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HOOKER FURNITURE CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion should be read in conjunction with the selected financial data and the consolidated financial statements, including the related notes, contained elsewhere in this annual report. We especially encourage users of this report to familiarize themselves with: ††† All of our recent public filings made with the Securities and Exchange Commission ("SEC"). Our public filings made with the SEC are available, without charge, at www.sec.gov and at http://investors.hookerfurniture.com; ††† The forward looking statements contained in Item 1 of this report, which describe the significant risks and uncertainties that could cause actual results to differ materially from those made in any forward-looking statements we make in this report, including those contained in this section of our annual report on Form 10-K; ††† The company-specific risks found in Item 1A "Risk Factors" of this report on Form 10-K. This section contains critical information regarding significant risks and uncertainties that we face. If any of these risks materialize, our business, financial condition and future prospects could be adversely impacted; and ††† Our commitments and contractual obligations and off-balance sheet arrangements described on page 31 and in Note 17 on page F-28 of this report. These sections describe commitments, contractual obligations and off-balance sheet arrangements, some of which are not reflected in our consolidated financial statements. All references to the Company in this discussion refer to the Company and its consolidated subsidiaries, unless specifically referring to segment information. Unless otherwise indicated, amounts shown in tables are in thousands, except for share and per share data. Our fiscal years end on the Sunday closest to January 31, in some years (generally once every six years) the fourth quarter will be fourteen weeks long and the fiscal year will consist of fifty-three weeks. For example, the 2013 fiscal year that ended on February 3, 2013 was a 53-week fiscal year. Our quarterly periods are based on thirteen-week "reporting periods" (which end on a Sunday) rather than quarterly periods consisting of three calendar months. As a result, each quarterly period generally is thirteen weeks, or 91 days, long, except as noted above. The financial statements filed as part of this annual report on Form 10-K include the: ††† fifty-two week period that began February 4, 2013 and ended on February 2, 2014 (fiscal 2014); ††† fifty-three week period that began January 30, 2012 and ended on February 3, 2013 (fiscal 2013); and ††† fifty-two week period that began January 31, 2011 and ended on January 29, 2012 (fiscal 2012). Nature of Operations Hooker Furniture Corporation (the "Company", "we," "us" and "our") is a home furnishings marketing and logistics company offering worldwide sourcing of residential casegoods and upholstery, as well as domestically-produced custom leather and fabric-upholstered furniture. We were incorporated in Virginia in 1924 and are ranked among the nation's top 10 largest publicly traded furniture sources, based on 2012 shipments to U.S. retailers, according to a 2013 survey published by Furniture Today a leading trade publication. We are a key resource for residential wood and metal furniture (commonly referred to as "casegoods") and upholstered furniture. Our major casegoods product categories include accents, home office, dining, bedroom and home entertainment furniture under the Hooker Furniture brand. Our residential upholstered seating companies include Bradington-Young (acquired in 2003), a specialist in upscale motion and stationary leather furniture and Sam Moore Furniture (acquired in 2007), a specialist in upscale occasional chairs, settees, sofas and sectional seating with an emphasis on cover-to-frame customization. An extensive selection of designs and formats along with finish and cover options in each of these product categories makes us a comprehensive resource for residential furniture retailers, primarily targeting the upper-medium price range. Our principal customers are retailers of residential home furnishings that are broadly dispersed throughout the United States. Our customers also include home furniture retailers in Canada and in over 10 other countries internationally. Other customers include independent furniture stores, specialty retailers, department stores, catalog and internet merchants, interior designers and national and regional chains. We launched two new initiatives during fiscal 2014, which are intended to help us reach a broader consumer base: ††† H Contract- which supplies upholstered seating and casegoods to upscale senior living facilities throughout the country; and ††† Homeware- which features customer-assembled, modular upholstered and casegoods products, as well as home accessories, designed for younger and more mobile furniture customers, marketed direct-to-consumer via the internet. 20-------------------------------------------------------------------------------- Table of Contents Overview Consumer home furnishings purchases are driven by an array of factors, including general economic conditions such as: ††† consumer confidence; ††† availability of consumer credit; ††† energy and other commodity prices; and ††† housing and mortgage markets; as well as lifestyle-driven factors such as changes in: ††† fashion trends; ††† disposable income; ††† household formation and turnover; and Economic and economic-related factors, such as high unemployment and changing consumer priorities, have resulted in a somewhat depressed retail environment for discretionary home furnishings and related purchases since 2008. However, the extended weakness in housing and housing-related industries is beginning to show signs of sustained recovery, and mostly positive news on housing and consumer confidence is encouraging. Our lower overhead, variable-cost import operations have driven our profitability over the last few years and provide us with more flexibility to respond to changing demand by adjusting inventory purchases from suppliers. On the other hand, our import model requires a larger investment in inventory and longer production lead times. In addition, we must constantly evaluate our imported furniture suppliers and, when quality concerns or inflationary pressures diminish the value proposition offered by our current suppliers, transition sourcing to other suppliers, often located in different countries or regions. Results for our domestic upholstery operations, which have significantly higher overhead and fixed costs than our import operations, have been particularly affected by the decline in demand for home furnishings and experienced operating losses or low operating profitability beginning with our fiscal 2009 second quarter through the second quarter of fiscal 2013. We initiated extensive cost reduction efforts over that time, which mitigated the effect of the weakness in demand. Our upholstery segment operations have been profitable for the last two fiscal years. The following are the primary factors that affected our consolidated results of operations for fiscal 2014. ††† Consolidated net sales increased, primarily due to higher average selling prices in both operating segments, partially offset by higher discounting and returns and allowances in our casegoods segment and five fewer shipping days in fiscal 2014 than in fiscal 2013. ††† Consolidated gross profit increased in absolute terms, due primarily to increased sales volume in both segments, but was essentially flat as a percentage of net sales. ††† Consolidated selling and administrative expenses increased in both absolute terms and as a percentage of net sales primarily due to start-up costs for our H Contract and Homeware business initiatives and a number of other factors such as higher marketing and professional expenses which are discussed in greater detail below ; and ††† Our upholstery segment nearly doubled operating profitability, primarily due to improvements in Bradington-Young's domestic leather operations due to increased sales due to higher selling prices, lower cost of sales due to improved material utilization and lower selling and administrative expenses due to lower marketing related costs. 