BIG 5 SPORTING GOODS CORP MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-K)
Throughout this section, the Big 5 Sporting Goods Corporation (“we,” “our,”
“us”) fiscal years ended January 1, 2023, January 2, 2022 and January 3, 2021
are referred to as fiscal 2022, 2021 and 2020, respectively. The following
discussion and analysis of our financial condition and results of operations for
the years presented includes information with respect to our plans and
strategies for our business and should be read in conjunction with the
consolidated financial statements and related notes, the risk factors and the
cautionary statement regarding forward-looking information included elsewhere in
this Annual Report on Form 10-K.
Our fiscal year ends on the Sunday nearest December 31. Fiscal 2022 and fiscal
2021 each included 52 weeks, and fiscal 2020 included 53 weeks.
Impact of Global Events
Recent global events, including the novel coronavirus (“COVID-19”) and the
ongoing conflict in Ukraine, have adversely affected global economies, disrupted
global supply chains and contributed to increased inflation, impacting the cost
of products and services.
Disruptions related to COVID-19 negatively impacted our financial results in the
first half of fiscal 2020 when we temporarily closed more than one-half of our
retail store locations in response to state and local shelter orders related to
the COVID-19 outbreak. As our stores reopened and COVID-19 restrictions began
easing, we experienced unprecedented consumer demand for our products and our
financial results improved during the second half of fiscal 2020 and throughout
fiscal 2021. In response to COVID-19 during fiscal 2020, measures we took to
reduce expense, preserve capital and enhance our liquidity benefited our
financial performance in the second half of fiscal 2020 and throughout fiscal
2021. Certain of those measures, such as reductions to advertising expense in
comparison with historical levels, continued to benefit fiscal 2022 and we
expect to maintain our advertising expense below pre-pandemic levels in the
foreseeable future.
Disruptions related to the ongoing conflict in Ukraine contributed to higher
fuel prices and, consequently, higher product costs. The ongoing conflict in
Ukraine may continue to lead to disruptions in the global supply chain, rising
fuel costs, or cybersecurity risks, and economic instability generally, any of
which could materially and adversely affect our business and results of
operations. As long as this conflict continues, we expect these challenges to
remain into fiscal 2023.
We will continue to monitor these events and take appropriate actions intended
to mitigate the risk of these global events, or any other global events that
arise, as necessary.
Overview
We are a leading sporting goods retailer in the western United States, operating
432 stores and an e-commerce platform under the name “Big 5 Sporting Goods” as
of January 1, 2023. We provide a full-line product offering in a traditional
sporting goods store format that averages approximately 12,000 square feet.
Through our e-commerce platform, we also offer selected products online.
E-commerce sales for fiscal 2022, 2021 and 2020 were not material. Our product
mix includes athletic shoes, apparel and accessories, as well as a broad
selection of outdoor and athletic equipment for team sports, fitness, camping,
hunting, fishing, home recreation, tennis, golf, and winter and summer
recreation.
We believe that over our 68-year history we have developed a reputation with the
competitive and recreational sporting goods customer as a convenient
neighborhood sporting goods retailer that consistently delivers value on quality
merchandise. Our stores carry a wide range of products at competitive prices
from well-known brand name manufacturers, including adidas, Coleman, Columbia,
Everlast, New Balance, Nike, Rawlings, Skechers, Spalding, Under Armour and
Wilson. We also offer brand name merchandise produced exclusively for us,
private label merchandise and specials on quality items we purchase through
opportunistic buys of vendor over-stock and close-out merchandise. We reinforce
our value reputation through digital marketing and print advertising in major
and local newspapers and direct mailers, in an effort to generate customer
traffic, drive sales and build brand awareness. Over the last several years we
have been reducing our overall advertising spend and also shifting our
advertising spend away from print media towards digital advertising, which we
believe allows us to more effectively manage our advertising expense. We also
maintain social media sites to enhance distribution capabilities for our
promotional offers and to enable communication with our customers.
26
——————————————————————————–
Throughout our history, we have emphasized controlled growth. Our store openings
during recent years reflect our cautious approach toward store expansion in the
current retail environment, which includes increasing e-commerce competition,
especially in response to changing consumer buying habits resulting from
concerns surrounding the COVID-19 pandemic. The following table summarizes our
store count for the periods presented:
Fiscal Year
2022 2021 2020
Beginning of period 431 430 434
New stores 3 5 -
Stores relocated (1 ) (2 ) -
Stores closed (1 ) (2 ) (4 )
End of period 432 431 430
Stores opened (closed) per year, net 1 1 (4 )
(1)
Stores that are relocated are classified as new stores. Sales from the prior
location are treated as sales from a closed store and thus are excluded from
same store sales calculations.
For fiscal 2023, we anticipate opening approximately six new stores and closing
approximately five stores.
