Tuesday Morning 10-K 2007
Documents found in this filing:
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2006
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 0-19658
Tuesday Morning Corporation
(Exact name of registrant as specified in its charter)
6250 LBJ Freeway
(Address, zip code and
telephone number, including area code,
Securities registered pursuant to Section 12 (b) of the Act: Common Stock, $.01 par value per share registered on the Nasdaq Global Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. x
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 o Accelerated filer x Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of shares of the registrants common stock held by non-affiliates of the registrant at June 30, 2006 was approximately $351,964,000, based upon the closing sale price on the Nasdaq National Market reported for such date.
At March 15, 2007, there were 41,428,321 outstanding shares of the registrants common stock.
Documents Incorporated By Reference:
Portions of the Registrants Proxy Statement for the 2007 Annual Meeting of Stockholders are incorporated herein by reference to the extent indicated in Part III of this Form 10-K.
This Form 10-K contains forward-looking statements within the meaning of the federal securities laws and the Private Securities Litigation Reform Act of 1995. These statements may be found throughout this Form 10-K, particularly under the headings Business and Managements Discussion and Analysis of Financial Condition and Results of Operation, among others. Forward-looking statements typically are identified by the use of terms such as may, will, should, expect, anticipate, believe, estimate, intend and similar words, although some forward-looking statements are expressed differently. You should consider statements that contain these words carefully because they describe our expectations, plans, strategies and goals and our beliefs concerning future business conditions, our results of operations, financial position, and our business outlook or state other forward-looking information based on currently available information. The factors listed below under the heading Risk Factors and in the other sections of this Form 10-K provide examples of risks, uncertainties and events that could cause our actual results to differ materially from the expectations expressed in our forward-looking statements.
The forward-looking statements made in this Form 10-K relate only to events as of the date on which the statements are made. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.
The terms Tuesday Morning, we, us, and our as used in this Form 10-K refer to Tuesday Morning Corporation and its subsidiaries.
We are a leading closeout retailer of upscale home furnishings, housewares, gifts and related items in the United States. We opened our first store in 1974 and operated 795 stores in 47 states as of December 31, 2006. Our stores operate during periodic sales events, that occur in each month except January and July. We are generally closed for the first two weeks of January and July which traditionally have been weaker months for retailers. We purchase first quality, brand name merchandise at closeout and sell it at prices 50% to 80% below those generally charged by department stores and specialty and catalog retailers. We do not sell seconds, irregulars, refurbished or factory rejects.
We believe that our well recognized, first quality brand name merchandise and value-based pricing have enabled us to establish and maintain strong customer loyalty. Our customers, who are predominantly women from middle and upper-income households, are brand savvy, value-conscious customers seeking quality products at discount pricing. While we offer our customers consistent merchandise categories, each sales event features limited quantities of new and appealing products within these categories, creating a treasure hunt atmosphere in our stores.
We believe that our customers are attracted to our stores by our advertising and direct mail program that emphasize the limited quantities of first quality, brand name merchandise which we offer at attractive prices, rather than location. This has allowed us to open our stores in secondary locations of major suburban markets such as strip malls, near our middle and upper income customers. We are able to obtain favorable lease terms because of our flexibility in site selection and our no-frills format, which allows us to use a wide variety of space configurations.
In 2006, we recorded sales of $911.1 million and operating income of $36.4 million. Since 1998, our compound annual growth in sales and operating income have been 11% and 4%, respectively. In June 2005, we paid the first annual cash dividend in our history of $0.65 per share and followed with a second annual dividend in March 2006 of $0.80 per share. Dividend payments are at the discretion of our Board of Directors, however, we currently anticipate paying dividends in the future.
Our success is based on the following operating strengths:
· Unique Event-Based Format. We distinguish ourselves from other retailers with a unique event-based selling strategy, creating the excitement of multiple grand openings and closeout sales each year. Merchandise is available in limited quantities and specific items are generally not replenished during a sales event, however, stores continue to receive new merchandise throughout a sales event. We believe that the limited quantities of specific items intensify customers sense of urgency to buy our merchandise. Accordingly, we have historically generated a majority of an events sales in the first five days of the event. We intend to continue to adhere to this strategy, but we have increased the frequency of shipments to our stores of new and different merchandise during the later stages of sales events to encourage new and repeat customer visits.
· Strong Sourcing Capabilities and Purchasing Flexibility. We have developed strong sourcing capabilities that allow us to gain favorable access to first quality, brand name merchandise at attractive prices. In many cases, we are the retailer of choice to liquidate inventory due to our ability to make purchasing decisions quickly and to rapidly sell large quantities of merchandise without disrupting the manufacturers traditional distribution channels or compromising their brand image. Our flexible purchasing strategy allows us to pursue new products and merchandise categories from
vendors as opportunities arise. We employ an experienced buying team, which has grown from 10 buyers in 1993 to 24 buyers currently, with an average of over 23 years of retail experience. Our buyers and our reputation as a preferred, reliable closeout retailer have enabled us to establish long-term relationships with a diverse group of top-of-the-line vendors.
· Loyal Customer Base of Brand Savvy and Value-Conscious Consumers. We have a loyal customer base consisting primarily of women ranging in age from 35 to 54 from middle and upper-income households with a median annual family income of approximately $60,000. In addition to making purchase decisions based on brand names and product quality, our customers are also value-conscious. We believe our value-based pricing, which enables our customers to realize savings of 50% to 80% over competing department store retail prices, has resulted in both strong customer loyalty and satisfaction. We have developed and currently maintain a proprietary mailing and email list consisting of over 8.0 million customers. These customers have visited our stores and requested mailings to alert them of upcoming sales events including the brand name merchandise and prices to be offered, prior to the advertising of a sales event to the general public.
· Attractive Store Level Economics. We have strong store level economics due to our low store operating expenses and the low initial investment required to open new stores. Our destination-oriented retail format allows us to open stores in a wide range of locations, resulting in attractive lease rates compared to those of other retailers. In addition to our low real estate costs, we maintain low operating and depreciation costs due to our no-frills, self-service format. Because we use low cost store fixtures and have low pre-opening costs, our new stores require a low initial investment and have historically generated a very attractive return on investment in their first full year.
· Disciplined Inventory and Supply Chain Management. We have developed disciplined inventory control and supply chain management procedures. Our purchasing flexibility and strong relationships with vendors allow us to coordinate the timing of purchases and receipt of merchandise closely with our sales events. Our merchandise and distribution systems allow us to quickly and efficiently process and ship merchandise from our distribution center to our stores. Finally, our point-of-sale systems allow us to effectively manage our inventory levels and sales performance. Our supply chain initiatives have allowed us to significantly reduce purchasing lead times and the amount of time we warehouse merchandise. We have increased our shipping and sorting capacity at our main distribution center to be able to accommodate our future growth to approximately 1,200 stores.
Our growth strategy is to continue to build on our position as a leading closeout retailer of upscale home furnishings, housewares, gifts and related items in the United States by:
· Expanding Our Store Base. During the planning process for 2007, we evaluated our current store base and plans for new store growth in 2007. As a result of this evaluation, we have planned to open fewer new stores during the current year and aggressively pursue expansion and relocation opportunities in our existing store base. For both new stores and relocations, we are negotiating for upgraded sites. With the expansion opportunities, the Company will be working with high producing stores and increasing the selling square footage. We believe that this adjustment in our real estate plan will benefit the Company and better position us for the long-term while still maintaining a low cost per square foot in rent expense. To that end, in 2007 we plan to add approximately 50 net new stores representing a 6% growth rate, expand approximately 25 existing stores and relocate approximately 50 existing stores. We also believe there is the potential for approximately 1,200 to 1,250 stores in the United States and do not anticipate any difficulties in identifying suitable additional store locations in areas with our target customer demographics.
· Enhancing Our Sales Productivity. We intend to increase our number of customer transactions by refining our merchandise mix and through other operating initiatives. For example, we have made shifts in our product mix to focus on functional, utilitarian items rather than purely decorative assortments. In addition, we have been very selective in our seasonal merchandise purchases and remain focused on high quality, high value items. We have increased our merchandise offerings throughout each sales event by increasing store deliveries to over 44 times in 2006. We believe this will attract new customers, encourage repeat visits by existing customers and increase our average transaction value during the later stages of each sales event. We have increased staffing at some of our high volume stores in an effort to improve our customer service levels and drive our sales volumes.
· Extending Our Customer Reach. Historically, we have used direct mailings, targeted emails and newspaper and print advertising to attract customers to our stores. While we believe that the use of direct mailing and email alerts remain effective, we also believe that broadcast advertising represents an effective means to attract new customers, encourage repeat visits by our existing customers and increase consumer awareness of Tuesday Morning. We have used television in select markets over the last four years and expect to continue our use of television advertising in 2007. We also operate our eTreasures® program that provides our customers with an email of our newest weekly arrivals, special offers and our monthly mailer, all in the convenience of their home or office.
As a closeout retailer of first quality, brand name merchandise, we benefit from attractive characteristics in the closeout industry. Closeout merchandise is generally available to closeout retailers at low prices for a variety of reasons, including the inability of a manufacturer to sell merchandise through regular channels, the discontinuance of merchandise due to a style or color change, the cancellation of orders placed by other retailers and the termination of business by a manufacturer or wholesaler. Occasionally, the closeout retailer may be able to purchase closeout merchandise because a manufacturer has excess raw materials or production capacity. Typically, closeout retailers have lower merchandise costs, capital expenditures and operating costs, allowing them to sell merchandise at lower prices than other retailers.
