Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Description
We are a leading provider of manufactured
vinyl coated fabrics. Our best-known brand, Naugahyde, is the product of many improvements on a rubber-coated fabric developed
a century ago in Naugatuck, Connecticut. We design, manufacture and market a wide selection of vinyl coated fabric products under
a portfolio of recognized brand names. We believe that our business has continued to be a leading supplier in its marketplace because
of our ability to provide specialized materials with performance characteristics customized to the end-user specifications, complemented
by technical and customer support for the use of our products in manufacturing.
Our vinyl coated fabric products have undergone
considerable evolution and today are distinguished by superior performance in a wide variety of applications as alternatives to
leather, cloth and other synthetic fabric coverings. Our standard product lines consist of more than 600 SKUs with combinations
of colors, textures, patterns and other properties. Our products are differentiated by unique protective top finishes and transfer
print capabilities. Additional process capabilities include embossing grains and patterns, and rotogravure printing, which imparts
five color character prints and non-registered prints, lamination and panel cutting.
Our vinyl coated fabric products have various
high-performance characteristics and capabilities. They are durable, stain resistant, easily processed, more cost-effective and
better performing than traditional leather or fabric coverings. Our products are frequently used in applications that require rigorous
performance characteristics such as automotive and non-automotive transportation, certain indoor/outdoor furniture, commercial
and hospitality seating, healthcare facilities and athletic equipment. We manufacture materials in a wide range of colors and textures.
They can be hand or machine sewn, laminated to an underlying structure, thermoformed to cover various substrates or made into a
variety of shapes for diverse end-uses. We are a long-established supplier to the global automotive industry and manufacture products
for interior soft trim components from floor to headliner, which are produced to meet specific component production requirements
such as cut and sew, vacuum forming/covering, compression molding, and high frequency welding. Some products are supplied with
micro perforations, which are necessary on most compression molding processes. Materials can also be combined with polyurethane
or polypropylene foam laminated by either flame or hot melt adhesive for seating, fascia and door applications.
Products are developed and marketed based
upon the performance characteristics required by end-users. For example, for recreational products used outdoors, such as boats,
personal watercraft, golf carts and snowmobiles, a product designed primarily for water-based durability and weatherability is
used. We also manufacture a line of products called BeautyGard®, with water-based topcoats that contain agents to
protect against bacterial and fungal micro-organisms and can withstand repeated cleaning, a necessity in the restaurant and health
care industries. These topcoats are environmentally friendlier than solvent-based topcoats. The line is widely used in hospitals
and other healthcare facilities. Flame and smoke retardant vinyl coated fabrics are used for a variety of commercial and institutional
furniture applications, including hospitals, restaurants and residential care centers and seats for school buses, trains and aircraft.
We currently conduct our operations in
manufacturing facilities that are located in Stoughton, Wisconsin and Earby, England.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial
statements and related disclosures in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires
management to make estimates and judgments that affect our reported amounts of assets and liabilities, revenues and expenses, and
related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and assumptions based
upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable
under the circumstances; however, actual results may vary from these estimates and assumptions under different future circumstances.
For further discussion of our significant accounting policies, refer to Note 1 – “Summary of Significant Accounting
Policies” to the consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition
and Results of Operations – Critical Accounting Policies, Judgments and Estimates” in our Annual Report on Form 10-K
for the fiscal year ended December 29, 2019.
Recent Accounting Pronouncements
See Note 14 – “Recent Accounting
Standards” to the consolidated financial statements for a discussion of recent accounting guidance.
Overview:
The Company and its subsidiaries use a
52/53-week fiscal year ending on the Sunday nearest to December 31. The current year ending January 3, 2021 is a 53-week year
whereas the prior year ended December 29, 2019 was a 52-week year. The Company’s U.K. subsidiaries use the calendar year
end of December 31. The activity of the U.K. subsidiaries that occurs on the days that do not coincide with the Company’s
year-end is not material since there generally is no production or sales during that period. The three months ended April 5, 2020
was a 14-week period and the three months ended March 31, 2019 was a 13-week period.
Our Earby, England operation’s functional
currency is the British Pound Sterling (“Pound Sterling”) and has sales and purchases transactions that are denominated
in currencies other than the Pound Sterling, principally the Euro. Approximately 29% of the Company’s global revenues and
31% of its global raw material purchases are derived from these Euro transactions.
