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Trans World Entertainment 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.
  5. Ex-32.

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

 

FORM 10-Q

 

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

 

 

FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2005

 

 

 

OR

 

 

 

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT

 

 

 

 

 

FOR THE TRANSITION PERIOD FROM          TO          

 

COMMISSION FILE NUMBER:  0-14818

 

TRANS WORLD ENTERTAINMENT CORPORATION

(Exact name of registrant as specified in its charter)

 

New York

 

14-1541629

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer
Identification Number)

 

38 Corporate Circle
Albany, New York 12203

(Address of principal executive offices, including zip code)

 

(518) 452-1242

(Registrant’s telephone number, including area code)

 

Indicate by a check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for 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 ý  No o 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý  No o 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Common Stock, $.01 par value,

32,602,579 shares outstanding as of June 1, 2005

 

 



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

PART 1. FINANCIAL INFORMATION

 

 

 

Item 1 - Financial Statements

 

 

 

Condensed Consolidated Balance Sheets (unaudited) at April 30, 2005,
January 29, 2005 and May 1, 2004

 

 

 

Condensed Consolidated Statements of Operations (unaudited) –
Thirteen Weeks Ended April 30, 2005 and May 1, 2004

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited)–
Thirteen Weeks Ended April 30, 2005 and May 1, 2004

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

 

 

Item 2 - Management’s Discussion and Analysis of Financial
Condition and Results of Operations

 

 

 

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

 

 

 

Item 4 – Controls and Procedures

 

 

 

PART II. OTHER INFORMATION

 

 

 

Item 2 – Changes in Securities and Use of Proceeds

 

 

 

Item 6 - Exhibits and Reports on Form 8-K

 

 

 

Signatures

 

 

2



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
PART 1.
FINANCIAL INFORMATION
Item 1 - Financial Statements
CONDENSED CONSOLIDATED
BALANCE SHEETS
(in thousands, except share amounts)
(unaudited)

 

 

 

April 30,
2005

 

January 29,
2005

 

May 1,
2004

 

ASSETS

 

 

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

68,005

 

$

229,768

 

$

89,094

 

Merchandise inventory

 

409,369

 

431,246

 

442,630

 

Deferred taxes

 

14,059

 

15,526

 

8,070

 

Other current assets

 

12,695

 

13,006

 

10,844

 

Total current assets

 

504,128

 

689,546

 

550,638

 

 

 

 

 

 

 

 

 

NET FIXED ASSETS

 

126,266

 

130,196

 

126,025

 

DEFERRED TAXES

 

27,755

 

25,039

 

39,112

 

OTHER ASSETS

 

14,369

 

14,872

 

14,906

 

TOTAL ASSETS

 

$

672,518

 

$

859,653

 

$

730,681

 

 

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

 

 

Accounts payable

 

$

184,942

 

$

358,396

 

$

242,975

 

Income taxes payable

 

2,170

 

8,592

 

15,306

 

Accrued expenses and other

 

36,473

 

43,712

 

42,289

 

Current portion of long-term debt

 

456

 

448

 

 

Current portion of capital lease obligations

 

1,312

 

332

 

407

 

Total current liabilities

 

225,353

 

411,480

 

300,977

 

 

 

 

 

 

 

 

 

LONG-TERM DEBT, less current portion

 

4,943

 

5,060

 

 

CAPITAL LEASE OBLIGATIONS, less current portion

 

11,752

 

6,977

 

7,359

 

DEFERRED RENT AND OTHER LIABILITIES

 

30,795

 

31,813

 

23,866

 

TOTAL LIABILITIES

 

272,843

 

455,330

 

332,202

 

 

 

 

 

 

 

 

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

Preferred stock ($0.01 par value; 5,000,000 shares authorized; none issued)

 

 

 

 

Common stock ($0.01 par value; 200,000,000 shares authorized; 55,429,941, 55,014,598 and 54,385,144 shares issued, respectively)

 

554

 

550

 

544

 

Additional paid-in capital

 

296,931

 

292,922

 

288,964

 

Unearned compensation – restricted stock

 

(41

)

(46

)

(6

)

Accumulated other comprehensive loss

 

(652

)

(1,094

)

 

Treasury stock at cost (22,550,549, 21,988,949 and 18,539,349 shares, respectively)

 

(194,452

)

(186,298

)

(149,930

)

Retained earnings

 

297,335

 

298,289

 

258,907

 

TOTAL SHAREHOLDERS’ EQUITY

 

399,675

 

404,323

 

398,479

 

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

 

$

672,518

 

$

859,653

 

$

730,681

 

 

See Notes to Condensed Consolidated Financial Statements.

