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| TWMC > SEC Filings for TWMC > Form 10-K on 16-Apr-2009 | All Recent SEC Filings |
16-Apr-2009
Annual Report
Overview
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 condition 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 game 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 "Selected Consolidated Financial Data" and the Consolidated Financial Statements and related notes included elsewhere in this report.
At January 31, 2009, the Company operated 712 stores totaling approximately 4.6 million square feet in the United States, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands. In the fiscal year ended January 31, 2009 (referred to herein as "Fiscal 2008"), the Company's net sales decreased as compared to the fiscal year ended February 3, 2008, (referred to herein as "Fiscal 2007") as a result of lower average store count and a decrease in comparable store sales. Comparable store sales decreased 10.8% during Fiscal 2008.
The Company focuses on the following areas in its effort to improve its business:
The Company tailors the product mix of its stores toward regional tastes in order to optimize the productivity of its stores, seeking to serve key customer segments within each store. We have also focused on creating a stronger value statement to our customers to drive additional traffic across the lease line and improve conversion. This involves tailoring the overall square footage allocation in line with a store's trend, and increasing inventory and square footage allocations for growth categories. As music sales have continued to decline, the Company has been able to partially offset the impact by shifting square footage allocations from music to other product categories. While adding inventory in other product categories, we remain focused on improving inventory turnover.
During Fiscal 2008 and Fiscal 2007, the Company closed 101 and 179 stores, respectively. The Company has not opened a new store in the last two years. The Company's real estate strategy is to reposition our store portfolio by reducing our store base to a core group of profitable locations.
The Company closes stores when minimum operating thresholds are not achieved or upon lease expiration when either renewal is not available or management determines that renewal is not in the Company's best interest. The composition of these stores changes from time-to-time as the result of competitive changes and other factors.
To strengthen customer loyalty, the Company offers its customers the option of signing up for a Backstage Pass card which provides an additional 10% discount off of everyday selling prices on nearly all product in addition to other value added offers members receive through the program in exchange for an annual membership fee. The Company also co-sponsors events in many of its stores to provide various segments of its customers an opportunity to experience entertainment and shop for unique and exclusive products based on their particular interests.
Key Performance Indicators
Management monitors a number of key performance indicators to evaluate its performance, including:
Net Sales: The Company measures 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. Mall stores relocated in the same shopping center after being open for at least thirteen months are considered comparable stores. Closed stores that were open for at least thirteen months are included in comparable store net sales through the month immediately prior to 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 a function of the cost of product in relation to its retail selling value. Changes in gross profit are impacted primarily by net sales levels, mix of products sold, vendor discounts and allowances and distribution costs. The Company records its distribution, freight and obsolescence expenses in cost of sales. Distribution expenses include those costs associated with receiving, inspecting and warehousing merchandise and costs associated with product returns to vendors.
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 indicators of its financial position. See Liquidity and Capital Resources for further discussion of these items.
Fiscal Year Ended January 31, 2009 ("Fiscal 2008") Compared to Fiscal Year Ended February 2, 2008 ("Fiscal 2007")
Net Sales. The following table sets forth a year-over-year comparison of the Company's total net sales:
2008 vs. 2007
---------- ------------ ------------- - ---------
($ in thousands) 2008 2007 $ %
---------- ------------ ------------- - ---------
Net Sales $987,625 $1,265,658 $ (278,033) (22.0%)
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The 22% net sales decline from prior year is due to the comparable store net sales decline of 11% coupled with an 18% decline in average store count. Total product units sold in Fiscal 2008 decreased 16% and the average retail price for units sold decreased 8%.
Net sales by merchandise category for Fiscal 2008 and Fiscal 2007 were as follows:
-- ------- - - ----- - - --------- - - ----- - --- -------- - ----- ---------- -
Total % Comparable
2008 % 2007 % Net Sales Store % Net
($ in thousands) Net Sales Total Net Sales Total Change Sales Change
-- ------- - - ----- - - --------- - - ----- - --- -------- - ----- ---------- -
Music $ 349,737 35.4 % $ 494,286 39.1 % (29.2 %) (20.2 %)
Video 407,884 41.3 491,360 38.8 (17.0 ) (3.1 )
Video games 90,233 9.1 114,431 9.0 (21.1 ) (14.3 )
Other 139,771 14.2 165,581 13.1 (15.6 ) (0.6 )
-- ------- - - ----- - - --------- - - ----- - - - ----- -- - -- -- ------- -- -
Total $ 987,625 100.0 % $ 1,265,658 100.0 % (22.0 %) (10.8 %)
-- ------- - - ----- - - --------- - - ----- - - - ----- -- - -- -- ------- -- -
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The "Other" category includes electronics, accessories and trend items, none of which individually exceed 10% of total net sales.
