UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
| x | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended October 29, 2011
| ¨ | Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File Number: 000-50563
BAKERS FOOTWEAR GROUP, INC.
(Exact name of registrant as specified in its charter)
| Missouri | 43-0577980 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
2815 Scott Avenue, St. Louis, Missouri | 63103 | |
| (Address of principal executive offices) | (Zip Code) | |
(314) 621-0699
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
| Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | x | |||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common Stock, par value $0.0001 per share, 9,295,916 shares issued and outstanding as of December 3, 2011.
BAKERS FOOTWEAR GROUP, INC.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 14 | |||
Item 3. Quantitative and Qualitative Disclosures About Market Risk | 25 | |||
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PART I — FINANCIAL INFORMATION
| ITEM 1. | FINANCIAL STATEMENTS |
CONDENSED BALANCE SHEETS
| October 30, 2010 | January 29, 2011 | October 29, 2011 | ||||||||||
| (Unaudited) | (Unaudited) | |||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 137,467 | $ | 146,263 | $ | 141,014 | ||||||
Accounts receivable | 1,903,112 | 1,484,809 | 1,758,789 | |||||||||
Inventories | 27,477,487 | 25,911,508 | 27,717,117 | |||||||||
Prepaid expenses and other current assets | 965,404 | 970,883 | 1,352,208 | |||||||||
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Total current assets | $ | 30,483,470 | 28,513,463 | $ | 30,969,128 | |||||||
Property and equipment, net | 19,586,088 | 18,405,166 | 15,274,164 | |||||||||
Other assets | 1,098,792 | 1,087,058 | 875,705 | |||||||||
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Total assets | 51,168,350 | $ | 48,005,687 | 47,118,997 | ||||||||
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Liabilities and shareholders’ deficit | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 16,292,855 | $ | 16,009,847 | $ | 23,184,890 | ||||||
Accrued expenses | 8,640,830 | 8,519,585 | 8,932,093 | |||||||||
Subordinated secured term loan | 901,407 | — | — | |||||||||
Subordinated convertible debentures – current portion | — | — | 1,000,000 | |||||||||
Sales tax payable | 1,043,072 | 1,122,024 | 952,656 | |||||||||
Deferred income | 1,133,335 | 1,120,444 | 731,806 | |||||||||
Revolving credit facility | 17,495,501 | 10,449,299 | 17,373,597 | |||||||||
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Total current liabilities | 45,507,000 | 37,221,199 | 52,175,042 | |||||||||
Accrued noncurrent rent liabilities | 8,911,771 | 8,648,272 | 7,819,893 | |||||||||
Subordinated convertible debentures | 4,000,000 | 4,000,000 | 3,000,000 | |||||||||
Subordinated debenture | 4,000,000 | 4,123,327 | 4,169,080 | |||||||||
Shareholders’ deficit: | ||||||||||||
Preferred stock, $0.0001 par value, 5,000,000 shares authorized, no shares outstanding | — | — | — | |||||||||
Common Stock, $0.0001 par value; 40,000,000 shares authorized, 9,228,916 shares outstanding at October 30, 2010 and January 29, 2011 and 9,295,916 shares outstanding at October 29, 2011 | 923 | 923 | 930 | |||||||||
Additional paid-in capital | 40,349,781 | 40,443,888 | 40,717,822 | |||||||||
Accumulated deficit | (51,601,125 | ) | (46,431,922 | ) | (60,763,770 | ) | ||||||
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Total shareholders’ deficit | (11,250,421 | ) | (5,987,111 | ) | (20,045,018 | ) | ||||||
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Total liabilities and shareholders’ deficit | $ | 51,168,350 | $ | 48,005,687 | $ | 47,118,997 | ||||||
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See accompanying notes.
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CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
| Thirteen Weeks Ended October 30, 2010 | Thirteen Weeks Ended October 29, 2011 | Thirty-nine Weeks Ended October 30, 2010 | Thirty-nine Weeks Ended October 29, 2011 | |||||||||||||
Net sales | $ | 40,575,879 | $ | 40,201,918 | $ | 127,393,042 | $ | 131,518,272 | ||||||||
Cost of merchandise sold, occupancy, and buying expenses | 34,225,698 | 35,264,873 | 98,373,653 | 101,353,821 | ||||||||||||
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Gross profit | 6,350,181 | 4,937,045 | 29,019,389 | 30,164,451 | ||||||||||||
Operating expenses: | ||||||||||||||||
Selling | 9,570,751 | 10,010,375 | 29,000,060 | 30,105,160 | ||||||||||||
General and administrative | 3,831,426 | 3,873,335 | 11,524,740 | 12,201,418 | ||||||||||||
Loss on disposal of property and equipment | 7,172 | 10,840 | 67,449 | 30,632 | ||||||||||||
Impairment of long-lived assets | 1,415,979 | 932,879 | 1,415,979 | 932,879 | ||||||||||||
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Operating loss | (8,475,147 | ) | (9,890,384 | ) | (12,988,839 | ) | (13,105,638 | ) | ||||||||
Other income (expense): | ||||||||||||||||
Interest expense | (542,348 | ) | (484,430 | ) | (1,537,184 | ) | (1,389,949 | ) | ||||||||
Other, net | 82,514 | 141,093 | 116,787 | 163,739 | ||||||||||||
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Loss before income taxes | (8,934,981 | ) | (10,233,721 | ) | (14,409,236 | ) | (14,331,848 | ) | ||||||||
Provision for income taxes | — | — | 51,704 | — | ||||||||||||
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Net loss | $ | (8,934,981 | ) | $ | (10,233,721 | ) | $ | (14,460,940 | ) | $ | (14,331,848 | ) | ||||
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Basic loss per share | $ | (1.03 | ) | $ | (1.10 | ) | $ | (1.85 | ) | $ | (1.54 | ) | ||||
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Diluted loss per share | $ | (1.03 | ) | $ | (1.10 | ) | $ | (1.85 | ) | $ | (1.54 | ) | ||||
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See accompanying notes.
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CONDENSED STATEMENT OF SHAREHOLDERS’ DEFICIT
(Unaudited)
| Common Stock | ||||||||||||||||||||
| Shares Issued and Outstanding | Amount | Additional Paid-In Capital | Accumulated Deficit | Total | ||||||||||||||||
Balance at January 29, 2011 | 9,228,916 | $ | 923 | $ | 40,443,888 | $ | (46,431,922 | ) | $ | (5,987,111 | ) | |||||||||
Stock-based compensation expense | — | — | 273,934 | — | 273,934 | |||||||||||||||
Issuance of restricted stock | 67,000 | 7 | — | — | 7 | |||||||||||||||
Net loss | — | — | — | (14,331,848 | ) | (14,331,848 | ) | |||||||||||||
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Balance at October 29, 2011 | 9,295,916 | $ | 930 | $ | 40,717,822 | $ | (60,763,770 | ) | $ | (20,045,018 | ) | |||||||||
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See accompanying notes.
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CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
| Thirty-nine Weeks Ended October 30, 2010 | Thirty-nine Weeks Ended October 29, 2011 | |||||||
Operating activities | ||||||||
Net loss | $ | (14,460,940 | ) | $ | (14,331,848 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation and amortization | 4,389,814 | 3,875,488 | ||||||
Accretion of debt discount | 178,795 | 45,753 | ||||||
Stock-based compensation expense | 269,981 | 273,934 | ||||||
Loss on disposal of property and equipment | 67,449 | 30,632 | ||||||
Impairment of long-lived assets | 1,415,979 | 932,879 | ||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (352,385 | ) | (273,980 | ) | ||||
Inventories | (7,244,280 | ) | (1,805,609 | ) | ||||
Prepaid expenses and other current assets | 269,383 | (381,325 | ) | |||||
Other assets | (13,713 | ) | 206,651 | |||||
Accounts payable | 6,154,220 | 7,175,043 | ||||||
Accrued expenses and deferred income | 978,113 | (145,498 | ) | |||||
Accrued noncurrent rent liabilities | (271,985 | ) | (828,379 | ) | ||||
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Net cash used in operating activities | (8,619,569 | ) | (5,226,259 | ) | ||||
Investing activities | ||||||||
Purchase of property and equipment | (852,334 | ) | (1,703,288 | ) | ||||
Proceeds from sale of property and equipment | 3,282 | — | ||||||
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Net cash used in investing activities | (849,052 | ) | (1,703,288 | ) | ||||
Financing activities | ||||||||
Net advances under revolving credit facility | 6,963,814 | 6,924,298 | ||||||
Net proceeds from the issuance of subordinated secured term loan and common stock | 4,549,704 | — | ||||||
Costs of issuing subordinated term loan and common stock | 385 | — | ||||||
Principal payments on subordinated secured term loan | (2,062,500 | ) | — | |||||
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Net cash provided by financing activities | 9,451,403 | 6,924,298 | ||||||
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Net decrease in cash and cash equivalents | (17,218 | ) | (5,249 | ) | ||||
Cash and cash equivalents at beginning of period | 154,685 | 146,263 | ||||||
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Cash and cash equivalents at end of period | $ | 137,467 | $ | 141,014 | ||||
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Supplemental disclosures of cash flow information | ||||||||
Cash paid for interest | $ | 1,048,992 | $ | 1,161,945 | ||||
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See accompanying notes.
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NOTES TO CONDENSED FINANCIAL STATEMENTS
Unaudited
1. Basis of Presentation
The accompanying unaudited condensed financial statements contain all adjustments that management believes are necessary to present fairly Bakers Footwear Group, Inc.’s (the Company’s) financial position, results of operations and cash flows for the periods presented. Such adjustments consist of normal recurring accruals. Certain information and disclosures normally included in notes to financial statements have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission. The Company’s operations are subject to seasonal fluctuations and, consequently, operating results for interim periods are not necessarily indicative of the results that may be expected for other interim periods or for the full year. The condensed financial statements should be read in conjunction with the audited financial statements and the notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended January 29, 2011. The Company has evaluated subsequent events through the date the financial statements were issued and filed with the Securities and Exchange Commission (“SEC”) and has made disclosures of all material subsequent events in the notes to the unaudited condensed interim financial statements.
2. Liquidity
The Company’s cash requirements are primarily for working capital, principal and interest payments on debt obligations, and capital expenditures. Historically, these cash needs have been met by cash flows from operations, borrowings under the Company’s revolving credit facility and sales of securities. The balance on the revolving credit facility fluctuates throughout the year as a result of seasonal working capital requirements and other uses of cash.