The average year-to-date exchange rate
for the Pound Sterling to the U.S. Dollar was approximately1.7% lower and the average exchange rate for the Euro to the Pound Sterling
was approximately 1.3% lower in 2020 compared to 2019. These exchange rate changes had the effect of decreasing net sales by approximately
$264,000 for the three months ended April 5, 2020. The overall currency effect on the Company’s net loss was a negative amount
of approximately $18,000 for the three months ended April 5, 2020.
On January 27, 2020, the Company announced
a one-for-five reverse stock split (“reverse stock split”) on its common stock that became effective on February 24,
2020. The amounts in common stock and additional paid-in capital as of April 5, 2020 have been adjusted to reflect the reverse
stock split. Share and per share amounts for the three months ended March 31, 2019 have been restated to give effect to the reverse
stock split.
The U.K. exit from the European Union on
January 31, 2020, commonly referred to as Brexit, has caused, and may continue to cause, uncertainty in the global markets. Political
and regulatory responses to the withdrawal are still developing, and we are in the process of assessing the impact that the withdrawal
may have on our business as more information becomes available. Any impact from Brexit on our business and operations over the
long term will depend, in part, on the outcome of tariff, tax treaties, trade, regulatory, and other negotiations the U.K. conducts.
Subsequent to year-end
2019, the World Health Organization declared the novel coronavirus (“COVID-19”) outbreak a public health
emergency. There have been mandates from international, federal, state and local authorities requiring forced closures of
various schools, businesses and other facilities and organizations. These forced closures have negatively impacted the
Company’s business. Primarily due to the negative impact that COVID-19 is having on the global economy, the Company
began to experience a decline in sales during the latter part of March 2020. In order to mitigate the effect of the decrease
in revenue, the Company is managing its costs, which includes temporarily reducing staff at its manufacturing facilities with
production at one-third capacity at the U.S. facility and the entire production staff furloughed at the U.K. facility since
late March and it will remain so until sales increase.
Additionally, the Company has
applied for loans under programs offered by the governmental agencies in the United States and in the United Kingdom and is exploring
options for other supplementary cash flow opportunities to provide further liquidity. During the second quarter of 2020, the Company
received $2.2 million in funds through the Paycheck Protection Program administered by the U.S. Small Business
Administration (“SBA”) under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“the CARES
Act”).
The loan matures on April 13, 2022 and bears an interest rate of 1.0%.
The Company is required to make monthly payments of principal and interest beginning November 13, 2020 based on the amount that
is outstanding on October 13, 2020 in order to fully amortize the loan by April 13, 2022. The loan may be prepaid by the
Company at any time prior to maturity with no prepayment penalties.
All or a portion of the loan may be forgiven by the SBA for costs the Company incurs for payroll, rent, and utilities during the eight-week period beginning
April 13, 2020. The Company intends to use all proceeds from the loan to maintain payroll and make lease and utility payments.
While the closures and limitations
on movement, domestically and internationally, are expected to be temporary due to the COVID-19 outbreak, the duration of the supply
chain disruption and related financial impact cannot be estimated at this time. Should the closures continue for an extended period
of time or should the effects of the coronavirus continue to spread, the impact could have a material adverse effect on the Company’s
financial position, results of operations and cash flows.