 

3



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)

 

 

 

Thirteen Weeks Ended

 

 

 

April 30,
2005

 

May 1,
2004

 

 

 

 

 

 

 

Sales

 

$

285,410

 

$

304,483

 

Cost of sales

 

180,845

 

191,178

 

Gross profit

 

104,565

 

113,305

 

Selling, general and administrative expenses

 

105,867

 

109,695

 

Income (loss) from operations

 

(1,302

)

3,610

 

Interest expense

 

229

 

317

 

Income (loss) before income taxes and extraordinary gain - unallocated negative goodwill

 

(1,531

)

3,293

 

Income tax expense (benefit)

 

(577

)

1,252

 

Income (loss) before extraordinary gain - unallocated negative goodwill

 

$

(954

)

$

2,041

 

Extraordinary gain - unallocated negative goodwill, net of income taxes of $0 and $253, respectively

 

 

418

 

Net income (loss)

 

$

(954

)

$

2,459

 

 

 

 

 

 

 

BASIC INCOME (LOSS) PER SHARE:

 

 

 

 

 

Income (loss) per share before extraordinary gain -unallocated negative goodwill

 

$

(0.03

)

$

0.06

 

Extraordinary gain - unallocated negative goodwill, net of income taxes of $0 and $253, respectively

 

 

0.01

 

Basic income (loss) per share

 

$

(0.03

)

$

0.07

 

 

 

 

 

 

 

Weighted average number of common shares outstanding – basic

 

32,945

 

35,981

 

 

 

 

 

 

 

DILUTED INCOME (LOSS) PER SHARE:

 

 

 

 

 

Income (loss) per share before extraordinary gain -unallocated negative goodwill

 

$

(0.03

)

$

0.06

 

Extraordinary gain - unallocated negative goodwill, net of income taxes of $0 and $253, respectively

 

 

0.01

 

Diluted income (loss) per share

 

$

(0.03

)

$

0.07

 

 

 

 

 

 

 

Weighted average number of common shares outstanding – diluted

 

32,945

 

37,609

 

 

See Notes to Condensed Consolidated Financial Statements.

 

4



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
CASH FLOWS
(in thousands)
(unaudited)

 

 

 

Thirteen Weeks Ended

 

 

 

April 30,
2005

 

May 1,
2004

 

Net cash used by operating activities

 

$

(156,410

)

$

(89,309

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of fixed assets

 

(5,497

)

(9,686

)

Net cash used by investing activities

 

(5,497

)

(9,686

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payments of long-term debt

 

(109

)

 

Proceeds from capital leases

 

5,947

 

 

Payments of capital lease obligations

 

(192

)

(94

)

Payments for purchases of treasury stock

 

(8,154

)

(3,875

)

Proceeds from the exercise of stock options

 

2,652

 

328

 

Net cash provided (used) by financing activities

 

144

 

(3,641

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(161,763

)

(102,636

)

Cash and cash equivalents, beginning of year

 

229,768

 

191,730

 

Cash and cash equivalents, end of period

 

$

68,005

 

$

89,094

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

Income tax benefit resulting from exercises of stock options

 

$

1,363

 

$

364

 

 

See Notes to Condensed Consolidated Financial Statements.

 

5



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
April 30, 2005 and May 1, 2004

 

Note 1. Nature of Operations

 

Trans World Entertainment Corporation and subsidiaries (“the Company”) is one of the largest specialty retailers of music, video, including DVD and VHS, video games and related products in the United States.  The Company operates a chain of retail entertainment stores and e-commerce sites, www.fye.com, www.coconuts.com, www.wherehouse.com, and www.secondspin.com in a single industry segment.  As of April 30, 2005, the Company operated 804 stores totaling approximately 4.9 million square feet in 46 states, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands, with a majority of the stores concentrated in the eastern half of the United States.

 

Note 2: Basis of Presentation

The accompanying unaudited condensed consolidated financial statements consist of Trans World Entertainment Corporation, its wholly owned subsidiary Record Town, Inc. (“Record Town”) and Record Town’s subsidiaries, all of which are wholly owned (“the Company”).   All significant intercompany accounts and transactions have been eliminated.

 

The interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  The information furnished in these condensed consolidated financial statements reflects all normal, recurring adjustments which, in the opinion of management, are necessary for the fair presentation of such financial statements.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to rules and regulations applicable to interim financial statements.

 

The information presented in the accompanying unaudited condensed consolidated balance sheet as of January 29, 2005 has been derived from the Company’s January 29, 2005 audited consolidated financial statements. All other information has been derived from the Company’s unaudited consolidated financial statements as of and for the thirteen weeks ended April 30, 2005 and May 1, 2004.   These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2005. Certain reclassifications have been made to prior periods to conform to the current period presentation.

 

The Company’s significant accounting policies are the same as those described in Note 1 to the Company’s Consolidated Financial Statements on Form 10-K for the fiscal year ended January 29, 2005.

 

Note 3. Seasonality

The Company’s business is seasonal in nature, with the fourth fiscal quarter constituting the Company’s peak selling period.  In 2004, the fourth fiscal quarter accounted for approximately 38% of annual sales.  In anticipation of increased sales activity during these months, the Company purchases additional

 

6



 

inventory and hires additional, temporary employees to supplement its permanent store sales staff.   If, for any reason, the Company’s net sales were below seasonal norms during the fourth quarter, the Company’s operating results, particularly operating and net income, could be adversely affected.  Additionally, quarterly sales results, in general, are affected by the timing of new product releases, new store openings or closings and the performance of existing stores.