Executive Summary
Our decreased net income for fiscal 2022 compared to fiscal 2021 was mainly
attributable to reduced net sales, lower merchandise margins and higher selling
and administrative expense year over year. Reduced net sales in fiscal 2022
primarily reflected comparisons to fiscal 2021 in which strong consumer demand
for various sporting goods products resulted from the easing of COVID-19
pandemic restrictions and consumers’ desire to recreate and stay active.
Decreases in net sales in fiscal 2022 in part reflected increased inflationary
pressures which dampened consumer sentiment and impacted discretionary spending.
Worsening inflation and higher labor costs also resulted in higher operational
expense which had an unfavorable impact on our earnings.
•
Net sales for fiscal 2022 decreased 14.3% to $995.5 million compared to $1,161.8
million for fiscal 2021. The decrease in net sales reflects a decline of 14.5%
in same store sales when compared with fiscal 2021. After experiencing strong
same store sales associated with the COVID-19 pandemic in fiscal 2021, our lower
same store sales in fiscal 2022 in part reflected significant inflationary
pressures and heightened recessionary concerns that negatively impacted consumer
sentiment, which contributed to reduced net sales across each of our major
merchandise categories of hardgoods, apparel and footwear.
•
Gross profit for fiscal 2022 represented 34.3% of net sales, compared with 37.5%
in the prior year. Merchandise margins were an unfavorable 63 basis points lower
than the prior year, while store occupancy expense and distribution expense,
including costs capitalized into inventory, as a percentage of net sales were
higher compared with fiscal 2021. While merchandise margins were down year over
year they remained healthy and continued to compare favorably to pre-pandemic
levels.
•
Selling and administrative expense for fiscal 2022 increased 2.6% to $307.7
million, or 30.9% of net sales, compared to $299.8 million, or 25.8% of net
sales, for fiscal 2021. The increase in selling and administrative expense
primarily reflects an increase in employee labor and benefit-related expense as
well as higher operational expense impacted by inflation, partially offset by a
decrease in company performance-based incentive accruals year over year.
•
Net income for fiscal 2022 was $26.1 million, or $1.18 per diluted share,
compared to net income of $102.4 million, or $4.55 per diluted share, for fiscal
2021. The decreased earnings reflect lower net sales, the unfavorable impact of
lower merchandise margins and higher selling and administrative expense year
over year.
Our principal liquidity requirements are for working capital, capital
expenditures and cash dividends. We fund our liquidity requirements primarily
through cash and cash equivalents, cash flows from operations and borrowings
from our revolving credit facility.
•
Operating cash flow for fiscal 2022 was a negative $28.4 million compared to a
positive $115.5 million in the prior year. The decreased operating cash flow was
due primarily to decreased net income, increased funding of merchandise
inventory and decreased accrued expenses primarily related to performance-based
incentive accruals.
•
Capital expenditures for fiscal 2022 increased to $13.2 million from $10.9
million in fiscal 2021, primarily reflecting store-related remodeling and the
opening of new stores in fiscal 2022 compared with fiscal 2021.
27
——————————————————————————–
•
We had cash of $25.6 million and cash and cash equivalents of $97.4 million as
of January 1, 2023 and January 2, 2022, respectively. The balance as of the end
of fiscal 2022 did not include cash equivalents, and the balance as of the end
of fiscal 2021 included cash equivalents of $75.0 million related to investments
in highly-liquid U.S. Treasury bills. We have had no borrowings under our credit
facility since the full pay-down of outstanding balances under the credit
facility in the third quarter of fiscal 2020.
•
We paid cash dividends in fiscal 2022 of $22.3 million, or $1.00 per share,
compared with $61.8 million, or $2.83 per share, in fiscal 2021. The decrease in
year-over-year dividends paid reflected special dividends of $2.00 per share
that were declared in the second quarter and fourth quarter of fiscal 2021.
•
We repurchased 295,719 shares of common stock for $4.1 million in fiscal 2022,
and we repurchased 361,323 shares of common stock for $7.6 million in fiscal
2021.
Results of Operations
The following table sets forth selected items from our consolidated statements
of operations by dollar and as a percentage of our net sales, and other
financial data, for the periods indicated:
Fiscal Year (1)
2022 2021 2020
(Dollars in thousands)
Statement of Operations
Data:
Net sales $995,538 100.0% $1,161,820 100.0% $1,041,212 100.0%
Cost of sales (2) 654,323 65.7 725,991 62.5 692,041 66.5
Gross profit 341,215 34.3 435,829 37.5 349,171 33.5
Selling and administrative
expense (3) 307,700 30.9 299,812 25.8 275,406 26.5
Other income - - - - (2,500) (0.2)
Operating income 33,515 3.4 136,017 11.7 76,265 7.2
Interest expense 572 0.1 893 0.1 1,880 0.2
Income before income taxes 32,943 3.3 135,124 11.6 74,385 7.0
Income tax expense 6,809 0.7 32,738 2.8 18,445 1.8
Net income $26,134 2.6% $102,386 8.8% $55,940 5.2%
Other Financial Data:
Net sales change (14.3)% 11.6% 4.5%
Same store sales change
(4) (14.5)% 13.9% 3.0%(1)
Fiscal 2022 and 2021 each included 52 weeks, and fiscal 2020 included 53 weeks.
