Results of Operations
April 30, 2016 and May 2, 2015
Management's Discussion and Analysis of Financial Condition and Results of
Operations provides information that the Company's management believes necessary
to achieve an understanding of its financial statements and results of
operations. To the extent that such analysis contains statements which are not
of a historical nature, such statements are forward-looking statements, which
involve risks and uncertainties. These risks include, but are not limited to,
changes in the competitive environment for the Company's merchandise, including
the entry or exit of non-traditional retailers of the Company's merchandise to
or from its markets; releases by the music, video and video games industries of
an increased or decreased number of "hit releases", general economic factors in
markets where the Company's merchandise is sold; and other factors discussed in
the Company's filings with the Securities and Exchange Commission. The following
discussion and analysis of the Company's financial condition and results of
operations should be read in conjunction with the unaudited condensed
consolidated financial statements and related notes included elsewhere in this
report and the audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
January 30, 2016.
At April 30, 2016, the Company operated 290 stores totaling approximately 1.7
million square feet in the United States, the District of Columbia and the
Commonwealth of Puerto Rico. The Company's stores offer predominantly
entertainment products, including video and music. In total, these two
categories represented 64% of the Company's net sales for the thirteen weeks
ended April 30, 2016. The balance of categories, including trend, electronics,
video games and related products represented 36% of the Company's net sales for
the thirteen weeks ended April 30, 2016.
The Company's results have been, and will continue to be, contingent upon
management's ability to understand industry trends and to manage the business in
response to those trends and general economic trends. Management monitors a
number of key performance indicators to evaluate its performance, including:
Net sales and comparable store net sales: The Company measures and reports the
rate of comparable store net sales change. A store is included in comparable
store net sales calculations at the beginning of its thirteenth full month of
operation. Stores relocated/expanded or downsized are excluded from comparable
store net sales if the change in square footage is greater than 20%. Closed
stores that were open for at least thirteen months are included in comparable
store net sales through the month immediately preceding the month of closing.
The Company further analyzes net sales by store format and by product category.
Cost of Sales and Gross Profit: Gross profit is impacted primarily by the mix of
products sold, by discounts negotiated with vendors and discounts offered to
customers. The Company records its distribution and product shrink expenses in
cost of sales. Distribution expenses include those costs associated with
receiving, shipping, inspecting and warehousing product and costs associated
with product returns to vendors. Cost of sales further includes obsolescence
costs and is reduced by the benefit of vendor allowances, net of direct
reimbursements of expense.
Selling, General and Administrative ("SG&A") Expenses: Included in SG&A expenses
are payroll and related costs, occupancy charges, general operating and overhead
expenses and depreciation charges (excluding those related to distribution
operations, as disclosed in Note 8 to the condensed consolidated financial
statements). Selling, general and administrative expenses also include fixed
asset write offs associated with store closures, if any.
Balance Sheet and Ratios: The Company views cash, net inventory investment
(merchandise inventory less accounts payable) and working capital (current
assets less current liabilities) as relevant indicators of its financial
position. See Liquidity and Capital Resources for further discussion of these
RESULTS OF OPERATIONS
Thirteen Weeks Ended April 30, 2016
Compared to the Thirteen Weeks Ended May 2, 2015
The following table sets forth a period over period comparison of the Company's
net sales by category:
Thirteen Weeks Ended
April 30, May 2
2016 2015 Change %
(in thousands, except store data)
Net sales $ 74,768 $ 77,963 $ (3,195 ) (4.1 %)
Other revenue 962 1,200 (238 ) (19.8 %)
Total revenue $ 75,730 79,163 $ (3,433 ) (4.3 %)
As a % of net sales
Video 39.7 % 46.1 %
Trend 25.5 % 14.3 %
Music 24.6 % 27.3 %
Electronics 9.0 % 9.0 %
Video Games 1.2 % 3.3 %
Store Count: 290 310 (20 ) (6.5 %)
Net sales. Comparable sales decreased 0.4% for the first quarter due to negative
comparable sales in the video and music categories. Net sales decreased 4.1%
during the thirteen weeks ended April 30, 2016, as compared to the same period
last year. The decline in net sales for the thirteen week period resulted
primarily from a decrease in store count of 6.5%.
Comparable store net sales in the video category decreased 13.0% during the
thirteen weeks ended April 30, 2016. The video category represented 39.7% of
total net sales for the thirteen weeks ended April 30, 2016 compared to 46.1% in
the comparable quarter last year, as the Company is shifting its product mix to
growing categories of entertainment and pop culture related merchandise.
According to statistics obtained from Warner Brothers Home Entertainment,
overall video industry retail sales as of April 30, 2016 were down 7.9% during
the period corresponding to the Company's first fiscal quarter.
