ITEM 1.
BUSINESS
Unless the context indicates otherwise, when this Annual Report on Form 10-K refers to “we,” “us” or “the Company,” we are referring to Big Dog Holdings, Inc. and its subsidiaries on a consolidated basis.
The following discussion should be read in conjunction with the audited financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K.
GENERAL
Big Dog Holdings, Inc. is the parent company of two retail chains, Big Dog USA, Inc. (“Big Dogs”) and The Walking Company (“TWC”). Big Dogs develops, markets and retails a branded, lifestyle collection of unique, high-quality, popular-priced consumer products, including active wear, casual sportswear, accessories and gifts for men and women of all ages. TWC is the world’s leading specialty retailer of authentic comfort footwear and accessories.
The Company’s Big Dogs products were first sold in 1983 and operations remained limited through 1992 when the current controlling stockholders acquired the BIG DOGS® brand and related assets. Following the acquisition of Big Dogs, the Company initiated a strategy of leveraging the brand through expansion of the Big Dogs’ product line and growth of its retail stores.
In March 2004, the Company, acquired the TWC retail stores out of bankruptcy. TWC sells high-quality, technically designed comfort footwear and accessories for men and women from leading comfort brands from around the world. Since its acquisition, the Company has expanded TWC through opening of new retail stores, acquisition of other retail store chains that it then converts into TWC stores, and development of an internet and catalog business to generate sales and promote its store-based business. TWC is now the world’s leading specialty retailer of authentic comfort footwear, operating 186 specialty stores as of December 31, 2007 in premium malls across the nation.
After early years of growth, Big Dogs reached a level of maturity in the number of stores and breadth of product. The Company grew the number of Big Dogs’ stores from five in 1993 to a peak of 231 in 2001 and has subsequently downsized that number to 100 by March 1, 2008 as customer traffic and sales in its outlet-based stores has declined. For Big Dogs, the Company is now focused on brand management and means of restoring profitability for its operations. See Risk Factors “CONTINUED LOSSES AND STORE CLOSURES IN BIG DOGS’ OPERATIONS.”
By 2007 the percentage of the Company’s income generated by TWC had increased to 70%. The Company expects that trend to continue. As previously announced, the Company intends to change its name from “Big Dog Holdings, Inc.” to “The Walking Company Holdings, Inc.” to reflect the shift in the main focus of the Company’s business to its TWC operations.
BUSINESS OF TWC
TWC is a chain of specialty retail stores selling high-quality, technically designed comfort footwear and accessories from around the world to both men and women, including such brands as ECCO®, Mephisto®, Dansko®, UGG® and Pikolinos®.
Having purchased the assets of TWC out of bankruptcy in March 2004, the Company re-focused TWC’s operations on its original core business of operating small specialty stores in premium malls selling the best brands in the comfort shoe category. We acquired the business of TWC based on, among other factors, our favorable assessment of its market niche, the favorable demographics of that market, and an anticipated ability to realize efficiencies and increase profitability by utilizing the retail store expertise of the Company and by consolidating TWC’s corporate overhead operations with those of the Company. The footwear products sold by TWC appeal to a large and growing demographic.
The Company has expanded TWC’s store chain through new store opening and strategic acquisitions. During 2005, the Company added to the TWC chain through the acquisition of Footworks. Footworks operated a chain of seven comfort footwear stores in strategic locations, including several high profile locations on the Las Vegas Strip. In January 2006, the Company acquired 37 store locations of Steve’s Shoes, Inc. out of bankruptcy. Steve’s Shoes had operated a chain of comfort footwear stores throughout the U.S. under the names Steve’s Shoes, Overland Trading Company and Sole Outdoor. In January 2008, the Company acquired the Natural Comfort Footwear chain of eight comfort footwear stores in Florida.
BUSINESS STRATEGY
Offer the Best Brands from Around the World. TWC seeks out and offers to its customers shoe brands that are of high quality, integrate comfort features, and are not widely distributed. TWC features a number of European and other foreign comfort shoe brands not widely found in other US shoe retailers. By editing the assortment of comfort brand for its customers and then explaining to them their benefits, TWC provides a unique and valued service to its customer, creating brand loyalty and repeat customers.
Authentic Comfort™. Each brand carried integrates comfort features such as shock absorbing EVA midsoles, hydrophobic foam insoles, waterproof leathers, anatomically contoured footbeds, and roomy toe boxes that follow the shape of the foot. TWC is uniquely positioned to be the only national retail shoe chain that markets comfort.
Target a Large and Growing Demographic. The Company has established TWC as the leading specialty retailer of comfort footwear appealing to a broad range of consumers. Although marketing focus is on baby boomers and working professionals, our customers include men and women of all ages. As the baby boomers age, there is an increasing focus on comfort footwear for both work and play. In addition, many of our brands are popular with working professionals such as teachers, medical staff, foodservice personnel and others who spend long days on their feet.
Utilize Strong Market Position. Through store expansion and a focus on comfort, TWC is now established as the only national specialty retailer of comfort footwear. TWC utilizes its preeminence in the comfort market to seek strong vendor relationships and widespread customer recognition.
MERCHANDISING
The TWC product line features high-quality branded comfort footwear and accessories from around the world. The professional comfort line focuses on working professionals who spend long hours on their feet. The dress comfort line includes more formal styles while maintaining the comfort for which TWC is known. The sport & active comfort line combines function and performance with style and design to create products that fit an active lifestyle. The casual comfort line includes comfort footwear for casual, everyday use. TWC also sells accessories that are designed to add to the comfort of the walking experience. TWC believes that all types of footwear are trending towards comfort and will merchandise accordingly.
TWC experiences a level of seasonality in the types of products it sells. During spring/summer, the focus shifts toward sandals. During the fall/winter, the focus shifts toward boots, slippers and all-weather footwear.
The majority of our footwear products range from between $80 and $150. The following table sets forth the approximate contribution made to total TWC net sales in our retail stores:
MARKETING
A significant focus of the Company’s efforts since its acquisition of TWC has been the implementation of an effective, coherent marketing image and strategy. This strategy has been implemented through a newly-developed store design and supporting marketing endeavors. Through new store development and refitting old stores, the large majority of the chain now have the new design. TWC further continues its brand awareness through consistent store layout and image, collateral materials (in-store posters, etc.), and development of brand-identifying trademarks and slogans (Authentic Comfort™, The Best Brands From Around the World, etc.) Such strategy has been implemented with relatively little media advertising, as we believe TWC’s most cost-effective marketing is through its stores themselves and our catalog and website. Also, almost all of the brands we carry contribute to a cooperative marketing fund with TWC, largely offsetting our collateral costs. In addition, many of the brands we feature engage in their own media advertising, which acts to support our stores. TWC is also able to leverage its marketing dollars by co-marketing with the companies whose brands it sells and with the malls in which it has stores.
RETAIL STORES
In 2007, our retail stores contributed 98% of TWC total net sales. As of December 31, 2007, we operated a total of 186 stores in 38 states and the District of Columbia. TWC stores are typically located in leading regional malls in prosperous urban areas where the Company believes demographics are favorable. In making site selections, we also consider a variety of other factors, including proximity to large population centers, area income, the prestige and potential customer-draw of the other tenants in the center or area, rent and operating costs, store location and visibility within the center, and the accessibility and visibility of the center from nearby thoroughfares.
The table below sets forth the number of TWC stores located in each state as of December 31, 2007.
Our TWC stores average approximately 1,700 square feet. We opened 41 new stores and closed six under-performing stores during 2007. Our cost to open a store in 2007, including leasehold improvements and furniture and fixtures, was approximately $293,000. The average per store initial inventory (largely financed by trade payables) for the new 2007 stores was approxi­mately $201,000 and pre-opening expenses averaged approximately $18,000 per store.
Our TWC store operations are managed by a Senior Vice President - Retail, Vice President - Retail, Director of Retail Operations, Director of Store Development, two Regional Managers, 14 district managers, and eight district training coordinators. Each of the stores is managed and operated by a store manager, an assistant manager and full-time and part-time sales associates. We seek to further enhance the TWC customer’s shopping experience by developing a knowledgeable and enthusiastic sales staff to distinguish TWC from its competition. In this regard, we (and the companies whose shoe brands we feature) provide instructive seminars and training to our staff to educate them on the technical quality of our shoes and to allow them to guide our customers to the products that best meet their comfort needs. We believe our commitment to knowledgeable customer service enhances our ability to generate repeat business and to attract new customers.
CATALOG AND INTERNET SALES
Our TWC catalog and internet sales, represented approximately 2% of TWC total net sales in 2007, compared to less than 1% in prior years.
SOURCING
Domestic and International Sourcing. TWC sources its product from a number of selected and approved brands located in the United States and abroad. TWC does not own or operate any manufacturing facilities. Occasionally, the Company goes directly to the manufacturer and has a shoe made to TWC specifications.
BUSINESS OF BIG DOGS
BIG DOGS® is an All-American, family-oriented brand that we believe has established a unique niche in its dedication to providing quality, value and fun. Our products are centered around the signature BIG DOGS® name, logo and "Big Dog" characters and are designed to appeal to a broad range of customers. The BIG DOGS® brand conveys a sense of fun, humor and a "Big Dog attitude," whereby each customer can feel that he or she is a "Big Dog."
The BIG DOGS® brand is designed to appeal to men, women and children of all ages, especially when they are engaged in leisure or recreational activities. We develop our apparel products, which include a wide variety of basic apparel and related products, with an emphasis on being functional rather than fashion-forward or trendy. These apparel products include graphic T-shirts, shorts, knit and woven shirts, fleece items, loungewear and boxer shorts. In addition to its BIG DOGS® line of activewear and casual sportswear for men and women, we have a LITTLE BIG DOGS® line of infants' and children's apparel and a BIG BIG DOGS® line of big-size apparel. We also sell a line of non-apparel products, including plush animals, stationery and pet products, which feature Big Dog graphics and are developed to complement our apparel.
After early years of growth, Big Dogs reached a level of maturity in the number of stores and breadth of product. The Company grew the number of Big Dogs stores from five in 1993 to a peak of 231 in 2001 and has subsequently downsized that number to 100 by March, 2008 as customer traffic and sales in its outlet-based stores has declined. For Big Dogs, the Company is now focused on brand management and means of restoring profitability for its operations. See Risk Factors “CONTINUED LOSSES AND STORE CLOSURES IN BIG DOGS OPERATIONS.”
BUSINESS STRATEGY
Promote the Big Dog Spirit of Fun. A key and unique element in our Big Dogs’ brand image is the focus on fun. This spirit of fun revolves around our Big Dog character that has broad appeal to men, women and children of all ages. We foster this spirit by creating positive, humorous, topical and inspiring graphics and slogans that we apply to our merchandise.
Deliver High Quality at a Good Value. Big Dogs' products are constructed using high-quality fabrics and other materials. Many of our products feature unique graphics characterized by advanced print techniques, as well as unique appliqués and embroideries on many of our apparel products.
Enhance Functional Products with Graphics. Big Dogs develops functional rather than fashion-forward products. Our focus on basics and our ability to leverage our graphics across multiple product categories have allowed us to eliminate the need for a traditional buyer or design staff, and thereby lower our product development costs compared to most fashion apparel companies.
Target a Broad, Diverse Customer Base. We believe we have established Big Dogs as an All-American, family-oriented brand featuring products, graphic themes, slogans and promotions that appeal to a broad range of consumers. Although our marketing focus is on baby boomers and their kids, our customers include men, women and children of all ages, who span a wide range of geographic areas and income levels. Furthermore, we believe that the millions of dog and other pet owners in the United States have a strong natural affinity for the dog-related images and themes in Big Dogs graphics. In addition, we believe that the positive image the brand brings to being a "Big Dog" has a special appeal to big-size customers.
Emphasize Grassroots Marketing. We believe Big Dogs’ most effective marketing is by the products themselves and their presentation in our retail stores, catalog and website. As a result, we have spent relatively little on advertising. Also important to our marketing strategy is our targeted "grassroots" marketing activities. These activities include local and charity sponsorships (such as high school sports teams) and community-oriented promotional events (such as the Company's annual dog parade in Santa Barbara).
MERCHANDISING
The Big Dogs’ product line features a branded, lifestyle collection of unique, high-quality, popular-priced consumer products, including activewear, casual sportswear, accessories and gifts. Our apparel lines include full collections of classic unisex casual sportswear and activewear for adults and for big sizes, as well as collections for infants and children. We continuously explore opportunities to further leverage our brand and graphics into new product lines.
Our apparel products are manufactured from premium cotton or quality synthetic fabrics. Big Dogs' apparel is characterized by quality fabrics, construction and embellishments, and is distinguished from other apparel lines by the BIG DOGS’® name, dog logo, graphics and slogans. In addition to our distinctive graphics, we believe we have achieved recognition for the quality and performance of our products.
The majority of Big Dogs’ products range from between $5 and $40. The following table sets forth the approximate contribution that each of Big Dogs’ product categories made to total net sales in our retail stores for the year ended December 31:
*Does not include catalog, wholesale and internet sales, which are skewed toward larger sizes.
Adult Apparel and Accessories. Big Dogs sells a complete line of adult unisex activewear and casual sportswear. We offer screen-printed and embroidered T-shirts and sweatshirts, in a variety of styles and colors that prominently display the Big Dogs’ graphics and slogans. In addition, we offer shorts, knit and woven casual shirts, fleece tops and bottoms, loungewear, boxer shorts, swimwear and sleepwear, all of which feature print designs or simply the BIG DOGS’® name and/or dog logo. Our adult apparel line primarily focuses on basic items that recur with relatively minor variation from season-to-season and year-to-year. While certain of our classic, popular items and graphics have been in the Big Dogs’ line with very little change for over ten years, we introduce new apparel and other products throughout the year to ensure that the merchandise assortments are consistent with the top sellers within our competitive market.
