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Item 2.
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Management’s Discussion and Analysis of Financial Condition
and Results of Operations
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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 525 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 – “Basis of Presentation and 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 January
3, 2021.
Recent Accounting Pronouncements
See Note 13 – “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 2, 2022 is a 52-week year whereas the prior year ended January
3, 2021 was a 53-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. The three months ended April 4, 2021 was
a 13-week period and the three months ended April 5, 2020 was a 14-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 33% of the Company’s global revenues and 35% 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 approximately 7.8% higher and the average exchange rate for the Euro to the Pound Sterling was approximately 1.3%
higher in 2021 compared to 2020. These exchange rate changes had the effect of increasing net sales by approximately $952,000 for the
three months ended April 4, 2021. The overall currency effect on the Company’s net income was a positive amount of approximately
$68,000 for the three months ended April 4, 2021.
Demand for our products continues to improve since
the initial impact of COVID-19 on the global economy, which began for us in the latter part of March 2020, and as businesses move closer
to resuming normal activities. However, COVID-19 is a continually evolving situation and we cannot predict the long-term impact the coronavirus
will have on the economy or our business. The impact could have a material adverse effect on our financial position, results of operations
and cash flows, which may require us to obtain additional financing. We continue to pursue supplementary cash flow opportunities to provide
further liquidity, as described below.
In March 2021, our U.S. operations received $2.0 million in
funds from One Community Bank through the Paycheck Protection Program (“PPP”) administered by the U.S. Small Business Administration
(“SBA”) under the Coronavirus Aid, Relief, and Economic Security Act (“the CARES Act”). The loan matures in March
2026 and bears an interest rate of 1.0%. The loan may be prepaid 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 we incur for payroll, rent, utilities and all other allowable expenses during the 24-week period that began March 1, 2021. We intend
to use all proceeds from the loan to maintain payroll and make payments for lease, utility and other allowable expenses. As a result,
management believes that we will meet the PPP eligibility criteria for forgiveness and has concluded that the loan represents, in substance,
a government grant that is expected to be forgiven. As such, in accordance with International Accounting Standards (“IAS”)
20, “Accounting for Government Grants and Disclosure of Government Assistance,” we recognized $838,864 as grant income, which
is included as a component of net other income (expense) in the consolidated statement of operations for the three months ended April
4, 2021. As of April 4, 2021, the remaining balance of the loan ($1,161,136) is expected to be recognized as forgiven debt during the
second quarter of 2021.
Three Months Ended April 4, 2021 Compared to the
Three Months Ended April 5, 2020
The following table sets forth, for the three months ended April
4, 2021 (“three months 2021”) and April 5, 2020 (“three months 2020”), certain operational data including their
respective percentage of net sales:
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Three Months Ended
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April 4, 2021
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April 5, 2020
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Change
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%
Change
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Net Sales
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$
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21,896,001
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100.0
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%
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$
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21,140,124
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100.0
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%
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$
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755,877
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3.6
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%
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Cost of Goods Sold
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18,658,664
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85.2
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%
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17,309,542
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81.9
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%
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1,349,122
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7.8
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%
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Gross Profit
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3,237,337
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14.8
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%
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3,830,582
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18.1
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%
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(593,245
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)
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-15.5
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%
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Operating Expenses:
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Selling
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898,712
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4.1
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%
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992,447
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4.7
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%
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(93,735
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)
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-9.4
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%
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General and administrative
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1,579,027
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7.2
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%
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1,603,717
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7.6
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%
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(24,690
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)
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-1.5
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%
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Research and development
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327,458
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1.5
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%
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348,402
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1.6
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%
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(20,944
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)
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-6.0
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%
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Total Operating Expenses
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2,805,197
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12.8
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%
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2,944,566
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13.9
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%
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(139,369
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)
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-4.7
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%
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Operating Income
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432,140
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2.0
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%
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886,016
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4.2
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%
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(453,876
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)
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-51.2
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%
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Interest expense