The Company’s losses in the first thirty-nine weeks of fiscal year 2011 and fiscal years after 2005 have had a significant negative impact on the Company’s financial position and liquidity. As of October 29, 2011, the Company had negative working capital of $21.2 million, unused borrowing capacity under its revolving credit facility of $1.0 million, and shareholders’ deficit of $20.0 million.
Comparable store sales for the first six weeks of the fourth quarter of 2011, through December 10, 2011, decreased 5.5%, reflecting lower demand for dress boots. The Company expects comparable store sales will continue lower for the remainder of the fourth quarter. The lower projected sales in the fourth quarter of fiscal year 2011 places additional pressure on the Company’s liquidity position.
The Company has updated its business plan for the remainder of fiscal year 2011 and for fiscal year 2012 to reflect anticipated mid-single digit decreases in comparable store sales for the remainder of fiscal year 2011, generally flat comparable sales for the first half of fiscal year 2012 and mid-single digit increases in comparable sales for the second half of 2012. The Company expects to maintain adequate liquidity for the remainder of fiscal year 2011 by working with its landlords and vendors to arrange payment terms that are reflective of its current cash flow. However, the Company does not expect to achieve significant additional liquidity through further extensions of payment terms. Also, the Company is initiating a plan to achieve $10.0 million of margin enhancements and cost cuts and is exploring opportunities to generate cash through the sale of selected corporate assets. The business plan for fiscal year 2012 reflects increased focus on inventory management and on timely promotional activity. The Company believes that this focus on inventory should improve overall gross margin performance in fiscal year 2012 compared to fiscal year 2011. The Company will need to continue working with its landlords and vendors to arrange payment terms that are reflective of its seasonal cash flow patterns. However, there is no assurance that the Company will achieve the sales, margin improvements, expense reductions or improved cash flow contemplated in its business plan.
On May 28, 2010, the Company amended its revolving credit facility. The amendment extended the maturity of the credit facility to May 28, 2013, modified the calculation of the borrowing base, added a new minimum availability or adjusted EBITDA interest coverage ratio covenant, added an obligation for the Company to extend the maturity of its subordinated convertible debentures, and made other changes to the agreement. The Company incurred fees and expenses of approximately $250,000 in connection with this amendment. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either the Company maintain unused availability greater than 20% of the calculated borrowing base or maintain a ratio of adjusted EBITDA to interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily and, if not met, then the adjusted EBITDA covenant is tested on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in the Company’s subordinated secured term loan. The Company did not meet these
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covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the Debenture and Stock Purchase Agreement discussed below. During the third and fourth quarters of fiscal year 2010 and the first three quarters of 2011, the Company met the bank covenant based on maintaining unused availability greater than 20% on a daily basis. The Company’s business plan for the remainder of fiscal year 2011 and 2012 also anticipates meeting the bank covenant on this basis. The Company continues to closely monitor its availability and continues to be constrained by its limited unused borrowing capacity. As of December 10, 2011, the balance on the revolving line of credit was $17.0 million and unused borrowing capacity in excess of the covenant commitment was $1.3 million.
Effective June 30, 2011, the Company amended its $4 million in aggregate principal amount of 9.5% subordinated convertible debentures, originally issued in June 2007. The amendments defer payment of principal under the debentures. Originally, all $4 million in principal amount was payable on June 30, 2012. Under the amendments, principal will be repaid in four equal annual installments of $1 million beginning on June 30, 2012. The interest rate on the debentures was also increased from 9.5% to 12% per annum. The amendments were consented to by the Company’s senior lender pursuant to an amendment to the Company’s senior credit facility. The bank amendment removed the covenant to refinance the subordinated convertible debentures and allows the Company to make the $1 million required principal payment on June 30, 2012, provided that certain conditions are met, including that the Company maintains at least a 1.0 to 1.0 ratio of adjusted EBITDA to its interest expense for the 12 month period ending May 26, 2012, all as calculated pursuant to the senior credit facility.
Based on the Company’s business plans for fiscal years 2011 and 2012 including the anticipated impact of the margin improvement and cost reduction program, the Company believes that it will be able to comply with the minimum availability or adjusted EBITDA coverage ratio covenant in the revolving credit facility and comply with the adjusted EBITDA requirement related to the scheduled principal payment on the convertible debentures in June 2012. However, given the inherent volatility in the Company’s sales performance such as the anticipated decreased comparable store sales in the fourth quarter of fiscal year 2011, there is no assurance that the Company will be able to do so. In addition, in light of the Company’s historical sales volatility and the current state of the economy, the Company believes that there is a reasonable possibility that the Company may not be able to comply with its financial covenants. Failure to comply would be a default under the terms of the Company’s revolving credit facility and could result in the acceleration of all of the Company’s debt obligations. If the Company is unable to comply with its financial covenants, it will be required to seek one or more amendments or waivers from its lenders. The Company believes that it would be able to obtain any required amendments or waivers, but can give no assurance that it would be able to do so on favorable terms, if at all. If the Company is unable to obtain any required amendments or waivers, the Company’s lenders would have the right to exercise remedies specified in the loan agreements, including accelerating the repayment of debt obligations and taking collection action against the Company. If such acceleration occurred, the Company currently has insufficient cash to pay the amounts owed and would be forced to seek alternative financing.
The Company continues to face considerable liquidity constraints. Although the Company believes the business plan, including the cost reduction and margin improvement plan, is achievable, should the Company fail to achieve the sales or gross margin levels anticipated, or if the Company were to incur significant unplanned cash outlays, it would quickly become necessary for the Company to obtain additional sources of liquidity or make further cost cuts to fund its operations. In recognition of existing liquidity constraints, the Company continues to look for additional sources of capital at acceptable terms. However, there is no assurance that the Company would be able to obtain such financing on favorable terms, if at all, or to successfully further reduce costs in such a way that would continue to allow the Company to operate its business.
The Company’s independent registered public accounting firm’s report issued in the Company’s most recent Annual Report on Form 10-K included an explanatory paragraph describing the existence of conditions that raise substantial doubt about the Company’s ability to continue as a going concern, including recent losses and working capital deficiency. The financial statements do not include any adjustments relating to the recoverability and classification of assets carrying amounts or the amount of and classification of liabilities that may result should the Company be unable to continue as a going concern.
3. Impairment of Long-Lived Assets
The Company reviews long-lived assets to be “held and used” for impairment when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. The Company regularly analyzes the operating results of its stores and assesses the viability of under-performing stores to determine whether they should be closed or whether their associated assets, including furniture, fixtures, equipment, and leasehold improvements, have been impaired. Asset impairment tests are performed at least annually, on a store-by-store basis. After allowing for an appropriate start-up period, unusual nonrecurring events, and favorable trends, fixed assets of stores indicated to be impaired are written down to fair value based on management’s estimates of future store sales and expenses, which are considered Level 3 inputs. During the thirty-nine weeks ended October 29, 2011 and October 30, 2010, the Company recorded $932,879 and $1,415,979, respectively, in noncash charges to earnings related to the impairment of long-lived assets.
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4. Revolving Credit Facility
The Company has a revolving credit agreement with a commercial bank (Bank). This agreement calls for a maximum line of credit of $30,000,000 subject to the calculated borrowing base as defined in the agreement, which is based primarily on the Company’s inventory level. The agreement is secured by substantially all assets of the Company. The credit facility is senior to the subordinated convertible debentures and the subordinated debenture. Interest is payable monthly at the bank’s base rate plus 3.5%. An unused line fee of 0.75% per annum is payable monthly based on the difference between the maximum line of credit and the average loan balance. The Company had approximately $2,814,000, $3,060,000 and $993,000 (under the terms of the minimum availability covenant discussed below) of unused borrowing capacity under the revolving credit agreement based upon the Company’s borrowing base calculation as of October 30, 2010, January 29, 2011, and October 29, 2011. The agreement has certain restrictive financial and other covenants relating to, among other things, use of funds under the facility in accordance with the Company’s business plan, prohibiting a change of control, including any person or group acquiring beneficial ownership of 40% or more of the Company’s common stock or combined voting power (as defined in the credit facility), maintaining a minimum availability, prohibiting new debt, restricting dividends and the repurchase of the Company’s stock, and restricting certain acquisitions. The revolving credit agreement also provides that the Company can elect to fix the interest rate on a designated portion of the outstanding balance as set forth in the agreement based on the LIBOR (London Interbank Offered Rate) plus 4.0%.
As described in Note 2, on May 28, 2010, the Company amended its revolving credit agreement. The amendment extended the maturity of the credit facility from January 31, 2011 to May 28, 2013, modified the calculation of the borrowing base, added a new minimum availability or adjusted EBITDA interest coverage ratio covenant, added an obligation for the Company to extend the maturity of its subordinated convertible debentures, and made other changes to the agreement. The Company incurred fees and expenses of approximately $250,000 in connection with this amendment. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either the Company maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of the Company’s adjusted EBITDA to its interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily and, if not met, then the adjusted EBITDA covenant is tested on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in the Company’s subordinated secured term loan.
In connection with an amendment to the Company’s subordinated convertible debentures, the Company amended its revolving credit facility to allow the Company to make a required $1 million principal payment in respect of the subordinated convertible debentures on June 30, 2012, provided that certain conditions are met, including that the Company maintains at least a 1.0 to 1.0 ratio of adjusted EBITDA to its interest expense for the 12 month period ending May 26, 2012, all as calculated pursuant to the senior credit facility.
5. Subordinated Debenture
On August 26, 2010, the Company entered into a Debenture and Stock Purchase Agreement with Steven Madden, Ltd. In connection with the agreement, the Company sold a subordinated debenture in the principal amount of $5,000,000. Under the subordinated debenture, interest payments are required to be paid quarterly at an interest rate of 11% per annum. The principal amount is required to be paid in four annual installments commencing August 31, 2017 and the subordinated debenture matures on August 31, 2020. The subordinated debenture is generally unsecured and subordinate to the Company’s other indebtedness. As additional consideration, Steven Madden, Ltd. also received 1,844,860 shares of the Company’s common stock, representing a 19.99% interest in the Company on a post-closing basis. In connection with the transaction, the Company received aggregate net proceeds of approximately $4.5 million after transaction and other costs.
