Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the quarterly period ended April 29, 2006 | ||
| OR | ||
o
|
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
| For the transition period from ___to ___ | ||
Commission file number 1-14987
(Exact name of registrant as specified in its charter)
| Delaware (State or other jurisdiction of incorporation or organization) |
31-1333930 (I.R.S. Employer Identification No.) |
|
| 8323 Walton Parkway, New Albany, OH (Address of principal executive offices) |
43054 (Zip Code) |
(614) 775-3500
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes þ No
o
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large
accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined n rule 12b-2 of
the Exchange Act).
Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as
of the latest practicable date.
| Common Stock | Outstanding at June 5, 2006 | |
| $.01 Par Value | 32,695,971 Shares |
Table of Contents
TOO, INC.
TABLE OF CONTENTS
| Page | ||||||||
| PART I. FINANCIAL INFORMATION | ||||||||
| Item 1. | Financial Statements | 3 | ||||||
| Consolidated Statements of Operations | ||||||||
| 3 | ||||||||
| Consolidated Balance Sheets | ||||||||
| 4 | ||||||||
| Consolidated Statements of Cash Flows | ||||||||
| 5 | ||||||||
| 6 | ||||||||
| Item 2. | Management's Discussion and Analysis of Financial Condition and | |||||||
| Results of Operations | 12 | |||||||
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 19 | ||||||
| Item 4. | Controls and Procedures | 19 | ||||||
| PART II. OTHER INFORMATION | ||||||||
| Item 1. | Legal Proceedings | 20 | ||||||
| Item 1A. | Risk Factors | 20 | ||||||
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 20 | ||||||
| Item 6. | Exhibits | 21 | ||||||
| EX-31.1 | ||||||||
| EX-31.2 | ||||||||
| EX-32.1 | ||||||||
| EX-32.2 | ||||||||
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PART I — FINANCIAL INFORMATION
Item 1. Financial Statements.
TOO, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)
| Thirteen Weeks Ended | ||||||||
| April 29, | April 30, | |||||||
| 2006 | 2005 | |||||||
Net sales |
$ | 195,136 | $ | 164,410 | ||||
Cost of goods sold, including buying
and occupancy costs |
121,390 | 102,807 | ||||||
Gross income |
73,746 | 61,603 | ||||||
General, administrative and store
operating expenses |
56,299 | 50,386 | ||||||
Operating income |
17,447 | 11,217 | ||||||
Interest income, net |
1,354 | 459 | ||||||
Earnings before income taxes |
18,801 | 11,676 | ||||||
Provision for income taxes |
7,112 | 4,266 | ||||||
Net income |
$ | 11,689 | $ | 7,410 | ||||
Net income per share: |
||||||||
Basic |
$ | 0.35 | $ | 0.21 | ||||
Diluted |
$ | 0.35 | $ | 0.21 | ||||
Weighted average common shares: |
||||||||
Basic |
33,154 | 34,758 | ||||||
Diluted |
33,711 | 35,452 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
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TOO, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except share amounts)
CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except share amounts)
| April 29, | January 28, | |||||||
| 2006 | 2006 | |||||||
ASSETS |
||||||||
Current Assets: |
||||||||
Cash and equivalents |
$ | 22,770 | $ | 22,248 | ||||
Investments |
137,515 | 163,451 | ||||||
Restricted assets |
1,197 | 1,193 | ||||||
Accounts receivable |
8,376 | 8,040 | ||||||
Inventories |
69,389 | 66,033 | ||||||
Store supplies |
13,283 | 12,216 | ||||||
Prepaid expenses and other current assets |
12,763 | 11,932 | ||||||
Total current assets |
265,293 | 285,113 | ||||||
Property and equipment, net |
207,744 | 201,983 | ||||||
Long-term investments |
9,447 | 8,464 | ||||||
Deferred income taxes |
9,895 | 10,208 | ||||||
Assets held in trust and other |
22,172 | 17,962 | ||||||
Total assets |
$ | 514,551 | $ | 523,730 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
||||||||
Current Liabilities: |
||||||||
Accounts payable |
$ | 23,893 | $ | 30,223 | ||||
Accrued expenses |
40,627 | 38,713 | ||||||
Deferred revenue |
8,847 | 11,859 | ||||||
Income taxes payable |
15,543 | 18,050 | ||||||
Total current liabilities |
88,910 | 98,845 | ||||||
Deferred tenant allowances from landlords |
46,146 | 45,817 | ||||||
Supplemental retirement and deferred compensation liability |
18,903 | 16,907 | ||||||
Accrued straight-line rent and other |
11,624 | 11,378 | ||||||
Commitments and contingencies |
— | — | ||||||
SHAREHOLDERS’ EQUITY |
||||||||
Preferred stock, 50 million shares authorized |
— | — | ||||||
Common stock, $.01 par value, 100 million shares authorized,
36.3 million and 36.1 million shares issued,
33.6 million and 33.3 million shares outstanding
at April 29, 2006 and January 28, 2006, respectively |
363 | 361 | ||||||
Treasury stock, at cost, 3.4 million and 2.7 million shares
at April 29, 2006 and January 28, 2006, respectively |
(80,594 | ) | (60,595 | ) | ||||
Paid in capital |
164,211 | 157,718 | ||||||
Retained earnings |
264,988 | 253,299 | ||||||
Total shareholders’ equity |
348,968 | 350,783 | ||||||
Total liabilities and shareholders’ equity |
$ | 514,551 | $ | 523,730 | ||||
The accompanying notes are an integral part of these consolidated financial statements.
