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ALCS > SEC Filings for ALCS > Form 10-Q on 18-Dec-2013All Recent SEC Filings

Show all filings for ALCO STORES INC

Form 10-Q for ALCO STORES INC


18-Dec-2013

Quarterly Report


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

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS, FINANCIAL CONDITION OR BUSINESS

Certain statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact may constitute "forward-looking statements" within the meaning of Section 21E of the Exchange Act. These statements are subject to risks and uncertainties, as described below. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, capital expenditures, store openings, store closings, payment or non-payment of dividends, capital structure and other financial items, (ii) statements of plans and objectives of the Company's management or Board of Directors, including plans or objectives relating to inventory, store development, marketing, competition, business strategy, store environment, merchandising, purchasing, pricing, distribution, transportation, store locations and information systems, (iii) statements of future economic performance, and (iv) statements of assumptions underlying the statements described in (i), (ii) and (iii). Forward-looking statements can often be identified by the use of forward-looking terminology, such as "believes," "expects," "may," "will," "should," "could," "intends," "plans," "estimates", "projects" or "anticipates," variations thereof or similar expressions.

Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. The Company's future results of operations, financial condition and business operations may differ materially from the forward-looking statements or the historical information stated in this Quarterly Report on Form 10-Q. Stockholders and investors are cautioned not to put undue reliance on any forward-looking statement.

There are a number of factors and uncertainties that could cause actual results of operations, financial condition or business contemplated by the forward-looking statements to differ materially from those discussed in the forward-looking statements made herein or elsewhere orally or in writing, by, or on behalf of, the Company, including those factors described below. Other factors not identified herein could also have such an effect. Factors that could cause actual results to differ materially from those discussed in the forward-looking statements and from historical information include, but are not limited to, those factors described below.

OVERVIEW

Economic conditions: The lingering economic slowdown has caused disruptions and significant volatility in financial markets, increased rates of mortgage loan default and personal bankruptcy, and declining consumer and business confidence, which has led to decreased customer traffic and reduced levels of consumer spending, particularly on discretionary items. The continuing economic recession has impacted the Company's customers, whom the Company believes to be primarily on a fixed or low income, and has negatively affected their ability to shop in our stores and buy our products. This decline in consumer and business confidence and the decreased levels of customer traffic and consumer spending have negatively impacted our business. We cannot predict how long the current economically challenging conditions will persist and how such conditions might affect us and our customers. Decreased customer traffic and reduced consumer spending, particularly on discretionary items, would, however, over an extended period of time negatively affect our financial condition, operating performance, revenues and income. In addition, we cannot predict how current or worsening economic conditions will affect our critical suppliers and distributors and any negative impact on our critical suppliers or distributors may also have an adverse impact on our business results or financial condition.

The economic slowdown also affects the Company's business environment. Due to lower discretionary spending by consumers and a high demand for lower cost goods, the discount retail industry has become highly competitive. This competitive environment impacts the Company because lower prices and greater markdowns on inventory are necessary to keep the Company's position in the industry and these factors may result in lower margins and profitability.

Another factor that continues to impact the Company is severe weather. We have experienced severe weather conditions, including snow and ice storms, flood and wind damage, tornadoes and droughts in some states that have slowed consumer confidence and customer traffic.

Management does not believe that its merchandising operations, net sales, revenue or results from continuing operations have been materially impacted by inflation during the past two fiscal years.

Operations. The Company is a regional broad line retailer operating in 23 states.

For purposes of this management's discussion and analysis of financial condition and results of operations, the financial numbers are presented in millions.

Strategy. The Company's overall business strategy involves identifying and opening stores in locations that will provide the Company with the highest return on investment. The Company also competes for retail sales with other entities, such as mail order companies, specialty retailers, stores, manufacturer's outlets and the internet. The Company initiated a transactional web site during November 2011. In July 2012, the Company expanded the product selection on its website which now includes more than 20,000 items of high-quality merchandise. Products offered on the ALCOstores.com website include video games and electronics, housewares, appliances and furniture, health & beauty aids, baby goods, office supplies, automotive and sporting goods, and much more. As in traditional ALCO stores, consumers can choose from a wide range of well-known brand names. In addition, the website includes brands not found in the Company's retail stores.


