LA-Z-BOY INC 10-K

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. We have prepared this Management's Discussion and Analysis as an aid to understanding our financial results. It should be read in conjunction with the accompanying Consolidated Financial Statements and related Notes to Consolidated Financial Statements. It also includes management’s analysis of past financial results and certain potential factors that may affect future results, potential future risks and approaches that may be used to manage those risks. See "Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report for a discussion of factors that may cause results to differ materially. Note that our 2020, 2019 and 2018 fiscal years included 52 weeks. Introduction Our Business We are the leading global producer of reclining chairs and the second largest manufacturer/distributor of residential furniture in the United States . The La-Z-Boy Furniture Galleries ® stores retail network is the third largest retailer of single-branded furniture in the United States . We manufacture, market, import, export, distribute and retail upholstery furniture products under the La-Z-Boy ® , England, Kincaid ® , and Joybird ® tradenames. In addition, we import, distribute and retail accessories and casegoods (wood) furniture products under the Kincaid ® , American Drew ® , Hammary ® , and Joybird ® tradenames. As of April 25, 2020 , we had six major manufacturing locations and six regional distribution centers in the United States and two facilities in Mexico to support our speed-to-market and customization strategy. We closed our manufacturing facility located in Redlands, California as of the end of the second quarter of fiscal 2020. On June 4, 2020, we announced the closure of our Newton, Mississippi upholstery manufacturing facility. Production from our Newton upholstery facility will be shifted to available capacity at the company’s Dayton, Tennessee, Neosho, Missouri, and Siloam Springs, Arkansas plants. Refer to Note 21, Subsequent Events, for further information. We operate a wholesale sales office that is responsible for distribution of our product in the United Kingdom and Ireland. We operate a global trading company in Hong Kong which helps us manage our Asian supply chain by establishing and maintaining relationships with our Asian suppliers, as well as identifying efficiencies and savings opportunities. We also participate in two joint ventures in Thailand that support our international businesses: one that operates a manufacturing facility and another that operates a wholesale sales office. We also have contracts with several suppliers in Asia to produce products that support our pure import model for casegoods. We sell our products through multiple channels: to furniture retailers or distributors in the United States, Canada, and approximately 60 other countries, including the United Kingdom, China, Australia, South Korea and New Zealand; directly to consumers through retail stores that we own and operate; and through our websites, www.la-z-boy.com and www.joybird.com. The centerpiece of our retail distribution strategy is our network of 354 La-Z-Boy Furniture Galleries ® stores and 555 La-Z-Boy Comfort Studio ® locations, each dedicated to marketing our La-Z-Boy branded products. We consider this dedicated space to be "proprietary." We own 154 of the La-Z-Boy Furniture Galleries ® stores. The remainder of the La-Z-Boy Furniture Galleries ® stores, as well as all 555 La-Z-Boy Comfort Studio ® locations, are independently owned and operated. La-Z-Boy Furniture Galleries ® stores help consumers furnish their homes by combining the style, comfort, and quality of La-Z-Boy furniture with our available design services. La-Z-Boy Comfort Studio ® locations are defined spaces within larger independent retailers that are dedicated to displaying and selling La-Z-Boy branded products. In total, we have approximately 7.9 million square feet of proprietary floor space dedicated to selling La-Z-Boy branded products in North America. We also have approximately 2.7 million square feet of floor space outside of North America dedicated to selling La-Z-Boy branded products. Our other brands, England, American Drew, Hammary, and Kincaid enjoy distribution through many of the same outlets, with approximately half of Hammary’s sales originating through the La-Z-Boy Furniture Galleries ® store network. Kincaid and England have their own dedicated proprietary in-store programs with 606 outlets and approximately 1.9 million square feet of proprietary floor space. In total, our proprietary floor space includes approximately 12.5 million square feet worldwide. Joybird sells product primarily online and has a limited amount of proprietary retail showroom floor space it uses to develop its brand. Our goal is to deliver value to our shareholders over the long term through executing our strategic initiatives. The foundation of our strategic initiatives is driving profitable sales growth in all areas of our business. We plan to drive growth in the following ways: • Our branded distribution channels, which include the La-Z-Boy Furniture Galleries ® store network and the La-Z-Boy Comfort Studio ® locations, our store-within-a-store format . We expect this initiative to generate growth in our Retail segment through an increased company-owned store count and in our wholesale Upholstery segment as our proprietary 23 Table of Contents distribution network expands. We are not only focused on growing the number of locations, but also on upgrading existing store locations to our new concept designs. • Our company-owned retail business. We are growing this business by increasing same-store sales through improved execution at the store level and by acquiring existing La-Z-Boy Furniture Galleries ® stores and opening new La-Z-Boy Furniture Galleries ® stores, primarily in markets that can be serviced through our regional distribution centers, where we see opportunity for growth, or where we believe we have opportunities for further market penetration. • Our unique multi-channel distribution network. In addition to our branded distribution channels, nearly 2,100 other dealers sell La-Z-Boy products, providing us the benefit of multi-channel distribution. These outlets include some of the best-known names in the industry, including Slumberland, Nebraska Furniture Mart and Mathis Brothers. Our other brands, England, American Drew, Hammary, and Kincaid, enjoy distribution through many of the same outlets. We believe there is significant growth potential for our brands through these retail channels. • Our on-trend product including stationary upholstered furniture featured in our Live Life Comfortably ® marketing campaign. While we are known for our iconic recliners, they account for less than half of our sales in dollars, and we believe we have the potential to expand sales of our other products. To stimulate growth, our Live Life Comfortably ® marketing campaign features celebrity brand ambassador, Kristen Bell, and focuses on expanding our digital marketing and e-commerce capabilities to build traffic across our multiple digital and physical properties. Millennial actress and social media influencer, Kristen Bell, injects youthful style and sensibility into our marketing campaign which enhances the appeal of our brand with a younger customer base. Further, we are driving change throughout our digital platforms to improve the user experience, with a specific focus on the ease by which customers browse through our broad product assortment, customize products to their liking, find stores to make a purchase, or purchase at www.la-z-boy.com. • Our innovative products, including stain-resistant iClean™ and eco-friendly Conserve ™ fabrics and our power products, some of which include a wireless hand remote, dual mechanisms and articulating headrests . Our innovation, duo ® , is a revolutionary product line that features the look of stationary furniture with the power