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RADIOSHACK CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ("MD&A").
(Edgar Glimpses Via Acquire Media NewsEdge)
This MD&A section discusses our results of operations, liquidity and financial
condition, risk management practices, critical accounting policies and
estimates, and certain factors that may affect our future results, including
economic and industry-wide factors. Our MD&A should be read in conjunction with
our consolidated financial statements and accompanying notes included in this
Annual Report on Form 10-K, as well as the Risk Factors set forth in Item 1A
above.
2012 SUMMARY
Net sales and operating revenues decreased $120.2 million, or 2.7%, to $4,257.8
million when compared with last year. This decrease was primarily driven by a
3.5% decrease in comparable store sales, which was partially offset by increased
sales in our Target Mobile centers that were open for all of 2012 but not all of
2011. The 3.5% decrease in comparable store sales was primarily driven by sales
decreases in our consumer electronics and mobility platforms at our U.S.
RadioShack company-operated stores, which were partially offset by increased
sales in our signature platform and increased comparable store sales at our
Target Mobile centers.
Gross profit decreased by $249.0 million, or 13.8%, to $1,561.8 million when
compared with last year. This decrease was primarily driven by decreased gross
profit in our postpaid wireless business in our U.S. RadioShack company-operated
stores. Gross margin rate decreased by 4.7 percentage points from last year to
36.7%. The decrease in our consolidated gross margin rate was a result of the
decrease in the gross margin rate of our postpaid wireless business. When
excluding the postpaid wireless business, the gross margin rate for the balance
of our business was comparable to 2011.
Selling, general and administrative ("SG&A") expense decreased $48.4 million
when compared with last year. This decrease was primarily driven by decreased
advertising expense, decreased rent and occupancy expense, and decreased
compensation expense in the second half of 2012. Additionally, SG&A in 2012 was
lower due to a one-time $23.4 million charge in 2011 related to our transition
from T-Mobile to Verizon and a one-time $9.5 million charge in 2011 related to
the closure of our Chinese manufacturing plant. These decreases were partially
offset by increased costs in the first half of 2012 to support additional Target
Mobile centers that were not open in the same period in 2011 and severance costs
of $8.5 million in connection with the departure of our Chief Executive Officer
combined with the termination of employment of certain corporate headquarters
support staff in the third quarter of 2012.
As a result of the factors above, we incurred an operating loss of $60.9
million, compared with operating income of $155.1 million last year. Operating
income for our U.S. RadioShack company-operated stores segment was $337.7
million, compared with $530.2 million last year. The operating loss for our
Target Mobile centers was $37.5 million, compared with an operating loss of
$21.0 million last year.
Our effective tax rate for 2012 was a negative 22.2%, compared with 37.5% for
2011. The 2012 effective tax rate was affected by a valuation allowance in the
amount of $68.8 million that we established to reduce our deferred tax assets.
The valuation allowance was partially offset by an income tax benefit related to
our current year operating loss. See Note 10 - "Income Taxes" in the Notes to
Consolidated Financial Statements included in this Annual Report on Form 10-K
for more information regarding our 2012 income tax expense and valuation
allowance.
Loss from continuing operations was $139.4 million, or $1.39 per share, in 2012,
compared with income from continuing operations of $67.1 million, or $0.70 per
diluted share, in 2011.
EXECUTIVE OVERVIEW
During 2012 our operating results were significantly affected by our postpaid
wireless business in our U.S. RadioShack company-operated stores and our Target
Mobile segment.
Postpaid Wireless Business
The combination of the following factors at our U.S. RadioShack company-operated
stores contributed to more than half of our $249.0 million decrease in
consolidated gross profit from 2011:
· Total postpaid units sold decreased by 20% from 2011
· The average cost per unit sold increased by 36% from 2011
· The average revenue per unit sold increased by 19% from 2011
These factors were also present at our Target Mobile centers; however, gross
profit increased at our Target Mobile centers in 2012 due to increased sales
primarily from the additional 646 Target Mobile centers that were open for the
full first six months of 2012 but were not open for the full first six months of
2011.
The decrease in the number of postpaid units sold at our U.S. RadioShack
company-operated stores was primarily driven by decreased unit sales in our
Sprint and AT&T postpaid wireless businesses. Some of the factors contributing
to our lower unit sales were changes in Sprint's customer and credit models and
the discontinuation of Sprint's early upgrade program for certain customers that
began in mid-2011; higher sales in the third quarter of 2011 related to a
special wireless handset promotion; the soft postpaid market due to consumer
anticipation of the iPhone 5 launch; and inventory supply constraints during the
initial iPhone 5 launch period.
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--------------------------------------------------------------------------------The increase in average cost per unit was driven by the change in our sales mix
towards higher cost smartphones such as the Apple iPhone and Android-based
smartphones.
The increase in the average revenue per postpaid unit was primarily driven by a
change in our sales mix towards higher-priced smartphones, which was partially
offset by an increase in commissions repaid to wireless service providers
related to customers whose wireless handsets were deactivated from a wireless
network because either they could not afford to, or chose not to, pay the higher
monthly payments for wireless service associated with their smartphones. We have
undertaken initiatives to reduce wireless service deactivations in 2013. For
further discussion of our accounting for these service deactivations, see
"Critical Accounting Policies and Estimates" later in this MD&A.
Target Mobile Centers
In October 2012, we exercised our contractual right to notify Target of our
intention to stop operating the Target Mobile centers if we could not amend the
current arrangement. An acceptable arrangement was not negotiated; therefore, we
will exit this business by April 8, 2013. We project that our Target Mobile
business will not be profitable in the first quarter of 2013.
Capital Transactions
During 2012 we took a number of actions regarding our liquidity:
· On July 25, 2012, we suspended our dividend payments to preserve cash as a
result of our operating performance
· In the second half of the year, we borrowed a total of $175 million in advance
of the maturity of our 2.50% convertible senior notes due August 1, 2013
("2013 Convertible Notes")
· In the third quarter, we repurchased $88.1 million principal amount of the
2013 Convertible Notes at a discount to their par value
For further discussion of our liquidity position, please see "Liquidity Outlook"
later in this MD&A.
RESULTS OF OPERATIONS
2012 COMPARED WITH 2011
Net Sales and Operating Revenues
Consolidated net sales and operating revenues are as follows:
Year Ended December 31,
(In millions) 2012 2011 2010
U.S. RadioShack company-operated stores $ 3,456.5 $ 3,663.3 $ 3,808.2
Target Mobile centers (1) 426.5 342.4 64.6
Other 374.8 372.3 393.0
Consolidated net sales and operating revenues $ 4,257.8 $ 4,378.0 $ 4,265.8
Consolidated net sales and operating revenues
(decrease) increase (2.7 %) 2.6 % 4.7 %
Comparable store sales (decrease) increase (2) (3.5 %) (2.2 %) 4.1 %
(1) In October 2012, we exercised
our contractual right to
notify Target of our intention
to stop operating the Target
Mobile centers if we could not
amend the current arrangement.
An acceptable arrangement was
not negotiated; therefore, we
will exit this business by
April 8, 2013.
(2) Comparable store sales include
the sales of U.S. and Mexico
RadioShack company-operated
stores and Target Mobile
centers with more than 12 full
months of recorded sales.
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The following table provides a summary of our consolidated net sales and
operating revenues by platform and as a percent of net sales and operating
revenues.