We leverage the Big Dogs’ trademarks, characters and more popular graphics by carefully translating them to a wide variety of apparel accessories, including caps, socks, sunglasses, bags, and wallets. These products are developed and introduced based on their consistency with Big Dog's brand image and whether they complement our other products. Our accessories not only provide an opportunity to create add-on purchases, but also minimize product development costs and inventory risk by utilizing graphics and slogans that have first proven popular on our graphic T-shirts.
Big-Size Apparel. We believe the BIG DOGS’® image and the positive emphasis the brand gives to being a "Big Dog" have a unique appeal to consumers who wear big sizes. Our BIG BIG DOGS’® category offers a line of unisex activewear and casual sportswear. As with the regular adult sizes, this category features screen-printed and embroidered T-shirts and sweatshirts, in a variety of styles and colors that prominently display the BIG DOGS’ graphic themes and slogans. In addition, we offer shorts, knit and woven casual and sports shirts, fleece tops and bottoms, loungewear, boxer shorts, swimwear and sleepwear, which may feature print designs or simply the BIG DOGS’® name and/or dog logo.
Infants’ and Children’s Apparel and Accessories. The LITTLE BIG DOGS® line includes infants, toddlers, kids and youth sizes. Products in this line include graphic T-shirts, shirts, fleece items, infant and toddler one-pieces, boxer shorts, dresses and shorts, virtually all of which feature distinctive graphics. The graphics and fabrics of this line are designed to mirror many of the more popular graphics and fabrics in the BIG DOGS® adult line in order to encourage family purchases and leverage overall product development costs. Our sales of children’s apparel have decreased in recent years, primarily due to increased competitive pressure in that category in pricing and from the mass market.
Non-Apparel Products. We further leverage our trademarks, characters and more popular graphics by applying them to a wide variety of adult's and children's non-apparel items, including pet products, plush animals and other toys, sporting goods, stationery, calendars and lunch boxes. As with apparel accessories, new non-apparel products are developed and introduced based on whether they are consistent with Big Dogs' brand image and complement our other products. As with apparel accessories, the graphics applied to these products have first proven popular on our T-shirts, resulting in lower product development costs and inventory risk.
MARKETING
Big Dogs strives to maintain a consistent brand image through the coordination of our merchandising, marketing and sales efforts. The goal of our marketing efforts is to present a distinctive image of quality, value and fun that consumers will associate with our products and thereby enhance the BIG DOGS® brand image. The BIG DOGS® brand image has been developed with relatively little advertising, as we believe its most effective marketing is its products themselves and their presentation in our retail stores and website.
RETAIL STORES
We seek to create a distinctive and fun shopping environment in Big Dogs stores through the innovative display of our graphic art and humor, including in-store "T-shirt walls" and other displays designed to immediately put the customer in a fun, relaxed state of mind.
In 2007, 2006 and 2005 our retail stores contributed approximately 91%, 93% and 94% of Big Dog Sportswear total net sales, respectively. As of December 31, 2007 we operated a total of 115 stores in 35 states. Big Dogs’ stores are located in outlet malls, many of which are in tourist and recreation-oriented shopping locations and other casual environments where the Company believes consumers are more likely to be in a fun, relaxed state of mind.
The table below sets forth the number of Big Dogs’ stores located in each state as of December 31, 2007.
Our outlet mall stores average approximately 2,800 square feet.
Our Big Dogs’ store operations are managed by an Executive Vice President-Merchandising/Retail, Director of Retail Operations, two regional managers and 11 district and market managers. Each of the stores is managed and operated by a store manager, an assistant manager and full-time and part-time sales associates.
DIRECT SALES (INTERNET)
Non-retail distribution channels, primarily catalog and internet sales, represent approximately 9%, 7%, and 6% of Big Dog Sportswear total net sales in 2007, 2006 and 2005, respectively.
Internet and Catolog. We have the benefit of being able to develop names for our emailing list through our retail store chain, which has been the primary source for such list. In recent years we have been migrating names away from the catalog operations and over to the website. The economics of the continued use of the catalog are being evaluated.
SOURCING
Domestic and International Sourcing. Big Dogs does not own or operate any manufacturing facilities but we instead source our products through third-party contractors with manufacturing facilities that are primarily overseas and to a limited extent, in Central America. We believe that outsourcing allows us to enhance production flexibility and capacity, while substantially reducing capital expenditures and avoiding the costs of managing a large production workforce. In addition, outsourcing allows us to leverage working capital, transfer risk and focus our energy and resources on merchandising, marketing and sales.
Big Dogs’ domestic sourcing is primarily limited to graphic T-shirts. Our graphic T-shirt business is managed in-house. This includes management of screen printing art and blanks, but not the actual screen-printing operations which are outsourced. Almost all other products, excluding T-shirts, are manufactured overseas, primarily in Asia, the Near and Middle East and Central Africa. In order to reduce our exposure to production risks and delays arising from trade disputes, political disruption or other factors relating to any one vendor or country, we utilize a diverse group of vendors. We source the majority of our product from trading companies. Through these trading companies and directly, we source from approximately 45 unaffiliated vendors, including 32 foreign vendors in a number of countries. In order to enhance our sourcing flexibility, we use trading companies rather than operate our own foreign sourcing office. These trading companies assist us in selecting and overseeing third-party vendors, sourcing fabric and monitoring quotas and other trade regulations. We do not have supply contracts with any of our suppliers. Although the loss of major suppliers could have a significant effect on our immediate operating results, since we are focused on basic apparel, we believe alternate sources of merchandise for most product categories are available at comparable prices and that we could replace these suppliers without any long-term adverse effect. As the Company has downsized the operations of Big Dogs in recent years, the decrease in the volume of product ordered from vendors has reduced certain economies of scale that previously existed. See RISK FACTORS-CONTINUED LOSSES AND STORE CLOSURES IN BIG DOGS OPERATIONS.
Quality Control. Our quality control program is designed to ensure that all goods bearing BIG DOGS® trademarks meet our standards. With respect to our products, Big Dogs, through its employees and sourcing agents, develops and inspects prototypes of each product prior to manufacture. For apparel products, Big Dogs, through its employees and sourcing agents, inspects the prototypes and fabrics prior to cutting by the contractors, establishes fittings based on the prototype and inspects samples. We or our sourcing agents inspect the final product prior to shipment to our warehouse or at the warehouse generally prior to payment.
BIG DOGS AND TWC OPERATIONS
SEGMENTS
The Company has two reportable segments, Big Dogs and TWC. See Note 10 of the Notes to Consolidated Financial Statements.
MANAGEMENT INFORMATION SYSTEMS
The Company is committed to utilizing technology to enhance its competitive position. We have put in place computer hardware, systems applications and networks that are the same as those used by a number of large retailers. These systems support the sales and distribution of products to our stores and customers and improve the integration and efficiency of our domestic and foreign sourcing operations. The Company’s management information system (“MIS”) provides integration of store, merchandising, distribution and financial systems. These systems include stock keeping unit ("SKU") and classification inventory tracking, purchase order management, open-to-buy, merchandise distribution, automated ticket making, general ledger, sales audit, accounts payable, fixed asset management, payroll and integrated financials. These systems operate on an IBM AS 400 platform and a Microsoft NT server network and utilize Island Pacific software. Our point-of-sale ("POS") system consists of registers providing price look-up, e-mail and credit card and check authorization. Through automated two-way communication with each store, sales information, e-mail and timekeeping information are uploaded to the host system, and receiving, price changes and systems maintenance are down-loaded through the POS devices. Sales are updated daily in the merchandising report systems by polling sales from each store's POS terminals. We evaluate information obtained through daily polling, including a daily tracking of gross margin, to implement merchandising decisions regarding reorders, markdowns and allocation of merchandise. Catalog operations are also supported by MIS applications from an established vendor, designed specifically to meet the unique requirements of this business. These applications include customer service phone center, order processing and mailing list maintenance.
ALLOCATION AND DISTRIBUTION OF MERCHANDISE
Allocation and distribution of our inventory is performed centrally at the SKU, merchandise classification and store levels using integrated third-party software. Utilizing our MIS capabilities, our planning and allocation group works closely with the merchandising and retail departments to monitor and respond to customer purchasing trends and meet the seasonal and locale-specific merchandising requirements of our retail stores.
Our main warehouse facility and our mail order warehouse and fulfillment facility are located in a 230,000 square-foot distribution facility in Charlotte, North Carolina. All merchandise is delivered by vendors to this facility, where it is inspected, entered into our merchandising software system, picked and boxed for shipment to the stores or customers. We ship merchandise to our stores at least weekly, to provide a steady flow of merchandise.
TRADEMARKS
The Company utilizes a variety of trademarks which it owns; including the U.S. registered trademarks THE WALKING COMPANY®, BIG DOGS®, BIG DOG SPORTSWEAR®, dog logo, BIG DOG®, LITTLE BIG DOGS®, and BIG BIG DOGS®. In addition, we have registered certain of our trademarks or have registration applications pending in other countries. We regard our trademarks and other proprietary rights as valuable assets and believe they have significant value in the marketing of our products. Like most popular brands, from time to time in the course of business we discover products or businesses in the marketplace that we believe infringe upon our trademark rights. In addition, in regard to Big Dogs, companies occasionally claim that a certain product or graphic of ours infringes on their intellectual property rights (sometimes in regard to our parodies of other’s trademarks that we do as part of the Big Dogs sense of fun). We take action protect our trademarks and defend ourselves against claims of others. Actions against infringers include the use of cease and desist letters, administrative proceedings and lawsuits.
COMPETITION
The level and nature of competition differ somewhat for Big Dogs versus TWC and among the product categories each of them feature. Both companies compete primarily on the basis of the brand image we develop and maintain for them, as well as product quality assortment and price, store location and layout, and customer service. Big Dogs also competes by offering a unique combination of quality, value and fun (in both its products and its store experience). TWC also competes by offering a unique assortment of quality, hard-to-find brands. The markets for each of our products are highly competitive. We believe that our long-term competitive position will depend upon our ability to anticipate and respond effectively to changing consumer demands and to offer customers a wide variety of high-quality, unique products at competitive prices.
Although we believe Big Dogs does not compete directly with any single company with respect to its entire range of merchandise, within each merchandise category it competes with well-known, value driven retail companies such as Penny’s, Kohl’s and Mervyn’s, as well as other national and regional department stores, specialty retailers and apparel designers and manufacturers. In addition, in recent years, the amount of casual sportswear and activewear manufactured specifically for department stores and sold under their own labels has significantly increased.
TWC competes primarily with small independent specialty shoe retailers (“mom & pop” operators), small shoes chains and also department store operators such as Nordstrom and Federated. We believe that due to the relatively high price points for the shoes TWC offers and the high-level of customer service required to effectively sell the technical comfort benefits of such shoes, the big-box, mass-market retailers do not present a significant potential competitive threat to TWC.
Some of the Company’s competitors are significantly larger and more diversified and have substantially greater financial, distribution, marketing and other resources and have achieved greater recognition for their brand names than the Company.
SEASONALITY
For a discussion of the extent to which the business of the Company is seasonal, see “Seasonality and Quarterly Results” in “Part I. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
WORKING CAPITAL ITEMS
The Company, as well as the retail industry, experiences significant fluctuations in working capital related to their seasonality. The Company maintains a line of credit, which provides them with the flexibility to increase inventory, as needed, in advance of those periods of higher sales demand.
EMPLOYEES
At March 3, 2008, we had approximately 1,100 full-time and 1,200 part-time employees. Our need for part-time retail employees fluctuates significantly based on seasonal needs. No employees are covered by collective bargaining agreements.
AVAILABLE INFORMATION
Big Dogs’ website is www.bigdogs.com and TWC’s website is at www.thewalkingcompany.com. We make available free of charge through our www.bigdogs.com website the Company’s annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practical after electronically filing such reports with the Securities and Exchange Commission. This website is intended to be an inactive textual reference only and none of the information contained in our website is part of this report or is incorporated in this report by reference.
ITEM 1A.
ITEM 1A.
RISK FACTORS
See discussion of Risk Factors in “Part I. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2.
PROPERTIES
Our corporate headquarters are in leased offices comprising approximately 24,000 square feet in Santa Barbara, California. This lease expires July 2011, with two options to extend for five years each. Our distribution facility is located in Charlotte, North Carolina in a building comprising approximately 230,000 square feet under a lease that expires in 2016. We have two options to extend this lease for ten years each. Additionally, the TWC merchandising department is in an office comprising approximately 17,500 square feet in Westlake Village, California. This lease expires in December 2013, with two options to extend for five years each.
We lease all of our store locations. Big Dogs store leases are typically for an initial term of five years with a five-year option and provide for base rent plus contingent rent based upon a percentage of sales in excess of agreed-upon sales levels. In recent years, we have negotiated shorter-term renewals for Big Dogs’ stores in malls where we perceive a risk of declining sales. See “Item 1. BUSINESS - RETAIL STORES” for both Big Dogs and TWC. The leases for TWC store locations typically have longer terms, as required by leading mall developers.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
In Marlene Korman v. The Walking Company, TWC was sued in the Eastern District of Pennsylvania in a purported class action lawsuit under the Fair and Accurate Credit Transactions Act (“FACTA”) because the plaintiff received a receipt with the expiration date from her debit credit card on it. The plaintiff alleges that that was a “willful” violation of FACTA, entitling her and the other members of the class to statutory damages of $100 to $1,000 per person. The Company has denied the complaint and is defending the action. The Company cannot predict the likelihood of a favorable or unfavorable outcome in this matter, but at this time does not believe that the outcome of such litigation will have a material adverse impact on our operations or financial condition.
From time to time we are involved in other pending or threatened litigation incidental to our business. We believe that the outcome of such litigation will not have a material adverse impact on our operations or financial condition.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF THE SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of our Company is traded on the NASDAQ Global Market under the symbol BDOG. The following table sets forth, for the period from the first quarter 2006 through the fourth quarter 2007, the high and low “sales” prices of the shares of our common stock, as reported on the NASDAQ Global Market.