In addition, we benefit from several trends in the retailing industry. The increase in just-in-time inventory management techniques and the rise in retailer consolidation have both resulted in a shift of inventory risk from retailers to manufacturers. In response to an increasingly competitive market, manufacturers are introducing new products and new packaging more frequently. We believe that these trends have helped make the closeout retailer an integral part of manufacturers overall distribution strategies. As a result, we believe manufacturers are increasingly looking for larger, more sophisticated closeout retailers such as Tuesday Morning that can purchase larger and more varied merchandise and can control the distribution and advertising of specific products in order to minimize disruption to the manufacturers traditional distribution channels.
We sell upscale home furnishings, housewares, gifts and related items. We do not sell seconds, irregulars, refurbished or factory rejects. Our merchandise primarily consists of lamps, rugs, kitchen accessories, small electronics, gourmet housewares, linens, luggage, bedroom and bathroom accessories, toys, stationary and silk plants as well as crystal, collectibles and silver serving pieces. We specialize in well-recognized, first quality, brand name merchandise, which has included Calphalon cookware, Krups, KitchenAid, Cuisinart appliances, Sferra and Donna Karan bath towels, Samsonite luggage, Wallace and Gorham flatware, Lenox and Dansk tabletop, Marquis crystal, Steinbach and Hummel collectibles, Madame Alexander dolls, Royal Doulton and Wedgwood china and giftware and many others.
We differ from discount retailers in that we do not stock continuing lines of merchandise. Because we offer a continuity of merchandise categories with ever-changing individual product offerings, we provide our customers a higher proportion of new merchandise items than general merchandisers. We are continually looking to add new complementary merchandise categories that appeal to our customers.
Since our inception, we have not experienced any significant difficulty in obtaining first quality, brand name closeout merchandise in adequate volumes and at attractive prices. We use a mix of domestic vendors and international vendors. As industry trends such as just-in-time inventory management, retailer consolidation and more frequent order cancellations by retailers place more inventory risk on manufacturers, we believe we will see an increase in the number of vendors looking for effective ways to reduce excess inventory. In addition, as we continue to increase our number of stores and distribution capacity, we believe our purchasing capacity will continue to increase and enable us to acquire larger quantities of closeout merchandise from individual vendors and manufacturers. Improvements in our distribution processes allow us to stock merchandise in our stores more quickly, which increases our purchasing flexibility. As a result of these trends and initiatives, we believe we will be able to take advantage of more and often larger, buying opportunities as well as offer an enhanced selection of products to our customers. In 2006, our top ten vendors accounted for approximately 10.3% of total purchases, with no one vendor accounting for more than 1.5%.
Our pricing policy is to sell all merchandise at 50% to 80% below the retail prices generally charged by department and specialty stores. Prices are determined centrally and are uniform at all of our stores. Once a price is determined for a particular item, labels displaying three-tiered pricing are affixed to the product. A typical price tag displays a competitors regular price, a competitors sale price and our closeout price. Our management and buyers verify retail prices by reviewing prices published in advertisements and catalogues and manufacturers suggested retail price lists and by visiting department or specialty stores selling similar merchandise. Our management information systems provide daily sales and inventory information, which enables us to markdown unsold merchandise on a timely and systematic basis and thereby effectively manage inventory levels.
We plan and implement an advertising program for each sale event. Prior to each sale event, we initiate a direct mailing or email to customers on our mailing list, which consists of customers who have previously visited our stores and requested mailings. These direct mailings alert customers to the opening of a sale event and the merchandise and prices we offer. We also communicate with customers by advertising in local newspapers in each of our markets and through our eTreasures® email program.
While we believe our direct mailings, targeted emails and newspaper and print advertising remain effective, we believe broadcast advertising may also represent an effective means to attract new customers, encourage repeat visits by our existing customers and increase consumer awareness of Tuesday Morning. We have used television advertising in select markets over the last five years and expect to continue our use of television advertising in 2007.
Site Selection. During the planning process for 2007, we evaluated our current store base and plans for new store growth in 2007. As a result of this evaluation, we have planned to open fewer new stores during the current year and aggressively pursue expansion and relocation opportunities in our existing
store base. For both new stores and relocations, we are negotiating for upgraded sites. With the expansion opportunities, the Company will be working with high producing stores and increasing the selling square footage. We believe that this adjustment in our real estate plan will benefit the Company and better position us for the long-term while still maintaining a low cost per square foot in rent expense. To that end, in 2007 we plan to add approximately 50 net new stores representing a 6% growth rate, expand approximately 25 existing stores and relocate approximately 50 existing stores. We expect our new stores to be similar in appearance and operation to our existing stores and do not anticipate any difficulties in identifying suitable additional store locations in areas with our target customer demographics. As we implement our expansion and relocation strategy, we will incur a minimal increase in the cost of real estate for those locations.
We believe that our customers are attracted to our stores by our advertising, direct mail and email programs that emphasizes the limited quantities of first quality, brand name merchandise which we offer at attractive prices, rather than by location. This has allowed us to open our stores in secondary locations of major suburban markets, such as strip malls, near our middle and upper-income customers. We are able to obtain favorable lease terms because of our flexibility in site selection and our no-frills format, which allows us to effectively use a wide variety of space configurations. As a result of this opportunistic approach to site selection, we believe our real estate costs are lower than those of other retailers.
Store Leases. Except for one store adjacent to our distribution center, we lease our store locations under non-cancelable operating leases that include optional renewal periods. Some of our leases also provide for contingent rent based upon store sales exceeding stipulated amounts.
Our store leases typically include kick clauses, which allow us, at our option, to exit the lease 24 to 36 months after entering into the lease. These kick clauses, when combined with our inexpensive and portable store fixtures provide us with flexibility in opening new stores by allowing us to quickly and cost-effectively vacate a site that does not meet our sales expectations. As a result, we generally do not operate locations with store level operating losses.
Store Layout. Our opportunistic site selection and no-frills approach to presenting merchandise allow us to use a wide variety of space configurations. The size of our stores generally ranges from 6,000 to 15,000 square feet and averaged approximately 9,200 square feet in 2006. We have designed our stores to be functional, with little emphasis placed upon fixtures and leasehold improvements. We display all merchandise at each store by type and size on racks or counters, and we maintain a minimum inventory in stockrooms.
Store Operations. We operate our stores during sales events, that occur once each month except for January and July. We are generally closed for the first two weeks of January and July, which have been traditionally weaker months for retailers. We have increased the frequency of shipments of new merchandise during a sales event, which has resulted in improved efficiency of merchandise receiving and restocking activities at our stores. We have implemented initiatives to enhance the process by which merchandise is unloaded at the store and moved to the selling floor and we have increased our internal training program for store managers. We believe that on-going training is a critical component to the success of our store management. Each store manager receives ongoing training beginning with new manager training upon being hired or promoted as well as attendance at one or more training sessions held in Dallas, Texas. In addition, store managers are supported not only by the corporate office, but also by regional and zone field managers.
Store Management. Each store has a manager who is responsible for recruiting, training and supervising store personnel and assuring that the store is managed in accordance with our established guidelines and procedures. Store managers are full-time employees. Our store managers are supported by regional field management and zone level support. We have increased regional and zone personnel over the past two years and consider this level of support will improve and maintain consistency of execution at
our stores. Our store managers are responsible for reviewing store inventory and ensuring their store is continually restocked for sales event and non-sales event periods. The store manager is assisted by part-time employees who serve as cashiers and help with merchandise restocking efforts.
Members of our management visit selected stores during sales event and non-sales event periods to review inventory levels and presentation, personnel performance, expense controls, security and adherence to company procedures. In addition, regional managers periodically meet with senior management to review store policies and to discuss purchasing, merchandising and advertising strategies for future sales events.
Store Locations. As of December 31, 2006, we operated 795 stores in 47 states. Specific store locations can be accessed through our web site www.tuesdaymorning.com.
An important aspect of our success involves our ability to process, sort and distribute inventory quickly and efficiently. The majority of our merchandise is ordered, received, inspected, counted, priced, ticketed and designated for individual stores at our central distribution center in the Dallas, Texas metropolitan area. As a general rule, we carry similar products in each of our stores, but the amount of inventory each store is allocated varies depending upon size, location and sales projections for that store. Consistent with our sales event strategy, we ship most of our merchandise to our stores within a few weeks of its arrival at our distribution center. We generally do not replenish specific merchandise during a sales event; however, new merchandise is shipped to stores throughout a sales event.
We have reduced the time merchandise remains in our distribution center from several months to just a few weeks and have increased store deliveries to over 44 times in 2006, all of which has allowed us to significantly reduce the amount of inventory stored at our distribution center and maintain more consistent in-store inventory levels. The increased number of shipments also allows our stores to process shipments more effectively and restock their shelves with new merchandise during sales events. We also use a bar-code locator system to track inventory from the time it is received until it is shipped to our stores. This system allows us to locate, price, sort and ship merchandise efficiently from our central distribution center.
We have invested significant resources in computers, bar code scanners and radio frequency terminals, software programming and related equipment, technology and training, and we will continue to update these systems as necessary. We maintain a corporate local area network computer system, which includes purchase order processing, imports, transportation, distribution, point of sale and financial systems and enables us to efficiently control and process our inventory.