Consolidated Net Sales and Operating Revenues
Year Ended December 31,
(In millions) 2012 2011 2010
Mobility (1) $ 2,260.2 53.1 % $ 2,251.2 51.4 % $ 1,884.9 44.2 %
Signature 1,293.3 30.4 1,265.8 28.9 1,314.9 30.8
Consumer electronics 661.9 15.5 831.1 19.0 1,030.7 24.2
Other sales (2) 42.4 1.0 29.9 0.7 35.3 0.8
Consolidated net
sales and operating
revenues $ 4,257.8 100.0 % $ 4,378.0 100.0 % $ 4,265.8 100.0 %
(1) The aggregate amounts of upfront commission revenue and residual
income received from wireless service providers and recorded in
this platform were $1,333.9 million, $1,499.1 million and
$1,270.5 million for 2012, 2011 and 2010, respectively.
(2) Other sales include outside sales from repair services and
outside sales of our global sourcing operations and domestic and
overseas manufacturing facilities. We closed our overseas
manufacturing facility in June 2011.
U.S. RadioShack Company-Operated Stores Segment
The following table provides a summary of our net sales and operating revenues
by platform and as a percent of net sales and operating revenues for the U.S.
RadioShack company-operated stores segment.
U.S. RadioShack Company-Operated Stores Segment
Net Sales and Operating Revenues
Year Ended December 31,
(In millions) 2012 2011 2010
Mobility $ 1,781.2 51.5 % $ 1,851.4 50.5 % $ 1,753.7 46.0 %
Signature 1,171.1 33.9 1,153.5 31.5 1,209.9 31.8
Consumer electronics 504.2 14.6 658.4 18.0 844.6 22.2
Net sales and
operating revenues $ 3,456.5 100.0 % $ 3,663.3 100.0 % $ 3,808.2 100.0 %
Sales in our U.S. RadioShack company-operated stores segment decreased $206.8
million or 5.6% in 2012.
Sales in our mobility platform (which includes postpaid and prepaid wireless
handsets, commissions and residual income, prepaid wireless airtime, e-readers,
and tablet devices) decreased 3.8% in 2012.
This decrease in sales was primarily driven by decreased sales in our postpaid
wireless business. This decrease was partially offset by increased sales of
tablet devices.
The sales decrease in our postpaid wireless business was driven by a decrease in
the number of postpaid units sold, which was partially offset by an increase in
the average revenue per unit sold. The decrease in the number of postpaid
wireless handsets sold was primarily driven by decreased unit sales in our
Sprint and AT&T postpaid wireless businesses.
Some of the factors contributing to our lower unit sales were changes in
Sprint's customer and credit models and the discontinuation of Sprint's early
upgrade program for certain customers that began in mid-2011; higher sales in
the third quarter of 2011 related to a special wireless handset promotion; the
soft postpaid market due to consumer anticipation of the iPhone 5 launch; and
inventory supply constraints during the initial iPhone 5 launch period.
The increase in the average revenue per postpaid unit was primarily driven by a
change in our sales mix towards higher-priced smartphones, which was partially
offset by an increase in commissions repaid to wireless service providers
related to wireless handset deactivations. See the executive summary of this
MD&A for further discussion of these wireless handset deactivations.
Sales in our signature platform (which includes accessories for wireless,
tablet, music, and home entertainment products; batteries and power products;
and technical products) increased 1.5% in 2012. Product categories with sales
increases during this period included wireless accessories, headphones, and
tablet accessories. Product categories with sales decreases during the period
included home entertainment accessories and personal computer accessories.
Sales in our consumer electronics platform (which includes laptop computers,
residential telephones, toys, GPS units, digital music players, personal
computing products, cameras, and other consumer electronics products) decreased
23.4% in 2012. This sales decrease was driven by sales declines in laptop
computers, cameras, music players, GPS devices, and televisions. The decrease in
sales for many of these categories has been driven by the migration of the
capabilities of these products into smartphones.
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--------------------------------------------------------------------------------Target Mobile Centers
Sales in our Target Mobile centers segment increased $84.1 million or 24.6% in
2012. This sales increase was driven primarily by increased sales at our Target
Mobile centers in the first half of 2012, when compared with the same period in
2011. This increase in Target Mobile center sales was driven by the additional
646 Target Mobile centers that were open for the full first six months of 2012
but were not open for the full first six months of 2011. In October 2012, we
exercised our contractual right to notify Target of our intention to stop
operating the Target Mobile centers if we could not amend the current
arrangement. An acceptable arrangement was not negotiated; therefore, we will
exit this business by April 8, 2013.
Other Sales
Amounts in other sales reflect our business activities that are not separately
reportable, including sales to our independent dealers, sales generated by our
www.radioshack.com website, and sales at our Mexican subsidiary. Each of these
business activities accounted for less than 5% of our consolidated net sales and
operating revenues in 2012. Other sales were essentially flat for 2012, when
compared with last year. Our sales increased at our Mexican subsidiary due to
new store openings, but this increase was substantially offset by decreased
sales to our U.S. independent dealers. Additionally, we recognized $3.0 million
of franchise fee revenue in the third quarter related to the opening of our
first franchised stores in Southeast Asia.
Gross Profit
Consolidated gross profit and gross margin are as follows:
Year Ended December 31,
(In millions) 2012 2011 2010
Gross profit $ 1,561.8 $ 1,810.8 $ 1,913.7
Gross profit (decrease) increase (13.8 %) (5.4 %) 2.2 %
Gross margin rate 36.7 % 41.4 % 44.9 %
Consolidated gross profit and gross margin for 2012 were $1,561.8 million and
36.7%, respectively, compared with $1,810.8 million and 41.4%, respectively, in
2011, resulting in a 13.8% decrease in gross profit dollars and a 4.7 percentage
point decrease in our gross margin. These decreases were primarily driven by
decreased gross profit of the postpaid wireless business in our U.S. RadioShack
company-operated stores.
The decrease in gross profit dollars of the postpaid wireless business in our
U.S. RadioShack company-operated stores was the result of decreases in 2012 in
the number of units sold and in the average gross profit dollars per unit sold,
when compared with 2011. Average gross profit dollars per unit sold decreased
because our average cost per unit increased from last year at a higher rate than
the increase in our average revenue per unit. The increase in average cost per
unit was driven by the change in our sales mix towards higher cost smartphones
such as the Apple iPhone and Android-based smartphones.
The decrease in our consolidated gross margin rate was a result of the decrease
in the gross margin rate of the postpaid wireless business in our U.S.
RadioShack company-operated stores and Target Mobile centers. The decrease in
the gross margin rate of our postpaid wireless business was driven by a change
in our sales mix towards lower-margin smartphones and a decrease in the average
gross profit dollars per unit sold.
When excluding the postpaid wireless business, the gross margin rate for the
balance of our business was comparable to 2011.
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Selling, General and Administrative Expense
Our consolidated SG&A expense decreased 3.1%, or $48.4 million, in 2012. SG&A as
a percentage of net sales and operating revenues was essentially flat when
compared with 2011. The table below summarizes the breakdown of various
components of our consolidated SG&A expense and their related percentages of
total net sales and operating revenues.