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TOO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
| Thirteen Weeks Ended | ||||||||
| April 29, | April 30, | |||||||
| 2006 | 2005 | |||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 11,689 | $ | 7,410 | ||||
Impact of other operating activities on cash flows: |
||||||||
Depreciation and amortization expense |
7,653 | 6,611 | ||||||
Amortization of tenant allowances |
(2,106 | ) | (1,782 | ) | ||||
Loss on disposal of fixed assets |
616 | 538 | ||||||
Deferred income taxes |
313 | 422 | ||||||
Tax benefit from stock option exercises |
(881 | ) | — | |||||
Stock-based compensation expense |
2,049 | 1,005 | ||||||
Changes in assets and liabilities: |
||||||||
Inventories |
(3,356 | ) | 6,669 | |||||
Accounts payable and accrued expenses |
(6,695 | ) | (8,152 | ) | ||||
Income taxes payable |
(1,626 | ) | (8,975 | ) | ||||
Income tax receivable |
— | (2,287 | ) | |||||
Other assets |
(2,365 | ) | 1,459 | |||||
Tenant allowances received |
2,435 | 1,098 | ||||||
Other long-term liabilities |
2,242 | 727 | ||||||
Net cash provided by operating activities |
9,968 | 4,743 | ||||||
Investing activities: |
||||||||
Capital expenditures |
(14,214 | ) | (11,444 | ) | ||||
Funding of nonqualified benefit plans |
(3,970 | ) | — | |||||
Purchase of investments |
(47,331 | ) | (82,838 | ) | ||||
Sale of investments |
72,175 | 112,555 | ||||||
Change in restricted assets |
(4 | ) | (3 | ) | ||||
Net cash provided by investing activities |
6,656 | 18,270 | ||||||
Financing activities: |
||||||||
Purchases of treasury stock |
(19,999 | ) | (27,281 | ) | ||||
Tax benefit from stock option exercises |
881 | — | ||||||
Change in cash overdraft |
(549 | ) | 1,459 | |||||
Stock options and other equity changes |
3,565 | 7,210 | ||||||
Net cash (used for) financing activities |
(16,102 | ) | (18,612 | ) | ||||
Net increase in cash and equivalents |
522 | 4,401 | ||||||
Cash and equivalents, beginning of year |
22,248 | 26,212 | ||||||
Cash and equivalents, end of period |
$ | 22,770 | $ | 30,613 | ||||
Supplemental disclosure of cash flow information: |
||||||||
Cash paid for income taxes |
$ | 8,620 | $ | 12,899 | ||||
Cash paid for interest |
$ | 48 | $ | 119 | ||||
(Decrease)/increase of fixed assets in accounts payable |
$ | (184 | ) | $ | 230 | |||
The accompanying notes are an integral part of these consolidated financial statements.
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TOO, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Summary of Significant Accounting Policies
Too, Inc., (referred to herein as “Too,” the “Company,” “we” or “us”) is the operator of two
specialty retailing businesses, Limited Too and Justice. We were established in 1987 and, prior to
our August 1999 spin-off, were a wholly-owned subsidiary of The Limited, Inc. (“The Limited” or
“Limited Brands”). Since the spin-off, we have operated as an independent, separately traded,
public company. Limited Too sells apparel, footwear, lifestyle and personal care products for
fashion-aware, trend-setting young girls ages seven to fourteen years. Justice, launched by us in
January 2004, sells value-priced sportswear and accessories for girls ages seven to fourteen years.
The accompanying consolidated financial statements include the accounts of Too, Inc. and all
subsidiaries that are more than 50% owned and reflect our assets, liabilities, results of
operations and cash flows on a historical cost basis. These statements have been prepared in
accordance with accounting principles generally accepted in the United States of America (“GAAP”).
All significant intercompany balances and transactions have been eliminated in consolidation.
In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures about
Segments of an Enterprise and Related Information,” (“SFAS No. 131”) we determine our operating
segments on the same basis that we use internally to evaluate performance and allocate resources.
The operating segments identified by us, Limited Too and Justice, have been aggregated and are
reported as one reportable financial segment. We aggregate our two operating segments as they are
similar in each of the following areas: class of customer, economic characteristics, nature of
products, nature of production processes and distribution methods.
In our opinion, the accompanying consolidated financial statements reflect all adjustments (which
are of a normal recurring nature) necessary to present fairly the financial position and results of
operations and cash flows for the interim periods, but are not necessarily indicative of the
results of operations to be anticipated for the fiscal year ending February 3, 2007 (the “2006
fiscal year”). A more complete discussion of our significant accounting policies can be found in
Note 1 to the consolidated financial statements in our Form 10-K for the fiscal year ended January
28, 2006 (the “2005 fiscal year”).
2. Stock Based Compensation
In 1999, we adopted the Too, Inc. 1999 Stock Option and Performance Incentive Plan and the Too,
Inc. 1999 Stock Plan for Non-Associate Directors. In 2005, our shareholders approved the adoption
of the 2005 Stock Option and Performance Incentive Plan and the 2005 Stock Plan for Non-Associate
Directors (collectively, the “Plans”).