The Company's stores offer a wide range of new and used CDs and music DVDs across most music genres, including new releases from current artists as well as an extensive catalog of music from past periods and artists. The music category declined as a percentage of total net sales and declined 20.2% on a comparable store sale basis due to the lack of new product releases and the shift to online downloading. The Company continues to shift square footage allocations to new categories to compensate for the decline.
Net sales of CDs represented approximately 95% of total net sales in the music category during Fiscal 2008. The Company's annual CD unit sales decreased 28% in Fiscal 2008 due to lower comparable store net sales and the decrease in average store count. According to SoundScan, total CD unit sales in the United States declined 20% during the period corresponding with the Company's Fiscal 2008.
The Company offers DVDs in all of its stores and high definition DVDs in a majority of its stores. The video category increased as a percentage of the Company's total net sales due to slower comparable store sales decline in this category than the other categories.
Total net sales for Fiscal 2008 in the video category decreased 17% due to a comparable store net sales decrease of 3% and the lower average store count. According to VideoScan, total video unit sales in the United States declined 9% during the period corresponding with the Company's Fiscal 2008.
Video games
The Company offers video game hardware and software in 347 stores. During Fiscal 2007, the Company discontinued the sale of video games in approximately 300 stores. The Company has narrowed the number of stores offering video games in order to increase average store video game sales by offering better assortment and more product in its best game sales stores.
The "Other" category consists of electronics, accessories and trend items. Net sales in this category have increased as a percentage of total net sales due to increased store square footage allocations and slower comparable store sales declines than music and video.
Gross Profit. The following table sets forth a year-over-year comparison of the Company's Gross Profit:
($ in thousands) 2008 vs. 2007
-----------------------
2008 2007 $ %
--------- --------- -----------------------
Gross Profit $ 330,895 $ 445,747 ($ 114,852 ) (25.8% )
As a percentage of net sales 33.5 % 35.2 %
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The 170 basis point decline in gross profit as a percentage of net sales was due to increased markdowns on slow moving inventory and lower vendor allowances.
Selling, General and Administrative Expenses.The following table sets forth a year-over-year comparison of the Company's SG&A expenses:
($ in thousands) 2008 vs. 2007
-------------------------
2008 2007 $ %
--------- --------- -------------------------
Selling, general and
administrative expenses $ 380,802 $ 470,386 ($ 89,584 ) (19.0% )
As a percentage of net sales 38.6 % 37.2 %
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The $90 million decrease in SG&A expenses is due to the Company operating an average of 18% fewer stores. Despite the decrease, SG&A as a percentage of net sales increased to 38.6% from 37.2% due to the sales decline of 22%.
Included in SG&A for Fiscal 2008 is a gain of approximately $3.1 million from the sale of the Canton, Ohio distribution facility.
Asset Impairment Charge.During Fiscal 2008 and Fiscal 2007, the Company concluded, based on a significant decline in sales and earnings during the fourth quarter, that triggering events had occurred, pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS No. 144"), requiring a test of long-lived assets for impairment at its retail stores and consolidated subsidiaries. Long-lived assets at locations where impairment was determined to exist were written down to their estimated fair values as of the end of each period resulting in the recording of asset impairment charges of $15.2 million and $30.7 million in Fiscal 2008 and Fiscal 2007, respectively. Estimated fair values for long-lived assets at these locations, including store fixtures and equipment, leasehold improvements and certain intangible assets, were determined based on a measure of discounted future cash flows over the remaining lease terms at the respective locations. Future cash flows were estimated based on store plans and were discounted at a rate approximating the Company's cost of capital. Management believes its assumptions were reasonable and consistently applied.
Interest Expense.Interest expense in Fiscal 2008 was $4.1 million compared to $6.5 million in Fiscal 2007. The increase is due to lower average borrowings on the Company's revolving line of credit and lower interest rates.
