Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following analysis of the results of operations and financial condition of the Company should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
COVID-19 Pandemic
The World Health Organization (“WHO”) on March 11, 2020 declared the novel coronavirus 2019 (“COVID-19”) a global pandemic. We are monitoring the impact of the COVID-19 pandemic on our business, results of operations and financial results. The impact on our business will depend on the length of the pandemic and local government regulations. We have taken precautionary measures to protect the health and safety our employees, including having our employees working from home. The COVID-19 pandemic remains fluid and the extent of the impact to our business may be significant, however, we are unable to predict the extent or nature of these impacts at this time.
Business Update
On April 28, 2020, we announced the exit of our Vehicle Seating and the remainder of the Hospitality product lines, and subsequently closed our Dubuque, Iowa and Starkville, Mississippi manufacturing facilities. We expect to complete the restructuring activities related to the exit of our Vehicle Seating and the remainder of the Hospitality product lines during fiscal 2021. Both of these product lines combined represented less than 8% of the Company’s total net sales for the fiscal year ended 2020.
On June 1, 2020, we announced our Board of Directors authorized a $6 million share repurchase program through June 9, 2021. Subsequent to June 30, 2020, on August 21, 2020, the Company’s Board of Directors authorized a new share repurchase program authorizing the Company to purchase up to an aggregate of $8 million of the Company’s common stock. There is no guarantee as to the exact number or value of shares that will be repurchased by the Company, and the Company may discontinue repurchases at any time that management determines additional repurchases are not warranted.
Results of Operations
The following table has been prepared as an aid in understanding the Company’s results of operations on a comparative basis for the fiscal years ended June 30, 2020, 2019 and 2018. Amounts presented are percentages of the Company’s net sales.
For the years ended June 30,
2020
2019
2018
Net sales
100.0
%
100.0
%
100.0
Cost of goods sold
85.5
84.2
79.9
Gross margin
14.5
15.8
20.1
Selling, general and administrative
19.7
18.3
14.7
Restructuring expense
9.3
2.3
—
Environmental remediation
—
—
0.8
ERP impairment
—
4.8
—
Gain on disposal of assets
5.2
—
0.4
Litigation settlement costs
—
0.1
—
Operating income (loss)
(9.4)
(9.7)
5.0
Other income
0.2
0.1
0.1
Interest (expense)
(0.0)
—
—
Income (loss) before income taxes
(9.2)
(9.6)
5.1
Income tax benefit (provision)
1.9
2.2
(1.5)
Net income (loss)
(7.3)
%
(7.4)
%
3.6
Fiscal 2020 Compared to Fiscal 2019
Net sales for fiscal year 2020 were $366.9 million compared to $443.6 million in the prior fiscal year, a decrease of 17.3%. For the fiscal year ended June 30, 2020, residential net sales were $331.9 million compared to $374.5 million for the year ended June 30, 2019, a decrease of 11.4%. The decline in residential net sales were primarily attributable to volume decreases on furniture imported from China as a result of the 25% tariff and the related price increases taken to the market, coupled with the COVID-19 pandemic. The decline was partially offset by an increase in our ready to assemble furniture sold through e-commerce, which grew 35.7% year over year, primarily driven by increased demand.
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Contract net sales were $35.0 million for the year ended June 30, 2020, a decrease of 49.3% from net sales of $69.1 million for the year ended June 30, 2019. The decline in contract net sales was primarily driven by our decision to exit the Commercial Office and custom-designed Hospitality product lines, coupled with a decline in healthcare and Vehicle Seating products due to demand. In April 2020, we announced the exit of our Vehicle Seating and the remainder of the Hospitality product lines.
Gross margin for the fiscal year ended June 30, 2020 was 14.5% compared to 15.8% for the prior year period, a decline of 130 basis points (bps). The 130 bps decline was primarily driven by a decline of 280 bps due to lower volume and product mix, a decline of 60 bps for increased costs to improve delivery lead times, partially offset by 120 bps from valuation allowance on foreign VAT as a result of collections made during the fiscal year and 80 bps from restructuring cost improvements.