The Company allocated the net proceeds received in connection with the subordinated debenture and the related issuance of common stock based on the relative fair values of the debt and equity components of the transaction. The fair value of the 1,844,860 shares of common stock issued was estimated based on the actual market value of the Company’s common stock at the time of the transaction net of a blockage discount based on the size of the issuance relative to average trading volume in the Company’s common stock and a discount to reflect unregistered shares were issued and could not be sold on the open market. The fair value of the $5.0 million principal amount of debt was estimated based on publicly available data regarding the valuation of debt of companies with comparable credit ratings. The relative fair values of the debt and equity components were then prorated into the net proceeds received by the Company to determine the amounts to be allocated to debt and equity. Other expenses incurred by the Company relative to this transaction will be allocated either to debt issuance costs or as a reduction of additional paid-in capital based on either
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specific identification of the particular expenses or on a pro rata basis. The Company accretes the initial value of the debt to the nominal value of the debt over the term of the loan using the effective interest method and recognizes such accretion as a component of interest expense. Likewise, the Company amortizes the related debt issuance costs using the effective interest method and recognizes this amortization as a component of interest expense.
6. Subordinated Convertible Debentures
The Company completed a private placement of $4,000,000 in aggregate principal amount of subordinated convertible debentures on June 26, 2007 and received net proceeds of approximately $3.6 million. Originally, the debentures bore interest at a rate of 9.5% per annum, payable semi-annually and the principal balance of $4,000,000 was payable in full on June 30, 2012. On June 30, 2011, the Company amended the debentures by changing the principal repayment terms to four equal annual installments of $1 million beginning on June 30, 2012. The interest rate on the debentures was also increased from 9.5% to 12% per annum. As discussed above, under the terms of the Company’s revolving credit facility, the Company is allowed to make the $1 million principal payment on June 30, 2012, which is due prior to expiration of the senior credit facility, provided that certain conditions are met, including that the Company maintains at least a 1.0 to 1.0 ratio of adjusted EBITDA to its interest expense for the 12 month period ending May 26, 2012, all as calculated pursuant to the senior credit facility.
The initial conversion price was $9.00 per share. The conversion price is subject to anti-dilution and other adjustments, including a weighted average conversion price adjustment for certain future issuances or deemed issuances of common stock at a lower price, subject to limitations as required under rules of the Nasdaq Stock Market. The Company can redeem the unpaid principal balance of the debentures if the closing price of the Company’s common stock is at least $16.00 per share, subject to the adjustments and conditions in the debentures.
The debentures contain a weighted average conversion price adjustment that is triggered by issuances or deemed issuances of the Company’s common stock. As a result of the issuance of shares of common stock, effective August 26, 2010, the conversion price of the debentures decreased to $6.76 with respect to $1 million in aggregate principal amount of debentures and to $8.10, the minimum conversion price, with respect to $3 million in aggregate principal amount of debentures held by directors and director affiliates.
The Company uses Financial Accounting Standards Board (FASB) guidance in Accounting Standards Certification (ASC) 815, Derivatives and Hedging, related to determining whether an instrument (or embedded feature) is indexed to an entity’s own stock and established a two-step process for making such determination. The Company accounts separately for the fair value of the conversion feature of the convertible debentures. As of October 30, 2010, January 29, 2011 and October 29, 2011, the Company determined that the fair value of the conversion feature was de minimis. Significant future increases in the value of the Company’s common stock would result in an increase in the fair value of the conversion feature which would result in expense recognition in future periods.
7. Subordinated Secured Term Loan
Effective February 4, 2008, the Company consummated a $7.5 million three-year subordinated secured term loan (the Loan) and issued 350,000 shares of the Company’s common stock as additional consideration. Net proceeds to the Company after transaction costs were approximately $6.7 million. The Company used the net proceeds to repay amounts owed under its senior revolving credit facility and for working capital purposes. The Loan was secured by substantially all of the Company’s assets and was subordinate to the Company’s revolving credit facility but had priority over the Company’s subordinated convertible debentures. The Loan required 36 monthly payments of principal and interest at an interest rate of 15% per annum and was fully repaid in January 2011.
8. Income Taxes
In accordance with ASC 740, Income Taxes, the Company regularly assesses available positive and negative evidence to determine whether it is more likely than not that its deferred tax asset balances will be recovered from (a) reversals of deferred tax liabilities, (b) potential utilization of net operating loss carrybacks, (c) tax planning strategies and (d) future taxable income. There are significant restrictions on the consideration of future taxable income in determining the realizability of deferred tax assets in situations where a company has experienced a cumulative loss in recent years. When sufficient negative evidence exists that indicates that full realization of deferred tax assets is no longer more likely than not, a valuation allowance is established as necessary against the deferred tax assets, increasing the Company’s income tax expense in the period that such conclusion is reached. Subsequently, the valuation allowance is adjusted up or down as necessary to maintain coverage against the deferred tax assets. If, in the future, sufficient positive evidence, such as a sustained return to profitability, arises that would indicate that realization of deferred tax assets is once again more likely than not, any existing valuation allowance would be reversed as appropriate, decreasing the Company’s income tax expense in the period that such conclusion is reached.
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Management believes it is more likely than not that the Company will not be able to realize benefits of net deferred tax assets, and therefore has established a valuation allowance against its net deferred tax assets. As of October 29, 2011, the Company has increased the valuation allowance to $25.2 million. The Company has scheduled the reversals of its deferred tax assets and deferred tax liabilities and has concluded that based on the anticipated reversals a valuation allowance is necessary only for the excess of deferred tax assets over deferred tax liabilities.
As of October 29, 2011, the Company has approximately $39.9 million of net operating loss carryforwards that expire in 2022 available to offset future taxable income.
| Thirteen Weeks Ended October 30, 2010 | Thirteen Weeks Ended October 29, 2011 | Thirty-nine Weeks Ended October 30, 2010 | Thirty-nine Weeks Ended October 29, 2011 | |||||||||||||
Current: | ||||||||||||||||
Federal | $ | (1,739,470 | ) | $ | (2,389,538 | ) | $ | (3,085,410 | ) | $ | (3,725,623 | ) | ||||
State and local | (399,418 | ) | (529,733 | ) | (643,147 | ) | (810,340 | ) | ||||||||
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Total current | (2,138,888 | ) | (2,919,271 | ) | (3,728,557 | ) | (4,535,963 | ) | ||||||||
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Deferred: | ||||||||||||||||
Federal | (1,089,568 | ) | (851,921 | ) | (1,469,185 | ) | (797,910 | ) | ||||||||
State and local | (198,103 | ) | (154,895 | ) | (267,124 | ) | (145,074 | ) | ||||||||
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Total deferred | (1,287,671 | ) | (1,006,816 | ) | (1,736,309 | ) | (942,984 | ) | ||||||||
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Valuation allowance | 3,426,559 | 3,926,087 | 5,516,570 | 5,478,947 | ||||||||||||
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Total income tax expense | $ | — | $ | — | $ | 51,704 | $ | — | ||||||||
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The differences between income tax expense at the statutory U.S. federal income tax rate of 35% and the amount reported in the statements of operations are as follows:
| Thirteen Weeks Ended October 30, 2010 | Thirteen Weeks Ended October 29, 2011 | Thirty-nine Weeks Ended October 30, 2010 | Thirty-nine Weeks Ended October 29, 2011 | |||||||||||||
Federal income tax at statutory rate | $ | (3,127,243 | ) | $ | (3,581,802 | ) | $ | (5,043,233 | ) | $ | (5,016,147 | ) | ||||
Impact of State NOL carryback refund restrictions | — | — | 51,704 | — | ||||||||||||
Impact of graduated Federal rates | 89,350 | 102,337 | 144,092 | 143,318 | ||||||||||||
State and local taxes, net of federal income taxes | (395,118 | ) | (452,547 | ) | (637,216 | ) | (633,810 | ) | ||||||||
Change in valuation allowance | 3,426,558 | 3,926,087 | 5,516,570 | 5,478,947 | ||||||||||||
Permanent differences | 6,453 | 5,925 | 19,787 | 27,692 | ||||||||||||
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Total income tax expense | $ | — | $ | — | $ | 51,704 | $ | — | ||||||||
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Deferred income taxes arise from temporary differences in the recognition of income and expense for income tax purposes. Deferred income taxes were computed using the liability method and reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes.
Components of the Company’s deferred tax assets and liabilities are as follows:
| October 30, 2010 | January 29, 2011 | October 29, 2011 | ||||||||||
Deferred tax assets: | ||||||||||||
Net operating loss carryforward | $ | 12,822,453 | $ | 10,775,110 | $ | 15,311,073 | ||||||
Vacation accrual | 410,565 | 405,473 | 419,513 | |||||||||
Inventory | 1,419,073 | 1,191,540 | 1,433,626 | |||||||||
Stock-based compensation | 1,221,810 | 1,258,512 | 1,365,346 | |||||||||
Accrued rent | 3,475,591 | 3,372,826 | 3,049,759 | |||||||||
Property and equipment | 2,664,962 | 2,842,665 | 3,770,303 | |||||||||
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Total deferred tax assets | 22,014,454 | 19,846,126 | 25,349,620 | |||||||||
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Deferred tax liabilities: | ||||||||||||
Prepaid expenses | 133,851 | 103,629 | 128,176 | |||||||||
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Valuation allowance | (21,880,603 | ) | (19,742,497 | ) | (25,221,444 | ) | ||||||
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Net deferred tax assets | $ | — | $ | — | $ | — | ||||||
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The Company’s federal income tax returns subsequent to the fiscal year ended January 1, 2005 remain open. As of October 29, 2011, the Company has not recorded any unrecognized tax benefits. The Company’s policy, if it had unrecognized benefits, is to recognize accrued interest and penalties related to unrecognized tax benefits as interest expense and other expense, respectively.
9. Stock-Based Compensation
During the thirty-nine weeks ended October 29, 2011, the Company issued 75,000 nonqualified stock options with a weighted average exercise price of $0.80. During the thirty-nine weeks ended October 30, 2010, the Company issued 227,000 nonqualified stock options with a weighted average exercise price of $2.50.These options are exercisable in equal annual installments of 20% on or after each of the first five years from the date of grant and expire ten years from the date of grant. The Company uses the Black-Scholes option pricing model to determine the fair value of stock options. During the thirty-nine weeks ended October 29, 2011, the Company also issued 67,000 shares of restricted common stock. Shares of restricted stock cliff vest on the five year anniversary of the grant date.
The number of stock options granted, their grant-date weighted-average fair value, and the significant assumptions used to determine fair-value during the thirty-nine weeks ended October 30, 2010 and October 29, 2011, are as follows:
| Thirty-nine Weeks Ended October 30, 2010 | Thirty-nine Weeks Ended October 29, 2011 | |||||||
Options granted | 227,000 | 75,000 | ||||||
Weighted-average fair value of options granted | $ | 1.96 | $ | 0.63 | ||||
Assumptions | ||||||||
Dividends | 0 | % | 0 | % | ||||
Risk-free interest rate | 2.8 | % | 2.2 | % | ||||
Expected volatility | 97 | % | 99 | % | ||||
Expected option life | 6 years | 6 years | ||||||
10. Loss Per Share
Basic loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted loss per share is computed using the weighted average number of common shares and potential dilutive securities that were outstanding during the period. Potential dilutive securities consist of outstanding stock options and warrants and shares underlying the subordinated convertible debentures.