 

Note 4. Stock Based Compensation

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation – An Interpretation of APB No. 25, in accounting for its fixed plan stock options.  Under this method, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price.  Unearned compensation recognized for restricted stock awards is shown as a separate component of shareholders’ equity and is amortized to expense over the vesting period of the stock award using the straight-line method.  Statement of Financial Accounting Standards (“SFAS”) No. 123,Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans.  As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123 and SFAS No.148.

 

The following table illustrates the effect on net income (loss) and income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:

 

 

 

Thirteen weeks ended

 

 

 

April 30, 2005

 

May 1, 2004

 

 

 

(in thousands except per share
amounts)

 

Net income (loss), as reported

 

$

(954

)

$

2,459

 

Add: Stock-based employee compensation expense included in reported net income (loss), net of income taxes

 

43

 

17

 

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of income taxes

 

(719

)

(516

)

Proforma net income (loss)

 

$

(1,630

)

$

1,960

 

Income (loss) per share:

 

 

 

 

 

Basic – as reported

 

$

(0.03

)

$

0.07

 

Basic– proforma

 

$

(0.05

)

$

0.05

 

Diluted – as reported

 

$

(0.03

)

$

0.07

 

Diluted – proforma

 

$

(0.05

)

$

0.05

 

 

7



 

Note 5. Defined Benefit Plan

The Company maintains a non-qualified Supplemental Executive Retirement Plan (“SERP”) for certain executive officers of the Company.  The SERP, which is unfunded, provides eligible executives defined pension benefits that supplement benefits under other retirement arrangements.  The annual benefit amount is based on salary and bonus at the time of retirement and number of years of service.

 

The Company provides the Board of Directors with a noncontributory, unfunded retirement plan (“Director Retirement Plan”) that pays a retired director an annual retirement benefit equal to 60% of the annual retainer at the time of retirement plus a 3% annual increase through the final payment.  Payments begin at age 62 or retirement, whichever is later, and continue for 10 years or the life of the director and his or her spouse, whichever period is shorter.  Partial vesting in the retirement plan begins after six years of continuous service.  Participants become fully vested after 12 years of continuous service on the Board. The Company accounts for the SERP and the Director Retirement Plan in accordance with the provisions of SFAS No. 87, Employers’ Accounting for Pensions.

 

Effective June 1, 2003, new directors are no longer covered by the Director Retirement Plan.  Current directors who were not yet vested in their retirement benefits had the present value of benefits already accrued as of the effective date converted to deferred shares under the Directors Stock Option Plan.  Directors that were fully or partially vested in their retirement benefits were given a one time election to continue to participate in the current retirement program or convert the present value of benefits already accrued to deferred shares under the Directors Stock Option Plan as of the effective date.

 

During the thirteen weeks ended April 30, 2005, the Company did not make any cash contributions to the SERP and the Director Retirement Plan, and presently expects to pay $35,000 in benefits relating to SERP and $15,000 in benefits relating to the Director Retirement Plan during fiscal 2005. The following represents the components of the net periodic pension cost related to the Company’s SERP and Director Retirement Plan for the respective periods:

 

 

 

Thirteen weeks ended

 

 

 

April 30, 2005

 

May 1, 2004

 

 

 

($ in thousands)

 

Service cost

 

$

133

 

$

101

 

Interest cost

 

196

 

157

 

Amortization of prior service cost

 

85

 

85

 

Amortization of net (gain)/loss

 

62

 

4

 

Net periodic pension cost

 

$

476

 

$

347

 

 

Note 6. Extraordinary Gain

The Company acquired substantially all the net assets of Wherehouse Entertainment Inc. and CD World Inc. in October 2003 for $35.2 million and $1.9 million, respectively. The purchase price was allocated on a preliminary basis using information available at the time. In accordance with SFAS No. 141, Business Combinations, the allocation of the purchase price to the assets and liabilities acquired were finalized during the thirteen weeks ended October 30, 2004, after obtaining more information regarding asset valuations and liabilities assumed.  During the thirteen weeks ended May 1, 2004, the Company adjusted the purchase price allocation in accordance with the provisions of SFAS No. 141, resulting in

 

8



 

an extraordinary gain of $0.7 million, net of income taxes of $0.3 million, related to unallocated negative goodwill. The gain represents the excess of the fair value of net assets acquired over the purchase price.

 

Note 7. Long-Term Debt and Capital Lease Obligations

During the thirteen weeks ended April 30, 2005, the Company signed an agreement to finance the replacement of its point-of-sale system through a capital lease of up to $12.0 million. When fully drawn, the lease will bear an average interest rate of 5.76% and will be repaid in monthly installments over 5 years. As of April 30, 2005, the Company had drawn $5.9 million under the lease agreement and anticipates drawing up to another $6.0 million by July 30, 2005.

