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| HAST > SEC Filings for HAST > Form 10-Q on 4-Dec-2008 | All Recent SEC Filings |
4-Dec-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.
At the beginning of 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.
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
operations, 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 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 only for 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 operations data, expressed as a
percentage of revenue, and the number of superstores open at the end of the
periods presented herein.
Three Months Ended Nine Months Ended
October 31, October 31,
2008 2007 2008 2007
Merchandise revenue 84.0 % 82.9 % 82.9 % 82.6 %
Rental revenue 16.0 17.1 17.1 17.4
Total revenues 100.0 100.0 100.0 100.0
Merchandise cost of revenue 69.5 69.5 69.4 69.6
Rental cost of revenue 34.2 35.6 34.2 33.6
Total cost of revenues 63.9 63.7 63.4 63.4
Gross profit 36.1 36.3 36.6 36.6
Selling, general and administrative expenses 40.1 35.6 36.0 34.5
Pre-opening expenses 0.1 - - -
Operating (loss) income (4.1 ) 0.7 0.6 2.1
Other income (expense):
Interest expense (0.5 ) (0.6 ) (0.4 ) (0.6 )
Other, net 0.1 - - -
(Loss) income before income taxes (4.5 ) 0.1 0.2 1.5
Income tax expense (benefit) (1.3 ) - 0.2 0.3
Net (loss) income (3.2 )% 0.1 % 0.0 % 1.2 %
Summary of Superstore Activity
Three Months Ended Nine Months Ended Year Ended
October 31, October 31, January 31,
2008 2007 2008 2007 2008
Beginning number of stores 152 153 153 154 154
Openings 1 - 1 - 1
Closings - (1 ) (1 ) (2 ) (2 )
Ending number of stores 153 152 153 152 153
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Financial Results for the Third Quarter of Fiscal Year 2008 Revenues. Total revenues for the third quarter decreased approximately $8.0 million, or 6.5%, to $114.3 million compared to $122.3 million for the third quarter of fiscal 2007. We believe the current financial crisis and its impact on consumer spending had a significant impact on our revenues for the third quarter of 2008. The following is a summary of our revenues results (dollars in thousands):
Three Months Ended October 31,
2008 2007
Percent of Percent of (Decrease)
Revenues Total Revenues Total Dollar Percent
Merchandise revenue $ 95,991 84.0 % $ 101,407 82.9 % $ (5,416 ) -5.3 %
Rental revenue 18,277 16.0 % 20,868 17.1 % (2,591 ) -12.4 %
Total revenues $ 114,268 100.0 % $ 122,275 100.0 % $ (8,007 ) -6.5 %
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Comparable-store revenues ("Comp"):
Total -6.5 %
Merchandise -5.1 %
Rental -13.3 %
Below is a summary of the Comp results for our major merchandise categories:
Three Months Ended October 31,
2008 2007
Trends 21.7 % 22.8 %
Consumables 13.1 % -0.1 %
Electronics 12.7 % 30.8 %
Hardback Café 7.9 % 9.7 %
Books 1.0 % 2.5 %
Movies -5.0 % 7.6 %
Video Games -14.8 % 34.0 %
Music -19.5 % -14.8 %
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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.
Trends Comps increased 21.7% for the quarter driven by strong sales of Webkinz
plush products, as well as increased sales of action figures, apparel (including
sports apparel, hats and bags), seasonal merchandise for Halloween, and posters.
Electronics Comps increased 12.7% for the quarter, due to strong sales of
digital converter boxes, as well as increased sales of third-party gift cards.
Books Comps increased 1.0% for the quarter, due to strong sales of new trade
paperback as well as used trade paperback and used hardbacks, partially offset
by lower sales of periodicals. Movie Comps decreased 5.0% for the period
primarily due to an unusually limited slate of releases during the third
quarter. Video Game Comps decreased 14.8% for the quarter primarily due to lower
sales of new video games and video game consoles, partially offset by increased
sales of used video games. The decrease in sales of new video games this quarter
is primarily due to the release of XBOX 360 title Halo 3 during the third
quarter of fiscal 2007, with no comparable title released in fiscal 2008. Music
Comps decreased 19.5% for the quarter resulting from a continued industry
decline, as well as our de-emphasis on the category through the reduction of the
retail space dedicated to music in twenty-nine stores, which were reformatted
during the first nine months of fiscal 2008. Merchandise Comps, excluding the
sale of music, decreased 1.2%.
