expected to be collected on past due accounts and increased our allowance for bad debts by $6.7 million when compared with the third quarter of fiscal 2008.  Our reserve balance against accounts receivable as of January 24, 2009 was $35.8 million.

 
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This increase was offset by an $8.0 million decrease in advertising in our Retail and Wholesale segments during the third quarter of fiscal 2009 as compared to the third quarter of fiscal 2008 due to sales volume declines and our attempt to keep our expenditures in line with our volume, as well as reducing production of new advertisements.  Advertising expense was 4.8% of sales in the third quarter of fiscal 2009, compared to 5.9% in the third quarter of fiscal 2008.  Due to the weak retail environment and the uncertainty in our sales volume for the remainder of the fiscal year, we expect advertising expense to continue to be lower for the fourth quarter of fiscal 2009, while staying in line as a percent of sales. Additionally, other variable selling expenses declined as a result of the decline in sales. 

Restructuring

Restructuring costs totaled $2.4 million for the third quarter of fiscal 2009 as compared with $0.2 million in restructuring expenses for the same period the prior year. The restructuring costs in the third quarter of fiscal 2009 related to the closure of our Tremonton, Utah facility, the closure of our Sherman, Mississippi facility, the restructuring of our La-Z-Boy U.K. subsidiary, the restructuring of our company-wide employment and the ongoing costs for the closure of retail facilities.  These costs were comprised mainly of severance and benefits, fixed asset and inventory impairments, transition costs for the Utah plant closure and the ongoing lease cost for our closed retail facilities.  The restructuring costs in the third quarter of fiscal 2008 related to the closure of several of our manufacturing facilities, consolidation of retail warehouses and the closure of underperforming retail stores.

Long-lived Asset Write-down

During the third quarter of fiscal 2009, we evaluated the recoverability of our long-lived assets of our key asset groups.  Due to our operating losses and a deterioration of economic conditions which reduced our estimated future cash flows for certain asset groups, we recognized a $7.0 million non-cash impairment charge relating to the long-lived assets of our Retail Group.

Intangible Write-down

During the third quarter of fiscal 2009, we evaluated the goodwill of our Upholstery and Retail operating segments and the trade names of our Casegoods segment.  Due to the steep decline in our stock price and its negative impact on our market capitalization, we recognized a $40.4 million non-cash impairment charge relating to the goodwill in our Retail and Upholstery segments and a $5.5 million non-cash impairment charge relating to the trade names in our Casegoods segment.

Operating Margin

Our consolidated operating margin was (23.7)% for the third quarter of fiscal 2009 and included 15.9 percentage points for the intangible write-down, 2.4 percentage points for the long-lived asset write-down and 0.8 percentage points of restructuring charges.  Operating margin for the third quarter of fiscal 2008 was 0.8% and included 0.1 percentage points for restructuring costs. With a decrease in our gross margin as a percent of sales, the effect of sales volume declines out-paced the impact of our cost reduction efforts thus reducing our operating margins.

The Upholstery Group operating margin decreased 7.9 percentage points to (1.0)% when compared with the third quarter of fiscal 2008.  Selling price increases positively impacted our operating margin.  However, this increase was offset by an increase in bad debt expense and an increase in raw material costs in the third quarter of fiscal 2009 as compared to the third quarter of fiscal 2008.  Additionally, in the third quarter of fiscal 2009, the Upholstery Group operating income was reduced by $3.3 million for the inter-company profit resulting from the previously mentioned change in reporting of the retail warehouse operations.  The remainder of the decrease during the quarter related to under absorption of overhead costs due to the reduction in sales volume.

 
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Our Casegoods Group operating margin decreased by 4.9 percentage points to (0.7)% in the third quarter of fiscal 2009 versus the third quarter of fiscal 2008.  With a 20.0% decrease in sales volume, we were unable to reduce our costs quickly enough to maintain our operating margin.

Our Retail Group operating margin decreased by 0.5 percentage points to (17.6)% during the third quarter of fiscal 2009 when compared with the third quarter of fiscal 2008.  The reduction primarily resulted from the fixed occupancy costs of our Retail operations coupled with the continued decline in sales, partially offset by selling price increases, reduced advertising expense and reduced warehousing costs.

Corporate and Other operating loss decreased $6.3 million during the third quarter of fiscal 2009 in comparison to the third quarter of fiscal 2008.  Our VIEs’ losses for the third quarter of fiscal 2009 were $0.1 million more than the same quarter the prior year.   The previously mentioned reporting change for the retail warehouse operations resulted in a $3.3 million increase in inter-company operating income eliminations.

Interest Expense

Interest expense for the third quarter of fiscal 2009 was $0.8 million less than the third quarter of fiscal 2008 due to a $37.3 million decrease in our average debt and a 1.1 percentage point decrease in our weighted average interest rate.

Income Taxes

Our effective tax rate was 6.2% in the third quarter of fiscal 2009 compared to 29.8% in the third quarter of fiscal 2008. The change in our tax rate during fiscal 2009 was primarily attributable to the recording of valuation allowances against the majority of our U.S. deferred tax assets in the second quarter of fiscal 2009, as well as additional valuation allowances recorded in the third quarter of fiscal 2009 against our deferred tax assets resulting from our current period losses.

The current period tax benefit results primarily from the reversal of deferred tax liabilities associated with trade names and goodwill that were written off in the third quarter of fiscal 2009, offset by income taxes on operations conducted by subsidiaries that are profitable on a separate entity basis.

Discontinued Operations

During the third quarter of fiscal 2008, our discontinued operations recognized income of $0.4 million after tax as we completed the liquidation of the remaining assets of Pennsylvania House.

 
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Results of Operations
Analysis of Operations: Nine Months Ended January 24, 2009
(First Nine Months of 2009 compared with 2008)

   
Nine Months Ended
     
(Amounts in thousands, except per share amounts and percentages)
 
01/24/09
   
01/26/08
   
Percent
change
Upholstery sales
  $ 684,252     $ 806,959       (15.2 )%
Casegoods sales
    138,710       165,126       (16.0 )%
Retail sales
    122,408       141,278       (13.4 )%
Other/eliminations*
    (3,194 )     (30,452 )     89.5 %
Consolidated sales
  $ 942,176     $ 1,082,911       (13.0 )%
                         
Consolidated gross profit
  $ 247,329     $ 289,585       (14.6 )%
Consolidated gross margin
    26.3 %     26.7 %        
                         
Consolidated S,G&A
  $ 287,873     $ 297,278       (3.2 )%
S,G&A as a percent of sales
    30.6 %     27.5 %        
                         
Upholstery operating income
  $ 16,037     $ 47,370       (66.1 )%
Casegoods operating income
    1,819       8,399       (78.3 )%
Retail operating loss
    (27,509 )     (27,700 )     0.7 %
Corporate and other
    (21,195 )     (33,315 )     36.4 %
Long-lived asset write-down
    (7,036 )           N/M  
Intangible write-down
    (47,677 )     (5,809 )     (720.7 )%
Restructuring
    (11,904 )     (4,893 )     (143.3 )%
Consolidated operating loss
  $ (97,465 )   $ (15,948 )     (511.1 )%
                         
Upholstery operating margin
    2.3 %     5.9 %        
Casegoods operating margin
    1.3 %     5.1 %        
Retail operating margin
    (22.5 )%     (19.6 )%        
Consolidated operating margin
    (10.3 )%     (1.5 )%