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(403,746
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)
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-1.8
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%
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(467,483
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)
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-2.2
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%
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63,737
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-13.6
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%
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Funding from Paycheck
Protection Program
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838,864
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3.8
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%
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-
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0.0
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%
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838,864
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-
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Other income (expense)
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206,304
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0.9
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%
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(190,889
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)
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-0.9
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%
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397,193
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<-100
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%
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Income before Tax Provision
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1,073,562
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4.9
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%
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227,644
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1.1
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%
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845,918
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>100
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%
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Tax provision (benefit)
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|
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37,561
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0.2
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%
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(52,630
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)
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-0.2
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%
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90,191
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<-100
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%
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Net Income
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1,036,001
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4.7
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%
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|
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280,274
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1.3
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%
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|
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755,727
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|
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>100
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%
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Preferred stock dividend
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|
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(816,414
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)
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-3.7
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%
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(792,835
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)
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-3.8
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%
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(23,579
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)
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3.0
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%
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Net Income (Loss) Allocable to
Common Shareholders
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$
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219,587
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1.0
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%
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$
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(512,561
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)
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|
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-2.4
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%
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$
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732,148
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|
|
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<-100
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%
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Revenue:
Total revenue for the three months 2021 increased $755,877 or
3.6% to $21,896,001 from $21,140,124 for the three months 2020. The increase in revenue included a favorable currency effect of approximately
$952,000.
For the three months 2021 compared to the three months 2020,
European automotive sales increased 5.8% (excluding the currency adjustment), which was partially offset by the 15.5% decrease in U.S.
automotive sales. The decrease in U.S. automotive sales was primarily due to a slower than expected start to new programs.
Additionally, sales for the industrial sector increased less
than 1.0% (-0.8% before the currency effect) primarily due to a decline in the U.S. contract market. However, future sales in the U.S.
contract market are expected to be more robust as our customers (mainly in the hospitality sector) are placing orders as their businesses
resume pre-coronavirus activities.
Gross Profit:
Total gross profit for the three months 2021 decreased $593,245
or 15.5% to $3,237,337 from $3,830,582 for the three months 2020. The gross profit percentage was 14.8% of sales for the three months
2021 compared to 18.1% for the three months 2020. The lower amount and percentage for the three months 2021 were primarily due to higher
costs of raw materials. To offset raw material price increases, the Company increased prices during the three months 2021 in several of
its markets. The decrease in gross profit was partially offset by a favorable currency effect of approximately $165,000.
Operating Expenses:
Selling expenses for the three months 2021 decreased $93,735
or 9.4% to $898,712 from $992,447 for the three months 2020. Selling expenses decreased primarily due to lower employment costs and travel
expenses, which have not returned to the levels of the period prior to the onset of COVID-19. There was a $45,000 unfavorable currency
effect that partially offset the decrease in selling expenses.
General and administrative expenses for the three months 2021
decreased $24,690 or 1.5% to $1,579,027 from $1,603,717 for the three months 2020. The decrease was primarily due to lower employment
related costs. Partially offsetting the decrease was an unfavorable currency effect of $30,000.
Research and development expenses for the three months 2021
decreased $20,944 or 6.0% to $327,458 from $348,402 for the three months 2020. The decrease was principally due to a decline in activities
such as new trials, which have not returned to the levels of the period prior to the onset of COVID-19. There was a $13,000 unfavorable
currency effect that partially offset the decrease in research and development expenses.
Operating Income:
Operating income for the three months 2021 decreased $453,876
or 51.2% to $432,140 from $886,016 for the three months 2020. The decrease was primarily due to the decline in gross profit, which was
partially offset by the decrease in operating expenses. The operating income percentage was 2.0% of sales for the three months 2021
compared to 4.2% for the three months 2020.
Interest Expense:
Interest expense for the three months 2021 decreased $63,737
or 13.6% to $403,746 from $467,483 for the three months 2020. The decrease was primarily due to lower interest rates on LIBOR and prime
during the three months 2021 compared to the three months 2020.
Funding from Paycheck Protection Program:
For the three months 2021, the $838,864 funding from the PPP
was the amount of proceeds from the PPP loan that the Company used during the first quarter for allowable expenses under the PPP. The
Company expects to receive forgiveness on this debt from the SBA under the CARES Act for these eligible costs incurred by the Company,
as previously discussed.