Year Ended December 31,
2012 2011 2010
% of % of % of
Sales & Sales & Sales &
(In millions) Dollars Revenues Dollars Revenues Dollars Revenues
Compensation $ 696.4 16.4 % $ 693.4 15.8 % $ 663.1 15.5 %
Rent and occupancy 252.3 5.9 261.5 6.0 265.3 6.2
Advertising 182.9 4.3 208.9 4.8 205.9 4.8
Other taxes (excludes
income taxes) 108.7 2.6 108.3 2.5 97.7 2.3
Utilities 53.5 1.3 56.0 1.3 54.4 1.3
Insurance 46.6 1.1 49.6 1.1 45.9 1.1
Credit card fees 35.9 0.8 35.6 0.8 34.9 0.8
Professional fees 30.5 0.7 26.7 0.6 21.3 0.5
Repairs and
maintenance 22.9 0.5 25.7 0.6 20.1 0.5
Licenses 14.5 0.3 14.9 0.3 13.2 0.3
Printing, postage and
office supplies 9.3 0.2 9.0 0.2 6.9 0.2
Recruiting, training
and employee
relations 6.3 0.1 6.5 0.1 5.4 0.1
Travel 6.1 0.1 6.4 0.1 4.9 0.1
Matching
contributions to
savings plans 5.1 0.1 4.9 0.1 5.4 0.1
Other 58.0 1.5 70.0 1.7 39.4 1.0
$ 1,529.0 35.9 % $ 1,577.4 36.0 % $ 1,483.8 34.8 %
The decrease in SG&A expense was driven by decreased advertising expense,
decreased rent and occupancy expense, and decreased compensation expense in the
second half of 2012. Additionally, SG&A in 2012 was lower due to a one-time
$23.4 million charge in 2011 related to our transition from T-Mobile to Verizon
and a one-time $9.5 million charge in 2011 related to the closure of our Chinese
manufacturing plant. These decreases were partially offset by increased costs in
the first half of 2012 to support additional Target Mobile centers that were not
open in the same period last year and severance costs of $8.5 million in
connection with the departure of our Chief Executive Officer combined with the
termination of employment of certain corporate headquarters support staff in the
third quarter of 2012.
We announced on September 25, 2012, that our Board of Directors and Mr. James F.
Gooch had agreed that Mr. Gooch would step down from his position as Chief
Executive Officer and as a director of the Company, effective immediately. Under
Mr. Gooch's employment agreement, he was entitled to a specified cash payment
and the accelerated vesting of certain stock awards. During the third quarter
ended September 30, 2012, we recorded $5.6 million of employee separation
charges in connection with Mr. Gooch's departure. This included a cash charge of
$4.0 million and a non-cash charge of $1.6 million related to the accelerated
vesting of stock awards.
During the third quarter ended September 30, 2012, we recorded $2.9 million of
employee separation charges in connection with the termination of the employment
of approximately 150 employees, who worked primarily at our corporate
headquarters.
Depreciation and Amortization
The table below provides a summary of our total depreciation and amortization by
segment.
Year Ended December 31,
(In millions) 2012 2011 2010
U.S. RadioShack company-operated stores $ 31.8 $ 37.9 $ 45.4
Target Mobile centers 6.4 4.7 1.5
Other 3.8 4.0 3.7
Unallocated 38.7 36.1 32.8
Total depreciation and amortization from
continuing operations $ 80.7 $ 82.7 $ 83.4
The table below provides an analysis of total depreciation and amortization.
Year Ended December 31,
(In millions) 2012 2011 2010
Depreciation and amortization expense $ 72.3 $ 75.2 $ 75.7
Depreciation and amortization included in cost of
products sold 8.4 7.5 7.7
Total depreciation and amortization from
continuing operations $ 80.7 $ 82.7 $ 83.4
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Impairment of Long-Lived Assets and Goodwill
Impairment of long-lived assets was $21.4 million in 2012 compared with $3.1
million in 2011.
Target Mobile Centers: In October 2012 we exercised our contractual right to
notify Target of our intention to stop operating the Target Mobile centers by no
later than April 2013 if we could not amend the current arrangement.
We concluded that the cash flows generated by our Target Mobile centers under
our current contractual arrangements would not recover the net book value of our
long-lived assets held and used in these locations. Therefore, the long-lived
assets at these locations with a total carrying value of $12.8 million were
written down to their fair value of $1.1 million, resulting in an impairment
charge of $11.7 million that was included in our operating results for the third
quarter of 2012. We will exit this business by April 8, 2013.
The fair value of these "in-use" assets was based on the projected cash flows at
each location under our current contractual arrangements.
U.S. RadioShack Company-Operated Stores: Impairments for long-lived assets held
and used in certain stores were $6.7 million in 2012 compared with $3.1 million
in 2011. This increase was primarily driven by an increase in the number of
stores that were evaluated for impairment throughout 2012 because of their
decreased operating results. If our operating results do not improve, we will
continue to incur a similar or higher amount of long-lived asset impairments for
U.S. RadioShack company-operated stores in future periods.
Goodwill Impairment: For the first half of 2012, we experienced a significant
decline in the market capitalization of our common stock, which was driven
primarily by lower than expected operating results. Our market capitalization
was lower than our consolidated net book value for much of this period. We
determined that these facts were an indicator that we should conduct an interim
goodwill impairment test in the third quarter.
After reviewing our reporting units, we determined that the fair value of our
U.S. RadioShack company-operated stores reporting unit could not support its
$3.0 million of goodwill due to our lower market capitalization. This resulted
in a $3.0 million impairment charge that was included in our operating results
for the third quarter of 2012. Our U.S. RadioShack company-operated stores
reporting unit is comprised of our U.S. RadioShack company-operated stores
operating segment, our overhead and corporate expenses that are not allocated to
our operating segments, and all of our interest expense.
Net Interest Expense
Consolidated net interest expense, which is interest expense net of interest
income, was $52.6 million in 2012, compared with $43.7 million in 2011.
In 2012 and 2011, interest expense consisted primarily of interest paid at the
stated coupon rate on our outstanding notes, the non-cash amortization of the
discounts on our long-term debt, and interest paid on our term loans. Interest
expense increased $7.7 million in 2012. This increase was driven by the
increased average amount of long-term debt outstanding during 2012. Non-cash
interest expense was $16.3 million in 2012 compared with $17.0 million in 2011.
Income Tax Expense
Our effective tax rate for 2012 was a negative 22.2%, compared with a positive
37.5% for 2011. The 2012 effective tax rate was affected by a valuation
allowance in the amount of $68.8 million that we established to reduce our U.S.
deferred tax assets. The valuation allowance was partially offset by an income
tax benefit related to our current year operating loss. See Note 10 - "Income
Taxes" in the Notes to Consolidated Financial Statements included in this Annual
Report on Form 10-K for more information regarding our 2012 income tax expense
and valuation allowance.
The 2011 effective tax rate was affected by the realization of job retention
credits generated pursuant to the Hiring Incentives to Restore Employment Act.
These credits lowered the effective tax rate by 1.1 percentage points.
2011 COMPARED WITH 2010
Net Sales and Operating Revenues
Net sales and operating revenues for 2011 increased $112.2 million, or 2.6%, to
$4,378.0 million when compared with 2010. Comparable store sales decreased 2.2%.
The increase in our net sales and operating revenues was driven primarily by
sales at the 646 Target Mobile centers that were open on December 31, 2011, but
not on December 31, 2010. The increase in sales that was driven by our
additional Target Mobile centers was partially offset by a decrease in
comparable store sales. The decrease in comparable store sales was primarily
driven by sales decreases in our consumer electronics and signature platforms,
which were partially offset by an increase in our mobility platform sales.
U.S. RadioShack Company-Operated Stores Segment
Sales in our U.S. RadioShack company-operated stores segment for 2011 decreased
$144.9 million or 3.8% when compared with 2010.