The following table sets forth the components of the computation of basic and diluted loss per share for the periods indicated.
| Thirteen Weeks Ended October 30, 2010 | Thirteen Weeks Ended October 29, 2011 | Thirty-nine Weeks Ended October 30, 2010 | Thirty-nine Weeks Ended October 29, 2011 | |||||||||||||
Numerator: | ||||||||||||||||
Net loss | $ | (8,934,981 | ) | $ | (10,233,721 | ) | $ | (14,460,940 | ) | $ | (14,331,848 | ) | ||||
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| |||||||||
Numerator for loss per share | (8,934,981 | ) | (10,233,721 | ) | (14,460,940 | ) | (14,331,848 | ) | ||||||||
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Interest expense related to convertible debentures | — | — | — | — | ||||||||||||
Numerator for diluted loss per share | $ | (8,934,981 | ) | $ | (10,233,721 | ) | $ | (14,460,940 | ) | $ | (14,331,848 | ) | ||||
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Denominator: | ||||||||||||||||
Denominator for basic loss per share — weighted average shares | 8,701,813 | 9,295,916 | 7,822,982 | 9,284,627 | ||||||||||||
Effect of dilutive securities | ||||||||||||||||
Stock options | — | — | — | — | ||||||||||||
Subordinated convertible debentures | — | — | — | — | ||||||||||||
Denominator for diluted loss per share — adjusted weighted average shares and assumed conversions | 8,701,813 | 9,295,916 | 7,822,982 | 9,284,627 | ||||||||||||
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The diluted loss per share calculation for the thirteen weeks ended October 29, 2011 excludes 28,627 incremental shares related to outstanding stock options and 518,299 incremental shares underlying convertible debentures because they are antidilutive. The diluted loss per share calculation for the thirty-nine weeks ended October 29, 2011 excludes 31,130 incremental shares related to outstanding stock options and 518,299 incremental shares underlying convertible debentures because they are antidilutive. The diluted loss per share calculation for the thirteen weeks ended October 30, 2010 excludes 28,365 incremental shares related to outstanding stock
12
options and 508,148 incremental shares underlying convertible debentures because they are antidilutive. The diluted loss per share calculation for the thirty-nine weeks ended October 30, 2010 excludes 34,241 incremental shares related to outstanding stock options and 490,281 incremental shares underlying convertible debentures because they are antidilutive.
11. Commitments and Contingencies
The Company has certain contingent liabilities resulting from litigation and claims incident to the ordinary course of business. Management believes the probable resolution of such contingencies will not materially affect the financial position or results of operations of the Company. The Company, in the ordinary course of store construction and remodeling, is subject to mechanic’s liens on the unpaid balances of the individual construction contracts. The Company obtains lien waivers from all contractors and subcontractors prior to or concurrent with making final payments on such projects.
12. Fair Value of Financial Instruments
The Company has adopted the provisions of ASC 825, Financial Instruments, related to interim disclosures about fair value of financial instruments. This guidance requires disclosures regarding fair value of financial instruments in interim financial statements, as well as in annual financial statements.
| October 30, 2010 | ||||||||
| Carrying Amount | Fair Value | |||||||
Cash and cash equivalents | $ | 137,467 | $ | 137,467 | ||||
Revolving credit facility | 17,495,501 | 17,495,501 | ||||||
Subordinated debenture | 4,000,000 | 4,000,000 | ||||||
Subordinated secured term loan | 901,407 | 901,407 | ||||||
Subordinated convertible debentures | 4,000,000 | 3,017,090 | ||||||
| January 29, 2011 | ||||||||
| Carrying Amount | Fair Value | |||||||
Cash and cash equivalents | $ | 146,263 | $ | 146,263 | ||||
Revolving credit facility | 10,449,299 | 10,449,299 | ||||||
Subordinated debenture | 4,123,327 | 4,039,445 | ||||||
Subordinated convertible debentures | 4,000,000 | 3,052,837 | ||||||
| October 29, 2011 | ||||||||
| Carrying Amount | Fair Value | |||||||
Cash and cash equivalents | $ | 141,014 | $ | 141,014 | ||||
Revolving credit facility | 17,373,597 | 17,373,597 | ||||||
Subordinated debenture | 4,169,080 | 3,937,837 | ||||||
Subordinated convertible debentures | 4,000,000 | 3,034,388 | ||||||
The carrying amount of cash equivalents approximates fair value because of the short maturity of those instruments. The carrying amount of the revolving credit facility approximates fair value because the facility has a floating interest rate. The fair values of the subordinated secured term loan, the subordinated convertible debentures and the subordinated debenture have been estimated based on current rates available to the Company for similar debt of the same maturity.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Company’s unaudited condensed financial statements and notes thereto provided herein and the Company’s audited financial statements and notes thereto in our annual report on Form 10-K for the fiscal year ended January 29, 2011. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. The factors that might cause such a difference also include, but are not limited to, those discussed in our Annual Report on Form 10-K under “Item 1. Business — Cautionary Note Regarding Forward-Looking Statements and Risk Factors” and under “Item 1. Business — Risk Factors” and those discussed elsewhere in our Annual Report on Form 10-K and related notes thereto and elsewhere in this quarterly report.
Overview
We are a national, mall-based, specialty retailer of distinctive footwear and accessories targeting young women who demand quality fashion products. We feature private label and national brand dress, casual and sport shoes, boots, sandals and accessories. As of October 29, 2011, we operated 233 stores, including 217 Bakers stores and 16 Wild Pair stores located in 34 states.
During the first thirty-nine weeks of 2011, our net sales increased 3.2% compared to the first thirty-nine weeks of 2010, as strong spring sales of dress shoes were partially offset by lower demand for opened up footwear in the summer and for dress boots in the fall. Comparable store sales in the first thirty-nine weeks of 2011 increased 5.1%, compared to an increase of 1.3% in the first thirty-nine weeks of last year. Gross profit percentage increased to 22.9% of sales in the first thirty-nine weeks of 2011 compared to 22.8% in the first thirty-nine weeks of 2010. We recognized noncash impairment expense of $0.9 million compared to $1.4 million last year. Our net loss was $14.3 million for the first thirty nine weeks of 2011, compared to a net loss of $14.5 million in the first thirty nine weeks of 2010.
Comparable store sales for the first six weeks of the fourth quarter of 2011, through December 10, 2011, decreased 5.5% reflecting lower demand for dress boots. We expect comparable store sales will continue lower for the remainder of the fourth quarter. The lower projected sales in the fourth quarter of fiscal year 2011 places additional pressure on our liquidity position.
Our losses in the first thirty-nine weeks of fiscal year 2011 and fiscal years after 2005 have had a significant negative impact on our financial position and liquidity. As of October 29, 2011, we had negative working capital of $21.2 million, unused borrowing capacity under our revolving credit facility of $1.0 million, and a shareholders’ deficit of $20.0 million.
As discussed in more detail in the “Liquidity and Capital Resources” section below, We have updated our business plan for the remainder of fiscal year 2011 and for fiscal year 2012 to reflect anticipated mid-single digit decreases in comparable store sales for the remainder of fiscal year 2011, generally flat comparable sales for the first half of fiscal year 2012 and mid-single digit increases in comparable sales for the second half of 2012. We expect to maintain adequate liquidity for the remainder of fiscal year 2011 by working with our landlords and vendors to arrange payment terms that are reflective of our current cash flow. However, we do not expect to achieve significant additional liquidity through further extensions of payment terms. Also, we are initiating a plan to achieve $10.0 million of margin enhancements and cost cuts and are exploring opportunities to generate cash through the sale of selected corporate assets. The business plan for fiscal year 2012 reflects increased focus on inventory management and on timely promotional activity. We believe that this focus on inventory should improve overall gross margin performance in fiscal year 2012 compared to fiscal year 2011. We will need to continue working with our landlords and vendors to arrange payment terms that are reflective of our seasonal cash flow patterns. However, there is no assurance that we will achieve the sales, margin improvements, expense reductions or improved cash flow contemplated in our business plan.
Under the terms of our revolving credit facility we are subject to certain financial and other covenants. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either we maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of our adjusted EBITDA to our interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily and, if not met, then the adjusted EBITDA covenant is tested on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in our subordinated secured term loan. We did not meet these covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the August 2010 debt and equity issuance discussed below. Beginning with the
14
third quarter of fiscal year 2010, we have met the bank covenant based on maintaining unused availability greater than 20% on a daily basis. Our business plan for the remainder of 2011 and 2012 also anticipates meeting the bank covenant on this basis. We continue to closely monitor our availability and continue to be constrained by our limited unused borrowing capacity. As of December 3, 2011, the balance on our revolving line of credit was $18.6 million, and our unused borrowing capacity in excess of the covenant minimum was $0.4 million.
In June 2011, we amended our $4 million in aggregate principal amount of 9.5% subordinated convertible debentures, which were originally issued in June 2007. The amendments defer payment of principal under the debentures. Originally, all $4 million in principal amount was payable on June 30, 2012. Under the amendments, principal will be repaid in four equal annual installments of $1 million beginning on June 30, 2012. The interest rate on the debentures was also increased from 9.5% to 12% per annum. The amendments were consented to by our senior lender pursuant to an amendment to our senior credit facility. The bank amendment removed the covenant to refinance our subordinated convertible debentures and allows us to make the $1 million required principal payment on June 30, 2012, which is the only principal payment now required under the debentures prior to maturity of the credit facility on May 28, 2013, provided that certain conditions are met. These conditions include a requirement that we maintain at least a 1.0 to 1.0 ratio of adjusted EBITDA to interest expense for the 12 month period ending May 26, 2012, all as calculated pursuant to the senior credit facility.
Based on our business plans for the remainder of fiscal year 2011 and for fiscal year 2012 including the anticipated impact of the margin improvement and cost reduction program, we believe that we will be able to comply with the minimum availability or adjusted EBITDA coverage ratio covenant in our revolving credit facility and comply with the adjusted EBITDA requirement related to the scheduled principal payment on the convertible debentures in June 2012. However, given the inherent volatility in our sales performance such as the anticipated decreased comparable store sales in the fourth quarter of fiscal year 2011, there is no assurance that we will be able to do so. In addition, in light of our historical sales volatility and the current state of the economy, we believe that there is a reasonable possibility that we may not be able to comply with the financial covenants. Failure to comply would be a default under the terms of the revolving credit facility and could result in the acceleration of all of our debt obligations. If we are unable to comply with our financial covenants, we will be required to seek one or more additional amendments or waivers from our lenders. We believe that we would be able to obtain any required amendments or waivers, but can give no assurance that we would be able to do so on favorable terms, if at all. If we are unable to obtain any required amendments or waivers, our lenders would have the right to exercise remedies specified in the loan agreements, including accelerating the repayment of debt obligations and taking collection action against us. If such acceleration occurred, we currently have insufficient cash to pay the amounts owed and would be forced to seek alternative financing.
