ITEM 1. BUSINESS
History
ALCO Stores, Inc., (the “Company”), was founded as a general merchandising operation in 1901 in Abilene, Kansas by A. L. Duckwall. From its founding until 1968, the Company conducted its retail operations as small variety or “dime” stores. In 1968, the Company followed an emerging trend to broad line retailing when it opened its first ALCO store. The Company’s overall business strategy involves identifying and opening stores in towns that will provide the Company with the highest return on investment. As of February 2, 2014, the Company operates 212 stores located in the central United States, and as of this date, there were fourteen stores in various stages of closing. These fourteen stores will be closed during the early portion of fiscal 2015.
The Company meets the requisite standard of a smaller reporting company under Rule 12b-2 of the Securities Exchange Act of 1934 (the “Exchange Act”).
The Company was incorporated on July 2, 1915 under the laws of Kansas. The Company’s executive offices are located at 751 Freeport Parkway, Coppell, Texas 75019, and its telephone number is (469) 322-2900. On April 10, 2013, the Company issued a press release to announce the relocation of the Company’s corporate headquarters from Abilene, Kansas to Coppell, Texas, a suburb of Dallas, Texas. The relocation of the Company’s corporate headquarters was completed in August 2013. The relocation of the Company’s corporate headquarters did not include the Company’s distribution center in Abilene, Kansas.
General
The Company is a regional retailer operating 212 stores in 23 states. The Company’s historical strategy has been to target smaller markets not served by other regional or national broad line retail chains and to provide the most convenient access to retail shopping within each market. The Company’s stores offer a broad line of merchandise consisting of approximately 35,000 items, including automotive, consumables and commodities, crafts, domestics, electronics, furniture, hardware, health and beauty aids, housewares, jewelry, ladies’, men’s and children’s apparel and shoes, pre-recorded music and video, sporting goods, seasonal items, stationery and toys.
The Company has historically preferred markets that do not have direct competition from national or regional broad line retail stores. The Company has expanded its search for future store locations to include various urban markets that may have national or regional broad line retail stores in the near proximity. During the third quarter of fiscal 2012, the Company opened a pilot store in Grand Prairie, TX and subsequently opened two additional pilot stores during November 2011; one in Pasadena, TX and one in Houston, TX. The results of these three test stores have not met the expected threshold for success and as such are included in the fourteen store closing group discussed above. The Company has yet to discern if future tests in urban markets will take place.
Of the Company’s 212 stores, approximately 78% operate in primary markets that do not have another broad line retailer. The current ALCO store averages approximately 21,000 square feet of selling space. The Company’s store expansion program is primarily directed toward opening stores with a design prototype of approximately 21,000 square feet of selling space. All of the Company’s stores are serviced by the Company’s 352,000 square foot distribution center in Abilene, Kansas.
For fiscal years 2014 and 2013, the percentage of sales by product category were as follows:
Business Strategy
The Company intends to focus on executing a business strategy that includes the following key components:
Markets: The Company intends to open stores in under-served markets. Historically, this strategy primarily included towns with populations less than 5,000 that are in trade areas with populations of less than 16,000 where: (1) there is no direct competition from national or regional broad line retailers; (2) economic and demographic criteria indicate the market is able to commercially support a broad line retailer; and (3) the opening of a store would significantly reduce the likelihood of the entry into such market by another broad line retailer. The Company had expanded its strategy for future store locations to include under-served areas within urban markets that may have national or regional broad line retail stores in the near proximity. During the third quarter of fiscal year 2012, the Company opened a pilot store in Grand Prairie, TX and subsequently opened two additional pilot stores during November 2011; one in Pasadena, TX and one in Houston, TX. The results of these three test stores have not met the expected threshold for success and will be closed. The Company has yet to discern if future tests in urban markets will take place.
Market Selection: The Company utilizes a detailed process to analyze under-served markets which includes examining factors such as distance from competition, trade area, demographics, retail sales levels, existence and stability of major employers, location of county government, disposable income, and distance from the Company’s distribution center. The Company has also determined that locating stores in proximity to grocery stores is a positive attribute, and not necessarily as a competitive threat, and as best it can, continue developing business relationships with grocery operators in new markets. Markets that are determined to be sizable enough to support a store and that have no direct competition from another broad line retailer are examined closely and eventually selected or passed over by the Company’s experienced management team.