Sales in our mobility platform increased 5.6% in 2011. This sales increase was
driven by increased sales in our AT&T postpaid business, sales in our Verizon
postpaid business, and sales of tablet devices. These sales increases were
partially offset by decreased sales in our T-Mobile postpaid wireless business
and decreased sales in our Sprint postpaid wireless business. The decreased
sales in our Sprint postpaid wireless business were due to changes in Sprint's
customer and credit models, which resulted in fewer new and upgrade activations
in the last three quarters of 2011.
25
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Sales in our signature platform decreased 4.7% in 2011. This sales decrease was
primarily driven by decreased sales of digital-to-analog television converter
boxes and related television antennas, music accessories, and media storage, but
was partially offset by increased sales of headphones and tablet accessories.
Sales in our consumer electronics platform decreased 22.0% in 2011. This sales
decrease was driven by sales declines in substantially all of the categories in
this platform, but was primarily driven by decreased sales of digital music
players, digital cameras and camcorders, and GPS devices. The convergence of
these products' functionality into smartphones contributed to these sales
decreases.
Target Mobile Centers
Sales in our Target Mobile centers segment for 2011 increased $277.8 million
when compared with 2010. This sales increase was driven primarily by sales at
the 646 Target Mobile centers that were open on December 31, 2011, but not on
December 31, 2010.
Other Sales
Other sales decreased $20.7 million, or 5.3%, in 2011. This sales decrease was
primarily driven by decreased sales to our independent dealers, which was
partially offset by a sales increase at our Mexican subsidiary. Our Mexican
subsidiary accounted for less than 5% of our consolidated net sales and
operating revenues in 2011.
Gross Profit
Consolidated gross profit and gross margin for 2011 were $1,810.8 million and
41.4%, respectively, compared with $1,913.7 million and 44.9%, respectively, in
2010, resulting in a 5.4% decrease in gross profit dollars and a 3.5 percentage
point decrease in our gross margin rate.
Gross margin decreased by 3.5 percentage points from 2010 to 41.4%. This
decrease was primarily driven by a change in our sales mix within our mobility
platform towards lower-margin smartphones and tablets, combined with the overall
growth of our mobility platform through our Target Mobile centers and U.S.
RadioShack company-operated stores. Smartphones generally, and the Apple iPhone
in particular, carry a lower gross margin rate given their higher average cost
basis. Revenue from smartphones as a percentage of our mobility platform in 2011
was 17.3 percentage points higher than in 2010. Additionally, our gross margin
rate was negatively affected by more promotional pricing in the fourth quarter
of 2011 when compared with the same period in 2010.
The gross margin rate for our U.S. RadioShack company-operated stores segment
decreased by 2.2 percentage points in 2011, primarily due to a change in sales
mix towards lower-margin smartphones as discussed above.
Selling, General and Administrative Expense
Our consolidated SG&A expense increased 6.3%, or $93.6 million, in 2011. This
represents a 1.2 percentage point increase as a percentage of net sales and
operating revenues compared to 2010.
The increase in SG&A expense was primarily driven by increased costs to support
our Target Mobile centers of approximately $76 million, a one-time charge of
$23.4 million related to our transition from T-Mobile to Verizon classified as
other SG&A, and $9.5 million in costs related to the closure of our Chinese
manufacturing plant. These increases were partially offset by decreased
incentive compensation expense in our other retail channels as well as our
corporate office.
Depreciation and Amortization
Total depreciation and amortization from continuing operations for 2011 declined
$0.7 million or 0.8%.
Impairment of Long-Lived Assets
Impairments of long-lived assets were $3.1 million and $4.0 million in 2011 and
2010, respectively. In 2011 these amounts were related primarily to
underperforming U.S. RadioShack company-operated stores. In 2010 this amount was
related primarily to underperforming U.S. RadioShack company-operated stores and
certain test store formats.
Net Interest Expense
Consolidated net interest expense, which is interest expense net of interest
income, was $43.7 million in 2011, compared with $39.3 million in 2010.
In 2011 and 2010, interest expense primarily consisted of interest paid at the
stated coupon rate on our outstanding notes, the non-cash amortization of the
discounts on our long-term debt, cash received on our interest rate swaps, and
the non-cash change in fair value of our interest rate swaps. Interest expense
increased $4.9 million in 2011. This increase was driven by the increased
average amount of long-term debt outstanding during 2011, the increased debt
discount amortization related to our 2013 Convertible Notes, and increased
commitment fees related to the five-year $450 million asset-based revolving
credit facility we entered into on January 4, 2011, with a group of lenders with
Bank of America, N.A., as administrative and collateral agent (the "2016 Credit
Facility"). Non-cash interest expense was $17.0 million in 2011 compared with
$15.2 million in 2010.
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Income Tax Expense
Our effective tax rate for 2011 was 37.5%, compared with 38.7% for 2010. The
2011 effective tax rate was affected by the realization of job retention credits
generated pursuant to the Hiring Incentives to Restore Employment Act. These
credits lowered the effective tax rate by 1.1 percentage points.
The 2010 effective tax rate was affected by the net reversal of approximately
$1.2 million in previously unrecognized tax benefits, deferred tax assets and
accrued interest due to the effective settlement of state income tax matters
during the period. These discrete items lowered the effective tax rate by 0.4
percentage points.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 - "Summary of Significant Accounting Policies" under the section
titled "New Accounting Standards" in the Notes to Consolidated Financial
Statements.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Overview
Operating Activities: Cash used in operating activities in 2012 was $43.0
million, compared with cash provided by operating activities of $217.9 million
in 2011. Cash flows from operating activities are comprised of net income or
loss plus non-cash adjustments to net income or loss and the net changes in
assets and liabilities. The amounts of cash provided by net income or loss plus
non-cash adjustments to net income or loss were $59.9 million and $215.4 million
in 2012 and 2011, respectively. The decrease in net income plus non-cash
adjustments was primarily driven by our net loss in 2012 of $139.4 million
compared with a net income of $72.2 million in 2011. The amount of cash used by
the net changes in assets and liabilities was $102.9 million in 2012, compared
with cash provided by the net changes in assets and liabilities of $2.5 million
in 2011. The increase in cash used by the net changes in assets and liabilities
in 2012 was primarily driven by cash used for our increased inventory balance at
December 31, 2012, which was partially offset by income tax refunds of $118.6
million and by cash provided by our increased accounts payable balance. Our
inventory balance was larger at December 31, 2012, than it was at December 31,
2011, primarily due to a higher average unit cost of, and larger quantities of,
wireless handsets. The increase in inventory was also driven by increased
inventory in our higher-margin signature platform, which was primarily driven by
increased wireless accessories and headphones.
Investing Activities: The amounts of cash used in investing activities were
$94.2 million and $80.1 million in 2012 and 2011, respectively. This change was
driven by the increase in our restricted cash balance, which was partially
offset by decreased capital expenditures in 2012. For further discussion of our
restricted cash, see "Cash Requirements" later in this MD&A. Capital
expenditures were $67.8 million in 2012 compared with $82.1 million in 2011.
This decrease was primarily driven by higher capital expenditures for our Target
Mobile centers in 2011 when we opened many of these locations. Capital
expenditures primarily related to our U.S. RadioShack company-operated stores
and information system projects in 2012 and 2011. Our capital expenditures in
2011 also related to our Target Mobile centers.
Financing Activities: Net cash provided by financing activities was $81.2
million in 2012 compared with net cash used in financing activities of $115.5
million in 2011. Our net cash provided by financing activities in 2012 was
primarily due to the $175.0 million of new borrowings. These borrowings were
partially offset by the purchase of $88.1 million principal amount of our 2013
Convertible Notes and our dividend payments of $24.9 million. Our net cash used
in financing activities for 2011 was primarily driven by the repurchase of
$113.3 million of our common stock and the payment of a $49.6 million annual
dividend.