On March 7, 2008, the last sales price of the common stock as reported on the NASDAQ Global Market was $7.61 per share. As of March 7, 2008, we had approximately 150 shareholders of record of our common stock.
Our current credit agreement prohibits the payment of dividends (see Liquidity and Capital Resources). We did not pay a dividend in 2007 and 2006, and do not expect to pay dividends in the foreseeable future.
Performance Graph
The performance graph below compares the cumulative shareholder return on the Big Dog Holdings’ Common Stock with the cumulative total return on the NASDAQ RETAIL INDEX and the NADAQ COMPOSITE INDEX. The graph assumes an investment of $100.00 on January 1, 2002. The performance graph represents past performance and should not be considered an indication of future performance.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in conjunction with the Consolidated Financial Statements and the Notes thereto and with "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this Form 10-K.
(1) Includes three temporary stores which were open as of December 31, 2003.
(2) Comparable store sales represent net sales of stores open at least one full year. Big Dog stores are considered comparable beginning on the first day of the third month following the one-year anniversary of their opening. TWC stores are considered comparable beginning on the first day of the first month following the one-year anniversary of their opening. Stores that are relocated but remain in the same shopping area remain in the comparable store base. The Company believes this method best reflects the effect of one-time promotional events and is most consistent with industry methods.
(3) In 2007, comparable store sales increase consists of an 8.1% increase in TWC comparable store sales, which is offset by an 8.3% decrease in Big Dogs comparable store sales. In 2006, comparable store sales increase consists of a 10.6% increase in TWC comparable store sales, which is offset by a 4.8% decrease in Big Dogs comparable store sales. In 2005, comparable store sales increase consists of a 12.8% increase in TWC comparable store sales, which is offset by a 4.1% decrease in Big Dogs comparable store sales. In 2004, comparable store sales increase consists of a 12.7% increase in TWC comparable store sales, which is offset by a 1.9% decrease in Big Dogs comparable store sales.
(4) Comparable store sales increase also includes internet and catalog sales after April 1, 2007. Our internet and catalog sales represent less than 3.0% of total sales in 2007.
(5) Includes notes payable, obligations under the bank line of credit and obligations under capital leases.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto of the Company contained elsewhere in this Form 10-K.
GENERAL
Big Dog Holdings, Inc. is the parent company of two retail chains, Big Dog USA, Inc., which does business as “Big Dog Sportswear” (“Big Dogs” or “Big Dog Sportswear”) and The Walking Company (“TWC”). Big Dogs develops, markets and retails a branded, lifestyle collection of unique, high-quality, popular-priced consumer products, including active wear, casual sportswear, accessories and gifts. TWC, acquired March 3, 2004, is a specialty retailer of authentic comfort footwear and accessories.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain selected statement of operations data expressed as a percentage of net sales:
YEARS ENDED DECEMBER 31, 2007 AND 2006
NET SALES. Net sales consist of sales from the Company’s stores, catalog, internet website, and corporate sales accounts, all net of returns and allowances. Net sales increased to $233.3 million in 2007 from $218.6 million in 2006, an increase of $14.7 million, or 6.7%. The increase is primarily driven by our TWC segment and relates to the impact of the TWC sales growth. The increase is offset in part by decreased sales from the Big Dogs’ segment.
TWC Operations. Net sales from TWC operations increased to $162.1 million in 2007 from $135.7 million in 2006, an increase of $26.4 million, or 19.5%. Of this increase $10.0 million related to an 8.1% increase in comparable store sales which includes TWC catalog/Internet sales after April 1, 2007; $14.5 million was attributable to an increase in TWC sales for stores not yet qualifying as comparable stores, which includes the closure of stores netted against new stores opened in the period; $1.5 million attributable to the acquisition of Steve’s Shoes in January, 2006, and a $0.4 million increase in the Company’s TWC catalog/Internet business prior to being included in comparable store sales. The increase in TWC comparable store sales is primarily related to improved inventory levels and merchandise selection at the TWC stores.
Big Dogs’ Operations. Net sales from Big Dogs’ operations decreased to $71.1 million in 2007 from $82.9 million in 2006, a decrease of $11.8 million, or 14.2%. Of this decrease $5.6 million was attributable to an 8.3% decrease in Big Dog Sportswear comparable store sales for the period, and $6.3 million was attributable to a decrease in Big Dog Sportswear sales for stores not qualifying as comparable stores, which includes the closure of unprofitable stores netted against new stores opened in the period. The decreases were offset by a $0.1 million increase in the Company’s Big Dog Sportswear corporate sales business. The decrease in Big Dog Sportswear comparable store sales is primarily related to an overall decrease in consumer traffic in our stores and outlet locations. The decrease in Big Dog Sportswear sales for stores not qualifying as comparable stores is primarily attributable to an additional nineteen net Big Dogs store closures during 2007 as compared to 2006, with 40 net Big Dogs stores closed in 2007 and 21 net Big Dog stores closed in 2006.
GROSS PROFIT. Gross profit increased to $122.4 million in 2007 from $116.9 million in 2006, an increase of $5.5 million, or 4.7%. As a percentage of net sales, gross profit decreased to 52.5% in 2007 from 53.5% in 2006. TWC’s gross profit remained relatively constant in 2007 and 2006 at 51.3% and 51.7%, respectively. Big Dogs’ gross profit remained relatively constant in 2007 and 2006 at 55.2% and 56.3%, respectively. Gross profit may not be comparable to those of other retailers, since some retailers include distribution costs and store occupancy costs in costs of goods sold, while we exclude them from gross margin, including them instead in selling, marketing and distribution expenses.
SELLING, MARKETING AND DISTRIBUTION EXPENSES. Selling, marketing and distribution expenses consist of expenses associated with creating, distributing, and selling products through all channels of distribution, including occupancy, payroll and catalog costs. Selling, marketing and distribution expenses increased to $113.0 million in 2007 from $103.4 million in 2006, an increase of $9.6 million, or 9.3%. As a percentage of net sales these expenses increased to 48.5% in 2007 from 47.3% in 2006, an increase of 1.2%. The increase is primarily related to spreading the fixed component of Big Dogs expenses over a smaller sales base, increased expenses related to operating the Steve’s Shoes stores acquired out of bankruptcy, and an increase in corporate infrastructure to facilitate future growth in the Company’s TWC segment.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses consist of administrative salaries, corporate occupancy costs and other corporate expenses. General and administrative expenses increased to $10.8 million in 2007 from $9.8 million in 2006. As a percentage of net sales these expenses remained relatively constant in 2007 and 2006 at 4.6% and 4.5%, respectively. The increase is attributable to an increase in administration to support the Company’s continued growth.
INTEREST INCOME. Interest income for 2007 and 2006 was less than $0.1 million. Interest income is primarily earned on excess cash balances invested on an overnight basis. As the Company generally uses excess cash to reduce the outstanding balances on their line of credit, interest income in future periods is not expected to be significant.
INTEREST EXPENSE. Interest expense increased to $4.3 million in 2007, from $2.1 million in 2006 related to an increase in borrowing as a result of new store construction and the Steve’s Shoes acquisition and additional working capital requirement.
INCOME TAXES. In 2007, the Company recorded an income tax benefit at an effective income tax rate of 38.5%. The Company believes it will fully realize this benefit by amending prior year tax returns to carry back the 2007 tax loss. In 2006, the provision for income taxes reflects a 37.5% effective tax rate.
YEARS ENDED DECEMBER 31, 2006 AND 2005
NET SALES. Net sales consist of sales from the Company’s stores, catalog, internet website, and corporate sales accounts, all net of returns and allowances. Net sales increased to $218.6 million in 2006 from $179.1 million in 2005, an increase of $39.5 million, or 22.1%. The increase is primarily driven by our TWC segment and relates to the impact of the TWC acquisitions as well as sales growth. The increase is offset in part by decreased sales from the Big Dogs’ segment.
TWC Operations. Net sales from TWC operations increased to $135.7 million in 2006 from $87.0 million in 2005, an increase of $48.7 million, or 56.0%. The increase was primarily attributable to the acquisitions of Footworks in August, 2005 and Steve’s Shoes in January, 2006, which increased sales by $7.5 million and $21.2 million in 2006, respectively. In addition, an increase of $8.5 million was attributable to a 10.6% increase in comparable store sales, $10.7 million attributable to an increase in TWC sales for stores not yet qualifying as comparable stores, which includes the closure of stores netted against new stores opened in the period, and a $0.8 million increase in the Company’s TWC catalog/Internet business. The increase in TWC comparable store sales is primarily related to improved inventory levels and merchandise selection at the TWC stores since the Company purchased TWC out of bankruptcy in March 2004.
Big Dogs’ Operations. Net sales from Big Dogs’ operations decreased to $82.9 million in 2006 from $92.1 million in 2005, a decrease of $9.2 million, or 10.0%. The decrease was related to $3.7 million attributable to a 4.8% decrease in Big Dog Sportswear comparable store sales for the period, $5.7 million attributable to a decrease in Big Dog Sportswear sales for stores not qualifying as comparable stores, which includes the closure of unprofitable stores netted against new stores opened in the period, and $0.1 million attributable to a decrease in the Company’s Big Dog Sportswear corporate sales business. The decreases were offset by a $0.3 million increase in the Company’s Big Dog Sportswear catalog/Internet business. The decrease in Big Dog Sportswear comparable store sales is primarily related to an overall decrease in consumer traffic in our stores and outlet locations. The decrease in Big Dog Sportswear sales for stores not qualifying as comparable stores is primarily attributable to an additional nine net Big Dog store closures during 2006 as compared to 2005, with 21 net Big Dog stores closed in 2006 and 12 net Big Dog stores closed in 2005.
GROSS PROFIT. Gross profit increased to $116.9 million in 2006 from $98.8 million in 2005, an increase of $18.1 million, or 18.3%. As a percentage of net sales, gross profit decreased to 53.5% in 2006 from 55.2% in 2005. TWC’s gross profit remained relatively constant in 2006 and 2005 at 51.7% and 51.8%, respectively. Big Dogs’ gross profit decreased to 56.3% in 2006 compared to 58.4% in 2005. The 2.1% decrease was primarily due to a shift to promotional sales from higher-margined sales. Gross profit may not be comparable to those of other retailers, since some retailers include distribution costs and store occupancy costs in costs of goods sold, while we exclude them from gross margin, including them instead in selling, marketing and distribution expenses.
SELLING, MARKETING AND DISTRIBUTION EXPENSES. Selling, marketing and distribution expenses increased to $103.4 million in 2006 from $80.6 million in 2005, an increase of $22.8 million, or 28.3%. The $22.8 million increase is primarily due to the acquisition of Footworks on August 31, 2005 and Steve’s Shoes on January 31, 2006. As a percentage of net sales these expenses increased to 47.3% in 2006 from 45.0% in 2005, an increase of 2.3%. The increase is primarily related to spreading the fixed component of Big Dog expenses over a smaller sales base, increased expenses related to operating the Steve’s Shoes stores acquired out of bankruptcy, an additional $0.7 million incurred to relocate the Company’s distribution center to a larger facility, and an increase in corporate infrastructure to facilitate future growth in the Company’s TWC segment.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses increased to $9.8 million in 2006 from $9.6 million in 2005. As a percentage of net sales these expenses decreased to 4.5% in 2006 from 5.4% in 2005, a decrease of 0.9%. The increase is attributable to a small increase in administration to support the Company’s continued growth.
INTEREST INCOME. Interest income for 2006 and 2005 was less than $0.1 million. Interest income is primarily earned on excess cash balances invested on an overnight basis. As the Company generally uses excess cash to reduce the outstanding balances on their line of credit, interest income in future periods is not expected to be significant.
INTEREST EXPENSE. Interest expense increased to $2.1 million in 2006, from $1.0 million in 2005 related to an increase in borrowing as a result of new store construction and the Footworks and Steve’s Shoes acquisitions and additional working capital requirement.
INCOME TAXES. In 2006, the provision for income taxes reflects a 37.5% effective tax rate, compared to a 38.0% effective tax rate in 2005.
SEASONALITY AND QUARTERLY RESULTS
Our two retail chains, Big Dog Sportswear and TWC, experience differing levels of seasonality. The seasonality of TWC stores closely resembles traditional retailers. The fourth quarter has historically accounted for the largest percentage of our TWC annual sales and profits. We believe the seasonality of our Big Dog Sportswear stores is somewhat different than many apparel retailers since a significant number of our Big Dog Sportswear stores are located in tourist areas and outdoor malls that have different visitation patterns than urban and suburban retail centers. The third and fourth quarters (consisting of the summer vacation, back-to-school and Christmas seasons) have historically accounted for the largest percentage of our Big Dog Sportswear annual sales and profits. We have historically incurred operating losses in the first half of the year and may be expected to do so in the foreseeable future.
Our quarterly results of operations may also fluctuate as a result of a variety of factors, including the timing of store openings, the amount of revenue contributed by new stores, changes in comparable store sales, changes in the mix of products sold, customer acceptance of new products, the timing and level of markdowns, competitive factors and general economic conditions.
OFF BALANCE SHEET ARRANGEMENTS
The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our consolidated financial condition, changes in our consolidated financial condition, revenues or expenses, consolidated results of operations, liquidity, capital expenditures or capital resources.
LIQUIDITY AND CAPITAL RESOURCES
During 2007, our primary uses of cash were for merchandise inventories, capital expenditures, and general operating activity. We satisfied our cash requirements from existing cash balances, funds provided by the convertible debt financing, and short-term borrowings under our line of credit agreements.
Cash provided by (used in) operating activities was $1.2 million and ($2.1) million for 2007 and 2006, respectively. The $3.3 million increase in cash provided by operating activities primarily relates to a $6.1 million decrease in inventory purchases and various fluctuations in operating assets and liabilities, which was offset by a $4.4 million decrease in our net income. Inventory purchases decreased as a result of reduced purchasing for the Big Dog segment.