Selling, general and administrative (SG&A) expenses for the twelve months ended June 30, 2020 decreased $8.9 million to $72.4 million compared to $81.3 million for the year ended June 30, 2019. As a percentage of net sales, SG&A was 19.7% for the year ended June 30, 2020 compared to 18.3% of net sales in the prior year period. The increase in SG&A as a percentage of net sales was primarily driven by higher bad debt expense of $5.0 million attributable to a customer bankruptcy and the current economic environment, right-of-use lease asset impairments of $2.9 million, partially offset by current year restructuring savings and lower expenses on reduced volume.
During the fiscal year ended June 30, 2020, we incurred $34.2 million of restructuring expenses primarily for write-down of assets due to impairment, facility closures, professional fees, pension withdrawal liability and employee termination costs as part of our previously announced comprehensive transformation program. See Note 5 Restructuring of the Notes to Consolidated Financial Statements, included in this Annual Report on Form 10-K for more information.
During the fiscal year ended June 30, 2020, we completed the sale of our Riverside, California property for the sale price of $20.5 million generating net proceeds of $19.6 million after customary closes costs, prorations and commissions. This resulted in a recognized pre-tax gain on sale of $18.9 million.
Subsequent to June 30, 2020, the Company sold one of its facilities in Harrison, Arkansas on August 14, 2020 for a sale price of $0.7 million.
For the twelve months ended June 30, 2020, the effective tax rate was 20.5% compared to 23.5% in the prior year period. The difference between the 2020 and 2019 rates relate to recording the current year benefit at 35% federal tax rate rather than the current statutory rate of 21% due to the carryback benefit discussed below. In addition, we recorded an $8.4 million valuation allowance against the federal and state deferred tax assets of $10.6 million.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted and signed into law in response to the COVID-19 global pandemic. Certain provisions of the CARES Act impacted the current fiscal year 2020. The CARES Act permits net operating losses (“NOLs”) incurred in tax years 2018, 2019, and 2020, (the Company’s fiscal years 2019, 2020 and 2021) to offset 100% of taxable income and be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The Company evaluated the impact of the CARES Act during the year ended June 30, 2020 and recorded an income tax receivable of $4.5 million for the benefit of carrying back the fiscal year 2020 NOL and an income tax receivable of $8.2M for the benefit of carryback the fiscal year 2019 NOL. As the Company is carrying the losses back to years beginning before January 1, 2018, the receivables were recorded at the previous 35% federal tax rate rather than the current statutory rate of 21%.
The above factors resulted in a net loss of $26.8 million or $3.37 per diluted share for fiscal year 2020 compared to a net loss of $32.6 million or $4.13 per diluted share in the prior year period.
Fiscal 2019 Compared to Fiscal 2018
Net sales for fiscal year 2019 were $443.6 million compared to $489.2 million in the prior fiscal year, a decrease of 9.3%. For the fiscal year ended June 30, 2019, residential net sales were $374.5 million compared to $413.7 million for the year ended June 30, 2018, a decrease of 9.5%. The implementation of the tariff on furniture imported from China at 10% followed by an increase to 25% drove approximately 45% of the overall contraction in residential net sales. An additional 38% of decline in residential net sales was driven by lost share on products sold through our e-commerce channel due to the significant disruption caused by the implementation of the ERP system in the beginning of fourth quarter of fiscal 2018. Over the 2019 fiscal year, the Company continued work stabilizing the ERP system, improving service levels, inventory positions and promotions to regain share positions through the end of the second quarter of fiscal 2019. In addition, the Company has brought in new leadership over the Company’s e-commerce strategy and execution as well as a new Chief Information Officer to drive the information technology backbone including the ERP solution to facilitate success in the channel. The remaining reduction in residential net sales versus the 2018 fiscal year was attributed to general market softness as well as two strong comparative quarters in fiscal 2018.