Under these Plans, as amended, up to 7.5 million shares were reserved and may be granted to our
employees and certain nonemployees. The Plans allow for the grant of incentive stock options,
non-qualified stock options and restricted stock to officers, directors and key associates. Stock
options are granted at the fair market value of our common shares on the date of grant and
generally have 10-year terms. Option grants generally vest ratably over the first four
anniversaries from the grant date. We generally issue new shares to satisfy option exercises.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial
Accounting Standards (“SFAS”) No. 123 (Revised 2004), Share-Based Payment (“SFAS No. 123(R)”).
SFAS No. 123(R) requires companies to recognize the cost of awards of equity instruments, such as
stock options and restricted stock, based on the fair value of those awards at the date of grant
and
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eliminates the choice to account for employee stock options under Accounting Principles Board
(“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. We adopted SFAS No.123(R)
effective January 29, 2006 using the modified prospective method and, as such, results for prior
periods have not been restated. Under this method, in addition to reflecting compensation expense
for new share-based awards, expense is also recognized to reflect the remaining service period of
awards that had been included in pro forma disclosures in prior periods. Prior to January 29,
2006, the fair value of restricted stock awards was expensed over the vesting period, while
compensation expense for stock options was recognized over the vesting period only to the extent
that the grant date market price of the stock exceeded the exercise price of the options.
For the thirteen weeks ended April 29, 2006, our results of operations include $2.0 million ($1.3
million net of tax) of stock-based compensation expense which had a $0.04 impact on both basic and
diluted earnings per share. Of this amount, $0.8 million ($0.5 million net of tax) is attributable
to the Company’s adoption of SFAS No. 123(R). This incremental expense from the adoption of SFAS
No. 123(R) had a $0.01 impact on both basic and diluted earnings per share. The additional
stock-based compensation expense not related to the adoption of SFAS No. 123(R) was related to the
vesting of restricted stock awards.
Prior to the adoption of SFAS No. 123(R), we presented the benefit of all tax deductions resulting
from the exercise of stock options and restricted stock awards as operating cash flows in the
consolidated statements of cash flows. SFAS No. 123(R) requires the benefits of tax deductions in
excess of grant-date fair value be reported as a financing cash flow, rather than as an operating
cash flow. Excess tax benefits of $0.9 million, which were classified as a financing cash inflow
in the first quarter of 2006, would have been classified as an operating cash inflow if we had not
adopted SFAS No. 123(R).
The following table illustrates the effect on net income and earnings per share if we had applied
the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,”
as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,”
to stock-based employee compensation prior to January 29, 2006 (in thousands, except per share
amounts):
| Thirteen | ||||
| Weeks Ended | ||||
| April 30, | ||||
| 2005 | ||||
Net income as reported |
$ | 7,410 | ||
Stock-based compensation expense
recorded under APB Opinion No. 25,
net of tax |
618 | |||
Stock-based compensation expense
determined under fair value based
method, net of tax |
(1,434 | ) | ||
Pro forma net income |
$ | 6,594 | ||
Earnings per share: |
||||
Basic — as reported |
$ | 0.21 | ||
Basic — pro forma |
$ | 0.19 | ||
Diluted — as reported |
$ | 0.21 | ||
Diluted — pro forma |
$ | 0.19 | ||
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The weighted average fair value per share of options granted is estimated using the
Black-Scholes option-pricing model and the following weighted average assumptions:
| Thirteen Weeks Ended |
||||||||
| April 29, | April 30, | |||||||
| 2006 | 2005 | |||||||
Expected life (in years) |
5.3 | 5.0 | ||||||
Forfeiture rate |
14 | % | 11 | % | ||||
Dividend rate |
— | — | ||||||
Price volatility |
47 | % | 48 | % | ||||
Risk-free interest rate |
4.3 | % | 4.0 | % | ||||
The weighted average fair value per share of options granted during the thirteen weeks ended
April 29, 2006 and April 30, 2005 was $14.17 and $13.17, respectively.
The following table is a summary of the balances and activity for the Plans related to stock
options for the thirteen weeks ended April 29, 2006:
| Weighted | ||||||||||||||||
| Weighted | Average | |||||||||||||||
| Average | Remaining | Aggregate | ||||||||||||||
| Number of | Exercise | Contractual | Intrinsic Value | |||||||||||||
| Shares | Price | Term (in years) | (in Thousands) | |||||||||||||
Outstanding, January 28, 2006 |
1,711,663 | $ | 23.02 | |||||||||||||
Granted |
253,807 | 29.73 | ||||||||||||||
Exercised |
(165,643 | ) | 20.51 | |||||||||||||
Cancelled |
(4,062 | ) | 15.96 | |||||||||||||
Outstanding, April 29, 2006 |
1,795,765 | $ | 24.22 | 6.65 | $ | 25,500 | ||||||||||
Exercisable, April 29, 2006 |
1,101,556 | $ | 24.12 | 5.42 | $ | 15,752 | ||||||||||
The aggregate intrinsic value in the table above is based on our closing stock price of $38.42
as of the last trading day of the quarter ended April 29, 2006. The total intrinsic value for
stock options exercised during the thirteen weeks ended April 29, 2006 and April 30, 2005 was $2.1
million and $13.6 million, respectively. Total proceeds received from the exercise of stock
options during the thirteen weeks ended April 29, 2006 and April 30, 3005 were $3.4 million and
$7.2 million, respectively.