21-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth the percentage relationship to net sales of certain items for the annual periods included in the consolidated statements of income: Fifty-two Fifty-three Fifty-two weeks ended weeks ended weeks ended February 2, February 3, January 29, 2014 2013 2012 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 76.0 75.9 78.0 Gross profit 24.0 24.1 22.0 Selling and administrative expenses 18.5 18.1 18.1 Intangible asset impairment charges - - 0.8 Operating income 5.5 5.9 3.0 Other income, net 0.0 0.1 0.1 Income before income taxes 5.5 6.0 3.1 Income taxes 2.0 2.0 0.8 Net income 3.5 4.0 2.3 Fiscal 2014 Compared to Fiscal 2013 Net Sales Fifty-two weeks ended Fifty-three weeks ended February 2, February 3, 2014 2013 $ Change % Change % Net Sales % Net Sales Casegoods $ 145,266 63.6 % $ 141,064 64.6 % $ 4,202 3.0 % Upholstery 83,027 36.4 % 77,295 35.4 % $ 5,732 7.4 % Consolidated $ 228,293 100.0 % $ 218,359 100.0 % $ 9,934 4.5 % Unit Volume and Average Selling Price FY14 % FY14 % Increase vs. Increase vs. Unit Volume FY13 Average Selling Price FY13 Casegoods -3.4 % Casegoods 5.9 % Upholstery 1.2 % Upholstery 6.2 % Consolidated -2.0 % Consolidated 6.3 % Because we report on a fiscal year that ends on the Sunday closest to January 31st of each year, the 2014 fiscal year was one week shorter than the comparable 2013 fiscal year which was 53 weeks long. The following table presents average net sales per shipping day in thousands for the 2014 and 2013 fiscal years: 22-------------------------------------------------------------------------------- Table of Contents Net Sales per Shipping Day Average Net Sales Per Shipping Day Fifty-two weeks ended Fifty-three weeks ended % February 2, 2014 February 3, 2013 Change Casegoods $ 581 $ 553 5.1 % Upholstery 332 303 9.6 % Consolidated $ 913 $ 856 6.6 % Shipping Days 250 255 Gross Profit Fifty-two weeks ended Fifty-three weeks ended February 2, February 3, 2014 2013 $ Change % Change % Net Sales % Net Sales Casegoods $ 39,332 27.1 % $ 38,054 27.0 % $ 1,278 3.4 % Upholstery 15,393 18.5 % 14,492 18.8 % 901 6.2 % Consolidated $ 54,725 24.0 % $ 52,546 24.1 % $ 2,179 4.1 % Consolidated gross profit increased in absolute terms, but was essentially flat as percentage of net sales in fiscal 2014, as compared to the same prior-year period, primarily due to increased sales and higher average selling prices in both segments and lower distribution costs in our casegoods segment due to the closure of several Asian warehouses and lower payroll expenses. Selling and Administrative Expenses Fifty-two weeks ended Fifty-three weeks ended February 2, February 3, 2014 2013 $ Change % Change % Net Sales % Net Sales Casegoods $ 28,742 19.8 % $ 26,102 18.5 % $ 2,640 10.1 % Upholstery 13,480 16.2 % 13,504 17.5 % (24 ) -0.2 % Consolidated $ 42,222 18.5 % $ 39,606 18.1 % $ 2,616 6.6 % Consolidated selling and administrative expenses increased both in absolute terms and as a percentage of net sales in the fiscal 2014 compared to the prior-year period. Casegoods selling and administrative expenses increased both in absolute terms and as a percentage of net sales, primarily due to: ††† start-up costs for our H Contract and Homeware initiatives, startup costs which were $2.1 million pre-tax, ($1.4 million, or $0.13 per share after tax), in fiscal 2014; ††† an increase in bad debts expense due to a favorable adjustment in the comparable fiscal 2013 period; ††† an increase in professional service expense due to increased compliance and regulatory costs; ††† an increase in salaries and wages due to hiring to fill open positions; and ††† an increase in selling expenses due to increased marketing and promotional activity. Upholstery selling and administrative expenses decreased in absolute terms and as a percentage of net sales due to increased sales volume. 23-------------------------------------------------------------------------------- Table of Contents Operating Income Fifty-two weeks ended Fifty-three weeks ended February 2, February 3, 2014 2013 $ Change % Change % Net Sales % Net Sales Casegoods $ 10,590 7.3 % $ 11,953 8.5 % $ (1,363 ) -11.4 % Upholstery 1,913 2.3 % 987 1.3 % 926 93.8 % Consolidated $ 12,503 5.5 % $ 12,940 5.9 % $ (437 ) -3.4 % Operating income decreased for fiscal 2014 compared to the prior-year both as a percentage of net sales and in absolute terms, due to the factors discussed above. The operating loss for our H Contract and Homeware initiatives was $1.5 million, which is reported in our casegoods segment. Income Taxes Fifty-two weeks ended Fifty-three weeks ended February 2, February 3, 2014 2013 $ Change % Change % Net Sales % Net Sales Consolidated income tax expense $ 4,539 2.0 % $ 4,367 2.0 % $ 172 3.9 % Effective Tax Rate 36.4 % 33.6 % We recorded income tax expense of $4.5 million during fiscal 2014, compared to $4.4 million for fiscal 2013, due primarily to our effective tax rate rising, which primarily resulted from a decrease in the favorable permanent difference attributable to the annual gain associated with Company-owned life insurance. Net Income and Earnings Per Share Fifty-two weeks ended Fifty-three weeks ended February 2, February 3, 2014 2013 $ Change % Change % Net Sales % Net Sales Consolidated $ 7,929 3.5 % $ 8,626 4.0 % $ (697 ) -8.1 % Earnings per share $ 0.74 $ 0.80 24-------------------------------------------------------------------------------- Table of Contents Fiscal 2013 Compared to Fiscal 2012 Net Sales Fifty-three weeks ended Fifty-two weeks ended February 3, January 29, 2013 2012 $ Change % Change % Net Sales % Net Sales Casegoods $ 141,064 64.6 % $ 147,927 66.5 % $ (6,863 ) -4.6 % Upholstery 77,295 35.4 % 74,578 33.5 % $ 2,717 3.6 % Consolidated $ 218,359 100.0 % $ 222,505 100.0 % $ (4,146 ) -1.9 % FY13 % FY13 % Increase vs. Increase vs. Unit Volume FY12 Average Selling Price FY12 Casegoods -19.7 % Casegoods 17.8 % Upholstery -4.3 % Upholstery 7.9 % Consolidated -15.8 % Consolidated 15.7 % The decrease in consolidated net sales was principally due to lower unit volume, particularly in our casegoods segment, partially offset by higher average selling prices in both segments. The casegoods sales decrease was driven by out-of-stock positions on several key items, groups and collections in the first half of the 2013 fiscal year and decreased discounting. The out-of-stock positions were primarily due to overly-aggressive inventory reductions that began in fiscal 2012 and continued into the fiscal 2013 first six months. To a lesser extent and consistent with our fiscal 2012 fourth quarter, vendor shifts from China to other Asian countries resulted in the delay of several well-placed new casegoods collections and negatively impacted fiscal 2013 first six month sales. These vendor shifts contributed to the out-of-stock positions and increased the demand for our best-selling, in-stock products. This accelerated demand cycle hastened the out-of-stock position on best sellers. Sales of imported products in fiscal 2012 were driven by heavy discounting, intended to reduce inventory of slow selling and discontinued products. Upholstery net sales increased compared to the same prior-year period, primarily due to increased average selling prices, partially offset by lower unit volume. Because we report on a fiscal year that ends on the Sunday closest to January 31st of each year, the 2013 fiscal year was one week longer than the comparable 2012 fiscal year. The following table presents average net sales per shipping day in thousands for the 2013 and 2012 fiscal years: Average Net Sales Per Shipping Day Fifty-three weeks ended % Fifty-two weeks ended February 3, 2013 Change January 29, 2012 Casegoods $ 553 -6.1 % $ 589 Upholstery 303 1.9 % 297 Consolidated $ 856 -3.8 % $ 886 Shipping Days 255 251 25-------------------------------------------------------------------------------- Table of Contents Gross Profit Fifty-three weeks ended Fifty-two weeks ended February 3, January 29, 2013 2012 $ Change % Change % Net Sales % Net Sales Casegoods $ 38,054 27.0 % $ 37,550 25.4 % $ 504 1.3 % Upholstery 14,492 18.8 % 11,313 15.2 % 3,179 28.1 % Consolidated $ 52,546 24.1 % $ 48,863 22.0 % $ 3,683 7.5 % As a percentage of net sales, consolidated gross margin increased, primarily due to decreased discounting in both segments and lower domestic upholstery manufacturing costs as a percentage of net sales, partially offset by modestly higher costs on some of our imported products. The higher levels of product discounting in fiscal 2012 were primarily due to efforts to reduce slow-moving inventory levels. In absolute terms, consolidated gross profit increased, primarily due to improved upholstery segment performance, partially offset by the decline in casegoods net