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Contract net sales were $69.1 million for the year ended June 30, 2019, a decrease of 8.5% from net sales of $75.5 million for the year ended June 30, 2018. Reductions in Commercial Office products followed by Hospitality products drove a majority of the year over year decline. In May 2019, the Company announced the exit of the Commercial Office and custom designed Hospitality product lines. The declines in these product lines was partially offset by 14% year on year growth in our Vehicle Seating product line.
Gross margin for the fiscal year ended June 30, 2019 was 15.8% compared to 20.1% for the prior year period, a decline of 430 basis points (bps). The key drivers in the margin deterioration were one-time in nature, such as charges related to inventory impairment due to restructuring activity of $7.7 million (170 bps), a valuation allowance on foreign VAT of $2.6 million (60 bps), and relocation costs of the Dubuque manufacturing facility of $1.0 million (20 bps).
The remaining deterioration to last year was driven primarily by improved pricing (80 bps) offset by higher material and input costs (180 bps) and higher inventory valuation allowances for excess and obsolescence as volume declined (50 bps).
Selling, general and administrative (SG&A) expenses for the twelve months ended June 30, 2019 were 18.3% of net sales compared to 14.7% of net sales in the prior year period. The increase in SG&A as a percentage of net sales was primarily driven by lower volume, higher IT costs associated with the implementation and stabilization of the new ERP system of $3.8 million, DMI Pension termination of $2.5 million, CEO transition costs of $2.0 million, and higher marketing and advertising costs of $1.5 million.
The twelve months ended June 30, 2018 included $3.6 million related to the April 25, 2018 United States Environmental Protection Agency’s (“EPA”) issuance of a Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) 106(a) order (the “Order”) for the Lane Street Groundwater Superfund Site located in Elkhart, Indiana reported in “Environmental remediation”. The after-tax basis reported in “Environmental remediation” is $2.5 million or $0.32 per share. The Company completed a $6.5 million sale of a facility and recognized a pre-tax gain of $1.8 million during fiscal year 2018. The after-tax basis reported in “Gain on sale of facility” is $1.3 million or $0.16 per share.
The twelve months ended June 30, 2019 included $21.3 million reported in “ERP impairment” related to the impairment of the abandoned components and development work associated with unusable elements of the business information system. The after-tax basis reported in “ERP Impairment” is $16.3 million or $2.06 per share for fiscal 2019. Reported under “Restructuring expense” in fiscal 2019 were $10.0 million associated with the restructuring plan the Company first announced on May 15, 2019. The Company has been in the process of executing the restructuring plan. In fiscal 2019, the after-tax basis reported in “Restructuring expense” were $7.7 million or $0.97 per share. In fiscal 2019, reported under “Legal settlement (costs) reimbursements” were $0.5 million associated with an employment matter and the after-tax basis reported in “Legal settlement (costs) reimbursements” were $0.4 million or $0.05 per share.
For the twelve months ended June 30, 2019, the effective tax rate was 23.5% compared to 29.7% in the prior year period. The fiscal 2019 results were favorably impacted by a full fiscal year impact of the 2018 Tax Cuts and Jobs Act in addition to net operating losses within the fiscal year ended June 30, 2019.
The above factors resulted in a net loss of ($32.6) million or ($4.13) per diluted share for fiscal year 2019 compared to a net income of $17.7 million or $2.23 per diluted share in the prior year period.
Liquidity and Capital Resources
COVID-19 update
Due to continued uncertainties as a result of COVID-19, we implemented measures to enhance our liquidity position and improve working capital. During the fourth quarter of fiscal year 2020, we reduced our quarterly dividend from $0.22 per share to $0.05 per share. We extended a 25% salary reduction for our CEO and CFO/COO and 50% cash compensation reduction for our Board of Directors through October 1, 2020. To further bolster liquidity, on August 28, 2020, we entered into an agreement with Dubuque Bank & Trust Company, for a secured $25.0 million credit facility with a two-year term. No borrowings have been made on the $25.0 million credit facility.