Rental Comps decreased 13.3% from the same period last year, primarily as a
result of an unusually limited slate of titles released during the third quarter
as well as a strong following of viewers for the Olympics during the period,
coverage of the 2008 political conventions, and media coverage of the current
crisis in the economy and financial markets. Rental Game Comps increased 15.0%
for the period while Rental Movie Comps decreased 16.6%. The combined sales and
rental of movies and video games resulted in a Comp decrease of 10.0%.
Gross Profit - Merchandise. For the third quarter, total merchandise gross
profit dollars decreased approximately $1.8 million, or 5.8%, to $29.2 million
from $31.0 million for the same period last year, directly as a result of lower
merchandise revenues. As a percentage of total merchandise revenue, merchandise
gross profit remained flat at 30.5% for the quarter as compared to the same
period in the prior year.
Gross Profit - Rental. For the third quarter, total rental gross profit dollars
decreased approximately $1.4 million, or 10.4%, to $12.0 million from
$13.4 million for the same period in the prior year primarily due to lower
rental revenues. As a percentage of total rental revenue, rental gross profit
increased to 65.8% for the quarter compared to 64.4% for the same period in the
prior year, resulting primarily from lower units purchased for the quarter as
compared to the same period in the prior year which resulted in less rental
asset depreciation expense for the period.
Selling, General and Administrative Expenses ("SG&A"). As a percentage of total
revenue, SG&A increased to 40.1% for the third quarter compared to 35.7% for the
same quarter in the prior year. SG&A increased approximately $2.3 million during
the quarter, or 5.3%, to $45.9 million compared to $43.6 million for the same
quarter last year, primarily as a result of additional costs associated with the
operation of new, expanded, and relocated stores as well as increased health
insurance costs, store utility costs, and advertising expense. SG&A for the
quarter was also negatively impacted by a non-recurring adjustment of
approximately $0.5 million related to prior periods' depreciation expense.
Interest Expense. For the third quarter, interest expense decreased
approximately $0.1 million, or 14.3%, to $0.6 million, compared to $0.7 million
during fiscal 2007 resulting primarily from lower interest rates. The average
rate of interest charged for the quarter decreased to 4.08% compared to 6.55%
for the same period in the prior year.
Income Tax Expense. During the third quarter of 2008, the Company recorded a
discrete tax charge of approximately $0.7 million related to an Internal Revenue
Service ("IRS") audit of the Company's previously filed federal tax returns. The
IRS audit resulted in a change in our tax method used to account for gift cards
and the $0.7 million represents interest due as a result of the audit. During
the three months ended October 31, 2007, there were no discrete tax items.
Primarily as a result of this discrete tax charge, the effective tax rate for
the three months ended October 31, 2008 and 2007 was (28.7%) and 33.0%,
respectively.
Financial Results for the Nine Months Ended October 31, 2008
Revenues. Total revenues for the first nine months of fiscal 2008 decreased
approximately $4.3 million, or 1.1%, to $371.9 million compared to
$376.2 million for the same period in the prior year. The following is a summary
of our revenue results (dollars in thousands):
Nine Months Ended October 31,
2008 2007
Percent of Percent of (Decrease)
Revenues Total Revenues Total Dollar Percent
Merchandise revenue $ 308,168 82.9 % $ 310,742 82.6 % $ (2,574 ) -0.8 %
Rental revenue 63,702 17.1 % 65,450 17.4 % (1,748 ) -2.7 %
Total revenues $ 371,870 100.0 % $ 376,192 100.0 % $ (4,322 ) -1.1 %
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Comparable-store revenues ("Comp"):
Total -0.5 % Merchandise -0.2 % Rental -2.3 % |
Below is a summary of the Comp results for our major merchandise categories:
Nine Months Ended October 31,
2008 2007
Trends 23.1 % 8.0 %
Electronics 22.0 % 26.4 %
Consumables 12.0 % 2.0 %
Hard Back Café 9.5 % 9.4 %
Video Games 5.4 % 12.7 %
Books 1.6 % 2.7 %
Movies 0.3 % 7.5 %
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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.
Trends Comps increased 23.1% for the nine months ended October 31, 2008,
primarily due to strong sales of Webkinz plush products, as well as strong sales
of action figures and apparel. Key drivers in the apparel category included
jewelry, bags, hats, and sports apparel. Electronics Comps increased 22.0%
primarily as a result of strong sales of refurbished iPods, MP3 players and
related accessories, as well as increased sales of third party gift cards. Video
Game Comps increased 5.4% for the period as a result of increased sales of new
. . .
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