(2)
Cost of sales includes the cost of merchandise, net of discounts or allowances
earned, freight, inventory reserves, buying, distribution center expense,
including depreciation, and store occupancy expense. Store occupancy expense
includes rent, amortization of leasehold improvements, common area maintenance,
property taxes and insurance.
(3)
Selling and administrative expense includes store-related expense, other than
store occupancy expense, as well as advertising, depreciation and amortization,
expense associated with operating our corporate headquarters and impairment
charges, if any.
(4)
Same store sales for a period reflect net sales from stores that operated
throughout the period as well as the full corresponding prior-year period and
sales from e-commerce. For purposes of reporting same store sales comparisons to
the prior year for fiscal 2022 and 2021, we used comparable 52-week periods. For
purposes of reporting same store sales comparisons to the prior year for fiscal
2020, we used comparable 53-week periods.28
——————————————————————————–
A discussion regarding our financial condition and results of operations for
fiscal 2022 compared to fiscal 2021 is presented below. A discussion regarding
our financial condition and results of operations for fiscal 2021 compared to
fiscal 2020 is incorporated herein by reference and can be found under Item 7 of
Part II of our Annual Report on Form 10-K for fiscal 2021, filed with the SEC on
March 2, 2022.
Fiscal 2022 Compared to Fiscal 2021
Net Sales. Net sales decreased by $166.3 million, or 14.3%, to $995.5 million
for fiscal 2022 from $1,161.8 million for fiscal 2021. The change in net sales
was primarily attributable to the following:
•
Same store sales decreased by $165.9 million, or 14.5%, for fiscal 2022 versus
the comparable prior-year period. The decrease in same store sales reflected the
following:
o
The decrease in same store sales in fiscal 2022 followed a 13.9% increase in
same store sales for fiscal 2021 that reflected strong consumer demand as
COVID-19 restrictions eased. Sales in fiscal 2022 were impacted in part by
significant inflationary pressures and heightened recessionary concerns that
negatively impacted consumer sentiment and discretionary spending, as well as
unfavorable warm and dry winter weather conditions in our markets in the first
quarter of fiscal 2022 that resulted in lower sales of winter-related products.
o
The increase in our same store sales achieved in fiscal 2021 resulted from
strong demand for many categories of sporting goods products as certain COVID-19
pandemic restrictions were lifted, and also reflected favorable comparisons
against temporary store closures related to COVID-19 during fiscal 2020.
o
Our lower same store sales in fiscal 2022 reflected a decrease in each of our
major merchandise categories of hardgoods, apparel and footwear.
o
Same store sales are made on a comparable-week basis. Same store sales for a
period normally consist of sales for stores that operated throughout the period
and the full corresponding prior-year period, along with sales from e-commerce.
Same store sales comparisons exclude sales from stores permanently closed, or
stores in the process of permanently closing, during the comparable periods.
Sales from e-commerce in fiscal 2022 and 2021 were not material.
•
We experienced decreased customer transactions of 11.2% and a lower average sale
per transaction of 3.3% in fiscal 2022 compared to the prior year.
Gross Profit. Gross profit decreased by $94.6 million to $341.2 million, or
34.3% of net sales, in fiscal 2022 from $435.8 million, or 37.5% of net sales,
in fiscal 2021. The change in gross profit was primarily attributable to the
following:
•
Net sales decreased by $166.3 million, or 14.3%, in fiscal 2022 compared to the
prior year.
•
Merchandise margins, which exclude buying, occupancy and distribution expense,
decreased by an unfavorable 63 basis points compared with fiscal 2021, when
merchandise margins increased by a favorable 250 basis points over the prior
year. Our lower merchandise margins primarily reflect an unfavorable shift in
our product sales mix, increased promotional pricing and increases in product
purchase costs. The higher product purchase costs we experienced reflected
increased raw material, labor, freight and fuel costs initially resulting from
shortages related to COVID-19, and were worsened by current inflationary
pressures. While merchandise margins were down year over year they remained
healthy and continued to compare favorably to pre-pandemic levels.
•
Store occupancy expense increased by $1.8 million, or an unfavorable 161 basis
points as a percentage of net sales, year over year in fiscal 2022.
•
Distribution expense, including costs capitalized into inventory, decreased by
$1.9 million compared to the prior year. However, reflecting lower sales in
fiscal 2022, distribution expense as a percentage of net sales increased by an
unfavorable 59 basis points year over year. The decrease in expense primarily
reflected increased costs capitalized into inventory, lower employee labor
expense and reduced trucking expense, partially offset by increased fuel expense
that resulted from gas price inflation.
