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| STLY > SEC Filings for STLY > Form 10-K on 20-Feb-2004 | All Recent SEC Filings |
20-Feb-2004
Annual Report
The following discussion should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements and Notes thereto contained elsewhere herein.
Overview
Over the past few years the residential wood furniture industry has experienced a surge in low cost imported products, primarily from China. Imports have grown dramatically in the past few years and according to industry sources it is estimated that imports now account for approximately half of all residential wood furniture sold in the United States.
In response to this trend we continue to develop a blended strategy of combining our domestic manufacturing capabilities with an expanding offshore sourcing program and to realign manufacturing capacity. We are integrating selected imported component parts and finished items in our product line to lower costs, provide design flexibility and offer a better value to our customers. Sourced products represented approximately 20% of our sales in 2003 and we anticipate this percentage to level off at approximately 30% of sales for 2004.
The increase in offshore sourcing has created excess capacity in our manufacturing facilities which has caused us to reduce and realign manufacturing capacity. We closed a manufacturing facility in 2002 (our former West End, North Carolina factory) and reduced operations at another manufacturing facility in 2003. We have realigned production so that each of our current manufacturing facilities is focused on specific product lines of compatible products to improve quality and lower production costs.
These actions have reduced our manufacturing capacity by approximately 15% to 20%. However, we operated at approximately 70% to 75% of this reduced capacity in 2003. Near-term operating margins will continue to be negatively impacted by low capacity utilization rates as the proportion of sourced goods is expected to grow from approximately 20% of sales in 2003 to approximately 30% of sales in 2004.
We are reluctant to further reduce our manufacturing capacity at the present time in order to provide protective capacity for improved demand and the uncertainty of the outcome of the dumping investigation currently being conducted by the U.S. Department of Commerce and the International Trade Commission. If the investigation determines Chinese manufacturers are illegally dumping wooden bedroom furniture into the U. S. market, tariffs will be applied to future imports of wooden bedroom furniture from China. While we cannot predict the outcome or quantify the potential impact, we believe a favorable ruling on behalf of the petitioners will have a positive impact on our financial performance since we source a smaller percentage of wooden bedroom furniture from China than most of our competition.
We will continue to evaluate our manufacturing capacity needs considering increased offshore sourcing, current and anticipated demand for our products, the outcome of the dumping investigation regarding wooden bedroom furniture produced in China, overall market conditions and other factors we consider relevant. Further capacity reductions could cause asset impairment or other restructuring charges in the future.
Results of Operations
The following table sets forth the percentage relationship to net sales of certain items included in the Consolidated Statements of Income:
For the Years Ended
December 31,
-------------------------
2003 2002 2001
----- ----- -----
Net sales .................................. 100.0% 100.0% 100.0%
Cost of sales .............................. 76.3 75.5 77.4
Restructuring and related charges .......... 1.5 1.0
----- ----- -----
Gross profit ............................. 23.7 23.0 21.6
Selling, general and administrative expenses 13.6 13.6 13.0
Unusual charge ............................. 1.2
Restructuring and related charges .......... .3
----- ----- -----
Operating income ......................... 10.1 9.4 7.1
Other income, net .......................... .1 .1
Interest expense ........................... 1.1 1.3 1.7
----- ----- -----
Income before income taxes ............... 9.1 8.2 5.4
Income taxes ............................... 3.3 2.9 1.8
----- ----- -----
Net income ............................... 5.8% 5.3% 3.6%
===== ===== =====
2003 Compared to 2002
Net sales increased $21.2 million, or 8.8%, in 2003 compared to 2002. The increase was due primarily to higher unit volume. We believe this higher unit volume is due to gains in market share resulting from our blended operating strategy that has allowed us to offer improved product styling and value to our customers. While industry sales trends improved in the second half of 2003, the industry reported a sales decrease in 2003.
Gross profit margin for 2003 increased to 23.7% from 23.0% in 2002. Lower gross profit margin in 2002 was due primarily to restructuring and related charges resulting from closing a factory to reduce our manufacturing capacity. The gross profit margin for 2003 increased due to savings from sourcing initiatives and the realignment of manufacturing capacity. These savings were mostly offset by transition and start up costs from increased offshore sourcing, lower production levels at our manufacturing facilities, and other inflationary costs including wages and employee benefits.
Selling, general and administrative expenses as a percentage of net sales was 13.6% for both 2003 and 2002. Selling, general and administrative expenditures increased $3.0 million in 2003 due primarily to higher sales, expansion of our offshore sourcing program and increased marketing and product development costs. These increases were partially offset by a $780,000 decrease in bad debt expense. We recognized $760,000 of bad debt expense in 2002 compared to a net reversal of $20,000 in 2003 due to a decrease in accounts receivable from certain customers experiencing financial difficulties. We expect the trend of higher sourcing costs and increases in certain marketing and product development costs to continue in 2004.
As a result of the above, operating income for 2003 increased to $26.2 million, or 10.1% as a percentage of net sales, from $22.4 million, or 9.4% as a percentage of net sales, in 2002.