Comparable store net sales in the music category decreased 10.9% during the
thirteen weeks ended April 30, 2016. The music category represented 24.6% of
total net sales for the thirteen weeks ended April 30, 2016 compared to 27.3% in
the comparable quarter last year.
According to Soundscan, total physical unit sales of albums industry-wide were
down 9.0% during the period corresponding to the Company's first fiscal quarter.
Comparable store net sales in the trend category increased 64.8% during the
thirteen weeks ended April 30, 2016. Trend product represented 25.5% of total
net sales for the thirteen weeks ended April 30, 2016 compared to 14.3% in the
comparable quarter last year. The Company continues to take advantage of
opportunities to strengthen product selection and shift product mix to growing
categories of entertainment and pop culture related merchandise.
Comparable store net sales in the electronics category decreased 0.2% during the
thirteen weeks ended April 30, 2016. Electronics net sales represented 9.0% of
total net sales for the thirteen weeks ended April 30, 2016, same percentage as
the comparable quarter last year.
Comparable store net sales for video games decreased 55.0% during the thirteen
weeks ended April 30, 2016. The Company continues to shift its inventory
investment and space allocation away from games to higher margin growth
categories. Video games net sales represented 1.2% of total net sales for the
thirteen weeks ended April 30, 2016 compared to 3.3% in the comparable quarter
Other Revenue. Other revenue, which was primarily related to commissions and
fees earned from third parties, was approximately $1.0 million and $1.2 million
for the thirteen weeks ended April 30, 2016 and May 2, 2015, respectively.
Gross Profit. The following table sets forth a period over period comparison of
the Company's gross profit:
Thirteen weeks ended
(in thousands) Change
April 30, May 2,
2016 2015 $ %
Gross Profit $ 30,826 $ 32,003 $ (1,177 ) (3.7 %)
As a % of total revenue 40.7 % 40.4 %
Gross profit decreased 3.7% for the thirteen weeks ended April 30, 2016 as
compared to the comparable period last year due to fewer stores in operation.
However, the increase in gross profit as a percentage of revenue was driven by
increases in all of our merchandise categories through the increased sales
contribution from the higher margin trend category and increased margin across
all of our merchandise categories.
SG&A Expenses. The following table sets forth a period over period comparison of
the Company's SG&A expenses:
Thirteen weeks ended
(in thousands) Change
April 30, May 2,
2016 2015 $ %
SG&A $ 31,511 $ 31,327 $ 184 0.6 %
As a % of total revenue 41.6 % 39.6 %
For the thirteen weeks ended April 30, 2016, SG&A expenses increased $184
thousand, or 0.6% on the total revenue decline of 4.3% resulting in a 200 basis
point increase in SG&A expenses as a percentage of total revenue. The increase
in SG&A as a percentage of total revenue is primarily due to the decrease in
revenue, increase in health care costs and higher capital expenditures.
Interest Expense. Interest expense was approximately $173 thousand during the
thirteen weeks ended April 30, 2016. Interest expense consisted primarily of
unused commitment fees and the amortization of fees related to the Company's
credit facility. Interest expense during the thirteen weeks ended May 2, 2015
was $465 thousand and, in addition to items listed above, included interest
payments on a capital lease which expired in December of 2015.
Other Income. Other income was $932 thousand dollars compared to $27 thousand
dollars last year. Other income included a gain of $800 thousand from the sale
of an investment. The remaining balance consisted of interest income.
Income Tax Expense (Benefit). In assessing the realizability of deferred tax
assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent on the generation of future
taxable income. Management considers the scheduled reversal of taxable temporary
differences, projected future taxable income and tax planning strategies in
making this assessment. Based on available objective evidence, management
concluded that a full valuation allowance should be recorded against the
Company's deferred tax assets. Management will continue to assess the need for
and amount of the valuation allowance against the deferred tax assets by giving
consideration to all available evidence to the Company's ability to generate
future taxable income in its conclusion of the need for a full valuation
allowance. Any reversal of the Company's valuation allowance will favorably
impact its results of operations in the period of reversal. The Company is
currently unable to determine whether or when that reversal might occur, but it
will continue to assess the realizability of its deferred tax assets and will
adjust the valuation allowance if it is more likely than not that all or a
portion of the deferred tax assets will become realizable in the future. The
Company has significant net operating loss carry forwards and other tax
attributes that are available to offset projected taxable income and current
taxes payable, if any, for the year ending January 30, 2016. The deferred tax
impact resulting from the utilization of the net operating loss carry forwards
and other tax attributes will be offset by a reduction in the valuation
allowance. As of January 30, 2016, the Company had a net operating loss carry
forward of $158.2 million for federal income tax purposes and approximately $236
million for state income tax purposes that expire at various times through 2035
and are subject to certain limitations and statutory expiration periods.