Three Months Ended April
5, 2020 Compared to the Three Months Ended March 31, 2019
The following table sets forth, for the
three months ended April 5, 2020 (“three months 2020”) and March 31, 2019 (“three months 2019”), certain
operational data including their respective percentage of net sales:
|
|
|
Three Months Ended
|
|
|
|
|
April 5, 2020
|
|
|
March 31, 2019
|
|
|
Change
|
|
|
%
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
21,140,124
|
|
|
|
100.0
|
%
|
|
|
$
|
25,393,860
|
|
|
|
100.0
|
%
|
|
|
$
|
(4,253,736
|
)
|
|
|
-16.8
|
%
|
|
|
Cost of Goods Sold
|
|
|
17,309,542
|
|
|
|
81.9
|
%
|
|
|
|
21,079,658
|
|
|
|
83.0
|
%
|
|
|
|
(3,770,116
|
)
|
|
|
-17.9
|
%
|
|
|
Gross Profit
|
|
|
3,830,582
|
|
|
|
18.1
|
%
|
|
|
|
4,314,202
|
|
|
|
17.0
|
%
|
|
|
|
(483,620
|
)
|
|
|
-11.2
|
%
|
|
|
Operating Expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling
|
|
|
992,447
|
|
|
|
4.7
|
%
|
|
|
|
1,103,038
|
|
|
|
4.3
|
%
|
|
|
|
(110,591
|
)
|
|
|
-10.0
|
%
|
|
|
General and administrative
|
|
|
1,603,717
|
|
|
|
7.6
|
%
|
|
|
|
1,510,800
|
|
|
|
5.9
|
%
|
|
|
|
92,917
|
|
|
|
6.2
|
%
|
|
|
Research and development
|
|
|
348,402
|
|
|
|
1.6
|
%
|
|
|
|
476,964
|
|
|
|
1.9
|
%
|
|
|
|
(128,562
|
)
|
|
|
-27.0
|
%
|
|
|
Other operating expenses
|
|
|
-
|
|
|
|
0.0
|
%
|
|
|
|
343,003
|
|
|
|
1.4
|
%
|
|
|
|
(343,003
|
)
|
|
|
-100.0
|
%
|
|
|
Total Operating Expenses
|
|
|
2,944,566
|
|
|
|
13.9
|
%
|
|
|
|
3,433,805
|
|
|
|
13.5
|
%
|
|
|
|
(489,239
|
)
|
|
|
-14.2
|
%
|
|
|
Operating Income
|
|
|
886,016
|
|
|
|
4.2
|
%
|
|
|
|
880,397
|
|
|
|
3.5
|
%
|
|
|
|
5,619
|
|
|
|
0.6
|
%
|
|
|
Interest expense
|
|
|
(467,483
|
)
|
|
|
-2.2
|
%
|
|
|
|
(514,296
|
)
|
|
|
-2.0
|
%
|
|
|
|
46,813
|
|
|
|
-9.1
|
%
|
|
|
Other income (expense)
|
|
|
(190,889
|
)
|
|
|
-0.9
|
%
|
|
|
|
228,133
|
|
|
|
0.9
|
%
|
|
|
|
(419,022
|
)
|
|
|
<-100
|
%
|
|
|
Income before Tax Provision
|
|
|
227,644
|
|
|
|
1.1
|
%
|
|
|
|
594,234
|
|
|
|
2.3
|
%
|
|
|
|
(366,590
|
)
|
|
|
-61.7
|
%
|
|
|
Tax benefit
|
|
|
(52,630
|
)
|
|
|
-0.2
|
%
|
|
|
|
(38,868
|
)
|
|
|
-0.2
|
%
|
|
|
|
(13,762
|
)
|
|
|
35.4
|
%
|
|
|
Net Income
|
|
|
280,274
|
|
|
|
1.3
|
%
|
|
|
|
633,102
|
|
|
|
2.5
|
%
|
|
|
|
(352,828
|
)
|
|
|
-55.7
|
%
|
|
|
Preferred stock dividend
|
|
|
(792,835
|
)
|
|
|
-3.8
|
%
|
|
|
|
(782,544
|
)
|
|
|
-3.1
|
%
|
|
|
|
(10,291
|
)
|
|
|
1.3
|
%
|
|
Net Loss Allocable to Common
Shareholders
|
|
$
|
(512,561
|
)
|
|
|
-2.4
|
%
|
|
|
$
|
(149,442
|
)
|
|
|
-0.6
|
%
|
|
|
$
|
(363,119
|
)
|
|
|
>100
|
%
|
|
Revenue:
Total revenue for the three months 2020
decreased $4,253,736 or 16.8% to $21,140,124 from $25,393,860 for the three months 2019. Excluding the negative currency effect
of the exchange rates, total revenue would have decreased by approximately $3,990,000 or 15.7%.
In August 2019, the Company decommissioned
and shut down equipment in the U.K. that manufactured calender product for both the automotive and industrial market. The Company
had built sufficient inventory of this product to service its customers for several months after the shutdown. Shortly before the
shutdown, the Company entered into agreements with another company to provide some of the calender film it originally produced.
Once the film was further processed by the Company, it was able to continue offering certain products to one of its customers.
During the three months 2020, the Company sold $681,138 of calender product principally using the purchased film compared to $1,379,691
for the three months 2019. Of these amounts, $626,607 and $932,639 were in the automotive market for the three months 2020 and
2019, respectively.
For the three months 2020 compared to the
three months 2019, U.S. automotive sales decreased 20.0% and European automotive sales decreased 17.6% (excluding the currency
adjustment). Additionally, sales for the industrial sector decreased 12.0% (11.7% before currency effect) primarily due to a decline
in the U.S. contract market. The negative impact of COVID-19 on the global economy was a major factor in the overall decline in
sales which principally occurred during the latter part of March 2020.
