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VALUEVISION MEDIA INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of financial condition and results of operations is qualified by reference to and should be read in conjunction with our accompanying unaudited condensed consolidated financial statements and notes included herein and the audited consolidated financial statements and notes included in our annual report on Form 10-K for the fiscal year ended February 1, 2014. Cautionary Statement Regarding Forward-Looking Statements The following Management's Discussion and Analysis of Financial Condition and Results of Operations and other materials we file with the SEC (as well as information included in oral statements or other written statements made or to be made by us) contain certain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Any statements contained herein that are not statements of historical fact, including statements regarding guidance, industry prospects or future results of operations or financial position made in this report are forward-looking. We often use words such as anticipates, believes, expects, intends and similar expressions to identify forward-looking statements. These statements are based on management's current expectations and accordingly are subject to uncertainty and changes in circumstances. Actual results may vary materially from the expectations contained herein due to various important factors, including (but not limited to): consumer preferences, spending and debt levels; the general economic and credit environment; interest rates; seasonal variations in consumer purchasing activities; the ability to achieve the most effective product category mixes to maximize sales and margin objectives; competitive pressures on sales; pricing and gross sales margins; the level of cable and satellite distribution for our programming and the associated fees or estimated cost savings from contract renegotiations; our ability to establish and maintain acceptable commercial terms with third-party vendors and other third parties with whom we have contractual relationships, and to successfully manage key vendor relationships; our ability to manage our operating expenses successfully and our working capital levels; our ability to remain compliant with our long-term credit facility covenants; our ability to maintain and successfully execute our long-term growth strategy; the market demand for television station sales; our management and information systems infrastructure; challenges to our data and information security; changes in governmental or regulatory requirements; litigation or governmental proceedings affecting our operations; the risks identified under "Risk Factors" in our Form 10-K for our fiscal year ended February 1, 2014 and any additional risk factors identified in our periodic reports since such date; significant public events that are difficult to predict, or other significant television-covering events causing an interruption of television coverage or that directly compete with the viewership of our programming; and our ability to obtain, retain and offer meaningful compensation to our key executives and employees. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this filing. We are under no obligation (and expressly disclaim any such obligation) to update or alter our forward-looking statements whether as a result of new information, future events or otherwise. 15-------------------------------------------------------------------------------- Table of Contents Overview Our Company We are a digital commerce company that markets, sells and distributes products to consumers through TV, telephone, online, mobile and social media. We operate a 24-hour television shopping network, ShopHQ, which is distributed primarily through cable and satellite affiliation agreements, through which we offer brand name and private label products in the categories of jewelry & watches; home & consumer electronics; beauty, health & fitness; and fashion & accessories. We also operate ShopHQ.com, a comprehensive digital commerce platform that sells products which appear on our television shopping channel as well as an extended assortment of online-only merchandise. Our programming and products are also marketed via mobile devices - including smartphones and tablets, and through the leading social media channels. In May 2013, we announced our intention to rebrand our 24-hour television shopping network, ShopNBC, and our companion digital commerce website, ShopNBC.com and on January 31, 2014, we officially transitioned to our new brand, ShopHQ and ShopHQ.com, to reinforce our positioning as the shopping headquarters for customers. Our investor relations website address is ShopHQ.com/ir. Our goal is to maintain the investor relations website as a way for investors to easily find information about us, including press releases, announcements of investor conferences, investor and analyst presentations and corporate governance. We also make available free of charge our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and all amendments to these filings as soon as practicable after that material is electronically filed with or furnished to the SEC. The information found on our website is not part of this or any other report we file with, or furnish to, the SEC. Products and Customers Products sold on our media channel platforms include primarily jewelry & watches, home & consumer electronics, beauty, health & fitness, and fashion & accessories. Historically jewelry & watches has been our largest merchandise category. We are working to shift our product mix to include a more diversified product assortment in order to grow our new and active customer base. The following table shows our merchandise mix as a percentage of television shopping and internet net merchandise sales for the years indicated by product category group: For the Three-Month For the Six-Month Periods Ended Periods Ended August 2, August 3, August 2, August 3, 2014 2013 2014 2013 Merchandise Category Jewelry & Watches 43% 48% 45% 48%Home & Consumer Electronics 24% 28% 25% 29% Beauty, Health & Fitness 15% 12% 14% 13% Fashion & Accessories 18% 12% 16% 10% Our product strategy is to continue to develop and expand new product offerings across multiple merchandise categories based on customer demand, as well as to offer competitive pricing and special values in order to drive new customers and maximize margin dollars per minute. Our digital commerce customers - those who interact with our network and transact through TV, internet and mobile device - are primarily married women between the ages of 40 and 70. We also have a strong presence of male customers of similar age and income range. We believe our customers make purchases based on our unique products, quality merchandise and value. Company Strategy As a digital commerce company, our strategy is to offer compelling proprietary merchandise using the Internet, mobile networks, social media and our commerce infrastructure, which includes television access to 87 million American cable and satellite homes. We believe our greatest growth opportunity lies in leveraging these digital commerce platforms in a way that engages customers far more often than just when they're in the mood to shop. By offering a wider assortment of proprietary merchandise (i.e. product that is not available elsewhere), presented in an engaging entertaining shopping centric format, we believe we will attract a larger customer base targeting a broader demographic. At the root of our efforts to attract a larger customer base is expanding and strengthening our relationships with the brands, personalities and manufacturers with whom we do business. We believe our comparatively smaller size demands a more "think nimble - act nimble" approach to doing business. This means establishing ourselves as a "launch pad" for new and fledgling proprietary brands that can leverage our unique reach on 16-------------------------------------------------------------------------------- Table of Contents our multiple digital commerce platforms. Properly executed, these initiatives should provide us a greater opportunity to grow our top and bottom lines in a more meaningful and competitive way. By positioning our organization as a digital commerce company, we are focusing on key initiatives such as customer resource management ("CRM"), partner relationship management, process improvements, brand building and delivering value to our customers and business partners. We believe that a fresh focus on existing as well as emerging platforms and technologies will begin repositioning our company as not simply a purely transactional distant third place "electronic retailer", but rather as a digital retailer that delivers a more engaging and enjoyable customer experience that exceeds sales and service expectations. Our Competition The direct marketing and digital commerce retail businesses are highly competitive. In our television shopping and digital commerce operations, we compete for customers with other television shopping and e-commerce retailers, infomercial companies, other types of consumer retail businesses, including traditional "brick and mortar" department stores, discount stores, warehouse stores and specialty stores; catalog and mail order retailers and other direct sellers. Our direct competitors within our industry include the QVC Network (owned by Liberty Interactive Corporation), and HSN, Inc., both of whom are substantially larger than we are in terms of annual revenues and customers, and whose programming is carried more broadly to U.S. households than our programming. Multimedia Commerce Group, Inc., which operates Jewelry Television, also competes with us for customers in the jewelry category. In addition, there are a number of smaller niche players and startups in the television shopping arena who compete with us. We believe that our major competitors incur cable and satellite distribution fees representing a significantly lower percentage of their sales attributable to their television programming than we do; and that their fee arrangements are substantially on a commission basis (in some cases with minimum guarantees) rather than on the predominantly fixed-cost basis that we currently have. At our current sales level, our distribution costs as a percentage of total consolidated net sales are higher than our competition. However, one of our key strategies is to maintain our fixed distribution cost structure in order to leverage our profitability as we grow our business. The digital commerce space is also highly competitive, and we are in direct competition with numerous other internet retailers, many of whom are larger, better financed and have a broader customer base than we do. We anticipate continuing competition for viewers and customers, for experienced television shopping personnel, for distribution agreements with cable and satellite systems and for vendors and suppliers - not only from television shopping companies, but also from other companies that seek to enter the television shopping and internet retail industries, including telecommunications and cable companies, television networks, and other established retailers. We believe that our ability to be successful in the digital commerce industry will be dependent on a number of key factors, including expanding our digital footprint to meet our customers' "watch and shop anytime, anywhere" needs, increasing the number of customers who purchase products from us and increasing the dollar value of sales per customer from our existing customer base. Summary Results for the Second Quarter and First Half of Fiscal 2014 Consolidated net sales for our fiscal 2014 second quarter were $156,587,000 compared to $148,564,000 for our fiscal 2013 second quarter, which represents a 5% increase. We reported an operating loss of $3,707,000 and net loss of $4,289,000 for our fiscal 2014 second quarter. The operating and net loss for the fiscal 2014 second quarter included charges of $2,473,000 relating to our activist shareholder response and CEO transition