to recline at the push of a button. We are committed to innovation throughout our business, and to support these efforts we opened our new state-of-the-art Innovation Center in January 2019 at our Dayton, Tennessee campus. • Our multi-faceted online strategy to participate in and leverage the growth of online furniture sales. On July 30, 2018, we purchased Joybird, a leading e-commerce retailer and manufacturer of upholstered furniture, which positions us for growth in the ever-changing online selling environment and allows us to better reach millennial and Gen X consumers and leverage our supply chain assets. In addition, we continue to increase online sales of La-Z-Boy furniture through la-z-boy.com and other digital players, such as Wayfair. Our reportable operating segments are the Upholstery segment, the Casegoods segment and the Retail segment. • Upholstery Segment . Our Upholstery segment is our largest business segment and consists primarily of two operating segments: La-Z-Boy, our largest operating segment, and the operating segment for our England subsidiary. The Upholstery segment also includes our international wholesale businesses. We aggregate these operating segments into one reportable segment because they are economically similar and because they meet the other aggregation criteria for determining reportable segments. Our Upholstery segment manufactures and imports upholstered furniture such as recliners and motion furniture, sofas, loveseats, chairs, sectionals, modulars, ottomans and sleeper sofas. The Upholstery segment sells directly to La-Z-Boy Furniture Galleries ® stores, operators of La-Z-Boy Comfort Studio ® locations, England Custom Comfort Center locations, major dealers, and a wide cross-section of other independent retailers. • Casegoods Segment. Our Casegoods segment consists of one operating segment that sells furniture under three brands: American Drew ® , Hammary ® , and Kincaid ® . The Casegoods segment is an importer, marketer, and distributor of casegoods (wood) furniture such as bedroom sets, dining room sets, entertainment centers and occasional pieces, and also manufactures some custom upholstered furniture. The Casegoods segment sells directly to major dealers, as well as La-Z-Boy Furniture Galleries ® stores, and a wide cross-section of other independent retailers. • Retail Segment. Our Retail segment consists of one operating segment comprising our 154 company-owned La-Z-Boy Furniture Galleries ® stores. The Retail segment primarily sells upholstered furniture, in addition to some casegoods and other accessories, to end consumers through these stores. 24 Table of Contents • Corporate & Other. Corporate & Other includes the shared costs for corporate functions, including human resources, information technology, finance and legal, in addition to revenue generated through royalty agreements with companies licensed to use the La-Z-Boy ® brand name on various products. We consider our corporate functions to be other business activities and have aggregated them with our other insignificant operating segments including our global trading company in Hong Kong and Joybird, an e-commerce retailer. Joybird manufactures and sells upholstered furniture such as sofas, loveseats, chairs, ottomans, sleeper sofas and beds, and also imports and sells casegoods (wood) furniture such as occasional tables and other accessories. Joybird sells to end consumers primarily online through its website, www.joybird.com. None of the operating segments included in Corporate & Other meet the requirements of reportable segments at this time. Impact of COVID-19 For a discussion of how COVID-19 has impacted and may continue to impact our business and financial condition, please refer to the discussion under the heading "Recent Developments" in Part I, Item 1 of this report. Results of Operations The following discussion provides an analysis of our results of operations and reasons for material changes therein for fiscal year 2020 as compared to fiscal year 2019. See “Results of Operations” in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s 2019 Annual Report on Form 10-K, filed with the SEC on June 18, 2019, for an analysis of the fiscal year 2019 results as compared to fiscal year 2018. Fiscal Year 2020 and Fiscal Year 2019 La-Z-Boy Incorporated (52 weeks) (52 weeks) (FY20 vs FY19) (Amounts in thousands, except percentages) 04/25/20 04/27/19 % Change Sales $ 1,703,982 $ 1,745,401 (2.4 )% Operating income 118,762 129,674 (8.4 )% Operating margin 7.0 % 7.4 % Sales Consolidated sales in fiscal 2020 declined $41.4 million compared with the prior year primarily due to lower sales in our Upholstery segment, partially offset by the benefit of a full year of sales from our Joybird and Retail segment acquisitions which occurred in the second quarter of fiscal 2019. In the first three quarters of fiscal 2020, consolidated sales increased 3.5%, or $45.1 million , driven primarily by strong sales in our Upholstery and Retail segments. This trend reversed in the fourth quarter due to the impact of COVID-19. Fiscal 2020 fourth quarter sales were down $86.5 million when compared to the fourth quarter last year, resulting in a 2.4% decrease in full year fiscal 2020 consolidated sales compared with last year. Operating Margin Operating margin, which is calculated as operating income as a percentage of sales, decreased 40 basis points in fiscal 2020 compared with the prior year. • Gross margin increased 200 basis points during fiscal 2020 compared with fiscal 2019 . ◦ Changes in our consolidated sales mix improved gross margin by 90 basis points in fiscal 2020 compared to last year. This benefit was driven by the growth of our Retail segment and Joybird, which have higher gross margins than our Upholstery and Casegoods segments. ◦ Due to U.S. tariff exclusions issued in the fourth quarter of fiscal 2020 related to sewn fabric and leather sets and actuators imported from China, we recognized a one-time $16.3 million benefit in cost of sales for the rebate of previously paid tariff costs which resulted in a 100 basis point increase in gross margin. ◦ Additionally, gross margin benefited from lower raw material commodity costs in our Upholstery segment during the year. Most of that benefit was offset by the temporary shutdown of our manufacturing facilities in the fourth quarter due to COVID-19, inflationary pressures in our supply chain, and costs incurred in 25 Table of Contents connection with our supply chain optimization initiative resulting from the shift in manufacturing operations from closed facilities to other manufacturing locations in fiscal 2020. • Selling, general, and administrative ("SG&A") expense as a percentage of sales increased 90 basis points during fiscal 2020 compared with fiscal 2019 . ◦ Changes in our consolidated sales mix increased SG&A expenses as a percentage of sales by 130 basis points in fiscal 2020 compared with last year. This increase was driven by the growth of our Retail segment and the acquisition of Joybird, which have higher levels of SG&A expense as a percent of sales than our Upholstery and Casegoods segments. ◦ SG&A as a percent of sales was negatively impacted by lower fiscal 2020 sales volume compared to last year due to the impact of COVID-19. ◦ Incentive compensation costs decreased $15.6 million in fiscal 2020 compared with last year, a 90 basis point decrease in SG&A as a percentage of sales. Certain financial metrics in fiscal 2020 were lower than incentive targets primarily due to the impact of COVID-19 in the fourth quarter. ◦ Bad debt expense increased $13.3 million in fiscal 2020, an 80 basis point increase in SG&A as a percent of sales, compared with last year. This increase was primarily due to the write-off of receivables related to the bankruptcy proceedings of Art Van Furniture Group during the fourth quarter of fiscal 2020, as well as an increase in the provision for credit losses recorded in the fourth quarter of fiscal 2020 