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OSH > SEC Filings for OSH > Form 10-Q on 12-Jun-2012All Recent SEC Filings

Show all filings for ORCHARD SUPPLY HARDWARE STORES CORP

Form 10-Q for ORCHARD SUPPLY HARDWARE STORES CORP


12-Jun-2012

Quarterly Report


ITEM 2.-MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

You should read the following discussion and analysis in conjunction with the Company's financial statements and related notes elsewhere in this report. Except for historical information, the discussion in this report contains certain forward-looking statements that involve risk and uncertainty. The Company has based these forward-looking statements on our current expectations and assumptions about future events. You can identify these statements by forward-looking words such as "outlook", "believes", "expects", "appears", "may", "will", "should", "intend", "target", "projects", "estimates", "plans", "forecast", "is likely to", "anticipates", or the negative thereof or comparable terminology. Examples of such statements include references to revenue growth, new store openings and remodels, comparable store sales, demand for the Company's products and services, the state of the California economy, inventory and in-stock positions, cash flow, and the like. Forward-looking statements are based on the Company's beliefs as well as the Company's current assumptions, expectations, and projections about future events based on information currently available to the Company. As a result, these statements are subject to various risks and uncertainties. For a discussion of material risks and uncertainties that the Company faces, see the discussion entitled "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended January 28, 2012.

EXECUTIVE OVERVIEW

Orchard Supply Hardware Stores Corporation, and its wholly-owned subsidiaries, Orchard Supply Hardware LLC and OSH Properties LLC (the "Company" or "we" or "our"), is a neighborhood hardware and garden store focused on paint, repair and the backyard. Founded as a purchasing cooperative in San Jose in 1931, today the stores average 44,000 square feet of enclosed retail space and 8,000 square feet of exterior nursery and garden space, carrying a broad assortment of merchandise for repair, maintenance and improvement needs for the home and backyard. As of April 28, 2012, we had 88 stores in California. Our stores are easy to navigate and convenient to shop and are designed to appeal to do-it-yourself customers. We also serve the small professional customer whose purchases are largely motivated by a need for incremental supplies and tools to complete construction projects. We offer customers a unique value proposition comprised of service, selection and convenience.

On December 30, 2011, we became an independent, publicly-traded company as a result of Sears Holdings Corporation's ("Sears Holdings") distribution of its shares of the Company to Sears Holdings' stockholders whereby Sears Holdings' stockholders of record as of the close of business on December 16, 2011 received one share of our Class A Common Stock and one share of our Series A Preferred Stock for every 22.141777 shares of Sears Holdings' common stock held (the "Spin-Off").

At the time of the Spin-Off, Class A Common Stock owned by Ares Corporate Opportunities Fund ("ACOF") immediately prior to the Spin-Off was exchanged for Class C Common Stock. Class A and Class C Common Stock represent approximately 80% and 20% of the general voting power of our outstanding capital stock, respectively. The outstanding shares of Preferred Stock represent 100% of our outstanding nonvoting capital stock.

Following the Spin-Off, since January 3, 2012, our Class A Common Stock has been listed and traded on NASDAQ under the symbol "OSH" and our Series A Preferred Stock has been quoted on the OTCQB under the symbol "OSHSP."

2012 First Quarter Financial Highlights

For the first quarter of fiscal 2012, net sales were $155.0 million, a decrease of $8.8 million, or 5.4% as compared to net sales of $163.8 million for the first quarter of fiscal 2011. The decrease in net sales was primarily driven by softness in outdoor and seasonal merchandise we believe to be a result of inclement weather.

Comparable store sales decreased 3.1%, which was primarily driven by a decline in comparable transaction volume of 4.4%, partially offset by a 1.3% increase in average ticket comparables.

Gross margin was $52.1 million, or 33.6% of net sales, for the first quarter of fiscal 2012, a decrease of $3.1 million, or 5.6% as compared to $55.2 million, or 33.7% of net sales, for the first quarter of fiscal 2011. The decrease in gross margin was primarily due to the decrease in net sales. The decrease in gross margin as a percentage of sales was primarily due to an increase in occupancy costs as a result of paying rent on previously owned properties prior to sale-leaseback transactions.


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We recorded $4.5 million in net loss for the first fiscal quarter of 2012, as compared to $1.0 million in net loss for the first quarter of fiscal 2011. The increase in net loss was primarily due to the decline in sales and gross margins.