costs totaling $2,620,000. We had an operating loss of $160,000 and a net loss of $799,000 for our fiscal 2013 second quarter. Consolidated net sales for the first six months of fiscal 2014 were $316,288,000 compared to $299,918,000 for the first six months of fiscal 2013, which represents a 5% increase. We reported an operating loss of $2,655,000 and net loss of $3,829,000 for the first six months of fiscal 2014. The operating and net loss for the fiscal 2014 first half included charges of $3,518,000 relating to our activist shareholder response and CEO transition costs totaling $2,620,000. We had operating income of $1,524,000 and net income of $224,000 for the first six months of fiscal 2013. Activist Shareholder Response Costs In October of 2013, the Company received a demand from an activist shareholder to call a special meeting of shareholders for the purpose, among other things, of voting on a new slate of directors and amending certain of the Company's bylaws. The Company retained a team of advisers, including a financial adviser, proxy solicitor, investor relations firm and legal counsel, to assist in responding to the demand and the solicitation of proxies. In conjunction with such activities, the Company recorded charges to income for the second quarter and year-to-date periods ended August 2, 2014 totaling $2,473,000 and $3,518,000, respectively, which includes $750,000 as reimbursement for a portion of the activist shareholder's expenses. As previously disclosed, the activist shareholder requested that the Company reimburse it for certain of its expenses relating to the proxy contest. In exchange for paying certain activist shareholder expenses, the Company obtained a customary standstill agreement from the 17-------------------------------------------------------------------------------- Table of Contents activist shareholder among other settlement provisions. The process of responding to the initial demand concluded with the Company's annual shareholder meeting on June 18, 2014. CEO Transition Costs On June 22, 2014, Keith R. Stewart resigned as a member of the Company's board of directors and as Chief Executive Officer of the Company. In conjunction with Mr. Stewart's resignation and separation agreement, the Company recorded charges to income totaling $2,620,000 for the second quarter ended August 2, 2014 relating primarily to severance payments which Mr. Stewart is entitled to in accordance with the terms of his employment agreement with the Company and other costs associated with the transition. Following Mr. Stewart's resignation, the Company's board of directors appointed Mr. Mark Bozek as Chief Executive Officer of the Company effective June 22, 2014. The Company filed an 8-K on June 25, 2014 disclosing the specific terms of the resignation, separation agreement and new appointment of its chief executive officer. Results of Operations Selected Condensed Consolidated Financial Data Operations (Unaudited) Dollar Amount as a Dollar Amount as a Percentage of Net Sales for the Percentage of Net Sales for the Three-Month Periods Ended Six-Month Periods Ended August 2, August 3, August 2, August 3, 2014 2013 2014 2013 Net sales 100.0 % 100.0 % 100.0% 100.0% Gross margin 38.6 % 37.5 % 38.1% 37.6% Operating expenses: Distribution and selling 32.0 % 31.3 % 31.6% 30.9% General and administrative 4.3 % 4.2 % 4.0% 4.0% Depreciation and amortization 1.4 % 2.1 % 1.4% 2.1% Activist shareholder response costs 1.6 % - % 1.1% -% CEO transition costs 1.7 % - % 0.8% -% 41.0 % 37.6 % 38.9% 37.0% Operating income (loss) (2.4 )% (0.1 )% (0.8)% 0.6% Key Performance Metrics (Unaudited) For the Three-Month For the Six-Month Periods Ended Periods Ended August 2, August 3, August 2, August 3, 2014 2013 Change 2014 2013 Change Program Distribution Total homes (average 000's) 87,522 86,538 1% 87,267 85,670 2% Merchandise Metrics Gross margin % 38.6 % 37.5 % +110 bps 38.1% 37.6% +50 bps Net shipped units (000's) 2,110 1,627 30% 4,023 3,124 29% Average selling price $ 67 $ 83 (19)% $71 $87 (18)% Return rate 22.9 % 22.5 % +40 bps 22.6% 22.5% +10 bps Internet net sales % (a) 43.5 % 45.1 % -160 bps 44.2% 45.7% -150 bps Total Customers - 12 Month Rolling (000's) 1,421 1,201 18% N/A N/A (a) Internet sales percentage is calculated based on net sales that are generated from our ShopHQ.com website and mobile platforms, which are primarily ordered directly online. 18-------------------------------------------------------------------------------- Table of Contents Program Distribution Average homes reached, or full time equivalent ("FTE") subscribers, grew 1% in the second quarter of fiscal 2014 over the comparable prior year quarter, resulting in a 1.0 million increase in average homes reached during that same period. The increase was driven primarily by increases in our footprint as we expand into more widely distributed digital tiers of service with improved channel positions. During fiscal 2012, we made low-cost infrastructure investments that have enabled us to launch an up-converted version of our digital signal in a high definition ("HD") format and that improved the appearance of our primary network feed. As of August 2, 2014, our up-converted high definition feed is carried in approximately 7 million households. We believe that having an HD feed of our service allows us to attract new viewers and customers. Our television home shopping programming is also simulcast live 24 hours a day, 7 days a week through our internet website, www.ShopHQ.com and is also available on all mobile channels, which are not included in the foregoing data on homes reached. Cable and Satellite Distribution Agreements We have entered into cable and direct-to-home distribution agreements that require each operator to offer our television network over their systems. The terms of the affiliation agreements typically range from two to five years. During the fiscal year, certain agreements with cable, satellite or other distributors may expire. Under certain circumstances, the cable operators or we may cancel the agreements prior to