Description

Mity Enterprises, Inc. (NASDAQ: MITY) is an exceptional little company ($46 million market cap) with a very high ROE, a solid growth rate, a strong management team and a dominant position in its market niche for premium quality and price folding plastic tables. Mity is trading at an attractive valuation (8x FCF) because the earnings and return-on-capital in its core business are currently hidden by the terrible performance of two small add-on acquisitions. Mity is in the process of exiting these add-on businesses over the next six months, which should make the financials of the core business clearer to investors (e.g. Mity may start to show up on small cap value screens again). In addition, management has not being telling the company’s story in the last 18 months because they have been focused on stabilizing the acquired businesses. Management hopes to re-ignite an investor relations effort sometime this year, including a road show. These factors, as well as internal growth, should be a catalyst for 2x price increase.

Business Overview
Mity is composed of three business segments:

1. Multipurpose Room Furniture:
$38 million in sales with a 20%+ historical growth rate. This is the company’s core business, composed of folding-leg plastic tables, a.k.a. banquet tables (80% of revenue) and stackable plastic chairs (15%). Mity has an amazing 70% market share in the niche for high quality folding plastic tables and serves about a dozen end markets equally. The overall market for folding banquet tables is $400 million, growing 5%. These are the ubiquitous rectangular and circular tables that you see at hotels, schools, conference centers, churches, etc. Most of these banquet tables are made of wood or particleboard. Mity created the market for high quality plastic tables when it was founded in 1987 and it has been taking share from wood tables ever since because its plastic tables are significantly lighter and more durable. Folding tables take a lot of abuse, being stacked and moved on and off of trucks frequently, so wood tables have many disadvantages relative to plastic tables: they are heavy, they splinter and warp, their edges get dented, they show scratches easily, they damage floors and walls when dropped, and if a worker drops one on his foot, it can cause a workers comp claim (this is actually a factor driving demand for Mity’s tables). A heavily used wood table will last a little over one year, whereas Mity’s tables come with 12-year warranties. For these benefits, Mity is able to charge 3x the price of similar-sized wood tables. Mity earns a 40% gross margin on tables and 28% on chairs.

2. Healthcare Seating
This is a very niche $4.4 million in sales business that Mity acquired in 1998. It sells specially designed chairs to healthcare facilities and nursing homes. Management says it has 30% to 40% annual growth potential with 50% gross margins.

3. Specialty Office Seating and Systems
This segment is composed of Mity’s two failed acquisitions: The DO Group (50% acquired in 1997, the remaining 50% acquired in 2000, for a total of $4.2 million) and Centercore (acquired in 1999 for $5.3 million). These companies manufacture specialty seating for a variety of applications including call centers, dispatch centers and control rooms. One of the businesses was acquired in a bank foreclosure and moved from New Jersey to the other acquired company’s facility in Arkansas, contributing to the problem. These businesses have been plagued with operational difficulties from the start and have been losing money. Management has been very upfront about their mistakes and has responded quickly to dispose of this segment. They hired McDonald Investments to sell “all or parts of the company” in February 2001, and in June the board decided to either sell or shut down this segment by March 2002. Management now expects the exit to occur by June 2002. They have had two small asset sales and they are currently talking with several buyers. In the June 30, 2001 quarter management decided to discontinue this segment for reporting purposes and took a charge of $3.3 million to account for the estimated loss on the disposal. Subsequently, this segment has become cash flow positive ($2.0 million of CF from operations in the last two quarters), so it is likely that a portion of this charge will be reversed when the disposal is completed.

Financials and Valuation
Because of its money losing segment, Mity’s EBITDA declined from $8.1 million in fiscal 2000 (ended March 31) to $1.4 million in fiscal 2001, while net income declined from $4.7 million to zero. LTM September 30, 2001 figures are basically the same.

Before the horrendous results of fiscal 2001, Mity was charging along, growing EBITDA 25% annually for the previous five years. In 1999 and 2000 Mity was showing up on Forbes’ and Business Week’s lists of fastest growing small companies. Its ROA and ROE from 1995 to 2000 were 16%-17% and 19%-20%, respectively. Over the same period Mity maintained large cash balances of between $6 million and $11 million, so the ROE ex-cash and interest income was amazing, ranging between 40% and 60%, especially considering the company had no debt.