Gross Profit:
Total gross profit for the three months
2020 decreased $483,620 or 11.2% to $3,830,582 from $4,314,202 for the three months 2019. The gross profit percentage improved
to 18.1% of sales for the three months 2020 compared to 17.0% for the three months 2019 primarily due to product mix and efficiencies
that decreased the cost of goods sold. The decrease in gross profit included a negative net currency effect of $65,000. Excluding
this effect, gross profit would have declined by 9.7%.
Operating Expenses:
Selling expenses for the three months 2020
decreased $110,591 or 10.0% to $992,447 from $1,103,038 for the three months 2019. As a result of the closure of the calender product
line and reduced sales, the decrease in selling expense was primarily attributable to a decline in employment and commission costs.
Also contributing to the decrease was the favorable currency effect of $13,000.
General and administrative expenses for
the three months 2020 increased $92,917 or 6.2% to $1,603,717 from $1,510,800 for the three months 2019. This increase was primarily
attributable to employment related and other administrative costs. Partially offsetting the increase was the favorable currency
effect of $17,000.
Research and development expenses for the
three months 2020 decreased $128,562 or 27.0% to $348,402 from $476,964 for the three months 2019. The decrease was principally
attributable to lower development costs for new trials and the favorable currency effect of $3,000.
There were no other operating expenses
for the three months 2020 and $343,003 for 2019. The amount for 2019 was cost incurred by the Company as part of a restructuring
plan to reduce inefficiencies at its U.K. facility.
Operating Income:
Operating income for the three months 2020
increased $5,619 or 0.6% to $886,016 from $880,397 for the three months 2019. The operating income percentage was 4.2% of sales
for the three months 2020 compared to 3.5% for the three months 2019. The increase in operating income was due to the non-recurring charge of $343,003 in 2019, as well as the decrease
in other operating expenses which was mainly offset by the decrease in gross profit primarily due to the decline in net sales.
Interest Expense:
Interest expense for the three months 2020
decreased $46,813 or 9.1% to $467,483 from $514,296 for the three months 2019. The decrease was primarily due to lower interest
rates on LIBOR and prime during the three months 2020 and debt repayments compared to the three months 2019.
Other Income (Expense):
Other expense for the three months 2020
was $190,889 compared to other income of $228,133 for the three months 2019. Included in other income (expense) are the currency
gains and losses recognized on foreign currency transactions and the change in the fair value of financial assets and liabilities
that are denominated in Euros as these currencies fluctuated during the quarter. Also included in other income (expense) are gains
and losses from the change in fair values on the Company’s foreign currency exchange contracts.
Tax Benefit:
The Company files income tax returns in
the United States as a C-Corporation, and in several state jurisdictions and in the United Kingdom. The Company’s U.S. operating
subsidiary, Uniroyal, is a limited liability company (LLC) for federal and state income tax purposes and as such, its income, losses,
and credits are allocated to its members. The Company made the acquisition of Uniroyal through UEPH, a limited liability company,
which issued preferred ownership interests to the sellers that provide for quarterly dividends. Uniroyal’s taxable income
is allocated entirely to UEPH as its sole member and since it is a pass-through entity, this income less the dividends paid to
the sellers of Uniroyal is reported on the Company’s tax return. The taxable income applicable to the dividends for the preferred
ownership interests is reported to the sellers who report it on their respective individual tax returns.
The Company does not have a history of
repatriating a significant portion of its foreign cash. However, if it decided to repatriate these foreign amounts to fund U.S.
operations, the Company would not be required to pay any additional U.S. tax related to these amounts since the Company previously
recorded a one-time transition tax on deemed repatriation of deferred foreign income.
The tax benefit for the three months 2020
was $52,630 compared to $38,868 for the three months 2019. The tax benefit for the three months 2020 was principally attributable
to the results of the U.K. operations while the tax benefit for the three months 2019 was principally attributable to the results
of the U.K. operations partially offset by a tax provision for the U.S. operations.
Preferred Stock Dividend:
The terms of the acquisitions in November
2014 resulted in the issuance of preferred ownership units/stock of UEP Holdings, LLC and UGEL (formerly EPAL) to the sellers.