their expiration. Additionally, we may elect not to renew distribution agreements whose terms result in sub-standard or negative contribution margins. If the operator drops our service or if either we or the operator fail to reach mutually agreeable business terms concerning the distribution of our service so that the agreements are terminated, our business may be materially adversely affected. Failure to maintain our distribution agreements covering a material portion of our existing households on acceptable financial and other terms could materially and adversely affect our future growth, sales revenues and earnings unless we are able to arrange for alternative means of broadly distributing our television programming. Net Shipped Units The number of net shipped units during the fiscal 2014 second quarter increased 30% from the prior year comparable quarter to 2,110,000 from 1,627,000. For the six months ended August 2, 2014, net shipped units increased 29% from the prior year's comparable period to 4,023,000 from 3,124,000. We believe the increase in net shipped units during the first six months of fiscal 2014 reflects the continued broadening of our merchandising assortment, particularly by the strong performances of our fashion and health & beauty product categories, the decline in our average selling price and the overall growth in net sales as discussed below. Average Selling Price The average selling price, or ASP, per net unit was $67 in the fiscal 2014 second quarter, a 19% decrease from the prior year quarter. For the six months ended August 2, 2014, the ASP was $71, an 18% decrease from the prior year's comparable period. The decreases in the ASP, which is a key component in our customer acquisition efforts by driving impulse shopping and increasing repeat customers, continues to reflect strong growth within our fashion & accessories and beauty, health & fitness categories, which typically have lower average selling prices, as well as a general shift to lower price points in our other merchandise categories. The decreases in our ASP are consistent with our long-term strategy to further broaden and expand our product assortment of lower priced items to reach a broader audience. Return Rates For the three months ended August 2, 2014, our return rate was 22.9% compared to 22.5% for the comparable prior year quarter, a 40 basis point increase. For the six months ended August 2, 2014, our return rate was 22.6% compared to 22.5% for the prior year comparable period, a 10 basis point increase. The increases in the return rates were driven by increases in our return rates within our fashion & accessories category and our watch and consumer electronics merchandise categories. We continue to monitor our return rates in an effort to keep our overall return rates commensurate with our current product mix and our average selling price levels. Total Customers Total customers purchasing over the last twelve months increased 18% to 1,421,000. We believe the increase in total customers is primarily due to continued broadening of our product assortment at lower price points as well as a product mix shift from the jewelry and watches category to the fashion and accessories and other product categories. We also believe that our improvements in customer satisfaction and channel positioning also contributed to overall customer growth. Net Sales Consolidated net sales for the fiscal 2014 second quarter were $156,587,000 as compared with $148,564,000 for the comparable prior year quarter, a 5% increase. Consolidated net sales for the six months ended August 2, 2014 were $316,288,000, 19-------------------------------------------------------------------------------- Table of Contents as compared to consolidated net sales of $299,918,000 for the comparable prior period, also an increase of 5%. The increase in quarterly and year-to-date consolidated net sales was driven primarily by sales growth in our fashion & accessories and beauty, health and fitness categories, offset by sales decreases in our consumer electronics product category. Our internet sales penetration, that is, the percentage of net sales that are generated from our ShopHQ.com website and mobile platforms, which are primarily ordered directly online, was 43.5% and 44.2% compared to 45.1% and 45.7%, respectively, for the second quarter and first six months of fiscal 2014 compared to fiscal 2013. Overall, we continue to deliver strong internet sales penetration. The decrease in penetration during the respective periods is primarily due to our mix shift away from watches and consumer electronics, which have a strong internet penetration. Our mobile penetration increased to 32.7% and 32.1% of total internet orders in the second quarter and first six months of 2014, respectively, versus 22.9% and 22.8% of total internet orders for the comparable prior year periods. Gross Profit Gross profit for the fiscal 2014 second quarter and fiscal 2013 second quarter was $60,435,000 and $55,657,000, respectively, an increase of $4,778,000, or 9%. Gross profit for the first six months of fiscal 2014 was $120,441,000, an increase of $7,751,000 or 7%, from $112,690,000 for the comparable prior year period. The increases in the gross profits experienced during the second quarter and first six-months of fiscal 2014 were primarily driven by the year-over-year sales increases discussed above and by higher gross margin percentages experienced. Gross margin percentages for the second quarters of fiscal 2014 and fiscal 2013 were 38.6% and 37.5%, respectively, a 110 basis point increase. On a year-to-date basis gross margin percentages were 38.1% and 37.6%, respectively, a 50 basis point increase. The increases in the second quarter and year-to-date gross margin percentages reflect the increased sales mix of fashion & accessories and beauty, health and fitness, which typically carry higher margin percentages, as well as margin rate improvements achieved across multiple merchandise categories. Operating Expenses Total operating expenses for the fiscal 2014 second quarter