The following table is a summary of the balance and activity for the Plans related to restricted
stock granted as compensation to employees and directors for the thirteen weeks ended April 29,
2006:
| Weighted | ||||||||
| Number of | Average Grant | |||||||
| Shares | Date Fair Value | |||||||
Outstanding, January 29, 2006 |
512,945 | $ | 25.52 | |||||
Granted |
128,285 | 29.73 | ||||||
Vested |
(101,316 | ) | 22.46 | |||||
Cancelled |
(3,994 | ) | 28.30 | |||||
Outstanding, April 29, 2006 |
535,920 | $ | 27.08 | |||||
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As of April 29, 2006, total unrecognized stock-based compensation expense related to
non-vested stock options was approximately $15.4 million, which is expected to be recognized over a
weighted average period of approximately 2.73 years.
3. Investments
At April 29, 2006, we held investments in securities that were classified as held-to-maturity based
on our intent and ability to hold the securities to maturity. We determined the appropriate
classification at the time of purchase. All such securities held by us at April 29, 2006 were
municipal debt securities issued by states of the United States or political subdivisions of the
states.
The table below details the investments classified as held-to-maturity owned by us at April 29,
2006 and January 28, 2006, respectively (in thousands):
| April 29, 2006 | January 28, 2006 | |||||||||||||||
| Maturity of | Maturity of | |||||||||||||||
| Less than 1 Year | 1 to 5 Years | Less than 1 Year | 1 to 5 Years | |||||||||||||
Aggregate fair value |
$ | 21,071 | $ | 9,328 | $ | 21,752 | $ | 8,413 | ||||||||
Gross unrealized holding gains |
— | — | — | — | ||||||||||||
Gross unrealized holding losses |
69 | 119 | 55 | 51 | ||||||||||||
Net carrying amount |
$ | 21,140 | $ | 9,447 | $ | 21,807 | $ | 8,464 | ||||||||
Investments also include auction rate municipal bonds, variable rate municipal demand notes,
and preferred shares of tax-exempt closed-end mutual funds classified as available-for-sale
securities. Our investments in these securities are recorded at cost, which approximates fair
value due to their variable interest rates, which typically reset every 7 to 35 days, and, despite
the long-term nature of their stated contractual maturities, we have the ability to quickly
liquidate these securities to support current operations. As a result, we have no accumulated
unrealized gains or losses in other comprehensive income from these current investments. All
income generated from these current investments is recognized as interest income.
During the quarter ended April 29, 2006, $40.9 million of cash was used to purchase
available-for-sale securities while $66.1 million of cash was generated by the sale of
available-for-sale securities. Additionally, $6.4 million of cash was used to purchase
held-to-maturity securities while $6.1 million of cash was generated by the sale of
held-to-maturity securities.
The table below details the marketable securities classified as available-for-sale owned by us at
April 29, 2006 and January 28, 2006, respectively (in thousands):
| April 29, 2006 | January 28, 2006 | |||||||
| Maturity of | Maturity of | |||||||
| Less than 1 Year | Less than 1 Year | |||||||
Aggregate fair value |
$ | 116,375 | $ | 141,644 | ||||
Net gains in
accumulated other
comprehensive income |
— | — | ||||||
Net losses in
accumulated other
comprehensive income |
— | — | ||||||
Net carrying amount |
$ | 116,375 | $ | 141,644 | ||||
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Interest income, net, consisted of the following (in thousands):
| Thirteen Weeks Ended | ||||||||
| April 29, 2006 | April 30, 2005 | |||||||
Interest income |
$ | 1,412 | $ | 796 | ||||
Interest expense |
(58 | ) | (337 | ) | ||||
Interest income, net |
$ | 1,354 | $ | 459 | ||||
4. Inventories
Inventories are principally valued at the lower of average cost or market, on a weighted average
cost basis, using the retail method. Under the retail method, the valuation of inventories at cost
and the resulting gross margins are calculated by applying a cost-to-retail ratio to the retail
value of inventories. The use of the retail method will result in valuing inventories at the lower
of cost or market when markdowns are currently taken as a reduction of the retail value and cost of
inventories. We review our inventory levels in order to identify slow-moving merchandise and
broken assortments (items no longer in stock in a sufficient range of sizes) and use markdowns to
sell through merchandise. We record a charge to cost of goods sold for all inventory on hand when
a permanent retail price reduction is reflected. We estimate and accrue our inventory shrinkage
for the period between the last physical count and the balance sheet date. Inherent in the retail
method are certain management judgments and estimates including, among others, future sales,
markdowns and shrinkage, which significantly impact the ending inventory valuation at cost as well
as the resulting gross margins. Inventory valuation at the end of the first and third quarters
reflects adjustments for inventory markdowns considering the total selling season. This mid-season
inventory valuation adjustment reduced our inventory balance by $4.8 million on April 29, 2006
compared to a $5.2 million reduction in inventory on April 30, 2005.
5. Property and Equipment
Property and equipment at April 29, 2006 and January 28, 2006 consisted of (in thousands):
| April 29, | January 28, | |||||||
| 2006 | 2006 | |||||||
Land and land improvements |
$ | 8,185 | $ | 8,181 | ||||
Buildings |
43,836 | 43,836 | ||||||
Furniture, fixtures and equipment |
192,792 | 191,085 | ||||||
Leasehold improvements |
118,145 | 117,061 | ||||||
Construction-in-progress |
16,692 | 7,932 | ||||||
Total |
379,650 | 368,095 | ||||||
Less: accumulated depreciation |
(171,906 | ) | (166,112 | ) | ||||
Property and equipment, net |
$ | 207,744 | $ | 201,983 | ||||
6. Credit Facility
In October 2005, we entered into a new unsecured $100 million credit facility with National City
Bank, Fifth Third Bank, Bank of America, N.A., LaSalle Bank National Association and Citicorp USA,
Inc. (“new credit facility”). The new credit facility replaced the April 29, 2003 credit facility
and provides for a $100 million revolving line of credit, which can be increased to up to $150
million at our option under certain circumstances. The new credit facility is available for direct
borrowing, issuance of letters of credit, stock repurchases and general corporate purposes. The
new credit facility is guaranteed on an
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unsecured basis by all current and future domestic
subsidiaries of Too, Inc. Our new credit facility contains financial covenants which require us to
maintain minimum net worth, cash flow and leverage covenants as well as restricts our ability to
incur additional debt. As of April 29, 2006, we believe we are in compliance with all applicable
terms of the new credit facility.