 

During 2004, the Company borrowed $5.8 million under a mortgage loan with South Trust Bank to finance the purchase of real estate. The mortgage loan is repayable in monthly installments of $64 thousand over 10 years with a fixed interest rate of 6.0% and is collateralized by the real estate. The mortgage loan contains a minimum net worth (shareholders’ equity) covenant of $290 million, excluding the impact, if any, of certain non-cash charges.

 

Note 8. Comprehensive Income (Loss)

The Company accounts for comprehensive income (loss) in accordance with SFAS No. 130, Reporting Comprehensive Income.  SFAS No. 130 requires only additional disclosures in the consolidated financial statements; it does not affect the Company’s financial position or results of operations.  Items of other comprehensive income that the Company currently reports are the excess additional minimum pension liability over unrecognized prior service cost and unrealized gains and losses on marketable securities categorized as available-for-sale.  The Company’s total comprehensive income (loss) for the thirteen weeks ended April 30, 2005 and May 1, 2004 was as follows:

 

 

 

Thirteen Weeks ended

 

 

 

April 30, 2005

 

May 1, 2004

 

 

 

($ in thousands)

 

Net income (loss)

 

$

(954

)

$

2,459

 

 

 

 

 

 

 

Other comprehensive income net of income taxes:

 

 

 

 

 

Change in unrealized gain on available-for-sale securities, net of income taxes of $306 and 0, respectively

 

442

 

 

Total comprehensive income (loss)

 

$

(512

)

$

2,459

 

 

Note 9. Recently Issued Accounting Standards

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment: an amendment of FASB Statements No. 123 and 95. This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the grant date (with limited exceptions) and recognize the compensation cost over the period during which an employee is required to provide service in exchange for the award. In March 2005, the U.S. Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”), which expresses views of the SEC staff regarding the application of SFAS No. 123(R). Among other

 

9



 

things, SAB 107 provides interpretive guidance related to the interaction between SFAS No. 123(R) and certain SEC rules and regulations, and provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. The Company is required to adopt SFAS No. 123(R) in its first quarter of its next fiscal year. The Company is currently evaluating the potential effects of this standard on its stock compensation arrangements and related effects on the Company’s condensed consolidated financial statements.

 

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets – Accounting Principles Board Opinion No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 requires that exchanges should be recorded and measured at the fair value of the assets exchanged, with certain exceptions. SFAS No. 153 is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS No. 153 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations. In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4. SFAS No. 151 clarifies that abnormal inventory costs such as costs of idle facilities, excess freight and handling costs, and wasted materials (spoilage) are required to be recognized as current period charges.  The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a significant impact on the Company’s consolidated financial position or results of operations.

 

Note 10. Depreciation and Amortization

Depreciation and amortization of fixed assets included in the condensed consolidated statements of operations is as follows:

 

 

 

Thirteen weeks ended

 

 

 

April 30, 2005

 

May 1, 2004

 

 

 

(in thousands)

 

Cost of sales

 

$

780

 

$

583

 

SG&A

 

8,220

 

8,526

 

 

 

 

 

 

 

Total

 

$

9,000

 

$

9,109

 

 

10



 

Note 11. Earnings Per Share

Weighted average shares are calculated as follows:

 

 

 

Thirteen weeks ended

 

 

 

April 30, 2005

 

May 1, 2004

 

 

 

 

 

 

 

Weighted average common shares outstanding – basic

 

32,945

 

35,981

 

Dilutive effect of employee stock options

 

 

1,628

 

 

 

 

 

 

 

Weighted average common shares outstanding–diluted

 

32,945

 

37,609

 

 

 

 

 

 

 

Anti-dilutive stock options

 

8,860

 

4,023

 

 

For the thirteen week period ended April 30, 2005, the impact of outstanding stock options was not considered because the Company reported a net loss and such impact would be anti-dilutive.

 

Note 12. Legal Proceedings

The Company is subject to legal proceedings and claims that have arisen in the ordinary course of its business and have not been finally adjudicated.  Although there can be no assurance as to the ultimate disposition of these matters, it is management’s opinion, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operations and financial condition of the Company.

 

11



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
Item 2 - Management’s Discussion and Analysis of Financial Condition and
Results of Operations
April 30, 2005 and May 1, 2004

 

Overview

Management’s Discussion and Analysis of Financial Condition and Results of Operations provides information that the Company’s management believes necessary to achieve an understanding of its financial statements and results of operations.  To the extent that such analysis contains statements which are not of a historical nature, such statements are forward-looking statements, which involve risks and uncertainties.  These risks include, but are not limited to, changes in the competitive environment for the Company’s merchandise, including the entry or exit of non-traditional retailers of the Company’s merchandise to or from its markets; releases by the music, video, including DVD and VHS, and video games industries of an increased or decreased number of “hit releases”; general economic factors in markets where the Company’s merchandise is sold; and other factors discussed in the Company’s filings with the Securities and Exchange Commission.  The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included elsewhere in this report and the audited financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2005.