We continue to face considerable liquidity constraints. Although we believe our revised business plan, including our margin improvement and cost reduction plan, is achievable, should we fail to achieve the sales or gross margin levels we anticipate, or if we were to incur significant unplanned cash outlays, it would quickly become necessary for us to seek additional sources of liquidity or make further cost cuts to fund our operations. In recognition of existing liquidity constraints, we continue to look for additional sources of capital at acceptable terms. However, there is no assurance that we would be able to obtain such financing on favorable terms, if at all, or to successfully further reduce costs in such a way that would continue to allow us to operate our business. Please see Item 1.A. Risk Factors – “Our fourth quarter 2011 sales trends have weakened and we are initiating a cost reduction and margin improvement plan that must be successful over the next year, or we may fail to maintain a liquidity position adequate to support our ongoing operations” in Part II of this Quarterly Report on Form 10-Q,which is incorporated herein by reference.
For comparison purposes, we classify our stores as comparable or non-comparable. A new store’s sales are not included in comparable store sales until the thirteenth month of operation. Sales from remodeled stores are excluded from comparable store sales during the period of remodeling. We include our Internet and call center sales (“Multi-Channel Sales”) as one store in calculating our comparable store sales.
Critical Accounting Policies
Our financial statements are prepared in accordance with U.S. generally accepted accounting principles, which require us to make estimates and assumptions about future events and their impact on amounts reported in our Financial Statements and related Notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates. These differences could be material to the financial statements.
We believe that our application of accounting policies, and the estimates that are inherently required by these policies, are reasonable. We believe that the following significant accounting policies may involve a higher degree of judgment and complexity.
15
Merchandise inventories
Merchandise inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out retail inventory method. Consideration received from vendors relating to inventory purchases is recorded as a reduction of cost of merchandise sold, occupancy, and buying expenses after an agreement with the vendor is executed and when the related inventory is sold. We physically count all merchandise inventory on hand annually, generally during the month of January, and adjust the recorded balance to reflect the results of the physical count. We record estimated shrinkage between physical inventory counts based on historical results. Inventory shrinkage is included as a component of cost of merchandise sold, occupancy, and buying costs. Permanent markdowns are recorded to reflect expected adjustments to retail prices in accordance with the retail inventory method. In determining permanent markdowns, we consider current and recently recorded sales prices, the length of time product is held in inventory, and quantities of various product styles contained in inventory, among other factors. The process of determining our expected adjustments to retail prices requires significant judgment by management. The ultimate amount realized from the sale of inventories could differ materially from our estimates. If market conditions are less favorable than those projected, additional inventory markdowns may be required.
Store closing and impairment charges
Long-lived assets to be “held and used” are reviewed for impairment when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. We regularly analyze the operating results of our stores and assess the viability of under-performing stores to determine whether they should be closed or whether their associated assets, including furniture, fixtures, equipment, and leasehold improvements, have been impaired. Asset impairment tests are performed at least annually, on a store-by-store basis. After allowing for an appropriate start-up period, unusual nonrecurring events, and favorable trends, fixed assets of stores indicated to be impaired are written down to fair value based on management’s estimate of future store sales and expenses, which are considered Level 3 inputs.
During the thirty-nine weeks ended October 29, 2011, we recorded $0.9 million in noncash charges to earnings related to the impairment of furniture, fixtures and equipment, leasehold improvements, and other assets at certain underperforming stores. We recognized impairment expense of $1.4 million during the thirty-nine weeks ended October 30, 2010.
Stock-based compensation expense
We compensate certain employees with various forms of share-based payment awards and recognize compensation expense for stock-based compensation based on the grant date fair value. Stock-based compensation expense is then recognized ratably over the service period related to each grant. We determine the fair value of stock-based compensation using the Black-Scholes option pricing model, which requires us to make assumptions regarding future dividends, expected volatility of our stock, and the expected lives of the options. We also make assumptions regarding the number of options and the number of shares of restricted stock and performance shares that will ultimately vest. The assumptions and calculations are complex and require a high degree of judgment. Assumptions regarding the vesting of grants are accounting estimates that must be updated as necessary with any resulting change recognized as an increase or decrease in compensation expense at the time the estimate is changed. Excess tax benefits related to stock option exercises are reflected as financing cash inflows and operating cash outflows.
Deferred income taxes
We calculate income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recognized based on the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and income tax reporting purposes. Deferred tax assets and liabilities are measured using the tax rates in effect in the years when those temporary differences are expected to reverse. Inherent in the measurement of deferred taxes are certain judgments and interpretations of existing tax law and other published guidance as applied to our operations.
We regularly assess available positive and negative evidence to determine whether it is more likely than not that our deferred tax asset balances will be recovered from (a) reversals of deferred tax liabilities, (b) potential utilization of net operating loss carrybacks, (c) tax planning strategies and (d) future taxable income. Accounting standards place significant restrictions on the consideration of future taxable income in determining the realizability of deferred tax assets in situations where a company has experienced a cumulative loss in recent years. When sufficient negative evidence exists that indicates that full realization of deferred tax assets is no longer more likely than not, a valuation allowance is established as necessary against the deferred tax assets, increasing our income tax expense in the period that such conclusion is reached. Subsequently, the valuation allowance is adjusted up or down as necessary to maintain coverage against the deferred tax assets. If, in the future, sufficient positive evidence, such as a sustained return to profitability, arises that would indicate that realization of deferred tax assets is once again more likely than not, any existing valuation allowance would be reversed as appropriate, decreasing our income tax expense in the period that such conclusion is reached.
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We have concluded that the realizability of net deferred tax assets is unlikely, and maintain a full valuation allowance against our net deferred tax assets. We have scheduled the reversals of our deferred tax assets and deferred tax liabilities and have concluded that based on the anticipated reversals, a valuation allowance is necessary only for the excess of deferred tax assets over deferred tax liabilities.
We anticipate that until we re-establish a pattern of continuing profitability, in accordance with the applicable accounting guidance, we will not recognize any material income tax expense or benefit in our statement of operations for future periods, as pretax profits or losses generally will generate tax effects that will be offset by decreases or increases in the valuation allowance with no net effect on the statement of operations. If a pattern of continuing profitability is re-established and we conclude that it is more likely than not that deferred income tax assets are realizable, we will reverse any remaining valuation allowance which will result in the recognition of an income tax benefit in the period that it occurs.
We regularly analyze filing positions in all of the federal and state jurisdictions where required to file income tax returns, as well as all open tax years in these jurisdictions. Our federal income tax returns subsequent to the fiscal year ended January 1, 2005 remain open. As of October 29, 2011, we have not recorded any unrecognized tax benefits. Our policy, if we had unrecognized benefits, is to recognize accrued interest and penalties related to unrecognized tax benefits as interest expense and other expense, respectively.
Results of Operations
The following table sets forth our operating results, expressed as a percentage of sales, for the periods indicated.
| Thirteen Weeks Ended October 30, 2010 | Thirteen Weeks Ended October 29, 2011 | Thirty- nine Weeks Ended October 30, 2010 | Thirty- nine Weeks Ended October 29, 2011 | |||||||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of merchandise sold, occupancy and buying expense | 84.4 | 87.7 | 77.2 | 77.1 | ||||||||||||
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Gross profit | 15.6 | 12.3 | 22.8 | 22.9 | ||||||||||||
Selling expense | 23.6 | 24.9 | 22.8 | 22.9 | ||||||||||||
General and administrative expense | 9.4 | 9.6 | 9.0 | 9.3 | ||||||||||||
Loss on disposal of property and equipment | — | — | 0.1 | — | ||||||||||||
Impairment of long-lived assets | 3.5 | 2.3 | 1.1 | 0.7 | ||||||||||||
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Operating loss | (20.9 | ) | (24.5 | ) | (10.2 | ) | (10.0 | ) | ||||||||
Other income, net | 0.2 | 0.3 | 0.1 | 0.1 | ||||||||||||
Interest expense | (1.3 | ) | (1.2 | ) | (1.2 | ) | (1.0 | ) | ||||||||
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Loss before income taxes | (22.0 | ) | (25.4 | ) | (11.3 | ) | (10.9 | ) | ||||||||
Provision for income taxes | — | — | — | — | ||||||||||||
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Net loss | (22.0 | )% | (25.4 | )% | (11.3 | )% | (10.9 | )% | ||||||||
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The following table sets forth our number of stores at the beginning and end of each period indicated and the number of stores opened and closed during each period indicated.
| Thirteen Weeks Ended October 30, 2010 | Thirteen Weeks Ended October 29, 2011 | Thirty- nine Weeks Ended October 30, 2010 | Thirty- nine Weeks Ended October 29, 2011 | |||||||||||||
Number of stores at beginning of period | 237 | 232 | 238 | 232 | ||||||||||||
Stores opened during period | 2 | 1 | 4 | 2 | ||||||||||||
Stores closed during period | (3 | ) | — | (6 | ) | (1 | ) | |||||||||
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Number of stores at end of period | 236 | 233 | 236 | 233 | ||||||||||||
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Thirteen Weeks Ended October 29, 2011 Compared to Thirteen Weeks Ended October 30, 2010
Net sales.Net sales decreased to $40.2 million for the thirteen weeks ended October 29, 2011 (third quarter 2011) from $40.6 million for the thirteen weeks ended October 30, 2010 (third quarter 2010), a decrease of $0.4 million or 1.0%, reflecting a softening in sales of dress shoes along with lower demand for opened up footwear and dress boots. Our comparable store sales for the third quarter of 2011 increased by 1.0% compared to a 5.9% increase in comparable store sales in the third quarter of 2010. Average unit selling prices increased 8.0% while unit sales decreased 7.7% compared to the third quarter of 2010. Our multi-channel sales increased 37.4% to $3.6 million.
