STLY Stanley Furniture Company Inc (QB)

ITEM 2.   Management ’ s Discussion and Analysis of Financial Condition and Results of Operations

Net sales of $11.7 million for the three month period ended April 2, 2016, decreased $3.0 million, or 20.4%, compared to the 2015 three month period, primarily due to lower unit volume and, to a lesser extent, lower average selling prices.  Lower unit volume was primarily a result of delays in shipping new product introduced in 2015 as the construction of the new factory in Vietnam dedicated solely to our new product took much longer than originally anticipated.  These initial orders of 2015 introductions should be on retail floors by the end of the second quarter, generating orders by the third quarter.   

Gross profit for the first three months of 2016 decreased to $2.5 million, or 21.7% of net sales, from $3.0 million, or 20.3% of net sales, for the comparable three months of 2015.  The decrease in gross profit was driven by the lower sales volume.  The improved gross margin resulted from lower freight costs.  Partially offsetting this improvement was the reduced absorption of fixed costs due to lower sales, higher discounting and higher quality costs from our existing vendor base.  The higher prior year product costs were driven by higher ocean freight costs resulting from West Coast port issues.     

Selling, general and administrative expenses decreased to $3.3 million, or 28.3% of net sales, for the three month period of 2016 from $3.6 million, or 24.8% of net sales, for the comparable three month period of 2015. The decrease in spending is the result of lower sales and delaying some marketing and advertising efforts awaiting sufficient stock availability. Partially offsetting these lower expenses was the decline in cash surrender value growth of corporate-owned life insurance policies, net of expenses, of $190,000. Selling, general and administrative expenses, as well as cost of goods sold, in the prior year quarters included an offset of approximately $365,000 per quarter as a result of the cash surrender value growth, net of expenses, in these policies that will be eliminated in 2016 as a result of these policies being surrendered during the first quarter of 2016. Approximately 60% of this growth was in selling, general and administrative expenses and the remaining 40% was in cost of goods sold. The elimination of this growth will be partially offset by a reduction in interest expense going forward. 

As a result, operating loss as a percentage of net sales was 6.6% for the three-month period of 2016 compared to a loss of 4.5% for the comparable 2015 period.

During the prior year three month period we recorded income of $3.8 million from the receipt of funds under the Continued Dumping and Subsidy Offset Act (CDSOA).  No proceeds were received in the current three month period.

Interest expense for the three month period of 2016 decreased $221,000 from the comparable 2015 period.  Interest expense is composed of interest on loans against cash surrender value of insurance policies used to fund our legacy deferred compensation plan.  The decrease in expense is due to lower outstanding loan balances in the current quarter compared to prior year from our continued efforts to pay down these loans using excess cash.  We began 2016 with $5.5 million in outstanding loans, paying down $2.4 million in late January and the remainder in late March.  As a result, interest expense related to these loans will be eliminated going forward.  In the prior year, we began with $11 million in outstanding loans, paying down $1.4 million of loans in the middle of March.  

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Our effective tax rate for the current quarter was a negative 69.9%.  As indicated above, we surrendered our corporate-owned life insurance policies during the first quarter of 2016, which resulted in taxable income for the period.  The premiums paid and the growth in surrender value of these policies were excludable from taxable income over the life of these polices when held until death of the covered lives, but this growth, net of premiums paid, became taxable when we surrendered the policies.  The aggregate impact of the surrender of these policies in the first quarter of this year was the creation of $24.0 million in taxable income.  The income tax expense recognized was largely the result of federal alternative minimum tax which limits our ability to offset income generated during the period with net operating carry-forwards, and, to a lesser extent, impact of the policy surrenders have on state income taxes.  The effective tax rate in the prior year quarter was 2.2%, also driven by the impact of the alternative minimum tax limiting the ability to offset the income received from the Continued Dumping and Subsidy Offset Act during that quarter.  The major reconciling items between our effective income tax rate and the federal statutory rate are the change in our valuation allowance and the cash surrender value on life insurance policies.

During 2014, we ceased production of our Young America product line and closed our manufacturing operation in Robbinsville, North Carolina.  A loss of $118,000 was recognized from discontinued operations in the first quarter of 2015, as we continued to sell off inventory and collect outstanding receivables.  