related to COVID-19 economic conditions. ◦ The sale of our Redlands facility, which resulted in a $9.7 million pre-tax gain, drove a 60 basis point improvement in SG&A expense as a percent of sales in fiscal 2020. ◦ The fair value of the Joybird contingent consideration liability was reduced by its full carrying value of $7.9 million resulting in a 50 basis point benefit to SG&A as a percent of sales in fiscal 2020, as we no longer expect any additional consideration amounts will be owed related to the acquisition of Joybird based on our most recent financial projections and the terms of the earnout agreement. ◦ In fiscal 2019 we recognized a one-time $3.8 million benefit due to changes to our employee vacation policies, the absence of which in fiscal 2020 resulted in a comparative 20 basis point increase in SG&A as a percent of sales. • During fiscal 2020 we recorded a $26.9 million goodwill impairment charge related to our Joybird reporting unit. Annual goodwill impairment testing, which occurred in the fourth quarter of 2020, determined the carrying value of the Joybird reporting unit exceeded its relative fair value. The impairment charge decreased operating margin by 150 basis points in fiscal 2020. The impairment was most notably driven by the impact of the COVID-19 pandemic on our future financial projections used in the fiscal 2020 impairment test, which were significantly lower than those used in the fiscal 2019 impairment test. Additionally, our future financial projections have been tempered by integration activities taking longer than anticipated and a slower than anticipated revenue growth rate due to a shifting focus on profitability. Refer to Note 7, Goodwill and Other Intangible Assets, for further information. We explain these items further when we discuss each segment's results later in this Management's Discussion and Analysis. Upholstery Segment (52 weeks) (52 weeks) (FY20 vs FY19) (Amounts in thousands, except percentages) 04/25/20 04/27/19 % Change Sales $ 1,204,259 $ 1,268,242 (5.0 )% Operating income 134,691 127,906 5.3 % Operating margin 11.2 % 10.1 % Sales The Upholstery segment’s sales declined 5.0% , or $64.0 million , in fiscal 2020 compared with fiscal 2019. For the first three quarters of fiscal 2020, sales increased 0.6% , or $6.0 million , compared with the same period a year ago. Sales trends experienced in the first three quarters of fiscal 2020 were impacted in the fourth quarter by COVID-19, which caused temporary closures of our manufacturing facilities, state and local restrictions limiting our ability to deliver product to customers, and store closures. For full year fiscal 2020, unit volume was 5.6% lower than the prior year. We also experienced a shift in product mix to sectionals which drove lower sales of our higher-priced products including power motion sofas and leather products, resulting in 0.7% lower sales in fiscal 2020. Partially offsetting these decreases, in response to tariffs imposed 26 Table of Contents on goods imported from China, our tariff surcharges increased sales by 1.1% in fiscal 2020, compared with last year. The tariff rate on goods from China was increased to 25% at the start of the current fiscal year, compared with 10% in the prior year. Operating Margin Our Upholstery segment's operating margin increased 110 basis points in fiscal 2020 compared with fiscal 2019 . • Gross margin increased 150 basis points during fiscal 2020 compared with fiscal 2019 . ◦ Due to U.S. tariff exclusions issued in the fourth quarter of fiscal 2020 related to sewn fabric and leather sets and actuators imported from China, we recognized a one-time $16.3 million benefit in cost of sales for the rebate of previously paid tariff costs. This resulted in a 130 basis point benefit in gross margin compared with the prior year. ◦ Lower raw material commodity prices provided a 120 basis point increase to the segment’s gross margin compared with the prior year. ◦ Partially offsetting these benefits, were the temporary shut down of our manufacturing facilities in the fourth quarter due to COVID-19, as well as inflationary pressures in our supply chain, which negatively impacted gross margin for the full fiscal year, as did costs recognized in connection with our supply chain optimization initiative. Together, these items decreased gross margin 100 basis points compared with the prior year. ◦ Additionally, the prior year included a one-time benefit due to changes to our employee vacation policies, the absence of which in fiscal 2020 resulted in a comparative 10 basis point decrease in the segment's gross margin. • SG&A expense as a percentage of sales increased 40 basis points during fiscal 2020 compared with fiscal 2019 . ◦ SG&A as a percent of sales was negatively impacted by lower fiscal 2020 sales volume due to the impact of COVID-19. ◦ Bad debt expense increased SG&A as a percent of sales 100 basis points primarily due to the write-off of receivables related to the bankruptcy proceedings of Art Van Furniture Group during the fourth quarter of fiscal 2020, as well as an increase in the provision for credit losses recorded in the fourth quarter of fiscal 2020 related to COVID-19 economic conditions. ◦ These items were partially offset by a $9.7 million pre-tax gain on the sale of the Redlands facility recognized in fiscal 2020 which provided an 80 basis point benefit to SG&A expense as a percent of sales. ◦ Additionally, lower incentive compensation costs d ue to fiscal 2020 financial performance against incentive targets decreased SG&A expense as a percent of sales by 40 basis points . Casegoods Segment (52 weeks) (52 weeks) (FY20 vs FY19) (Amounts in thousands, except percentages) 4/25/2020 4/27/2019 % Change Sales $ 106,035 $ 114,473 (7.4 )% Operating income 7,749 12,589 (38.4 )% Operating margin 7.3 % 11.0 % Sales Our Casegoods segment's sales decreased $8.4 million in fiscal 2020 compared with fiscal 2019 , due to continued lower sales volume on certain occasional tables that have been impacted by higher tariff costs with a further decline in the fourth quarter of fiscal 2020 due to the impact of COVID-19 which resulted in the closure of retail channels and disruption in our supply chain. Operating Margin Our Casegoods segment's operating margin decreased 370 basis points in fiscal 2020 compared with the prior year. • Gross margin decreased 300 basis points during fiscal 2020 compared with fiscal 2019 , primarily due to higher ocean freight costs, the impact of tariffs on certain occasional tables and lower absorption of fixed costs on a decrease in sales driven by the impact of COVID-19. • SG&A expense as a percentage of sales increased 70 basis points during fiscal 2020 compared with fiscal 2019 . 27 Table of Contents ◦ Bad debt expense increased SG&A as a percent of sales 80 basis points , primarily due to the write-off of receivables and an increase in the provision for credit losses related to COVID-19 economic conditions, both recorded in the fourth quarter of fiscal 2020. ◦ In fiscal 2019 we recognized a one-time benefit due to changes to our employee vacation policies, the absence of which in fiscal 2020 resulted in a comparative 20 basis point increase. ◦ These increases were partially offset by lower incentive compensation costs d ue to fiscal 2020 financial performance against incentive targets and disciplined spending in response to lower sales volume. Retail Segment (52 weeks) (52 weeks) (FY20 vs FY19) (Amounts in thousands, except percentages) 4/25/2020 4/27/2019 % Change Sales $ 598,554 $ 570,201 5.0 % Operating income 48,256 37,922 27.3 % Operating margin 8.1 % 6.7 % Sales Our Retail segment's full year sales increased 5.0% , or $28.4 million , driven by strong sales in the first three quarters of fiscal 2020 that were disrupted by COVID-19, which resulted in temporary store closures in the fourth quarter and negatively impacted our sales trajectory. For the first three quarters of fiscal 2020, sales increased 9.7% , or $40.6 