sales discussed above. Selling and Administrative Expenses Fifty-three weeks ended Fifty-two weeks ended February 3, January 29, 2013 2012 $ Change % Change % Net Sales % Net Sales Casegoods $ 26,102 18.5 % $ 26,905 18.2 % $ (803 ) -3.0 % Upholstery 13,504 17.5 % 13,470 18.1 % 34 0.3 % Consolidated $ 39,606 18.1 % $ 40,375 18.1 % $ (769 ) -1.9 % Casegoods selling and administrative expenses increased as a percentage of net sales primarily due to the net sales decrease discussed above, but decreased in absolute terms, primarily due to: ††† increased amounts billed to our imported upholstery division for its share of administrative costs compared to prior periods; ††† lower contributions expense, due to lower levels of distressed inventory; ††† lower bad debt expense, due to favorable collections experience; ††† reduced advertising and sample expenses, due to cost-cutting measures; and ††† lower sales and design commissions, due to lower net sales. These expense improvements were partially offset by increases in: ††† bonus expense, due to the reversal of an accrual for long-term performance grant awards in the comparable prior-year period; ††† salary expense, primarily due to an executive promotion and other salary increases; and ††† fees for professional services, due to additional fees for several corporate initiatives. Upholstery selling and administrative expenses decreased as a percentage of net sales, primarily due to decreases in: ††† salary expense, due to an executive promotion to a corporate position and cost reduction efforts undertaken in fiscal 2012; ††† benefits expense, due to decreased headcount and lower health claims; and ††† sample and advertising expenses, due to cost-cutting measures. These decreases were partially offset by an increase in the upholstery segment's share of Company-wide administrative costs. 26-------------------------------------------------------------------------------- Table of Contents Operating Income Fifty-three weeks ended Fifty-two weeks ended February 3, January 29, 2013 2012 $ Change % Change % Net Sales % Net Sales Casegoods $ 11,953 8.5 % $ 10,644 7.2 % $ 1,309 12.3 % Upholstery 987 1.3 % (3,971 ) -5.3 % 4,958 124.9 % Consolidated $ 12,940 5.9 % $ 6,673 3.0 % $ 6,267 93.9 % Operating profitability increased both as a percentage of net sales and in absolute terms, due to the factors discussed above. The upholstery segment returned to operating profitability during the 2013 fiscal first quarter and, despite a modest operating loss in the fiscal 2013 second quarter, posted an operating profit for fiscal 2013. The upholstery segment has returned to operating profitability due to operational improvements and the non-recurrence of intangible asset impairment charges in fiscal 2013. During the fourth quarter of fiscal 2012, our upholstery segment recorded a non-cash intangible asset impairment charge of $1.8 million ($1.1 million, or $0.10 per share, after tax) to write-down the value of the Bradington-Young trade name. We wrote down the carrying value of the Bradington-Young trade name because of operating losses incurred in that division through fiscal 2012. Income Taxes Fifty-three weeks ended Fifty-two weeks ended February 3, January 29, 2013 2012 $ Change % Change % Net Sales % Net Sales Consolidated income tax expense $ 4,367 2.0 % $ 1,888 0.8 % $ 2,479 131.4 % Effective Tax Rate 33.6 % 27.2 % We recorded income tax expense of $4.4 million during fiscal 2013, compared to $1.9 million for fiscal 2012, due primarily to an increase in pre-tax income. Our effective tax rate rose to 33.6% from 27.2%. The effective rate in fiscal 2013 was higher than in fiscal 2012 mainly because our taxable income was higher and the dollar value of the favorable permanent differences we recognized each year (for officers' life insurance, distributions received from our offshore insurance affiliate and charitable contributions of inventory) remained fairly constant in dollar terms, but as a percentage of taxable income the benefit was significantly smaller. Net Income and Earnings Per Share Fifty-three weeks ended Fifty-two weeks ended February 3, January 29, 2013 2012 $ Change % Change % Net Sales % Net Sales Net Income Consolidated $ 8,626 4.0 % $ 5,057 2.3 % $ 3,569 70.6 % Earnings per share $ 0.80 $ 0.47 27-------------------------------------------------------------------------------- Table of Contents Financial Condition, Liquidity and Capital Resources Balance Sheet and Working Capital The following chart shows changes in our total assets, current assets, current liabilities, net working capital and working capital ratio at February 2, 2014 compared to February 3, 2013: Balance Sheet and Working Capital February 2, 2014 February 3, 2013 $ Change Total Assets $ 155,481 $ 155,823 $ (342 ) Cash $ 23,882 $ 26,342 $ (2,460 ) Trade Receivables 29,393 28,272 1,121 Inventories 49,016 49,872 (856 ) Prepaid Expenses & Other 4,758 5,181 (423 ) Total Current Assets $ 107,050 $ 109,667 $ (2,618 ) Trade accounts payable $ 7,077 $ 11,620 $ (4,543 ) Accrued salaries, wages and benefits 3,478 3,316 162 Other accrued expenses, commissions and deposits 2,352 2,531 (180 ) Total current liabilities $ 12,907 $ 17,467 $ (4,560 ) Net working capital $ 94,142 $ 92,200 $ 1,942 Working capital ratio 8.3 to 1 6.3 to 1 As of February 2, 2014, total assets decreased $342,000 compared to fiscal 2013, due principally to decreased cash balances and inventories, partially offset by increased cash surrender value of Company-owned life insurance net property, plant and equipment and income tax recoverable. Cash decreased primarily due to the reduction in accounts payable resulting from the timing of payments. Inventory decreased from our efforts to match inventory levels with projected demand. Cash surrender value of Company-owned life insurance increased due to premiums paid during fiscal 2014. Property, plant and equipment, net, increased primarily due to expenditures related to our ongoing ERP efforts and other capital projects to enhance our facilities and operations, partially offset by normal depreciation. Fiscal 2014 year-end net working capital (current assets less current liabilities) increased compared to the 2013 fiscal year-end, primarily due to larger decreases in current liabilities than in current assets. Current liabilities decreased $4.6 million primarily due to: ††† decreased accounts payable due to lower inventory purchases, from our efforts to match inventory levels with projected demand; and decreased accrued expenses due to the timing of income tax payments. Current assets decreased $2.6 million primarily due to: ††† decreased cash balances as we paid down outstanding accounts payable balances; and ††† decreased inventories from our efforts to match inventory levels with projected demand. 28-------------------------------------------------------------------------------- Table of Contents Summary Cash Flow Information - Operating, Investing and Financing Activities Fifty-Two Fifty-Three Fifty-Two Weeks Ended Weeks Ended Weeks Ended February 2, February 3, January 29, 2014 2013 2012 Net cash provided by (used in) operating activities $ 5,696 $ (3,333 ) $ 32,276 Net cash used in investing activities (3,855 ) (4,623 ) (4,229 ) Net cash used in financing activities (4,301 ) (6,057 ) (4,315 ) Net (decrease) increase in cash and cash equivalents $ (2,460 ) $ (14,013 ) $ 23,732 During fiscal 2014, $5.7 million of cash generated from operations, cash on hand and proceeds received on Company-owned life insurance policies of $517,000, funded cash dividends of $4.3 million, purchases of property and equipment of $3.5 million and Company-owned life insurance premium payments of $834,000. Company-owned life insurance policies are in place to compensate us for the loss of key employees, to facilitate business continuity and to serve as a funding mechanism for certain executive benefits. During fiscal 2013, $14 million of cash on hand funded $3.3 million in operating activities, cash dividends of $5.4 million, $671,000 for the purchase and retirement of common stock, capital expenditures of $4.1 million related to our business operating systems and facilities and premiums paid on Company-owned life insurance policies of $902,000. During fiscal 2012, $32.3 million in cash generated from operations funded an increase in cash and cash equivalents of $23.7 million, cash dividends of $4.3 million, capital expenditures of $3.8 million related to our business operating systems and facilities and premiums paid on Company-owned life insurance policies