At the store level, we have computer-based registers that capture daily sales data at the SKU level. Sales information, inventory information, open to buy, and other operational data is distributed daily to designated levels of management and to the individuals or groups that have responsibility for specific aspects of the business.
We believe the principal factors by which we compete are price and product offering. We believe we compete effectively by pricing the merchandise we sell at 50% to 80% below department and specialty store prices and by offering a broad assortment of high-end, first quality, brand name merchandise. We currently compete against a diverse group of retailers, including department and discount stores and specialty, e-commerce and catalog retailers, which sell, among other products, home furnishings, housewares and related products. We also compete in particular markets with a substantial number of retailers that specialize in one or more types of home furnishing products that we sell. Some of these
competitors have substantially greater financial resources that may, among other things, increase their ability to purchase inventory at lower costs or to initiate and sustain aggressive price competition.
We are distinguishable from our competitors in several respects. Unlike our competitors, which primarily offer continuing lines of merchandise, we offer changing lines of merchandise depending on availability at suitable prices. Most retailers in the closeout retailing industry are either general merchandisers or focus on apparel, while our focus is on primarily upscale home furnishings, housewares and related items. In addition, most closeout retailers focus on lower and middle-income consumers, while we generally cater to middle and upper-income customers. Finally, our business model has been and continues to be focused on ten major sales events which are promoted and advertised to our customers through direct mailings, emails and television advertising. We believe that our sales events create a sense of urgency and excitement on the part of our customers because they know that the availability of merchandise during a sales event is limited.
Our business is highly seasonal, with a significant portion of our net sales and operating income generated during the fourth quarter, which includes the holiday shopping season. Net sales in the fourth quarters of 2006, 2005 and 2004 accounted for approximately 35%, 36% and 37% respectively, of annual net sales for such years. Operating income for the fourth quarter of 2006, 2005 and 2004 accounted for approximately 64%, 58% and 59%, respectively, of annual operating income for such years.
As of March 7, 2007, we employed approximately 2,100 persons on a full-time basis and approximately 6,800 individuals on a part-time basis. Our employees are not represented by any union. We have not experienced any work stoppage due to labor disagreements and we believe that our employee relations are good.
The tradename Tuesday Morning is material to our business. We have registered the name Tuesday Morning as a service mark with the United States Patent and Trademark office. We have also registered other trademarks including Closing Time® and eTreasures®.
Tuesday Morning Corporation is a Delaware corporation incorporated in 1991. Our principal executive offices are located at 6250 LBJ Freeway, Dallas, Texas 75240, and our telephone number is (972) 387-3562.
We maintain an internet website at http://www.tuesdaymorning.com. Copies of our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed with, or furnished to, the Securities and Exchange Commission (the SEC) are available for viewing and copying at our internet website, free of charge, as soon as reasonably practicable after we file such material with, or furnish them to, the SEC.
Any materials filed by us with the SEC may also be read and copies made at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet website, http://www.sec.gov, which contains reports, proxy and information statements and other information which we file electronically with the SEC.
Our business is subject to significant risks. You should carefully consider the risks and uncertainties described below and the other information in this Form 10-K, including our consolidated financial statements and the notes to those statements. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we do not presently know about or that we currently believe are immaterial may also affect our business operations. If any of the events described below actually occur, our business, financial condition or results of operations could be adversely affected in a material way. This could cause the trading price of our common stock to decline, perhaps significantly, and you may lose part or all of your investment.
As part of our growth strategy, we have planned to open fewer new stores during the current year and aggressively pursue expansion and relocation opportunities in our existing store base. For both new stores and relocations, we are negotiating for upgraded sites. With the expansion opportunities, the Company will be working with high producing stores and increasing the selling square footage. We believe that this adjustment in our real estate plan will benefit the Company and better position us for the long-term while still maintaining a low cost per square foot in rent expense. To that end, in 2007 we plan to add approximately 50 net new stores representing a 6% growth rate, expand approximately 25 existing stores and relocate approximately 50 existing stores. However, we cannot assure you that we will be able to achieve our relocation or expansion goals or that we will be able to operate our new stores profitably. Further, we cannot assure you that any new store will achieve similar operating results to those of our existing stores or that new stores opened in markets in which we operate will not have a material adverse effect on the revenues and profitability of our existing stores. The success of our planned expansion will be dependent upon numerous factors, many of which are beyond our control, including the following:
· the ability of our personnel to adequately analyze and identify suitable markets and individual store sites within those markets;
· the competition for suitable store sites;
· our ability to negotiate favorable lease terms with landlords;
· our ability to obtain governmental and other third-party consents, permits and licenses needed to operate our stores;
· the availability of employees to staff new stores and our ability to hire, train, motivate and retain store personnel;
· the availability of adequate management and financial resources to properly manage an increased number of stores;
· our ability to adapt our distribution and other operational and management systems to an expanded network of stores; and
· our ability to attract customers and generate sales sufficient to operate new stores profitably.
We opened stores in several new markets during 2006 and intend to enter into additional new markets in 2007 and beyond. These markets may have different competitive conditions, consumer trends and discretionary spending patterns than our existing markets, which may cause our new stores in these markets to be less successful than stores in our existing markets.
The success of our business depends to a significant extent upon the level of consumer spending. A number of factors affect the level of consumer spending on merchandise that we offer, including, among other things:
· general economic, industry and weather conditions;
· housing market;
· high crude oil prices, that affect gasoline and heating oil prices;
· the level of consumer debt;
· interest rates;
· tax rates and policies;
· war, terrorism and other hostilities; and
· consumer confidence in future economic conditions.
The merchandise we sell generally consists of discretionary items. Reduced consumer confidence, lower housing starts and spending cut backs may result in reduced demand for our discretionary items and may force us to take significant inventory markdowns. Reduced demand also may require increased selling and promotional expenses. Adverse economic conditions and any related decrease in consumer demand for discretionary items could have a material adverse effect on our business, results of operations and financial condition.
Our business and results of operations are subject to uncertainties arising out of world events. These uncertainties may include a global economy slowdown, changes in consumer spending, the increase in gasoline and natural gas prices, the outbreak of illnesses such as Bird Flu and the economic consequences of military action or additional terrorist activities. Any future events arising as a result of terrorist activity or other world events may have a material impact on our business, our ability to source products, results of operations and financial condition in the future.
The retail home furnishings industry is intensely competitive. As a closeout retailer of home furnishings, we currently compete against a diverse group of retailers, including department and discount stores, specialty and e-commerce retailers, which sell, among other products, home furnishing products similar and often identical to those we sell. We also compete in particular markets with a substantial number of retailers that specialize in one or more types of home furnishing and houseware products that we sell. Many of these competitors have substantially greater financial resources that may allow them to initiate and sustain aggressive price competition. A number of different competitive factors could have a material adverse effect on our business, results of operations and financial condition, including:
· increased operational efficiencies of competitors;
· competitive pricing strategies, including deep discount pricing by a broad range of retailers during periods of poor consumer confidence or economic instability;
· continued and prolonged promotional activity by competitors;
· expansion by existing competitors;
· entry by new competitors into markets in which we currently operate; and
· adoption by existing competitors of innovative store formats or retail sales methods, including e-commerce and gift cards.
We cannot assure you that we will be able to continue to compete successfully with our existing or new competitors, or that prolonged periods of deep discount pricing by our competitors will not materially harm our business.
By its nature, specific closeout merchandise items are available from manufacturers or vendors generally on a non-recurring basis. As a result, we do not have long-term contracts with our vendors for supply, pricing or access to products, but make individual purchase decisions, which are often for large quantities. Although we have many sources of merchandise and do not foresee any shortages of closeout merchandise in the near future, we cannot assure you that manufacturers or vendors will continue to make closeout merchandise available to us in quantities or on terms acceptable to us or that our buyers will continue to identify and take advantage of appropriate buying opportunities. In addition, if we misjudge consumer demand for products, we may significantly overstock unpopular products and be forced to take significant markdowns and miss opportunities to sell more popular products. Our inability to acquire suitable merchandise in the future or to accurately anticipate consumer demand for such merchandise would have an adverse effect on our business, results of operations and financial condition.
With minor exceptions, all inventory is shipped directly from suppliers to our centralized distribution center in the Dallas, Texas metropolitan area, where the inventory is then processed, sorted and shipped to our stores. We depend in large part on the orderly operation of this receiving and distribution process, which depends, in turn, on adherence to shipping schedules and effective management of the distribution center. Although we believe that our receiving and distribution process is efficient and well positioned to support our expansion plans, we cannot assure you that we have anticipated all of the changing demands which our expanding operations will impose on our receiving and distribution system or that events beyond our control, such as disruptions in operations due to fire or other catastrophic events, labor disagreements or shipping problems, will not result in delays in the delivery of merchandise to our stores.
Our freight cost is impacted by changes in fuel prices through surcharges. Fuel prices and surcharges affect freight cost both on inbound freight from vendors to our distribution center and outbound freight from our distribution center to our stores. In addition, the U.S. government requires drivers of over-the-road trucks to take certain rest periods which reduce the available amount of time they can drive during a 24 hour period. Increases in fuel prices and surcharges, as well as stringent driver regulations, may increase freight costs and thereby increase our cost of goods sold.
Although we maintain business interruption and property insurance, we cannot assure you that our insurance will be sufficient, or that insurance proceeds will be timely paid to us, in the event our distribution center is shut down for any reason.