million , compared with the same period a year ago. However, fiscal 2020 fourth quarter sales were down $12.2 million , compared with the same period a year ago. Fiscal 2020 full year sales included $22.2 million from acquired stores and delivered a same-store sales increase of 0.7% , or $4.1 million . To demonstrate the impact of COVID-19 on our Retail segment, same-store delivered sales in the first three quarters of fiscal 2020 were up 3.6% , driven by improved traffic trends and continued strong execution at the store level, but were down 10.0% in the fourth quarter, reflecting the impact of store closures and state and local restrictions limiting our ability to deliver product to consumers. Same-store delivered sales include the sales of all currently active stores which have been open for each comparable period. Operating Margin Our Retail segment's operating margin increased 140 basis points in fiscal 2020 compared with the prior year. • Gross margin increased 40 basis points during fiscal 2020 compared with fiscal 2019 , primarily due to favorable product mix and higher purchase accounting charges in fiscal 2019 due to prior year acquisitions, the absences of which in fiscal 2020 resulted in a comparative 20 basis point increase. • SG&A expense as a percentage of sales decreased 100 basis points during fiscal 2020 compared with fiscal 2019 , primarily due to acquired stores which operate with lower SG&A expense as a percentage of sales compared with our existing stores. Additionally, we were better able to leverage our fixed costs (primarily advertising and occupancy) on increased delivered sales in the first three quarters of fiscal 2020, but some of this benefit was negated in the fourth quarter of fiscal 2020 due to the impact of COVID-19. Additionally, incentive compensation costs were lower in fiscal 2020 compared with the prior year due to current year performance against incentive targets. Partially offsetting these items, the prior year included a one-time benefit due to changes to our employee vacation policies, the absence of which in fiscal 2020 resulted in a comparative 20 basis point increase. Corporate and Other (52 weeks) (52 weeks) (FY20 vs FY19) (Amounts in thousands, except percentages) 4/25/2020 4/27/2019 % Change Sales $ 89,092 $ 74,012 20.4 % Eliminations (293,958 ) (281,527 ) 4.4 % Operating loss (71,934 ) (48,743 ) 47.6 % 28 Table of Contents Sales Sales increased $15.1 million in fiscal 2020 compared with fiscal 2019 , primarily due to a $16.2 million increase from Joybird, which contributed $75.3 million in sales in fiscal 2020. Joybird sales were down 29.6% in the fourth quarter of fiscal 2020 due to COVID-19 and the temporary closure of our manufacturing facilities and the impact of state and local restrictions limiting our ability to deliver product to consumers. Joybird was acquired at the start of the second quarter of fiscal 2019, therefore, the sales comparison for the full year includes the benefit of one additional quarter of sales in fiscal 2020. Eliminations increased in fiscal 2020 compared with fiscal 2019 due to higher sales from our Upholstery and Casegoods segments to our Retail segment, resulting from increased sales in the Retail segment and the impact of acquired stores. Operating Loss Our Corporate and Other operating loss was $23.2 million higher in fiscal 2020 compared with fiscal 2019 , primarily due to a $26.9 million non-cash pre-tax impairment charge to reduce the carrying value of goodwill associated with Joybird. Annual goodwill impairment testing, which occurred in the fourth quarter of 2020, determined the carrying value of the Joybird reporting unit exceeded its relative fair value. The impairment was most notably driven by the impact of the COVID-19 pandemic on our future financial projections used in the fiscal 2020 impairment test, which were significantly lower than those used in the fiscal 2019 impairment test. Additionally, our future financial projections have been tempered by integration activities taking longer than anticipated and a slower than anticipated revenue growth rate due to a shifting focus on profitability. Refer to Note 7, Goodwill and Other Intangible Assets, for further information. Also impacting fiscal 2020 compared with the prior year was a larger Joybird operating loss, primarily due to our integration efforts taking longer than anticipated, and the fourth quarter impact of COVID-19. This was partially offset by the reversal of the fair value of the Joybird contingent consideration liability by its full carrying value of $7.9 million , as we no longer expect any additional consideration amounts will be owed related to the acquisition of Joybird based on our most recent financial projections and the terms of the earnout agreement. Further, corporate incentive compensation costs decreased $7.4 million in fiscal 2020 compared with last year, as certain fiscal 2020 financial metrics were lower than incentive targets primarily due to the impact of COVID-19 in the fourth quarter. Fourth Quarter of Fiscal Year 2020 vs. Fourth Quarter of Fiscal Year 2019 The fourth quarter of fiscal 2020 started strong for the company, led by written same-store sales increasing 20.4% for the La-Z-Boy Furniture Galleries® network in the month of February. However, the trajectory of our sales growth and financial results for the quarter were significantly and negatively impacted by the temporary closure of our manufacturing facilities for four weeks, state and local restrictions limiting our ability to deliver product to consumers, and the temporary closure of our company-owned stores consistent with most retailers across North America beginning in mid-March due to COVID-19. This impact significantly changed sales and profit trends for the company and as a result, we are providing this additional discussion of our fiscal 2020 fourth quarter results. Quarter Ended (Unaudited, amounts in thousands) 4/25/20 4/27/19 Sales Upholstery $ 253,292 $ 323,303 Casegoods 21,395 26,645 Retail 139,660 151,870 Corporate and Other 18,560 24,920 Eliminations (65,626 ) (72,947 ) Consolidated sales $ 367,281 $ 453,791 Operating Income (Loss) Upholstery segment $ 29,832 $ 37,304 Casegoods segment 413 2,416 Retail segment 14,984 12,743 Corporate and Other (31,803 ) (15,292 ) Consolidated operating income $ 13,426 $ 37,171 29 Table of Contents Consolidated sales in the fourth quarter of fiscal 2020 , compared with the same period last year, decreased 19.1% to $367.3 million . Consolidated operating income for the quarter was $13.4 million , down $23.7 million compared with the same period last year and operating margin decreased to 3.7% compared with 8.2% in the prior-year quarter. In the fourth quarter of fiscal 2020, sales in the company’s Upholstery segment decreased 21.7% to $253.3 million . Operating margin in the Upholstery segment increased to 11.8% compared with 11.5% in last year’s fourth quarter, primarily due to a one-time $16.3 million benefit in cost of sales for the rebate of previously paid tariffs on sewn fabric and leather sets and actuators imported from China, along with favorable commodity costs. In the fourth quarter of fiscal 2020, SG&A as a percent of sales was higher than the same period last year, primarily due to lower sales volume, partially offset by lower incentive compensation costs and expense reductions in response to the impact of COVID-19 including temporary salary reductions, lower wages attributable to furloughed employees, and a decrease in advertising expense and non-essential spending. Additionally, bad debt expense recognized in the period was higher, due to the bankruptcy proceedings of Art Van Furniture Group, and a provision for credit losses due to COVID-19 economic conditions. Sales in the Casegoods segment in the fourth quarter of fiscal 2020 decreased 19.7% to $21.4 million and operating margin was 1.9% compared with 9.1% in the prior-year period, primarily reflecting the impact of COVID-19, related