of $1.1 million. Liquidity, Financial Resources and Capital Expenditures We believe that we have the financial resources, including available cash and cash equivalents, expected cash flow from operations, lines of credit and the cash surrender value of Company-owned life insurance, needed to meet business requirements for the foreseeable future, including capital expenditures and working capital, as well as to pay regular quarterly cash dividends on our common stock. Cash flow from operations is highly dependent on incoming order rates and our operating performance. As of February 2, 2014, we had an aggregate $12.9 million available under our revolving credit facility to fund working capital needs. Standby letters of credit in the aggregate amount of $2.1 million, used to collateralize certain insurance arrangements and for imported product purchases, were outstanding under the revolving credit facility as of February 2, 2014. There were no additional borrowings outstanding under the revolving credit facility on February 2, 2014. Loan Agreement and Revolving Credit Facility We have a $15 million unsecured revolving credit facility under a loan agreement with Bank of America, N.A., up to $3.0 million of which can be used to support letters of credit. The loan agreement allows the Company to permanently terminate or reduce the $15 million revolving commitment without penalty and includes, among others, the following terms: ††† a maturity date of July 31, 2018; ††† a floating interest rate, adjusted monthly, based on LIBOR, plus an applicable margin based on the ratio of our funded debt to our EBITDA (each as defined in the loan agreement); ††† a quarterly unused commitment fee of 0.20%; and ††† no pre-payment penalty. 29-------------------------------------------------------------------------------- Table of Contents The loan agreement also includes customary representations and warranties and requires us to comply with customary covenants, including, among other things, the following financial covenants: ††† Maintain a tangible net worth of at least $95.0 million; ††† Limit capital expenditures to no more than $15.0 million during any fiscal year; and ††† Maintain a ratio of funded debt to EBITDA not exceeding 2.0:1.0. We were in compliance with each of these financial covenants at February 2, 2014 and expect to remain in compliance with existing covenants for the foreseeable future. The loan agreement does not restrict our ability to pay cash dividends on, or repurchase shares of, our common stock, subject to complying with the financial covenants under the agreement. Factoring Arrangement We factor substantially all of our domestic upholstery accounts receivable, in most cases without recourse to us. We factor these receivables because factoring: ††† allows us to outsource the administrative burden of the credit and collections functions for our domestic upholstery operations; ††† allows us to transfer the collection risk associated with the majority of our domestic upholstery receivables to the factor; and ††† provides us with an additional, potential source of short-term liquidity. Capital Expenditures We expect to spend between $3 million to $4 million in capital expenditures in the 2015 fiscal year to maintain and enhance our operating systems and facilities. Of these estimated amounts, we expect to spend approximately $1.1 million on the implementation of our ERP system in our upholstery segment during fiscal 2015. Enterprise Resource Planning Our new Enterprise Resource Planning (ERP) system became operational for our casegoods and imported upholstery operations early in the third quarter of fiscal 2013. ERP conversion efforts began for our domestic upholstery units early in the fiscal 2014 first quarter, with full implementation scheduled to be completed during fiscal 2015. Once both segments are fully operational on the ERP platform, we expect to realize operational efficiencies and cost savings as well as present a single face to our customers and leverage best practices across the organization. Cost savings are difficult to quantify until the ERP system becomes fully operational Company-wide. We expect to be able to reduce administrative functions, which are presently duplicated across our segments and improve our purchasing power and economies of scale. In addition to the capital expenditures discussed above, our ERP implementation will require a significant amount of time invested by our associates. We refer you to Item "1A. Risk Factors", above, for additional discussion of risks involved in our ERP system conversion and implementation. Share Repurchase Authorization During the fiscal 2013 first quarter, our Board of Directors authorized the repurchase of up to $12.5 million of the Company's common shares. The authorization does not obligate us to acquire a specific number of shares during any period and does not have an expiration date, but it may be modified, suspended or discontinued at any time at the discretion of our Board of Directors. Repurchases may be made from time to time in the open market, or through privately negotiated transactions or otherwise, in compliance with applicable laws, rules and regulations, and subject to our cash requirements for other purposes, compliance with the covenants under the loan agreement for our revolving credit facility and other factors we deem relevant. We have entered into a trading plan under Rule 10b-18 and Rule 10b5-1 of the Securities Exchange Act of 1934 for effecting some or all of the purchases under this repurchase authorization. The trading plan contains provisions that could restrict the amount and timing of purchases. We can terminate this plan at any time. In fiscal 2013, we used approximately $671,000 of the authorization to purchase 57,700 of our common shares (at an average price of $11.63 per share). No shares were purchased during fiscal 2014. Approximately $11.8 million remains available for future purchases under the authorization as of the end of the 2014 fiscal year. 30-------------------------------------------------------------------------------- Table of Contents Dividends On March 4, 2014, our Board of Directors declared a quarterly cash dividend of $0.10 per share, payable on March 31, 2014 to shareholders of record at March 17, 2014. Commitments and Contractual Obligations As of February 2, 2014, our commitments and contractual obligations were as follows: Cash Payments Due by Period (In thousands) Less than More than 1 Year 1-3 Years 3-5 Years 5 years Total Deferred compensation payments (1) $ 354 $ 1,490 $ 1,398 $ 8,494 $ 11,736 Operating leases (2) (3) 924 939 6 - 1,869 Other long-term obligations (4) 734 22 - - 756 Total contractual cash obligations $ 2,012 $ 2,451 $ 1,404 $ 8,494 $ 14,361 __________________ (1) These amounts represent estimated cash payments to be paid to participants in our supplemental retirement income plan or "SRIP" through fiscal year 2038, which is 15 years after the last current SRIP participant is assumed to have retired. The present value of these benefits (the actuarially derived projected benefit obligation for this plan) was approximately $7.7 million at February 2, 2014 and is shown on our consolidated balance sheets, with $354,000 recorded in current liabilities and $7.3 million recorded in long-term liabilities. In addition, the monthly retirement benefit for each participant, regardless of age, would become fully vested and the present value of that benefit would be paid to each participant in a lump sum upon a change in control of the Company as defined in the plan. See note 11 to the consolidated financial statements beginning on page F-18 for additional information about the SRIP. (2) These amounts represent estimated cash payments due under operating leases for office equipment, warehouse equipment and real estate utilized in our operations. See Item 2 "Properties," for a description of our leased real estate. (3) On April 1, 2014, we entered into a new, seven-year operating lease for a 628,000 square foot warehouse facility that we currently lease in Henry County, Virginia. We currently occupy approximately 400,000 square feet of this facility. We expect that the new lease will increase the operating lease obligations shown above by the following amounts (in thousands): ††† Less than 1 Year: $942 ††† 1-3 Years: $2,321 ††† 3-5 Years: $2,415 ††† More than 5 Years: $2,725 See note 20 to the consolidated financial statements on page F-29 for additional information about this lease. (4) These amounts represent estimated cash payments due under various long-term service and support agreements, for items such as warehouse management services, information technology support and human resources related consulting and support. Off-Balance Sheet Arrangements Standby letters of credit in the aggregate amount of $2.1 million, used to collateralize certain insurance arrangements and for imported product purchases, were outstanding under our revolving credit facility as of February 2, 2014. See the "Commitments and Contractual Obligations" table above and Note 16 to the consolidated financial statements included in this annual report on Form 10-K for additional information on our off-balance sheet arrangements. 