Gross profit.Gross profit decreased to $4.9 million in the third quarter of 2011 from $6.4 million in the third quarter of 2010, a decrease of $1.5 million, or 22.2%. As a percentage of sales, gross profit decreased to 12.3% in the third quarter of 2011 from 15.7% in the third quarter of 2010. We attribute the decrease in gross profit dollars to the following components: a decrease of $1.4 million from reduced gross margin percentage and a decrease of $0.1 million from net store closures. Total markdown costs increased to $10.0 million in the third quarter of 2011 from $9.1 million in the third quarter of 2010.
Selling expense.Selling expense increased to $10.0 million in the third quarter of 2011 from $9.6 million in the third quarter of 2010, an increase of $0.4 million or 4.6%, and increased as a percentage of sales to 24.9% from 23.6%. The increase was primary the result of $0.4 million increase in marketing expenses.
General and administrative expense.General and administrative expense increased to $3.9 million in the third quarter of 2011 from $3.8 million in the third quarter of 2010, an increase of $0.1 million or 1.0%, and increased as a percentage of sales to 9.6% from 9.4%.
Impairment of long-lived assets. Based on the criteria in ASC 360, long-lived assets to be “held and used” are reviewed for impairment when events or circumstances exist that indicate the carrying amount of those assets may not be recoverable. During the third quarter of 2011, we recognized $0.9 million in noncash charges related to the impairment of fixed assets and other assets at specific underperforming stores compared to $1.4 million in the third quarter of 2010.
Interest expense.Interest expense remained flat at $0.5 million year over year.
Net loss. Net loss increased to $10.2 million in the third quarter of 2011 compared to a net loss of $8.9 million in the third quarter of 2010.
Thirty-nine Weeks Ended October 29, 2011 Compared to Thirty-nine Weeks Ended October 30, 2010
Net sales.Net sales increased to $131.5 million for the thirty-nine weeks ended October 29, 2011 from $127.4 million for the thirty-nine weeks ended October 30, 2010, an increase of $4.1 million or 3.2%, as strong spring sales of dress shoes were partially offset by lower demand for opened up footwear in the summer and for dress boots in the fall. Our comparable store sales for the first thirty-nine weeks of 2011 increased by 5.1% compared to a 1.3% increase in comparable store sales in the first thirty-nine weeks of 2010. Average unit selling prices increased 9.4% and unit sales decreased 4.9% compared to the first thirty-nine weeks of 2010. Our multi-channel sales increased 20.0% to $9.1 million for the first three quarters of 2011.
Gross profit.Gross profit increased to $30.2 million in 2011 from $29.0 million in 2010, an increase of $1.2 million or 3.9%. As a percentage of sales, gross profit increased to 22.9% in 2011 from 22.8% in 2010. We attribute the increase in gross profit dollars to the following components: an increase $1.6 million from our comparable store sales increase, partially offset by a $0.4 million decrease from net store closures. Total markdown costs increased to $22.8 million in the first thirty-nine weeks of 2011 from $21.2 million in the first thirty-nine weeks of 2010.
Selling expense.Selling expense increased to $30.1 million in 2011 from $29.0 million in 2010, an increase of $1.1 million or 3.8%, and increased as a percentage of sales to 22.9% from 22.8%. This increase primarily reflects a $0.9 million increase in marketing expenses, $0.5 million increase in store payroll expenses, $0.1 million increase in credit and gift card expenses, partially offset by $0.4 million decrease in lower store depreciation expense.
General and administrative expense.General and administrative expense increased to $12.2 million in 2011 from $11.5 million in 2010, an increase of $0.7 million or 5.9%, and increased as a percentage of sales to 9.3% from 9.0%. This increase primarily reflects $0.3 million of higher group health insurance costs, $0.3 million increase in payroll costs, $0.2 million increase in travel and meal expenses, partially offset by a $0.1 decrease in depreciation.
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Impairment of long-lived assets. During the first three quarters of 2011, we recognized $0.9 million in noncash charges related to the impairment of fixed assets and other assets at specific underperforming stores. We recognized $1.4 million of impairment expense in the first three quarters of 2010.
Interest expense.Interest expense decreased to $1.4 million in 2011 from $1.5 million in 2010.
Net loss. We had a net loss of $14.3 million in the first three quarters of 2011 compared to a net loss of $14.5 million in the first three quarters of 2010.
Seasonality and Quarterly Fluctuations
Our operating results are subject to significant seasonal variations. Our quarterly results of operations have fluctuated, and are expected to continue to fluctuate in the future, as a result of these seasonal variances, in particular our principal selling seasons. We have five principal selling seasons: transition (post-holiday), Easter, back-to-school, fall and holiday. Sales and operating results in our third quarter are typically much weaker than in our other quarters. Quarterly comparisons may also be affected by the timing of sales promotions and costs associated with remodeling stores, opening new stores, or acquiring stores.
Liquidity and Capital Resources
Our cash requirements are primarily for working capital, principal and interest payments on our debt obligations and capital expenditures. Historically, these cash needs have been met by cash flows from operations, borrowings under our revolving credit facility and sales of securities. As discussed below in “Financing Activities” the balance on our revolving credit facility fluctuates throughout the year as a result of our seasonal working capital requirements and our other uses of cash.
Our losses in the first three quarters of fiscal year 2011 and recent years have had a significant negative impact on our financial position and liquidity. As of October 29, 2011, we had negative working capital of $21.2 million, unused borrowing capacity under our revolving credit facility of $1.0 million, and shareholders’ deficit of $20.0 million.
We have updated our business plan for the remainder of fiscal year 2011 and for fiscal year 2012 to reflect anticipated mid-single digit decreases in comparable store sales for the remainder of fiscal year 2011, generally flat comparable sales for the first half of fiscal year 2012 and mid-single digit increases in comparable sales for the second half of 2012. The lower projected sales in the fourth quarter of fiscal year 2011 place additional pressure on our liquidity position. We expect to maintain adequate liquidity for the remainder of fiscal year 2011 by working with our landlords and vendors to arrange payment terms that are reflective of our current cash flow. However, we do not expect to achieve significant additional liquidity through further extensions of payment terms. Also, we are initiating a plan to achieve $10.0 million of margin enhancements and cost cuts and are exploring opportunities to generate cash through the sale of selected corporate assets. The business plan for fiscal year 2012 reflects increased focus on inventory management and on timely promotional activity. We believe that this focus on inventory should improve overall gross margin performance in fiscal year 2012 compared to fiscal year 2011. We will need to continue working with our landlords and vendors to arrange payment terms that are reflective of our seasonal cash flow patterns. However, there is no assurance that we will achieve the sales, margin improvements, expense reductions or improved cash flow contemplated in our business plan.
We closely monitor the financial covenants under our revolving credit facility. The facility’s minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either we maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of our adjusted EBITDA to our interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily and, if not met, then the adjusted EBITDA covenant is tested on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in our subordinated secured term loan. We did not meet these covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the August 2010 debt and equity issuance. Beginning with the third quarter of fiscal year 2010, we have met the bank covenant based on maintaining unused availability greater than 20% on a daily basis. Our business plan for the remainder of 2011 and 2012 also anticipates meeting the bank covenant on this basis. We continue to closely monitor our availability and continue to be constrained by our limited unused borrowing capacity. As of December 3, 2011, the balance on our revolving line of credit was $18.6 million, and our unused borrowing capacity in excess of the covenant minimum was $0.4 million.
In June 2011, we amended our $4 million in aggregate principal amount of 9.5% subordinated convertible debentures, which were originally issued in June 2007. The amendments defer payment of principal under the debentures. Originally, all $4 million in
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principal amount was payable on June 30, 2012. Under the amendments, principal will be repaid in four equal annual installments of $1 million beginning on June 30, 2012. The interest rate on the debentures was also increased from 9.5% to 12% per annum. The amendments were consented to by our senior lender pursuant to an amendment to our senior credit facility. The bank amendment removed the covenant to refinance our subordinated convertible debentures and allows us to make the $1 million required principal payment on June 30, 2012, which is the only principal payment now required under the debentures prior to maturity of the credit facility on May 28, 2013, provided that certain conditions are met. These conditions include a requirement that we maintain at least a 1.0 to 1.0 ratio of adjusted EBITDA to interest expense for the 12 month period ending May 26, 2012, all as calculated pursuant to the senior credit facility.
Based on our updated business plan for fiscal year 2011, and for fiscal year 2012 including the anticipated impact of the margin improvement and cost reduction program, we believe that we will be able to comply with the minimum availability or adjusted EBITDA coverage ratio covenant in our revolving credit facility and comply with the adjusted EBITDA requirement related to the scheduled principal payment on the convertible debentures in June 2012. However, given the inherent volatility in our sales performance, such as the anticipated decreased comparable store sales in the fourth quarter of fiscal year 2011, there is no assurance that we will be able to do so. In addition, in light of our historical sales volatility and the current state of the economy, we believe that there is a reasonable possibility that we may not be able to comply with the financial covenants. Failure to comply would be a default under the terms of the revolving credit facility and could result in the acceleration of all of our debt obligations. If we are unable to comply with our financial covenants, we will be required to seek one or more additional amendments or waivers from our lenders. We believe that we would be able to obtain any required amendments or waivers, but can give no assurance that we would be able to do so on favorable terms, if at all. If we are unable to obtain any required amendments or waivers, our lenders would have the right to exercise remedies specified in the loan agreements, including accelerating the repayment of debt obligations and taking collection action against us. If such acceleration occurred, we currently have insufficient cash to pay the amounts owed and would be forced to seek alternative financing.
We continue to face considerable liquidity constraints. Although we believe our updated business plan is achievable, should we fail to achieve the sales or gross margin levels we anticipate, or if we were to incur significant unplanned cash outlays, it would become necessary for us to quickly seek additional sources of liquidity or make further cost cuts to fund our operations. In recognition of existing liquidity constraints, we continue to look for additional sources of capital at acceptable terms. However, there is no assurance that we would be able to obtain such financing on favorable terms, if at all, or to successfully further reduce costs in such a way that would continue to allow us to operate our business.
Our independent registered public accounting firm’s report issued in our most recent Annual Report on Form 10-K included an explanatory paragraph describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern, including our recent losses and working capital deficiency. See Note 2 to our financial statements. Our financial statements do not include any adjustments relating to the recoverability and classification of assets carrying amounts or the amount of and classification of liabilities that may result should we be unable to continue as a going concern. We have taken several steps that we believe will be sufficient to allow us to continue as a going concern and to improve our liquidity, operating results and financial condition. See “Item 1. Business — Risk Factors — The report issued by our independent registered public accounting firm on our fiscal year 2010 financial statements contains language expressing substantial doubt about our ability to continue as a going concern” in our Annual Report on Form 10-K for the fiscal year ended January 29, 2011.