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During the second quarter of fiscal 2013, the Company adopted regional pricing and merchandising. Regional pricing will allow the Company to identify opportunities to price specific items differently in different markets, depending on regional competitive situations, while maintaining the Company's superior value positioning with shoppers in each market. Regional merchandising consists of tailoring product offerings for specific needs in the Company's regions, such as adding fire-retardant clothing in stores in oil-drilling areas and higher-end outdoor apparel in areas frequented by outdoors enthusiasts, such as Colorado and other Western states.

The Company uses a variety of broad-based targeted marketing and advertising strategies to reach consumers. These strategies include full-color photography advertising circulars of eight to 20 pages distributed through newspaper insertion or, in the case of inadequate newspaper coverage, through direct mail. During fiscal 2014, the Company will distribute approximately 48 circulars in the Company's markets. The Company also uses in-store marketing. The Company's merchandising and marketing teams work together to present the products in an engaging and innovative manner, which is coordinated so that it is consistent with the current print advertisements. The Company regularly changes its banners and in-store promotions, which are advertised throughout the year, to attract consumers to the stores, to generate strong customer frequency and to increase average sales per customer. Net marketing and promotion costs represented approximately 1.1% and 1.0% of net sales during the third quarter of fiscal 2014 and 2013, respectively. Net marketing and promotion costs represented approximately 1.1% and 1.1% of net sales during the thirty-six weeks ended November 3, 2013 and October 28, 2012, respectively. Management believes it has developed a comprehensive marketing strategy, intended to increase customer traffic and same-store sales. The Company continues to operate as a high-low retailer and has included in many of its marketing vehicles cross departmental products. For example, the Company has used an Elder Care page with over-the-counter products, "as seen on TV" items, and dry meals-all targeting customers who have reached retirement age. The Company believes that by providing the breadth of these key items to this targeted audience we can serve our customers' needs more efficiently and garner a greater share of the purchases made by this demographic. The Company's stores offer a broad line of merchandise consisting of approximately 35,000 items, including automotive, consumables and commodities, crafts, domestics, electronics, furniture, hardware, health and beauty aids, housewares, jewelry, ladies', men's and children's apparel and shoes, pre-recorded music and video, sporting goods, seasonal items, stationery and toys. The Company is constantly evaluating the appropriate mix of merchandise to improve sales and gross margin performance. Corporate merchandising is provided to each store to ensure a consistent Company-wide store presentation. To facilitate long-term merchandising planning, the Company divides its merchandise into three core categories:
primary, secondary, and convenience. The primary core receives management's primary focus, with a wide assortment of merchandise being placed in the most accessible locations within the stores and receiving significant promotional consideration. The secondary core consists of categories of merchandise for which the Company maintains a strong assortment that is easily and readily identifiable by its customers. The convenience core consists of categories of merchandise for which the Company maintains convenient (but limited) assortments, focusing on key items that are in keeping with customers' expectations for a broad line retail store. Secondary and convenience cores include merchandise that the Company feels is important to carry, as the target customer expects to find them within a broad line retail store and they ensure a high level of customer traffic. The Company continually evaluates and ranks all product lines, shifting product classifications when necessary to reflect the changing demand for products. In addition, the Company's merchandising systems are designed to integrate the key retailing functions of seasonal merchandise planning, purchase order management, merchandise distribution, sales information and inventory maintenance and replenishment. All of the Company's ALCO stores have point-of-service computer terminals that capture sales information and transmit such information to the Company's data processing facilities where it is used to drive management, financial, and supply chain functions.

Store Expansion. The continued growth of the Company is dependent, in large part, upon the Company's ability to open and operate new stores on a timely and profitable basis. The Company opened one store during fiscal 2014 and a total of five stores during fiscal 2013. While the Company believes that adequate sites are available for future store openings, the rate of new store openings is subject to various contingencies, many of which are beyond the Company's control. These material contingencies include:

the Company's ability to hire, train, and retain qualified personnel;

the availability of adequate capital resources for us to purchase inventory, equipment, and fixtures and make other capital expenditures necessary for store expansion; and

the ability of our landlords and developers to find appropriate financing in the current credit market to develop property to be leased by the Company.