31-------------------------------------------------------------------------------- Table of Contents Recently Issued Accounting Pronouncements In December 2011, the Financial Accounting Standards Board issued Accounting Standards Update No. 2011-12,"Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05," which deferred the requirement to present on the face of the financial statements items that are reclassified from other comprehensive income to net income. In February 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update No. 2013-02, which finalized the reporting requirements of reclassifications out of accumulated other comprehensive income. We adopted this guidance beginning in the first quarter of fiscal year 2014 when it was required. The adoption of this update did not have a material effect on our statements of income, financial position or cash flows. In December 2011, the FASB issued Accounting Standards Update No. 2011-11, "Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities," which requires disclosure of both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to agreements similar to master netting arrangements. In January 2013, the Financial Accounting Standards Board issued Accounting Standards Update No. 2013-01, "Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities," which clarified the scope of Accounting Standards Update No. 2011-11. We adopted this guidance beginning in the first quarter of fiscal year 2014 when it was required. The adoption of this update did not have a material effect on our statements of income, financial position or cash flows. Strategy Our strategy is to offer world-class style, quality and product value as a complete residential casegoods and upholstered furniture resource through excellence in product design, global sourcing, manufacturing, logistics, sales, marketing and customer service. We strive to be an industry leader in sales growth and profitability performance, thereby providing an outstanding investment for our shareholders and contributing to the well-being of our customers, employees, suppliers and communities. Additionally, we strive to nurture the relationship-focused, team-oriented and honor-driven corporate culture that has distinguished our company for over 90 years. Fiscal 2014 in Review Casegoods Segment Casegoods sales have been slower to regain their pre-recession momentum, possibly due to the longer life of wood furniture and its higher average purchase prices compared to upholstery. However, we are shipping better than last year thanks to a much improved inventory position and the strength of our best-selling lines. In the fiscal 2014 third quarter, we hired a seasoned furniture design professional who is focusing on expanding our merchandising reach in the "good" and "better" parts of our "good-better-best" product offerings. In fiscal 2015, we expect to bring a strong assortment of good and better casegoods to market, as well as a new program that will allow retailers to order mixed containers of good and better-priced products that will allow us to offer more competitive prices in this market segment. Our goal is to have the strongest possible offerings at all three levels of good, better and best merchandise. We believe this will increase our competitiveness and give us further opportunities to grow sales and market share. Upholstery Segment We have seen significant improvement in our upholstery segment results since early in the 2013 fiscal year thanks to higher sales volume and to a number of cost control initiatives. The upholstery segment has higher fixed costs than our casegoods segment, due to the upholstery segment's domestic manufacturing operations. To mitigate the impact of sales declines in recent years, we streamlined our upholstery operations by improving efficiency, reducing overhead and operating costs and adjusting capacity to better match costs to current and expected sales volume levels. Further significant cost reductions in our upholstery segment will be challenging. Future profitability increases will continue to require us to increase sales while maintaining Bradington-Young gross margins at, or close to, current levels and improving manufacturing processes and work flow at Sam Moore facility. 32-------------------------------------------------------------------------------- Table of Contents We believe that the upholstery segment product lines are gaining market share due to: ††† the expansion of Sam Moore's product offering to include sofas, sectionals, recliners and ottomans, in addition to the core decorative chair line; ††† the success of Bradington-Young's Comfort@Home gallery program, which is now in approximately 150 retailers. Growth among our Comfort@Home dealers has outpaced the rest of our dealer base and the Comfort@Home program now drives approximately 35% of our domestic leather business; ††† the success of Bradington-Young's "So You!" highly customizable special order program introduced at the 2013 October High Point International Home Furnishings Market; and ††† an approximate 7.0% increase in incoming order rates at Seven Seas for the 2014 fiscal year. At Sam Moore, the challenge of increasing production, expanding capacity and improving manufacturing productivity has proven greater than expected. Over the last several quarters, we have continued to hire new manufacturing associates, but it typically takes at least six to nine months before a new sewer or upholsterer makes a direct contribution. Consequently, we have incurred significant training and overtime costs. Due to these production challenges and increased sales, our order backlog was 40% higher at the end of the fiscal 2014 third quarter as compared to the end of the fiscal 2013 third quarter. However, we have made significant progress in boosting our capacity and believe we have reached a turning point where our capacity has now exceeded our order rate. Consequently, we successfully reduced our backlog over the fiscal 2014 fourth quarter by approximately 18% compared to our fiscal 2014 third quarter to more historical levels. This has allowed us to improve our service to retailers; however, Sam Moore was not profitable in the 2014 fiscal year. As we move forward, we expect to continue to reduce our order backlog to our targeted four to five week level and also expect to reduce our training and overtime costs for additional savings. While the progress has been slower than we would like, we are optimistic about the long-term future for both sales growth and achieving profitability at Sam Moore. We continue to face inflationary pressures on leather and other upholstery raw materials, such as plywood, and we implemented two price increases in the second half of fiscal 2014. Inflation in leather and foreign labor costs are a particular challenge for our imported Seven Seas Seating line, since it is positioned as a more affordable, moderately-priced leather line and is in a more price-sensitive niche. In order to mitigate the impact of leather and raw materials inflation we aggressively expanded the product offerings in our Seven Seas product line and introduced stationary sofas and sectionals at some very attractive wholesale price points at the October 2013 High Point International Home Furnishings Market. We expect that leather raw material cost increases will be a challenge for the foreseeable future on our premium leather products, too, since we believe the price increases are a function of demand for leather outpacing supply. Rising leather costs present inventory challenges for us and we are forced to pass along the increases to our customers. We expect to be successful in increasing prices in both operating segments to offset rising expenses for raw materials and imported products; however, we cannot predict the magnitude of the impact on the demand for these products. Bradington-Young was fairly flat in net sales growth, but reported operating income for sixteen consecutive months through the fiscal year just ended, demonstrating sustainable profitability after several unprofitable years. Despite these challenges in our upholstery segment, we were pleased to have grown upholstery and to have improved profitability in total for the year. New Initiatives Our H Contract product line, which supplies upholstered seating and casegoods to upscale senior living facilities throughout the country, officially launched early in the fiscal 2014 second quarter. It has been well received in initial meetings with designers, architects and end-users across the country. H Contract products have been included in a number of upcoming projects, which we expect to positively impact sales well into fiscal 2015. While H Contract is still operating somewhat below expectations, we are beginning to see sales momentum. Based on our current forecast, we expect H Contract to contribute positively to consolidated operating profitability in fiscal 2015. 