Store Expansion: The Company’s expansion program is designed primarily around the prototype Class 21 Store. This prototype details shelf space, merchandise presentation, store items to be offered, parking, storage requirements, as well as other store design considerations. The 21,000 square feet of selling space is large enough to permit a full line of the Company’s merchandise, while minimizing capital expenditures, labor costs and general overhead costs. The Company will also consider opportunities in acceptable markets to open stores in available space in buildings already constructed.
E-commerce: The Company initiated a transactional web site during November 2011. In July 2012, the Company expanded the product selection on its website which now includes more than 20,000 items of high-quality merchandise. Products offered on the ALCOstores.com website include video games and electronics, housewares, appliances and furniture, health & beauty aids, baby goods, office supplies, automotive and sporting goods, and much more. As in traditional ALCO stores, consumers can choose from a wide range of well-known brand names. In addition, the website includes brands not found in the Company’s retail stores.
Advertising and Promotion: The Company utilizes full-color photography advertising circulars of 12 to 24 pages distributed through newspaper insertion or, in the case of inadequate newspaper coverage, through direct mail. During fiscal 2014, these circulars were distributed 47 times. The Company’s marketing program is designed to create awareness and recognition of its competitive pricing on a comprehensive merchandise selection for the whole family. During fiscal 2015, the Company will distribute approximately 47 circulars.
Store Environment: The Company’s stores are open, clean, bright and offer a pleasant atmosphere with disciplined product presentation, attractive displays and efficient check-out procedures. The Company endeavors to staff its stores with courteous, highly motivated, knowledgeable store associates in order to provide a convenient, friendly and enjoyable shopping experience.
Store Development
During fiscal 2015, the Company currently expects to open three stores and is currently in process of closing fourteen stores. The Company continually reviews underperforming stores to determine potential closures and, at this time, does not anticipate any additional store closures during fiscal 2015. During fiscal 2014, the Company opened three additional stores and closed eight, resulting in a year-end total of 212 stores. The Company’s strategy regarding store development is to increase sales and profitability at existing stores by continually refining the merchandising mix and improving operating efficiencies, and through new store openings in the Company’s targeted base of under-served markets in the central United States. The following table summarizes the Company’s store development during the past two fiscal years:
As of February 2, 2014, the Company owned five locations and leased 207 locations. The Company’s present intention is to lease all new stores; however, the Company may purchase some of the locations. The investment to open a new prototype ALCO store, that is leased, is approximately $1.0 million for the equipment and inventory.
Store Environment and Merchandising
The Company manages its stores to attractively and conveniently display a full line of merchandise within the confines of the stores’ available square footage. Corporate merchandising direction is provided to each store to ensure a consistent Company-wide store presentation. To facilitate long-term merchandising planning, the Company divides its merchandise into three core categories driven by the Company’s customer profile: primary, secondary, and convenience. The primary core receives management’s primary focus, with a wide assortment of merchandise being placed in the most accessible locations within the stores and receiving significant promotional consideration. The secondary core consists of categories of merchandise for which the Company maintains a strong assortment that is easily and readily identifiable by its customers. The convenience core consists of categories of merchandise for which the Company will maintain convenient (but limited) assortments, focusing on key items that are in keeping with customers’ expectations for a broad line retail store. Secondary and convenience cores include merchandise that the Company believes is important to carry, as the target customer expects to find them within a broad line retail store and they ensure a high level of customer traffic. The Company continually evaluates and ranks all product lines, shifting product classifications when necessary to reflect the changing demand for products.
Purchasing
Procurement and merchandising of products is directed by the President and performed by a team of merchandise buyers. Buyers are assisted by a management information system that provides them with current price, volume information and on-hand quantities by SKU (stock keeping unit), thus allowing them to react quickly with buying and pricing adjustments dictated by customer buying patterns.
The Company has a partnership with Associated Wholesale Grocer, (“AWG”), whereby the Company purchases several categories of product through AWG.
The Company purchases its merchandise from approximately 1,100 suppliers. The Company generally does not utilize long-term supply contracts. AWG accounted for approximately 26% of the Company’s total purchases in fiscal 2014. Competing brand name and private label products are available from other suppliers at competitive prices. The Company believes that its relationships with its suppliers are good, but a change in the relationship with AWG would potentially cause the Company to incur increases in its cost of certain merchandise.