Historically, we have been able to hire, train, and retain qualified personnel and we anticipate being able to do so in the future. In order to address the increase in demand for qualified management, the Company will continue to recruit for those interested in working and living in our communities. Once hired, the management personnel will complete an in-store, hands-on management training program coupled with e-learning modules to ensure operational efficiencies and align to the Company priorities. We believe this training process will allow the Company to see the benefits of prompt time-to-productivity, employee engagement and commitment, and overall employee retention.

We currently believe that we will have the capital resources necessary to purchase the inventory, equipment, and fixtures, and to fund the other capital expenditures necessary for future store expansions. If we lack such capital resources, however, it would limit our expansion plans and negatively impact our operations going forward. The Company has been working closely with multiple developers and landlords that the Company believes have the financial resources to develop property to be leased by the Company and hold such property as a long-term investment in their portfolios. If such developers and landlords do not have, and cannot obtain, the financial resources to develop and hold such property, it would limit our expansion plans and negatively impact our operations going forward.

Financial Risk: The Company closely monitors IRS Section 382 regarding technical change of control. This particular section of the tax code would place an annual limit on the Company's right to use its net operating loss carry-forwards ("NOLs") should the aggregate shift in 5% shareholders be more than 50% in the preceding three-year testing period or as a result of certain reorganizations ("Tripping Event"). The annual limitation approximates 3% of the Company's market capitalization just prior to the Tripping Event. In the event of a Tripping Event, management believes the Company would still be able to utilize its NOLs prior to their expiration, albeit over a longer period of time.


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In 2010, the "Patient Protection and Affordable Care Act" and the "Health Care and Education Affordability Reconciliation Act of 2010" (the "2010 Healthcare Acts") were signed into law. This legislation expands health care coverage to many uninsured individuals and expands coverage for those already insured. The 2010 Healthcare Acts, as well as other healthcare reform legislation being considered by Congress and state legislatures, may have a negative impact on our business. This impact could increase our employee healthcare related costs. While the costs of the 2010 Healthcare Acts will occur after December 31, 2013, due to provisions of this legislation being phased in over time, changes to our healthcare cost structure could have an adverse effect on the Company's financial condition. While the Company cannot currently project the full amount of providing health insurance to all employees or the penalties that would be imposed if the Company did not offer health care to all employees, the Company believes that a reasonable range of incremental costs could be between $1.0 and $4.0 million, annually.

On April 10, 2013, the Company issued a press release to announce the relocation of the Company's corporate office from Abilene, Kansas to Coppell, Texas, a suburb of Dallas, Texas. On August 7, 2013, the Company received the certificate of occupancy for its corporate office in Coppell, TX. As of November 3, 2013, the transition of nearly all the Company's administrative support functions had been completed. If the Company does not continue to execute its relocation plan properly and in accordance with budget constraints, then costs associated with such relocation may adversely affect the financial performance of the Company.

Recent Events.

On October 30, 2013, the Company held a special meeting of its stockholders, to vote on the proposal to adopt the Agreement and Plan of Merger, dated as of July 25, 2013. The proposal to adopt the Merger Agreement did not receive approval from more than a majority of the outstanding shares of the Company's common stock, and therefore was not approved by the Company's Stockholders. As a result of the failure to receive such stockholder approval, on October 30, 2013, the Company delivered to Parent and Merger Sub a written notice (the "Termination Notice") terminating the Merger Agreement in accordance with
Section 7.2(b) of the Merger Agreement. As a result of the Termination Notice, the Merger Agreement was terminated and the merger contemplated thereby was abandoned.

On November 22, 2013, pursuant to Section 2.16 of the Facility, the Board of Directors unanimously approved a request to increase the revolving credit commitments of the Company by $10.0 million (the "Commitment Increase"); thereby, increasing the overall Facility from $120.0 million to $130.0 million. Except for the Commitment Increase, the Facility remains unchanged and in full force and effect.

Key Items in the Third Quarter of Fiscal 2014.

The Company measures itself against a number of financial metrics to assess its performance. Some of the important financial items, from continuing operations, during the third quarter of fiscal 2014 were:

Net sales from continuing operations during the third quarter of fiscal 2014 increased 0.7% to $106.7 million, compared to net sales during the third quarter of fiscal 2013 of $105.9 million.

Gross margin percentage is a key measure of the Company's ability to maximize profit on the purchase and subsequent sale of merchandise, while minimizing promotional and clearance markdowns, shrinkage, damage and returns. Gross margin percentage is defined as net sales less cost of sales, expressed as a percentage of net sales.