were $64,142,000 compared to $55,817,000 for the comparable prior year period, an increase of 15%. Total operating expenses for the six months ended August 2, 2014 were $123,096,000 compared to $111,166,000 for the comparable prior period, an increase of 11%. Total operating expenses for the second quarter and year-to-date fiscal 2014 includes activist shareholder response charges of approximately $2,473,000 and $3,518,000, respectively, and CEO transition costs of $2,620,000. Excluding shareholder activist response and CEO transition costs, total operating expenses as a percentage of net sales were 38% during the second quarters of both fiscal 2014 and fiscal 2013 and 37% for the first half of both fiscal years. Distribution and selling expense increased $3,568,000, or 8%, to $50,110,000, or 32.0% of net sales during the fiscal 2014 second quarter compared to $46,542,000, or 31.3% of net sales for the comparable prior year fiscal quarter. Distribution and selling expense increased during the quarter primarily due to increased program distribution expense of $1,974,000 relating to a 1% increase in average homes reached during the quarter as well as investments made associated with improved channel positions which began in the second half of fiscal 2013. The increase over the prior year quarter was also due to increases in variable salaries, wages and consulting costs of $874,000, customer service expenses of $516,000 and variable credit card processing fees and other credit expenses of $408,000, partially offset by decreased share-based compensation expenses of $120,000. Total variable expenses during the second quarter of fiscal 2014 were approximately 9.0% of total net sales versus 8.3% of total net sales for the prior year comparable period. Distribution and selling expense increased $7,045,000 or 8%, to $99,839,000, or 31.6% of net sales during the six months ended August 2, 2014 compared to $92,794,000 or 30.9% of net sales for the comparable prior year period. Distribution and selling expense increased primarily due to increased program distribution expense of $3,569,000, variable credit card processing fees and other credit expenses of $1,138,000, variable salaries, wages and consulting costs of $965,000, customer service and telecommunications expenses of $848,000 and advertising and promotion expense of $150,000, partially offset by lower share-based compensation expense of $151,000. Total variable expenses during the first six months of fiscal 2014 were approximately 8.7% of total net sales versus 7.9% of total net sales for the prior year comparable period. The increase in variable expense as a percentage of net sales for both the second quarter and first half of fiscal 2014 coincides with our reduction in average selling price and resulting 30% and 29% increase in net shipped units during the respective second quarter and first six-months of fiscal 2014. To the extent that our average selling price continues to decline, our variable expense as a percentage of net sales could increase as the number of our shipped units increase. Program distribution expense is primarily a fixed cost per household, however, this expense may be impacted by growth in the number of average homes reached or by rate changes associated with improvements in our channel position. General and administrative expense for the fiscal 2014 second quarter increased $599,000, or 10% to $6,776,000 or 4.3% of net sales, compared to $6,177,000 or 4.2% of net sales for the comparable prior year fiscal quarter. General and administrative 20-------------------------------------------------------------------------------- Table of Contents expense increased during the second quarter primarily as a result of increased share based compensation expense of $1,119,000 associated with our CEO transition and new board member grants, partially offset by lower salary and accrued incentive compensation expenses of $381,000. For the six months ended August 2, 2014, general and administrative expense increased $619,000, or 5%, to $12,688,000, or 4.0% of net sales, compared to $12,069,000, or 4.0% of net sales, for the prior year period. General and administrative expense increased primarily as a result of increased share-based compensation expense of $1,300,000 associated with our CEO transition and new board member grants, partially offset by lower salary and accrued incentive compensation expenses of $839,000. Depreciation and amortization expense for the fiscal 2014 second quarter was $2,163,000 compared to $3,098,000 for the comparable prior year quarter, representing a decrease of $935,000 or 30%. Depreciation and amortization expense as a percentage of net sales for the three-month periods ended August 2, 2014 and August 3, 2013 was 1.4% and 2.1%, respectively. Depreciation and amortization expense for the six months ended August 2, 2014 was $4,431,000 compared to $6,303,000 for the comparable prior year period, representing a decrease of $1,872,000, or 30%. Depreciation and amortization expense as a percentage of net sales for the six months ended August 2, 2014 and August 3, 2013 was 1.4% and 2.1%, respectively. The decrease in the quarterly and year-to-date depreciation and amortization expense was primarily due to decreased amortization expense associated with the expiration of our NBC trademark license of $999,000 and $1,999,000, respectively. Operating Income (Loss) For the fiscal 2014 second quarter, we reported an operating loss of $3,707,000 compared to an operating loss of $160,000 for the fiscal 2013 second quarter, representing a decrease of $3,547,000. For the six months ended August 2, 2014, we reported an operating loss of $2,655,000 compared to operating income of $1,524,000 for the comparable prior year period, representing a decrease of $4,179,000. Our operating results for the second quarter of fiscal 2014 decreased primarily as a result of activist shareholder costs, CEO transition costs, higher distribution and selling and general and administrative expense incurred during the quarter (as noted above), offset by