29
——————————————————————————–
Selling and Administrative Expense. Selling and administrative expense increased
by $7.9 million, or 2.6%, to $307.7 million, or 30.9% of net sales, in fiscal
2022 from $299.8 million, or 25.8% of net sales, in fiscal 2021. The change in
selling and administrative expense was primarily attributable to the following:
•
Store-related expense, excluding occupancy, increased by $10.8 million, due
largely to increased employee labor and benefit-related expense and other
operating expenses driven by inflation and to support our increased store
operating hours compared with the reduced store operating hours that we
maintained in the prior year in response to the pandemic. While store operating
hours were higher in fiscal 2022 compared with last year, store operating hours
remain below pre-pandemic levels. Wages continue to reflect the incremental
impact of legislated minimum wage rate increases primarily in California, where
over half of our stores are located. In California, state-wide minimum wage
rates have risen from $10.00 per hour in 2017 to $15.00 per hour in 2022, and
again to $15.50 beginning on January 1, 2023. Additionally, certain other
jurisdictions within California, including Los Angeles and San Francisco, as
well as various other states in which we do business, are and have been
implementing their own scheduled increases, which may also include interim
impacts effective at various points throughout the year. Labor expense in fiscal
2022 also reflected higher demand for labor in many of our markets resulting in
higher wages. We estimate that the combined impact of these wage pressures
caused our labor expense to increase by approximately $3.1 million for fiscal
2022 compared with fiscal 2021.
•
Advertising expense increased by $1.2 million primarily reflecting increases in
digital advertising as well as newspaper advertising, combined with higher
advertising labor expense. Despite this year-over-year increase, our expense
remains less than half of pre-pandemic expense as a result of initial measures
we took in response to COVID-19 in fiscal 2020. We expect our expense to
continue to benefit from reduced advertising activity in the foreseeable future
as we continue to evaluate the impact on our sales.
•
Administrative expense decreased by $4.1 million, primarily attributable to a
decrease in company performance-based incentive accruals, partially offset by an
increase in employee labor and benefit-related expense in the current fiscal
year combined with the elimination of an employment agreement-related liability
in fiscal 2021.
Interest Expense. Interest expense decreased to $0.6 million in fiscal 2022
compared with $0.9 million in fiscal 2021.
Income Taxes. The provision for income taxes decreased to $6.8 million for
fiscal 2022 compared to $32.7 million for fiscal 2021, primarily reflecting
lower pre-tax income in fiscal 2022 compared to fiscal 2021. Our effective tax
rate of 20.7% for fiscal 2022 compared with 24.2% for fiscal 2021. Our lower
effective tax rate for fiscal 2022 reflected a higher tax deduction related to
share-based compensation combined with lower pre-tax income.
Liquidity and Capital Resources
Our principal liquidity requirements are for working capital, capital
expenditures and cash dividends. We fund our liquidity requirements primarily
through cash and cash equivalents, cash flows from operations and borrowings
from our revolving credit facility. We believe our cash and cash equivalents,
future cash flows from operations and borrowings from our revolving credit
facility will be sufficient to fund our cash requirements for at least the next
12 months.
We ended fiscal 2022 and 2021 with $25.6 million of cash and $97.4 million of
cash and cash equivalents, respectively, and no revolving credit borrowings. The
following table summarizes our cash flows from operating, investing and
financing activities:Fiscal Year
2022 2021 2020
(In thousands)
Total cash (used in) provided by:
Operating activities $ (28,440 ) $ 115,528 $ 148,743
Investing activities (13,180 ) (10,615 ) (5,360 )
Financing activities (30,235 ) (72,147 ) (86,952 )
Net (decrease) increase in cash and cash
equivalents $ (71,855 ) $ 32,766 $ 56,431
The seasonality of our business generally provides greater cash flows from
operations during the holiday and winter selling season. We use operating cash
flows and borrowings under our revolving credit facility, if necessary, to fund
inventory increases in anticipation of the holidays and our inventory levels are
normally at their highest in the months leading up to Christmas. As holiday
sales typically reduce inventory levels, this reduction, combined with net
income, historically provides us with strong cash flows from operations at the
end of our fiscal year.
30
——————————————————————————–
For fiscal 2022, we experienced weaker consumer demand that reflected in part
significant inflationary pressures and heightened recessionary concerns that
negatively impacted consumer sentiment. The higher inflation and softening
consumer demand led to lower sales and higher expenses which contributed to
decreased net income year over year. Funding for merchandise inventory increased
in fiscal 2022 as we continued to replenish depleted inventory levels resulting
from strong consumer demand and supply chain challenges in fiscal 2021. The
decrease in our operating cash flow for fiscal 2022 compared to the prior year
primarily reflects our lower earnings and increased funding of merchandise
inventory.