33-------------------------------------------------------------------------------- Table of Contents Our Homeware product line, featuring customer-assembled, modular upholstered and casegoods products designed for younger and more mobile furniture customers, officially launched in August 2013 on two major home furnishings e-commerce websites. During our fiscal third quarter, we added a third e-commerce website. Early in our fiscal fourth quarter, we launched the Homeware.com website and hired a seasoned e-commerce development professional to help drive traffic to Homeware.com. With about ten months of experience in this business, we are enthusiastic about the brand and the future of online furniture retailing. We have seen steady improvement in month-over-month website traffic and other key performance indicators, along with double-digit month-over-month sales gain in recent months from a low base. In the coming fiscal year, we've planned at least four major rollouts of new product lines, including home entertainment furniture, major upholstery such as sofas and sectionals and the home décor categories of rugs, lighting and mirrors, and casual dining furniture. Expanding the product line will be an important catalyst for growth. We believe the Homeware initiative is critical to address the migration of retail business to online outlets, but realize it will take longer than H Contract to reach critical mass and profitability. However, we view this investment as a vital step toward the future of consumer-centric home furnishings retailing. Collectively, these new ventures increased net sales by approximately $1.5 million. Startup costs associated with both new product lines were approximately $2.1 million before tax, and $1.4 million after-tax, or $0.13 per share, in fiscal 2014. Results from these new business initiatives are aggregated with the results from our casegoods operating segment. Review of Fiscal 2014 Goals In our fiscal 2013 annual report on Form 10-K, we outlined goals for fiscal 2014. Those goals and our fiscal 2014 performance are assessed below. · Develop the right product: ††† We increased casegoods and upholstery segment net sales. · Continue to refine our import supplier base with our product standards for quality, delivery, value and cost: ††† We reduced the number of factories we use and strengthened our relationships with the remaining suppliers, who we believe best meet our product expectations; and ††† Investigated and took initial steps toward implementing a consolidating warehouse in Vietnam, in order to offer more container direct options for products from our Vietnamese suppliers. · Build on upholstery segment profitability by continuing to focus on labor efficiency, cost reduction projects and volume increases driven by new and updated products and improved volume at key retailers: ††† Our upholstery segment operating profitability nearly doubled in fiscal 2014; ††† We continued successful expansion of Sam Moore's product offering to include sofas, sectionals, recliners and ottomans, in addition to the core decorative chair line; ††† Sam Moore provided product development expertise for H Contract and Homeware upholstery; ††† We continued successful expansion of Bradington-Young's Comfort@Home gallery program; and ††† We successfully launched Bradington-Young's "So You!" highly customizable special order program introduced at the October 2013 High Point International Home Furnishings Market. ††† However, operating losses increased at Sam Moore, which partially offset the gains discussed above, as Sam Moore struggled to increase manufacturing capacity during the year. · Improve casegoods segment volume and build on its profitability improvements by continued focus on offering strong product lines, limiting discounting through improved inventory management and growing our international business: ††† While casegoods net sales increased, unit volume and operating profitability decreased in fiscal 2014; ††† Discounting increased as we exited our youth and other slow-moving product lines; ††† We began to see improvements in inventory management due to sales and operations planning disciplines implemented during fiscal year 2013; and ††† Our international business began to grow again in fiscal 2014, with net sales increasing approximately 13% compared to fiscal 2013. · Work towards implementing our ERP system in our domestic upholstery operation in fiscal 2015: ††† Substantial progress was made in our upholstery segment ERP project in fiscal 2014 and we expect to complete implementation during fiscal 2015. 34-------------------------------------------------------------------------------- Table of Contents · Build on our fiscal 2013 efforts to connect directly with our consumers: ††† Our Preferred Partner Program or "P3", a digital marketing partnership with our key independent retailers, met with a great deal of interest, but as a new program offered to an unfamiliar customer base, the program was slow to pay benefits. We re-launched the P3 program in the fiscal 2014 fourth quarter by holding two 'dealer summits' which brought together retailers, digital marketing experts and several successful current P3 participants for a day of education, information sharing and exchange of ideas. · Expand into the senior living market: ††† H Contract was launched, as planned, in April 2013 at a national trade show for the senior living industry. Throughout the year, we developed sales materials, built an internal staff and a sales force and spent a great deal of time getting to know the industry and our potential customers. Several months after launch, we began shipping market-specific upholstery products as well as accent and occasional wood furniture into this new distribution channel. Our network of sales representatives now reaches 75% of the US and H Contract is steadily becoming a factor in its segment. · Launch our new Homeware line: ††† Homeware was launched in August 2013. Building this brand, with a unique product in a distribution channel that is new to us, and to much of the furniture industry, has been slow but we remain enthusiastic about the product and the future of on-line furniture retailing. Following a mid-summer introduction with on-line retailers, we launched our own e-retail site in time for the Christmas shopping season. In addition to our unique, ready to assemble, easy to ship chairs, we introduced other home accessories on the site, helping us build brand recognition and traffic to www.homeware.com. Outlook Given the mostly positive macro-economic news over the past year, we are optimistic about our longer-term future, both with our core businesses and our new ventures. In particular, recent news about record U.S. household wealth, rising home prices and increased home equity is particularly encouraging, since we believe our performance is tied to the strength of the U.S. housing market, and is particularly sensitive to consumer confidence, which is, in part, tied to household wealth and financial markets. We believe we are positioned to capitalize on continued improvements in the economy as they occur. In the shorter-term, however, the recovery in furniture sales has been somewhat inconsistent and skewed toward upholstery, which is typically a smaller ticket purchase and generally has lower profit margins. Additionally, the combined impact of rising mortgage rates and slowing home sales could adversely impact our short-term results. As we enter fiscal 2015, we