The following table summarizes certain key liquidity measurements as of the dates indicated:
| October 30, 2010 | January 29, 2011 | October 29, 2011 | ||||||||||
Cash | $ | 137,467 | $ | 146,263 | $ | 141,014 | ||||||
Inventories | 27,477,487 | 25,911,508 | 27,717,117 | |||||||||
Total current assets | 30,483,470 | 28,513,463 | 30,969,128 | |||||||||
Property and equipment, net | 19,586,088 | 18,405,166 | 15,274,164 | |||||||||
Total assets | 51,168,350 | 48,005,687 | 47,118,997 | |||||||||
Accounts Payable | 16,292,855 | 16,009,847 | 23,184,890 | |||||||||
Revolving credit facility | 17,495,501 | 10,449,299 | 17,373,597 | |||||||||
Subordinated convertible debentures | 4,000,000 | 4,000,000 | 4,000,000 | |||||||||
Subordinated debenture | 4,000,000 | 4,123,327 | 4,169,080 | |||||||||
Subordinated secured term loan | 901,407 | — | — | |||||||||
Total current liabilities | 45,507,000 | 37,211,199 | 52,175,042 | |||||||||
Total shareholders’ deficit | (11,250,421 | ) | (5,987,111 | ) | (20,045,018 | ) | ||||||
Net working capital | (15,023,530 | ) | (8,707,737 | ) | (21,205,914 | ) | ||||||
Unused borrowing capacity* | 2,813,626 | 3,060,582 | 993,008 | |||||||||
| * | as calculated under the terms of our revolving credit facility |
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Operating activities
Cash used in operating activities was $5.2 million in the first three quarters of 2011 compared to $8.6 million in the first three quarters of 2010. Other than our net loss of $14.3 million, the most significant use of cash in operating activities in the first three quarters of 2011 relates to a $1.8 million increase in inventory partially offset by significant noncash expenses ($3.9 million of depreciation, $0.9 million of impairment expense and $0.3 million of stock-based compensation expense and accretion of debt discount) and a $6.2 million increase of accounts payables, accrued expenses and accrued liabilities, as we have been working with our vendors and landlords to maintain terms that are reflective of our seasonal cash flow patterns.
Besides our net loss of $14.5 million in the first three quarters of 2010, the most significant use of cash in operating activities in the first three quarters of 2010 relates to a $7.2 million increase in inventory partially offset by significant noncash expenses ($4.4 million of depreciation, $1.4 million of impairment expense, $0.3 million of stock-based compensation expense and $0.2 million of accretion of debt discount) and a $6.9 million increase of accounts payables, accrued expenses and accrued liabilities, as we have been working with our vendors and landlords to maintain terms that are reflective of our seasonal cash flow patterns.
Inventories at October 29, 2011 increased $0.2 million, or 1.0%, over inventories at October 30, 2010. We believe that at October 29, 2011, inventory levels and valuations are appropriate given current and anticipated sales trends, there is always the possibility that fashion trends could change suddenly. We monitor our inventory levels closely and will take appropriate actions, including taking additional markdowns, as necessary, to maintain the freshness of our inventory.
Investing activities
Cash used in investing activities was $1.7 million in the first three quarters of 2011 compared to $0.8 million for the first three quarters of 2010. During each period, cash used in investing activities substantially consisted of capital expenditures for furniture, fixtures and leasehold improvements for both new and remodeled stores.
We currently anticipate that our capital expenditures in fiscal year 2011, primarily related to new stores, store remodeling, distribution and general corporate activities, will be approximately $2.0 million, which we expect to fund from internally generated cash flow.
Financing activities
Cash provided by financing activities was $6.9 million in the first three quarters of 2011 compared to $9.5 million for the first three quarters of 2010. The source of cash from financing activities in the first three quarters of 2011 was the net draws of $6.9 million on our revolving line of credit. The principal sources of cash from financing activities in the first three quarters of 2010 were the net draws of $7.0 million on our revolving line of credit, $4.5 million aggregate net proceeds from the issuance of common stock and the subordinated debenture, partially offset by $2.1 million of principal payments on our prior subordinated secured term loan.
Revolving Credit Facility
We have a $30 million senior secured revolving credit facility with Bank of America, N.A. On May 28, 2010, we amended our revolving credit agreement to extend the maturity of the credit facility from the end of fiscal year 2010 to May 28, 2013, modify the calculation of the borrowing base, add a new minimum availability or adjusted EBITDA interest coverage ratio covenant, add an obligation for the Company to extend the maturity of its subordinated convertible debentures by May 2012, add an early termination fee, and make other changes to the agreement. The minimum availability or adjusted EBITDA interest coverage ratio covenant requires that either the Company maintain unused availability greater than 20% of the calculated borrowing base or maintain the ratio of our adjusted EBITDA to our interest expense (both as defined in the amendment) of no less than 1.0:1.0. The minimum availability covenant is tested daily, and if not met the adjusted EBITDA covenant is tested monthly on a rolling twelve month basis. The adjusted EBITDA calculation is substantially similar to the calculation used previously in our subordinated secured term loan. We did not meet these covenants for the months of June and July 2010; however, this covenant violation was waived by the bank in connection with the issuance of the subordinated debenture issued in August 2010 discussed below.
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In connection with an amendment to our subordinated convertible debentures, in June 2011, we amended our revolving credit facility to allow us to make a required $1 million principal payment in respect of the subordinated convertible debentures on June 30, 2012, provided that certain conditions are met, including that we maintain at least a 1.0 to 1.0 ratio of adjusted EBITDA to interest expense for the 12 month period ending May 26, 2012, all as calculated pursuant to the senior credit facility.
Amounts borrowed under the facility bear interest at a rate equal to the base rate (as defined in the agreement) plus a margin amount between 3.0% and 3.5%. The base rate equals the greater of the bank’s prime rate, the federal funds rate plus 0.50% or the Libor rate plus 1.0% (all as defined in the agreement).
The revolving credit facility also allows us to apply an interest rate based on Libor (as defined in the agreement) plus a margin amount to a designated portion of the outstanding balance as set forth in the agreement. The Libor margin (as defined in the agreement) ranges from 3.5% to 4.0%. Following the occurrence of any event of default, the bank may increase the rate by an additional two percentage points.
The unused line fee is 0.75% per annum. The unused line fee is payable monthly based on the difference between the revolving credit ceiling and the average loan balance under the agreement. The aggregate amount that we may borrow under the agreement at any time is further limited by a formula, which is based substantially on our inventory level but cannot be greater than the revolving credit ceiling of $30 million.
Amounts borrowed under the credit facility are secured by substantially all of our assets. If contingencies related to early termination of the revolving credit facility were to occur, or if we request and receive an accommodation from the lender in connection with the facility, we may be required to pay additional fees. We may be required to pay an early termination fee of up to $150,000 in the event we terminate the facility before May 2012.
The credit facility includes financial, reporting and other covenants relating to, among other things, use of funds under the facility in accordance with our business plan, prohibiting a change of control, including any person or group acquiring beneficial ownership of 40% or more of our common stock or combined voting power (as defined in the credit facility), maintaining a minimum availability, prohibiting new debt, restricting dividends and the repurchase of our stock, and restricting certain acquisitions. In the event that we violate any of these covenants, including the minimum availability or adjusted EBITDA interest coverage financial covenant or the obligation to extend the maturity of our subordinated convertible debentures (both as described above), or if other indebtedness in excess of $1.0 million could be accelerated, or in the event that 10% or more of our leases could be terminated (other than solely as a result of certain sales of our common stock), the bank would have the right to accelerate repayment of all amounts outstanding under the agreement, or to commence foreclosure proceedings on our assets.
We had balances under our revolving credit facility of $17.4 million, $10.4 million and $17.5 million as of October 29, 2011, January 29, 2011 and October 30, 2010, respectively. We had approximately $1.0 million, $3.1 million and $2.8 million in unused borrowing capacity calculated under the provisions of our revolving credit facility as of October 29, 2011, January 29, 2011, and October 30, 2010, respectively. During the first thirty-nine weeks of fiscal years 2011 and 2010, the highest outstanding balances on our revolving credit facility were $17.6 million and $17.5 million, respectively. We primarily have used the borrowings on our revolving credit facility for working capital purposes and capital expenditures.
Subordinated Convertible Debentures
On June 26, 2007, we issued $4 million in aggregate principal amount of subordinated convertible debentures to seven accredited investors in a private placement generating net proceeds of approximately $3.6 million, which were used to repay amounts owed under our revolving credit facility. The subordinated convertible debentures are nonamortizing, originally bore interest at a rate of 9.5% per annum, payable semi-annually on each June 30 and December 31, and mature on June 30, 2012. The amendment to our revolving credit facility, discussed above, required that we amend the subordinated convertible debentures on or before May 1, 2012, to extend the maturity to a date beyond July 27, 2013. Investors included corporate director Scott C. Schnuck, former corporate director Andrew N. Baur and an entity affiliated with Mr. Baur, and advisory directors Bernard A. Edison and Julian Edison.
In June 2011, we amended the debentures to defer payment of principal and to increase the interest rate. Under the amendments, principal will be repaid in four equal annual installments of $1 million beginning on June 30, 2012. The interest rate on the debentures was also increased from 9.5% to 12% per annum. The amendments were consented to by our senior lender pursuant to an amendment to our senior credit facility. The bank amendment removed the covenant to refinance our subordinated convertible debentures and allows us to make the $1 million required principal payment on June 30, 2012, provided that certain conditions are met. These conditions include a requirement that we maintain at least a 1.0 to 1.0 ratio of adjusted EBITDA to interest expense for the 12-month period ending May 26, 2012, all as calculated pursuant to the senior credit facility.
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The subordinated convertible debentures are convertible into shares of common stock at any time. The initial conversion price was $9.00 per share. The conversion price, and thus the number of shares into which the debentures are convertible, is subject to anti-dilution and other adjustments. If we distribute any assets (other than ordinary cash dividends), then generally each holder is entitled to receive a like amount of such distributed property. In the event of a merger, consolidation, sale of substantially all of our assets, or reclassification or compulsory share exchange, then upon any subsequent conversion each holder will have the right to either the same property as it would have otherwise been entitled or cash in an amount equal to 100% principal amount of the debenture, plus interest and any other amounts owed. The subordinated convertible debentures also contain a weighted average conversion price adjustment generally for future issuances, at prices less than the then current conversion price, of common stock or securities convertible into, or options to purchase, shares of common stock, excluding generally currently outstanding options, warrants or performance shares and any future issuances or deemed issuances pursuant to any properly authorized equity compensation plans. The subordinated convertible debentures contain limitations on the number of shares issuable pursuant to the subordinated convertible debentures regardless of how low the conversion price may be, including limitations generally requiring that the conversion price not be less than $8.10 per share for subordinated convertible debentures issued to advisory directors, corporate directors or the entity that was affiliated with Mr. Baur, that we do not issue common stock amounting to more than 19.99% of our common stock in the transaction or such that following conversion, the total number of shares beneficially owned by each holder does not exceed 19.999% of our common stock. These limitations may be removed with shareholder approval.