Pricing
The Company’s pricing strategy, with its promotional activities, is designed to bring consistent value to the customer. In fiscal 2015, promotions on various items will be offered approximately 47 times through advertising circulars.
On January 9, 2013, the Company announced a partnership with Revionics, Inc., the leading provider of end-to-end merchandise optimization solutions, which expires January 31, 2018 and will support optimal pricing decisions throughout ALCO’s 198 continuing stores. Revionics® Life Cycle Price Optimization solutions and Analytic Services will enable the Company to design and execute regional, localized pricing initiatives, timing of markdowns, promotional pricing and analysis of customer market baskets and key volume items.
Distribution and Transportation
The Company operates a 352,000 square foot distribution center in Abilene, Kansas, from which it services all stores. The distribution center is responsible for distributing approximately 80% of the Company’s merchandise, with the balance being delivered directly to the Company’s stores by its vendors. The distribution center maintains an integrated management information system, allowing the Company to utilize such cost cutting efficiencies as perpetual inventories, safety programs, and employee productivity software. The Company’s partnership with AWG has allowed for the reduction of inventory, improved inventory turnover and lower operating expenses at its distribution facility in Abilene, Kansas and increased the frequency of “cross-dock” opportunities; the practice of unloading inbound materials directly into outbound trucks destined for delivery to its stores.
Management Information Systems
The Company has made a significant investment in the purchase and implementation of industry standard technology with the intent to lower costs, improve customer service, improve associate productivity, provide necessary controls and enhance general business planning and execution. In general, the Company’s merchandising systems are designed to integrate the key retailing functions of seasonal merchandise planning, purchase order management, merchandise distribution, sales information and inventory maintenance and replenishment. All of the Company’s stores have point of sale, (“POS”), computer terminals that capture sales information and transmit to the Company’s data processing facilities where it is used to drive management, financial, and supply chain functions.
The Company has committed significant efforts towards establishing a technical infrastructure, and a core of operational systems, that will support the Company’s future needs. The Company will continue to maintain and leverage this core of systems, plus add industry leading business area specific solutions to meet business objectives. The Company has established an integrated infrastructure of data, processes, and technology that provides the necessary business and regulatory controls, while positioning for future growth and efficiency. The Company is aligned on the need to use technology to enhance customer service, support fact based decision making, improve associate productivity and drive business functionality and efficiency. In conjunction with maintaining its core systems, the Company has evaluated and intends to increase its investment in technology to migrate various system applications over the course of the next 36 months. In addition to Revionics, the Company has evaluated and made initial technology systems investments in merchandising, supply chain, finance, human resources and warehouse management. The implementation of these new systems is ongoing with completion expected by the end of fiscal 2015. Thereafter, additional investments to migrate other system applications may be considered in fiscal 2016.
Financial Information About Segments
The Company derives 100% of its revenue through the sale of merchandise in the United States. See Item 8. Financial Statements & Supplemental Data, Note 12, for more information by product category.
Store Locations
As of February 2, 2014, the Company operated 212 stores in 23 states located in mostly smaller communities in the central United States. The stores average approximately 21,000 square feet of selling space, with an additional 4,000 square feet utilized for merchandise processing, temporary storage and administration. The current geographic distribution of the Company’s stores is as follows:
Competition
While the broad line retail business in general is highly competitive, the Company’s business strategy is to locate its stores in smaller markets where there is no direct competition with larger national or regional broad line retail chains, and where it is believed no such competition is likely to develop. Accordingly, the Company’s primary method of competing is to offer its customers a conveniently located store with a wide range of merchandise at value prices in trade areas with population of less than 16,000 that do not have a large national or regional broad line retail store. The Company believes that trade area size is a significant deterrent to larger national and regional broad line retail chains.
In the broad line retail business in general, price, merchandise selection, merchandise quality, advertising and customer service are all important aspects of competing. The Company encounters direct competition with national broad line retail stores in approximately 17% of its markets, and another 6% of the stores are in direct competition with regional broad line retail stores. The competing national broad line retailers are generally larger than the Company and the stores of such competitors in the Company’s markets are substantially larger, have a somewhat wider selection of merchandise and are very price competitive in some lines of merchandise. Where there are no national or regional broad line retail stores directly competing with the Company’s stores, the Company’s customers nevertheless shop at broad line retail stores and other retailers located in regional trade centers, and to that extent the Company competes with such broad line stores and retailers. The Company also competes for retail sales with other entities, such as specialty retailers, mass merchandisers, dollar stores and the internet. The Company competes directly with a dollar store in approximately 88% of all markets, however, in recent year’s, the most intrusive and fastest growing competition has been the internet.