Interest expense for 2003 decreased due primarily to lower average debt levels.
The Company's effective income tax rate for 2003 increased to 36.0% from 35.5% in 2002, due primarily to higher state income taxes resulting from the phase-out of certain state tax credits.
2002 Compared to 2001
Net sales increased $5.2 million, or 2.2%, for 2002 compared to 2001. The increase was due primarily to higher unit volume.
Gross profit margin for 2002 increased to 23.0% from 21.6% in 2001. The increase was due primarily to cost savings resulting from closing our former West End, North Carolina facility, offshore sourcing initiatives and lower raw material cost. This improvement was partially offset by increased restructuring related charges, lower production levels and higher wage and employee benefit expenses, primarily increased health care claims and pension expense.
Selling, general and administrative expenses for 2002 as a percentage of net sales increased to 13.6% from 13.0% for 2001. Selling, general and administrative expenses increased $2.2 million compared to 2001 primarily as a result of the reinstatement of management bonuses due to higher earnings, higher selling expenses related to new product introductions and increased sales.
An unusual charge of $2.8 million was recorded in 2001 to write off amounts due from a major customer, which declared bankruptcy and closed its stores.
As a result of closing a facility to reduce our manufacturing capacity, we recorded total restructuring and related charges of $6.5 million. In 2002, we recorded restructuring and related charges, as a component of cost of sales, of $3.5 million pretax, that included $1.7 million for accelerated depreciation and $1.8 million for other exit costs, including plant operating inefficiencies and severance cost. In 2001, we recorded restructuring and related charges of $3.0 million that included $2.0 million in accelerated depreciation and $1.0 million for other exit costs. The restructuring accrual at December 31, 2002 of $450,000 consists of a lease obligation for real estate and severance cost.
As a result of the above, operating income increased to $22.4 million from $16.7 million in 2001.
Interest expense for 2002 decreased due primarily to lower average debt levels.
The Company's effective income tax rate increased to 35.5% for 2002 from 34.0% in 2001. The lower 2001 percentage was due to lower state income taxes.
Financial Condition, Liquidity and Capital Resources
Our sources of liquidity include cash on hand, cash from operations and amounts available under a $25.0 million credit facility. These sources have been adequate for day-to-day expenditures, debt payments, purchases of the Company's stock, capital expenditures and payment of cash dividends to stockholders. We expect these sources of liquidity to continue to be adequate for the future.
Working capital has increased due to higher overall finished goods inventory levels as the proportion of our sales from sourced products has increased. To support our delivery performance, we maintain a higher inventory level of sourced products compared to those we manufacture. This is partially offset by lower raw material inventories. We expect this trend to continue in 2004.
Capital expenditures for 2004 are anticipated to be approximately $2.0 million to $3.0 million for normal replacements and improvements. As both our sales and the proportion of sourced goods increase we anticipate the need for additional warehouse space. Near-term we anticipate leasing space to accommodate our needs. However, should we decide to invest in our own facilities this could increase our anticipated capital expenditures.
During 2003, the Company purchased 566,000 shares of its stock in the open market at an average price of $26.15. At December 31, 2003, approximately $10.2
million remains authorized by our Board of Directors to repurchase shares of the Company's common stock. Consequently, we may, from time to time, either directly or through agents, repurchase our common stock in the open market, through negotiated purchases or otherwise, at prices and on terms satisfactory to the Company. Depending on market prices and other conditions relevant to the Company, such purchases may be discontinued at any time. The Company's Board of Directors initiated an annual dividend policy of $.20 per share in January 2003 and increased the annual dividend policy to $.40 per share in January 2004. The aggregate payments for 2004 are expected to be approximately $2.5 million.
The Company generated cash from operations of $14.3 million in 2003 compared to $16.1 million in 2002 and $19.8 million in 2001. The increase in cash received from customers and cash paid to suppliers and employees for 2003 was due primarily to higher sales. Higher tax payments in 2003 compared to 2002 resulted from timing of estimated tax payments and higher income. The decrease in cash generated from operations for 2002 compared to 2001 is attributable primarily to reduced collections from customers as a majority of the sales increase occurred in the fourth quarter of 2002 and was collected in the first quarter of 2003. Offsetting this decrease in 2002 was lower tax payments required during 2002 as overpayments in 2001 were applied to 2002. The cash generated from operations in 2003, 2002 and 2001 was used to repurchase common stock, reduce borrowings, pay cash dividends and fund capital expenditures, reflecting the Company's balanced strategy regarding its use of capital.
Net cash used by investing activities was $1.3 million in 2003 compared to $342,000 and $4.2 million in 2002 and 2001, respectively. The decline in capital expenditures for both 2003 and 2002 compared to 2001 is due to the relocation of a significant portion of the machinery and equipment from a previously closed facility to other Company facilities and used in lieu of normal replacements. The expenditures in 2003, 2002 and 2001 were primarily for plant and equipment and other assets in the normal course of business. In 2002, the Company received net proceeds of $695,000 from the sale of real estate at its former West End, North Carolina facility.