As a result of prior issuances of shares, the weighted average conversion price of the subordinated convertible debentures has decreased from $8.31 to $6.76 with respect to $1 million in aggregate principal amount of debentures and to $8.10, the minimum conversion price, with respect to $3 million in aggregate principal amount of debentures held by directors and director affiliates. The debentures are now convertible into a total of 518,299 shares of the Company’s common stock.
The subordinated convertible debentures generally provide for customary events of default, which could result in acceleration of all amounts owed, including default in required payments, failure to pay when due, or the acceleration of other monetary obligations for indebtedness (broadly defined) in excess of $1 million (subject to certain exceptions), failure to observe or perform covenants or agreements contained in the transaction documents, including covenants relating to using the net proceeds, maintaining legal existence, prohibiting the sale of material assets outside of the ordinary course, prohibiting cash dividends and distributions, share repurchases, and certain payments to our officers and directors. We generally have the right, but not the obligation, to redeem the unpaid principal balance of the subordinated convertible debentures at any time prior to conversion if the closing price of our common stock (as adjusted for stock dividends, subdivisions or combinations) is equal to or above $16.00 per share for each of 20 consecutive trading days and certain other conditions are met. We have also agreed to provide certain piggyback and demand registration rights, until two years after the subordinated convertible debentures cease to be outstanding, to the holders under the Securities Act of 1933 relating to the shares of common stock issuable upon conversion of the subordinated convertible debentures.
Subordinated Debenture
On August 26, 2010, we entered into a Debenture and Stock Purchase Agreement with Steven Madden, Ltd. In connection with the agreement, we sold to Steven Madden, Ltd. a debenture in the principal amount of $5,000,000 (the “subordinated debenture”). Under the subordinated debenture, interest payments are required to be paid quarterly at an interest rate of 11% per annum. The principal amount is required to be repaid in four annual installments commencing on August 31, 2017, through the final maturity on August 31, 2020. As additional consideration, Steven Madden, Ltd. also received 1,844,860 shares of the our common stock which are subject to a voting agreement in favor of Peter Edison, representing a 19.99% interest in the Company on a post-closing basis. In connection with the transaction, we received aggregate net proceeds of $4.5 million after transaction and other costs.
The transaction documents contain standstill provisions which generally prohibit Steven Madden, Ltd. from owning more than 19.999% of our outstanding shares of common stock or from engaging in certain transactions in our common stock for ten years, subject to certain conditions. Until the earlier of August 26, 2012 or the termination or departure of Peter A. Edison as our Chief Executive Officer, Steven Madden, Ltd. is generally prohibited from transferring the shares issued or the subordinated debenture.
The subordinated debenture is subordinate to our other indebtedness and is generally unsecured. We are required to offer to redeem the subordinated debenture at 101% of the outstanding principal amount in certain circumstances, including a change of control of the Company (as defined in the subordinated debenture), including the termination or departure of Peter A. Edison as our Chief Executive Officer for any reason.
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The subordinated debenture generally provides for customary events of default, including default in the payment of principal or interest or other required payments in favor of Steven Madden, Ltd., breach of representations, and specified events of bankruptcy or specified judgments against us. Upon the occurrence of an event of default under the subordinated debenture, Steven Madden, Ltd. would be entitled to acceleration of the debt (at between 102% and 100% of principal depending on when a default occurred) plus all accrued and unpaid interest, with the interest rate increasing to 13.0% per annum. We may prepay the debenture at any time, subject to prepayment penalties of between 1% and 2% of the principal amount over the first two years. We also granted certain demand and piggy-back registration rights in respect of the shares covering a period of ten years.
Off-Balance Sheet Arrangements
At October 29, 2011, January 29, 2011, and October 30, 2010, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could otherwise have arisen if we had engaged in such relationships.
Contractual Obligations
The following table summarizes our contractual obligations as of October 29, 2011:
| Payments due by Period | ||||||||||||||||||||
Contractual Obligations | Total | Less than 1 Year | 1 - 3 Years | 3 -5 Years | More than 5 Years | |||||||||||||||
Long-term debt obligations (1) | $ | 14,434,667 | $ | 2,038,000 | $ | 3,708,334 | $ | 2,221,666 | $ | 6,466,667 | ||||||||||
Operating lease obligations (2) | 124,920,165 | 24,680,782 | 44,876,885 | 34,100,154 | 21,262,344 | |||||||||||||||
Purchase obligations (3) | 35,141,730 | 29,891,730 | 3,000,000 | 2,250,000 | — | |||||||||||||||
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Total | $ | 174,496,562 | $ | 56,610,512 | $ | 51,585,219 | $ | 38,571,820 | $ | 27,729,011 | ||||||||||
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| (1) | Includes principal and interest payments on our subordinated convertible debentures and our subordinated debenture. |
| (2) | Includes minimum payment obligations related to our store leases. |
| (3) | Includes merchandise on order, minimum royalty payments related to the H by Halston license, and payment obligations relating to store construction and miscellaneous service contracts. |
Recent Accounting Pronouncements
None.
Impact of Inflation
Overall, we do not believe that inflation has had a material adverse impact on our business or operating results during the periods presented. We cannot give assurance, however, that our business will not be affected by inflation in the future.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures provided reasonable assurance that the disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and in accumulating and communicating such information to management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Internal Control Over Financial Reporting. The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes occurred during the Company’s third fiscal quarter ended October 29, 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change during the Company’s third quarter of fiscal year 2011.
We are involved from time to time in various lawsuits and claims arising in the ordinary course of business. Although the outcomes of these lawsuits and claims are uncertain, we do not believe any of them will have a material adverse effect on our business, financial condition or results of operations.
Our fourth quarter 2011 sales trends have weakened and we are initiating a cost reduction and margin improvement plan that must be successful over the next year, or we may fail to maintain a liquidity position adequate to support our ongoing operations.
We incurred significant net losses in the last few years and in the first three quarters of fiscal 2011. These losses have had a significant negative impact on our financial position and liquidity. As of October 29, 2011, we had negative working capital of $21.2 million, unused borrowing capacity under our revolving credit facility of $1.0 million, and a shareholders’ deficit of $20.0 million.
We have updated our business plan for the remainder of fiscal year 2011 and for fiscal year 2012 to reflect anticipated mid-single digit decreases in comparable store sales for the remainder of fiscal year 2011, generally flat comparable sales for the first half of fiscal year 2012 and mid-single digit increases in comparable sales for the second half of 2012. The lower projected sales in the fourth quarter of fiscal year 2011 place additional pressure on our liquidity position. We expect to maintain adequate liquidity for the remainder of fiscal year 2011 by working with our landlords and vendors to arrange payment terms that are reflective of our current cash flow. However, we do not expect to achieve significant additional liquidity through further extensions of payment terms. Also, we are initiating a plan to achieve $10.0 million of margin enhancements and cost cuts and are exploring opportunities to generate cash through the sale of selected corporate assets. The business plan for fiscal year 2012 reflects increased focus on inventory management and on timely promotional activity. We believe that this focus on inventory should improve overall gross margin performance in fiscal year 2012 compared to fiscal year 2011. We will need to continue working with our landlords and vendors to arrange payment terms that are reflective of our seasonal cash flow patterns. However, there is no assurance that we will achieve the sales, margin improvements, expense reductions or improved cash flow contemplated in our business plan.
If we do not achieve our updated business plan and our margin improvement and cost reduction plan, or if we were to incur significant unplanned cash outlays, it would become necessary for us to quickly seek additional sources of liquidity, or to find additional cost cutting
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measures. Any future financing would be subject to our financial results, market conditions and the consent of our lenders. We may not be able to obtain additional financing or we may only be able to obtain such financing on terms that are substantially dilutive to our current shareholders and that may further restrict our business activities. If we cannot obtain needed financing, our operations may be materially negatively impacted and we may be forced into bankruptcy or to cease operations and you could lose your investment in the Company.
For more information, please see “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Financing Activities” in the Company’s Quarterly Report on Form 10-Q for the period ended October 29, 2011.
See Exhibit Index herein
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed, on its behalf by the undersigned thereunto duly authorized.
Date: December 13, 2011
| BAKERS FOOTWEAR GROUP, INC. | ||
| (Registrant) | ||
| By: | /s/ Peter A. Edison | |
| Peter A. Edison | ||
| Chairman of the Board, Chief Executive Officer and President | ||
| (Principal Executive Officer) | ||
| Bakers Footwear Group, Inc. | ||
| (On behalf of the Registrant) | ||
| By: | /s/ Charles R. Daniel, III | |
| Charles R. Daniel, III | ||
| Executive Vice President and Chief Financial Officer, Controller, Treasurer, and Secretary | ||
| (Principal Financial Officer and Principal Accounting Officer) | ||
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| Exhibit No. | Description | |
| 3.1 | Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2004 filed on April 2, 2004 (File No. 000-50563)). | |
| 3.2 | Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended January 3, 2004 filed on April 2, 2004 (File No. 000-50563)). | |
| 11.1 | Statement regarding computation of per share earnings (incorporated by reference from Note 10 to the unaudited interim financial statements included herein). | |
| 31.1 | Rule 13a-14(a)/15d-14(a) Certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Chief Executive Officer). | |
| 31.2 | Rule 13a-14(a)/15d-14(a) Certification (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, executed by Chief Financial Officer). | |
| 32.1 | Section 1350 Certifications (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, executed by Chief Executive Officer and the Chief Financial Officer). | |
| 101 | Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Balance Sheets at October 30, 2010, January 29, 2011, and October 29, 2011; (ii) Condensed Statements of Operations for the thirteen and thirty-nine weeks ended October 30, 2010 and October 29, 2011; (iii) Condensed Statement of Shareholders’ Deficit; (iv) Condensed Statements of Cash Flows for the thirty-nine weeks ended October 30, 2010 and October 29, 2011; and (v) Notes to Condensed Financial Statements for the thirteen and thirty-nine weeks ended October 29, 2011. In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, and shall not be deemed “filed” or part of any registration statement or prospectus for purposes of Section 11 or 12 under the Securities Act or the Exchange Act, or otherwise subject to liability under those sections, except as shall be expressly set forth by specific reference in such filing. | |
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