Cash used in investing activities was $19.0 million and $20.5 million for 2007 and 2006, respectively. Of the cash used in investing activities in 2007, $19.2 million was used for capital expenditures, including 41 new TWC store openings, two new Big Dog Sportswear store openings, retrofitting existing stores and corporate additions, which was offset by $0.2 million of proceeds from the sale of equipment related to the relocation of our distribution center from California to North Carolina at the end of 2006. Of the cash used in investing activities in 2006, $15.9 million was used for capital expenditures, including 24 new TWC store openings, three new Big Dog Sportswear store openings, retrofitting existing stores and corporate additions. In addition, $4.6 million was used to acquire Steve’s Shoes, Inc.
Cash provided by financing activities in 2007 was $16.7 million compared to $22.6 million of cash used in financing activities in 2006. The decrease is primarily related to reduced borrowings in 2007 as compared to 2006. During 2007 we provided for our cash needs in part through longer term borrowings with the issuance of convertible debt and proceeds from a sale/leaseback transaction.
In October 2001, the Company entered into a credit facility with Wells Fargo Retail Finance (“WFRF”), which was most recently amended in March 2008 (the “Amended Credit Agreement”) and previously amended in November, 2006. Subsequent to the November 2006 amendment, the Amended Credit Agreement provides for a total commitment of $60,000,000 with the ability for the Company to issue documentary and standby letters of credit of up to $3,000,000. Prior to the amendment, the agreement provided for a total commitment of $47,000,000. The Company’s ability to borrow under the facility was determined using an availability formula based on eligible assets. The facility was collateralized by substantially all of the Company’s assets and requires daily, weekly and monthly financial reporting as well as compliance with financial, affirmative and negative covenants. The most significant of the amended financial covenants, amended in March 2008, includes compliance with a pre-defined annual maximum capital expenditure amount and a restriction on the payment of dividends. At December 31, 2007, the Company was not in compliance with one of its covenants, and subsequently obtained a waiver from WFRF. For all other periods presented, the Company was in compliance with all covenants, as amended. This credit agreement provides for a performance-pricing structured interest charge which was based on excess availability levels. The interest rate ranged from the bank’s base rate (7.25% as of December 31, 2007) or a LIBOR loan rate plus a margin ranging up to 1.75% (6.43% as of December 31, 2007). The Company had $2,203,000 in borrowings based on the bank’s base rate and $21,000,000 in LIBOR loans outstanding at December 31, 2007. The Amended Credit Agreement expires in October 2011. At December 31, 2007, the Company had approximately $1,733,000 of outstanding letters of credit expiring through October 2008, which includes a $1,000,000 stand-by letter of credit related to a promissory note entered in conjunction with the acquisition of Footworks in 2005.
Long-term Borrowings
Notes Payable
On April 3, 2007, the Company entered into a Convertible Note Purchase Agreement with certain purchasers, including some officers of the Company, pursuant to which the Company issued and sold $18.5 million of 8.375% Convertible Notes (“Note” or “Notes”) due March 31, 2012, interest payable quarterly. $3.0 million of the Notes were sold to management. The Notes are convertible into fully paid and nonassessable shares of the Company’s common stock to an aggregate of up to 1,027,777 shares at any time after the issuance date, at an initial conversion price of $18.00 per share. Any time after the eighteen month anniversary of the issuance date, the Company has the right to require the holder of a Note to convert any remaining amount under a Note into common stock if: (i) (x) the closing sale price of the common stock exceeds 175% of the conversion price on the issuance date for each of any 20 consecutive trading days or (y) following the consummation of a bona fide firm commitment underwritten public offering of the common stock resulting in gross proceeds to the Registrant in excess of $30 million, the closing sale price of the common stock exceeds 150% of the conversion price on the issuance date for each of any 20 consecutive trading days and (ii) certain equity conditions have been met. In circumstances where Notes are being converted either in connection with a voluntary conversion or an exercise of the Company’s right to force conversion, the Company has the option to settle such conversion by a net share settlement, for some or all of the Notes. If it exercises such right, the Company is to pay the outstanding principal amount of a Note in cash and settle the amount of equity in such Investor’s conversion right by delivery of shares of common stock of equal value. If the Notes are not converted before its maturity, the Notes will be redeemed by the Company on the maturity date at a redemption price equal to 100% of the principal amount of the notes then outstanding, plus any accrued and unpaid interest. The offer and sale of the Notes were made in accordance with Rule 506 of Regulation D of the Securities Act of 1933. The net proceeds from the sale of the Notes were $17,141,000 after $1,359,000 of debt issuance costs. Debt issuance costs are being amortized over the term of the note. Amortization of debt issuance costs totaling $204,000 is included in interest expense for the year ended December 31, 2007 on the accompanying statements of operations. As of December 31, 2007, the convertible note payable balance includes unamortized debt issuance costs of $1,155,000 in the accompanying consolidated balance sheet. The net proceeds of this offering were used to reduce the outstanding balance of Company’s line of credit. On June 21, 2007, the Company filed an S-3 Registration Statement to register the 1,027,777 shares of common stock which are convertible under the agreement and it became effective in September 2007. As of December 31, 2007, the Company’s stock price was $14.45, which was less than the conversion price of $18.00. Accordingly, the Company anticipates the Notes will be settled in cash at maturity.
On May 9, 2007, the Company purchased from the officers of the Company all of the vested employee stock options held by them that would otherwise have expired on or before May 9, 2008. Options for a total of 245,000 shares were purchased from five officers (no options were purchased from the CEO, Andrew Feshbach). The purchase price was $16.00 per share, less the exercise price of the options, which ranged from $6.50 to $10.00 per share. The $16.00 price represents a discount of approximately 5% from the May 9, 2007 closing price of $16.80. The net purchase price was $1,965,000. The Company paid for the options by delivery of notes bearing interest at 7% per annum and payable in two equal installments on April 10, 2008 and April 10, 2009. At December 31, 2007, $982,000 of the notes is classified as current portion of long-term debt to related parties in the accompanying consolidated balance sheet.
In conjunction with the Company’s acquisition of Footworks in 2005, Wells Fargo Retail Finance issued a $3,000,000 four-year term loan facility. Monthly payments of $55,555 were due beginning in March of 2006 with the balance due at the maturity date of the loan, October 2009. The term loan interest charge is Prime plus .5% or LIBOR plus 2.75% (7.75% at December 31, 2007). At December 31, 2007, $667,000 of the term loan facility is classified as current and is included in current portion of long-term debt in the accompanying consolidated balance sheet.
Additionally, in conjunction with the acquisition of Footworks, the Company also entered into a $3,000,000 three-year promissory note with the seller, Bianca of Nevada, Inc. The principal on this note is payable in three annual installments beginning August 31, 2006. The note bears an interest rate of 5.0% and accrued interest is payable quarterly beginning December 2005. The note is partially secured by a $1,000,000 stand-by letter of credit as the second principal installment was paid in August 2007. At December 31, 2007, $1,000,000 of the promissory note is classified as current and is included in current portion of long-term debt in the accompanying consolidated balance sheet.
As part of the acquisition of The Walking Company, TWC assumed priority tax claims totaling approximately $627,000. The Bankruptcy Code requires that each holder of a priority tax claim will be paid in full with interest at the rate of six percent per year with annual payments for a period of six years. At December 31, 2007 and 2006, $51,000 and $60,000, respectively, of the priority tax claim note is classified as current and is included in current portion of long-term debt in the accompanying consolidated balance sheets. As of December 31, 2007 and 2006, the remaining notes had a balance of $4,000 and $52,000, respectively.
Capital Lease
In the first quarter 2007, the Company entered into a $2,973,000 four-year capital lease agreement to finance equipment purchased for the Company’s new distribution center located in North Carolina. The capital lease agreement requires monthly payments of approximately $75,000 through March 2011 and includes a dollar purchase option at the end of the term. Depreciation expense of equipment purchased under this capital lease is included in selling, marketing and distribution expense in the accompanying consolidated statement of operations.
Management believes that available cash, the credit facilities in place at December 31, 2007, and cash generated from operations will be adequate to fund the Company’s working capital requirements for the foreseeable future.
COMMITMENTS AND OBLIGATIONS
As of December 31, 2007, we had the following obligations, which include both principal and interest payments:
Revolving Lines of Credit - We have a revolving credit facility with Wells Fargo Retail Finance that we use to finance our operations. Commitments related to interest on the credit facility are estimated based on the prior year’s average balance and the current weighted average interest rate (6.51% at December 31, 2007). See “Part I. Item 7. - Liquidity and Capital Resources” for additional information regarding our credit facility.
Convertible Debt - On April 3, 2007, we issued and sold $18.5 million of 8.375% Convertible Notes due March 31, 2012, interest payable quarterly. The Notes are convertible into fully paid and nonassessable shares of the Company’s common stock to an aggregate of up to 1,027,777 shares at any time after the issuance date, at an initial conversion price of $18.00 per share. See “Part I. Item 7. - Liquidity and Capital Resources” for additional information regarding our convertible debt.
Notes Payable, Related Party - On May 9, 2007, we purchased from certain officers of the Company all of the vested employee stock options held by them that would otherwise have expired on or before May 9, 2008. The Company paid for the options by delivery of notes bearing interest at 7% per annum and payable in two equal installments on April 10, 2008 and April 10, 2009. See “Part I. Item 7. - Liquidity and Capital Resources” for additional information regarding our notes payable, related party.
Notes Payable - In conjunction with the acquisition of Footworks, we entered into two loans used to finance the purchase. Commitments related to interest expense on these loans are estimated based on expected balance and the current interest rates (ranging from 5% to 7.75% at December 31, 2007). See “Part I. Item 7. - Liquidity and Capital Resources” for additional information regarding our notes payable.
Priority Tax Claims - In conjunction with the acquisition of The Walking Company, we assumed priority tax claims. Commitments related to interest expense on these claims are estimated based on the expected balance and the current interest rate of 6%. See “Part I. Item 7. - Liquidity and Capital Resources” for additional information regarding our priority tax claim debt.
Operating Leases - We lease retail and office space under various operating leases. Certain leases are cancelable with substantial penalties. See “Part I. Item 2. - Properties” for additional information regarding our leases.
Capital Leases - We lease certain warehouse equipment, computer and copier equipment under various capital leases. Certain leases are cancelable with substantial penalties.
Letters of Credit - We open letters of credit to facilitate inventory purchases as required by certain vendors. The letters of credit list certain documentation requirements that each vendor must present to our bank before payment is made. We are obligated to make these payments upon presentation of these documents.
See additional discussion above under Liquidity and Capital Resources.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. In addition, FIN 48 excludes income taxes from SFAS No. 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006 and provides transitional guidance for treating differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption. We implemented FIN 48 effective January 1, 2007. The implementation had no impact on the Company’s consolidated financial statements.
In July 2006, the Emerging Issues Task Force promulgated Issue No. 06-3 (“Issue”), How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (i.e., Gross Versus Net Presentation). The Task Force concluded that entities should present these taxes in the income statement on either a gross or a net basis based upon their accounting policy. However, this Issue states that if such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. This Issue should be applied to financial reports for interim and annual reporting periods beginning after December 15, 2006. Since the Company currently records taxes on a net basis (i.e., sales tax is not included in sales, but is instead recorded as a liability under accrued expenses), the adoption of this Issue did not have a material impact on the Company’s consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement provides guidance for using fair value to measure assets and liabilities. The statement also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The statement applies whenever other statements require (or permit) assets or liabilities to be measured at fair value, but does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. There are numerous previously issued statements dealing with fair values that are amended by SFAS No. 157. The Company is in the process of evaluating the impact, if any, that the adoption of SFAS No. 157 will have on the Company’s consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 (a.k.a. SAB Topic 1.N) addresses quantifying the financial statement effects of misstatements or, more specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. SAB No. 108 does not change the SEC staff’s previous positions in SAB No. 99, Materiality (a.k.a. SAB Topic 1.M) regarding qualitative considerations in assessing the materiality of misstatements. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have a material impact on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 provides companies with an option to report many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The FASB believes that SFAS No. 159 helps to mitigate accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities, and would require entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, Fair Value Measurements. This statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. The Company is in the process of evaluating the impact, if any, that the adoption of SFAS No. 159 will have on the Company’s consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”), which establishes principles and requirements for how the acquirer of a business is to (i) recognize and measure in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (ii) recognize and measure the goodwill acquired in the business combination or a gain from a bargain purchase; and (iii) determine what information to disclose to enable users of its financial statements to evaluate the nature and financial effects of the business combination. This statement requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. This replaces the guidance of SFAS No. 141, “Business Combinations” (“SFAS No. 141”) which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. In addition, costs incurred by the acquirer to effect the acquisition and restructuring costs that the acquirer expects to incur, but is not obligated to incur, are to be recognized separately from the acquisition. SFAS No. 141(R) applies to all transactions or other events in which an entity obtains control of one or more businesses. This statement requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. An acquirer is required to recognize assets or liabilities arising from all other contingencies as of the acquisition date, measured at their acquisition-date fair values, only if it is more likely than not that they meet the definition of an asset or a liability in FASB Concepts Statement No. 6, “Elements of Financial Statements.” This Statement requires the acquirer to recognize goodwill as of the acquisition date, measured as a residual, which generally will be the excess of the consideration transferred plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired. Contingent consideration should be recognized at the acquisition date, measured at its fair value at that date. SFAS No. 141(R) defines a bargain purchase as a business combination in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any noncontrolling interest in the acquiree, and requires the acquirer to recognize that excess in earnings as attributable to the acquirer. This statement is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early application is prohibited. The Company is currently evaluating the effect SFAS No. 141(R) will have on its accounting for, and reporting of, business combinations consummated on or after January 1, 2009.