Our future performance will depend in large part upon the efforts and abilities of our senior management, particularly Kathleen Mason, our Chief Executive Officer, and our other key employees, including our buyers. The loss of service of these persons could have a material adverse effect on our business and future prospects. We do not maintain key person life insurance for Ms. Mason or our other senior management.
We, like other retailers, rely on external funding sources to finance our operations and growth. We currently believe that our cash flow from operations and funds available under our revolving credit facility will satisfy our capital requirements for the next 12 months. Our ability to obtain additional financing is dependent upon our future operating performance, general economic and competitive conditions and financial, business and other factors, many of which we cannot control.
Merchandise manufactured and imported from overseas is the majority of our total product purchases acquired both domestically and internationally. A disruption in the shipping of our imported merchandise or an increase in the cost of those products may significantly decrease our sales and profits. In addition, if imported merchandise becomes more expensive or unavailable, the transition to alternative sources may not occur in time to meet our demands. Products from alternative sources may also be of lesser quality and more expensive than those we currently import. Risks associated with our reliance on imported products include:
· disruptions in the shipping and importation of imported products because of factors such as:
· raw material shortages, work stoppages, strikes and political unrest;
· problems with oceanic shipping, including shipping container shortages;
· increased custom inspections of import shipments or other factors causing delays in shipments;
· economic crises, international disputes and wars; and
· increases in the cost of purchasing or shipping foreign merchandise resulting from:
· loss of most favored nation trading status by the United States in relation to a particular foreign country;
· import duties, import quotas and other trade sanctions; and
· increases in shipping rates.
The products we buy abroad are often priced in foreign currencies and, therefore, we are affected by fluctuating exchange rates. In the past, we have entered into foreign currency exchange contracts with major financial institutions to hedge these fluctuations. We might not be able to successfully protect ourselves in the future against currency rate fluctuations, and our financial performance could suffer as a result. You should read Managements Discussion and Analysis of Financial Condition and Results of Operation and Quantitative and Qualitative Disclosures About Market Risk for more information about our foreign currency exchange rate exposure and hedging activities.
Under various federal, state and local environmental laws and regulations, current or previous owners or occupants of property may become liable for the costs of removing any hazardous substances found on the property. These laws and regulations often impose liability without regard to fault. As of December 31, 2006, we leased all but one of our stores and 444,000 square feet of land containing a 30,000 square foot building. We own 1,318,000 square feet of distribution facilities. In addition, we operate three aboveground diesel storage tanks at our distributions facilities. We have adopted policies regarding the handling and disposal of these products, and we train our employees on how to handle and dispose of them. Although we have not been notified of, and are not aware of, any current environmental liability, claim or non-compliance, we could incur costs in the future related to our leased properties, owned buildings or our storage tanks. We cannot assure you that our policies and training will successfully help us avoid potential violations of these environmental laws and regulations in the future.
Our success depends upon our marketing, advertising and promotional efforts. If we are unable to implement them successfully, or if our competitors are more effective than we are, our revenue may be adversely affected.
We use marketing and promotional programs to attract customers to our stores and to encourage purchases by our customers. We use various media for our promotional efforts, including print, television, database marketing and direct marketing. If we fail to choose the appropriate medium for our efforts, or fail to implement and execute new marketing opportunities, our competitors may be able to attract some of our customers and cause them to decrease purchases in our stores and increase purchases elsewhere, which could negatively impact our revenues. Changes in the amount and degree of promotional intensity or merchandising strategy by our competitors could cause us to have difficulties in retaining existing customers and attracting new customers.
Customers willingness to shop and their demand for the merchandise in our stores is affected by adverse and inclimate weather. Frequent or unusually heavy snow, ice or rain storms, severe cold or heat or extended periods of unseasonable temperatures in our markets could adversely affect our sales and increase markdowns.
The retail business is highly competitive. We compete for customers, associates, locations, merchandise, services and other important aspects of our business with many other local, regional, national and international retailers. We also face competition from alternative retail distribution channels such as catalogues and internet websites. Changes in the merchandising, pricing and promotional activities of those competitors and in the retail industry generally, may adversely affect our performance.
If we do not attract and retain quality sales, distribution center and other associates in large numbers, as well as, experienced buying and management personnel, our performance could be adversely affected.
Our performance is dependent on recruiting, developing, training and retaining quality sales, distribution center and other associates in large numbers, as well as, experienced buying and management personnel. Many of our associates are in entry level or part-time positions with historically high rates of turnover. Our ability to meet our labor needs while controlling costs is subject to external factors such as unemployment levels, prevailing wage rates, minimum wage legislation and changing demographics. In the event of increasing wage rates, if we do not increase our wages competitively, our customer service could suffer because of a declining quality of our workforce, or our earnings would decrease if we increase our wage rates. Further, our off-price model limits the market for experienced buying and management
personnel and requires us to do significant internal training and development. Changes that adversely impact our ability to attract and retain quality associates and management personnel could adversely affect our performance.
The efficient operation of our business is dependent on our information systems, including our ability to operate them effectively and successfully to implement new technologies, systems, controls and adequate disaster recovery systems. In addition, we must protect the confidentiality of our and our customers data. The failure of our information systems to perform as designed or our failure to implement and operate them effectively could disrupt our business or subject us to liability and thereby harm our profitability.
Our business is dependent upon our operations generating strong cash flows to support our capital expansion requirements, our general operating activities and to fund debt repayment. Our inability to continue to generate sufficient cash flows to support these activities or the lack of availability of financing in adequate amounts and on appropriate terms could adversely affect our financial performance and our earnings per share growth.
We maintain a system of internal controls over financial reporting, but there are limitations inherent in internal control systems. If we are unable to maintain adequate and effective internal control over financial reporting, our financial reporting could be adversely affected. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition, the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be appropriate relative to their costs.
Our success depends on our ability to anticipate and respond in a timely manner to changing customer demands and preferences for products and supplies used in creative activities. If we misjudge the market, we may significantly overstock unpopular products and be forced to take significant inventory markdowns, which would have a negative impact on our operating results and cash flow. However, shortages of key items could also have a material adverse impact on our operating results
Our business is highly seasonal. Our inventories and short-term borrowings, if any, grow in the second and third quarters as we prepare for our peak selling season in the third and fourth quarters. Our most important quarter in terms of sales, profitability and cash flow historically has been the fourth quarter. If for any reason our fourth quarter results were substantially below expectations, our operating results for the full year would be materially adversely affected, and we could have substantial excess inventory.
Our business is highly seasonal, with a significant portion of our net sales and operating income generated during the fourth quarter, which includes the holiday shopping season. Net sales in the fourth quarters of 2006, 2005 and 2004 accounted for approximately 35%, 36% and 37%, respectively, of annual net sales for such years. Operating income for the fourth quarter of 2006, 2005 and 2004 accounted for approximately 64%, 58% and 59%, respectively, of annual operating income for such years. For more information about our seasonality, please read Managements Discussion and Analysis of Financial Condition and Results of OperationQuarterly Results and Seasonality. Because a significant percentage of our net sales and operating income are generated in the fourth quarter, we have limited ability to compensate for shortfalls in fourth quarter sales or earnings by changes in our operations or strategies in other quarters. A significant shortfall in results for the fourth quarter of any year could have a material adverse effect on our annual results of operations and on the market price of our common stock. Our quarterly results of operations also may fluctuate significantly based on such factors as:
· the timing of new store openings;
· the amount of net sales contributed by new and existing stores;
· the timing of certain holidays and sales events;
· changes in our merchandise mix;
· general economic, industry and weather conditions that affect consumer spending; and
· actions of competitors, including promotional activity.
A number of factors have historically affected, and will continue to affect, our comparable store sales results, including:
· general regional and national economic conditions;
· inclement weather such as hurricanes Katrina, Rita and Wilma that affected the Southern U.S. in the fall of 2005;
· consumer trends, such as less spending due the impact of higher gasoline prices;
· changes in our merchandise mix;
· our ability to distribute merchandise efficiently to our stores;
· timing and type of sales events, promotional activities or other advertising;
· new merchandise introductions; and
· our ability to execute our business strategy effectively.
Our comparable store sales results have fluctuated in the past, and we believe such fluctuations may continue. Our comparable store sales decreased 7.9% in 2006, 4.0% in 2005 and 1.7% in 2004. The unpredictability of our comparable store sales may cause our revenue and results of operations to vary from quarter to quarter, and an unanticipated decline in revenues or operating income may cause our
stock price to fluctuate significantly. A failure to grow or maintain our comparable store sales results could have a material adverse effect on our results of operations and could cause the price of our common stock to decrease significantly.
At March 13, 2007, Madison Dearborn Capital Partners II, L.P. held a 27% shareholder interest in us. This percentage represents a substantial amount of our common stock and Madison Dearborn will continue to have significant influence over election of our directors, approval of mergers, sales of assets and other matters. The interests of Madison Dearborn may conflict with the interests of other holders of our common stock.
If our largest shareholder sells substantial amounts of our common stock in the public market, the market price of our common stock could fall. Such sales might make it more difficult for us to sell equity or equity-related securities in the future. As of March 13, 2007, Madison Dearborn beneficially owned 11,388,526 shares of common stock, or approximately 27% of our outstanding shares. Madison Dearborn has advised us that it expects to continue to reduce its ownership interest in our company over time, subject to prevailing market conditions. We have granted Madison Dearborn certain rights with respect to the registration of shares of our common stock held by it, including the right to require that we register the sale of all or part of the shares it holds.