For the thirteen week periods ended April 30, 2016 and May 2, 2015, the
Company's current tax expense was associated with quarter-specific items
attributable to interest accruals on related uncertain tax positions and state
taxes based on modified gross receipts incurred for these thirteen week periods.
Net Income. The following table sets forth a period over period comparison of
the Company's net income:
Thirteen weeks ended
April 30, May 2,
2016 2015 Change
Income before income tax $ 74 $ 238 $ (164 )
Income tax expense 47 44 3
Net income $ 27 $ 194 $ (167 )
For the thirteen weeks ended April 30, 2016, the Company's net income decreased
$167 thousand to a profit of $27 thousand from a profit of $194 thousand for the
thirteen weeks ended May 2, 2015.
Liquidity and Cash Flows: The Company's primary sources of working capital are
cash and cash equivalents on hand, cash provided by operations and borrowing
capacity under its revolving credit facility (See Note 6 to the condensed
consolidated financial statements for further details). The Company's cash flows
fluctuate from quarter to quarter due to various items, including seasonality of
net sales and earnings, merchandise inventory purchases and returns and the
related terms on the purchases and capital expenditures. Management believes it
will have adequate resources to fund its cash needs for the next twelve months
and beyond, including its capital spending, its seasonal increase in merchandise
inventory and other operating cash requirements and commitments.
Management anticipates that any future cash requirements due to a shortfall in
cash from operations would be funded by the Company's cash and cash equivalents
on hand and its revolving credit facility, discussed hereafter. The Company does
not expect any material changes in the mix (between equity and debt) or the
relative cost of capital resources.
The following table sets forth a summary of key components of cash flow and
working capital for each of the thirteen weeks ended April 30, 2016 and May 2,
2015, or at those dates:
As of or for the
Thirteen weeks ended Change
April 30, May 2,
(in thousands) 2016 2015 $
Operating Cash Flows (8,284 ) (12,009 ) 3,725
Investing Cash Flows (2,565 ) (3,379 ) 814
Financing Cash Flows (2,606 ) (609 ) (1,987 )
Capital Expenditures (4,165 ) (3,379 ) (786 )
Cash and Cash Equivalents 90,856 102,540 (11,684 )
Merchandise Inventory 116,648 121,577 (4,929 )
Working Capital 157,104 171,248 (14,144 )
The Company had cash and cash equivalents of $90.9 million at April 30, 2016,
compared to $102.5 million at May 2, 2015. Merchandise inventory was $70 per
square foot at April 30, 2016 compared to $68 per square foot as of May 2, 2015.
Cash used by operating activities was $8.3 million for the thirteen weeks ended
April 30, 2016. The primary use of cash was a $10.8 million seasonal reduction
of accounts payable, partially offset by a $3.4 million reduction in inventory.
The Company's merchandise inventory and accounts payable are influenced by the
seasonality of its business. A significant reduction of accounts payable occurs
annually in the fiscal first quarter, reflecting payments for merchandise
inventory purchased during the prior year's holiday season.
Cash used by investing activities was $2.6 million for the thirteen weeks ended
April 30, 2016, which consisted of $4.2 million in capital expenditures, offset
by $1.6 million related to proceeds from the sale of an investment.
Cash used by financing activities was $2.6 million for the thirteen weeks ended
April 30, 2016, comprised of stock repurchases.
During the first quarter, the Company repurchased 676,437 shares of common stock
at an average price of $3.85 per share. Since the inception of the program, the
Company has repurchased approximately 2.5 million shares of common stock at an
average price of $3.82 per share. The Company has approximately $12.2 million
dollars available for purchase under its repurchase program.
In May 2012, the Company entered into a $75 million credit facility ("Credit
Facility") which amended the previous credit facility. The principal amount of
all outstanding loans under the Credit Facility together with any accrued but
unpaid interest, are due and payable in May 2017, unless otherwise paid earlier
pursuant to the terms of the Credit Facility. Payments of amounts due under the
Credit Facility are secured by the assets of the Company.
The Credit Facility includes customary provisions, including affirmative and
negative covenants, which include representations, warranties and restrictions
on additional indebtedness and acquisitions. The Credit Facility also includes
customary events of default, including, among other things, material adverse
effect, bankruptcy, and certain changes of control. The Credit Facility also
contains other terms and conditions, including limitations on the payment of
dividends and covenants around the number of store closings. The Company is
compliant with all covenants.