This does not even tell the whole story. Management calculates that the ROE ex-cash (again, no debt) on its core Multipurpose Room Furniture business was a whopping 90%, 136% and 89% in 1999, 2000 and 2001 respectively. (Note: this ROE calculation is adjusted to exclude $5.4 million of capital expenditures the company invested in the last two years to build a new facility for expanded chair production. See below for a description.) These ROEs are higher than the ROE for the overall business because of the poor results of the Specialty Office segment. They are also higher than the historical ROE because Mity has been able to scale the business without significant capital expenditures. For example, it has moved from single shift to double shift production. I discuss more of the operational reasons for Mity’s awesome profitability below.

The key to valuation is figuring out what the continuing operations are earning. Based on the segment data disclosed in the footnotes, ongoing operations generated EBITDA of $8.2 million for the twelve months ended September 30, 2001. EBIT for the same period is $7.1 million, and based on a 40% tax rate I calculate that net income is $4.3 million before adding interest on the cash. At its current price of $9.10 per share with no debt and $10.5 million of cash, Mity has a $46.4 million market cap and a $35.9 million TEV. This results in a valuation of 4.4x EBITDA, 8.4x earnings (ex-cash) and 1.8x book value. Management thinks capital expenditures going forward will be between $1-$1.2 million (maintenance capex in 2001 and 2000 was $0.9 million and $0.5 million, respectively), which means the core business throws off $4.1 to $4.3 million of free cash flow, before interest income and changes in working capital (Here’s how I calculate FCF: $8.2 million of EBITDA, less $2.9 million of taxes on EBIT, less $1.0/$1.2 million of capex).

Growth and Competition
Management’s goal is to grow the business 20% per year. They conservatively expect the core tables business to grow 5% to 10% per year as opposed to the historical rate of 20%. Mity has three primary competitors in the plastic table segment: Krueger International, Virco and Palmer-Snyder. Virco is also a major manufacturer of wood tables. Mity expects that it will be able to continue to maintain market share because its competitors were later to the market, have a narrower product range, have diversified operations of which plastic tables represent a small part, and because they sell through their existing dealer networks as opposed to Mity’s direct model (see below). Mity has never seen competition from imports and does not anticipate any.

In the last two years Mity has invested $5.4 million to double its manufacturing space and increase its capacity to manufacture plastic chairs by 10x. Management thinks they can grow chair sales 30% to 40% per year off the current base of $5 to $6 million in sales.

The big question is what management will do with the $10.5 million of cash on the balance sheet and the free cash flow the company will generate going forward. Management has said they are considering new product areas, but won’t disclose anything until they have a definite strategy. It is pretty clear that management has learned from the acquisition mistakes and will not likely be making acquisitions soon. On the last quarterly call, the CEO said the board thought $4 to $5 million was the right amount of cash to keep on the balance sheet going forward, indicating that more share buybacks are possible (data on share buybacks is below).

Operational Excellence
Part of what makes Mity such a good company is its strong manufacturing capability and its direct distribution model. Mity has a three to four week order-to-delivery time (compared to several months for most furniture manufacturers) and a remarkable 25x annual inventory turnover in its core business (17x overall), which helps drive its high return-on-capital. They are able to keep inventory levels so low because they don’t start manufacturing until they receive an order. Mity has also been able to double its manufacturing capacity without investing more capital by moving to a second shift of full production.

On the distribution side, Mity has a very successful and unique direct sales approach through its call center staffed with 45 fulltime sales representatives. Most of Mity’s growth comes from proactively cold calling new customers. Sales reps generate leads from the company’s database of 170,000 purchasers, which represent 90% of the potential customers in Mity’s markets. The lower cost of sales by going direct combined with premium pricing gives Mity a 20% operating income margin vs. 10% (or less) for most furniture manufacturers.

Management
The management team is refreshingly forthright and seemingly very shareholder friendly. The CEO, who founded the company in 1987, pays himself less than $200,000 including bonus. In his shareholder letters he talks about “stewardship” and “integrity”, he refers to maintaining the “austerity” of the company’s new offices in order to reduce costs, and he even quotes Buffett. The CEO owns 24% of the shares while two directors, who have each been on the board for 14 years, own another 23%. The company has bought back $2.2 million of its own stock in the last three years and recently announced plans to buy back another 2.5% of the outstanding shares.

Catalyst

In addition to fundamental value, the company is exiting an underperforming segment, which should make the financials of the core business clearer to investors. Also, management hopes to re-ignite an investor relations effort sometime this year (after an 18 month hiatus), including a road show.