7. Earnings per Share
Basic earnings per share are computed by dividing net income by the weighted average number of
common shares outstanding for the period. Diluted earnings per share reflect the potential
dilution that could occur if stock options and restricted stock were converted to common stock
using the treasury stock method.
The following table shows the amounts used in the computation of basic and diluted earnings per
share (in thousands):
| Thirteen Weeks Ended |
||||||||
| April 29, | April 30, | |||||||
| 2006 | 2005 | |||||||
Net income |
$ | 11,689 | $ | 7,410 | ||||
Weighted average common shares — basic |
33,154 | 34,758 | ||||||
Dilutive effect of stock options and
restricted stock |
557 | 694 | ||||||
Weighted average common shares — diluted |
33,711 | 35,452 | ||||||
Due to the options’ strike price exceeding the average market price of the common shares for
the reporting periods, certain options were excluded from the calculation of net income per diluted
share. For the thirteen weeks ended April 29, 2006 and April 30, 2005, options to purchase 25.0
thousand and 1.1 million common shares, respectively, were not included in the computation.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Company Overview
We operate two brands: Limited Too and Justice. Limited Too is a specialty retailer of quality
apparel, accessories, footwear, lifestyle and personal care products for fashion-aware,
trend-setting tweens, ages 7 to 14. Limited Too customers are active, creative and
image-conscious, enjoy shopping and describe themselves as “fun” and “cool.” We believe they want
a broad assortment of merchandise for their range of dressing occasions, including school, leisure
activities and special occasions. We continually update the merchandise assortment, which includes
non-apparel merchandise, such as candy, jewelry, toiletries, cosmetics and lifestyle furnishings
for her room. Limited Too also offers a select portion of its assortment through its website
(www.limitedtoo.com) and its catazine.
Justice, launched in 2004, is a specialty retail brand offering value-priced fashionable sportswear
and related accessories for tween girls. Our Justice stores are located primarily in power
centers, off-mall retail locations that draw customers intent on apparel shopping. We believe our
customer loves the latest in fashion and accessories and we strive to provide this to our
value-conscious customers. Justice stores are fun, interactive places to shop. Store exteriors
display the logo “Justice... Just for Girls” and the interiors are bright, colorful inviting spaces
with unique fixtures highlighting the merchandise assortment.
Our fiscal year is comprised of two principal selling seasons: spring (the first and second
quarters) and fall (the third and fourth quarters).
Performance Overview
Both of our brands had an excellent start to fiscal 2006 and to spring season. We achieved a 67%
diluted earnings per share increase on 10% comparable store sales growth. We reached net sales of
$195.1 million, a first-quarter record for us, and a 19% increase over the prior year. We achieved
an improvement of 150 basis points as a percentage of net sales (“bps”) in net income for the
quarter, driven by both improved gross margin and better leveraging of general, administrative and
store operating expenses. We ended the quarter with 667 stores.
Our 19% sales increase over first quarter 2005 was the result of both additional store count and
10% comparable store sales growth. Our average number of units per sales transaction (“UPT”)
remained steady at 4.1 units while our average dollar sale (“ADS”) has increased 13% over the prior
year first quarter, driven primarily by lower markdowns and product mix. Our analysis of
transaction activity indicates the number of transactions per store has decreased slightly,
however transactions over $50 have increased to 42% of all transactions, up from 38% in Q1 2005
indicating an overall higher quality of sale. We ended the quarter with $11.7 million of net
income, an increase of 58% over the $7.4 million reported for the first quarter of 2005.
Both Limited Too and Justice continue to benefit from effective marketing and promotional
initiatives. In the first quarter of 2006, for the first time Limited Too combined the
distribution of its Too Bucks with its spring bonus card, concentrating on a higher transaction
value and increased profitability at its stores. We did not repeat our spring television
marketing, a five-week branded ad campaign rolled out in the prior year, however, we continue to
utilize our voicemail marketing program, which serves as an additional reminder to customers about
our marketing programs. The savings from the elimination of television helped us reduce our
general, administrative and store operating expenses rate from first quarter 2005 to first quarter
2006. Limited Too mailed three catazines in the first quarter of 2006 versus one in the first
quarter of 2005. All catazines included 20% off coupons, good for 2-3 weeks, which proved to be a
more effective marketing vehicle than last year’s television advertising campaign. Our Justice
brand circulated
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direct-mail pieces to select customers for the first time in first quarter 2006, each containing a
promotion or percentage off to help drive increased traffic and sales. Justice plans to roll out
its first catazine, a back-to-school edition, in the beginning of the third quarter followed by two
additional fall editions.