have seen decreased demand for our products compared to the same period a year ago, which we attribute to a particularly rough winter in many parts of the country. However, we continue to increase production capacity at our upholstery manufacturing facilities, maintain good inventory positions on our best-selling casegoods products and promote what we believe to be our strongest product line in several years. As we progress through fiscal 2015, we will continue to focus on: ††† pursuing additional distribution channels, including through our new H Contract and Homeware initiatives; ††† controlling costs; ††† expanding our merchandising reach in the "good" and "better" parts of our "good-better-best" casegoods product offerings; ††† adjusting product pricing on our main-line products in order to mitigate inflation and improve margins; ††† achieving proper inventory levels, while optimizing product availability on best-selling items; ††† sourcing product from cost-competitive locations and from quality-conscious sourcing partners and strengthening our relationships with key vendors; ††† improving profitability and production capacity at Sam Moore; ††† offering an array of new products and designs, which we believe will help generate additional sales; and ††† upgrading and refining our information systems capabilities to support our businesses. We face a number of significant risks and uncertainties, as more fully discussed in Item 1A, "Risk Factors" beginning on page 10 and in our "Forward Looking Statements" beginning on page 9, that can affect adversely our results of operations and financial condition. 35-------------------------------------------------------------------------------- Table of Contents Environmental Matters Hooker Furniture is committed to protecting the environment. As a part of our business operations, our manufacturing sites generate non-hazardous and hazardous wastes; the treatment, storage, transportation and disposal of which are subject to various local, state and national laws relating to protecting the environment. We are in various stages of investigation, remediation or monitoring of alleged or acknowledged contamination at current or former manufacturing sites for soil and groundwater contamination, none of which we believe is material to our results of operations or financial position. Our policy is to record monitoring commitments and environmental liabilities when expenses are probable and can be reasonably estimated. The costs associated with our environmental responsibilities, compliance with federal, state and local laws regulating the discharge of materials into the environment, or costs otherwise relating to the protection of the environment, have not had and are not expected to have a material effect on our financial position, results of operations, capital expenditures or competitive position. We participate in a voluntary industry-wide environmental stewardship program referred to as Enhancing Furniture's Environmental Culture or "EFEC." In September of fiscal 2010, the American Home Furnishings Alliance granted us initial EFEC registration, recognizing the successful company-wide implementation of the EFEC program, which includes the successful reduction of water and electricity usage, recycling efforts to reduce landfill use and the implementation of a community outreach program. Since our initial registration we have: ††† recycled over 700,000 pounds of paper, cardboard and plastic; ††† reduced electricity usage by an average of 6% per year; and ††† reduced natural gas usage by an average of 9% per year. We are inspected annually by the EFEC organization in order to maintain our registration under this program and are currently certified through January 2015. Critical Accounting Policies and Estimates Hooker Furniture's significant accounting policies are described in "Note 1 - Summary of Significant Accounting Policies" to the consolidated financial statements beginning at page F-1 in this report. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying financial statements and related notes. In preparing these financial statements, we have made our best estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. We do not believe that actual results will deviate materially from our estimates related to our accounting policies described below. However, because application of these accounting policies involves the exercise of judgment and the use of assumptions as to future uncertainties, actual results could differ materially from these estimates. Allowance for Doubtful Accounts. We evaluate the adequacy of our allowance for doubtful accounts at the end of each quarter. In performing this evaluation, we analyze the payment history of our significant past due accounts, subsequent cash collections on these accounts and comparative accounts receivable aging statistics. Based on this information, along with consideration of the general condition of the economy, we develop what we consider to be a reasonable estimate of the uncollectible amounts included in accounts receivable. This estimate involves significant judgment and actual uncollectible amounts may differ materially from our estimate. Valuation of Inventories. We value all of our inventories at the lower of cost (using the last-in, first-out ("LIFO") method) or market. LIFO cost for all of our inventories is determined using the dollar-value, link-chain method. This method allows for the more current cost of inventories to be reported in cost of sales, while the inventories reported on the balance sheet consist of the costs of inventories acquired earlier, subject to adjustment to the lower of cost or market. Hence, if prices are rising, the LIFO method will generally lead to higher cost of sales and lower profitability as compared to the first-in, first-out ("FIFO") method. We evaluate our inventory for excess or slow moving items based on recent and projected sales and order patterns. We establish an allowance for those items when the estimated market or net sales value is lower than their recorded cost. This estimate involves significant judgment and actual values may differ materially from our estimate. Income Taxes. At times, tax law and generally accepted accounting principles differ in the treatment of certain income and expense items. These items may be excluded or included in taxable income at different times than is required for GAAP or "book" reporting purposes. These differences may be permanent or temporary in nature. 36-------------------------------------------------------------------------------- Table of Contents We determine our annual effective income tax rate based on forecasted pre-tax book income and forecasted permanent book and tax differences. The rate is established at the beginning of the year and is evaluated on a quarterly basis. We consider the level and mix of income of our separate legal entities, statutory tax rates, business credits available in the various jurisdictions in which we operate and permanent tax differences. Significant judgment is required in evaluating tax positions that affect the annual tax rate. Any changes to the forecasted information may cause adjustments to the effective rate. Additional tax, interest and penalties associated with uncertain tax positions are recognized in tax expense on a quarterly basis. To the extent that any book and tax differences are temporary in nature, that is, the book realization will occur in a different period than the tax realization, a deferred tax asset or liability is established. To the extent that a deferred tax asset is created, we evaluate our ability to realize this asset. If we determine that we will not be able to fully utilize deferred tax assets, we establish a valuation reserve. In assessing the realization of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is primarily dependent upon the generation of future taxable income during the periods in which those temporary differences reverse. Restructuring and Impairment of Long-Lived Assets Tangible Assets We regularly review our property, plant and equipment for indicators of impairment, as specified in the Property, Plant and Equipment topic of the Accounting Standards Codification. Although not exhaustive, this accounting guidance lists potential indicators of impairment, which we use to facilitate our review. These potential indicators of impairment include: ††† A significant decrease in the market value of the long-lived asset; ††† A significant adverse change in the extent or manner in which a