Employees
As of February 2, 2014, the Company employed approximately 3,300 people. Of these employees, approximately 320 were employed in the store support centers (Abilene, Kansas and Coppell, Texas) and the Abilene, Kansas distribution center and approximately 3,000 in store locations. Additional employees are hired on a seasonal basis, most of whom are sales personnel. The Company offers a broad range of Company-paid benefits to its employees, including a 401(k) plan, medical and dental plans, short-term and long-term disability insurance, paid vacation and merchandise discounts. Eligibility for and the level of these benefits varies depending on employees full-time or part-time status and/or length of service. There is no collective bargaining agreement for any of the Company’s employees. The Company considers its relations with its employees to be excellent.
Seasonality
The Company, like that of most retailers, is subject to seasonal influences. The Company’s highest sales levels occur in the fourth quarter of its fiscal year, which includes the Christmas holiday selling season. For more information on seasonality, see “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operation - Seasonality and Quarterly Results.”
Trademarks and Service Marks
The names “Duckwall” and “ALCO” are registered service marks of the Company. The Company considers these marks and the accompanying name recognition to be valuable to the business. At the annual meeting of the Company’s stockholders held on June 27, 2012, the Company’s stockholders approved an amendment to the Company’s Amended and Restated Articles of Incorporation to change the name of the Company to ALCO Stores, Inc. The Company changed its name from Duckwall-ALCO Stores, Inc. to ALCO Stores, Inc. effective as of July 6, 2012.
Available Information
The Company files reports with the Securities and Exchange Commission (“SEC”), including Annual Reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and other reports as required. The public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company is an electronic filer and the SEC maintains an Internet site at www.sec.gov that contains the reports, proxy and information statements, and other information filed electronically.
The Company’s internet website is www.ALCOstores.com. Through the “Investors” portion of this website, the Company makes available, free of charge, our proxy statements, Annual Reports on Form 10-K, Interactive Data Files, and any amendments to those reports as soon as reasonably practicable after such material has been filed with, or furnished to, the SEC.
Charters of the Company’s Board of Directors’ Audit Committee and Compensation Committee; and Code of Business Conduct and Ethics for Directors and Senior Officers as well as for Associates have also been posted on our website, under the caption “Investors - Corporate Governance.”
Information contained on the Company’s website is not part of this Annual Report on Form 10-K. The materials listed above will be provided without charge to any stockholder submitting a written request to the Company’s Secretary at 751 Freeport Parkway, Coppell, TX 75019.
ITEM 1A.
ITEM 1A. RISK FACTORS
Our business is subject to a variety of risks, most of which are beyond our control.
If we are unable to improve our operating results, working capital and cash flows, we may require additional capital to fund our business, the failure to obtain which could have a material adverse effect on our business and financial condition.
If we are unable to improve our operating results, working capital and cash flows, we may require additional capital to fund our business. Our ability to make such improvements will depend on our ability to effectively implement one or more of the following:
· Stabilizing sales for fiscal 2015;
· Reducing our expenses and cash requirements;
· Effective managing our inventory and reducing our inventory levels;
· Effectively responding to changes in cash-flow, liquidity and cash needs;
· Accessing debt or equity capital markets or other sources of funds to obtain any additional financing, if and when needed;
· Adjusting our operating plans in response to changing conditions; and
· Maintaining relationships with suppliers, customers, employees and sources of trade credit.
If we are not successful in implementing the foregoing improvements and actions to the necessary degree, our future operating results and cash flows may not be sufficient to meet our working capital requirements, required payments on our indebtedness, and all of the other cash requirements of our business. Consequently, we may have to take actions such as substantially modifying our business plan to conserve cash, pursuing additional external liquidity sources, seeking additional debt or equity financing, further reducing or delaying capital expenditures, or restructuring our existing indebtedness. If we engage in financing or restructuring transactions to secure greater liquidity, the financings may be on terms that are expensive, restrictive to our business or financial flexibility, or dilutive to our stockholders.