 

At April 30, 2005, the Company operated 804 stores totaling approximately 5.0 million square feet in 46 states, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands. The Company’s stores offer predominantly entertainment software, including music, video, including DVD and VHS, and video games.  In total, these categories represented 91% of the Company’s sales in the thirteen weeks ended April 30, 2005.  The balance of categories, including software accessories, boutique and electronic products, represented 9% of the Company’s sales in the thirteen weeks ended April 30, 2005.

 

The Company’s success has been, and will continue to be contingent upon management’s ability to understand general economic and business trends and to manage the business in response to those trends. Management monitors a number of key performance indicators to evaluate its performance, including:

 

Sales:  The Company measures the rate of comparable store sales change. A store is included in comparable store sales calculations at the beginning of its thirteenth full month of operation.  Mall stores relocated in the same shopping center after being open for at least thirteen months are considered comparable stores.  Closed stores that were open for at least thirteen months are included in comparable store sales through the month immediately preceding the month of closing.  The Company further analyzes sales by store format (i.e., mall versus freestanding) and by product category.

 

Cost of Sales and Gross Profit:  Gross profit is impacted primarily by the mix of products sold and by discounts negotiated with vendors.  The Company records its distribution and product shrink expenses in cost of sales. Distribution expenses include those costs associated with purchasing, receiving, inspecting and warehousing product and costs associated with product returns to vendors.  Cost of sales further includes obsolescence costs and is reduced by the benefit of vendor allowances.

 

12



 

Selling, General and Administrative (“SG&A”) expenses: Included in SG&A expenses are payroll and related costs, occupancy charges, professional and service fees, general operating and overhead expenses and depreciation charges (excluding those related to distribution operations, as discussed in Note 10 to the Condensed Consolidated Financial Statements).  SG&A expenses also include asset impairment charges and write-offs, if any, and miscellaneous items, other than interest.

 

Balance Sheet and Ratios:  The Company views cash, net inventory investment (inventory less accounts payable) and working capital (current assets less current liabilities) as indicators of its financial position.  See Liquidity and Capital Resources for further discussion of these items.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires that management apply accounting policies and make estimates and assumptions that affect results of operations and the reported amounts of assets and liabilities in the financial statements.  Management continually evaluates its estimates and judgments including those related to merchandise inventory and return costs, valuation of long-lived assets, income taxes, and accounting for vendor allowances.  Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable under the circumstances.  Actual results may differ from these estimates under different assumptions or conditions.   Note 1 of Notes to the Consolidated Financial Statements on Form 10-K for the year ended January 29, 2005 includes a summary of the significant accounting policies and methods used by the Company in the preparation of its condensed consolidated financial statements. Management believes that of the Company’s significant accounting policies, the following may involve a higher degree of judgment or complexity:

 

Merchandise Inventory and Return Costs: Inventory is stated at the lower of cost or market as determined by the average cost method. Inventory valuation requires significant judgment and estimates, including obsolescence, shrink and any adjustments to market value, if market value is lower than cost. The Company records obsolescence and any adjustments to market value (if lower than cost) based on current and anticipated demand, customer preferences, and market conditions. The provision for inventory shrink is estimated as a percentage of sales for the period from the last date a physical inventory was performed to the end of the fiscal year.  Such estimates are based on historical results and trends, and the shrink results from the last physical inventory.  Physical inventories are taken at least annually for all stores throughout the year, and inventory records are adjusted accordingly.

 

The Company is entitled to return merchandise purchased from major vendors for credit against other purchases from these vendors.   These vendors often reduce the credit with a merchandise return charge ranging from 0% to 20% of the original merchandise purchase price depending on the type of merchandise being returned.  The Company records merchandise return charges in cost of sales.

 

13



 

Valuation of Long-Lived Assets:  The Company assesses the potential impairment of long-lived assets to determine if any part of the carrying values may not be recoverable. Factors that the Company considers when assessing impairment include:

         significant underperformance relative to historical results;

         significant changes in the manner of the use of assets or the strategy for the Company’s overall business;

         significant negative industry or economic trends;

 

If the Company were to determine that the carrying value of a long-lived asset may not be recoverable based on one or more of the above indicators, the Company would test for impairment to determine if a write-down is needed.

 

Income Taxes: Income taxes are accounted for under the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax operating loss carryforwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date.  Accounting for income taxes requires management to make estimates and judgments regarding interpretation of various taxing jurisdictions, laws and regulations as well as the ultimate realization of deferred tax assets.  These estimates and judgments include the generation of future taxable income, viable tax planning strategies and support of tax filings.  Valuation allowances are recorded against deferred tax assets if, based upon management’s estimates of realizability, it is more likely than not that some portion or all of these deferred tax assets will not be realized.