Other Income (Expense):
Other income for the three months 2021 was $206,304 compared
to other expense of $190,889 for the three months 2020. 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 period.
Tax Provision (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 pass through
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 provision for the three months 2021 was $37,561 compared
to a tax benefit of $52,630 for the three months 2020. The $37,561 tax provision for the three months 2021 was principally attributable
to the results of the U.K. operations partially offset by the tax benefit attributable to the U.S. operations. The $52,630 tax benefit
for the three months 2020 was principally attributable to the results of the U.K. operations.
Preferred Stock Dividend:
Pursuant to the terms of their acquisitions, the issuance of
preferred ownership units/stock of UEP Holdings, LLC and UGEL (formerly EPAL) were issued 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% increased by 0.5% on the anniversary of the issuance and is now at the maximum of 8.0%.
Quarterly dividend payments have been deferred each quarter beginning with the dividends that were accrued for the three months ended
December 29, 2019 through the dividends that were accrued for the three months ended April 4, 2021 in order to preserve cash and provide
additional liquidity. As of April 4, 2021 and January 3, 2021, accrued dividends of $4,775,094 and $4,019,905, 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 $44,000,000 subject to the underlying borrowing base
specified in the agreements. Of the total outstanding borrowings of $18,629,921 at April 4, 2021, $14.3 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 $4.3 million bears interest
at the bank’s prime or base lending rate which was 3.25% at April 4, 2021. The lines provided additional availability of approximately
$2.5 million and, combined with UEP’s and UGL’s total cash balances, liquidity was approximately $4.3 million at April 4,
2021. We plan to use this availability and cash provided by operating activities to finance our cash needs for the remaining months of
fiscal 2021 and future periods. The balances due under the lines of credit are recorded as current liabilities on the consolidated balance
sheets.
Impacting the liquidity discussion above, in March of 2021,
the Company’s U.S. operations received $2.0 million in funds through the Paycheck Protection Program administered by the United
States Small Business Administration. As previously stated, the Company believes that all of this debt will be forgiven.
The ratio of current assets to current liabilities, including the amount due under
our lines of credit, was 0.93 at April 4, 2021 and 0.89 at January 3, 2021.
Cash balances increased $147,102 before the effects of currency
translation of $16,520, to $1,820,504 at April 4, 2021 from $1,656,882 at January 3, 2021. Of the above noted amounts, $285,505 and $1,621,692
were held outside the U.S. by our foreign subsidiaries as of April 4, 2021 and January 3, 2021, respectively.
Cash used in operations was $1,794,634 for the three
months 2021 compared to cash provided by operations of $2,164,732 for the three months 2020. For the three months 2021, cash used in operations was primarily
due to changes in working capital of $(2,725,218) and adjustments for non-cash items of $(141,471) offset by net income of
$1,036,001 and changes in other assets and liabilities of $36,054. 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 and net income of $280,274
offset by changes in other assets and liabilities of $(60,429).
Cash used in investing activities was $252,679 for the three
months 2021 compared to $484,114 for the three months 2020. During 2021 and 2020, 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 2021, cash provided by financing activities
was $2,194,415 compared to cash used in financing activities of $1,312,099 for the three months 2020. Impacting cash flows from financing
activities for the three months 2021 were proceeds from issuance of long-term debt of $2,000,000 through the Paycheck Protection Program.
There was no issuance of long-term debt for the three months 2020. Also impacting cash flows from financing activities for the three months
2021 and 2020 were net advances on lines of credit of $782,781 and net payments on lines of credit of $139,799, respectively. The changes
in the lines of credit reflect the funding of working capital. Payments of $387,443 and $484,533 were also made during the three months
2021 and 2020, respectively, on long-term debt and finance lease liabilities. Additionally during the three months 2020, payments of $525,000
were made on subordinated secured promissory notes to our majority shareholder, net of proceeds of $200,000 from our majority shareholder.
Our credit agreements contain customary affirmative and negative
covenants. We were in compliance with our debt covenants as of April 4, 2021 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 off balance sheet arrangements.