There are no other accounting standards issued as of March 12, 2007 that are expected to have a material impact on the Company’s consolidated financial statements.
CRITICAL ACCOUNTING POLICIES
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are discussed in Note 1 to the consolidated financial statements. Certain of these accounting policies as discussed below require management to make estimates and assumptions about future events that could materially affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Our most critical estimate relates to projecting future cash flows used in assessing future store operating performance and testing long-lived assets, including goodwill, for impairment.
We evaluate the carrying value of long-lived assets, including goodwill, for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. This evaluation is performed based on the estimated undiscounted future cash flows from operating activities compared with the carrying value of the related asset. If the undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets, with such estimated fair values determined using the best information available generally based on prices for similar assets for stores recently opened. There were no impairment losses included in the consolidated results of operations for the years ended December 31, 2007, 2006 and 2005.
The Company is self insured for medical insurance coverage. The self insurance liability is based on the historical claims rate and is anticipated to cover reported claims as well as incurred but not reported claims. The Company also maintains stop loss insurance coverage which reimburses the Company for an individual claim in excess of $130,000 and for company-wide claims in excess of an aggregate amount. The annual aggregate amount is determined based on a per month, per participant amount which ranges from $283 to $749.
Inventories, consisting substantially of finished goods, are valued at the lower of cost (first-in, first-out and weighted average methods) or market. We continually evaluate our inventories by assessing slow moving current product as well as prior seasons' inventory. Market value of non-current inventory is estimated based on historical sales trends for this category of inventory, the impact of market trends, and an evaluation of economic conditions. The Company closely monitors its off-price sales to ensure the actual results closely match initial estimates. Estimates are regularly updated based upon this continuing review. Inventory adjustments incurred during the years ended December 31, 2007 and 2006 were $0.6 and $0.2, respectively. No adjustment was made in 2005.
We account for income taxes using an asset and liability approach for measuring deferred income taxes based on temporary differences between the financial statement and income tax bases of assets and liabilities existing at each balance sheet date. A valuation allowance is established, when necessary, to reduce deferred income tax assets to the amount expected to be realized. The Company considers a number of factors to determine if a valuation allowance is necessary, including historical earnings and past experience with similar timing differences. For the three years ended December 31, 2007, the Company determined that a valuation allowance was not required.
Effective January 1, 2007 we began accounting for uncertain tax provisions under the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize and measure the impact of uncertain tax positions on its financial statements. Determining whether an uncertain tax position should be recognized and how to measure the amount of the tax benefit requires significant judgment. As a result of adoption, we did not record any initial amount for previously unrecognized tax liabilities, and as of December 31, 2007, we did not recognize any additional estimated liability.
RISK FACTORS
Investors in the Company should consider the following risk factors as well as the other information contained herein.
CONTROL BY MAJORITY SHAREHOLDER, SMALL PUBLIC FLOAT, AND LOW TRADING VOLUME OF SHARES. Our Chairman of the Board, Fred Kayne, owns approximately 56% of Big Dogs’ outstanding common stock. In addition, approximately 66% of our shares are held by Mr. Kayne and other directors, officers or beneficial owners of more than 10%, none of whom have historically traded in the shares on any regular basis. As a result, Mr. Kayne, acting either individually or with the Company’s current directors and executive officers, will be able to control the election of directors, and to determine the outcome of any other matter submitted to a vote of our stockholders, including a change in control. While our shares are currently listed on the NASDAQ Global Market System, the average daily trading volume, particularly in recent years, has been very low. Due to all the foregoing, and other factors, there has been and can expect to be significant illiquidity in our shares.
CONTINUED LOSSES AND STORE CLOSURES IN BIG DOGS OPERATIONS. Big Dogs incurred net losses of over $1.2 million in 2006 and $2.6 million in 2007. Such losses are largely attributable to declining traffic in its outlet-based retail stores. In 2007, the Company closed 42 underperforming Big Dogs stores, and has closed another 15 Big Dogs store in 2008 to date. Further store closures are expected as the Company seeks opportunities to shift the focus of Big Dogs business more toward means of generating income outside of its retail stores. Store closures will reduce sales and result in the Company incurring additional costs related to the closure. One result of such downsizing of Big Dogs is that the decrease in the volume of product ordered from vendors has reduced certain economies of scale that previously existed, which can be expected to increase costs.
CHANGES IN CONSUMER PREFERENCES. The consumer products industry in general and the apparel industry in particular, are subject to changing consumer demands and preferences. Although we believe our Big Dogs and TWC products historically have not been significantly affected by fashion trends, its products are subject to changing consumer preferences. Big Dogs’ results will depend significantly on our ability to produce popular graphics and products that anticipate, gauge and respond in a timely manner to changing consumer demands and preferences. We also continue to evaluate our introduction of more risqué graphics in the Big Dogs line in recent years, and balance their sales against the risk of offending some customers. In addition, over the years general consumer preferences rise and decline in regard to the type of graphic and logo-oriented merchandise provided by Big Dogs, which can have an effect on our business.
FACTORS AFFECTING STORE TRAFFIC. Nearly all of our stores for both Big Dogs and TWC are located in malls. Accordingly our sales in such stores are, and will in the future continue to be, affected by the ability of such malls to continue to generate customer traffic. Big Dogs stores are located largely in outlet malls, with a majority of such malls we have selected being in tourist areas or tourist-serving areas where we think the customers will be attracted to Big Dogs merchandise. Outlet mall traffic appears to have declined overall in recent years. In addition, tourism may from time to time adversely be affected by such factors as economic downturns, adverse weather, war or international conflict, acts of terrorism or terrorism alerts, and increases in the cost of travel. In addition, customer traffic in both outlet malls and the regional malls in which TWC has stores is also affected by such factors as changing consumer preferences, opening of new malls in the area, the closing of high-profile stores in the mall and declines in the desirability of the shopping environment in a particular mall.
DEPENDENCE ON KEY PERSONNEL. Our success is significantly dependent on the performance of our key management, particularly Chief Executive Officer, Andrew Feshbach, Executive Vice President-Merchandising, Doug Nilsen, Executive Vice President - Business Affairs, General Counsel, Anthony Wall, Chief Financial Officer, Roberta Morris, Senior Vice President - Retail Operations, Lee Cox and Senior Vice President - Merchandising, Michael Grenley. We cannot assure you that we will be able to attract and retain key personnel. The loss of our key personnel could have an adverse effect on the Company’s results of operations and financial position. We do, however, maintain key-person life insurance policies on all of our senior executive officers.
DEPENDENCE ON THIRD-PARTY AND FOREIGN MANUFACTURERS AND SUPPLIERS. We do not own or operate any manufacturing facilities and are therefore dependent on third parties for the manufacture and supply of our Big Dogs and TWC products. The loss of major suppliers or the failure of such suppliers to timely deliver our products or to meet our quality standards, could adversely affect our ability to deliver products to our customers in a timely manner. The majority of our Big Dogs products are purchased from trading companies with relationships with manufacturing facilities located outside the United States. Our operations could be adversely affected by events that result in disruption of trade from foreign countries in which our suppliers are located. Our staff or agents periodically visit and observe the operations of such foreign and domestic manufacturers, but we do not control such manufacturers or their labor practices. Therefore we cannot necessarily prevent legal or ethical violations by independent manufacturers of Big Dogs goods, and it is uncertain what impact such violations would have on us.
SUBSTANTIAL COMPETITION. The markets for each of our products are highly competitive. In regard to our Big Dogs apparel products, the increased consumer shift toward large mass-market and discount retailers has put substantial pricing and competitive pressure on apparel retailers in general. We believe Big Dogs’ long-term competitive position will depend upon our ability to anticipate and respond effectively to changing consumer demands and to offer customers a wide variety of high-quality, fun products at competitive prices.
RELIANCE ON INFORMATION SYSTEMS. We rely on various information systems to manage our operations and regularly make investments to upgrade, enhance or replace such systems. Substantial disruptions affecting our information systems could have an adverse effect on our business.
DEPENDENCE ON TRADEMARKS. We use a number of trademarks, the primary ones of which are registered with the United States Patent and Trademark Office and in a number of foreign countries. While we believe our trademark rights are strong, in our pursuit and defense of particular infringement claims it cannot be assured that we will always prevail. See “Business - Trademarks.”
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties. The statements contained in this Form 10-K that are not purely historical are forward-looking statements, including without limitation statements regarding our expectations, beliefs, intentions or strategies regarding the future. Such forward-looking statements include the discussions in this Management’s Discussion and Analysis of Financial Condition and Results of Operations regarding the seasonality of business, expected new store openings, integration of acquisition and costs and inflation risks. All forward-looking statements in this document are based upon information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We do not believe we have material exposure to losses from market-rate sensitive instruments. We have not invested in derivative financial instruments. Our overseas sourcing contracts are denominated in US dollars.
Our consolidated financial position and consolidated results of operations are subject to market risk associated with interest rate movements on borrowings. Currently, our credit facilities contain a performance-pricing structured-interest charge based on excess availability levels and index based on Prime or LIBOR. Additionally, we have a term loan with an interest charge index based on Prime or LIBOR. We had $23,203,000 outstanding borrowings under these arrangements as of December 31, 2007. Based on these outstanding borrowings at December 31, 2007 and the current market condition, a one percent increase in the applicable interest rates would decrease our annual cash flow and pretax earnings by approximately $232,000. Conversely, a one percent decrease in the applicable interest rates would increase annual cash flow and pretax earnings by $232,000. Our market risk on interest rate movements will increase based on higher borrowing levels. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.”
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See “Index to Consolidated Financial Statements” at Item 15(a) for a listing of the consolidated financial statements filed as part of this report.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded accurately, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. As required by Rules 13a-15(b) and 15d-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of senior management, including our Chief Executive Officer and our Chief Financial Officer, of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act, as of the end of the period covered by this report. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report.
(b) Management’s Annual Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our internal control over financial reporting as of December 31, 2007 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under that framework and applicable Securities and Exchange Commission rules, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.
(c) Attestation Report of Registered Public Accounting Firm. This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
(d) Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting during our fourth fiscal quarter for 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION.
None.
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Other information with respect to this item is incorporated by reference from the registrant’s definitive proxy statement to be filed with the Commission not later than 120 days after the end of the registrant’s fiscal year.
EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below are the names, ages, titles and present and recent past positions of persons serving as our executive officers as of March 1, 2008:
ANDREW D. FESHBACH co-founded the Company in May 1992 and has served as President, Chief Executive Officer and as a director since that time. From 1990 until the present, he has served as a Vice President of Fortune Financial, a private merchant banking firm owned by the Company’s Chairman and majority stockholder, Fred Kayne. Mr. Feshbach has an M.B.A. from Harvard University.
DOUGLAS N. NILSEN has served as Executive Vice President-Merchandising for Big Dog USA for more than five years. From 1990 to September 1995, he served as Director of Merchandise at Walt Disney Attractions, Inc. for its U.S. theme parks and resorts, and in such capacity was responsible for merchandising all apparel and accessories. Mr. Nilsen has an M.B.A. from New York University.
ANTHONY J. WALL has served as Executive Vice President, General Counsel and Secretary of the Company for more than five years. Mr. Wall also provides occasional legal services to Fortune Fashions Industries LLC, a custom manufacturer of embellished apparel, Paige Premium Denim, a designer and manufacturer of denim jeans and casuals apparel, Fortune Swimwear, a manufacturer of swimwear for the mass market, and Terravant Wine Company, a custom-crush wine facility, all of which are controlled by Fred Kayne.
ROBERTA J. MORRIS has served as Chief Financial Officer since March 1998, having previously served as Senior Vice President-Finance since January 1995. Prior to joining the Company in 1993, Ms. Morris was employed as a Senior Audit Manager with Deloitte & Touche LLP. Ms. Morris is a certified public accountant.
LEE M. COX joined the Company in September 2000 and has served as Senior Vice President - Retail since February 2001. From 1994 until September 2000, Mr. Cox was employed by Adidas Retail, Inc. in various capacities, most recently as Director of Retail Stores.
MICHAEL GRENLEY joined the Company in March 2004 and serves as Senior Vice President - Merchandising for TWC. From 1994 until the Company’s acquisition of The Walking Company, Mr. Grenley served as Executive Vice President - Merchandise and Chief Operations Officer for the previous The Walking Company. Prior to The Walking Company, Mr. Grenley was a Vice President of Merchandise at Macy's California.
The members of the Audit Committee of the Board of Directors are Steven Good (Chairman), David Walsh and Skip Coomber. Our Board, in its judgment, has determined that Mr. Good meets the Securities and Exchange Commission’s definition of audit committee financial expert and has designated him as such. Our Board has further determined that Messrs. Good, Walsh and Coomber are independent as such term is used under Schedule 14A of the Securities Exchange Act of 1934.
We have adopted a code of ethics for our principal executive officer and senior financial officers. Copies of the code of ethics are available by writing to Big Dog Holdings, Inc., Attention General Counsel, 121 Gray Ave., Santa Barbara, CA 93101. Should any changes to or waivers of this code of ethics be made, such changes to or waivers will be timely disclosed on the Company’s website, unless the same is disclosed in a current report on Form 8-K filed with the Securities Exchange Commission.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Information with respect to this item is incorporated by reference from the registrant’s definitive proxy statement to be filed with the Commission not later than 120 days after the end of the registrant’s fiscal year.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information with respect to this item is incorporated by reference from the registrant’s definitive proxy statement to be filed with the Commission not later than 120 days after the end of the registrant’s fiscal year.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Information with respect to this item is incorporated by reference from the registrant’s definitive proxy statement to be filed with the Commission not later than 120 days after the end of the registrant’s fiscal year.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 of Part III is incorporated by reference from the Proxy Statement of Big Dog Holdings, Inc., relating to the 2008 Annual Meeting of Stockholders, to be filed with the SEC within 120 days of the fiscal 2007 year end.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a)
1.