These preferred units have carried quarterly dividend requirements on a total value of $55,000,000 at rates ranging from 5.0% to
8.0%. The dividend rate on the Series B UEP Holdings preferred units which started at 5.5% increases by 0.5% on the anniversary
of the issuance up to a maximum of 8.0%. The payment of dividends for the three months ended April 5, 2020 and December 29, 2019
was deferred to preserve cash and provide additional liquidity. As of April 5, 2020 and December 29, 2019, accrued dividends of
$1,569,066 and $788,599, respectively, were included in accrued expenses and other liabilities in the accompanying consolidated
balance sheets.
Liquidity and Sources of Capital
Cash, as it is needed, is provided by using
the Company’s lines of credit. These lines provide for a total borrowing commitment in excess of $42,000,000 subject to the
underlying borrowing base specified in the agreements. Of the total outstanding borrowings of $19,784,561 at April 5, 2020, $14.7
million of the lines bears interest at LIBOR or the Eurodollar rate plus a range of 1.95% to 2.45%, depending on the underlying
borrowing base and $5.1 million bears interest at the bank’s prime or base lending rate which was 3.25% at April 5, 2020.
At April 5, 2020, the lines provided an additional availability of approximately $1.9 million. We plan to use this availability
and cash provided by operating activities to finance our cash needs for the remaining months of fiscal 2020 and future periods.
The balances due under the lines of credit are recorded as current liabilities on the consolidated balance sheets.
As previously discussed, the Company has
applied for loans under programs offered by the governmental agencies in the United States and in the United Kingdom. Early in
the second quarter of 2020, the Company received $2.2 million in funds through the Paycheck Protection Program administered by
the United States Small Business Administration. In the U.K., the Company has also received funding available under the Coronavirus
Job Retention Scheme which reimburses the Company with some limitations for 80% of the compensation expense paid to furloughed
employees.
The ratio of current assets to current
liabilities, including the amount due under our lines of credit, was 0.87 at April 5, 2020 and 0.89 at December 29, 2019.
Cash balances increased $368,519, before
the effects of currency translation of $(40,824), to $841,283 at April 5, 2020 from $513,588 at December 29, 2019. Of the above
noted amounts, $692,643 and $498,007 were held outside the U.S. by our foreign subsidiaries as of April 5, 2020 and December 29,
2019, respectively.
Cash provided by operations was $2,164,732
for the three months 2020 compared to $374,184 used in operations for the three months 2019. For the three months 2020, cash provided
by operations was primarily due to changes in working capital of $1,322,814, adjustments for non-cash items of $622,073, net income
of $280,274 offset by changes in other assets and liabilities of $60,429. For the three months 2019, cash used in operations was
primarily due to changes in working capital of $(1,545,990) offset by net income of $633,102, adjustments for non-cash items of
$512,925 and changes in other assets and liabilities of $25,879.
Cash used in investing activities was $484,114
for the three months 2020 compared to $194,752 for the three months 2019. During 2020 and 2019, cash used in investing activities
was principally for purchases of machinery and equipment at our manufacturing locations and payments made for company-owned key
man life insurance premiums.
For the three months 2020, cash used in
financing activities was $1,312,099 compared to $723,319 provided by financing activities for the three months 2019. Impacting
cash flows from financing activities for the three months 2020 and 2019 were net payments on lines of credit of $139,799 and net
advances on lines of credit of $1,624,665, respectively. The changes in the lines of credit reflect the funding of working capital.
There were no preferred dividend payments during the three months 2020 compared to $779,863 during the three months 2019, which
impacted cash flows from financing activities. As previously stated, the dividends for the three months 2020 were deferred to preserve
cash and provide additional liquidity. During the three months 2020, payments of $525,000 were made on subordinated secured promissory
notes to our majority shareholder. There were no similar payments made during the three months 2019.
Our credit agreements contain customary
affirmative and negative covenants. We were in compliance with our debt covenants as of April 5, 2020 and through the date of filing
of this report.
We currently have several on-going capital
projects that are important to our long-term strategic goals. Machinery and equipment will also be added as needed to increase
capacity or enhance operating efficiencies in our manufacturing plants. We will use a combination of financing arrangements to
provide the necessary capital. We believe that our existing resources, including cash on hand and our credit facilities, together
with cash generated from operations and additional bank borrowings, will be sufficient to fund our cash flow requirements through
at least the next twelve months. However, there can be no assurance that additional financing will be available on favorable terms,
if at all.
We have no material off balance sheet arrangements.