long-lived asset group is being used, or in its physical condition; ††† A significant adverse change in the legal factors or in the business climate that could affect the value of a long-lived asset, including an adverse action or assessment by a regulator; ††† An accumulation of costs significantly in excess of the amount originally expected to acquire or construct a long-lived asset; ††† A current period operating or cash flow loss or a projection or forecast that demonstrates continuing losses associated with the long-lived asset's use; and ††† A current expectation that more-likely-than-not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The impairment test for our property, plant and equipment requires us to assess the recoverability of the value of the assets by comparing their net carrying value to the sum of undiscounted estimated future cash flows directly associated with and arising from use and eventual disposition of the assets. We principally use our internal forecasts to estimate the undiscounted future cash flows used in our impairment analyses. These forecasts are subjective and are largely based on management's judgment, primarily due to the changing industry in which we compete; changing consumer tastes, trends and demographics; and the current economic environment. We monitor changes in these factors as part of the quarter-end review of these assets. While our forecasts have been reasonably accurate in the past, during periods of economic instability, uncertainty, or rapid change within our industry, we may not be able to accurately forecast future cash flows from our long-lived assets and our future cash flows may be diminished. Therefore, our estimates and assumptions related to the viability of our long-lived assets may change, and are reasonably likely to change in future periods. These changes could adversely affect our consolidated statements of income and consolidated balance sheets. As of February 2, 2014, the fair value of our property, plant and equipment was substantially in excess of its carrying value. When we conclude that any of these assets is impaired, the asset is written down to its fair value. Any impaired assets that we expect to dispose of by sale are measured at the lower of their carrying amount or fair value, less estimated cost to sell; are no longer depreciated; and are reported separately as "assets held for sale" in the consolidated balance sheets, if we expect to dispose of the assets in one year or less. The costs to dispose of these assets are recognized when we commit to a plan of disposal. Severance and related benefits to be paid to terminated employees affected by facility closings are recorded in the period when management commits to a plan of termination. We recognize liabilities for these exit and disposal activities at fair value in the period in which the liability is incurred. Asset impairment charges related to the closure of facilities are based on our best estimate of expected sales prices, less related selling expenses for assets to be sold. The recognition of asset impairment and restructuring charges for exit and disposal activities requires significant judgment and estimates by management. We reassess our accrual of restructuring and asset impairment charges each reporting period. Any change in estimated restructuring and related asset impairment charges is recognized in the period during which the change occurs. 37-------------------------------------------------------------------------------- Table of Contents Intangible Assets We own certain indefinite-lived intangible assets, including those related to Bradington-Young, Sam Moore and Homeware. We may acquire additional amortizable assets and/or indefinite lived intangible assets in the future. Our principal indefinite-lived intangible assets are trademarks, trade names and a URL, which are not amortized but are tested for impairment annually or more frequently if events or circumstances indicate that the asset might be impaired. The fair value of our indefinite-lived intangible assets is determined based on the estimated earnings and cash flow capacity of those assets. The impairment test consists of a comparison of the fair value of the indefinite-lived intangible assets with their carrying amount. If the carrying amount of the indefinite-lived intangible assets exceeds their fair value, an impairment loss is recognized in an amount equal to that excess. Trade names are tested for impairment annually as of the first day of our fiscal fourth quarter or more frequently if events or changes in circumstances indicate that the asset might be impaired. Circumstances that could indicate a potential impairment include, but are not limited to: ††† a significant adverse change in the economic or business climate either within the furniture industry or the national or global economy; ††† significant changes in demand for our products; ††† loss of key personnel; and ††† the likelihood that a reporting unit or significant portion of a reporting unit will be sold or otherwise disposed of. The assumptions used to determine the fair value of our intangible assets are highly subjective and judgmental and include long term growth rates, sales volumes, projected revenues, assumed royalty rates and factors used to develop an applied discount rate. If the assumptions that we use in these calculations differ from actual results, we may realize additional impairment on our intangible assets which may have a material-adverse effect on our results of operations and financial condition. During the fiscal 2012 fourth quarter, we recorded a $1.8 million ($1.1 million after tax, or $0.10 per share) intangible asset impairment charge to write down the value of our upholstery segment's Bradington-Young trade name, due to operating losses in that division over preceding years and near-term performance expectations. Despite this charge, we believe we have taken the proper steps to adjust capacity and reduce the cost structure at Bradington-Young and expect it to continue to contribute to consolidated profitability. At February 2, 2014, the fair value of our Bradington-Young trade name exceeded its carrying value by approximately $257,000, and the fair value of our Sam Moore trade name was approximately $747,000 in excess of its carrying value. Concentrations of Sourcing Risk We source imported products through over 24 different vendors, from 26 separate factories, located in five countries. Because of the large number and diverse nature of the foreign factories from which we can source our imported products, we have some flexibility in the placement of products in any particular factory or country. Factories located in China are an important resource for Hooker Furniture. In fiscal year 2014, imported products sourced from China accounted for approximately 74% of import purchases, and the factory in China from which we directly source the most product accounted for approximately 57% of our worldwide purchases of imported product. A sudden disruption in our supply chain from this factory, or from China in general, could significantly impact our ability to fill customer orders for products manufactured at that factory or in that country. If such a disruption were to occur, we believe that we would have sufficient inventory currently on hand in and in transit to our U.S. warehouses in Martinsville, VA to adequately meet demand for approximately five months, with an additional three months available for immediate shipment from our Asia warehouse. Also, with the broad spectrum of product we offer, we believe that, in some cases, buyers could be offered similar product available from alternative sources. We believe that we could, most likely at higher cost, source most of the products currently sourced in China from factories in other countries and could produce certain upholstered products domestically at our own factories. However, supply disruptions and delays on selected items could occur for five to six months. If we were to be unsuccessful in obtaining those products from other sources, or at comparable cost, then a sudden disruption in the supply chain from our largest import furniture supplier, or from China in general, could have a short-term material adverse effect on our results of operations. Given the capacity available in China and other low-cost producing countries, we believe the risks from these potential supply disruptions are manageable. 38-------------------------------------------------------------------------------- Table of Contents |