The financial statements listed in the “Index to Consolidated Financial Statements” at page are filed as a part of this report.
2.
Schedule II - Valuation and Qualifying Accounts
Schedules other than that referred to above have been omitted because they are not applicable or are not required under the instructions contained in Regulation S-X or because the information is included elsewhere in the Consolidated Financial Statements or the Notes thereto.
3.
Exhibits included or incorporated herein:
See “Index to Exhibits.”
(b)
Reports on Form 8-K.
On November 9, 2007 the Company filed a Form 8-K to disclose third quarter financial results.
On December 6, 2007 the Company filed a Form 8-K to report that the holiday sales for The Walking Company were successfully launched with strong results over the Thanksgiving weekend.
SIGNATURES
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 March 28, 2008 on its behalf by the undersigned, thereunto duly authorized.
Each person whose signature appears below hereby authorizes Andrew D. Feshbach and Anthony J. Wall or either of them, as attorneys-in-fact to sign on his behalf, individually, and in each capacity stated below and to file all amendments and/or supplements to the Annual Report on Form 10-K.
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.
SIGNATURE
TITLE
DATE
/s/ANDREW D. FESHBACH
Chief Executive Officer, President and Director (Principal Executive Officer)
March 28, 2008
Andrew D. Feshbach
/s/ROBERTA J. MORRIS
Chief Financial Officer, Treasurer and Assistant Secretary (Principal Financial and Accounting Officer)
March 28, 2008
Roberta J. Morris
/s/FRED KAYNE
Chairman of the Board
March 28, 2008
Fred Kayne
/s/SKIP R. COOMBER, III
Director
March 28, 2008
Skip R. Coomber, III
/s/STEVEN C. GOOD
Director
March 28, 2008
Steven C. Good
/s/DAVID J. WALSH
Director
March 28, 2008
David J. Walsh
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2007, 2006, and 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Big Dog Holdings, Inc. and subsidiaries
Santa Barbara, California
We have audited the consolidated balance sheets of Big Dog Holdings, Inc. and subsidiaries (collectively, the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule of the Company listed in Item 15(a). These financial statements and financial statement schedule are the responsibility of the Company's 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, the Company has adopted the provisions of Statement of Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109” on January 1, 2007.
We were not engaged to examine management's assertion about the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007 and, accordingly, we do not express an opinion thereon.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
March 28,
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See notes to consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See notes to consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
The consolidated financial statements include the accounts of Big Dog Holdings, Inc. and its subsidiaries Big Dog Sportswear (“Big Dogs”) and The Walking Company (“TWC”), collectively the "Company". All significant intercompany accounts and transactions have been eliminated.
Big Dogs principally develops and markets apparel and other consumer products through Company-operated retail stores located throughout the United States, corporate sales accounts, catalogs and the Internet website.
TWC principally markets and sells authentic comfort footwear and accessories through Company-operated retail stores located throughout the United States, catalogs and the Internet website.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of less than three months when purchased to be cash equivalents.
RECEIVABLES, NET
Receivables, net consist primarily of tenant allowances, corporate sales and credit card transactions that remain outstanding at the end of the period. These amounts are reflected net of any allowance for doubtful accounts. The Company does not extend credit to its customers, except through third-party credit cards.
INVENTORIES
Inventories, consisting substantially of finished goods, are valued at the lower of cost (first-in, first-out and weighted average methods) or market. The Company continually evaluates its inventories by assessing slow moving current product as well as prior seasons' inventory. Market value of non-current inventory is estimated based on historical sales trends for this category of inventory, the impact of market trends, and an evaluation of economic conditions. The Company closely monitors its off-price sales to ensure the actual results closely match initial estimates. Estimates are regularly updated based upon this continuing review. Inventory adjustments incurred during the years ended December 31, 2007 and 2006 were $559,000 and $213,000, respectively. No adjustment was made in 2005.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated depreciation. Depreciation and amortization of property and equipment are provided using the straight-line method over the following useful lives:
Leasehold improvements are depreciated over the lesser of the estimated useful life of the asset or the term of the lease, whichever is shorter.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. This evaluation is performed based on the estimated undiscounted future cash flows from operating activities compared with the carrying value of the related asset. If the undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets, with such estimated fair values determined using the best information available generally based on prices for similar assets for stores recently opened. The Company’s evaluation for the years ended 2007, 2006 and 2005, which included all retail locations, indicated that no asset impairment existed and therefore no write-down of assets was recorded.
GOODWILL AND OTHER INTANGIBLE ASSETS
Indefinite Lived Intangibles
The Company accounts for indefinite lived intangible assets in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. The Company tests trademarks for impairment in the fourth quarter of each year and more often as circumstances require. As of December 31, 2007 and 2006, net trademarks totaled $300,000 and $299,000, respectively. Based on its most recent analysis, management does not believe any impairment of its trademark related intangible assets existed at December 31, 2007 and 2006, respectively.
Leasehold Intangible Assets
In conjunction with the Footworks acquisition in 2005 (see Note 4), the Company acquired lease related intangible assets valued at $4,408,000, which are being amortized over the life of the related leases. Accumulated amortization was $1,020,000 and $583,000 at December 31, 2007 and 2006, respectively.
The estimate of aggregate amortization expense for the subsequent years is as follows:
Goodwill
The Company accounts for goodwill in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. In 2005, the Company recorded $3,131,000 of goodwill in conjunction with the Footworks acquisition (see Note 4). All of the Company’s goodwill is allocated to the TWC segment. The Company tests goodwill for impairment in the fourth quarter of each year and more often as circumstances require. Based on its most recent analysis, management does not believe any impairment of its goodwill existed at December 31, 2007 and 2006, respectively.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
REVENUE RECOGNITION
Substantially all of the Company's revenues are generated by its retail operations, which are recognized at the time of sale. The Company also generates revenues through its corporate sales, Internet and mail order catalog operations, which are recognized at the time of shipment. Outbound shipping charges billed to customers are included in net sales when the products are shipped for corporate sales, Internet and mail order catalog sales. Sales tax charged, when applicable, is not included in net sales. The Company records an allowance for estimated returns in the period of sale based on prior experience. Gift certificates and gift card sales are recorded as a liability, until the certificate or card is redeemed. As the gift certificates and gift cards do not expire, the Company does not record income for unused gift certificates or gift cards. The Company accrues for estimated sales returns by customers based on historical sales return results.
INCOME STATEMENT COMPONENTS
Cost of goods sold consists of the cost of the product and related overhead costs related to the product, including purchasing, inbound freight charges, warehouse receiving costs, quality control inspection costs, internal product development costs and shipping and other handling costs to our stores or customers. Depreciation is not included in the calculation of cost of goods sold.
Selling, marketing and distribution expenses consist of expenses associated with creating, distributing, and selling products through all channels of distribution, including occupancy, payroll and catalog costs. The distribution costs included in selling, marketing and distribution expense were $5,612,000, $5,329,000 and $3,314,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
General and administrative expenses consist of administrative salaries, corporate occupancy costs and other corporate expenses.
VENDOR ALLOWANCES
Vendor allowances include allowances, rebates and cooperative advertising funds received from vendors. The amount of these funds is determined for each fiscal year and the majority is based on various quantitative contract terms. Amounts received from vendors relating to the purchase of merchandise inventories are recognized as a reduction of cost of the inventory. Amounts that represent a reimbursement of costs incurred, such as advertising, are recorded as a reduction to the related expense in the period that the related expense is incurred.
STORE PREOPENING EXPENSES
The Company expenses store pre-opening costs as incurred, which totaled $834,000, $311,000 and $236,000 in 2007, 2006 and 2005, respectively.
ADVERTISING COSTS
Costs associated with the production of our mail order catalogs are capitalized and expensed over the expected revenue stream following the mailing of the respective catalog, generally three months. All other advertising costs are expensed as incurred. Advertising expense charged to operations for the years ended December 31, 2007, 2006 and 2005 was $3,858,000, $3,211,000 and $1,389,000, respectively. Capitalized advertising costs related to our mail order catalogs were $278,000 and $295,000 as of December 31, 2007 and 2006, respectively, and are included in prepaid expenses and other current assets on the consolidated balance sheets.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
DEFERRED LEASE INCENTIVES
The Company accounts for landlord allowances in accordance with SFAS 13, “Accounting for Leases” and FASB Technical Bulletin 88-1, “Issues Relating to Accounting for Leases”. Accordingly, all incentives received from landlords to fund tenant improvements are recorded as deferred liabilities and then amortized over the related store’s lease term.
STRAIGHT-LINE RENT
The Company accounts for rent expense in accordance with SFAS 13, “Accounting for Leases,” and FASB Technical Bulletin 85-3, “Accounting for Operating Leases with Scheduled Rent Increases.” Accordingly, rent expense under the Company’s store operating leases is recognized on a straight-line basis over the original term of each store’s lease, inclusive of rent holiday periods during store construction and excluding any lease renewal options.
MEDICAL SELF-INSURANCE RESERVE
The Company is self-insured for medical insurance coverage. The self-insurance liability is based on the historical claims rate and is anticipated to cover reported claims as well as incurred but not reported claims. The Company also maintains stop loss insurance coverage which reimburses the Company for an individual claim in excess of $130,000 and for company-wide claims in excess of an aggregate amount. The annual aggregate amount is determined based on a per month, per participant amount which ranges from $283 to $749.
INCOME TAXES
The Company accounts for income taxes using an asset and liability approach for measuring deferred income taxes based on temporary differences between the financial statement and income tax bases of assets and liabilities existing at each balance sheet date. A valuation allowance is established, when necessary, to reduce deferred income tax assets to the amount expected to be realized. The Company considers a number of factors to determine if a valuation allowance is necessary, including historical earnings and past experience with similar timing differences. For the three years ended December 31, 2007, the Company determined that a valuation allowance was not required.
Effective January 1, 2007 the Company began accounting for uncertain tax provisions under the provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (“FIN 48”). FIN 48 prescribes a comprehensive model for how a company should recognize and measure the impact of uncertain tax positions on its financial statements. Determining whether an uncertain tax position should be recognized and how to measure the amount of the tax benefit requires significant judgment. As a result of adoption, the Company did not record any initial amount for previously unrecognized tax liabilities, and as of December 31, 2007, the Company did not recognize any additional estimated liability. (See Note 7).
EARNINGS PER SHARE
Basic earnings per share is calculated based on the weighted average number of shares outstanding. Diluted earnings per share is calculated based on the same number of shares plus additional shares representing stock distributable under stock-based plans computed using the treasury stock method.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
The following reconciles the numerator and denominator of the basic and diluted per-share computations for net (loss) income:
Basic (loss) income earnings per share is computed by dividing net (loss) income earnings by the weighted average number of common shares outstanding for the period. Diluted (loss) income earnings per share reflects the potential dilution that could occur if options were exercised or converted into common stock. Shares attributable to the exercise of outstanding options or conversion of convertible notes that are antidilutive are excluded from the calculation of diluted loss per share. Antidilutive options, warrants and convertible debt consist of stock options, warrants and convertible debt for the respective years that had an exercise price greater than the average market price during the year.
ACCOUNTING FOR STOCK-BASED COMPENSATION
On January 1, 2006, the Company adopted the provisions of Financial Accounting Standards Board Statement No. 123R, Share-Based Payment (“SFAS 123R”). The statement provides for, and the Company has elected to adopt the standard using the modified prospective application under which compensation cost is recognized on or after the required effective date for the fair value of all future share based award grants and the portion of outstanding awards at the date of adoption of this statement for which the requisite service has not been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for pro forma disclosures.
Prior to January 1, 2006, the Company accounted for its stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost was reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The Company recorded a $1,220,000 and $540,000 tax benefit for the years ended December 31, 2007 and 2006, respectively, related to the exercise of stock options for which no compensation expense was recorded.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock-based compensation for the year ended December 31, 2005 was determined using the intrinsic value method. The following table provides supplemental information for that period as if stock-based compensation had been recognized under SFAS 123R:
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK
The Company had $199,000, $135,000 and $845,000 of cash on deposit with a high credit quality financial institution in excess of the Federal Deposit Insurance Corporation limits as of December 31, 2007, 2006 and 2005, respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of receivables, accounts payable and short-term borrowings approximate their carrying values because of the short-term maturity of these instruments.
The fair value of the Company’s debt instruments are based on the amount of future cash flows associated with each instrument discounted using the Company’s borrowing rate. At December 31, 2007 and 2006, the carrying value of all financial instruments was not materially different from fair value, as both the fixed and variable rate debt approximated rates currently available to the Company.
RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. In addition, FIN 48 excludes income taxes from SFAS No. 5, Accounting for Contingencies. FIN 48 is effective for fiscal years beginning after December 15, 2006 and provides transitional guidance for treating differences between the amounts recognized in the statements of financial position prior to the adoption of FIN 48 and the amounts reported after adoption. The Company implemented FIN 48 effective January 1, 2007. The implementation had no impact on the Company’s consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In July 2006, the Emerging Issues Task Force promulgated Issue No. 06-3 (“Issue”), How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement (i.e., Gross Versus Net Presentation). The Task Force concluded that entities should present these taxes in the income statement on either a gross or a net basis based upon their accounting policy. However, this Issue states that if such taxes are significant, and are presented on a gross basis, the amounts of those taxes should be disclosed. This Issue should be applied to financial reports for interim and annual reporting periods beginning after December 15, 2006. Since the Company currently records taxes on a net basis (i.e., sales tax is not included in sales, but is instead recorded as a liability under accrued expenses), the adoption of this Issue did not have a material impact on the Company’s consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This statement provides guidance for using fair value to measure assets and liabilities. The statement also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. The statement applies whenever other statements require (or permit) assets or liabilities to be measured at fair value, but does not expand the use of fair value in any new circumstances. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. There are numerous previously issued statements dealing with fair values that are amended by SFAS No. 157. The Company is in the process of evaluating the impact, if any, that the adoption of SFAS No. 157 will have on the Company’s consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 (a.k.a. SAB Topic 1.N) addresses quantifying the financial statement effects of misstatements or, more specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. SAB No. 108 does not change the SEC staff’s previous positions in SAB No. 99, Materiality (a.k.a. SAB Topic 1.M) regarding qualitative considerations in assessing the materiality of misstatements. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have a material impact on the Company’s consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 provides companies with an option to report many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. The FASB believes that SFAS No. 159 helps to mitigate accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities, and would require entities to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. The new statement does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, Fair Value Measurements. This statement is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007. The Company is in the process of evaluating the impact, if any, that the adoption of SFAS No. 159 will have on the Company’s consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”), which establishes principles and requirements for how the acquirer of a business is to (i) recognize and measure in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; (ii) recognize and measure the goodwill acquired in the business combination or a gain from a bargain purchase; and (iii) determine what information to disclose to enable users of its financial statements to evaluate the nature and financial effects of the business combination. This statement requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date. This replaces the guidance of SFAS No. 141, “Business Combinations” (“SFAS No. 141”) which required the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. In addition, costs incurred by the acquirer to effect the acquisition and restructuring costs that the acquirer expects to incur, but is not obligated to incur, are to be recognized separately from the acquisition. SFAS No. 141(R) applies to all transactions or other events in which an entity obtains control of one or more businesses. This statement requires an acquirer to recognize assets acquired and liabilities assumed arising from contractual contingencies as of the acquisition date, measured at their acquisition-date fair values. An acquirer is required to recognize assets or liabilities arising from all other contingencies as of the acquisition date, measured at their acquisition-date fair values, only if it is more likely than not that they meet the definition of an asset or a liability in FASB Concepts Statement No. 6, “Elements of Financial Statements.” This Statement requires the acquirer to recognize goodwill as of the acquisition date, measured as a residual, which generally will be the excess of the consideration transferred plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired. Contingent consideration should be recognized at the acquisition date, measured at its fair value at that date. SFAS No. 141(R) defines a bargain purchase as a business combination in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any noncontrolling interest in the acquiree, and requires the acquirer to recognize that excess in earnings as attributable to the acquirer. This statement is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early application is prohibited. The Company is currently evaluating the effect SFAS No. 141(R) will have on its accounting for, and reporting of, business combinations consummated on or after January 1, 2009.
RECLASSIFICATIONS
Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform to the current year’s presentation.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Depreciation and amortization expense of property and equipment totaled $7,177,000, $6,174,000 and $3,940,000 in 2007, 2006 and 2005, respectively.
In May 1999, the Company purchased the building which houses its downtown Santa Barbara retail store for $1,600,000. In August 1999, the Company sold this building for $2,119,000 and simultaneously entered into a 10-year lease. The $527,000 gain related to the sale of this building is being deferred over the life of the lease.
3. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consist of the following:
4. ACQUISITIONS
FOOTWORKS ACQUISITION
On August 31, 2005, the Company acquired substantially all of the assets of Footworks, a division of a privately held shoe retailer. The total purchase price was approximately $10.1 million which included the payment and issuance of cash and notes by the Company pursuant to the definitive agreement. The acquisition included a chain of 7 retail stores selling comfort shoes and accessories. Footworks’ operations have historically focused on high-visibility stores in Las Vegas, Nevada. The Company has converted the majority of the acquired stores into “The Walking Company” stores. Through an independent valuation, intangibles related to below market leases acquired were valued at approximately $4.4 million and acquired trademark intangibles were valued at approximately $0.1 million. Intangibles related to below market leases are amortized over the remaining lease term. Goodwill recorded in connection with the acquisition is approximately $3.1 million. The results of the Company’s operations for the Footworks stores have been included in the Company’s consolidated financial statements since the acquisition date. Pro forma results of operations are not presented as the acquisition is not considered material to the Company’s consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. ACQUISITIONS (continued)
STEVE’S SHOES ACQUISITION
On January 31, 2006, the Company acquired, through bankruptcy court, substantially all of the assets and assumed certain liabilities of Steve’s Shoes, Inc., pursuant to an asset purchase agreement for a purchase price of approximately $4.2 million. The Company also incurred acquisition related costs of $0.4 million. Of this amount $2.1 million was allocated to fixed assets, $2.6 million was allocated to inventory and $0.1 million was allocated to liabilities. The Company assumed liabilities for $65,000 in accrued vacation, $39,000 in outstanding sales returns and $30,000 in gift certificates. The purchase price allocation is subject to adjustment related to additional acquisition related costs and assumed liabilities and is expected to be finalized in the first quarter 2007.
Under the terms of the asset purchase agreement, TWC acquired substantially all of the assets of Steve’s Shoes, Inc. including, but not limited to, the inventory and fixed assets of 37 stores. The primary reason for the acquisition was to continue the growth of TWC by acquiring stores in strategic locations. During 2006 and 2007, the Company has or will be converting the majority of the acquired stores into “The Walking Company” stores. The transaction was accounted for under the purchase method of accounting, and accordingly the results of operations have been consolidated in the Company’s financial statements since acquisition on January 31, 2006.
The Company funded the purchase price by drawing upon existing lines of credit, and from available cash. No goodwill was recorded in connection with the acquisition. Pro forma results of operations will not be presented as the acquisition is not considered material (either individually or combined with Footworks) to the Company’s consolidated financial statements.
5. SHORT-TERM BORROWINGS
In October 2001, the Company entered into a credit facility with Wells Fargo Retail Finance (“WFRF”), which was most recently amended in March, 2008 (the “Amended Credit Agreement”) and previously amended in November, 2006. Subsequent to the November 2006 amendment, the Amended Credit Agreement provides for a total commitment of $60,000,000 with the ability for the Company to issue documentary and standby letters of credit of up to $3,000,000. Prior to the amendment, the agreement provided for a total commitment of $47,000,000. The Company’s ability to borrow under the facility was determined using an availability formula based on eligible assets. The facility was collateralized by substantially all of the Company’s assets and requires daily, weekly and monthly financial reporting as well as compliance with financial, affirmative and negative covenants. The most significant of the amended financial covenants, most recently amended in March 2008, includes compliance with a pre-defined annual maximum capital expenditure amount and a restriction on the payment of dividends. At December 31, 2007, the Company was not in compliance with one of its covenants and subsequently obtained a waiver from the WFRF. For all other periods presented, the Company was in compliance with all covenants, as amended. This credit agreement provides for a performance-pricing structured interest charge which was based on excess availability levels. The interest rate ranged from the bank’s base rate (7.25% as of December 31, 2007) or a LIBOR loan rate plus a margin ranging up to 1.75% (6.43% as of December 31, 2007). The Company had $2,203,000 in borrowings based on the bank’s base rate and $21,000,000 in LIBOR loans outstanding at December 31, 2007. The Amended Credit Agreement expires in October 2011. At December 31, 2007, the Company had approximately $1,733,000 of outstanding letters of credit expiring through October 2008, which includes a $1,000,000 stand-by letter of credit related to a promissory note entered in conjunction with the acquisition of Footworks in 2005.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. DEBT
Debt consists of the following as of December 31, 2007 and 2006:
The aggregate annual principal repayments required in respect of debt as of December 31, 2007 are as follows:
CONVERTIBLE DEBT
On April 3, 2007, the Company entered into a Convertible Note Purchase Agreement with certain purchasers, including some officers of the Company, pursuant to which the Company issued and sold $18.5 million of 8.375% Convertible Notes (“Note” or “Notes”) due March 31, 2012, interest payable quarterly. $3.0 million of the Notes were sold to management. The Notes are convertible into fully paid and nonassessable shares of the Company’s common stock to an aggregate of up to 1,027,777 shares at any time after the issuance date, at an initial conversion price of $18.00 per share. Any time after the eighteen month anniversary of the issuance date, the Company has the right to require the holder of a Note to convert any remaining amount under a Note into common stock if: (i) (x) the closing sale price of the common stock exceeds 175% of the conversion price on the issuance date for each of any 20 consecutive trading days or (y) following the consummation of a bona fide firm commitment underwritten public offering of the common stock resulting in gross proceeds to the Registrant in excess of $30 million, the closing sale price of the common stock exceeds 150% of the conversion price on the issuance date for each of any 20 consecutive trading days and (ii) certain equity conditions have been met. In circumstances where Notes are being converted either in connection with a voluntary conversion or an exercise of the Company’s right to force conversion, the Company has the option to settle such conversion by a net share settlement, for some or all of the Notes. If it exercises such right, the Company is to pay the outstanding principal amount of a Note in cash and settle the amount of equity in such Investor’s conversion right by delivery of shares of common stock of equal value. If the Notes are not converted before its maturity, the Notes will be redeemed by the Company on the maturity date at a redemption price equal to 100% of the principal amount of the notes then outstanding, plus any accrued and unpaid interest. The offer and sale of the Notes were made in accordance with Rule 506 of Regulation D of the Securities Act of 1933. The net proceeds from the sale of the Notes were $17,141,000 after $1,359,000 of debt issuance costs. Debt issuance costs are being amortized over the term of the note. Amortization of debt issuance costs totaling $204,000 is included in interest expense for the year ended December 31, 2007 on the accompanying statements of operations. As of December 31, 2007, the convertible note payable balance includes unamortized debt issuance costs of $1,155,000 in the accompanying consolidated balance sheet. The net proceeds of this offering were used to reduce the outstanding balance of Company’s line of credit. On June 21, 2007, the Company filed an S-3 Registration Statement to register the 1,027,777 shares of common stock which are convertible under the agreement and it became effective in September 2007. As of December 31, 2007, the Company’s stock price was $14.45, which was less than the conversion price of $18.00. Accordingly, the Company anticipates the Notes will be settled in cash at maturity.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. DEBT (continued)
NOTES PAYABLE, RELATED PARTY
On May 9, 2007, the Company purchased from the officers of the Company all of the vested employee stock options held by them that would otherwise have expired on or before May 9, 2008. Options for a total of 245,000 shares were purchased from five officers (no options were purchased from the CEO). The purchase price was $16.00 per share, less the exercise price of the options, which ranged from $6.50 to $10.00 per share. The $16.00 price represents a discount of approximately 5% from the May 9, 2007 closing price of $16.80. The net purchase price was $1,965,000. The Company paid for the options by delivery of notes bearing interest at 7% per annum and payable in two equal installments on April 10, 2008 and April 10, 2009. At December 31, 2007, $982,000 of the notes is classified as current portion of long-term debt to related parties in the accompanying consolidated balance sheet.
NOTES PAYABLE
In conjunction with the Company’s acquisition of Footworks in 2005, Wells Fargo Retail Finance issued a $3,000,000 four-year term loan facility. Monthly payments of $55,555 were due beginning in March of 2006 with the balance due at the maturity date of the loan, October 2009. The term loan interest charge is Prime plus .5% or LIBOR plus 2.75% (7.25% at December 31, 2007). At December 31, 2007, $667,000 of the term loan facility is classified as current and is included in current portion of long-term debt in the accompanying consolidated balance sheet.
Additionally, in conjunction with the acquisition of Footworks, the Company also entered into a $3,000,000 three-year promissory note with the seller, Bianca of Nevada, Inc. The principal on this note is payable in three annual installments beginning August 31, 2006. The note bears an interest rate of 5.0% and accrued interest is payable quarterly beginning December 2005. The note is partially secured by a $1,000,000 stand-by letter of credit as the second principal installment was paid in August 2007. At December 31, 2007, $1,000,000 of the promissory note is classified as current and is included in current portion of long-term debt in the accompanying consolidated balance sheet.
As part of the acquisition of The Walking Company, TWC assumed priority tax claims totaling approximately $627,000. The Bankruptcy Code requires that each holder of a priority tax claim will be paid in full with interest at the rate of six percent per year with annual payments for a period of six years. At December 31, 2007 and 2006, $51,000 and $60,000, respectively, of the priority tax claim note is classified as current and is included in current portion of long-term debt in the accompanying consolidated balance sheet. As of December 31, 2007 and 2006, the remaining notes had a long-term balance of $4,000 and $52,000, respectively.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. INCOME TAXES
The (benefit from) provision for income taxes consists of the following:
The Company's effective income tax rate differs from the federal statutory rate due to the following:
Significant components of the Company's net deferred income tax assets are as follows:
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. INCOME TAXES (continued)
Implementation of FIN 48
On January 1, 2007, the Company adopted the provisions of FIN 48 (see Note 1). As a result of adoption, the Company did not record any initial amount for previously unrecognized tax liabilities. The Company does not expect the amounts of unrecognized benefits to change significantly in the next 12 months.
As of December 31, 2007, the Company did not recognize any additional estimated liability.
Although no adjustments were recorded as of December 31, 2007, effective with the adoption of FIN 48, the Company will record any future accrued interest resulting from unrecognized tax benefits as a component of interest expense and accrued penalties resulting from unrecognized tax benefits as a component of income tax expense.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various state jurisdictions. The Company’s Federal and State income tax returns remain subject to examination for all tax years ended on or after December 31, 2000, with regard to all tax positions and the results reported.
On March 14, 2006, the Company received a notice of proposed adjustments from the Internal Revenue Service ("IRS”) related to its audit of the Company’s 2002 Tax Year. The IRS had proposed adjustments to increase the Company’s income tax payable for the 2002 year that was under examination. The adjustments related to the tax accounting for two short bond transactions recorded in 2002. The Company disagreed with the audit findings and obtained expert legal tax counsel to assist in its appeal. In September 2007, the Company received a notice from the IRS Appeals Office stating that they agreed with the Company’s appeal and there is no deficiency or over-assessment with regard to the audited year. The Company had not recorded a reduction in tax benefits in accordance with FIN 48 related to this audit. Since the audit is now resolved as such, no further analysis or adjustment is needed.
8. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases retail stores, office buildings and warehouse space under lease agreements that expire through 2019. Future minimum lease payments under noncancelable operating and capital leases are as follows:
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. COMMITMENTS AND CONTINGENCIES (continued)
The above amounts do not include contingent rentals based on sales in excess of the stipulated minimum that may be paid under certain leases on retail stores. Additionally, certain leases contain future adjustments in rental payments based on changes in a specified inflation index. The effective annual rent expense for the Company is the total rent paid over the term of the lease, amortized on a straight-line basis. The difference between the actual rent paid and the effective rent recognized for financial statement purposes is reported as deferred rent.
Rent expense for 2007, 2006 and 2005, totaled $37,702,000, $33,659,000 and $26,478,000, respectively, and includes a lease termination fee of $491,000 recorded in 2007 related to the relocation of the Company’s distribution center (described below) and contingent rentals of $787,000, $681,000 and $586,000 for 2007, 2006, and 2005, respectively, which are included in operating expenses in the consolidated statements of income. The cost of equipment under capital leases at December 31, 2007 and 2006 was $3,044,000 and $432,000, respectively, and accumulated depreciation for such equipment at December 31, 2007 and 2006 was $363,000 and $210,000, respectively.
In the first quarter 2007, the Company entered into a $2,973,000 four-year capital lease agreement to finance equipment purchased for the Company’s new distribution center located in North Carolina. The capital lease agreement requires monthly payments of approximately $75,000 through March 2011 and includes a dollar purchase option at the end of the term. Depreciation expense of equipment purchased under this capital lease is included in selling, marketing and distribution expense in the accompanying consolidated statement of operations.
In January 2007, the Company terminated their lease of a 143,000 square foot facility in Santa Fe Springs, California and as a result paid a $491,000 termination fee. The Company’s distribution center was housed in this facility prior to its relocation to a larger facility in Charlotte, North Carolina. The termination of the lease was recorded in accordance with SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. Under SFAS 146, liabilities arising from exit or disposal activities are recognized only when incurred, and measured at their fair value.
LITIGATION
In Marlene Korman v. The Walking Company, TWC was sued in the Eastern District of Pennsylvania in a purported class action lawsuit under the Fair and Accurate Credit Transactions Act (“FACTA”) because the plaintiff received a receipt with the expiration date from her debit credit card on it. The plaintif alleges that that was a “willful” violation of FACTA, entitling her and the other members of the class to statutory damages of $100 to $1,000 per person. The Company has denied the complaint and is defending the action. The Company cannot predict the likelihood of a favorable or unfavorable outcome in this matter, but at this time does not believe that the outcome of such litigation will have a material adverse impact on our operations or financial condition.
From time to time the Company is involved in other pending or threatened litigation incidental to its business. The Company believes that the outcome of such litigation will not have a material adverse impact on its consolidated operations or financial condition.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. STOCKHOLDERS' EQUITY
COMMON STOCK
The Company is authorized to issue 30,000,000 shares of common stock. As of December 31, 2007 and 2006, the Company had 11,187,608 and 10,973,264 of common stock issued, respectively.
In March 1998, the Board of Directors authorized the repurchase of up to $10,000,000 of its common stock. The Company has repurchased 1,710,598 shares totaling $9,446,000 as of December 31, 2007 and 2006.
On April 3, 2007, the Company entered into a Convertible Note Purchase Agreement with certain purchasers, including some officers of the Company, pursuant to which the Company issued and sold $18.5 million of 8.375% Convertible Notes due March 31, 2012, interest payable quarterly. The Notes are convertible into fully paid and nonassessable shares of the Company’s common stock to an aggregate of up to 1,027,777 shares at any time after the issuance date, at an initial conversion price of $18.00 per share. On June 21, 2007, the Company filed an S-3 Registration Statement to register the 1,027,777 shares of common stock which are convertible under the agreement and it became effective in September 2007. As of December 31, 2007, the Company’s stock price was $14.45, which was less than the conversion price of $18.00. Accordingly, the Company anticipates the Notes will be settled in cash at maturity. See Note 6. Debt.
The Company’s credit agreement prohibits the payment of dividends. The Company did not pay a dividend in 2007 and 2006, and does not expect to pay dividends in the future.
PREFERRED STOCK
The Company is authorized to issue 3,000,000 shares of preferred stock. As of December 31, 2007 and 2006, the Company did not have any preferred stock issued or outstanding. Under the Company’s Certificate of Incorporation, the Board of Directors is authorized to fix the terms of the preferred stock provided for in such Certificate.
STOCK OPTIONS
In August 1997, the Company adopted the 1997 Performance Award Plan to attract, reward and retain officers and employees. The maximum number of shares reserved for issuance under this plan was 1,000,000. In February 1998, the Company amended the 1997 Performance Award Plan (the “Plan”) to increase the maximum number of shares reserved for issuance under the Plan to 2,000,000. The Company amended the Plan again in April 2002 to increase the maximum number of shares reserved for issuance under the Plan to 3,000,000. Awards under this Plan may be in the form of nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, performance shares, stock bonuses, or cash bonuses based upon performance.
On January 1, 2006, the Company adopted the provisions of Financial Accounting Standards Board Statement No. 123R, Share-Based Payment (“SFAS 123R”). This statement establishes standards surrounding the accounting for transactions in which an entity exchanges its equity instruments for goods or services. The statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions, such as the options issued under the Company’s Stock Option Plans. The statement provides for, and the Company has elected to adopt the standard using the modified prospective application under which compensation cost is recognized on or after the required effective date for the fair value of all future share based award grants and the portion of outstanding awards at the date of adoption of this statement for which the requisite service has not been rendered, based on the grant-date fair value of those awards calculated under Statement 123 for pro forma disclosures. The Company’s stock option compensation expense was $167,000 and $211,000 for years ended December 31, 2007 and 2006, respectively, and is included in operating expenses in the accompanying consolidated statements of income. The Company also recorded a related tax benefit of $64,000 and $79,000 in 2007 and 2006, respectively, and a deferred tax asset of $123,000 and $69,000 is recorded for years ended December 31, 2007 and 2006, respectively. In addition, the Company recorded a tax benefit of $1,220,000 and $540,000 related to options for which no compensation expense was recorded.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. STOCKHOLDERS’ EQUITY (continued)
The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model. This model incorporates certain assumptions for inputs including a risk-free market interest rate, expected dividend yield of the underlying common stock, expected option life and expected volatility in the market value of the underlying common stock. The Company used the following assumptions for options granted in the years ended December 31, 2005. There were no options granted in the years ended December 31, 2006 and 2007.
Expected volatilities are based on the historical volatility of the Company’s common stock. The risk free interest rate is based upon quoted market yields for United States Treasury debt securities. The expected dividend yield is zero as the Company is subject to a debt covenant prohibiting the payment of dividends. Expected term is derived from the historical option exercise behavior.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. STOCKHOLDERS’ EQUITY (continued)
The following table summarizes stock option activity during the years ended December 31, 2005, 2006 and 2007:
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. STOCKHOLDERS’ EQUITY (continued)
The weighted-average grant-date fair value of options granted during the years ended December 31, 2005 was $2.73. No options were granted in the years ended December 31, 2006 and 2007. The total intrinsic value of options exercised during the year ended December 31, 2007, 2006 and 2005 was $2,296,000, $1,487,000, $200,000, respectively, determined as of the date of each option exercised. The intrinsic value is the amount by which the current market value exceeds the exercise price of the stock option.
As of December 31, 2007, there was $199,000 of total unrecognized compensation cost, net of a 10% expected forfeiture rate, related to unvested options granted under the Company’s option plans. That cost is expected to be recognized on a straight-line basis over a weighted average period of 1 year. The total grant date fair value of shares vested during the year ended December 31, 2007 was $196,000.
Cash received from option exercise under share-based payment arrangements for the years ended December 31, 2007, 2006 and 2005 was $1,186,000, $959,000 and $322,000, respectively.
On May 9, 2007, the Company purchased from the officers of the Company all of the vested employee stock options held by them that would otherwise have expired on or before May 9, 2008. Options for a total of 245,000 shares were purchased from five officers (no options were purchased from the CEO). The purchase price was $16.00 per share, less the exercise price of the options, which ranged from $6.50 to $10.00 per share. The $16.00 price represents a discount of approximately 5% from the May 9, 2007 closing price of $16.80. The net purchase price was $1,965,000. The Company paid for the options by delivery of notes bearing interest at 7% per annum and payable in two equal installments on April 10, 2008 and April 10, 2009. See Note 6. Debt.
The following table summarizes information about stock options outstanding at December 31, 2007:
10. SEGMENT INFORMATION
For the years ended December 31, 2007, 2006 and 2005, the Company operated its business under two reportable segments: (i) Big Dog Sportswear business, and (ii) TWC business. The Big Dog Sportswear business includes the Company’s 115 Big Dog retail stores (primarily located in outlet malls), corporate sales, and its catalog and internet business selling quality sportswear. The TWC business includes the Company’s 186 The Walking Company stores located primarily in leading retail malls selling comfort footwear. These two retail chains are managed separately.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
10. SEGMENT INFORMATION (continued)
The accounting policies of the reportable segments are consistent with the consolidated financial statements of the Company. The Company evaluates individual store profitability in terms of a store’s contribution which is defined as gross margin less direct selling, occupancy, and certain indirect selling costs. Below are the results of operations on a segment basis for the years ended December 31, 2007, 2006 and 2005:
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
11. EMPLOYEE BENEFIT PLAN
The Company has a Retirement Savings Plan (the “Plan”), a defined contribution plan adopted pursuant to Section 401(k) of the Internal Revenue Code. The Plan is available to substantially all of the Company’s employees. The Company amended the Plan in November 2000 to match each dollar deferred up to 3% of compensation, which is limited to $1,000 annually, per participant. Participants vest in the Company’s contribution at varying rates of 0% to 20% per year over six years. The Company contributed approximately $278,000, $188,000 and $187,000 in 2007, 2006 and 2005, respectively.
12. RELATED PARTY TRANSACTIONS
On April 3, 2007, the Company entered into a Convertible Note Purchase Agreement with certain purchasers, including some officers of the Company, pursuant to which the Company issued and sold $18.5 million of 8.375% Convertible Notes due March 31, 2012, interest payable quarterly. $3.0 million of the Notes were sold to management. The Notes are convertible into fully paid and nonassessable shares of the Company’s common stock to an aggregate of up to 1,027,777 shares at any time after the issuance date, at an initial conversion price of $18.00 per share. As of December 31, 2007, the Company’s stock price was $14.45, which was less than the conversion price of $18.00. Accordingly, the Company anticipates the Notes will be settled in cash at maturity. See Note 6. Debt.
On May 9, 2007, the Company purchased from the officers of the Company all of the vested employee stock options held by them that would otherwise have expired on or before May 9, 2008. Options for a total of 245,000 shares were purchased from five officers (no options were purchased from the CEO). The purchase price was $16.00 per share, less the exercise price of the options, which ranged from $6.50 to $10.00 per share. The $16.00 price represents a discount of approximately 5% from the May 9, 2007 closing price of $16.80. The net purchase price was $1,965,000. The Company paid for the options by delivery of notes bearing interest at 7% per annum and payable in two equal installments on April 10, 2008 and April 10, 2009. See Note 6. Debt.
Two of the Company's stockholders and directors have ownership interests in two former merchandise vendors to the Company. Merchandise inventory purchased from these related vendors totaled $35,000, $3,000 and $135,000 in 2007, 2006 and 2005, respectively.
The Company engaged a related party to perform retail construction services. Construction services provided to the Company totaled $203,000 in 2005. No construction services were provided in 2007 or 2006.
In the normal course of business, one of the Company's officers pays for certain operating expenses which are reimbursed by the Company. At December 31, 2007 and 2006, the related outstanding payable was $63,000 and $70,000, respectively.
From time to time, the Company rents a plane for its own corporate travel use from a company where a majority stockholder and director is also the majority owner of the Company. The Company has no obligation to use such plane for any minimum amount, and to the extent it does use it, the Company pays for such use on terms at least as favorable to the Company as could be obtained from an independent third party. Costs associated with the use of such plane totaled $268,000, $215,000 and $189,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
13. SUBSEQUENT EVENTS
On January 15, 2008, The Walking Company purchased substantially all of the assets of Natural Comfort Footwear, Inc. net of certain liabilities for approximately $3.6 million. The purchase price was funded in part through existing working capital. Additionally, the Company entered into a $1.7 million three-year promissory note with the seller of Natural Comfort Footwear, Inc. The entire principal on this note is payable on January 15, 2011. The note bears an interest rate of 7% and accrued interest is payable quarterly beginning March 31, 2008. The assets include 8 store locations, inventory, trademarks, tangible personal property, and goodwill. Proforma results of operations will not be presented as the acquisition is not considered material to the Company’s consolidated financial statements.
BIG DOG HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
14. QUARTERLY FINANCIAL DATA (unaudited)
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2006 AND 2007
INDEX TO EXHIBITS
(1)
Incorporated by reference from the Company’s Current Report on Form 8-K filed as of March 3, 2004. The exhibits and schedules to the Plan have been omitted from this filing pursuant to Item 601(b)(2) of Regulation S-K. Big Dog Holdings, Inc. will furnish copies of any of such exhibits and schedules to the Securities and Exchange Commission upon request.
(2)
Incorporated by reference from the Company’s S-1 Registration Statement (No. 333-33027) as amended , which became effective September 25, 1997.
(3)
Incorporated by reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 1997.
(4)
Incorporated by reference from the Company’s Schedule TO filed July 31, 2000.
(5)
Incorporated by reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 1998.
(6)
Incorporated by reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
(7)
Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2005.
(8)
Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2005.
(9)
Incorporated by reference from the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
(10)
Incorporated by reference from the Company’s Current Report on Form 8-K filed as of May 4, 2006.
(11)
Incorporated by reference from the Company’s Current Report on Form 8-K filed as of December 20, 2006.