Financial Condition, Liquidity and Capital Resources

Sources of liquidity include cash on hand and cash generated from operations. While we believe that our business strategy will be successful, we cannot predict with certainty the ultimate impact on our revenues, operating costs and cash flow from operations.  We expect cash on hand to be adequate for ongoing operational and capital expenditures for the foreseeable future.  At April 2, 2016, we had $25.9 million in cash and $663,000 in restricted cash.

Working capital, excluding cash and restricted cash, increased slightly to $21.7 million at April 2, 2016 from $21.2 million on December 31, 2015.  The increase was primarily the result of a decrease in accounts payable as we paid for inventory that was in-transit from Asia, partially offset by decreases in accounts receivable and prepaid and other assets and an increase in other accrued liabilities.

Cash used by operations was $2.2 million in the current quarter of 2016 compared to cash generated from operations of $736,000 in the comparable prior year quarter.  The cash generation in 2015 was the result of receiving $3.8 million on CDSOA proceeds during the period. Excluding these proceeds, less cash was used by operations during the first quarter of 2016 due to lower freight costs and lower interest payments on loans against corporate owned life insurance policies.    

Cash generated from investing activities in the first quarter of 2016 was due to $28.1 million in proceeds from the surrender of corporate-owned life insurance policies.  No investing activities occurred in the first quarter of 2015.  

Net cash used by financing activities in the current quarter of 2016 was $6.5 million compared to $1.4 million in the comparable quarter of 2015.  During the current quarter we used $5.5 million to pay off the remaining outstanding life insurance policy loans in conjunction with our decision to surrender these corporate-owned life insurance policies and $1.0 million for the repurchase and retirement of 400,000 shares of our common stock.  In the first quarter of 2015 we used $1.4 million to pay-down life insurance policy loans.  

Continued Dumping and Subsidy Offset Act ( “ CDSOA ” )

The CDSOA provides for distribution of monies collected by U.S. Customs and Border Protection ( “ Customs ” ) for imports covered by antidumping duty orders entering the United States through September 30, 2007 to eligible domestic producers that supported a successful antidumping petition ( “ Supporting Producers ” ) for wooden bedroom furniture imported from China. Antidumping duties for merchandise entering the U.S. after September 30, 2007 have remained with the U.S. Treasury.

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Certain manufacturers who did not support the antidumping petition ( “ Non-Supporting Producers ” ) filed actions in the United States Court of International Trade, challenging the CDSOA ’ s “ support requirement ” and seeking to share in the distributions.  As a result, Customs held back a portion of those distributions (the “ Holdback ” ) pending resolution of the Non-Supporting Producers ’ claims.  The Court of International Trade dismissed all of the actions of the Non-Supporting Producers, who appealed to the United States Court of Appeals for the Federal Circuit.  Customs advised that it expected to distribute the Holdback to the Supporting Producers after March 9, 2012.  The Non-Supporting Producers sought injunctions first from the Court of International Trade and, when those efforts were unsuccessful, from the Federal Circuit directing Customs to retain the Holdback until the Non-Supporting Producers ’ appeals were resolved.

On March 5, 2012, the Federal Circuit denied the motions for injunction, “ without prejudicing the ultimate disposition of these cases. ”  As a result, we received a CDSOA distribution of $39.9 million in April 2012. On August 19, 2013, the Federal Circuit issued a decision affirming the dismissal of the claims of two of the four Non-Supporting Producers. On January 3, 2014, the Federal Circuit denied those Non-Supporting Producers ’ petitions for rehearing en banc.  On May 2, 2014, these Non-Supporting Producers filed a petition for writ of certiorari, seeking review by the United States Supreme Court.   On October 6, 2014, the Supreme Court denied two of three of the Non-Supporting Producers ’ petitions for certiorari review, and on December 15, 2014, the Supreme Court denied the third petition for review.  Accordingly, Customs should not seek or be entitled to obtain a return of our CDSOA distribution received in April 2012.

In November 2012, December 2013, and November 2014 Customs disclosed that it withheld $3.0 million, $6.4 million, and $5.7 million respectively in each of those years, in funds related to the antidumping duty order on wooden bedroom furniture from China that was otherwise available for distribution until the amounts at issue in the pending litigation had been resolved.  In March 2015, following the conclusion of all appeals, Customs began distributing the withheld funds to the Supporting Producers.  Our allocated share of the distributed 2012, 2013, and 2014 withheld funds totaled $4.8 million, which we received during late March and early April 2015.  