Our certificate of incorporation authorizes our board of directors, subject to any limitations prescribed by law and our revolving credit facility, to issue shares of preferred stock in one or more series without shareholder approval. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire, or discouraging a third party from acquiring, a majority of our outstanding common stock.
Stores. We lease all of our stores, except one located adjacent to our distribution facility, from unaffiliated third parties normally through non-cancelable leases. At December 31, 2006, the remaining terms of our store leases generally range from six months to five years with a small percentage out to ten years. The average initial term of a store lease is approximately five years with options available for renewal. We intend to continue to lease all of our new stores from unaffiliated third parties. Leases may contain renewal clauses which are often executed and may contain additional terms regarding percentage of rent payments. Our store leases typically include kick clauses, which allow us, at our option, to exit the lease 24 to 36 months after entering the lease.
Distribution Facilities and Corporate Headquarters. We own approximately 1,318,000 square feet of distribution facilities and a 79,000 square foot building which houses our corporate office in the Dallas, Texas metropolitan area.
We have leases on approximately 444,000 square feet of land for trailer storage and a 30,000 square foot building, which expire in February 2007, April 2009 and December 2013. We believe our current distribution facilities are adequate to meet our requirements for the next several years. We will, however, need to acquire or lease additional warehouse space in approximately three to four years to accommodate our distribution requirements as our store base grows.
During 2001 and 2002, we were named as a defendant in three complaints filed in the Superior Court of California in and for the County of Los Angeles. The plaintiffs are seeking to certify a statewide class made up of some of our current and former employees, which they claim are owed compensation for overtime wages, penalties and interest. The plaintiffs are also seeking attorneys fees and costs. In October 2003, we entered into a settlement agreement with a sub-class of these plaintiffs consisting of manager-in-training/management trainees which was paid in November 2005 with no material impact to our financial statements. The trial date related to the remaining complaint is currently scheduled for September 2007. A similar lawsuit was filed in Orange County, California in 2004 by managers, managers-in-training and assistant managers and an amended complaint was recently filed in January 2007. This case is still in the discovery phase. We do not expect either of these complaints to have a material impact to our financial statements.
In June 2004, we were named as a defendant in a complaint filed in the U.S. District Court, Central District of California. The plaintiff, Thomas Kinkade Company (f/k/a/ Media Arts Group Inc.), alleged copyright infringement, trademark infringement and false advertisements on merchandise we sold in the second quarter of 2004. We entered into a settlement agreement on November 14, 2006 with the plaintiff. The settlement was paid in December 2006 with no material impact to our financial statements.
We intend to vigorously defend all pending actions. We do not believe these or any other legal proceedings pending or threatened against us would have a material adverse effect on our financial condition or results of operations.
No matters were submitted to a vote of our security holders during the quarter ended December 31, 2006.
Our common stock has traded on The NASDAQ Global Market since our initial public offering on April 22, 1999, under the symbol TUES. The following table sets forth for the periods indicated the high and low sales prices per share as reported on The NASDAQ Global Market.
On March 13, 2007, the last reported sale price for our common stock on The NASDAQ Global Market was $15.37 per share. As of March 13, 2007, there were approximately 27 holders of record, and an estimated 21,000 beneficial owners of our common stock.
During the second quarter of 2005, we paid our first annual cash dividend of $0.65 per share totaling $26.9 million to our common stockholders. In 2006, we increased our annual cash dividend to $0.80 per share totaling $33.1 million which was paid in the first quarter of 2006. On March 9, 2007, the board of directors declared an annual cash dividend of $0.80 per common share payable on March 30, 2007. The continuation of these payments, the amount of such dividends, and the form in which the dividends are paid (cash or stock) depend on many factors, including our results of operations and financial condition. Subject to these qualifications, we expect to pay future dividends on an annual basis.
The board of directors has not authorized us to repurchase any common stock and there were no repurchases of our common stock during the fourth quarter of 2006.
The following graph illustrates a comparison of the cumulative total stockholder return (change in stock price plus reinvested dividends) for the five years ended December 31, 2006, of (1) our common stock, (2) the S&P 500 Index and (3) a peer group of companies consisting of Big Lots, Inc.; TJX Companies Inc.; Dollar Tree Stores Inc.; Dollar General Corporation; Family Dollar Stores, Inc.; Williams-Sonoma Inc.; Bed Bath & Beyond Inc.; Bombay Company, Inc.; Ross Stores Inc.; and Cost Plus, Inc. The chart assumes that $100 was invested on December 31, 2001 in our common stock and each of the comparision indices, and assumes that all dividends were reinvested.
The following table sets forth the selected consolidated financial and operating data for, and as of the end of, each of the five years ended December 31, 2006. The statement of operations data for the years ended December 31, 2006, 2005 and 2004 and the balance sheet data as of December 31, 2006 and 2005 are derived from our audited consolidated financial statements that appear herein. The statement of operations data for the years ended December 31, 2003 and 2002 and the balance sheet data as of December 31, 2004, 2003 and 2002 are derived from our audited consolidated financial statements that are not included in this Form 10-K. The selected consolidated financial and operating data should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operation and our consolidated financial statements and related notes included elsewhere in this Form 10-K.
(1) In the first quarter of 2004, we refined our methodology for calculating our comparable store sales, in light of changes to the timing of store openings during a quarter. Stores are now included in the same store calculation at the beginning of the quarter following the anniversary date of the store opening. Previously, stores were included in the same store calculation at the beginning of the quarter that contained the anniversary date of the store opening, since the majority of our store openings used to be only at the beginning of the respective quarter. The comparable store sales increase for 2003 has been updated based on using our refined methodology. The previously reported comparable sales increase was 2.9% for 2003. Comparable store sales for 2002 is as originally reported. Stores that relocate within the same geographic market are still considered same store for purposes of this computation. The number of days our stores are open may fluctuate from period to period.
(2) Average sales per store is the sum of the average of the sales per store for each quarter.
(3) Inventory turnover is the ratio of cost of sales to average inventory. Average inventory is calculated by taking the average of the previous year-end and quarter-end inventory levels throughout the year.
The following discussion and analysis should be read in conjunction with Selected Financial Data and our consolidated financial statements and related notes included elsewhere in this Form 10-K.
· We sell upscale, name brand home furnishings, housewares, gifts and related items significantly below retail prices charged by department and specialty stores throughout 795 stores in 47 states. We have a unique event-based selling strategy that creates a sense of urgency and excitement for our customer base.
· Our store base has grown approximately 9% to 10% per year for each of the last five years and during 2006 we expanded our store base by a net of 63 stores comprised of 71 new store openings and 8 store closures.
· During the first quarter of 2006, we paid a cash dividend of $0.80 per share totaling $33.1 million to our common stockholders and intend in the future to continue our payment of an annual cash dividend to our stockholders.
· Operating profits along with more efficient use of working capital have increased cash flow which has in turn been used to reduce debt. At December 31, 2006 and 2005, we had no debt outstanding. We anticipate using our revolving credit facility in the future to fund our inventory purchases, capital expenditures and a cash dividend payment, but we expect to generate excess cash flow for the fiscal year 2007.
Between 1986 and 1997, we were a publicly traded company. On December 29, 1997, Madison Dearborn, other unaffiliated investors and some of the members of our management at that time acquired substantially all of our outstanding capital stock in a recapitalization transaction. Despite significant debt after the recapitalization, we continued to operate profitably (excluding recapitalization fees and expenses in 1997) and to expand our store base. In April 1999, we completed an initial public offering of our common stock, and used substantially all of the proceeds to redeem a portion of the senior subordinated notes and all of the senior preferred stock that we issued in the recapitalization.
From our initial public offering through 2000, we continued to expand our number of stores and experience strong sales growth. During this time, our warehouse inventory levels increased significantly above historical levels. In order to accommodate these higher inventory levels, we expanded the use of third party regional distribution centers. Our higher inventory levels and use of regional distribution centers resulted in additional handling, freight and distribution expenses, which negatively impacted our results of operations in 2000 and the first nine months of 2001.
In July 2000, we recruited Kathleen Mason, our current President and Chief Executive Officer. Under Ms. Masons leadership, we have improved our focus on profitability, implemented new supply chain and inventory management strategies to control our inventory levels and to ensure increased product availability in our sales events, upgraded management information systems and initiated television advertising.
As a result of these and other initiatives, we have increased our shipping and sorting capacity at our distribution center in Dallas, Texas to accommodate our future growth to approximately 1,200 stores, to discontinue use of 16 third party regional distribution centers and to reduce our long-term interest bearing debt from $187.0 million in 2000 to zero at December 31, 2006.
Managements Discussion and Analysis is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of certain assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. On a recurring basis, we evaluate our significant estimates which are based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
InventoryOur inventories are stated at the lower of cost or market using the retail inventory method for store inventory and the specific identification method for warehouse inventory. Amounts are removed from inventory based on the retail inventory method which applies a cost-to-retail ratio to our various retail deductions (sales, markdowns, shrink, etc.) to arrive at our cost of sales. Buying, distribution, freight and certain other general and administrative costs are capitalized as part of inventory and are expensed as cost of sales as the related inventory is sold. We conduct full physical inventories at June 30 and December 31 to measure quantities on-hand and make appropriate adjustments to our financial statements. At December 31, 2006 and 2005, our books and records have been fully adjusted for the year-end physical inventories conducted. During periods for which physical observations do not occur, we utilize an estimate for recording shrinkage reserves based on the historical trends of shrinkage as a percentage of sales. This estimate may require a favorable or unfavorable adjustment to actual results to the extent that our subsequent actual physical inventories yield a different result. Since we count our inventories twice a year, this reduces the subjective nature of our shrink percentage and can limit our exposure and risk of a significant error.
