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| HAST > SEC Filings for HAST > Form 10-Q on 5-Sep-2008 | All Recent SEC Filings |
5-Sep-2008
Quarterly Report
Critical Accounting Estimates
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. We
believe the following critical accounting estimates comprise our more
significant estimates and assumptions used in the preparation of our financial
statements. Our significant estimates and assumptions are reviewed, and any
required adjustments are recorded, on a monthly or quarterly basis.
Lower of Cost or Market for Merchandise Inventory. Our merchandise inventories
are recorded at the lower of cost, which approximates the first-in, first-out
("FIFO") method, or market. As with any retailer, economic conditions, cyclical
customer demand and changes in purchasing or distribution can affect the
carrying value of inventory. As circumstances warrant, we record the lower of
cost or market inventory adjustments. In some instances, these adjustments can
have a material effect on the financial results of an annual or interim period.
In order to determine such adjustments, we evaluate the age, inventory turns and
estimated fair value and returnability of merchandise inventory by product
category and record an adjustment if estimated market value is below cost.
Through merchandising and an automated-progressive markdown program, we quickly
take the steps necessary to increase the sell-off of slower moving merchandise
to eliminate or lessen the effect of these adjustments.
Rental Asset Depreciation. We have established rental asset depreciation
policies that match rental product costs with the related revenues. These
policies require that we make significant estimates, based upon our experience,
as to the ultimate revenue and the timing of the revenue to be generated from
our rental product. We utilize an accelerated method of depreciation because it
approximates the pattern of demand for the product, which is higher when the
product is initially released for rental by the studios and declines over time.
In establishing salvage values for our rental product, we consider the sales
prices and sales volume of our previously rented product and other used product.
We currently depreciate the cost of our rental assets on an accelerated basis
over six months or nine months, except for rental assets purchased for the
initial stock of a new store, which are depreciated on a straight-line basis
over 36 months. Rental assets, which include DVDs, Books on CD, Video Games, and
VHS, are depreciated to salvage values ranging from $1.70 to $10. Rental assets
purchased for less than established salvage values are not depreciated.
Beginning in the second quarter of fiscal 2008, we decreased the salvage value
on VHS rental assets from $2.50 to $1.70 to better match the salvage value with
the anticipated recovery rate on VHS rental units. This change in estimate
related to our VHS rental assets did not have a material impact on our cost of
rental revenues for the second quarter.
We also review the carrying value of our rental assets to ensure that estimated
future cash flows exceed the carrying value. We periodically record adjustments
to the value of previously rented product primarily for estimated obsolescence
or excess product based upon changes in our original assumptions about future
demand and market conditions. If future demand or actual market conditions are
less favorable than our original estimates, additional adjustments, including
adjustments to useful lives or salvage values, may be required. We continually
evaluate the estimates surrounding the useful lives and salvage values used in
depreciating our rental assets. Changes to these estimates resulting from
changes in consumer demand, changes in our customer preferences or the price or
availability of retail products may materially impact the carrying value of our
rental assets and our rental margins.
The costs of rental product purchased pursuant to revenue-sharing arrangements,
which are recorded in rental cost of sales on the consolidated statements of
earnings, typically include a lower initial product cost with a percentage of
the net rental revenues to be shared with studios over an agreed period of time.
Any up-front costs exceeding the designated salvage value are amortized on an
accelerated basis and revenue-sharing payments pursuant to the applicable
arrangement are expensed as the related revenue is earned. Additionally, certain
titles have performance guarantees. We analyze titles that are subject to
performance guarantees and recognize an estimated expense for under-performing
titles throughout the applicable period based upon our analysis of the estimated
shortfall. We revise these estimates on a monthly basis, based on actual
results.
Impairment or Disposal of Long-Lived Assets. We evaluate under performing stores
on a quarterly basis to determine whether projected future cash flows over the
remaining initial lease term are sufficient to recover the carrying value of the
fixed asset investment in each individual store. If projected future cash flows
are less than the carrying value of the fixed asset investment, an impairment
charge is recognized if the fair value is less than the carrying value of such
assets. The carrying value of leasehold improvements as well as certain other
property and equipment is subject to impairment write-down.