Merchandise inventory was $173.4 million at the end of the first quarter of fiscal 2012, a decrease of $5.2 million, or 2.9%, as compared to merchandise inventory of $178.6 million at the end of the first quarter of fiscal 2011.

Adjusted EBITDA was $7.5 million for the first fiscal quarter of 2012, as compared to Adjusted EBITDA of $11.2 million for the first fiscal quarter of 2011. Adjusted EBITDA as presented below under 'Results of Operations' is a supplemental measure of our operating performance that is not required by or presented in accordance with GAAP. Adjusted EBITDA should not be considered as an alternative to net income (loss) or any other performance measures derived in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity. The decrease in Adjusted EBITDA of $3.7 million was primarily due to lower net sales as well as the Company's cost associated with the transition to a public company.

2012 First Quarter Business Highlights

The Company continues to focus on five key strategic priorities in its goal to become the neighborhood hardware and garden store focused on paint, repair and the backyard. These five key priorities are:

Project a consistent and compelling brand identity;

Drive sales through merchandising and marketing initiatives;

Improve operational efficiencies;

Align resources and talent; and

Strengthen our financial position.

The Company is continuing to focus and execute on its turn-around initiatives. Key accomplishments during the first quarter of fiscal 2012 included:

Brand Identity. During the first quarter, the Company opened a new store in Fresno, California featuring our newly designed store format. We have signed a lease for a new store in Tigard, Oregon. This will be our first new store outside of California and is expected to open in early 2013. During the quarter, we refurbished approximately 35 stores with new exterior signage and paint in our updated logo and colors, and provided direct access from the parking lot to the Company's higher margin nursery and garden centers at approximately 15 additional stores.

Drive Sales. The decrease in comparable store sales during the first quarter was primarily attributable to softness in outdoor and seasonal goods. We believe that the cold, wet weather had a negative impact on consumer traffic in these categories. In addition, we believe the continuing challenges of the California economy will require us to focus additional effort on marketing, promotions and consumer communications to drive increased traffic. We also continue to focus on improving our product assortments through product line reviews, as well as initiatives such as our distribution agreement with Benjamin Moore & Co.

Improve Operating Efficiencies. During the first quarter, we initiated several programs to more effectively deploy labor hours in order to increase the amount of time our associates can spend with customers.

Align Resources and Talent. During the first quarter, we reorganized our merchandising organization to improve efficiencies and enhance capabilities. We also initiated several new store-level training programs to better enable our store associates to serve our customers.

Financial Position. During the first quarter, we generated $6.6 million in net proceeds from the sale of one parcel of land and one sale-leaseback transaction. The proceeds were primarily used to pay down debt. We will also continue to examine a number of alternatives with respect to optimizing our financial position, including raising additional capital through debt or equity financing transactions.


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RESULTS OF OPERATIONS

The discussion that follows should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements that are included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012, as well as the unaudited interim consolidated financial statements and accompanying notes contained in this report. Our unaudited consolidated results of operations for the 13 weeks ended April 28, 2012 and April 30, 2011 are summarized below (dollars and shares in millions except per share amounts and store count).

                                                                      13 Weeks Ended
                                                                    % of                           % of
                                                   April 28,         Net          April 30,        Net
                                                     2012           Sales           2011          Sales
NET SALES                                         $     155.0          100 %     $     163.8         100 %
COST OF SALES AND EXPENSES:
Cost of sales (excluding depreciation and
amortization)                                           102.9         66.4             108.6        66.3
Gross Margin                                             52.1         33.6              55.2        33.7
Selling and administrative                               45.9         29.6              44.0        26.9
Depreciation and amortization                             7.8          5.0               7.2         4.4
Gain on sale of real property                            (0.6 )       (0.4 )              -         (0.0 )

Total cost of sales and expenses                        156.0        100.6             159.8        97.6

OPERATING (LOSS) INCOME                                  (1.0 )       (0.6 )             4.0         2.4
INTEREST EXPENSE, NET                                     6.6          4.3               5.6         3.4

LOSS BEFORE INCOME TAXES                                 (7.6 )       (4.9 )            (1.6 )      (1.0 )
INCOME TAX BENEFIT                                       (3.1 )       (2.0 )            (0.6 )      (0.4 )