If we cannot improve our operating results, working capital and cash flows or access additional capital, we may consider alternatives that could dilute or impair the value of our common stock.
We may enter into various transactions to secure funding or modify our capital structure, which may include issuances of equity securities or incurrence of further indebtedness. Any debt securities or preferred stock we issue will have priority or liquidation rights, preferences and privileges senior to those of current holders of our common stock. The issuance of additional shares of our common stock may also be dilutive to our stockholders. Any of these results could have a material adverse effect on our financial condition or the value of our common stock. In addition, there is a possibility that any financing or restructuring efforts may result in holders of our common stock receiving little or no value for their holdings and the holders of our existing or future indebtedness receiving a significant portion of, or all, the equity.
We rely on trade credit for a substantial amount of our working capital, and any deterioration in our relationship with our trade creditors could have a material adverse effect on our business and financial condition.
We depend on extensions of credit from our suppliers to fund our working capital needs, including to purchase inventory. These trade creditors may make the terms of their credit more expensive or burdensome, or may discontinue the extension of credit in their sole discretion. If our trade creditors lose confidence in our credit worthiness, we may have to seek other sources of funding in order to support our operations. If we cannot secure such alternative financing, or if the terms of such alternative financing are unfavorable, it would have a material adverse effect on our business and financial condition.
Our revolving credit facility contains provisions that could restrict our operations and our ability to obtain additional financing. In addition, our revolving credit facility is secured by a substantial amount of our property that may be subject to foreclosure or other remedies in the event of our default.
In July of 2011 we entered into a revolving credit facility that is secured by substantially all our assets, including our inventory and credit card receivables. Our credit facility now provides for up to $130 million in revolving loans, subject to borrowing availability. Our revolving credit facility contains customary covenants and restrictions, which include limitations on additional indebtedness, prepayments, acquisition of assets, granting of liens, certain investments and payments of dividends and require our meeting specified financial covenants. These covenants and restrictions impose operating and financial limitations on us, which could result in reducing our liquidity, restricting our ability to enter into particular transactions, and to engage in other actions that we may believe are advisable for our business or finances.
If an event of default under our credit facility occurs, our outstanding obligations thereunder could be declared immediately due and payable. If we cannot remedy the default or refinance our indebtedness, our lender could foreclose on or exercise other remedies with respect to the assets securing the revolving credit facility. The occurrence of an event of default could have a material adverse effect on our business, financial condition, results of operations, and liquidity, including requiring us to seek protection under applicable laws protecting the rights of debtors.
Decreases in customer discretionary spending may adversely affect our sales and profitability.
The lingering economic recession may continue to negatively affect our customers’ discretionary spending and thereby may negatively affect our sales and profitability. The Company believes that many of the Company’s customers are on fixed or low incomes and may have limited discretionary spending. Furthermore, many of our customers may have experienced financial hardship as a result of job losses, foreclosures or their inability to obtain short-term financing, all of which may negatively affect their ability to shop in our stores and buy our products. Reductions in our customers’ discretionary spending could cause our customers to shift their spending to products other than those sold by us or to products sold by us that are less profitable than other product choices, all of which could result in lower net sales, decreases in inventory turnover, greater markdowns on inventory, and a reduction in profitability due to lower margins.
The Company is in an increasingly competitive industry.
Due to the continued economic slowdown, the discount retail industry has become highly competitive. Although the Company prefers markets that don’t have direct competition from national or regional broad line retail stores, competition still exists. Even in non-competitive markets, the Company’s customers shop at broad line retail stores and other retailers located in regional trade centers. The Company also competes for retail sales with other entities, such as specialty retailers, mass merchandisers, and dollar stores. Furthermore, the retail industry continues to experience a trend towards internet sales and the Company faces increased competition from internet-based businesses. Some internet-based retailers may have an advantage because such businesses may not be required to collect and remit sales taxes in certain states, which can negatively impact the ability of store-based retailers, like the Company, to be competitive. This competitive environment subjects the Company to a risk of reduced profitability because every day lower prices and greater markdowns on inventory, which are required to maintain the Company’s position in the industry, may result in lower margins. Our competitors may also use competitive and costly marketing strategies which the Company may need to respond to in order to maintain its position in the industry.