Net cash used by financing activities was $19.7 million, $8.5 million and $15.4 million in 2003, 2002 and 2001, respectively. In 2003 and 2002, cash from operations and proceeds from the exercise of stock options provided cash for purchase and retirement of the Company's common stock and senior debt payments. In 2003, these funds were also used to pay cash dividends. In 2001, cash from operations and proceeds from the issuance of $10.0 million in senior notes provided cash for reduction of borrowings under the revolving credit facility, senior debt payments, capital expenditures and purchase and retirement of the Company's common stock. In 2002, 85,914 shares of the Company's common stock were surrendered by an executive officer to the Company in payment of a $2.6 million outstanding loan and accrued interest, relating to stock option exercises in 2000.
At December 31, 2003, long-term debt including current maturities was $22.7 million. Debt service requirements are $7.0 million in 2004, $4.3 million in 2005, $2.9 million in 2006 and $2.9 million in 2007. As of December 31, 2003, approximately $25.0 million of additional borrowings were available under the Company's revolving credit facility and cash on hand was $2.5 million.
The following table sets forth the Company's contractual cash obligations and other commercial commitments at December 31, 2003:
Payment due or commitment expiration
Less than Over
Total 1 year 2-3 years 4-5 years 5 years
Contractual cash obligations:
Long-term debt ...................... $22,700 $ 7,014 $ 7,114 $ 4,286 $ 4,286
Operating leases .................... 1,125 774 294 57
------- ------- ------- ------- -------
Total contractual cash obligations $23,825 $ 7,788 $ 7,408 $ 4,343 $ 4,286
======= ======= ======= ======= =======
Other commercial commitments:
Letters of credit ................... $ 2,382 $ 2,382
======= =======
14
Critical Accounting Policies
Management has chosen accounting policies that are necessary to accurately
and fairly report the Company's operational and financial position. Below are
the critical accounting policies that involve the most significant judgments and
estimates used in the preparation of the Company's consolidated financial
statements.
Allowance for doubtful accounts - The Company maintains an allowance for doubtful receivables for estimated losses resulting from the inability of trade customers to make required payments. The Company provides an allowance for specific customer accounts where collection is doubtful and also provides an allowance for other accounts based on historical collection and write-off experience. Judgment is critical because some customers have experienced financial difficulties. As the financial condition of these customers change, the level of such allowances will be reevaluated. During 2003, the credit exposure related to certain customer accounts experiencing financial difficulties declined resulting in a decrease in the allowance for doubtful receivables.
Inventory valuation - Inventory is valued at the lower of cost or market. Cost for all inventories is determined using the first-in, first-out (FIFO) method. The Company evaluates its inventory to determine excess or slow moving items based on current order activity and projections of future demand. For those items identified, the Company estimates its market value or net sales value based on current trends. Those items having a net sales value less than cost are written down to their net sales value. This process recognizes projected inventory losses when they become evident rather than at the time they are sold.
Long-lived assets - Property and intangible assets are reviewed for possible impairment when events indicate that the carrying amount of an asset may not be recoverable. Assumptions and estimates used in the evaluation of impairment may affect the carrying value of long-lived assets, which could result in impairment charges in future periods. Depreciation and amortization policies reflect judgments on the estimated useful lives of assets.
Tax Contingencies - Tax contingencies are recorded to address potential exposures involving tax positions the Company has taken that could be challenged by taxing authorities. These potential exposures result from the varying applications of statutes, rules, regulations and interpretations. The Company's estimate of the value of its tax contingencies contains assumptions based on past experiences and judgments about potential actions by taxing jurisdictions. The ultimate resolution of these matters may be greater or less than the amount that the Company has accrued.
Pension costs - The Company's pension expense is developed from actuarial valuations. Inherent in these valuations are key assumptions, including discount rates and expected return on plan assets, which are usually updated on an annual basis at the beginning of each year. The Company is required to consider current market conditions, including changes in interest rates, in making these assumptions. Changes in pension costs may occur in the future due to changes in these assumptions. The key assumptions used in developing 2003 net pension costs were 6.5% for both the discount rate and expected return on plan assets compared to 7.25% and 7.50%, respectively, in 2002. As a result, net pension cost increased $301,000, excluding the impact of settlement expense. In establishing its expected return on plan assets assumption, the Company reviews asset allocation considering plan maturity and develops return assumptions based on different asset classes adjusting for plan operating expenses. Actual asset over/under performance compared to expected returns will respectively decrease/increase unrecognized loss. The change in the unrecognized loss will change amortization cost in upcoming periods. A one percentage point change in the expected return assumption in the current year would have resulted in a change in pension expense of approximately $150,000. Net pension cost for 2004 is expected to increase slightly, primarily as a result of a reduction in the discount rate from 6.5% to 6.0%.
The Company does not have transactions or relationships with "special purpose" entities, and the Company does not have any off balance sheet financing other than normal operating leases primarily for showroom and certain technology equipment.
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