Other Income. Other income includes interest income, which was $0.2 million and $0.4 million in Fiscal 2008 and 2007, respectively.
Income Tax (Benefit) Expense. The following table sets forth a year-over-year comparison of the Company's income tax expense (benefit):
($ in thousands) 2008 vs. 2007
----------------
2008 2007 $
---------- ------------- ----------------
Income tax (benefit) expense ($28 ) $ 37,975 ($38,003)
Effective tax rate 0.0 % (61.8 %)
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Net Loss. The following table sets forth a year-over-year comparison of the Company's net loss:
($ in thousands) 2008 vs. 2007
----------- ----------- ---------------
2008 2007 $
----------- -----------
Net loss ($ 68,955 ) ($ 99,435 ) $30,480
- --------- - ---------
Net loss as a percentage of net sales (7.0 %) (7.9 %)
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The Fiscal 2008 net loss of $69.0 million was due to the decline in comparable store sales and the impairment charge of $15.2 million. The $30.5 million reduction in net loss as compared to 2007 was due to a lower impairment charge and the $42.5 million deferred tax charge recorded in Fiscal 2007, partially offset by lower sales and the 170 basis point decrease in gross margin.
Net Sales. The following table sets forth a year-over-year comparison of the Company's total net sales:
($ in thousands) 2007 vs. 2006
---------------------------
2007 2006 $ %
------------ ------------ ---------------------------
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The 14% net sales decline from prior year is due to the comparable store net sales decline of 8.5% coupled with a 6.6% decline in average store count. Additionally, Fiscal 2006 contained a 53rd week of business which contributed approximately $23.0 million in net sales. Total product units sold in Fiscal 2007 decreased 14.5% and the average retail price for units sold increased 1.4%.
Net sales by merchandise category for Fiscal 2007 and Fiscal 2006 were as follows:
- --------- - - ----- - - --------- - - ----- - --- -------- - ----- ---------- -
($ in thousands) Total % Comparable
2007 % 2006 % Net Sales Store % Net
Net Sales Total Net Sales Total Change Sales Change
----------- - ------- - ----------- - ------- - ------------ - ---------------- -
Music $ 494,286 39.1 % $ 676,091 46.0 % (26.9 %) (23.2 %)
Video 491,360 38.8 529,900 36.0 (7.3 ) 1.1
Video games 114,431 9.0 114,654 7.8 (0.2 ) 8.3
Other 165,581 13.1 150,512 10.2 10.0 14.2
- --------- - - ----- - - --------- - - ----- - - - ----- -- - -- -- ------- -- -
Total $ 1,265,658 100.0 % $ 1,471,157 100.0 % (14.0 %) (8.5 %)
- --------- - - ----- - - --------- - - ----- - - - ----- -- - -- -- ------- -- -
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The "Other" category includes electronics, accessories and trend items, none of which individually exceed 10% of total net sales.
The Company's stores offer a wide range of new and used CDs and music DVDs across most music genres, including new releases from current artists as well as an extensive catalog of music from past periods and artists. The music category declined as a percentage of total net sales and declined 23.2% on a comparable store sale basis due to the lack of new product releases and the shift to online downloading. The Company continues to shift square footage allocations to growth categories to compensate for the decline.
Net sales of CDs represented approximately 95% of total net sales in the music category during Fiscal 2007. The Company's annual CD unit sales decreased 26% in Fiscal 2007 due to lower comparable store net sales and the decrease in average store count. According to SoundScan, total CD unit sales in the United States declined 19% during the period corresponding with the Company's Fiscal 2007.
The Company offers DVDs and high definition DVDs in all its stores. The video category increased as a percentage of the Company's total net sales due to the increase in store square footage to support the category.
Total net sales for Fiscal 2007 in the video category decreased 7.3% despite the comparable store net sales increase of 1.1% due to the lower average store count. According to VideoScan, total video unit sales in the United States declined 3% during the period corresponding with the Company's Fiscal 2007.
Video games
The Company offers video game hardware and software in approximately half its stores. During Fiscal 2007, the Company discontinued the sale of video games in approximately 300 stores. The Company has narrowed the number of stores offering video games in order to increase total video game sales by offering better assortment and more product in its best game sales stores.