Free Cash Flow: Our free cash flow, defined as cash flows from operating
activities less dividends paid and additions to property, plant and equipment,
was a negative $135.7 million in 2012, $86.2 million in 2011, and $48.4 million
in 2010. The decrease in free cash flow for 2012 was attributable to decreased
cash flow from operating activities as described above.
We believe free cash flow is a relevant indicator of our ability to repay
maturing debt, change dividend payments or fund other uses of capital that
management believes will enhance shareholder value. See "Liquidity Outlook"
later in this MD&A for further discussion of our sources of liquidity and our
cash requirements in future periods. The comparable financial measure to free
cash flow under generally accepted accounting principles is net cash flows
provided by or used in operating activities. Net cash flows used in operating
activities was $43.0 million in 2012, compared with net cash provided by
operating activities of $217.9 million and $155.0 million in 2011 and 2010,
respectively. We do not intend for the presentation of free cash flow, a
non-GAAP financial measure, to be considered in isolation or as a substitute for
measures prepared in accordance with GAAP, nor do we intend to imply that free
cash flow represents cash flow available for discretionary expenditures. The
following table is a reconciliation of cash flows from operating activities to
free cash flow.
27--------------------------------------------------------------------------------
Year Ended December 31,
(In millions) 2012 2011 2010Net cash (used in) provided by operating activities $ (43.0 ) $ 217.9
$ 155.0
Less:
Additions to property, plant and equipment 67.8 82.1 80.1
Dividends paid 24.9 49.6 26.5
Free cash flow $ (135.7 ) $ 86.2 $ 48.4
SOURCES OF LIQUIDITY
As of December 31, 2012, we had $535.7 million in cash and cash equivalents,
compared with $591.7 million as of December 31, 2011. The table below lists our
credit commitments from various financial institutions at December 31, 2012.
(In millions) Commitment Expiration per Period
Total Amounts Less Than Over
Credit Commitments Committed 1 Year 1-3 Years 3-5 Years 5 Years
Lines of credit (1) $ 450.0 $ -- $ -- $ 450.0 $ --
Standby letters of credit -- -- -- -- --Total commercial commitments $ 450.0 $ -- $
-- $ 450.0 $ --
(1) At December 31, 2012, our maximum availability for revolving
borrowings was $393.7 million. No revolving borrowings have been
made under the facility, and letters of credit totaling $3.1
million had been issued as of December 31, 2012, resulting in
$390.6 million of availability for revolving borrowings.
2016 Credit Facility: In August 2012 we entered into an amended and restated
credit agreement ("Restated 2016 Credit Facility" or "2016 Credit Facility")
with a group of lenders with Bank of America, N.A., as the administrative and
collateral agent. The Restated 2016 Credit Facility amends and restates the
Company's existing asset-based revolving credit agreement (the "Original 2016
Credit Facility"). The Restated 2016 Credit Facility revised the terms of the
Original 2016 Credit Facility to, among other things, provide for $75 million of
term loans.
Like the Original 2016 Credit Facility, the Restated 2016 Credit Facility
matures on January 4, 2016, and provides for an asset-based revolving credit
line of $450 million, subject to a borrowing base, which was $642.8 million at
December 31, 2012. As with the Original 2016 Credit Facility, obligations under
the Restated 2016 Credit Facility are secured by substantially all of our
inventory, accounts receivable, cash, and cash equivalents. Obligations under
the Restated 2016 Credit Facility are also secured by certain real estate.
As with the Original 2016 Credit Facility, revolving borrowings under the
Restated 2016 Credit Facility bear interest at our choice of a bank's prime rate
plus 1.25% to 1.75% or LIBOR plus 2.25% to 2.75%. The applicable rates in these
ranges are based on the aggregate average availability under the facility. The
Restated 2016 Credit Facility also contains a $200 million sub-limit for the
issuance of standby and commercial letters of credit. The issuance of letters of
credit reduces the amount available under the facility. Letter of credit fees
are 2.25% to 2.75% for standby letters of credit and 1.125% to 1.375% for
commercial letters of credit. We pay commitment fees to the lenders at an annual
rate of 0.50% of the unused amount of the facility.
The maximum availability for revolving borrowings under the 2016 Credit Facility
is determined at the end of each month and is calculated as the lesser of:
· $450 million, or
· Our borrowing base for revolving borrowings less $45 million (calculated as
$597.8 million at December 31, 2012), or
· Our borrowing base for revolving borrowings up to a maximum amount of $450
million less the greater of 12.5% (currently $56.3 million) or $45 million if
we do not meet a specified consolidated fixed charge coverage ratio during a
trailing twelve-month period (calculated as $393.7 million at December 31,
2012).
As of December 31, 2012, our maximum availability for revolving borrowings under
the 2016 Credit Facility was $393.7 million as a result of us not meeting the
consolidated fixed charge coverage ratio at December 31, 2012. As of December
31, 2012, no revolving borrowings had been made under the facility, and letters
of credit totaling $3.1 million had been issued, resulting in $390.6 million of
availability for revolving borrowings under the 2016 Credit Facility. We believe
that we will not meet the consolidated fixed charge coverage ratio for at least
the next twelve months.
28--------------------------------------------------------------------------------
If at any time the outstanding revolving borrowings and term loans under the
2016 Credit Facility exceed the sum of the revolving borrowing base and the term
loan borrowing base, we will be required to repay an amount equal to such
excess. No payments (whether optional or mandatory) may be made in respect of
the principal amount of these term loans unless all revolving borrowings have
been repaid, any outstanding letters of credit have been cash collateralized,
and all other commitments under the Restated 2016 Credit Facility have been
repaid or otherwise satisfied. The revolving borrowing base and term loan
borrowing base are subject to customary reserves that may be implemented by the
administrative agent at its permitted discretion.
The Restated 2016 Credit Facility contains customary affirmative and negative
covenants and events of default that are substantially consistent with those
contained in the Original 2016 Credit Facility. These covenants could, among
other things, restrict certain payments, including dividends and share
repurchases. We do not believe the limitations contained in the credit facility
will, in the foreseeable future, adversely affect our ability to use the credit
facility and execute our business plan.
CASH REQUIREMENTS
Capital Expenditures: The nature of our capital expenditures is comprised of a
base level of investment required to support our current operations and a
discretionary amount related to our strategic initiatives. The base level of
capital expenditures required to support our operations ranges from $40 million
to $50 million. The remaining amount of anticipated capital expenditures relates
to strategic initiatives as reflected in our annual plan. These capital
expenditures are discretionary and, therefore, may not be spent if we decide not
to pursue one or more of our strategic initiatives. We estimate that our capital
expenditures for 2013 will range from $70 million to $90 million based on our
operating performance during the year. U.S. RadioShack company-operated store
remodels and relocations and information systems projects will account for the
majority of our anticipated 2013 capital expenditures. Cash and cash equivalents
and cash generated from operating activities will be used to fund future capital
expenditure needs. Additionally, our 2016 Credit Facility could be utilized to
fund capital expenditures.
Restricted Cash: Restricted cash totaled $26.5 million at December 31, 2012, and
is included in other current assets in our Consolidated Balance Sheets. This
cash is pledged as collateral for a standby letter of credit issued to our
general liability insurance provider. We have the ability to withdraw this cash
at any time and instead provide a letter of credit issued under our 2016 Credit
Facility similar to the letter of credit that was issued under our 2016 Credit
Facility at December 31, 2011. We have elected to pledge this cash as collateral
to reduce our costs associated with our general liability insurance.