For fiscal 2021, as COVID-19 restrictions continued easing in many of our
markets, we experienced strong consumer demand across a broad assortment of
product categories, including increased consumer demand for team sports
products, which was weak in fiscal 2020 due to the COVID-19 pandemic. This
strong consumer demand for fiscal 2021 contributed to higher sales and margins
and increased net income year-over-year. After reducing merchandise inventory in
fiscal 2020 in response to COVID-19, we increased purchases of merchandise
inventory in fiscal 2021 to support the strong consumer demand. Although our
operating cash flow for fiscal 2021 was healthy, reflecting our higher earnings,
the increased funding of merchandise inventory for the year contributed to
reduced operating cash flow compared to fiscal 2020.
Operating Activities. Operating cash flows for fiscal 2022 and 2021 were a
negative $28.4 million and a positive $115.5 million, respectively. The
decreased cash flow from operating activities in fiscal 2022 compared to fiscal
2021 primarily reflects decreased net income, increased funding of merchandise
inventory and decreased accrued expenses primarily related to performance-based
incentive accruals.
Investing Activities. Net cash used in investing activities for fiscal 2022 and
2021 was $13.2 million and $10.6 million, respectively. Capital expenditures,
excluding non-cash acquisitions, represented substantially all of the cash used
in investing activities for each period. In fiscal 2021, capital expenditures of
$10.9 million were partially offset by a portion of settlement proceeds related
to a civil unrest insurance recovery of $0.2 million. Our capital expenditures
primarily reflect store-related remodeling, new store openings, distribution
center investments and computer hardware and software purchases. Capital
expenditures by category are as follows:
Fiscal Year
2022 2021 2020
(In thousands)
Store-related remodels $ 7,805 $ 5,381 $ 4,849
New stores 3,577 2,727 169
Distribution center 1,212 1,177 840
Computer hardware, software and other 599 1,579 1,489
Total
$ 13,193 $ 10,864 $ 7,347
Capital expenditures in the fiscal years presented included investment in
existing store remodeling to support our merchandising initiatives and
enhancement of information security measures to support our infrastructure. Our
capital expenditures included three new stores, including relocations, in fiscal
2022 and five new stores, including relocations, in fiscal 2021.
Financing Activities. Financing cash flows for fiscal 2022 and 2021 were a
negative $30.2 million and a negative $72.1 million, respectively. For fiscal
2022 and 2021, net cash was used primarily to fund dividend payments, purchase
treasury stock and make principal payments on finance lease liabilities,
partially offset by proceeds received from the exercise of employee share option
awards. The change in cash flow from financing activities for fiscal 2022
primarily reflects a decrease in dividends paid in fiscal 2022 compared to the
prior year, which included special dividends of $2.00 per share that were
declared in the second and fourth quarters of fiscal 2021.
As of January 1, 2023, we had no revolving credit borrowings and letter of
credit commitments of $1.4 million outstanding. These balances compare to no
revolving credit borrowings and letter of credit commitments of $1.1 million
outstanding as of January 2, 2022.
In fiscal 2022, 2021 and 2020 we paid cash dividends of $1.00, $2.83 and $0.25
per share of outstanding common stock. Dividends declared in fiscal 2021
included special dividends totaling $2.00 per share of outstanding common stock.
In the first quarter of fiscal 2023, our Board of Directors declared a quarterly
cash dividend of $0.25 per share of outstanding common stock, which will be paid
on March 24, 2023 to stockholders of record as of March 10, 2023.
31
——————————————————————————–
Periodically, we repurchase our common stock in the open market pursuant to
programs approved by our Board of Directors. We may repurchase our common stock
for a variety of reasons, including, among other things, our alternative cash
requirements, existing business conditions and the current market price of our
stock. In fiscal 2016, our Board of Directors authorized a share repurchase
program for the purchase of up to $25.0 million of our common stock, which was
in effect through the fourth quarter of fiscal 2021 and under which a total of
$7.7 million remained available for share repurchases as of January 2, 2022. In
the first quarter of fiscal 2022, our Board of Directors authorized a new share
repurchase program of up to $25.0 million of our common stock, which replaced
the previous share repurchase program. Under these programs, we may purchase
shares from time to time in the open market or in privately negotiated
transactions in compliance with the applicable rules and regulations of the
Securities and Exchange Commission. However, the timing and amount of such
purchases, if any, would be at the discretion of our management and Board of
Directors, and would depend on market conditions and other considerations. We
repurchased 295,719 shares of common stock in fiscal 2022, repurchased 361,323
shares of common stock in fiscal 2021 and repurchased no shares of common stock
in fiscal 2020. Since the inception of our initial share repurchase program in
May 2006 through January 1, 2023, we have repurchased a total of 4,186,014
shares for $53.6 million.
Loan Agreement. As of January 3, 2021, we had a credit agreement with Wells
Fargo Bank, National Association (“Wells Fargo”), as administrative agent, and a
syndicate of other lenders, as amended (the “Prior Credit Agreement”), which was
terminated and replaced on February 24, 2021 as discussed below.