increased gross profit and a decrease in depreciation and amortization expense. Our year-to-date operating results decreased during the first half of fiscal 2014 primarily as a result of activist shareholder costs, CEO transition costs, higher distribution and selling and general and administrative expense incurred during the first half of fiscal 2014, offset by increased gross profit and lower depreciation and amortization expense. Net Income (Loss) For the fiscal 2014 second quarter, we reported a net loss of $4,289,000 or $0.08 per share on 52,199,792 weighted average basic common shares outstanding compared with a net loss of $799,000 or $0.02 per share on 49,406,562 weighted average basic common shares outstanding in the fiscal 2013 second quarter. For the six months ended August 2, 2014, we reported a net loss of $3,829,000 or $0.08 per share on 51,022,023 weighted average basic common shares outstanding compared to net income of $224,000 or $0.00 per share on 49,316,539 weighted average basic common shares outstanding ($0.00 per share on 55,206,943 diluted shares) for the comparable prior year period. Net loss for the second quarter of fiscal 2014 includes costs related to an activist shareholder response of approximately $2,473,000, CEO transition costs of $2,620,000 and interest expense of $387,000, offset by interest income totaling $6,000 earned on our cash and investments. Net loss for the second quarter of fiscal 2013 includes interest expense of $348,000, offset by interest income totaling $3,000 earned on our cash and investments. Net loss for the six months ended August 2, 2014 includes costs related to an activist shareholder response of approximately $3,518,000, CEO transition costs of $2,620,000 and interest expense of $778,000, offset by interest income totaling $6,000 earned on our cash and investments. Net income for the six months ended August 3, 2013 includes interest expense of $726,000, offset by interest income totaling $14,000 earned on our cash and investments. For the second quarter and first six months of fiscal 2014, net loss reflects an income tax provision of $201,000 and $402,000. The fiscal 2014 second quarter and first half tax provision included a non-cash expense charge of approximately $196,000 and $393,000 relating to changes in our long-term deferred tax liability related to the tax amortization of our indefinite-lived intangible FCC license asset that is not available to offset existing deferred tax assets in determining changes to our income tax valuation allowance. As we continue to amortize the carrying value of our indefinite-lived intangible asset for tax purposes, we expect to record additional non-cash income tax expense of approximately $394,000 over the remainder of fiscal 2014. For the second quarter and first six months of fiscal 2013, net income (loss) reflects an income tax provision of $294,000 and $588,000, which included a non-cash tax expense charge of $290,000 and $580,000 related to changes in our long-term deferred tax liability related to the tax amortization of our indefinite-lived intangible FCC license asset discussed above. We have not recorded any income tax benefit on previously recorded net losses due to the uncertainty of realizing income tax benefits in the future as indicated by our recording of an income tax valuation allowance. Based on our recent history of losses, a full valuation allowance has been recorded and was calculated in accordance with GAAP, which places primary importance on our most recent operating results when assessing the need for a valuation allowance. We will continue to maintain a valuation 21-------------------------------------------------------------------------------- Table of Contents allowance against our net deferred tax assets, including those related to net operating loss carry-forwards, until we believe it is more likely than not that these assets will be realized in the future. Adjusted EBITDA Reconciliation Adjusted EBITDA (as defined below) for the fiscal 2014 second quarter was $5,528,000 compared with Adjusted EBITDA of $3,780,000 for the fiscal 2013 second quarter. For the six months ended August 2, 2014, Adjusted EBITDA was $11,042,000 compared with an Adjusted EBITDA of $9,576,000 for the comparable prior year period. A reconciliation of Adjusted EBITDA to its comparable GAAP measurement, net income (loss), follows, in thousands: For the Three-Month For the Six-Month Periods Ended Periods Ended August 2, August 3, August 2, August 3, 2014 2013 2014 2013 Adjusted EBITDA (a) $ 5,528 $ 3,780 $ 11,042 $ 9,576 Less: Activist shareholder response costs (2,473 ) - (3,518 ) - CEO transition costs (2,620 ) - (2,620 ) - Non-cash share-based compensation expense (1,874 ) (791 ) (2,918 ) (1,650 ) EBITDA (as defined) (1,439 ) 2,989 1,986 7,926 A reconciliation of EBITDA to net income (loss) is as follows: EBITDA (as defined) (1,439 ) 2,989 1,986 7,926 Adjustments: Depreciation and amortization (2,268 ) (3,149 ) (4,641 ) (6,402 ) Interest income 6 3 6 14 Interest expense (387 ) (348 ) (778 ) (726 ) Income taxes (201 ) (294 ) (402 ) (588 ) Net income (loss) $ (4,289 ) $ (799 ) $ (3,829 ) $ 224 (a) EBITDA as defined for this statistical presentation represents net income (loss) for the respective periods excluding depreciation and amortization expense, interest income (expense) and income taxes. We define Adjusted EBITDA as EBITDA excluding debt extinguishment; non-operating gains (losses), non-cash impairment charges and writedowns; activist shareholder response costs, CEO transition costs and non-cash share-based compensation expense. We have included the term "Adjusted EBITDA" in our EBITDA reconciliation in order to adequately assess the operating performance of our television and internet businesses and in order to maintain comparability to our analyst's coverage and financial guidance, when given. Management believes that Adjusted EBITDA allows investors to make a more meaningful comparison between our core business operating results over different periods of time with those of other similar