Seasonal Inventory Buildup: Typically, our annual cash requirements for
pre-seasonal inventory buildup from August to November range between $150
million and $250 million. The funding required for this buildup will be
primarily from cash and cash equivalents and any cash generated from operating
activities. Additionally, our 2016 Credit Facility could be utilized to fund the
inventory buildup, if necessary.
Operating Leases: We use operating leases, primarily for our retail locations
and our corporate campus, to lower our capital requirements.
29
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Contractual Obligations
The table below contains our known contractual commitments as of December 31,
2012.
(In millions) Payments Due by Period
Less Than More than
Contractual Obligations Total 1 Year 1-3 Years 3-5 Years 5 Years
Long-term debt obligations (1) $ 787.9 $ 286.9 $ 9.4 $ 166.6 $ 325.0
Interest obligations 209.7 42.1 73.0 65.2 29.4
Operating lease obligations (2) 598.9 202.8 260.2 106.7 29.2
Purchase obligations (3) 313.0 301.7 11.3 -- --
Other long-term liabilities
reflected on the balance sheet
(4) 167.9 6.4 33.5 128.0
Total $ 2,077.4 $ 833.5 $ 360.3 $ 372.0 $ 511.6
(1) For more information regarding long-term debt, refer to Note 5 -
"Indebtedness and Borrowing Facilities" of our Notes to
Consolidated Financial Statements included elsewhere in this
Annual Report on Form 10-K.
(2) For more information regarding lease commitments, refer to Note
14 - "Commitments and Contingencies" of our Notes to
Consolidated Financial Statements included elsewhere in this
Annual Report on Form 10-K.
(3) Purchase obligations primarily include our product commitments
and marketing agreements.
(4) These long-term liabilities reflected on our Consolidated
Balance Sheet represented contractual obligations for which we
could reasonably estimate the timing of cash payments.
Additionally, we had a $21.2 million non-current deferred tax
liability that we are not able to reasonably estimate the amount
by which this liability will increase or decrease over time;
therefore, this amount has not been included in the table. The
remaining non-current liabilities reflected on our Consolidated
Balance Sheet did not represent contractual obligations for
future cash payments.
In 2012 we entered into a $50 million secured term loan due in January 2016, a
$100 million secured term loan due in September 2017, and a $25 million secured
term loan due in September 2017. We borrowed these amounts in advance of the
maturity of our 2013 Convertible Notes. These new loans represented
approximately 47% of the original $375 million principal amount of the 2013
Convertible Notes. We repurchased $88.1 million principal amount of the 2013
Convertible Notes at a discount in 2012. We plan to repay the remaining $286.9
million of 2013 Convertible Notes with cash on hand and borrowings from our 2016
Credit Facility, if necessary. For more information regarding our long-term
debt, refer to Note 5 - "Indebtedness and Borrowing Facilities" of our Notes to
Consolidated Financial Statements included elsewhere in this Annual Report on
Form 10-K.
LIQUIDITY OUTLOOK
As of December 31, 2012, we had $535.7 million in cash and cash equivalents,
compared with $591.7 million in 2011. Additionally, we had a credit facility of
$450 million with availability of $390.6 million as of December 31, 2012. This
resulted in a total liquidity position of $926.3 million at December 31, 2012.
We experienced a loss of $139.4 million in 2012, and our cash flows from
operating activities declined from cash provided by operations of $217.9 million
in 2011 to cash used in operations of $43.0 million in 2012. Although we do not
anticipate borrowing under our 2016 Credit Facility during 2013, we may cause
letters of credit to be issued under this credit facility, which would reduce
our total liquidity position.
If our results of operations for 2013 are significantly worse than 2012, or if
our trade payables decrease, we could be required to utilize more of our 2016
Credit Facility in the form of borrowings or additional letters of credit.
However, in this event, we could implement cash conservation activities such as
reducing our spending for professional fees, reducing our capital expenditures,
reducing our spending for advertising, lowering our inventory balances or not
taking advantage of discounts for early payments to vendors.
We have considered the impact of our financial projections on our liquidity
analysis and have evaluated the appropriateness of the key assumptions in our
forecast such as sales, gross profit and SG&A expenses. We have analyzed our
cash requirements, including our inventory position, other working capital
changes, capital expenditures and borrowing availability under our credit
facility. Based upon these evaluations and analyses, we expect that our
anticipated sources of liquidity will be sufficient to meet our obligations
without disposition of assets outside the ordinary course of business or
significant revisions of our planned operations through 2013.
If the trend in our results of operations continues or worsens after 2013, we
may be required to borrow more under our 2016 Credit Facility, or to take
additional actions to improve our liquidity that would be outside the ordinary
course of business. These actions could include: incurring additional debt at
higher interest rates, reducing our capital expenditures to amounts below those
required to support our current level of operations, closing a significant
number of stores, further reducing our employee headcount, or selling one or
more subsidiaries.
Capitalization
The declaration of dividends, the dividend rate, and the amount and timing of
share repurchases are at the sole discretion of our Board of Directors, and
plans for future dividends and share repurchases may be revised by the Board of
Directors at any time.
30--------------------------------------------------------------------------------
The following table sets forth information about our capitalization on the dates
indicated.
December 31,
2012 2011
% of Total % of Total
(Dollars in millions) Dollars Capitalization Dollars Capitalization
Short-term debt $ 278.7 20.2 % $ -- 0.0 %
Long-term debt 499.0 36.3 670.6 47.1
Total debt 777.7 56.5 670.6 47.1
Stockholders' equity 598.7 43.5 753.3 52.9
Total capitalization $ 1,376.4 100.0 % $ 1,423.9 100.0 %
Our debt-to-total capitalization ratio increased in 2012 from 2011, primarily
due to the $175.0 million of new borrowings under the secured term loans due in
2016 and 2017. These borrowings were partially offset by purchase of $88.1
million principal amount of the 2013 Convertible Notes.
Dividends: We paid $0.125 per share dividends in the first and second quarters
of 2012. On July 25, 2012, we announced that we were suspending our dividend. We
paid per share annual dividends of $0.50 and $0.25 in 2011 and 2010,
respectively. Our dividend payments totaled $24.9 million, $49.6 million, and
$26.5 million in 2012, 2011 and 2010, respectively, and were funded from cash on
hand.
2011 Share Repurchase Program: In October 2011 our Board of Directors approved a
share repurchase program with no expiration date authorizing management to
repurchase up to $200 million of our common stock to be executed through open
market or private transactions. During the fourth quarter of 2011, we paid $11.9
million to purchase approximately 0.9 million shares of our common stock in open
market purchases. As of December 31, 2011, there was $188.1 million available
for share repurchases under this program. We announced on January 30, 2012, that
we had suspended further share repurchases under this program.
2008 Share Repurchase Program: In November 2010 we completed a $300 million
accelerated share repurchase ("ASR") program that we entered into in August
2010. We repurchased 14.9 million shares under the ASR program. In addition,
after the conclusion of the ASR program in November 2010, we repurchased $98.6
million worth of shares in the open market, representing 4.9 million shares.
During the second quarter of 2011, we paid $101.4 million to purchase 6.3
million shares of our common stock in open market purchases. This completed our
purchases under our 2008 share repurchase program.
OFF-BALANCE SHEET ARRANGEMENTS
Other than the operating leases described above, we do not have any off-balance
sheet financing arrangements, transactions, or special purpose entities.