temporary manufacturing facility and retail closures and an increase in bad debt expense, due to the write-off of receivables and a provision for credit losses due to COVID-19 economic conditions. Sales in the Retail segment decreased only 8.0% to $139.7 million in the fourth quarter of fiscal 2020 , due to strong prior period written sales which were delivered during the period. Operating margin in the Retail segment improved to 10.7% from 8.4% in last year’s fourth quarter primarily due to lower operating expenses related to closed stores and prior quarter written sales driving continued deliveries through the period. Additionally, as a part of our COVID-19 response plan, operating expenses decreased in the fourth quarter of fiscal 2020 due to lower wages for furloughed employees, temporary salary reductions, and a decrease in advertising expense and non-essential spending. Same-store sales declined 10.0% in the fourth quarter of fiscal 2020 compared with the same period last year due to store closures in the last four weeks of the period. Fiscal 2020 fourth quarter sales for Joybird, which are reported in Corporate & Other, decreased 29.6% to $15.4 million , and resulted in a larger loss versus the same quarter last year. The increase in Joybird's operating losses when compared with the same quarter last year are primarily due a $26.9 million non-cash pre-tax impairment charge to reduce the carrying value of the Joybird reporting unit's goodwill, which was partially offset by the reduction of the fair value of the Joybird contingent consideration liability by its full carrying value of $7.9 million . Additionally, operating income was negatively impacted in the fourth quarter of fiscal 2020 by lower sales volume, the temporary closure of our manufacturing facilities and the impact of state and local restrictions limiting our ability to deliver product to consumers due to COVID-19. Interest Expense Interest expense was $0.3 million lower in fiscal 2020 compared with fiscal 2019 . The decrease in interest expense in fiscal 2020 was primarily due to lower average short-term borrowings during the year. A draw of $75.0 million on our credit line was proactively taken in the fourth quarter of 2020 to manage liquidity in response to the economic impact of COVID-19. Primarily due to the length of borrowings outstanding but also due to lower interest rates, interest expense on the borrowings in fiscal 2020 was lower than interest expense on prior year borrowings. A draw of $35 million on our credit line was taken in the second quarter of fiscal 2019 and repaid by the end of fiscal 2019, and was used to help fund our acquisitions during that year. Pension Termination Charge During the fourth quarter of fiscal 2019, we terminated our defined benefit pension plan for eligible factory hourly employees in our La-Z-Boy operating unit. In connection with the plan termination, we settled all future obligations under the plan through a combination of lump-sum payments to eligible participants who elected to receive them, and transferred any remaining benefit obligations under the plan to a highly rated insurance company. We recognized a non-cash pre-tax charge of $32.7 million in our consolidated statement of income associated with the plan termination during the fourth quarter of fiscal 2019. During the second quarter of fiscal 2020, we received a pre-tax refund of $1.9 million from the insurance company, representing an overpayment of the expected benefit obligations that were settled during the fourth quarter of fiscal 2019. We recognized the refund in our consolidated statement of income, consistent with the charge recorded in the fourth quarter of fiscal 2019. 30 Table of Contents Other Expense, Net Other expense, net was $4.7 million higher in fiscal 2020 compared with fiscal 2019 , due to a $6.0 million impairment of our investment in a privately held start-up company in fiscal 2020, partially offset by lower pension related costs in fiscal 2020 as compared with the prior year, due to the termination of our defined benefit pension plan in the fourth quarter of fiscal 2019. Income Taxes Our effective income tax rate was 31.4% for fiscal 2020 and 26.4% for fiscal 2019 . Impacting our effective tax rate for fiscal 2020 was a net tax expense of $4.0 million primarily from the tax effect of a non-deductible goodwill impairment charge related to the Joybird reporting unit and tax expense of $1.3 million from deferred tax attributable to undistributed foreign earnings no longer permanently reinvested. Absent discrete adjustments, the effective tax rate in fiscal 2020 would have been 26.4% . Impacting our effective tax rate for fiscal 2019 was a net tax expense of $1.2 million primarily from the tax expense of the defined benefit pension plan termination of $2.6 million and a net tax benefit of $1.4 million primarily from excess tax benefits from shared-based payments. Absent discrete adjustments, the effective tax rate in fiscal 2019 would have been 25.1% . Liquidity and Capital Resources Our sources of liquidity include cash and equivalents, short-term and long-term investments, cash from operations, and amounts available under our credit facility. We believe these sources remain adequate to meet our short-term and long-term liquidity requirements, finance our long-term growth plans, and fulfill other cash requirements for day-to-day operations and capital expenditures. We had cash, cash equivalents and restricted cash of $263.5 million at April 25, 2020 , compared with $131.8 million at April 27, 2019 . In addition, we had investments to enhance our returns on cash of $28.6 million at April 25, 2020 , compared with $31.5 million at April 27, 2019 . We maintain a revolving credit facility secured primarily by all of our accounts receivable, inventory, cash deposit and securities accounts. Availability under the agreement fluctuates according to a borrowing base calculated on eligible accounts receivable and inventory. We amended this agreement on December 19, 2017, extending its maturity date to December 19, 2022. The credit agreement includes affirmative and negative covenants that apply under certain circumstances, including a fixed-charge coverage ratio requirement that applies when excess availability under the credit line is less than certain thresholds. In response to economic conditions resulting from COVID-19, to strengthen our financial position and maintain liquidity, the Company proactively borrowed $75.0 million from our revolving credit facility in the fourth quarter of 2020. At April 25, 2020 , we were not subject to the fixed-charge coverage ratio requirement and had excess availability of $55.5 million of the $150.0 million credit commitment. Excess availability was lower than the total remaining credit commitment primarily due to lower eligible assets as of April 25, 2020, which were primarily lower eligible accounts receivable due to lower sales in the quarter as a result of the impact of COVID-19. Capital expenditures for fiscal 2020 were $46.0 million compared with $48.4 million for fiscal 2019 . Capital expenditures were lower in fiscal 2020, primarily due to the elimination of non-essential spending in the fourth quarter of fiscal 2020 to maintain liquidity in response to lower sales volume due to COVID-19. Fiscal year 2020 capital expenditures primarily included manufacturing machinery and equipment, upgrades to our Dayton, Tennessee upholstered furniture manufacturing facility and improvements to select retail stores. We have no material contractual commitments outstanding for future capital expenditures. We expect capital expenditures to be in the range of $25 to $40 million for fiscal 2021, largely dependent on liquidity and scaled in response to the recovery of the business environment, economic conditions, and consumer demand for our products. Our fiscal 2021 capital spending will reflect essential maintenance spending, other projects as business conditions permit, and projects that have already begun, which will include plant upgrades to our upholstery manufacturing and distribution facilities in Dayton, Tennessee and Neosho, Missouri, technology upgrades and improvements to several of our retail stores. Our board of directors has sole authority to determine if and when we will declare future dividends and on what terms. As announced on March 29, 2020, the June 2020 dividend was eliminated to preserve near-term financial flexibility in response to the impact of COVID-19. In accordance with our long-term capital allocation strategy, we will seek to return value to our shareholders through dividends and share repurchases when it becomes appropriate to do so. Future cash dividends will depend on our earnings, capital requirements, financial condition, excess availability under our credit agreement and other factors considered relevant by us and will be subject to final determination by our board of directors. 