Working capital (current assets less current liabilities) at June 30, 2020 was $128.4 million compared to $118.2 million at June 30, 2019. The $10.2 million increase in working capital was due to an increase in cash of $26.0 million, primarily attributable to proceeds from the sale of the Riverside, California facility of $20.5 million, increase in assets held for sale of $12.3 million, increase in other current assets of $6.6 million, and a decrease in restructuring liability of $4.2 million, partially offset by $23.1 million in inventory reduction as a result of inventory management and SKU rationalization activities, decrease in trade receivables of $5.9 million due to lower sales, and an increase in accounts payable of $9.3 million.
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A summary of operating, investing and financing cash flow is show in the following table:
For the years ended June 30,
(in thousands)
2020
2019
Net cash provided by operating activities
$
18,287
$
6,714
Net cash provided by (used in) investing activities
16,785
(5,170)
Net cash used in financing activities
(9,122)
(7,047)
Increase (decrease) in cash and cash equivalents
$
25,950
$
(5,503)
Net cash provided by operating activities
For the twelve months ended June 30, 2020, net cash provided by operating activities was $18.3 million, which primarily consisted of net loss of $26.8 million, adjusted for non-cash depreciation of $8.4 million, gain from sale of capital assets of $19.0 million, stock based compensation of $4.9 million, asset impairment charges of $20.4 million, change in deferred income taxes of $5.5 million and change in accounts receivable and VAT allowance of $0.5 million. Net cash provided by operating assets and liabilities was $25.6 million. The cash provided by operating assets and liabilities of $25.6 million, was primarily due to a decline in inventory and accounts receivable of $23.1 million and $4.4 million, respectively, coupled with an increase in accounts payable of $9.3 million, partially offset by a decline in accrued liabilities of $6.0 million.
For the twelve months ended June 30, 2019, net cash provided by operating activities was $6.7 million, which primarily consisted of net loss of $32.6 million, adjusted for non-cash depreciation of $7.4 million, stock based compensation of $1.4 million, ERP asset impairment charge of $21.3 million, change in deferred income taxes of $6.1 million, VAT allowance of $2.6 million, and defined benefit plan termination of $2.5 million. Net cash provided by operating assets and liabilities was $6.7 million. The cash provided by operating assets and liabilities of $10.4 million, was primarily due to decline in inventory and accounts receivable of $2.5 million and $3.1 million, respectively, couple with an increase in accounts payable and accrued liabilities, partially offset by an increase in other assets of $6.1 million.
Net cash provided by (used in) investing activities
For the twelve months ended June 30, 2020, net cash provided by investing activities was $16.8 million, due to proceeds of $20.5 million for the sale of our Riverside, California facility and other capital assets, partially offset by capital expenditures of $3.7 million.
For the twelve months ended June 30, 2019, net cash used in investing activities was $5.2 million, due to capital expenditures of $21.3 million, proceeds from the disposition of capital assets of $0.2 million and net proceeds of investments of $15.9 million.
Net cash used in financing activities
For the twelve months ended June 30, 2020, net cash used in financing activities was $9.1 million, primarily due to dividends paid of $7.0 million, treasury stock purchases of $1.6 million and $0.6 million for tax payments on employee vested restricted shares.
For the twelve months ended June 30, 2019, net cash used in financing activities was $7.0 million, primarily due to dividend paid of $6.9 million.
Lines of Credit
On August 28, 2020, we entered into a secured $25.0 million credi t facility with Dubuque Bank & Trust Company, with a two year term and interest of 1.50% plus LIBOR, subject to a floor of 3.0%. The credit facility expires on August 28, 2022. The credit facility is secured by essentially all of the Company’s assets, excluding real property and requires the Company maintain compliance with certain financial and non-financial covenants. No borrowings have been made on the $25.0 million credit facility.