INFLATION
Inflation has not significantly affected us over the past three years. We do not
expect inflation to have a significant effect on our operations in the
foreseeable future.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements are prepared in accordance with generally
accepted accounting principles ("GAAP") in the United States. The application of
GAAP requires us to make estimates and assumptions that affect the reported
values of assets and liabilities at the date of the financial statements, the
reported amount of revenues and expenses during the reporting period, and the
related disclosures of contingent assets and liabilities. The use of estimates
is pervasive throughout our financial statements and is affected by management's
judgment and uncertainties. Our estimates, assumptions and judgments are based
on historical experience, current market trends and other factors that we
believe to be relevant and reasonable at the time the consolidated financial
statements are prepared. We continually evaluate the information used to make
these estimates as our business and the economic environment change. Actual
results may differ materially from these estimates under different assumptions
or conditions.
In the Notes to Consolidated Financial Statements, we describe the significant
accounting policies used in the preparation of our consolidated financial
statements. The accounting policies and estimates we consider most critical are
revenue recognition; inventory valuation; estimation of reserves and valuation
allowances specifically related to insurance, tax and legal contingencies;
valuation of long-lived assets and goodwill; and stock-based compensation.
We consider an accounting policy or estimate to be critical if it requires
difficult, subjective or complex judgments, and is material to the portrayal of
our financial condition, changes in financial condition or results of
operations. The selection, application and disclosure of our critical accounting
policies and estimates have been reviewed by the Audit and Compliance Committee
of our Board of Directors.
Revenue Recognition
Description
Our revenue is derived principally from the sale of name brand and private brand
products and services to consumers. Revenue is recognized, net of an estimate
for customer refunds and product returns, when persuasive evidence of an
arrangement exists, delivery has occurred or services have been rendered, the
sales price is fixed or determinable, and collectability is reasonably assured.
31
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Certain products, such as wireless telephone handsets, require the customer to
use the services of a third-party wireless service provider. The wireless
service provider pays us an upfront commission for obtaining a new customer or
upgrading an existing customer and, in some cases, a monthly recurring residual
amount based upon the ongoing arrangement between the service provider and the
customer. For certain new customers the upfront commission revenue is repaid to
the wireless service provider if the wireless handset is subsequently
deactivated from the wireless network during a specified period. Our sale of an
activated wireless handset is the single event required to meet the delivery
criterion for both the upfront commission and the recurring residual revenue.
Upfront commission revenue, net of estimated wireless service deactivations, is
recognized at the time an activated wireless handset is sold to the customer at
the point-of-sale. Recurring residual revenue, which is not fixed and
determinable at the point of sale, is recognized as earned under the terms of
each contract with the wireless service provider, which is typically as the
wireless service provider bills its customer, generally on a monthly basis.
Judgments and uncertainties involved in the estimate
Our revenue recognition accounting methodology requires us to make certain
judgments regarding the estimate of future sales returns and wireless service
deactivations. Our estimates for product refunds and returns, wireless service
deactivations and commission revenue adjustments are based on historical
information pertaining to these items. Based on our extensive history in selling
activated wireless handsets, we have been able to establish reliable estimates
for wireless service deactivations. However, our estimates for wireless service
deactivations can be affected by certain characteristics of and decisions made
by our service providers. These factors include changes in the quality of their
customer service, the quality and performance of their networks, their rate plan
offerings, their policies regarding extensions of customer credit, and their
wireless handset product offerings. These factors add uncertainty to our
estimates.
Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to estimate sales
returns or wireless service deactivations during the past three fiscal years. We
continue to update our estimate for wireless service deactivations to reflect
the most recently available information regarding the characteristics of and
decisions made by our service providers discussed above. If actual results
differ from our estimates due to these or various other factors, the amount of
revenue recorded could be materially affected. A 10% difference in our reserves
for the estimates noted above would have affected net sales and operating
revenues by approximately $5.6 million in 2012.
Inventory Valuation
Description
Our inventory consists primarily of finished goods available for sale at our
retail locations or within our distribution centers and is recorded at the lower
of cost - on a first-in first-out basis - or market. The cost components
recorded within inventory are the vendor invoice cost, which is net of vendor
allowances, and certain allocated freight, distribution, warehousing and other
costs relating to merchandise acquisition required to bring the merchandise from
the vendor to the location where it is offered for sale.
Judgments and uncertainties involved in the estimate
Typically, the market value of our inventory is higher than its aggregate cost.
Determination of the market value may be very complex and, therefore, requires a
high degree of judgment. In order for management to make the appropriate
determination of market value, the following items are commonly considered:
inventory turnover statistics, current selling prices, seasonality factors,
consumer trends, competitive pricing, performance of similar products or
accessories, planned promotional incentives, technological obsolescence, and
estimated costs to sell or dispose of merchandise such as sales commissions.
If the estimated market value, calculated as the amount we expect to realize,
net of estimated selling costs, from the ultimate sale or disposal of the
inventory, is determined to be less than the recorded cost, we record a
provision to reduce the carrying amount of the inventory item to its net
realizable value.
Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to establish our
inventory valuation or the related reserves during the past three fiscal years,
and we do not believe there is a reasonable likelihood that there will be a
material change in the future estimates or assumptions we use to estimate our
inventory valuation reserves. Differences between management estimates and
actual performance and pricing of our merchandise could result in inventory
valuations that differ from the amount recorded at the financial statement date
and could also cause fluctuations in the amount of recorded cost of products
sold. If our estimates regarding market value are inaccurate or changes in
consumer demand affect certain products in an unforeseen manner, we may be
exposed to material losses or gains in excess of our established valuation
reserve. We believe that we have sufficient current and historical knowledge to
record reasonable estimates for our inventory valuation reserves. However, it is
possible that actual results could differ from recorded reserves.
32
--------------------------------------------------------------------------------Estimation of Reserves and Valuation Allowances for Self-Insurance, Income
Taxes, and Litigation Contingencies
Description
The amount of liability or valuation allowance we record related to insurance
claims, tax positions, and legal contingencies requires us to make judgments
about the amount of expense that will ultimately be incurred or the realization
of certain assets.
We are insured for certain losses related to workers' compensation, property and
other liability claims, with deductibles up to $1.0 million per occurrence. This
insurance coverage limits our exposure for any catastrophic claims that result
in liability in excess of the deductible. We also have a self-insured health
program administered by a third-party covering the majority of our employees
that participate in our health insurance programs. We estimate the amount of our
reserves for all insurance programs discussed above at the end of each reporting
period. This estimate is based on historical claims experience, demographic
factors, severity factors, and other factors we deem relevant.
We are subject to periodic audits from multiple domestic and foreign tax
authorities related to income tax, sales and use tax, personal property tax, and
other forms of taxation. These audits examine our tax positions, timing of
income and deductions, and allocation procedures across multiple jurisdictions.
Our accounting for tax estimates and contingencies requires us to evaluate tax
issues and establish reserves in our consolidated financial statements based on
our estimate of the probability of realizing these tax exposures. Depending on
the nature of the tax issue, we could be subject to audit over several years;
therefore, our estimated reserve balances might exist for multiple years before
an issue is resolved by the taxing authority.
We record a valuation allowance to reduce a deferred tax asset if based on the
consideration of all available evidence, it is more likely than not that all or
some portion of the deferred tax asset will not be realized. Significant weight
is given to evidence that can be objectively verified. We evaluate our deferred
income taxes quarterly to determine if valuation allowances are required by
considering available evidence, including historical and projected taxable
income and tax planning strategies. Any deferred tax asset subject to a
valuation allowance is still available to us to offset future taxable income,
and we will adjust a previously established valuation allowance if we change our
assessment of the amount of deferred income tax asset that is more likely than
not to be realized.