Inventory is the largest asset on our balance sheet and represents approximately 62% and 61% of total assets at December 31, 2006 and 2005, respectively. Inventory increased 5.2% or $12.0 million to $242.7 million in 2006 from $230.6 million in 2005. On a per store basis our inventory decreased approximately 3.2%. The decrease was primarily due to managements initiative to reduce purchasing levels during the third and fourth quarters of 2006.
MarkdownsWe have used markdowns to promote the effective and timely sale of merchandise that allows us to consistently provide fresher merchandise to our customers. We are also utilizing markdowns coupled with promotional events to drive traffic and stimulate sales during non-sales event periods. Markdowns may be temporary or permanent. Temporary markdowns are for a designated period of time with markdowns recorded based on quantities sold during the period. Permanent markdowns may vary throughout the quarter or year in timing with higher markdowns traditionally recorded in the second and fourth quarters due primarily to seasonal merchandise. Permanent markdowns are charged to cost of sales immediately based on the total quantities on-hand in the stores. We review all inventory on an aged basis or during each quarter on a continual basis to ensure all necessary price actions are taken to adequately value our inventory at the lower of cost or market. These actions which involve actual or planned permanent markdowns are considered by management to be the appropriate prices to stimulate demand for the merchandise. Actual required permanent markdowns could differ materially from managements initial estimates based on future customer demand or economic conditions.
Insurance and Self-Insurance ReservesWe use a combination of insurance and self-insurance plans to provide for the potential liabilities for workers compensation, general liability, property insurance, director and officers liability insurance, vehicle liability and employee health care benefits. Liabilities associated with the risks that are retained by us are estimated, in part, by historical claims experienced, severity factors and the use of loss develop factors as determined by a third-party independent actuary. Our estimated reserves may be materially different from our future actual claim costs, and, in the future, if we conclude an adjustment to our reserves is required, the liability will then be adjusted accordingly in the period that determination is made.
Tax, Legal and Other Contingent ReservesWe record reserves for certain legal, income tax (federal, state and local) or other contingencies when estimated future expenditures associated with such contingencies become probable and the amounts can be reasonably estimated. However, new information may become available, or circumstances (such as applicable laws and regulations) may change, which are difficult to forecast or predict thereby resulting in an adjustment in the amount required to be accrued for such matters in future periods.
Based on certain views expressed in a letter of February 7, 2005 from the Office of the Chief Accountant of the Securities and Exchange Commission to the American Institute of Certified Public Accountants, we reviewed our accounting policies and practices associated with operating leases. Consistent with industry practices, we historically reported straight-line rental expense beginning on the lease commencement date. This had the effect of excluding the rent holiday associated with the pre-opening or build-out period of our stores from the calculation of the period over which we expensed rent. Following our review, we modified our accounting policies such that we begin recording rent expense on the date we take possession of or have the right to use the premises.
As a result of this adjustment, we recorded a one-time, non-cash, $3.9 million ($2.4 million, net of income tax) cumulative charge to earnings during the first quarter of 2005. The adjustment did not impact historical or future net cash flows or the timing of the payments under related leases. We believe that the new lease accounting policies will not have a material effect on future diluted earnings per share. Prior years financial statements were not restated as the impact of this issue was immaterial to previously reported results for any individual previous periods.
The following table sets forth, for the periods indicated, selected statement of operations data, expressed as a percentage of net sales, as well as the number of stores open at the end of each period.
We capitalize into inventory all merchandise costs and certain costs incurred to purchase, distribute and deliver merchandise to our stores in order to more accurately match the cost of merchandise with the timing of its sale. These costs are included in cost of sales when the merchandise is sold. Other cost of sales components include merchandise markdowns, shrink and damages, which are expensed as they are incurred
Selling, general and administrative expenses are comprised of wages and benefits, rent and occupancy costs, depreciation, advertising, store operating expenses and corporate office costs. Increases in dollar amounts of these expenses are attributable to increases in the number of stores and increases in variable expenses due to sales growth. Variable expenses include payroll and related benefits, advertising expense and other expenses such as credit card fees.
Net sales decreased $20.7 million or 2.2% to $911.1 million in 2006 from $931.8 million in 2005, of which, $71.5 million of the decrease was attributable to a 7.9% decrease in comparable store sales from 2005 offset by an increase of $50.8 million year over year in sales from non-comparable new stores. Comparable store transactions decreased 7.3% and comparable store average ticket decreased 0.7%. Our average annual sales per store in 2006 was $1.2 million, a decrease of $138,000 or 10.4% from 2005. The decrease in average sales per store has been impacted by those stores opening in new markets performing below historical trends. Comparable store sales and sales per store decreased primarily due to lower traffic levels than anticipated. Traffic levels have declined due to the increase in supply of home furnishing products, the promotional environment of home furnishing retailers in this sector, as well as the economic pressures impacting the discretionary income of consumers.
Gross profit decreased $14.8 million or 4.1% to $342.5 million in 2006 compared to $357.3 million in 2005, of which, $20.7 million of the gross profit decrease was directly attributable to a decrease in our net sales. Our gross profit percentage decreased to 37.6% in 2006 from 38.3% in 2005. This 0.7% decrease in our gross profit percentage was primarily attributable to a 0.6% increase in temporary and permanent markdowns, 0.3% increase in shrink and damages and a 0.1% increase in purchasing, freight and distribution expenses offset by 0.3% in improved overall product cost.
Selling, general and administrative expenses increased $23.3 million or 8.9% to $284.1 million in 2006 from $260.7 million in the prior year. The increase was mostly attributable to a $16.6 million increase in store occupancy costs, store personnel costs and store fixed asset depreciation expense primarily due to the expansion of our store base. Also contributing to the increase is $4.0 million in stock compensation
expense as a result of our adoption of Statement 123(R) on January 1, 2006. As a percentage of sales these expenses increased 3.2% to 31.2% in 2006 from 28.0% in 2005. The increased percentage is primarily due to reduced leverage on expenses as a result of our negative comparable store sales for the year and a 2.2% increase related to store occupancy costs, store personnel costs and store fixed asset depreciation expense.
Net interest and other expense increased $605 thousand to $1.1 million in 2006 compared to $526 thousand in 2005. This increase was attributable to $747 thousand higher interest expense due to higher average borrowing levels in 2006 than in 2005.
Income tax expense decreased $14.2 million to $20.9 million in 2006 from $35.1 million in 2005 due to decreased profitability. Our effective tax rate decreased slightly to 36.4% in 2006 from 36.5% in 2005 primarily due to the net adjustment of tax reserves related to net favorable settlements with certain state taxing authorities.
Net sales increased $34.0 million or 3.8% to $931.8 million in 2005 from $897.8 million in 2004, of which, $68.6 million of the increase was attributable to sales from non-comparable new stores offset by a 4.0% decrease in comparable store sales from 2004. Comparable store transactions decreased 4.4% offset by an increase of 0.4% in comparable store average ticket. Our average annual sales per store decreased by $99,000 or 6.9% to $1.3 million in 2005. Comparable store sales and sales per store decreased primarily due to lower traffic levels than anticipated. At the time, management believed traffic levels were lower due to the lower discretionary income availability of our customers resulting from the impact of higher gasoline and energy costs.
Gross profit increased $16.1 million or 4.7% to $357.3 million in 2005 compared to $341.2 million in 2004, of which, $12.9 million of the gross profit increase was directly attributable to an increase in our net sales. Our gross profit percentage increased to 38.3% in 2005 from 38.0% in 2004. This 0.3% increase in our gross profit percentage was primarily attributable to a 0.1% decrease in temporary and permanent markdowns, net of inventory shrink and a 0.2% improvement in the leveraging of our distribution and freight expenses.
Selling, general and administrative expenses increased $23.6 million or 10.0% to $260.7 million in 2005 from $237.1 million in the prior year. The increase was mostly attributable to the $3.9 million one-time, non-cash lease accounting adjustment taken in the first quarter of 2005 and a $15.8 million increase in store occupancy costs, store personnel costs, and store fixed asset depreciation expense primarily due to the expansion of our store base. As a percentage of sales these expenses increased 1.5% to 27.9% in 2005 from 26.4% in 2004. The increased percentage is primarily due to reduced expense leveraging given our negative comparable store sales for the year and includes a 0.4% increase in rent expense due to the lease accounting adjustment and a 1.0% increase related to store occupancy costs, store personnel costs and store fixed asset depreciation expense.
Net interest and other expense decreased $1.7 million to $526 thousand in 2005 compared to $2.3 million in 2004. This decrease was attributable to $600 thousand less interest expense due to lower average borrowings levels in 2005 than in 2004 and to $1.1 million in less deferred financing costs amortization due to the replacement of our revolving credit facility in December 2004 and less deferred financing costs required for amortization.
Income tax expense decreased $4.1 million to $35.1 million in 2005 from $39.2 million in 2004 due to decreased profitability. Our effective tax rate decreased to 36.5% in 2005 from 38.5% in 2004 primarily due to the net adjustment of tax reserves related to net favorable settlements with certain state taxing authorities and due to a change in our state tax planning strategies.