companies. In addition, management uses Adjusted EBITDA as a metric measure to evaluate operating performance under our management and executive incentive compensation programs. Adjusted EBITDA should not be construed as an alternative to operating income, net income or to cash flows from operating activities as determined in accordance with GAAP and should not be construed as a measure of liquidity. Adjusted EBITDA may not be comparable to similarly entitled measures reported by other companies. Critical Accounting Policies and Estimates A discussion of the critical accounting policies related to accounting estimates and assumptions are discussed in detail in our fiscal 2013 annual report on Form 10-K under the caption entitled "Critical Accounting Policies and Estimates." Recently Issued Accounting Pronouncements In May 2014, the Financial Accounting Standards Board issued Revenue from Contracts with Customers, Topic 606 (Accounting Standards Update (ASU) No. 2014-09), which provides a framework for the recognition of revenue, with the objective that recognized revenues properly reflect amounts an entity is entitled to receive in exchange for goods and services. This guidance, which includes additional disclosure requirements regarding revenue, cash flows and obligations related to contracts with customers, will be effective for interim and annual reporting periods beginning after December 15, 2016. We are currently evaluating the impact of adopting ASU 2014-09 on our consolidated financial statements. 22-------------------------------------------------------------------------------- Table of Contents Financial Condition, Liquidity and Capital Resources As of August 2, 2014, we had cash and cash equivalents of $20,790,000 and had restricted cash and investments of $2,100,000 pledged as collateral for our issuances of commercial letters of credit. Our restricted cash and investments are generally restricted for a period ranging from 30-60 days and to the extent that commercial letters of credit remain outstanding. In addition, under our Credit Facility, we are required to maintain a minimum of $10 million of unrestricted cash and unused line availability at all times. As of February 1, 2014, we had cash and cash equivalents of $29,177,000 and had restricted cash and investments of $2,100,000 pledged as collateral for our issuances of standby letters of credit, which can fluctuate in relation to the level and nature of our overseas purchases. For the first six months of fiscal 2014, working capital decreased $2,188,000 to $77,753,000. Our current ratio (our total current assets over total current liabilities) was 1.8 at August 2, 2014 and 1.7 at February 1, 2014. Sources of Liquidity Our principal source of liquidity is our available cash and cash equivalents of $20,790,000 as of August 2, 2014. At August 2, 2014, our cash and cash equivalents were held in bank depository accounts primarily for the preservation of cash liquidity. On February 9, 2012, we entered into a Credit Facility with PNC and on May 1, 2013 and then again on January 31, 2014, we amended our credit facility, most recently, increasing the size of the revolving line of credit from $50 million to $60 million. The revolving line of credit under the Credit Facility, as amended, bears interest at LIBOR plus 3% per annum. All borrowings under the amended Credit Facility mature and are payable on May 1, 2018. Subject to certain conditions, the Credit Facility also provides for the issuance of letters of credit in an aggregate amount up to $6 million which, upon issuance, would be deemed advances under the Credit Facility. Maximum borrowings under the Credit Facility are equal to the lesser of $60 million or a calculated borrowing base comprised of eligible accounts receivable and eligible inventory. Remaining capacity under the amended Credit Facility, currently $21.3 million, provides liquidity for working capital and general corporate purposes. The amended PNC Credit Facility also provides for a $15 million term loan on which the Company will draw to fund an expansion at the Company's distribution facility in Bowling Green, Kentucky. The amended Credit Facility contains customary covenants and conditions, including, among other things, maintaining a minimum of unrestricted cash plus facility availability of $10 million at all times and limiting annual capital expenditures. Certain financial covenants, including minimum EBITDA levels (as defined in the Credit Facility) and a minimum fixed charge coverage ratio, become applicable only if unrestricted cash plus facility availability falls below $16 million or upon an event of default. In addition, the Credit Facility places restrictions on the Company's ability to incur additional indebtedness or prepay existing indebtedness, to create liens or other encumbrances, to sell or otherwise dispose of assets, to merge or consolidate with other entities, and to make certain restricted payments, including payments of dividends to common shareholders. As of August 2, 2014, the Company was in compliance with the applicable financial covenants of the amended Credit Facility. Another potential source of near-term liquidity is our ability to increase our cash flow resources by reducing the percentage of our sales offered under our ValuePay installment program or by decreasing the length of time we extend credit to our customers under this installment program. However, any such change to the terms of our ValuePay installment program could impact future sales, particularly for products sold with higher price points. Cash Requirements Currently, our principal cash requirements are to fund our business operations, which consist primarily of purchasing inventory for resale, funding accounts receivable growth through the use of our ValuePay installment program in support of sales growth, funding our basic operating expenses, particularly our contractual commitments for cable and satellite programming, and the funding of necessary capital expenditures. We closely manage our cash resources and our working