31 Table of Contents In addition to the items noted above, we have taken swift action to conserve cash in the near term. Some of those actions include the furlough of approximately 70% of our workforce while our manufacturing and retail operations were temporarily closed, temporary 50% salary reductions for our executive team and 25% salary reductions for the rest of our salaried workforce, the temporary suspension of our 401(k) match and our share repurchase program. As of our filing date, our manufacturing facilities and stores are open and thus far we are pleased with consumer traction. In addition, the majority of our furloughed employees are expected to return to work by July 1, 2020. The temporary salary reductions instituted on March 29, 2020, ended and full base salaries were reinstated as of June 1, 2020, for all employees other than the executive officers of the Company. The 50% salary reductions for our executive officers remain in effect as of the date of this filing. We believe our cash flows from operations, present cash, cash equivalents and restricted cash balance of $263.5 million , short- and long-term investments to enhance returns on cash of $28.6 million , and current excess availability under our credit facility of $55.5 million , will be sufficient to fund our business needs, including fiscal 2021 contractual obligations of $266.5 million as presented in our contractual obligations table. Included in our cash, cash equivalents and restricted cash at April 25, 2020 , is $53.4 million held by foreign subsidiaries, a portion of which we have determined to be permanently reinvested. The following table illustrates the main components of our cash flows: Fiscal Year Ended (52 weeks) (52 weeks) (Amounts in thousands) 4/25/2020 4/27/2019 Cash Flows Provided By (Used For) Net cash provided by operating activities $ 164,242 $ 150,745 Net cash used for investing activities (40,765 ) (122,567 ) Net cash provided by (used for) financing activities 9,408 (32,787 ) Exchange rate changes (1,144 ) (475 ) Change in cash, cash equivalents and restricted cash $ 131,741 $ (5,084 ) Operating Activities During fiscal 2020 , net cash provided by operating activities was $164.2 million . Our cash provided by operating activities was primarily attributable to net income generated during fiscal 2020 and a $29.7 million decrease in receivables driven by lower sales volume at the end of the fiscal year due to COVID-19, partially offset by a $18.4 million lower accrued compensation costs due to fiscal 2020 financial performance against incentive targets. During fiscal 2019, net cash provided by operating activities was $150.7 million . Our cash provided by operating activities was primarily attributable to net income generated during fiscal 2019 as well as a $12.9 million increase in payroll and other compensation due to higher accrued incentive compensation costs that were paid in the first quarter of fiscal 2020. Investing Activities During fiscal 2020 , net cash used for investing activities was $40.8 million , primarily due to $46.0 million used for capital expenditures. This was partially offset by $11.3 million in proceeds from the disposal of assets primarily due to the sale of the Redlands upholstery facility in the third quarter of fiscal 2020. Our capital expenditures during the year primarily related to spending on manufacturing machinery and equipment, upgrades to our Dayton, Tennessee upholstered furniture manufacturing facility and improvements to select retail stores. Spending was lower in fiscal 2020 than expected due to cancellation of non-essential capital expenditures in the fourth quarter due to COVID-19. During fiscal 2019, net cash used for investing activities was $122.6 million , primarily due to $76.5 million used for acquisitions and $48.4 million used for capital expenditures. Our cash used for acquisitions during the period included the acquisition of the assets of two independent operators of La-Z-Boy Furniture Galleries ® stores, one that operated nine stores and two warehouses in Arizona and one that operated one store in Massachusetts, as well as the acquisition of Joybird, an e-commerce retailer and manufacturer of upholstered furniture. Our capital expenditures during the year primarily related to spending on manufacturing machinery and equipment, construction of our new Innovation Center, upgrades to our Dayton, Tennessee upholstered furniture manufacturing facility, expansion of our England subsidiary's plant and construction of their new corporate office building, and relocation of one of our regional distribution centers. 32 Table of Contents Financing Activities During fiscal 2020 , net cash provided by financing activities was $9.4 million , which included a $75.0 million draw under our revolving credit facility, partially offset by $43.4 million used to repurchase shares of our common stock pursuant to the board's prior authorization and $25.1 million paid to our shareholders in quarterly dividends. Share repurchases under the board's prior authorization were temporarily halted to prioritize near-term financial flexibility in response to the impact of COVID-19. During fiscal 2019, net cash used for financing activities was $32.8 million , which included $23.0 million used to repurchase our common stock pursuant to our share repurchase authorization and $23.5 million paid to our shareholders in quarterly dividends. This was partly offset by $13.9 million in cash received upon exercise of employee stock awards, net of shares withheld for taxes. Our board of directors has authorized the repurchase of company stock. As of April 25, 2020 , 4.5 million shares remained available for purchase pursuant to this authorization. The authorization has no expiration date. We repurchased 1.4 million shares during fiscal 2020 for a total of $43.4 million . As announced on March 29, 2020, share repurchases under the board of directors’ prior authorization were temporarily halted to prioritize near-term financial flexibility in response to the impact of COVID-19. Reinstatement of a share repurchase program under the board’s prior authorization will depend on our earnings, capital requirements, financial condition and other factors that we consider to be relevant, such as the timing and extent of the economic recovery and the consumer demand for our products. Other The following table summarizes our contractual obligations of the types specified as of April 25, 2020 : Payments Due by Period (Amounts in thousands) Total Less than 1 Year 1 - 3 Years 4 - 5 Years More than 5 Years Operating lease obligations $ 378,549 $ 75,500 $ 120,328 $ 81,715 $ 101,006 Purchase obligations (1) 110,051 110,051 — — — Debt obligations 75,000 75,000 — — — Future guaranteed payments 21,200 5,200 11,000 5,000 — Legal liability 583 583 — — — Interest obligations 112 112 — — — Capital lease obligations 13 13 — — — Total contractual obligations $ 585,508 $ 266,459 $ 131,328 $ 86,715 $ 101,006 (1) Related to open purchase orders, primarily with foreign and domestic