NET LOSS                                          $      (4.5 )       (2.9 )%    $      (1.0 )      (0.6 )%

Basic and diluted loss per share                  $     (0.75 )                  $     (0.16 )
Basic and diluted weighted average common
shares outstanding                                        6.0                            6.0
OTHER DATA:
ADJUSTED EBIDTA                                   $       7.5                    $      11.2
STORE COUNT                                                88                             89

In addition to our net loss determined in accordance with accounting principles generally accepted in the United States ("GAAP"), for purposes of evaluating operating performance, we use Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA"), a non-GAAP financial measure, which is adjusted to exclude certain significant items as set forth below. Our management uses Adjusted EBITDA to evaluate the operating performance of our business, as well as executive compensation metrics, for comparable periods. Adjusted EBITDA should not be used by investors or other third parties as the sole basis for formulating investment decisions as it excludes a number of important cash and non-cash recurring items. Adjusted EBITDA should not be considered as a substitute for GAAP measurements.

While Adjusted EBITDA is a non-GAAP financial measurement, management believes that it is an important indicator of operating performance because:

Adjusted EBITDA excludes the effects of financing and investing activities by eliminating the effects of interest and depreciation costs;

Management considers gain/(loss) on the sale of assets to result from investing decisions. Asset impairments and equity compensation expenses are excluded as they are non-cash charges; and

Other significant items, while periodically affecting our results, may vary significantly from period to period and have a disproportionate effect in a given period, which affects comparability of results.


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The following table and the discussion that follows presents information related to the non-GAAP performance measure Adjusted EBITDA. Due to the fact that Adjusted EBITDA is a non-GAAP measure, we have also included a reconciliation from Adjusted EBITDA to net loss (in millions).

                                                                   13 Weeks Ended
                                                           April 28,             April 30,
                                                              2012                 2011
Net loss                                                  $       (4.5 )        $      (1.0 )
Interest expense, net                                              6.6                  5.6
Income tax benefit                                                (3.1 )               (0.6 )
Depreciation and amortization                                      7.8                  7.2
Net loss on sale of real property and impairment of
assets                                                             0.2                  0.1
Stock-based compensation                                           0.2                  0.1
Other significant items                                            0.3                 (0.2 )

Adjusted EBITDA                                           $        7.5          $      11.2

Adjusted EBITDA as a % of net sales                                4.8 %                6.8 %

Adjusted EBITDA is not the same as EBITDA as defined for our Senior Secured Term Loan and Real Estate Term Loan.

Other significant items include certain reserves and charges not in the normal course of our operations that periodically affect the comparability of our results. We recorded severance charges of $0.3 million during each of the first quarters of fiscal 2012 and 2011 due to changes in our management structure and in connection with our cost cutting initiatives. In the first quarter of fiscal 2011, we reversed $0.5 million of legal fees related to the Save Mart Supermarkets legal judgment, as described in Note 12, "Commitment and Contingencies" of our Annual Report on Form 10-K for the fiscal year ended January 28, 2012.

Comparable sales figures are defined as follows:

1. Comparable store sales. Measured by the increase or decrease in net sales year over year, excluding new and closed stores and E-commerce. Additionally, and because of an agreement the Company entered into with Sears Holdings (the "Appliances Agreement") on October 26, 2011 whereby the Company now sells appliances on a consignment basis and receives commission income for sales of such appliances and related protection agreements, comparable store sales also exclude approximately $4.1 million of sales of Sears Holdings branded appliances in the first quarter of fiscal 2011 and approximately $0.5 million of commission income in the first quarter of fiscal 2012.

2. Comparable transaction volume. Derived from the increase or decrease in the number of transactions year over year, excluding new and closed stores, appliance sales, and E-commerce.

3. Average ticket comparables. Derived using net sales divided by the number of transactions year over year.

A store is included in the calculation of comparable metrics above if it has been open for at least 12 months, including relocated and remodeled stores. Comparable sales metrics discussed above are intended only as supplemental information and are not a substitute for information presented in accordance with generally accepted accounting principles.

13-week period ended April 28, 2012 compared to 13-week period ended April 30, 2011

Net sales

13 Weeks Ended Increase (Decrease) April 28, 2012 April 30, 2011 $ % Net sales $ 155.0 $ 163.8 $ (8.8 ) (5.4 )%

Net sales decreased $8.8 million, or 5.4%, to $155.0 million for the first quarter of fiscal 2012, as compared to $163.8 million for the first quarter of fiscal 2011. Approximately $5.0 million of the decrease in sales was reflected in our 3.1% decline in comparable store sales, comprised of a decline in comparable transactions of 4.4%, partially offset by a 1.3% increase in average ticket comparables. The decline in comparable store sales is primarily attributable to (a) a decline in sales in outdoor and seasonal merchandise we believe to be a result of inclement weather in March and April and (b) the decline in promotional activity during the period. The balance of the decline in net sales is attributed to the impact of the Appliances Agreement (see the definition of comparable store sales above).