Income Taxes. In determining net earnings for financial statement purposes, we
make certain estimates and judgments in the calculation of tax expense and the
resulting tax liabilities and in the recoverability of deferred tax assets that
arise from temporary differences between the tax and financial statement
recognition of revenue and expense. We record deferred tax assets and
liabilities for future income tax consequences that are attributable to
differences between financial statement carrying amounts of assets and
liabilities and their income tax bases. We base the measurement of deferred tax
assets and liabilities on enacted tax rates that we expect will apply to taxable
earnings in the year when we expect to settle or recover those temporary
differences. We recognize the effect on deferred tax assets and liabilities on
any change in income tax rates in the period that includes the enactment date.
The tax benefit from an uncertain tax position is recognized only if it is more
likely than not the tax position will be sustained on examination by the taxing
authorities, based on the technical merits of the position. The tax benefits
recognized in the financial statements from such a position are measured based
on the largest benefit that has a greater than fifty percent likelihood, on a
cumulative basis, of being realized upon ultimate settlement. We recognize
interest and penalties relating to any uncertain tax positions as a component of
income tax expense.
Share-Based Compensation. Determining the amount of share-based compensation to
be recorded in the statement of earnings requires us to develop estimates that
are used in calculating the grant-date fair value of stock options. In
determining the fair value of stock options, we use the Black-Scholes valuation
model, which requires us to make estimates of the following assumptions:
• Expected volatility - The estimated stock price volatility is derived based
upon actual historical stock prices over the expected life of the option.
• Expected life of the option - The estimate of an expected life is calculated based on historical data relating to grants, exercises, and cancellations, as well as the vesting period and contractual life of the option.
• Risk-free interest rate - The risk-free interest rate is based on the yield on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected life of the option.
Our stock price volatility and option lives involve management's best estimates
at that time, both of which impact the fair value of the option calculated under
the Black-Scholes pricing model and, ultimately, the expense that will be
recognized over the life of the option.
We recognize compensation expense for only the portion of options that are
expected to vest. Therefore, we apply estimated forfeiture rates that are
derived from historical employee termination behavior. If the actual number of
forfeitures differs from those estimated by management, additional adjustments
to compensation expense may be required in future periods.
In addition to stock options, we award performance-based stock awards.
Compensation expense is recognized for these awards if management deems it
probable that the performance conditions will be met. Management must use their
judgment to determine the probability that a performance condition will be met.
If actual results differ from management's assumptions, future results could be
materially impacted.
Results of Operations
The following tables present our statement of earnings data, expressed as a
percentage of revenue, and the number of superstores open at the end of the
periods presented herein.
Three Months Ended Six Months Ended
July 31, July 31,
2008 2007 2008 2007
Merchandise revenue 82.6 % 82.8 % 82.4 % 82.4 %
Rental revenue 17.4 17.2 17.6 17.6
Total revenues 100.0 100.0 100.0 100.0
Merchandise cost of revenue 69.5 70.0 69.4 69.7
Rental cost of revenue 34.8 33.7 34.2 32.7
Total cost of revenues 63.5 63.8 63.2 63.2
Gross profit 36.5 36.2 36.8 36.8
Selling, general and administrative expenses 35.3 34.3 34.2 34.0
Pre-opening expenses - - - -
Operating earnings 1.2 1.9 2.6 2.8
Other income (expense):
Interest expense (0.3 ) (0.7 ) (0.3 ) (0.6 )
Other, net - - - -
Earnings before income taxes 0.9 1.2 2.3 2.2
Income tax expense (benefit) 0.4 (0.3 ) 0.9 0.5
Net earnings 0.5 % 1.5 % 1.4 % 1.7 %