The positive comparable store net sales in video games were due to improved hardware allocations of Wii, PS3 and Nintendo DS Lite, as well as improved software sales. According to NPD, industry video games sales during calendar year 2007, including portable and console hardware, software and accessories increased 43% over calendar year 2006 sales.
The "Other" category consists of electronics, accessories and trend items. Net sales in this category have increased as a percentage of total net sales due to increased store square footage allocations which have driven double digit comparable store net sales growth.
($ in thousands) 2007 vs. 2006
--------------------------
2007 2006 $ %
--------- --------- --------------------------
Gross Profit $ 445,747 $ 519,222 $ (73,475) (14.2%)
As a percentage of net sales 35.2 % 35.3 %
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The 10 basis point decline in gross profit as a percentage of net sales was due to a loss of leverage of distribution and freight costs against the net sales decline.
Selling, General and Administrative Expenses. The following table sets forth a year-over-year comparison of the Company's SG&A expenses:
($ in thousands) 2007 vs. 2006
--------------------------
2007 2006 $ %
--------- --------- --------------------------
Selling, general and
administrative expenses $ 470,386 $ 519,246 $ (48,860) (9.4%)
As a percentage of net sales 37.2 % 35.3 %
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The $48.9 million decrease in SG&A expenses is due to the lower average store count and the absence of approximately $7.9 million in transition costs related to the Musicland acquisition that were incurred in Fiscal 2006. The increase in SG&A expenses as a percentage of net sales is due to a loss of leverage on fixed costs due to the net sales decline.
Asset Impairment Charge.During Fiscal 2007, the Company concluded, based on a significant decline in sales and earnings during the fourth quarter, that triggering events had occurred, pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS No. 144")., requiring a test of long-lived assets for impairment at its retail stores and consolidated subsidiaries. Long-lived assets at locations where impairment was determined to exist were written down to their estimated fair values as of February 2, 2008, resulting in the recording of an asset impairment charge of $30.7 million. Estimated fair values for long-lived assets at these locations, including store fixtures and equipment, leasehold improvements and certain intangible assets, were determined based on a measure of discounted future cash flows over the remaining lease terms at the respective locations. Future cash flows were estimated based on store operating plans and were discounted at a rate approximating the Company's cost of capital. Management believes its assumptions were reasonable and consistently applied.
Interest Expense.Interest expense in Fiscal 2007 was $6.5 million compared to $5.5 million in Fiscal 2006. The increase is due to higher average borrowings on the Company's credit facility.
Other Income. Other income includes interest income, which was $0.4 million and $0.9 million in Fiscal 2007 and 2006, respectively. Fiscal 2006 other income also includes a $3.5 million gain on the sale of an investment.
Income Tax Expense (Benefit).The following table sets forth a year-over-year comparison of the Company's income tax expense (benefit):
($ in thousands) 2007 vs. 2006
---------------
2007 2006 $
-------- -------- ---------------
Income tax expense (benefit) $ 37,975 $ (2,041 ) $ 40,016
Effective tax rate (61.8 %) 186.7 %
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During Fiscal 2007 the Company recorded deferred tax expense of $42.5 million, which was primarily due to the establishment of a full valuation allowance against the Company's net deferred tax assets. This was partially offset by a $5.7 million federal income tax benefit recognized as the result of a net operating loss carryback. The remaining components of income tax expense, totaling approximately $1.2 million, include certain state and local taxes, adjustments to the reserve for uncertain tax positions and the accrual of interest and penalties on uncertain tax positions. See Note 6 in the Notes to Consolidated Financial Statements for further detail.
The Fiscal 2006 income tax benefit is attributable to a tax favored gain from the sale of an investment, which resulted in a $1.4 million reduction of the valuation allowance attributable to losses on investments, favorable settlements of income tax examinations ($0.9 million) and federal income tax credits ($0.3 million), partially offset by unfavorable state tax legislation enacted during the year and changes in management's
Extraordinary Gain. In Fiscal 2006, the Company recorded an extraordinary gain of $10.7 million, net of income taxes of $6.7 million, as a result of acquiring substantially all of the net assets of Musicland Holding Corp. on March 27, 2006. The gain represented the excess of the fair value of the net assets . . .
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