From a merchandising standpoint, our camisoles and casual cut and sewn tops, including our ultimate
collection of longer, leaner tees, tanks and henleys, continue to perform well as do our Bermuda
shorts, skirts and leggings. In our ready-to-wear category, jackets, early spring casual dresses
and swimwear all posted double-digit average store sales increases for the quarter over the first
quarter of 2005, highlighted by our short-sleeved shrug jackets and embellished swimwear. Our
lifestyles department gained momentum this quarter with the release of the Disney Channel’s High
School Musical soundtrack, the current tween generation’s version of the musical Grease and a
must-have. We also expanded our half size woven bottoms to all stores during the quarter. By fall
2006, we plan to offer our girl half sizes for nearly all bottoms, while only a select number of
stores carried half sizes in fall 2005.
We have succeeded in providing our girl with an assortment of fashionable tops and bottoms,
including matching swimwear, embellished footwear and accessories to complete her entire summer
wardrobe, head-to-toe. We will continue to focus on our girl’s styles and trends to provide her
with the fashion and looks she wants. We hope to keep our first quarter momentum alive into the
second quarter and fall season to be our girls’ one-stop-shop for back-to-school 2006.
The table below shows line items as a percentage of net sales:
| Thirteen Weeks Ended |
||||||||
| April 29, | April 30, | |||||||
| 2006 | 2005 | |||||||
Net sales |
100.0 | % | 100.0 | % | ||||
Cost of goods sold, including buying
and occupancy costs |
62.2 | % | 62.5 | % | ||||
Gross income |
37.8 | % | 37.5 | % | ||||
General, administrative and store
operating expenses |
28.9 | % | 30.7 | % | ||||
Operating income |
8.9 | % | 6.8 | % | ||||
Interest income, net |
0.7 | % | 0.3 | % | ||||
Earnings before income taxes |
9.6 | % | 7.1 | % | ||||
Provision for income taxes |
3.6 | % | 2.6 | % | ||||
Net income |
6.0 | % | 4.5 | % | ||||
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Operational Summary
Summarized operational data for the thirteen week periods ended April 29, 2006 and April 30, 2005
is presented below:
| Thirteen Weeks Ended | ||||||||||||
| Limited Too Division | April 29, | April 30, | Percent | |||||||||
| 2006 | 2005 | Change | ||||||||||
Net sales (millions) (1) |
$ | 171.7 | $ | 155.7 | 10 | % | ||||||
Comparable store sales (3) |
9 | % | 1 | % | ||||||||
Net store sales per average square foot (4) |
$ | 71 | $ | 65 | 9 | % | ||||||
Sales per average store (thousands) (5) |
$ | 297.3 | $ | 270.7 | 10 | % | ||||||
Average dollar sales value per transaction (“ADS”) (6) |
$ | 57.22 | $ | 50.35 | 14 | % | ||||||
Average number of units per transaction (“UPT”) |
4.03 | 4.04 | — | % | ||||||||
Number of transactions per average store |
5,191 | 5,377 | -3 | % | ||||||||
Average store size at period end (gross square feet) |
4,158 | 4,127 | 1 | % | ||||||||
Total gross square feet at period end (thousands) |
2,349 | 2,344 | — | % | ||||||||
Inventory per gross square foot at period end (7) |
$ | 25.9 | $ | 22.3 | 16 | % | ||||||
Inventory per store at period end (7) |
$ | 107,694 | $ | 92,095 | 17 | % | ||||||
Number of stores: |
||||||||||||
Beginning of period |
574 | 568 | ||||||||||
Opened |
3 | 2 | ||||||||||
Closed |
(12 | ) | (2 | ) | ||||||||
End of period |
565 | 568 | ||||||||||
Limited Too stores remodeled |
10 | 5 | ||||||||||
| Thirteen Weeks Ended | ||||||||||||
| Justice Division | April 29, | April 30, | Percent | |||||||||
| 2006 | 2005 | Change | ||||||||||
Net sales (millions) (2) |
$ | 23.4 | $ | 8.7 | 169 | % | ||||||
Comparable store sales (3) |
30 | % | 15 | % | ||||||||
Net store sales per average square foot (4) |
$ | 57 | $ | 48 | 19 | % | ||||||
Sales per average store (thousands) (5) |
$ | 245.7 | $ | 207.0 | 19 | % | ||||||
Average dollar sales value per transaction (“ADS”)
(6) |
$ | 52.66 | $ | 45.73 | 15 | % | ||||||
Average number of units per transaction (“UPT”) |
4.51 | 4.34 | 4 | % | ||||||||
Number of transactions per average store |
4,668 | 4,555 | 2 | % | ||||||||
Average store size at period end (gross square feet) |
4,314 | 4,381 | -2 | % | ||||||||
Total gross square feet at period end (thousands) |
440 | 202 | 118 | % | ||||||||
Inventory per gross square foot at period end (8) |
$ | 19.4 | $ | 17.2 | 13 | % | ||||||
Inventory per store at period end (8) |
$ | 83,745 | $ | 75,283 | 11 | % | ||||||
Number of stores: |
||||||||||||
Beginning of period |
92 | 35 | ||||||||||
Opened |
10 | 11 | ||||||||||
Closed |
— | — | ||||||||||
End of period |
102 | 46 | ||||||||||
| (1) | Total Limited Too net sales includes: store sales, net of associate discounts; direct sales; international revenue and partner advertising revenue. | |
| (2) | Total Justice net sales is defined as store sales, net of associate discounts. | |
| (3) | A store is included in our comparable store sales calculation once it has completed 52 weeks of operation. Further, stores that have changed more than 20% in gross square feet are treated as new stores for purposes of this calculation. | |
| (4) | Net store sales per average square foot is the result of dividing net store sales for the fiscal year by the monthly average gross square feet, which reflects the impact of opening and closing stores throughout the period. | |
| (5) | Sales per average store is the result of dividing gross store sales for the fiscal period by average store count, which reflects the impact of opening and closing stores throughout the period. | |
| (6) | Average dollar sales value per transaction is the result of dividing gross store sales dollars for the period by the number of store transactions. | |
| (7) | Inventory value for Limited Too includes stores, direct and all valuation adjustments. | |
| (8) | Inventory value for Justice includes stores inventory and all valuation adjustments. |
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Gross Income
Our gross income rate for the first quarter 2006 improved 30 bps over the first quarter of 2005.