We have financed our operations with funds generated from operating activities and borrowings under our revolving credit facility. Our cash flow strategy during the last three years has been focused on funding our store growth, distribution improvements and payment of our cash dividend. Our cash flows will continue to be utilized for the expansion of our business and, at the Boards discretion, the payment of an annual cash dividend.
Net cash flows provided from operating activities in 2006, 2005 and 2004 were $54.3 million, $38.7 million and $44.8 million, respectively. In 2006, the increase in net cash from operating activities is due primarily to a lower volume of inventory purchases offset by a decrease in net income. In 2005, the decrease in net cash from operating activities from the previous year is due to our negative comparable stores sales for the year and lower sales per store than anticipated. Cash and cash equivalents as of December 31, 2006, 2005 and 2004 were $49.6 million, $43.5 million and $45.1 million, respectively.
Capital expenditures, principally associated with new store openings and distribution center systems enhancements, were $15.7 million, $16.1 million and $23.0 million for 2006, 2005 and 2004, respectively. During each year, capital expenditures were primarily for new store openings, various distribution center equipment and improvements and corporate office equipment and improvements. In 2007, we expect to spend approximately $18 million for capital expenditures, primarily for new store openings. Capital expenditures will be financed with funds generated from operations and borrowings under our revolving credit facility.
During the first quarter of 2006, our Board of Directors approved an annual cash dividend of $0.80 per share of common stock. The cash dividend of $33.1 million was paid on March 30, 2006 to shareholders of record on March 10, 2006. During the second quarter of 2005, our Board of Directors approved the first annual cash dividend of $0.65 per share of common stock. The cash dividend of $26.9 million was paid on June 20, 2005 to shareholders of record on June 6, 2005. On March 9, 2007, the board of directors declared an annual cash dividend of $0.80 per common share payable on March 30, 2007. We will pay future dividends at the discretion of the Board of Directors. The continuation of these payments, the amount of such dividends, and the form in which the dividends are paid (cash or stock) depend on many factors, including our results of operations and financial condition. Subject to these qualifications, we currently expect to pay dividends on an annual basis.
We have a $210 million revolving credit facility which expires December 2009. Any borrowing under the revolver will incur interest at LIBOR or the prime rate, depending on the term of the borrowing, plus an applicable margin. We incur commitment fees of up to 0.25% on the unused portion of the revolving credit facility. This rate is reduced or increased as our average total leverage ratio changes. Our indebtedness under the credit facility is secured by a lien on our inventory and cash accounts, as well as a pledge of our ownership interests in all of our subsidiaries.
We had no balances outstanding related to our revolving credit facility at December 31, 2006 and 2005 and had borrowing availability of $201.9 million at December 31, 2006. As of December 31, 2006, we had outstanding letters of credit of $8.1 million under the revolving credit facility, primarily for self-insurance purposes.
The revolving credit facility contains certain restrictive covenants, which among other things, require us to comply with certain financial ratios covering maximum leverage, minimum fixed charge coverage and minimum interest coverage. Other restrictions affect our ability to incur liens or make certain other restricted payments, sell assets or merge or consolidate with any other person. As of December 31, 2006, we were in compliance with all covenants.
We anticipate that our net cash flows from operations and borrowings under our revolving credit facility will be sufficient to fund our working capital needs, planned capital expenditures, cash dividends and interest payments for the next twelve months.
We do not have any off-balance sheet arrangements, as defined in Regulation S-K Item 303(a)(4)(ii)(A)-(D), that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
The following table summarizes our contractual obligations at December 31, 2006 and the effects such obligations are expected to have on our liquidity and cash flow in future periods (in thousands):
We do not consider merchandise purchase orders to be contractual obligations due to designated cancellation dates on the face of the purchase order. We have no capital lease obligations or long-term debt at December 31, 2006.
The following tables set forth some of our quarterly financial data for the eight quarters ended December 31, 2006. The quarterly information is unaudited but has been prepared on the same basis as the audited financial statements included elsewhere in this Form 10-K. In our opinion, all necessary adjustments (consisting only of normal recurring adjustments) have been included to present fairly the unaudited quarterly results when read in conjunction with our consolidated financial statements and related notes included elsewhere in this Form 10-K. The results of operations for any quarter are not necessarily indicative of the results for any future period. (In thousands, except for per share data and comparable store sales)
(1) Includes stock compensation expense in 2006 as a result of our adoption of Statement 123(R) on January 1, 2006. On a quarterly basis, stock compensation expense was $579,000, $559,000, $973,000 and $820,000 for the first, second, third and fourth quarters, respectively, net of tax.
(2) Includes the lease accounting adjustment of $3.9 million ($2.4 million, net of income tax) which was recorded in the first quarter of 2005.
Our quarterly results of operations may fluctuate based upon such factors as the number and timing of store openings, the amount of net sales contributed by new and existing stores, the mix of merchandise sold, pricing, store closings or relocations, competitive factors and general economic and weather-related conditions. The timing of sales events could impact the weighting of sales between quarters. We expect to continue to experience seasonal fluctuations in our business, with a significant percentage of our net sales and operating income being generated in the fourth quarter, which includes the holiday selling season.
Inflation has had some effect on our results of operations in the current year primarily in transportation, utilities and waste management costs. However, in our opinion, the overall effect of inflation has not had a material effect on our results of operations. We cannot assure you that inflation will not materially affect us in the future.
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB No. 108), Considering the Effects of Prior Year Misstatements in the Current Year Financial Statements. SAB No. 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires an entity to evaluate misstatements using a balance sheet and income statement approach and evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. The requirements of SAB No. 108 are effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 will not have any effect on our consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measures. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and requires additional disclosures about fair value measurements. SFAS No. 157 applies to fair value measurements that are already required or permitted by other accounting standards, except for measurements of share-based payments and measurements that are similar to, but not intended to be, fair value and does not change existing guidance as to whether or not an instrument is carried at fair value. The provisions of SFAS No. 157 are effective for the specified fair value measures for financial statements issued for fiscal years beginning after November 15, 2007. We are currently evaluating the impact, if any, that the adoption of SFAS No. 157 will have on our consolidated financial statements.
In July 2006, the FASB issued Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of SFAS No. 109, Accounting for Income Taxes. FIN-48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with SFAS No. 109. The interpretation applies to all tax positions accounted for in accordance with Statement 109 and requires a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken, in an income tax return. Subsequent recognition, derecognition, and measurement is based on managements best judgment given the facts, circumstances and information available at the reporting date. FIN 48 is effective for fiscal years beginning after December 15, 2006. Early adoption is permitted as of the beginning of an enterprises fiscal year, provided the enterprise has not yet issued financial statements, including financial statements for any interim period for that fiscal year. We are currently evaluating the affect, if any, that the adoption of FIN 48 will have on our consolidated financial statements.
In March 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue No. 06-3, How Taxes Collected from Customers and Remitted to the Governmental Authorities Should be Presented in the Income Statement (that is, Gross versus Net Presentation). Taxes within the scope of EITF Issue No. 06-3 include any taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales taxes, use taxes, value added taxes, and some excise taxes. The EITF concluded that the presentation of these taxes on either a gross (included in revenues and costs) or a net (excluded from revenues) basis is an accounting policy decision which should be disclosed. For any such taxes that are reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements. Our policy is to exclude all such taxes from revenue. The provisions of EITF Issue No. 06-3 are effective for interim and annual reporting periods beginning after December 15, 2006. We do not expect the adoption of EITF Issue No. 06-3 will have any affect on our future consolidated financial statements.
In May 2005, the FASB issued SFAS No, 154, Accounting Changes and Error Corrections, a Replacement of Accounting Principles Board Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods financial statements for changes in accounting principles, unless it is impracticable to determine either the period-specific effect or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of change in accounting principle be limited to the direct effects of the change, indirect effects of a change in accounting principle, such as a change in non-discretionary profit sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived non-financial assets be accounted for as a change in accounting estimate affected by a change in principle. The provisions of SFAS No. 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date the Statement was issued. The Company is required to adopt the provisions of SFAS No. 154, as applicable, beginning in fiscal year 2007. We do not expect the adoption of SFAS No. 154 will have a significant effect on our future consolidated financial statements.
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), Share-Based Payment (Statement 123(R)), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee
stock options, to be recognized in the income statement based on their fair values at the time of grant. Pro forma disclosure is no longer an alternative.
Statement 123(R) permits public companies to adopt its requirements using one of two methods: (1) a modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date; (2) a modified retrospective method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. We have adopted Statement 123(R) based on the modified prospective method effective January 1, 2006.
We recognized stock-based compensation costs under the requirements of Statement 123(R) for the fiscal year 2006 as follows (in thousands):
Consistent with our inventory accounting policies, the payroll costs of buying, distribution and certain other general and administrative expenses, and with the adoption of Statement 123(R), the related stock-based compensation of these functions, are capitalized as a part of inventory and expensed as cost of sales when the related inventory is sold. The adoption of Statement 123(R) also caused a $0.07 decrease in basic and diluted earnings per share for the year ending December 31, 2006. We incurred approximately $2.9 million, net of tax, in stock-based compensation for the year ended December 31, 2006.