We had an unsecured credit agreement with Wells Fargo Bank N.A. (“Wells”) that provided short-term capital financing up to $10.0 million with interest of LIBOR plus 1%. The credit agreement expired on June 30, 2020 and there was no balance outstanding as of June 30, 2020. Letters of credit outstanding at Wells as of June 30, 2020, totaled $1.2 million, of which $1.3 million of our cash held at Wells is pledged as collateral.
We had an additional unsecured $10.0 million line of credit with MidwestOne Bank, with interest at prime minus 2%, subject to a floor of 3.75%. The credit agreement expired on June 30, 2020 and there was no balance outstanding as of June 30, 2020.
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Contractual Obligations
The following table summarizes our contractual obligations at June 30, 2020 and the effect these obligations are expected to have on our liquidity and cash flow in the future (in thousands):
2-3
4-5
More than
Total
1 Year
Years
Years
5 Years
Operating lease obligations
$
12,795
$
4,804
$
5,404
$
2,587
$
—
At June 30, 2020, we had no capital lease obligations, and no purchase obligations for raw materials or finished goods.
Financing Arrangements
See Note 9 Credit Arrangements of Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.
Outlook
The COVID-19 global pandemic presents unprecedented challenges during fiscal 2021. Our focus for fiscal 2021 will be to preserve cash and liquidity, improve our cost structure, return to profitability at lower sales levels, and improve our capital efficiency.
During fiscal 2021, the Company anticipates spending $3 million to $4 million for capital expenditures. The Company believes it has adequate working capital to meet these requirements.
Critical Accounting Policies
The discussion and analysis of our consolidated financial statements and results of operations are based on consolidated financial statements prepared in accordance with generally accepted accounting principles (GAAP) in the United States of America. Preparation of these consolidated financial statements requires the use of estimates and judgments that affect the reported results. We use estimates based on the best information available in recording transactions and balances resulting from business operations. Estimates are used for such items as collectability of trade accounts receivable and inventory valuation. Ultimate results may differ from these estimates under different assumptions or conditions.
Accounts Receivable Allowances – we establish accounts receivable allowances to reduce trade accounts receivable to an amount that reasonably approximates their net realizable value. Our accounts receivable allowances consist of an allowance for doubtful accounts which is established through review of open accounts, historical collection, and historical write-off amounts. The amount ultimately realized from trade accounts receivable may differ from the amount estimated in the consolidated financial statements.
Inventories – we value inventory at the lower of cost or net realizable value. Our inventory valuation reflects markdowns for the excess of the cost over the amount expected to be realized and considers obsolete and excess inventory. Markdowns establish a new cost basis for the Company’s inventory. Subsequent changes in facts or circumstances do not result in the reversal of previously recorded markdowns or an increase in that newly established cost basis.
Valuation of Long–Lived Assets – we periodically review the carrying value of long-lived assets and estimated depreciable or amortizable lives for continued appropriateness. This review is based upon projections of anticipated future cash flows and is performed whenever events or changes in circumstances indicate that asset carrying values may not be recoverable or that the estimated depreciable or amortizable lives may have changed. For assets held for sale, if the net book value of the asset is greater than its estimated fair value less cost to sell, an impairment is recorded for the excess of net book value over estimated fair value less cost to sell. We recorded impairments of $20.4 million and $21.3 million in fiscal 2020 and 2019, respectively. The $20.4 million impairment recorded in fiscal 2020 include $2.9 million related to our leases of two showroom spaces. No impairment was recorded in fiscal 2018.
Restructuring Costs – The Company groups exit or disposal cost obligations into three categories: Involuntary employee termination benefits, costs to terminate contracts, and other associated costs. Involuntary employee termination benefits must be a one-time benefit, and this element of restructuring cost is recognized as incurred upon communication of the plan to the identified employees. Costs to terminate contracts are recognized upon termination agreement with the provider. Other associated restructuring costs are expensed as incurred. Any inventory impairment costs as a result of restructuring activities are accounted for as cost of goods sold.
Recently Issued Accounting Pronouncements
See Item 8. Note1 to the Company’s consolidated financial statements.
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