We are involved in legal proceedings and governmental inquiries associated with
employment and other matters. Our accounting for legal contingencies requires us
to estimate the probable losses in these matters. These estimates have been
developed in consultation with in-house and outside legal counsel and are based
upon a combination of litigation and settlement strategies.
Judgments and uncertainties involved in the estimate
Our liabilities for insurance, tax and legal contingencies contain uncertainties
because we are required to make assumptions and to apply judgment to estimate
the exposures associated with these items. We use our history and experience, as
well as the specific circumstances surrounding these claims, in evaluating the
amount of liability we should record. As additional information becomes
available, we assess the potential liability related to our various claims and
revise our estimates as appropriate. These revisions could materially affect our
results of operations and financial position or liquidity.
Effect if actual results differ from assumptions
We have not made any material changes in the methodology used to estimate our
insurance, tax, or legal contingencies reserves during the past three fiscal
years, and we do not believe there is a reasonable likelihood that there will be
a material change in the future estimates or assumptions for these items.
However, a 10% change in our insurance reserves at December 31, 2012, would have
affected net income by approximately $3.9 million. As of December 31, 2012,
actual losses had not exceeded our estimates. Additionally, for claims that
exceed our deductible amount, we record a gross liability and corresponding
receivable representing expected recoveries, since we are not legally relieved
of our obligation to the claimant.
Although we believe that our insurance, tax and legal reserves are based on
reasonable judgments and estimates, actual results could differ, which may
expose us to material gains or losses in future periods. These actual results
could materially affect our effective tax rate, earnings, deferred tax balances
and cash flows in the period of resolution.
Valuation of Long-Lived Assets and Goodwill
Description
Long-lived assets, such as property and equipment, are reviewed for impairment
when events or changes in circumstances indicate that the carrying amount may
not be recoverable, such as insufficient cash flows or plans to dispose of or
sell long-lived assets before the end of their previously estimated useful
lives. The carrying amount is considered not recoverable if it exceeds the sum
of the undiscounted cash flows expected to result from the use and eventual
disposition of the asset. If the carrying amount is not recoverable, we
recognize an impairment loss equal to the amount by which the carrying amount
exceeds fair value. We estimate fair value based on projected future discounted
cash flows. Impairment losses, if any, are recorded in the period in which the
impairment occurs. The carrying value of the asset is adjusted to the new
carrying value, and any subsequent increases in fair value are not recorded.
Additionally, if it is determined that the estimated remaining useful life of
the asset should be decreased, the periodic depreciation expense is adjusted
based on the new existing carrying value of the asset and the new remaining
useful life. Our policy is to evaluate long-lived assets for impairment at a
store level for retail operations.
33
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We have acquired goodwill related to business acquisitions. Goodwill represents
the excess of the purchase price over the fair value of net assets acquired. We
review our goodwill balances on an annual basis, during the fourth quarter, and
whenever events or changes in circumstances indicate the carrying value of a
reporting unit might exceed its fair value. If the carrying amount of a
reporting unit exceeds its fair value, we recognize an impairment loss for this
difference.
Judgments and uncertainties involved in the estimate
Our impairment loss calculations for long-lived assets contain uncertainties
because they require us to apply judgment and estimates concerning future cash
flows, strategic plans, useful lives and assumptions about market performance.
We also apply judgment in the selection of a discount rate that reflects the
risk inherent in our current business model.
Our impairment loss calculations for goodwill contain uncertainties because they
require us to estimate fair values of our reporting units. We estimate fair
values based on various valuation techniques such as discounted cash flows and
comparable market analyses. These types of analyses contain uncertainties
because they require us to make judgments and assumptions regarding future
profitability, industry factors, planned strategic initiatives, discount rates
and other factors.
Effect if actual results differ from assumptions
We have not made any material changes in the accounting methodologies we use to
assess impairment loss for long-lived assets or goodwill during the past three
fiscal years, and we do not believe there is a reasonable likelihood that there
will be a material change in the estimates or assumptions we use in calculating
goodwill impairment. If actual results or performance of certain business units
are not consistent with our estimates and assumptions, we may be exposed to
additional impairment charges, which could be material to our results of
operations. For example, if the profitability of our U.S. RadioShack
company-operated stores segment does not increase from our 2012 level, there
could be a material increase in the impairment of long-lived assets at certain
of our U.S. RadioShack company-operated stores in future periods.
The total value of our goodwill at December 31, 2012, was $36.6 million. Of this
amount, $36.1 million related to goodwill from the purchase of RadioShack de
Mexico. Based on our most recent review of goodwill impairment, we noted that
the fair values of our reporting units that had goodwill balances were
substantially greater than their carrying values.
Stock-Based Compensation
Description
We have historically granted certain stock-based awards to employees and
directors in the form of non-qualified stock options, incentive stock options,
restricted stock and deferred stock units. See Note 2 - "Summary of Significant
Accounting Policies" and Note 8 - "Stock-Based Incentive Plans" in the Notes to
Consolidated Financial Statements included elsewhere in this Annual Report on
Form 10-K for a more complete discussion of our stock-based compensation
programs.
At the date an award is granted, we determine the fair value of the award and
recognize the compensation expense over the requisite service period, which
typically is the period over which the award vests. The restricted stock and
deferred stock units are valued at the fair market value of our stock on the
date of grant. The fair value of stock options with only service conditions is
estimated using the Black-Scholes-Merton option-pricing model. The fair value of
stock options with service and market conditions is valued utilizing a lattice
model with Monte Carlo simulations.
Judgments and uncertainties involved in the estimate
The Black-Scholes-Merton and lattice models require management to apply judgment
and use subjective assumptions, including expected option life, volatility of
stock prices, and employee forfeiture rate. We use historical data and judgment
to estimate the expected option life and employee forfeiture rate, and use
historical and implied volatility when estimating the stock price volatility.
Changes in these assumptions can materially affect the fair value estimate.
Effect if actual results differ from assumptions
We have not made any material changes in the accounting methodologies used to
record stock-based compensation during the past three years. While the
assumptions that we develop are based on our best expectations, they involve
inherent uncertainties based on market conditions and employee behavior that are
outside of our control. If actual results are not consistent with the
assumptions used, the stock-based compensation expense reported in our financial
statements may not be representative of the actual economic cost of the
stock-based compensation. Additionally, if actual employee forfeitures
significantly differ from our estimated forfeitures, we may have an adjustment
to our financial statements in future periods. A 10% change in our stock-based
compensation expense in 2012 would have affected our net income by approximately
$0.7 million.
34--------------------------------------------------------------------------------
FACTORS THAT MAY AFFECT FUTURE RESULTS
Matters discussed in our MD&A and in other parts of this Annual Report on Form
10-K include forward-looking statements within the meaning of the federal
securities laws, including Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Exchange Act. These forward-looking statements
are statements that are not historical and may be identified by the use of words
such as "expect," "believe," "anticipate," "estimate," "intend," "potential" or
similar words. These matters include statements concerning management's plans
and objectives relating to our operations or economic performance and related
assumptions. We specifically disclaim any duty to update any of the information
set forth in this report, including any forward-looking statements.
Forward-looking statements are made based on management's current expectations
and beliefs concerning future events and, therefore, involve a number of
assumptions, risks and uncertainties, including the risk factors described in
Item 1A, "Risk Factors," of this Annual Report on Form 10-K. Management cautions
that forward-looking statements are not guarantees, and our actual results could
differ materially from those expressed or implied in the forward-looking
statements.
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