Interest under the Credit Facility will accrue, at the election of the Company,
at a Base Rate or LIBO Rate, plus, in each case, an Applicable Margin, which is
determined by reference to the level of availability, with the Applicable Margin
for LIBO Rate loans ranging from 2.25% to 2.75% and the Applicable Margin for
Prime Rate loans ranging from 0.75% to 1.25%. In addition, a commitment fee
ranging from 0.375% to 0.50% is also payable on unused commitments.
The availability under the Credit Facility is subject to limitations based on
sufficient inventory levels.
During the first quarters of Fiscal 2016 and 2015, the Company did not have any
borrowings under the Credit Facility. The Company did not have any borrowings
under its Credit Facility during Fiscal 2015, Fiscal 2014 and Fiscal 2013. As of
April 30, 2016 and May 2, 2015, the Company had no outstanding letter of credit
obligations under the Credit Facility. The Company had $37million and $38
million available for borrowing as of April 30, 2016 and May 2, 2015,
Capital Expenditures. During the thirteen weeks ended April 30, 2016, the
Company made capital expenditures of $4.2 million. The Company currently plans
to spend approximately $17.0 million for capital expenditures in fiscal 2016.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements and related disclosures in conformity
with accounting principles generally accepted in the United States requires that
management apply accounting policies and make estimates and assumptions that
affect results of operations and the reported amounts of assets and liabilities
in the financial statements. Management continually evaluates its estimates and
judgments including those related to merchandise inventory and return costs and
income taxes. Management bases its estimates and judgments on historical
experience and other factors that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates under different
assumptions or conditions.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations included in the Form 10-K for the year ended January 30, 2016
includes a summary of the critical accounting policies and methods used by the
Company in the preparation of its condensed consolidated financial statements.
There have been no material changes or modifications to the policies since
January 30, 2016.
Recently Issued Accounting Pronouncements:
In 2014, the FASB issued Accounting Standard Update ("ASU") No. 2014-09, Revenue
from Contracts with Customers, which requires an entity to recognize the amount
of revenue to which it expects to be entitled for the transfer of promised goods
or services to customers. The ASU will replace most existing revenue recognition
guidance in U.S. GAAP when it becomes effective. The new standard is effective
for the Company's fiscal year beginning January 28, 2018. Early application is
not permitted. The standard permits the use of either the retrospective or
cumulative effect transition method. The Company is evaluating the effect that
ASU 2014-09 will have on its consolidated financial statements and related
disclosures. The Company has not yet selected a transition method nor has it
determined the effect of the standard on its ongoing financial reporting.
In August 2014, the FASB issued ASU No. 2014-15, Disclosures of Uncertainties
about an Entity's Ability to Continue as a Going Concern, which requires the
Company to assess their ability to continue as a going concern by incorporating
and expanding upon certain principles that are currently in U.S. auditing
standards. Specifically, the amendments (1) provide a definition of the term
substantial doubt, (2) require an evaluation every reporting period including
interim periods, (3) provide principles for considering the mitigating effect of
Company's plans, (4) require certain disclosures when substantial doubt is
alleviated as a result of consideration of management's plans, (5) require an
express statement and other disclosures when substantial doubt is not
alleviated, and (6) require an assessment for a period of one year after the
date that the financial statements are issued (or available to be issued). The
new standard is effective for reporting periods beginning after December 15,
2016. Early application is permitted. The Company does not expect the adoption
of this update to have a significant effect on our financial statements.
In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of
Inventory. The amendments, which apply to inventory that is measured using any
method other than the last-in, first-out (LIFO) or retail inventory method,
require that entities measure inventory at the lower of cost or net realizable
value. ASU 2015-11 is effective for fiscal years, and interim periods within
those years, beginning after December 15, 2016 and should be applied on a
prospective basis. We are currently
assessing the potential impact of adopting this ASU, but do not, at this time,
anticipate a material impact to our consolidated results of operations,
financial positions or cash flows.
In February 2016, the FASB issued ASU No. 2016-02, Leases, which will replace
most existing lease accounting guidance in U.S. GAAP. The core principle of the
ASU is that an entity should recognize the rights and obligations resulting from
leases as assets and liabilities. ASU 2016-02 requires qualitative and specific
quantitative disclosures to supplement the amounts recorded in the financial
statements so that users can understand more about the nature of an entity's
leasing activities, including significant judgments and changes in judgments.
ASU 2016-02 will be effective for the Company beginning in fiscal 2019, and
requires the modified retrospective method of adoption. Early adoption is
permitted. The Company is in the process of determining the method and timing of
adoption and assessing the impact of ASU 2016-02 on its consolidated financial
TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
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