 

14



 

RESULTS OF OPERATIONS

 

Thirteen Weeks Ended April 30, 2005
Compared to the Thirteen Weeks Ended May 1, 2004

 

The following table sets forth a period over period comparison of the Company’s sales by category:

 

 

 

Thirteen weeks ended

 

 

 

 

 

 

 

 

 

April 30,
2005

 

May 1,
2004

 

Change

 

%

 

Comp
Store Sales

 

 

 

 

 

(in thousands)

 

 

 

 

 

 

 

Sales

 

$

285,410

 

$

304,483

 

$

(19,073

)

(6.3

)%

(1.5

)%

As a percentage of sales

 

 

 

 

 

 

 

 

 

 

 

Music

 

56

%

59

%

 

 

 

 

(5.3

)%

Video (VHS/DVD)

 

28

%

28

%

 

 

 

 

(2.6

)%

Video Games

 

7

%

5

%

 

 

 

 

39.0

%

Other

 

9

%

8

%

 

 

 

 

11.0

%

 

 

 

 

 

 

 

 

 

 

 

 

Store Count:

 

 

 

 

 

 

 

 

 

 

 

Mall

 

556

 

590

 

(34

)

(5.8

)%

(1.5

)%

Freestanding

 

248

 

269

 

(21

)

(7.8

)%

(1.4

)%

Total

 

804

 

859

 

(55

)

(6.4

)%

 

 

 

Sales.   The decrease in sales resulted from a comparable store sales decrease of 1.5% and a decrease in the average number of stores in operation.  The average number of stores in operation decreased to 807 in the thirteen weeks ended April 30, 2005 from 870 in the thirteen weeks ended May 1, 2004.

 

15



 

Music:

The Company’s stores offer a wide range of compact discs (“CD”), audio cassettes and singles across most music genres, including new releases from current artists as well as an extensive catalog of music from past periods and artists. The Company’s music sales for the thirteen weeks ended April 30, 2005 decreased 9.6% and comparable store sales in the CD category decreased 4.3%. The decrease was due to lower sales of new releases during the quarter versus the prior year period.  During the thirteen weeks ended April 30, 2005, industry unit sales of music in the U.S. decreased 9.2% according to Soundscan.

 

Video:

The Company offers video, including digital video discs (“DVD”) and videocassettes, in all of its stores.  Comparable store sales in the DVD category increased 2.4%.  The increase in DVD did not offset the decline in comparable store sales in the videocassette category during the quarter.

 

Video Games:

The Company offers video game hardware and software in most of its stores, with a mix that favors software.  The increase in comparable store sales of 39.0% in this category was due mostly to the release of Sony’s PSP game system.

 

Other:

The Company offers items for the use, care and storage of entertainment software, along with boutique and electronic products.  The increase is due to the  Company’s merchandising initiatives to improve this category, including the introduction of new lines, and adding new SKU’s (“stock keeping unit”) to further complement the core merchandise categories of music, video and video games.

 

Gross Profit.  The following table sets forth a period over period comparison of the Company’s gross profit:

 

 

 

Thirteen weeks ended

 

Change

 

 

 

(in thousands)

 

 

 

 

 

April 30, 2005

 

May 1, 2004

 

$

 

%

 

Gross Profit

 

$

104,565

 

$

113,305

 

$

(8,740

)

(7.7

)%

As a percentage of sales

 

36.6

%

37.2

%

 

 

 

 

 

The decrease in the gross profit rate as a percentage of sales was due to a shift in the mix of the Company’s sales toward the lower margin categories of DVD and games and higher markdowns in the electronics, accessories and boutique categories due to promotions and clearance activity.

 

16



 

SG&A Expenses.  The following table sets forth a period over period comparison of the Company’s SG&A expenses:

 

 

 

Thirteen weeks ended

 

Change

 

 

 

(in thousands)

 

 

 

 

 

April 30, 2005

 

May 1, 2004

 

$

 

%

 

SG&A Expenses

 

$

105,867

 

$

109,695

 

$

(3,828

)

(3.5

)%

As a percentage of sales

 

37.1

%

36.0

%

 

 

 

 

 

SG&A expenses decreased $3.8 million due to the decrease in the number of stores in operation. Although variable SG&A expenses decreased due to fewer stores in operation, fixed expenses remained consistent year over year resulting in the loss of expense leverage  as a percentage of sales on the total sales decline of 6.3%.

 

Income Tax Expense (Benefit).  The following table sets forth a period over period comparison of the Company’s income tax expense (benefit):

 

 

 

Thirteen weeks ended

 

 

 

(in thousands)

 

 

 

April 30, 2005

 

May 1, 2004

 

Income tax expense (benefit) before change in state tax laws

 

$

(624

)

$

1,252

 

 

 

 

 

 

 

 

 

Effective tax rate before impact of change in state tax laws

 

40.8

%

38.0

%

 

 

 

 

 

 

Effect of changes in state tax laws enacted during the thirteen weeks ended April 30, 2005

 

47

 

 

 

 

 

 

 

 

Income tax expense (benefit)

 

$

(577

)

$

1,252

 

 

The increase in the effective tax rate before the impact of change in state tax laws as compared to the thirteen weeks ended May 1, 2004, is attributable to projected higher state deferred taxes resulting from increased utilization of state loss carryforwards.  The effective tax rate including the effect of a change in state tax laws for the thirteen weeks ended April 30, 2005 was 37.7%.