capital. We attempt to manage our inventory receipts and reorders in order to ensure our inventory investment levels remain commensurate with our current sales trends. We also monitor the collection of our credit card and ValuePay installment receivables and manage our vendor payment terms in order to more effectively manage our working capital which includes matching cash receipts from our customers, to the extent possible, with related cash payments to our vendors. Our ValuePay installment program entitles customers to purchase merchandise and generally make payments in two or more equal monthly credit card installments. ValuePay remains a cost effective promotional tool for us. We continue to make strategic use of our ValuePay program in an effort to increase sales and to respond to similar competitive programs. During fiscal 2014, we began a significant operational expansion initiative with respect to overall warehousing capacity and new equipment and system upgrades at our Bowling Green, Kentucky distribution facility. The expansion project will include the construction of a new building which, when completed, will expand our current 260,000 square foot facility to an approximately 600,000 square foot facility. The expansion project is expected to be completed in the first half of fiscal 2015. The updated facilities will also include new high-speed parcel shipping, handling and item sortation equipment to support our increased level of shipments and units and a new call center facility to better serve our customers. Total cost of the expansion will be approximately $25 million and will be financed with our expanded PNC revolving line of credit and a $15 million PNC term loan. Construction 23-------------------------------------------------------------------------------- Table of Contents started in the second quarter of fiscal 2014 with expected cash commitments of approximately $18 million during fiscal 2014 and cash commitments of approximately $7 million during the first and second quarters of fiscal 2015. As of August 2, 2014, we have expended approximately $400,000 relating to the Bowling Green expansion initiative. We also have significant future commitments for our cash, primarily payments for cable and satellite program distribution obligations and the eventual repayment of our Credit Facility. We believe that our existing cash balances will be sufficient to maintain liquidity to fund our normal business operations over the next twelve months. We currently have total contractual cash obligations and commitments primarily with respect to our cable and satellite agreements and payments required under our Credit Facility and operating leases totaling approximately $322 million over the next five fiscal years. For the six months ended August 2, 2014, net cash used for operating activities totaled $2,155,000 compared to net cash provided by operating activities of $12,724,000 for the comparable fiscal 2013 period. Net cash provided by (used for) operating activities for the fiscal 2014 and 2013 periods reflects net income (loss), as adjusted for depreciation and amortization, share-based payment compensation, deferred taxes and the amortization of deferred revenue and deferred financing costs. In addition, net cash used for operating activities for the six months ended August 2, 2014 reflects decreases in accounts receivable, accounts payable and accrued liabilities as well as an increase in inventories and prepaid expenses. Accounts receivable decreased as a result of collections made on outstanding receivables balances resulting from our seasonal high fourth quarter. Inventories increased slightly as a result of planned purchases in support of higher sales levels during the third quarter. Accounts payable and accrued liabilities decreased during the first six months of fiscal 2014 primarily due to decreased inventory receipts compared to our seasonal high fourth quarter, the timing of payments made to vendors and a decrease in accrued incentive compensation and employee benefit contributions following payments made during the first quarter of fiscal 2014. Net cash used for investing activities totaled $6,138,000 for the first six months of fiscal 2014 compared to net cash used for investing activities of $6,655,000 for the comparable fiscal 2013 period. For the six months ended August 2, 2014 and August 3, 2013, expenditures for property and equipment were $6,138,000 and $3,825,000, respectively, and primarily relate to capital expenditures made for the development, upgrade and replacement of computer software, order management and merchandising systems, related computer equipment, digital broadcasting equipment and other office equipment, warehouse equipment and production equipment. During the six-month period ending August 3, 2013, we also made a cash payment of $2,830,000 in connection with our NBC trademark license. Principal future capital expenditures are expected to include the development, upgrade and replacement of various enterprise software systems, a significant expansion of warehousing capacity and related equipment improvements at our distribution facility in Bowling Green, Kentucky, security in our information technology, the upgrade and digitalization of television production and transmission equipment and related computer equipment associated with the expansion of our television shopping business and digital commerce initiatives. Net cash used for financing activities totaled $94,000 for the six months ended August 2, 2014 and related primarily to payments totaling $300,000 for deferred issuance costs incurred in connection with increasing our Credit Facility and capital lease payments totaling $26,000, offset by cash proceeds of $232,000 from the exercise of stock options. Net cash used for financing activities totaled $186,000 for the six months ended August 3, 2013 and related to payments totaling $264,000 for deferred issuance costs incurred in connection with increasing our Credit Facility, offset by cash proceeds of $78,000 from the exercise of stock options. |