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Gross margin

13 Weeks Ended Increase (Decrease) April 28, 2012 April 30, 2011 $ % Gross margin $ 52.1 $ 55.2 $ (3.1 ) (5.6 )% Percent of net sales 33.6 % 33.7 %

Gross margin decreased $3.1 million to $52.1 million, or 33.6% of net sales, for the first quarter of fiscal 2012, as compared to $55.2 million or 33.7% of net sales, for the first quarter of fiscal 2011. The decrease of 10 basis points in gross margin was primarily due to approximately 160 basis points of higher occupancy costs as a result of paying rent on properties previously owned prior to the sale-leaseback transactions and as a result of deleverage of occupancy and distribution center costs due to lower net sales. These were partially offset by improved merchandise margins of approximately 140 basis points because of improved initial markups, reduced markdowns due to lower levels of clearance activity, and higher vendor subsidies due to the transition of product suppliers.

Selling and administrative

                                                    13 Weeks Ended                         Increase (Decrease)
                                        April 28, 2012           April 30, 2011             $                %
Selling and administrative            $             45.9        $           44.0        $     1.9              4.3 %
Percent of net sales                                29.6 %                  26.9 %

Selling and administrative expenses increased $1.9 million to $45.9 million or 29.6% of net sales, for the first quarter of fiscal 2012, as compared to $44.0 million or 26.9% of net sales, for the first quarter of fiscal 2011. The increase in selling and administrative expenses was primarily due to
(a) non-cash charges of approximately $0.8 million related to the write-down of store assets that were disposed of or determined to be impaired, (b) a $1.0 million increase in operating costs associated with being a public company, and
(c) a $0.5 million legal accrual reversed in the first quarter of fiscal 2011 with no corresponding reversal in the first quarter of fiscal 2012. These were partially offset by approximately $1.1 million in reduced advertising and marketing expense in the first quarter of fiscal 2012 as compared to the first quarter of fiscal 2011.

Gain on sale of real property

13 Weeks Ended Increase (Decrease) April 28, 2012 April 30, 2011 $ % Gain on sale of real property $ (0.6 ) $ - $ (0.6 ) -

During first fiscal quarter of 2012, we recorded a non-cash gain of $0.6 million in connection with the sale-leaseback transactions involving our store in San Lorenzo, California and a parcel of land in San Jose, California. There was no sale of real property in the prior year for the same quarter.

Depreciation and amortization

13 Weeks Ended Increase (Decrease) April 28, 2012 April 30, 2011 $ % Depreciation and amortization $ 7.8 $ 7.2 $ 0.6 8.3 %

Depreciation and amortization increased $0.6 million to $7.8 million or 8.3% for the first quarter of fiscal 2012, as compared to $7.2 million for the first quarter of fiscal 2011. The increase in depreciation and amortization expense was primarily due to accelerated depreciation on stores currently being remodeled.

Interest expense, net

13 Weeks Ended Increase (Decrease) April 28, 2012 April 30, 2011 $ % Interest expense, net $ 6.6 $ 5.6 $ 1.0 17.9 %

Interest expense increased $1.0 million to $6.6 million or 17.9% for the first quarter of fiscal 2012, as compared to $5.6 million for the first quarter of fiscal 2011. The $1.0 million increase in interest expense was primarily due to higher interest rates associated with amendments to our Senior Secured Term Loan and Real Estate Secured Term Loan, as well as additional interest expense on capital lease properties.


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Income tax benefit

13 Weeks Ended Increase (Decrease) April 28, 2012 April 30, 2011 $ % Income tax benefit $ (3.1 ) $ (0.6 ) $ (2.5 ) 416.7 % Effective tax rate 40.8 % 37.5 %

Income tax benefit was $3.1 million for the first quarter of fiscal 2012 as compared to an income tax benefit of $0.6 million recorded for the first quarter of fiscal 2011. The effective tax rate was 40.8% and 37.5% for the first quarter of fiscal 2012 and 2011, respectively. The change in our effective tax rate was primarily due to differences in tax credits applicable year over year.


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