 

Extraordinary Gain – Unallocated Negative Goodwill. In October 2003, the Company acquired substantially all of the net assets of Wherehouse Entertainment Inc. and CD World Inc. During the thirteen weeks ended May 1, 2004, the Company adjusted the purchase price allocation in accordance with the provisions of SFAS No. 141, Business Combinations, resulting in an extraordinary gain of $0.7 million, net of income taxes of $0.3 million, related to unallocated negative goodwill. The gain represents the excess of the fair value of net assets acquired over the purchase price.

 

17



 

Net Income (Loss). The following table sets forth a period over period comparison of the Company’s net income (loss):

 

 

 

Thirteen weeks ended

 

 

 

(in thousands)

 

 

 

April 30, 2005

 

May 1, 2004

 

Income (loss) before extraordinary gain

 

$

(954

)

$

2,041

 

 

 

 

 

 

 

 

 

Extraordinary gain – unallocated negative goodwill, net of income taxes of $0 and $253 respectively

 

 

418

 

 

 

 

 

 

 

Net income (loss)

 

$

(954

)

$

2,459

 

 

The decrease was due to lower sales and gross margins.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity. The Company’s primary sources of working capital are cash provided by operations and borrowings under its revolving credit facility.  The Company’s cash flows fluctuate from quarter to quarter due to various items, including seasonality of sales and results from operations, inventory purchases and the related terms on the purchases, tax payments, capital expenditures and stock repurchase activity and store acquisitions.  Management believes it will have adequate resources to fund its cash needs for the foreseeable future.

 

The following table sets forth a summary of key components of cash flow and working capital for each of the thirteen weeks ended April 30, 2005 and May 1, 2004:

 

 

 

Thirteen weeks ended

 

Change

 

(in thousands)

 

April 30, 2005

 

May 1, 2004

 

$

 

Operating Cash Flows

 

$

(156,410

)

$

(89,309

)

$

(67,101

)

Financing Cash Flows

 

144

 

(3,641

)

3,785

 

 

 

 

 

 

 

 

 

Capital Expenditures

 

5,497

 

9,686

 

(4,189

)

 

 

 

 

 

 

 

 

Cash and Cash Equivalents

 

68,005

 

89,094

 

(21,089

)

Inventories

 

409,369

 

442,630

 

(33,261

)

Working Capital

 

278,775

 

249,661

 

29,114

 

Inventory turns

 

0.4

 

0.5

 

 

 

 

18



 

The Company had cash balances of $68.0 million at April 30, 2005, compared to $229.8 million at January 29, 2005 and $89.4 million at May 1, 2004.  Inventory was $82 per square foot at April 30, 2005, compared to $84 per square foot at May 1, 2004.

 

Cash used by operating activities was $156.4 million for the thirteen weeks ended April 30, 2005.  The primary uses of cash were a $173.5 million seasonal reduction of accounts payable and a $6.4 million reduction in income taxes payable, offset by a $21.9 million decrease in merchandise inventory,. The Company’s inventory and accounts payable are heavily influenced by the seasonality of its business. A significant reduction of accounts payable occurs annually in the fiscal first quarter, reflecting payments for merchandise inventory sold during the prior year’s holiday season.  Similarly, inventory increases each year throughout the fall season and peaks during the holiday selling season.  The seasonality of the Company’s earnings in its fiscal fourth quarter also results in the timing of substantially all of income tax payments to be made subsequent to year end. These cash uses are offset by a significant cash source in the fiscal fourth quarter from the increase in sales during the holiday season.

 

Cash provided by financing activities was $144 thousand for the thirteen weeks ended April 30, 2005.  The primary source of cash was through a capital lease transaction of $5.9 million to finance the replacement of the Company’s point-of-sale system and the exercise of stock options of $2.7 million. The primary use of cash was $8.2 million for the purchase of approximately 560,000 shares of common stock under a stock repurchase program authorized by the Company’s Board of Directors in May 2003.  The authorized stock repurchase program allows the Company to repurchase 10 million shares of Common Stock from time to time on the open market and has no expiration date. As of May 31, 2005, the Company had 2.2 million remaining shares authorized for repurchase.

 

The Company has a three-year, $100 million secured revolving credit facility with Congress Financial Corporation that expires in July 2006 and renews on a year-to-year basis thereafter with the consent of both parties. The revolving credit facility contains certain restrictive provisions, including provisions governing cash dividends and acquisitions and is collateralized by merchandise inventory and other assets. The Company anticipates the amount of the revolving credit facility being fully available to the Company through its term, and does not anticipate any difficulty in obtaining a similar, replacement facility upon its expiration. As of April 30, 2005, the Company had $0.1 million in outstanding letter of credit obligations under the revolving credit facility, and $99.9 million was available for borrowing. As of May 1, 2004, the Company had no borrowings under the revolving credit facility.

 

During 2004, the Company borrowed $5.8 million under a mortgage loan with South Trust Bank to finance the purchase of real estate. The mortgage loan is repayable in monthly installments of $64 thousand over 10 years with a fixed interest rate of 6.0% and is secured by the real estate.