Statement 123(R) includes several modifications to the way that incomes taxes are provided for in the financial statements. The expense for stock option grants is only deductible for tax purposes at the time the taxable event takes place, which will cause variability in our effective tax rates recorded throughout each year. The expected variability in our effective tax rate is caused by Statement 123(R)s forbiddance of companies from predicting when these taxable events will take place. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow. This requirement will reduce net operating cash flows and increase net financing cash flows in annual periods after adoption.
In November 2005, the FASB issued Staff Position No. FAS 123R-3, Transition Election Related to Accounting for the Tax Effects of the Share-Based Payment Awards (FSP FAS 123R-3). We have elected to adopt the transition guidance for the additional paid-in-capital pool (APIC Pool) pool in paragraph 81 of Statement 123(R). The prescribed transition method is a detailed method to establish the beginning balance of the APIC Pool related to the tax effects of share-based compensation, and to determine the subsequent impact on the APIC Pool and Consolidated Statement of Cash Flows of the tax effects of share-based compensation awards that are outstanding upon adoption of Statement 123(R).
In prior years, we accounted for our stock-based compensation plans utilizing the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB 25). Generally, no compensation expense was recognized for fixed stock option plans because the exercise prices of employee stock options equaled or exceeded the market prices of the underlying stock on the dates of grant. Had we applied the fair value based method and recognition provisions of Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, (as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation Transition and Disclosure) previously reported net income, basic earnings per share and diluted earnings per share would have changed to the pro forma amounts shown below (in thousands except per share amounts):
Consistent with prior years, the fair value of each stock option granted during 2006 was estimated at the date of grant using a Black-Scholes option pricing model. The expected term of an option is based on our historical review of employee exercise behavior based on the employee class (executive or non-executive) and based on our consideration of the remaining contractual term if limited exercise activity existed for a certain employee class. The risk-free interest rate is the constant maturity risk free interest rate for U.S. Treasury instruments with terms consistent with the expected lives of the awards. The expected volatility is based on the historical volatility of our stock based on our historical stock prices. In 2006, we increased the number of data points used to calculate volatility from quarterly stock prices to daily stock prices which decreased our volatility assumption. For 2006, 2005 and 2004 these factors were as follows:
We are exposed to various market risks, including changes in foreign currency exchange rates and interest rates. Market risk is the potential loss arising from adverse changes in market prices and rates, such as foreign currency exchange and interest rates. Based on our market risk sensitive instruments outstanding as of December 31, 2006, as described below, we have determined that there was no material market risk exposure to our consolidated financial position, results of operations or cash flows as of such date. We do not enter into derivatives or other financial instruments for trading or speculative purposes.
Foreign Currency Exchange Rates. We enter into foreign currency forward contracts with major financial institutions to manage and reduce the impact of changes in foreign currency exchange rates on contractual merchandise purchases with certain international vendors. During 2006, the only transactions we hedged were for inventory purchase orders placed with foreign vendors for which the purchase order had to be settled in the vendors foreign currency. The periods for the forward foreign exchange contracts correspond to the periods of the hedged transactions. Gains and losses on forward foreign exchange contracts are reflected in the statement of income and were immaterial to us as a whole in 2006. At
December 31, 2006, we had outstanding forward foreign currency contracts to purchase approximately $935,000 of US dollar equivalent Euros with maturities ranging between 26 and 243 days.
The estimated fair value of foreign currency contracts represents the amount required to enter into offsetting contracts with similar remaining maturities based on quoted market prices. At December 31, 2006, the difference between the fair value of all outstanding contracts and the face amount of such contracts was immaterial. A large fluctuation in exchange rates for these currencies could have a material affect on their fair value; however, because we only use these forward foreign currency contracts to hedge future inventory purchases at a fixed price in the vendors foreign currency at the time the purchase order is made, any fluctuations in the exchange rate should not materially affect us.
The table below provides information about our forward foreign currency contracts at December 31, 2006 that are sensitive to foreign currency exchange rates and presents such information in U.S. dollar equivalents because that is our reporting currency. All the related contracts mature in 2007.
You can find more information about the accounting policies for our forward foreign currency contracts and our financial instruments in Notes 1 and 10 of the notes to our consolidated financial statements included elsewhere in this Form 10-K.
Interest Rates. We had no outstanding debt at December 31, 2006; however, we use our revolving credit facility to fund our operations as needed. We are exposed to financial market risk due to fluctuating interest rates on our revolving line of credit. Any borrowing under our revolver will incur interest at LIBOR or the prime rate depending on the term of the borrowing plus an applicable margin. During the twelve month period ended December 31, 2006, the LIBOR and Prime rates varied from 4.83% to 5.44% and 7.25% to 8.25%, respectively. We incur commitment fees of up to 0.25% on the unused portion of the revolving credit facility. This rate is reduced or increased as our leverage ratio changes. We do not hold any derivatives related to interest rate exposure for any of our debt facilities. You can find more information about our debt in Note 4 of the notes to our consolidated financial statements included elsewhere in this Form 10-K.
The following consolidated financial statements of Tuesday Morning and its subsidiaries and Report of Independent Registered Public Accounting Firm are included in this Form 10-K.
There were no disagreements with our auditors for the years ended December 31, 2006, 2005 and 2004, respectively.
Based on our managements evaluation (with participation of our principal executive officer and our principal financial officer), our principal executive officer and our principal financial officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) were effective as of December 31, 2006 to ensure that information required to be disclosed by us in this Annual Report on Form 10-K was (1) recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commissions rules and forms and (2) accumulated and communicated to our management, including our principal executive and principal financial officers, to allow timely decisions regarding required disclosure.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our chief executive officer and chief financial officer have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were effective to provide reasonable assurance that the objectives of our disclosure control system were met.
Management of Tuesday Morning is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) or Rule 15(d)-15(f) under the Exchange Act. Tuesday Mornings internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Our management (with the participation of our principal executive officer and our principal financial officer) assessed the effectiveness of Tuesday Mornings internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal ControlIntegrated Framework. Based on our assessment, we believe that, as of December 31, 2006, Tuesday Mornings internal control over financial reporting is effective based on those criteria.
Managements assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, has been audited by Ernst & Young, LLP, the independent registered public accounting firm who also audited Tuesday Mornings consolidated financial statements included in this Annual Report on Form 10-K. Ernst & Youngs attestation report on managements assessment of Tuesday Mornings internal control over financial reporting appears on page F-2 hereof.
There were no changes in Tuesday Mornings internal control over financial reporting that occurred during Tuesday Mornings last fiscal quarter that have materially affected or are reasonably likely to materially affect Tuesday Mornings internal control over financial reporting.
The information required by this Item 10 is incorporated herein by reference to the disclosure found in our definitive proxy statement to be filed pursuant to Regulation 14A of the Exchange Act in connection with Tuesday Mornings 2007 Annual Meeting of Stockholders.
We have adopted a Code of Ethics for Senior Financial Officers that establishes the ethical standards to be followed by the persons serving as principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. We have also adopted a Code of Conduct that establishes the business conduct to be followed by all of our officers, employees and members of our Board of Directors. Both are available on our website at http://www.tuesdaymorning.com under Investor RelationsCorporate Governance.
The information required by this Item 11 is incorporated herein by reference to the disclosure found in our definitive proxy statement to be filed pursuant to Regulation 14A of the Exchange Act in connection with Tuesday Mornings 2007 Annual Meeting of Stockholders.
The information required by this Item 12 is incorporated herein by reference to the disclosure found in our definitive proxy statement to be filed pursuant to Regulation 14A of the Exchange Act in connection with Tuesday Mornings 2007 Annual Meeting of Stockholders.
The following table provides information about our common stock that may be issued upon the exercise of options under equity compensation plans approved by stockholders at December 31, 2006. We do not have any equity compensation plans that were not approved by our stockholders.
The information required by this Item 13 is incorporated herein by reference to the disclosure found in our definitive proxy statement to be filed pursuant to Regulation 14A of the Exchange Act in connection with Tuesday Mornings 2007 Annual Meeting of Stockholders.
The information required by this Item 14 is incorporated herein by reference to the disclosure found in our definitive proxy statement to be filed pursuant to Regulation 14A of the Exchange Act in connection with Tuesday Mornings 2007 Annual Meeting of Stockholders.
(a) The following documents are filed as part of this Form 10-K.
(1) Financial Statements:
The list of financial statements required by this item is set forth in Item 8.
(2) Financial Statement Schedules:
All financial statement schedules called for under Regulation S-X are not required under the related instructions, are not material or are not applicable and, therefore, have been omitted or are included in the consolidated financial statements or notes thereto included elsewhere in this Form 10-K.
Management contract or compensatory plan or arrangement
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
of Directors and Stockholders of
We have audited managements assessment, included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting, that Tuesday Morning Corporation maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Tuesday Morning Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, managements assessment that Tuesday Morning Corporation maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Tuesday Morning Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Tuesday Morning Corporation as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2006 of Tuesday Morning Corporation and our report dated March 13, 2007 expressed an unqualified opinion thereon.
/s/ ERNST AND YOUNG LLP
The Board of Directors and Stockholders
We have audited the accompanying consolidated balance sheets of Tuesday Morning Corporation as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tuesday Morning Corporation at December 31, 2006 and 2005, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the financial statements, in 2006 the Company changed its method of accounting for stock-based compensation.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Tuesday Morning Corporations internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2007, expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
(1) On March 9, 2007, the board of directors declared an annual cash dividend of $0.80 per common share payable on March 30, 2007.
The accompanying notes are an integral part of these consolidated financial statements.