In November 2014, Customs also announced that 2014 and 2015 CDSOA distributions were subject to sequestration under the Budget Control Act at the rate of 7.2 percent and 7.3 percent, respectively.  On March 17, 2015, however, the government concluded that the amounts sequestered during Fiscal Year 2014 and Fiscal Year 2015 would become available in the subsequent fiscal year.  Our share of the 2014 sequestered funds, totaling $147,000, was received in April 2015 and no funds were sequestered in 2015.  

In November 2015, Customs distributed $1.2 million in collected duties that were available for distribution in 2015.  Our portion of this distribution was $412,000, representing 33.6% of the balance available for distribution.  According to Customs, as of October 1, 2015, approximately $2.6 million in duties had been secured by cash deposits and bonds on unliquidated entries of wooden bedroom furniture that are subject to the CDSOA, and this amount is potentially available for distribution under the CDSOA to eligible domestic manufacturers in connection with the case involving bedroom furniture imported from China.  The amount ultimately distributed will be impacted by appeals from the annual administrative review process and importers ’ actions concerning the amount of duties owed with respect to specific entries, which can retroactively increase or decrease the actual duties owed on entries secured by cash deposits and bonds.  Assuming our percentage allocation in future years is the same as it was for the 2015 distribution (approximately 33.6% of the funds distributed) and the $2.6 million collected by the government as of October 1, 2015 does not change as a result of the annual administrative review process or otherwise, we could receive approximately $860,000 in CDSOA funds.

Due to the uncertainty of the administrative processes, we cannot provide assurances as to future amounts of additional CDSOA funds that ultimately will be received, if any, and we cannot predict when we may receive any additional CDSOA funds.   

New Accounting Pronouncements

In February 2016, the FASB issued its final lease accounting standard, FASB Accounting Standard Codification ("ASC") Topic 842, Leases , which requires lessees to reflect most leases on their balance sheet as assets and obligations. The effective date for the standard is for fiscal years beginning after December 15, 2018. Early adoption is permitted. We are evaluating the effect that ASC 842 will have on our consolidated financial statements and related disclosures. The standard is to be applied under the modified retrospective method, with elective reliefs, which requires application of the new guidance for all periods presented.

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In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting ( “ ASU 2016-09).  The amendments in ASU 2016-09 simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows.  The effective date for the standard for public entities is for fiscal years beginning after December 15, 2016. Early adoption is permitted. We are evaluating the effect that ASU 2016-09 will have on our consolidated financial statements and related disclosures.

Critical Accounting Policies

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, “ Management ’ s Discussion and Analysis of Financial Condition and Results of Operations ” , included in our 2015 Annual Report on Form 10-K.

Forward-Looking Statements

Certain statements made in this report are not based on historical facts, but are forward-looking statements.  These statements can be identified by the use of forward-looking terminology such as “ believes, ” “ estimates, ” “ expects, ” “ may, ” “ will, ” “ should, ” “ could ” , or “ anticipates, ” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy.  These statements reflect our reasonable judgment with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.  Such risks and uncertainties include disruptions from transitioning  to and using a single contract manufacturer for substantially all of our products including those arising in the event the manufacturer is not able to manufacture as anticipated in terms of cost, quality or timeliness or in the event we lost this relationship, disruptions in foreign sourcing including those arising from supply or distribution disruptions or those arising from changes in political, economic and social conditions, as well as laws and regulations, in countries from which we source products, international trade policies of the United States and countries from which we source products, the inability to raise prices in response to inflation and increasing costs, lower sales due to worsening of current economic conditions, the cyclical nature of the furniture industry, business failures or loss of large customers, failure to anticipate or respond to changes in consumer tastes, fashions and perceived values in a timely manner, competition in the furniture industry,  environmental, health, and safety  compliance costs, and failure or interruption of our information technology infrastructure.  Any forward-looking statement speaks only as of the date of this filing and we undertake no obligation to update or revise any forward-looking statements, whether as a result of new developments or otherwise.

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