On February 24, 2021, we terminated the Prior Credit Agreement and entered into
a Loan, Guaranty and Security agreement with Bank of America, N.A. (“BofA”), as
agent and lender, which was amended on November 22, 2021 and October 19, 2022
(as so amended, the “Loan Agreement”). The Loan Agreement has a maturity date of
February 24, 2026 and provides for a revolving credit facility with an aggregate
committed availability of up to $150.0 million. We may also request additional
increases in aggregate availability, up to a maximum of $200.0 million, in which
case the existing lender under the Loan Agreement will have the option to
increase their commitment to accommodate the requested increase. If the lender
does not exercise that option, we may (with the consent of BofA in its role as
the administrative agent, not to be unreasonably withheld) seek other lenders
willing to provide such commitments. The credit facility includes a $50.0
million sublimit for issuances of letters of credit.
Similar to the Prior Credit Agreement, we may borrow under the Loan Agreement
from time to time, provided the amounts outstanding will not exceed the lesser
of the then aggregate committed availability (as discussed above) and the
Borrowing Base (such lesser amount being referred to as the “Line Cap”). As
defined in the Loan Agreement, the “Borrowing Base” generally is comprised of
the sum, at the time of calculation, of (a) 90.00% of eligible credit card
receivables; plus (b) the cost of eligible inventory (other than eligible
in-transit inventory), net of inventory reserves, multiplied by 90.00% of the
appraised net orderly liquidation value of eligible inventory (expressed as a
percentage of the cost of eligible inventory); plus (c) the cost of eligible
in-transit inventory, net of inventory reserves, multiplied by 90.00% of the
appraised net orderly liquidation value of eligible in-transit inventory
(expressed as a percentage of the cost of eligible in-transit inventory), minus
(d) certain agreed-upon reserves as well as other reserves established by BofA
in its role as the administrative agent in its reasonable discretion.
Generally, we may designate specific borrowings under the Loan Agreement as
either base rate loans or Term SOFR rate loans. The applicable interest rate on
our borrowings is a function of the daily average, over the preceding fiscal
quarter, of the excess of the Line Cap over amounts borrowed (such amount being
referred to as the “Average Daily Availability”). Those loans designated as Term
SOFR rate loans bear interest at a rate equal to the then applicable secured
overnight financing rate as administered by the Federal Reserve Bank of New York
(“SOFR”) rate plus a 0.10% “SOFR adjustment” spread, plus an applicable margin
as shown in the table below. Those loans designated as base rate loans bear
interest at a rate equal to the applicable margin for base rate loans (as shown
below) plus the highest of (a) the Federal funds rate, as in effect from time to
time, plus one-half of one percent (0.50%), (b) the one-month SOFR rate, plus
one percentage point (1.00%), or (c) the rate of interest in effect for such day
as announced from time to time within BofA as its “prime rate.” The applicable
margin for all loans is a function of Average Daily Availability for the
preceding fiscal quarter as set forth below.
SOFR Rate Base Rate
Level Average Daily Availability Applicable Margin Applicable Margin
I Greater than or equal to $70,000,000 1.375% 0.375%
II Less than $70,000,000 1.500% 0.500%
The commitment fee assessed on the unused portion of the credit facility is
0.20% per annum.
32
——————————————————————————–
Obligations under the Loan Agreement are secured by a general lien on and
security interest in substantially all of our assets. The Loan Agreement
contains covenants that require us to maintain a fixed charge coverage ratio of
not less than 1.0:1.0 in certain circumstances, and limits our ability to, among
other things, incur liens, incur additional indebtedness, transfer or dispose of
assets, change the nature of the business, guarantee obligations, pay dividends
or make other distributions or repurchase stock, and make advances, loans or
investments. We may generally declare or pay cash dividends or repurchase stock
only if, among other things, no default or event of default then exists or would
arise from such dividend or repurchase of stock and, after giving effect to such
dividend or repurchase, certain availability and/or fixed charge coverage ratio
requirements are satisfied, although we are permitted to make up to $5.0 million
of dividend payments or stock repurchases per year without satisfaction of the
availability or fixed charge coverage ratio requirements, but dividends or stock
repurchases made without satisfying the availability and/or fixed charge
coverage ratio requirements will require the establishment of an additional
reserve that will reduce borrowing availability under the Loan Agreement for 75
days. The Loan Agreement contains customary events of default, including,
without limitation, failure to pay when due principal amounts with respect to
the credit facility, failure to pay any interest or other amounts under the
credit facility, failure to comply with certain agreements or covenants
contained in the Loan Agreement, failure to satisfy certain judgments against
us, failure to pay when due (or any other default which permits the acceleration
of) certain other material indebtedness in principal amount in excess of $5.0
million, and certain insolvency and bankruptcy events.