casegoods, leather and fabric suppliers, which are generally cancellable if production has not begun. Our consolidated balance sheet as April 25, 2020 reflected a $1.0 million net liability for uncertain income tax positions. We do not expect that the net liability for uncertain income tax positions will significantly change within the next 12 months. The remaining balance will be settled or released as tax audits are effectively settled, statutes of limitation expire, or other new information becomes available. We do not expect our continuing compliance with existing federal, state and local statutes dealing with protection of the environment to have a material effect on our capital expenditures, earnings, competitive position or liquidity. Critical Accounting Policies We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. In some cases, these principles require management to make difficult and subjective judgments regarding uncertainties and, as a result, such estimates and assumptions may significantly impact our financial results and disclosures. We base our estimates on currently known facts and circumstances, prior experience and other assumptions we believe to be reasonable. We use our best judgment in valuing these estimates and may, as warranted, use external advice. Actual results could differ from these estimates, assumptions, and judgments and these differences could be significant. We make frequent comparisons throughout the year of actual experience to our assumptions to reduce the likelihood of significant adjustments. We record adjustments when differences are known. The following critical accounting policies affect our consolidated financial statements. 33 Table of Contents Revenue Recognition and Related Allowances Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to receive in exchange for those goods or services. We generate revenues primarily by manufacturing/importing and delivering upholstery and casegoods (wood) furniture products to independent furniture retailers, independently owned La-Z-Boy Furniture Galleries ® stores or the end consumer. Each unit of furniture is a separate performance obligation, and we satisfy our performance obligation when control of our product is passed to our customer, which is the point in time that our customers are able to direct the use of and obtain substantially all of the remaining economic benefit of the goods or services. The majority of our wholesale shipping agreements are freight-on-board shipping point and risk of loss transfers to our customer once the product is out of our control. Accordingly, revenue is recognized for product shipments on third-party carriers at the point in time that our product is loaded onto the third-party container or truck and that container or truck leaves our facility. For our imported products, we recognize revenue at the point in time that legal ownership is transferred, which may not occur until after the goods have passed through U.S. Customs. In all cases, this revenue includes amounts we bill to customers for freight charges, because we have elected to treat shipping activities that occur after the customer has obtained control of our product as a fulfillment cost rather than an additional promised service. Because of this election, we recognize revenue for shipping when control of our product passes to our customer, and the shipping costs are accrued when the freight revenue is recognized. Revenue for product shipments on company-owned trucks is recognized for the product and freight at the point in time that our product is delivered to our customer's location. We recognize revenue for retail sales and online sales to the end consumer through our company-owned retail stores, www.la-z-boy.com or www.joybird.com once the end consumer has taken control of the furniture, at which point legal title has passed to them. This takes place when the product is delivered to the end consumer's home. Home delivery is not a promised service to our customer, and is not a separate performance obligation, because home delivery is a fulfillment activity as the costs are incurred as part of transferring our product to the end consumer. At the time the customer places an order through our company-owned retail stores or www.la-z-boy.com, we collect a deposit on a portion of the total merchandise price. We record this as a customer deposit, which is included in accrued expenses and other current liabilities on our consolidated balance sheet. The balance of the order is paid in full prior to delivery of the product. Once the order is taken through our company-owned retail stores or www.la-z-boy.com we recognize a contract asset and a corresponding deferred revenue liability for the difference between the total order and the deposit collected. The contract asset is included in other current assets on our consolidated balance sheet and the deferred revenue is included in accrued expenses and other current liabilities on our consolidated balance sheet. At the time the customer places an order through www.joybird.com, we collect the entire amount owed and record this as a customer deposit. Because the entire amount owed is collected at the time of the order, there is no contract asset recorded for Joybird sales. At the time we recognize revenue, we make provisions for estimated refunds, product returns, and warranties, as well as other incentives that we may offer to customers. When estimating our incentives, we utilize either the expected value method or the most likely amount to determine the amount of variable consideration. We use either method depending on which method will provide the best estimate of the variable consideration, and we only include variable consideration when it is probable that there will not be a significant reversal in the amount of cumulative revenue recognized when the uncertainty associated with the variable consideration is subsequently resolved. Incentives offered to customers include cash discounts, rebates, advertising agreements and other sales incentive programs. Our sales incentives, including cash discounts and rebates, are recorded as a reduction to revenues. Service allowances are for a distinct good or service received from our customer and are recorded as a component of SG&A expense in our consolidated statement of income, and are not recorded as a reduction of revenue and are not considered variable consideration. We use substantial judgment based on the type of variable consideration or service allowance, historical experience and expected sales volume when estimating these provisions. Sales, value added, and other taxes we collect concurrent with revenue-producing activities are excluded from revenue. The expected costs associated with our warranties and service allowances are recognized as expense when our products are sold. All orders are fulfilled within one year of order date, therefore we do not have any unfulfilled performance obligations. Additionally, we elected the practical expedient to not adjust the promised amount of consideration for the effects of a significant financing component because at contract inception we expect the period between when we transfer our product to our customer and when the customer pays for the product to be one year or less. Trade accounts receivable arise from the sale of products on trade credit terms. On a quarterly basis, we review all significant accounts as to their past due balances, as well as collectability of the outstanding trade accounts receivable for possible write off. It is our policy to write off the accounts receivable against the allowance account when we deem the receivable to be 34 Table of Contents uncollectible. Additionally, we review orders from dealers that are significantly past due, and we ship product only when our ability to collect payment from our customer for the new order is probable. Our allowance for credit losses reflects our best estimate of probable losses inherent in the trade accounts