This was due primarily to a decrease in markdowns resulting from having the right fashion for our
customer as well as the impact of a timing shift in promotional markdowns driven by the late Easter
holiday. We also leveraged our store occupancy expenses in the first quarter 2006, however, those
savings were substantially offset by the costs related to the additional two catazines mailed
during the quarter.
Our gross income may not be comparable to that of certain other retailers since all significant
costs related to our distribution network, with the exception of freight costs, are included in
general, administrative and store operating expenses (see “General, Administrative and Store
Operating Expenses” section below).
General, Administrative and Store Operating Expenses
General, administrative and store operating expenses increased $5.9 million, however, this
represented a 180 bps decrease from the first quarter of 2005 as outlined in the table below (in
thousands, except basis point amounts):
| Q1 2006 vs. Q1 2005 | |||||||||||
| increase/(decrease) in | Q1 2006 vs. Q1 2005 | ||||||||||
| dollars | increase/(decrease) in bps | ||||||||||
Changes in: |
|||||||||||
Marketing |
$ | (3,105 | ) | (210 | ) | ||||||
Home office |
5,561 | 150 | |||||||||
Store payroll and operating expenses |
3,457 | (120 | ) | ||||||||
Total Change |
$ | 5,913 | (180 | ) | |||||||
Marketing expenses for first quarter 2006 were significantly lower than the first quarter of
2005 mainly due to the elimination of our spring television campaign, which ran in the prior year.
Home office expenses for the quarter increased primarily due to higher headcount in our home office
as well as in our overseas sourcing operations. Consulting services related to our multi-year
information technology initiative and expensing of stock options as required by SFAS No. 123(R)
also contributed to this increase. Store operating expenses for the quarter increased 11% in
dollars from the first quarter of 2005, however, this increase was leveraged by a 19% increase in
net sales, leading to a 120 bps reduction when compared with first quarter 2005. This dollar
increase was primarily driven by the net addition of 58 stores and additional associate hours
required by our higher sales volume.
Income Taxes
The effective tax rate for the first quarter of 2006 increased to 37.8%, up 130 basis points from
the first quarter 2005 effective tax rate of 36.5%. The increase was the result of additional
expense relating to prior year tax liabilities and the impact of expensing incentive stock options
under SFAS No. 123(R).
Financial Condition
Our balance sheet continues to benefit from our strong cash flows from operations. We were able to
finance all capital expenditures with existing working capital and cash generated from operations.
We ended the quarter with $160.3 million in cash and short-term investments. In assessing the
financial condition of the business, we consider factors such as cash flow from operations, capital
expenditures and investment activities to be key indicators of financial health.
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Liquidity and Capital Resources
Cash generated from operations remains the primary source to support ongoing operations, projected
business growth, seasonal working capital requirements, and capital expenditures. In an effort to
increase shareholder value, we have also used and may continue to use our capital to repurchase
common stock. After using $20.0 million of cash in first quarter 2006 to repurchase common stock,
working capital (defined as current assets less restricted assets and current liabilities)
decreased from $185.1 million at January 28, 2006 to $175.2 million at April 29, 2006. Although we
expect to maintain significant overall liquidity, we recognize that the specialty retail industry
can be highly volatile and fashion missteps can quickly impact the ability to generate operating
cash.
The table below summarizes our working capital position and capitalization (in thousands):
| April 29, | January 28, | |||||||
| 2006 | 2006 | |||||||
Working capital, excluding restricted assets of
$1.2 million and $1.2 million at April 29, 2006
and January 28, 2006, respectively |
$ | 175,186 | $ | 185,075 | ||||
Capitalization: |
||||||||
Long-term debt |
— | — | ||||||
Shareholders’ equity |
348,968 | 350,783 | ||||||
Total capitalization |
$ | 348,968 | $ | 350,783 | ||||
Amounts available under the
credit facility |
$ | 99,662 | $ | 98,802 | ||||
Cash Flows from Operating Activities
Net cash provided by operating activities amounted to $10.0 million for the quarter ended April 29,
2006, up $5.3 million when compared to $4.7 million for the same period of 2005. The table below
outlines the changes in cash flow from operating activities during the thirteen week period (in
millions):
| Q1 2006 vs Q1 2005 | |||||||
| increase/(decrease) | |||||||
Changes in: |
|||||||
Net income, net of non-cash expenses |
$ | 5.1 | |||||
Income taxes |
8.7 | ||||||
Inventory |
(10.0 | ) | |||||
Tenant allowances received |
1.3 | ||||||
Other |
0.2 | ||||||
Total change in cash flows from operating activities |
$ | 5.3 | |||||
Net income, net of non-cash expenses, was up nearly 40% over Q1 2005. The decrease in the use
of cash for income taxes for the first quarter 2006 over the same period in 2005 is due primarily
to the timing of extension payments on prior year taxes. Cash used to purchase inventory was
higher in the first quarter of 2006 versus the same period 2005 mainly due to increased overall
store count and anticipated increased sales in the second quarter of 2006. Additional tenant
allowances were received during the current quarter based on increases in store count in our
Justice brand.
