STLY Stanley Furniture Company Inc (QB)

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

Net sales of $12.1 million for the three month period ended July 2, 2016, decreased $3.1 million, or 20.4%, compared to the comparable 2015 period. For the six month period ended July 2, 2016, net sales decreased $6.1 million, or 20.4%, from the comparable 2015 period. The decrease in both periods was due to lower unit volume and lower average selling prices. Lower unit volume was primarily a result of delays in shipping new product introduced in 2015 as the production ramp up of the new factory in Vietnam dedicated solely to our new product has taken longer than originally anticipated. The initial orders of 2015 introductions should be on retail floors during the third quarter and begin to generate orders in the second half of this year. Lower average selling prices are the result of aggressive discounting to move older discontinued product and also on inline product to achieve additional floor space to fuel future sales.

Gross profit for the current three month period decreased to $2.1 million, or 17.1% of net sales, from $3.8 million, or 25.4% of net sales, for the comparable three months of 2015. Gross profit for the current six month period decreased to $4.6 million, or 19.4% of net sales, from $6.8 million, or 22.9% of net sales, for the comparable six months of 2015. The decrease in gross profit and gross margin in both the three and six month periods was driven by lower sales volume, higher sales discounting and higher quality costs from our existing vendor base. Partially offsetting the impact of these items in the three and six month periods was lower ocean freight costs and, to a lesser extent, lower operation support costs. The prior year three and six month periods contained higher freight costs resulting from West Coast port issues.

Selling, general and administrative expenses for the three and six month periods of 2016 were $3.5 million and $6.8 million, or 29.1% and 28.7% of net sales, respectively, compared to $3.5 million and $7.1 million, or 22.8% and 23.8% of net sales, in the comparable 2015 periods. Expenditures for the current three month period were flat to the comparable prior year period and slightly lower in the current six month period compared to last year. Spending reductions in both periods were driven by lower sales commissions and marketing costs, and lower equity compensation expenses on performance awards. In addition, trade showroom related costs are down as the prior year periods included the preparation of our showroom for the launch of the new product line.  Partially offsetting these lower expenditures were increased legal and professional costs and higher benefit costs as we liquidated our corporate owned life insurance policies in late March of this year eliminating any growth in cash surrender value from these policies. The decline in cash surrender value growth of corporate-owned life insurance policies, net of expenses was $347,000 in the current three month period and $541,000 during the six month period.  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 the elimination of interest expense going forward. The higher selling, general and administrative percentages in the current year are due to lower sales impairing absorption for fixed cost components of expenses.

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As a result, operating loss as a percentage of net sales was 12.0% for the current three month period and 9.3% for the current six month period compared to income of 2.6% in the prior year three month period and a loss of 0.9% in the prior year six month period.

During the prior year three and six month periods we recorded income of $1.1 million and $4.9 million, respectively, from the receipt of funds under the Continued Dumping and Subsidy Offset Act (CDSOA). No proceeds were received in the current three and six month periods.

Interest expense for the three and six month periods of 2016 decreased $210,000 and $431,000, respectively, from the comparable 2015 periods. 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 paying down these outstanding loans with excess cash starting in late 2015 and eventually paying them off when we liquidated our corporate-owned life insurance policies in the first quarter of 2016.   

Our effective tax rates for the current three and six month periods were 3.3% and negative 24.3%, respectively.  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 $24.0 million in taxable income.  The income tax expense associated with the surrender of the corporate-owned life insurance policies was recognized in full during the first quarter as that is when the surrender was complete. Therefore, the income tax benefit recognized during the current three month period was the result of normal operating losses incurred during the period. These will ultimately offset the income recognized in the first three months, which will lower the impact of the federal alternative minimum tax and state income taxes. The income tax expense recognized during the current six month period was the result of federal alternative minimum tax and, to a lesser extent, the impact of surrendering these policies have on state income taxes. The effective tax rates in the prior year three and six month periods were 1.1% and 2.0%, respectively, 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 those periods. 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.

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 July 2, 2016, we had $26.7 million in cash and $663,000 in restricted cash.

Working capital, excluding cash and restricted cash, decreased to $19.3 million at July 2, 2016 from $21.2 million on December 31, 2015.  The decrease was primarily the result of a decrease in accounts receivable as a result of our lower sales volumes and a decrease in prepaid and other assets, partially offset by an increase in accrued taxes and a slight increase in inventories.

Cash used by operations was $1.4 million in the current six months of 2016 compared to cash generated from operations of $1.9 million in the comparable prior year period. The cash generation in 2015 was the result of receiving $4.9 million on CDSOA proceeds during the period. Excluding these proceeds, less cash was used by operations during the first six months 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 six months of 2016 was due to $28.1 million in proceeds from the surrender of corporate-owned life insurance policies.  Cash provided by investing activities was $527,000 in the prior year six months with the release of restricted cash.

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   Net cash used by financing activities in the current six months of 2016 was $6.5 million compared to $4.3 million in the comparable six months of 2015.  During the current year 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 six months of 2015 we used $4.3 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.

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 $4.9 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. As of April 30, 2016, Customs preliminarily reported that approximately $3.2 million is potentially available for distribution under the CDSOA during the fourth quarter of calendar year 2016 to eligible domestic manufacturers in connection with the case involving bedroom furniture imported from China. The final amounts available for distribution may be higher or lower than the preliminary amounts reported due to liquidations, reliquidations, protests, and other events affecting entries that may take place before the end of the government’s fiscal year.  Assuming our percentage allocation in 2016 is the same as it was for the 2015 distribution (approximately 33.6% of the funds distributed) and the $3.2 million collected by the government as of April 30, 2016 does not change, we could receive approximately $1.1 million in CDSOA funds in the fourth quarter of 2016.

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. 

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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.

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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