 

19



 

The revolving credit facility restricts the amount of dividends that the Company can declare up to 10% of its annual net income, excluding certain non-cash gains.  Payment of any dividends is further subject to levels of availability on the Company’s revolving credit facility. The mortgage loan and the revolving credit facility contain a minimum net worth (shareholders’ equity) covenant of $290 million, excluding the impact, if any, of certain non-cash charges.

 

During the thirteen weeks ended April 30, 2005, the Company signed an agreement to finance the replacement of its point-of-sale system through a capital lease of up to $ 12.0 million. When fully drawn, the lease will bear an average interest rate of 5.76% and will be repaid in monthly installments over 5 years. As of April 30, 2005, the Company had drawn $5.9 million of the lease and anticipates drawing up to another $6.0 million by July 30, 2005.

 

Capital Resources.  During the thirteen weeks ended April 30, 2005, the Company made capital expenditures of $5.5 million. The Company plans to spend approximately $45 million for capital expenditures in fiscal 2005.  During the thirteen weeks ended April 30, 2005, the Company opened or relocated 4 stores and closed 10 stores.

 

20



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

PART I – FINANCIAL INFORMATION

 

Item 3 - Quantitative and Qualitative Disclosures about Market Risk

 

To the extent the Company borrows under its credit facility, the Company is subject to risk resulting from interest rate fluctuations since interest on the Company’s borrowings under its credit facility can be variable.  Interest on the revolving credit facility is payable monthly in arrears at a variable rate of either the prime rate or LIBOR plus 1.65%.  If interest rates on the Company’s credit facility were to increase by 25 basis points, and to the extent borrowings were outstanding, for every $1,000,000 outstanding on the facility,  income before income taxes would be reduced by $2,500 per year. For a discussion of the Company’s accounting policies for financial instruments and further disclosures relating to financial instruments, see “Nature of Operations and Summary of Significant Accounting Policies” in the Notes to Consolidated Financial Statements in the Company’s Form 10-K for the year ended January 29, 2005. The Company does not hold any derivative instruments and does not engage in hedging activities.

 

Item 4 – Controls and Procedures

 

 (a)    Evaluation of disclosure controls and procedures.    The Company’s Chief  Executive Officer and Chief Financial Officer after evaluating the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as of April 30, 2005, have concluded that as of such date the Company’s disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to the Company and its subsidiaries would be made known to such officers on a timely basis.

 

 (b)    Changes in internal controls.    There have been no changes in the Company’s internal controls over financial reporting that occurred during the fiscal quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

 

21



 

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

PART II - OTHER INFORMATION

 

Item 2 – Changes in Securities and Use of Proceeds

 

On May 28, 2003, the Company’s Board of Directors authorized the repurchase of 10 million outstanding shares of the Company’s Common Stock from time to time on the open market. The program has no expiration date.  The Company had repurchased 15 million shares of common stock under previously announced programs. As of April 30, 2005 the Company had purchased 7.4 million shares, at a total cost of $65.3 million, and 2.6 million shares remained to be purchased under the current program. The following table shows the purchase of equity securities purchased under the repurchase program as required by Regulation 229.703 Item 703:

 

Period

 

Total Number of
Shares Purchased

 

Average Price Paid
per Share

 

Total Number of
Shares Purchased as
Part of Publicly
Announced
Programs

 

Maximum Number
of Shares that May
Yet Be Purchased
Under the Plan

 

January 30, 2005 – February 26, 2005

 

20,800

 

$

13.55

 

20,800

 

3,096,241

 

February 27, 2005 – March 26, 2005

 

490,800

 

$

14.50

 

490,800

 

2,605,441

 

March 27, 2005 – April 30, 2005

 

50,000

 

$

14.82

 

50,000

 

2,555,441

 

Total

 

561,600

 

$

14.52

 

561,600

 

2,555,441

 

 

Item 6 - Exhibits and Reports on Form 8-K

 

(A)       Exhibits -

 

Exhibit No.

 

Description

 

31.1

 

Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

 

 

31.2

 

Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

 

 

32

 

Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

(B)       Reports on Form 8-K –

 

A Form 8-K was filed on February 25, 2005, incorporating by reference Trans World Entertainment’s February 24, 2005 press release announcing the Company’s financial results for the quarter and year ended January 29, 2005.

 

A Form 8-K was filed on May 13, 2005 incorporating by reference the Company’s May 12, 2005 press release announcing the Company’s financial results for the thirteen weeks ended April 30, 2005.

 

Omitted from this Part II are items which are not applicable or to which the answer is negative to the periods covered.

 

22



 

SIGNATURES

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

TRANS WORLD ENTERTAINMENT CORPORATION

 

June 9, 2005

By:

/s/ ROBERT J. HIGGINS

 

 

 

Robert J. Higgins

 

 

Chairman and Chief Executive Officer

 

 

(Principal Executive Officer)

 

 

 

 

June 9, 2005

By:

/s/ JOHN J. SULLIVAN

 

 

 

John J. Sullivan

 

 

Executive Vice President and Chief Financial Officer (Principal Financial
and Chief Accounting Officer)

 

23


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