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Summary of Superstore Activity
Three Months Ended Six Months Ended Year Ended
July 31, July 31, January 31,
2008 2007 2008 2007 2008
Beginning number of stores 153 154 153 154 154
Openings - - - - 1
Closings (1 ) (1 ) (1 ) (1 ) (2 )
Ending number of stores 152 153 152 153 153
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Financial Results for the Second Quarter of Fiscal Year 2008 Revenues. Total revenues for the second quarter decreased $0.2 million, or 0.2%, to $125.7 million compared to $125.9 million for the second quarter of fiscal 2007. During the second quarter, we closed our store in Galveston, Texas. The loss of revenues compared to the second quarter of fiscal 2007 associated with this closure was $0.4 million. The following is a summary of our revenue results (dollars in thousands):
Three Months Ended July 31,
2008 2007 Increase/(Decrease)
Percent of Percent of
Revenues Total Revenues Total Dollar Percent
Merchandise revenue $ 103,860 82.6 % $ 104,270 82.8 % $ (410 ) -0.4 %
Rental revenue 21,806 17.4 % 21,635 17.2 % 171 0.8 %
Total revenues $ 125,666 100.0 % $ 125,905 100.0 % $ (239 ) -0.2 %
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Comparable-store revenues ("Comp"):
Total 0.6 %
Merchandise 0.3 %
Rental 2.0 %
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Below is a summary of the Comp results for our major merchandise categories:
Three Months Ended July 31,
2008 2007
Electronics 25.7 % 32.3 %
Trends 13.6 % 18.9 %
Consumables 10.4 % 5.5 %
Hard Back Café 6.5 % 9.4 %
Video Games 4.6 % 14.0 %
Movies 2.6 % 10.6 %
Books -1.1 % 6.9 %
Music -11.7 % -14.2 %
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Stores included in the Comps calculation are those stores that have been open
for a minimum of 60 weeks. Also included are stores that were remodeled or
relocated during the comparable period. Sales via the Internet are included and
closed stores are removed from each comparable period for the purpose of
calculating Comps.
Electronics department Comps increased 25.7% for the quarter, primarily due to
strong sales of refurbished iPods, MP3 players and related accessories, as well
as increased sales of third-party gift cards. Trends Comps increased 13.6% for
the quarter due to strong sales of Webkinz plush products, as well as increased
apparel sales. Key drivers in the apparel category were fashion branded bags
including totes and wallets, and fashion branded jewelry, which is targeted
towards our college age customers. Video Game Comps increased 4.6% primarily due
to strong sales of Grand Theft Auto IV, which was released at the end of the
first quarter. Sales of Grand Theft Auto IVfor the second quarter totaled
approximately $1.3 million. Movie Comps increased 2.6% primarily as a result of
strong sales of new DVDs, including boxed sets and Blu-ray format movies, as
well as strong sales of used categories. Hit titles released during the quarter
that helped drive new DVD sales included National Treasure 2, The Bucket List,
P.S. I Love You, Jumper, and 10,000 BC. Books Comps decreased 1.1% due to the
release of Harry Potter and the Deathly Hallows, the seventh and final book in
the Harry Potter series during the second quarter of fiscal 2007. Excluding the
sales of Harry Potter and the Deathly Hallows, Books Comps increased 5.4% for
the quarter, driven by strong sales of new hardback and trade paperback books.
This growth was driven by several hit titles, such as The Twilight Saga series
by Stephenie Meyer, The Last Lecture by Randy Pausch, and The Shack by William
P. Young. Music Comps decreased 11.7% for the quarter resulting from continued
industry decline, as well as our de-emphasis on the category through the
reduction of the retail space dedicated to music in twenty-two stores, which
were reformatted during the first six months of fiscal 2008. Merchandise Comps,
excluding the sales of Music, increased 3.6%.
Rental Comps increased 2.0% from the same period last year primarily as a result
of increases in video games and Blu-ray movie format rentals, as well as from
the release of hit titles during the second quarter. Additionally, we held fewer
promotions during the second quarter, as compared to the prior year, resulting
in higher rental revenues per unit. The combined sale and rental of movies and
video games resulted in a Comp increase of 2.8%.