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Cash Flows from Investing Activities
Net cash provided by investing activities amounted to $6.7 million for the quarter ended April 29,
2006, down $11.6 million from $18.3 provided in the first quarter of 2005. The table below
outlines the changes in cash flow from investing activities during the thirteen week period (in
millions):
| Q1 2006 vs Q1 2005 | |||||||
| increase/(decrease) | |||||||
Changes in: |
|||||||
Investments |
$ | (4.9 | ) | ||||
Capital expenditures |
(2.8 | ) | |||||
Non-qualified benefit plan funding and other |
(3.9 | ) | |||||
Total change in cash flows from investing activities |
$ | (11.6 | ) | ||||
We generated $24.8 million in the first quarter of 2006 by liquidating our marketable
securities, a decrease of $4.9 million when compared to the $29.7 million generated in 2005.
Capital expenditures increased $2.8 million during the quarter versus the same period in 2005 due
to increased store construction related to our Justice store increase and technology related
capital spending. Non-qualified benefit plan funding increased to $3.9 million, compared to $0
funding in the prior year.
Cash Flows from Financing Activities
Financing activities used approximately $16.1 million of cash in the quarter ended April 29, 2006
versus using $18.6 million of cash in the quarter ended April 30, 2005. The decrease in cash usage
is primarily related to the decrease in common stock repurchased during the quarter versus the same
period in 2005. During the first quarter of 2005, approximately 1.1 million shares were
repurchased for an aggregate repurchase price of $27.3 million, whereas in the first quarter of
2006, approximately 0.6 million shares were repurchased for an aggregate repurchase price of $20.0
million. Our share repurchase program is ongoing and an additional 0.3 million shares have been
repurchased thus far in the second quarter. Refer to Item 2 of PART II of this Form 10-Q for
further information. The remaining fluctuation in cash flows from financing activities for first
quarter 2006 versus first quarter 2005 was primarily related to stock option activity and a
decrease in our cash overdraft position from first quarter 2005 to first quarter 2006.
Credit Facility
In October 2005, we entered into a new unsecured credit facility providing us with a $100 million
revolving line of credit, which can be increased up to $150 million at management’s option, under
certain circumstances. Refer to Note 6 for further detail.
Stock Repurchase Program
We amended our share repurchase program in November 2005 to restore the amount that may be used to
repurchase shares to $125 million over a two year period beginning November 17, 2005. The
purchases may occur from time to time, subject to market conditions, in open market or in privately
negotiated
transactions, and in accordance with Securities and Exchange Commission requirements. There can be
no assurance that we will repurchase any additional shares under the amended share repurchase
program.
Capital Expenditures
We expect 2006 capital expenditures to be in the $55 to $58 million range, mainly allocated to new
store construction, improvements to existing stores and information technology (“IT”) initiatives.
We expect cash on hand and short-term investments and cash generated from operating activities will
fund substantially all capital expenditures for 2006.
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We continue to implement our multi-year IT modernization strategy, which combines system upgrades
and new software to ensure our systems infrastructure can fully support our expected future growth.
For a complete discussion refer to our Annual Report on Form 10-K for the year ended January 28,
2006, as filed with the Securities and Exchange Commission on April 10, 2006 (the “Fiscal 2005 Form
10-K”).
Critical Accounting Policies and Estimates
Our critical accounting policies and estimates can be found in the “Management’s Discussion and
Analysis of Financial Condition and Results of Operation” section of our Fiscal 2005 Form 10-K.
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation
Reform Act of 1995 (the “PSLRA”). This Quarterly Report on Form 10-Q contains various
“forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of
1995 and other applicable securities laws. Such statements can be identified by the use of the
forward-looking words “anticipate,” “estimate,” “project,” “target,” “believe,” “intend,” “plan,”
“expect,” “hope,” “risk,” “could,” “pro forma,” “potential,” “outlook,” or similar words. These
statements discuss future expectations, contain projections regarding future developments,
operations or financial conditions, or state other forward-looking information. These
forward-looking statements involve various important risks, uncertainties and other factors that
could cause our actual results for 2006 and beyond to differ materially from those expressed. The
following factors, among others, could affect our future financial performance and cause actual
future results to differ materially from those expressed or implied in any forward-looking
statements included in this Form 10-Q:
| • | Changes in consumer spending patterns, consumer preferences and overall economic conditions; | ||
| • | Decline in the demand for our merchandise; | ||
| • | The impact of competition and pricing; | ||
| • | Effectiveness of our brand awareness and marketing programs; | ||
| • | A significant change in the regulatory environment applicable to our business; | ||
| • | Risks associated with our sourcing and logistics functions; | ||
| • | Changes in existing or potential trade restrictions, duties, tariffs or quotas; | ||
| • | Currency and exchange risks; | ||
| • | Availability of suitable store locations at appropriate terms; | ||
| • | Ability to develop new merchandise; | ||
| • | Ability to hire and train associates; | ||
| • | The potential impact of health concerns relating to severe infectious diseases, particularly on manufacturing operations of our vendors in Asia and elsewhere; |
18