Gross margin, as a percentage of net sales, was 26.2% during the third quarter of fiscal 2014, compared to 31.1% during the third quarter of fiscal 2013.

Selling, general and administrative expenses ("SG&A") are a measure of the Company's ability to manage and control its expenses to purchase, distribute and sell merchandise.

SG&A as a percentage of net sales was 32.8% during the third quarter of fiscal 2014, compared to 30.1% during the third quarter of fiscal 2013. Included in SG&A are costs associated with the Company's merger activity in the amount of $1.1 million during the third quarter of fiscal 2014 and $2.3 million for the thirty-nine weeks ended November 3, 2013.

During the third quarter of fiscal 2014, the Company recorded a non-cash charge of $9.8 million attributable to a valuation allowance on the Company's cumulative net deferred tax asset. The establishment of a valuation allowance does not have any impact on cash, nor does such an allowance preclude the Company from utilizing its loss carryforwards in the future.

Earnings per share ("EPS") is an indicator of the returns generated for the Company's stockholders.

Net loss per diluted share for the third quarter of fiscal 2014 was $5.11, compared to a net loss per diluted share of $0.37 during third quarter of fiscal 2013.

RESULTS OF OPERATIONS

The following table sets forth the components of the Company's statements of
operations expressed as percentages of net sales:

                                             Thirteen Week Periods Ended               Thirty-Nine Week Periods Ended
                                           November 3,         October 28,
                                              2013                2012           November 3, 2013           October 28, 2012
Net sales                                        100.0 %             100.0 %                 100.0 %                    100.0 %
Cost of sales                                     73.8                68.9                    70.8                       68.9
Gross margin                                      26.2                31.1                    29.2                       31.1
Selling, general and administrative               32.8                30.1                    29.9                       28.6
Depreciation and amortization                      2.0                 2.1                     1.9                        1.9
Total operating expenses                          34.8                32.2                    31.8                       30.5
Operating income (loss) from continuing           (8.6 )              (1.1 )
operations                                                                                    (2.6 )                      0.6
Interest expense                                   0.8                 0.8                     0.8                        0.7
Loss from continuing operations before            (9.4 )              (1.9 )
income taxes                                                                                  (3.4 )                     (0.1 )
Income tax expense (benefit)                       5.6                (0.7 )                   1.6                        0.0
Loss from continuing operations                  (15.0 )              (1.2 )                  (5.0 )                     (0.1 )
Loss from discontinued operations, net            (0.5 )              (0.2 )
of income tax benefit                                                                         (0.2 )                     (0.2 )
Net loss                                         (15.5 )%             (1.4 )%                 (5.2 )%                    (0.3 )%



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Thirteen Weeks Ended November 3, 2013 Compared to Thirteen Weeks Ended October 28, 2012

Net sales from continuing operations, including the Company's transactional website, during the third quarter of fiscal 2014 increased 0.7% to $106.7 million, compared to net sales during the third quarter of fiscal 2013 of $105.9 million. Net sales from the Company's transactional website during the third quarter of fiscal 2014 were $25 thousand, a decrease of $6 thousand compared to the third quarter of fiscal 2013.

Net sales from same-stores, excluding the Company's two fuel center locations, decreased 2.9%, or $3.0 million, to $101.1 million during the third quarter of fiscal 2014, compared to $104.1 million during the third quarter of fiscal 2013. The decrease in same-store sales was primarily due to a 4.0% decrease in customer transactions occurring at a same-store and partially offset by a 1.1% increase in the average sale per customer transaction occurring at a same-store.

Net sales from non-same stores during the third quarter of fiscal 2014 increased $2.0 million and net sales from the Company's two fuel center locations during the third quarter of fiscal 2014 decreased $0.3 million.

Gross margin from continuing operations for the third quarter of fiscal 2014 decreased $5.0 million, or 15.2%, to $27.9 million compared to $32.9 million during the third quarter of fiscal 2013. As a percentage of net sales, gross margin was 26.2% and 31.1% during the third quarter of fiscal 2014 and fiscal 2013, respectively. Gross margin generated by non same-stores was $1.5 million during the third quarter of fiscal 2014.