In the first quarter of fiscal 2021, we paid and capitalized $0.7 million in new
creditor and third-party fees associated with the Loan Agreement, which is
amortized over the term of the Loan Agreement, and extinguished $0.2 million of
deferred financing fees associated with the Prior Credit Agreement.
Future Capital Requirements. We had cash on hand of $25.6 million as of January
1, 2023. We expect capital expenditures for fiscal 2023, excluding non-cash
acquisitions, to range from approximately $15.0 million to $20.0 million,
primarily to fund the opening of new stores, store-related remodeling,
distribution center investments and computer hardware and software purchases.
For fiscal 2023, we anticipate opening approximately six new stores and closing
approximately five stores.
Dividends are paid at the discretion of the Board of Directors. In fiscal 2022,
2021 and 2020 we paid annual cash dividends of $1.00 per share, $2.83 per share
and $0.25 per share, respectively, of outstanding common stock. Dividends
declared in fiscal 2021 included special dividends in the amount of $2.00 per
share of outstanding common stock. In the first quarter of fiscal 2023, our
Board of Directors declared a quarterly cash dividend of $0.25 per share of
outstanding common stock, which will be paid on March 24, 2023 to stockholders
of record as of March 10, 2023.
As of January 1, 2023, a total of $20.9 million remained available for share
repurchases under our new share repurchase program. We repurchased 295,719
shares of our common stock in fiscal 2022, repurchased 361,323 shares of our
common stock in fiscal 2021 and repurchased no shares of our common stock in
fiscal 2020. We consider several factors in determining when and if we make
share repurchases including, among other things, our alternative cash
requirements, existing business conditions and the market price of our stock.
We believe we will be able to fund our cash requirements from cash on hand,
operating cash flows and borrowings from our credit facility, for at least the
next 12 months.
Contractual Obligations. Our material contractual obligations include operating
lease commitments associated with our leased properties and other occupancy
expense, finance lease obligations, borrowings under our credit facility, if
any, and other liabilities. Operating lease commitments consist principally of
leases for our retail store facilities, distribution center and corporate
offices. These leases frequently include options which permit us to extend the
terms beyond the initial fixed lease term, and we intend to renegotiate most of
these leases as they expire. Operating lease commitments also generally consist
of information technology (“IT”) systems hardware, distribution center delivery
tractors and vehicle leases. Additional information regarding our operating
leases is available in Item 2, Properties and Note 7, Lease Commitments, of the
Notes to Consolidated Financial Statements included in Item 8, Financial
Statements and Supplementary Data, of this Annual Report on Form 10-K.
As of the end of fiscal 2022 and 2021, we had no borrowings under our revolving
credit facility. Our zero borrowings reflect improved profitability and positive
operating cash flow from increased consumer demand related to the COVID-19
pandemic during fiscal 2020 and 2021.
In the ordinary course of business, we enter into arrangements with vendors to
purchase merchandise in advance of expected delivery. Because most of these
purchase orders do not contain any termination payments or other penalties if
cancelled, they are not considered as outstanding contractual obligations.
33
——————————————————————————–
Critical Accounting Estimates
Our critical accounting estimates detailed below are included in our significant
accounting policies as described in Note 2 of the Consolidated Financial
Statements included in Item 8, Financial Statements and Supplementary Data, of
this Annual Report on Form 10-K. Those consolidated financial statements were
prepared in accordance with GAAP. Critical accounting estimates are those that
we believe are most important to the portrayal of our financial condition and
results of operations. The preparation of our consolidated financial statements
requires us to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenue and expense. Our estimates are evaluated on an
ongoing basis and drawn from historical experience, current trends and other
factors that management believes to be relevant at the time our consolidated
financial statements are prepared. Actual results may differ from our estimates.
Management believes that the following accounting estimates are critical and
reflect the more significant judgments and estimates we use in preparing our
consolidated financial statements.
Valuation of Merchandise Inventories, Net
Our merchandise inventories are valued at the lower of cost or net realizable
value using the weighted-average cost method that approximates the first-in,
first-out (“FIFO”) method. Average cost consists of the direct purchase price of
merchandise inventory, net of vendor allowances and cash discounts, in-bound
freight-related costs and allocated overhead costs associated with our
distribution center.
We record valuation reserves on a quarterly basis for merchandise items with
slow-moving or obsolescence exposure and merchandise that has a carrying value
that exceeds net realizable value. These reserves are estimates of a reduction
in value to reflect inventory valuation at the lower of cost or net realizable
value. Factors included in determining slow-moving or obsolescence reserve
estimates include recent customer demand, merchandise aging, seasonal trends and
decisions to discontinue certain products. Because of our merchandise mix, we
have not historically experienced significant occurrences of obsolescence. Our
inventory valuation reserves for damaged and defective merchandise, slow-moving
or obsolete merchandise and for lower of cost or net realizable value provisions
totaled $2.7 million as of January 1, 2023 and January 2, 2022, representing
approximately 1% of our merchandise inventory for both periods.