receivable balance. We determine the allowance based on known troubled accounts, historic experience, and other currently available evidence. Long-Lived Assets We review long-lived assets for impairment whenever events or changes in circumstances indicate that we may not be able to recover the carrying amount of an asset or asset group. Using either quoted market prices or an analysis of undiscounted projected future cash flows by asset groups, we determine whether there is any indicator of impairment requiring us to further assess the fair value of our long-lived assets. Our asset groups consist of our operating segments in our Upholstery reportable segment, our Casegoods segment, each of our retail stores, our Joybird ® business and other corporate assets. Intangible Assets and Goodwill We test intangible assets and goodwill for impairment on an annual basis in the fourth quarter of each fiscal year, and more frequently if events or changes in circumstances indicate that an asset might be impaired. Indefinite-lived intangible assets include our American Drew trade name, and the reacquired right to own and operate La-Z-Boy Furniture Galleries ® stores we have acquired. We have amortizable intangible assets related to the acquisition of the La-Z-Boy wholesale business in the United Kingdom and Ireland, which are primarily comprised of acquired customer relationships. We also have an amortizable trade name related to the Joybird ® acquisition. We establish the fair value of our trade names and reacquired rights based upon the relief from royalty method. We establish the fair value of our other amortizable intangible assets based on the multi-period excess earnings method, a variant of the income approach, and also using the relief from royalty method. Our goodwill relates to the acquisition of La-Z-Boy Furniture Galleries ® stores and the La-Z-Boy wholesale business in the United Kingdom and Ireland, along with the acquisition of Joybird ® , an e-commerce retailer and manufacturer of upholstered furniture. The reporting unit for goodwill arising from retail store acquisitions is our Retail operating segment. The reporting unit for goodwill arising from the acquisition of the La-Z-Boy wholesale business in the United Kingdom and Ireland and the acquisition of Joybird is each respective business. We establish the fair value for the reporting unit based on the discounted cash flows to determine if the fair value of our goodwill exceeds its carrying value. Other Loss Reserves We have various other loss exposures arising from the ordinary course of business, including inventory obsolescence, health insurance, litigation, environmental claims, insured and self-insured workers' compensation, restructuring charges, and product liabilities. Establishing loss reserves requires us to use estimates and management's judgment with respect to risk and ultimate liability. We use legal counsel or other experts, including actuaries as appropriate, to assist us in developing estimates. Due to the uncertainties and potential changes in facts and circumstances, additional charges related to these reserves could be required in the future. We have various excess loss coverages for health insurance, auto, product liability and workers' compensation liabilities. Our deductibles generally do not exceed $1.5 million . Income Taxes We use the asset and liability method to account for income taxes. We recognize deferred tax assets and liabilities based on the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. We measure deferred tax assets and liabilities using enacted tax rates in effect for the year in which we expect to recover or settle those temporary differences. When we record deferred tax assets, we are required to estimate, based on forecasts of taxable earnings in the relevant tax jurisdiction, whether we are more likely than not to recover them. In making judgments about realizing the value of our deferred tax assets, we consider historic and projected future operating results, the eligible carry-forward period, tax law changes and other relevant considerations. 35 Table of Contents Product Warranties We account for product warranties by accruing an estimated liability when we recognize revenue on the sale of warrantied product. We estimate future warranty claims based on claim experience and any additional anticipated future costs on previously sold product. We incorporate repair costs in our liability estimates, including materials, labor, and overhead amounts necessary to perform repairs, and any costs associated with delivering repaired product to our customers and consumers. We use considerable judgment in making our estimates. We record differences between our estimated and actual costs when the differences are known. Stock-Based Compensation We measure stock-based compensation cost for equity-based awards on the grant date based on the awards' fair value and recognize expense over the vesting period. We measure stock-based compensation cost for liability-based awards on the grant date based on the awards' fair value and recognize expense over the vesting period. We remeasure the liability for these awards and adjust their fair value at the end of each reporting period until paid. We recognize compensation cost for stock-based awards that vest based on performance conditions ratably over the vesting periods when the vesting of such awards becomes probable. Determining the probability of award vesting requires judgment, including assumptions about future operating performance. While the assumptions we use to calculate and account for stock-based compensation awards represent management's best estimates, these estimates involve inherent uncertainties and the application of our management's best judgment. As a result, if we revise our assumptions and estimates, our stock-based compensation expense could be materially different in the future. We estimate the fair value of each option grant using a Black-Scholes option-pricing model. We estimate expected volatility based on the historic volatility of our common shares. We estimate the average expected life using the contractual term of the stock option and expected employee exercise and post-vesting employment termination trends. We base the risk-free rate on U.S. Treasury issues with a term equal to the expected life assumed at the date of grant. We estimate forfeitures at the date of grant based on historic experience. We estimate the fair value of each performance award grant that vests based on a market condition using a Monte Carlo valuation model. The Monte Carlo model incorporates more complex variables than closed-form models such as the Black-Scholes option valuation model used for option grants. The Monte Carlo valuation model simulates a distribution of stock prices to yield an expected distribution of stock prices over the remaining performance period. The stock-paths are simulated using volatilities calculated with historical information using data from a look-back period that is equal to the vesting period. The model assumes a zero-coupon, risk-free interest rate with a term equal to the vesting period. The simulations are repeated many times and the mean of the discounted values is calculated as the grant date fair value for the award. The final payout of the award as calculated by the model is then discounted back to the grant date using the risk-free interest rate. Both the Monte Carlo and Black-Scholes methodologies are based, in part, on inputs for which there are little or no observable market data, requiring us to develop our own assumptions. Inherent in both of these models are assumptions related to expected stock-price volatility, expected life, risk-free interest rate, and dividend yield. Recent Accounting Pronouncements See Note 1, Accounting Policies, to the condensed consolidated financial statements included in this Form 10-K for a discussion of recently adopted accounting standards and other new accounting standards.