Gross margin for the third quarter of fiscal 2014 was negatively impacted by higher promotional activity and partially offset by lower freight costs. Increased promotional activity during the third quarter of fiscal 2014 included an aggressive inventory reduction strategy, especially in certain discretionary categories such as apparel and home. Net freight costs during the third quarter of fiscal 2014 decreased $0.2 million, or 3.8%, to $4.0 million compared to $4.2 million during the third quarter of fiscal 2013. As a percentage of net sales, net freight costs were 3.8% and 4.0% during the third quarter of fiscal 2014 and fiscal 2013, respectively.

SG&A from continuing operations increased $3.2 million, or 10.1%, to $35.0 million during the third quarter of fiscal 2014, compared to $31.8 million during the third quarter of fiscal 2013. The increase in SG&A is primarily attributable to costs associated with merger activity of the Company ($1.1 million), increase in same-stores ($1.0 million), and increase due to new stores ($0.8 million). As a percentage of net sales, SG&A was 32.8% and 30.1% during the third quarter of fiscal 2014 and fiscal 2013, respectively. Excluding share-based compensation, costs associated with merger activity, and loss on sale of assets, SG&A was 31.7% and 29.9% of net sales for the third quarter of fiscal 2014 and fiscal 2013, respectively.

Depreciation and amortization expense from continuing operations decreased $0.1 million or 3.0% to $2.1 million during the third quarter of fiscal 2014 compared to $2.2 million during the third quarter of fiscal 2013.

Interest expense was $0.9 million during the third quarter for both fiscal 2014 and fiscal 2013. Excluding interest on capital lease obligations and amortization of debt financing costs, interest expense was $0.5 million during the third quarter for both fiscal 2014 and fiscal 2013.

Income tax expense on continuing operations was $6.0 million during the third quarter of fiscal 2014 compared to income tax benefit of $0.8 million during the third quarter of fiscal 2013. During the third quarter of fiscal 2014, the Company recorded a non-cash charge of $9.8 million attributable to a valuation allowance on the Company's cumulative net deferred tax asset. Based on cumulative book, pre-tax loss over the 36 month period ended November 3, 2013, management concluded it is more likely than not, the Company will not realize the benefits of these deductible differences. The establishment of a valuation allowance does not have any impact on cash, nor does such an allowance preclude the Company from utilizing its loss carryforwards in the future. The effective tax rate was (59.4) % during the third quarter of fiscal 2014 compared to 40.5% during the third quarter of fiscal 2013.

Loss from continuing operations, including income tax expense, increased $14.9 million to $16.1 million during the third quarter of fiscal 2014 compared to loss from continuing operations, net of tax benefit, of $1.1 million during the third quarter of fiscal 2013. As a percentage of net sales, loss from continuing operations was 15.0% during the third quarter of fiscal 2014 compared to net loss of 1.2% during the third quarter of fiscal 2013.

Loss from discontinued operations, net of income tax benefit, was $0.6 million during the third quarter of fiscal 2014 compared to $0.2 million during the third quarter of fiscal 2013.

Thirty-Nine Weeks Ended November 3, 2013 Compared to Thirty-Nine Weeks Ended October 28, 2012

Net sales from continuing operations, including the Company's transactional website, during the thirty-nine weeks ended November 3, 2013 increased 1.5% to $343.2 million, compared to net sales during the thirty-nine weeks ended October 28, 2012 of $338.2 million. Net sales from the Company's transactional website during the thirty-nine weeks ended November 3, 2013 were $75 thousand, an increase of $31 thousand compared to the thirty-nine weeks ended October 28, 2012.

Net sales from same-stores, excluding the Company's two fuel center locations, decreased 1.5%, or $5.0 million, to $327.6 million during the thirty-nine weeks ended November 3, 2013, compared to $332.6 million during the thirty-nine weeks ended October 28, 2012. The decrease in same-store sales was primarily due to a 5.0% decrease in customer transactions occurring at a same-store and partially offset by a 3.6% increase in the average sale per customer transaction occurring at a same-store.

Net sales from non-same stores during the thirty-nine weeks ended November 3, 2013 increased $8.5 million and net sales from the Company's two fuel center locations during the thirty-nine weeks ended November 3, 2013 decreased $0.7 million.


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Gross margin from continuing operations for the thirty-nine weeks ended November . . .
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