A 10% change in our inventory valuation reserves estimate in total as of January
1, 2023, would result in a change in reserves of $0.3 million and a change in
pre-tax earnings by the same amount. Our reserves are estimates, which could
vary significantly, either favorably or unfavorably, from actual results if
future economic conditions, consumer demand and competitive environments differ
from our expectations. At this time, we do not believe that there is a
reasonable likelihood that there will be a material change in the future
estimates or assumptions that we use to calculate our inventory reserves.
Valuation of Long-Lived Assets
In accordance with ASC 360, Property, Plant and Equipment, we review our
long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Long-lived assets are reviewed for recoverability at the lowest level in which
there are identifiable cash flows (“asset group”), usually at the store level.
The carrying amount of a store asset group includes stores’ operating lease
right-of-use (“ROU”) assets and property and equipment, which consists primarily
of leasehold improvements. Factors that could trigger an impairment review
include a current-period operating or cash flow loss combined with a history of
operating or cash flow losses, and a projection that demonstrates continuing
losses or insufficient income over the remaining reasonably certain lease term
associated with the use of a store asset group. Other factors may include an
adverse change in the business climate or an adverse action or assessment by a
regulator in the market of a store asset group.
We evaluate the store asset groups with indicators of impairment by estimating
future undiscounted cash flows of a store asset group over its remaining
reasonably certain lease term to determine whether the long-lived assets are
recoverable. In situations where the carrying amount of the store asset group
exceeds the undiscounted cash flows, a fair value of the store asset group is
determined using discounted cash flow valuation techniques and impairment is
recognized when the carrying amount exceeds the fair value.
We determine the sum of the undiscounted cash flows expected to result from the
asset group by projecting future revenue, gross margin and operating expense for
each store under evaluation for impairment. The estimates of future cash flows
involve management judgment and are based upon assumptions about expected future
operating performance. Assumptions used in these forecasts are consistent with
internal planning, and include assumptions about sales growth rates, gross
margins, operating expense in relation to the current economic environment and
our future expectations, competitive factors in our various markets, inflation,
sales trends and other relevant environmental factors that may impact the store
under evaluation. The actual cash flows could differ from management’s estimates
due to changes in business conditions, operating performance and economic
conditions.
34
——————————————————————————–
The resulting impairment charge, if any, is allocated to the property and
equipment, primarily leasehold improvements, and operating lease ROU assets on a
pro rata basis using the relative carrying amounts of those assets. The
allocated impairment charge to a long-lived asset is limited to the extent that
the impairment charge does not reduce the carrying amount of the long-lived
asset below its individual fair value. The estimation of the fair value of an
ROU asset involves the evaluation of current market value rental amounts for
leases associated with ROU assets. The estimates of current market value rental
amounts are primarily based on recent observable market rental data of other
comparable retail store locations. The fair value of an ROU asset is measured
using a discounted cash flow valuation technique by discounting the estimated
current and future market rental values using a property-specific discount rate.
Our evaluation resulted in no impairment charges recognized in fiscal 2022, 2021
and 2020.
Seasonality and Impact of Inflation
We experience seasonal fluctuations in our net sales and operating results,
which can suffer when weather does not conform to seasonal norms, such as the
first quarter of fiscal 2022 when we experienced warm and dry winter-weather
conditions across our markets that resulted in significant carryover of winter
inventory. Seasonality in our net sales influences our buying patterns which
directly impacts our merchandise and accounts payable levels and cash flows. We
purchase merchandise for seasonal activities in advance of a season and
supplement our merchandise assortment as necessary and when possible during the
season. Our efforts to replenish products during a season are not always
successful. In the fourth fiscal quarter, which includes the holiday selling
season and the start of the winter selling season, we normally experience higher
inventory purchase volumes and increased expense for staffing and advertising.
If we miscalculate the consumer demand for our products generally or for our
product mix in advance of a season, particularly the fourth quarter, our net
sales can decline, which can harm our financial performance. A significant
shortfall from expected net sales, particularly during the fourth quarter, can
negatively impact our annual operating results.
In fiscal 2021 and 2022, we experienced greater inflation in the cost of
products that we purchase for resale as well as higher freight costs than in
previous years. While our merchandise inventory costs have been impacted by
these inflationary pressures, we have generally been able to adjust our selling
prices in response to these higher product purchase costs. However, if we are
unable to adjust our selling prices for product purchase cost increases that
might occur in the future, then our merchandise margins could decline, which
would adversely impact our operating results. In fiscal 2021 and 2022, we also
experienced increased wage expense as a result of higher demand and intensifying
competition for labor in many of our markets and we expect these dynamics to
continue into fiscal 2023. Broad-based inflationary pressures adversely impacted
many categories of costs and expenses during fiscal 2022 and this impact is
expected to continue into fiscal 2023.
Recently Issued Accounting Updates
See Note 2 to the Consolidated Financial Statements included in Item 8,
Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
© Edgar Online, source Glimpses