Gross Profit - Merchandise. For the second quarter, total merchandise gross
profit dollars increased approximately $0.4 million, or 1.3%, to $31.7 million
from $31.3 million for the same period last year, primarily as a result of
higher margin rates. As a percentage of total merchandise revenue, merchandise
gross profit increased to 30.5% for the quarter compared to 30.0% for the same
period in the prior year primarily as a result of lower markdown expense as well
as continued improvements in margin rates, partially offset by higher freight
costs and shrinkage for the period.
Gross Profit - Rental. For the second quarter, total rental gross profit dollars
decreased approximately $0.1 million, or 0.7% to $14.2 million from
$14.3 million for the same period in the prior year. Higher rental revenues were
offset by lower rental margin rates. As a percentage of total revenue, rental
gross profit decreased to 65.2% for the quarter compared to 66.3% for the same
period in the prior year, which was primarily due to a change in the mix of
revenues generated on revenue sharing titles, which led to lower margin rates,
and increased rental asset depreciation expense for the period due to an
increase in the percentage of traditional titles purchased, which have a higher
per unit cost, versus revenue sharing titles.
Selling, General and Administrative Expenses ("SG&A"). As a percentage of total
revenue, SG&A increased to 35.3% for the second quarter compared to 34.3% for
the same quarter in the prior year. SG&A increased approximately $1.0 million
during the quarter, or 2.3%, to $44.3 million compared to $43.3 million for the
same quarter last year, primarily as a result of increased store occupancy costs
and store labor expense.
Interest Expense. For the second quarter, interest expense decreased
$0.3 million, or 37.5%, to $0.5 million, compared to $0.8 million during fiscal
2007 resulting primarily from lower interest rates on our outstanding borrowings
under our credit facility. The average rate of interest charged for the quarter
decreased to 4.02% compared to 6.76% for the same period in the prior year.
Income Tax Expense. The effective tax rate for the three months ended July 31,
2008 and 2007 was 39.9% and (19.7)%, respectively. During the three months ended
July 31, 2007, we recognized a discrete tax benefit in the amount of
$0.9 million related to a favorable settlement of a prior year's state tax
liability. During the three months ended July 31, 2008, no related tax
settlements occurred.
Financial Results for the Six Months Ended July 31, 2008
Revenues. Total revenues for the first six months of fiscal 2008 increased
approximately $3.7 million, or 1.5%, to $257.6 million compared to
$253.9 million for the same period in the prior year. The following is a summary
of our revenue results (dollars in thousands):
Six Months Ended July 31,
2008 2007 Increase
Percent of Percent of
Revenues Total Revenues Total Dollar Percent
Merchandise revenue $ 212,177 82.4 % $ 209,334 82.4 % $ 2,843 1.4 %
Rental revenue 45,425 17.6 % 44,583 17.6 % 842 1.9 %
Total revenues $ 257,602 100.0 % $ 253,917 100.0 % $ 3,685 1.5 %
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Comparable-store revenues ("Comp"):
Total 2.3 %
Merchandise 2.2 %
Rental 3.0 %
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Below is a summary of the Comp results for our major merchandise categories:
Six Months Ended July 31,
2008 2007
Electronics 26.5 % 24.3 %
Trends 23.8 % 1.5 %
Video Games 16.4 % 3.8 %
Consumables 11.5 % 3.0 %
Hard Back Café 10.4 % 9.2 %
Movies 2.8 % 7.5 %
Books 2.0 % 2.8 %
Music -14.0 % -13.6 %
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Stores included in the Comps calculation are those stores that have been open
for a minimum of 60 weeks. Also included are stores that were remodeled or
relocated during the comparable period. Sales via the Internet are included and
closed stores are removed from each comparable period for the purpose of
calculating Comps.
Electronics department Comps increased 26.5% primarily due to strong sales of
refurbished iPods, MP3 players and related accessories, as well as increased
sales of third-party gift cards. Trends Comps increased 23.8% primarily as a
result of strong sales of Webkinz plush products, as well as strong apparel
sales. Key drivers in the apparel category included fashion branded jewelry
which is targeted towards our college age customers, fashion branded bags
including totes and wallets, and hats. Video Game Comps increased 16.4% for the
. . .
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