We are highly susceptible to the state of macroeconomic conditions and consumer confidence in the United States.
All of our stores are located within the United States, making our results highly dependent on U.S. consumer confidence and the health of the U.S. economy. A slowdown in the U.S. economy or other economic conditions affecting disposable consumer income, such as employment levels, inflation, business conditions, fuel and energy costs, consumer debt levels, lack of available credit, interest rates, and tax rates, may affect our business adversely by reducing overall consumer spending or by causing customers to shift their spending to products other than those sold by us or to products sold by us that are less profitable than other product choices, all of which could result in lower net sales, decreases in inventory turnover or a reduction in profitability due to lower margins. In addition, a significant portion of our total sales is derived from stores located in these states: Kansas, Texas and Nebraska, resulting in further dependence on local economic conditions in these states. Deterioration in macroeconomic conditions and consumer confidence in the United States, particularly in Kansas, Texas or Nebraska, could negatively affect our business in many ways, including slowing sales growth or reduction in overall sales, and reducing gross margins.
We are vulnerable to cost increases, inflation and energy prices.
Future increases in our costs, such as the cost of merchandise, shipping rates, and freight and fuel costs, may reduce our profitability. These cost changes may be the result of inflationary pressures or changes in foreign currency values versus the US dollar; especially with respect to countries whom produce the products we procure. A decline in the value of the US dollar, versus currencies of the countries that produce the product, will increase our cost of goods and may reduce our sales or profitability. Increases in other operating costs, including changes in energy prices, wage rates and utility costs, may increase our costs of goods or operating expenses and reduce our profitability. For example, increases in the cost of diesel fuel may result in an increase in transportation costs, which may increase our overall operating costs and possibly lower profitability.
If we cannot effectively open new stores, our ability to improve our financial results will be adversely affected.
The growth in the Company’s sales and operating income depends to a substantial degree on its expansion program. This expansion strategy is dependent upon the Company’s ability to open and operate new stores effectively, efficiently and on a profitable basis. The Company’s ability to open new stores timely and to expand into additional market areas depends in part on the following factors: availability of store locations, the ability to hire and train new store personnel, the ability to react to consumer needs and trends on a timely basis, and the availability of sufficient capital for expansion. The Company continually reviews underperforming stores to determine potential closures. As a result of closing underperforming stores, the Company may not be able to effectively absorb fixed overhead.
If we are unable to access the capital markets or obtain bank credit, our growth plans, liquidity and results of operations could suffer.
Disruptions in the capital and credit markets, as have been experienced since fiscal 2008, could adversely affect the ability of lenders to meet their commitments. Our access to funds under our credit facility is dependent on the ability of the banks that are parties to the facility to meet their funding commitments. Those banks may not be able to meet their funding commitments to us if they experience shortages of capital and liquidity, or if they experience excessive volumes of borrowing requests within a short period of time.
Constrained capital markets could threaten our liquidity and capital resources. Longer term disruptions in the capital and credit markets as a result of uncertainty, changing or increased regulation, reduced alternatives, or failures of significant financial institutions could adversely affect our access to liquidity needed for our business. Any disruption could require us to take measures to conserve cash until the markets stabilize or until alternative credit arrangements or other funding for our business needs can be arranged. Such measures could include deferring capital expenditures and reducing other discretionary uses of cash. We believe operating cash flows and current credit facilities will be adequate to fund our working capital requirements, scheduled debt repayments and to support the development of our short-term and long-term operating strategies.
If we cannot effectively implement or use information technology, our financial results and operations would be adversely affected.
If we cannot effectively implement technology upgrades, it could have a material impact on the Company’s results of operations. The Company depends on information systems to process transactions, manage inventory, purchase, sell and ship goods on a timely basis. In conjunction with maintaining its core systems, the Company has evaluated and intends to increase its investment in technology to migrate various system applications over the course of the next 36 months. The initial investments occurred during fiscal year 2014 and will include its supply chain, stock ledger, and warehouse management systems, with anticipated implementation and migration beginning in 3-12 months. Thereafter, additional investments to migrate other system applications may be considered with potential implementation and migration beginning in 6-24 months. Any material disruption or slowdown of our systems could cause information to be lost or delayed which could have a negative effect on our business.
Changes in federal, state or local laws and regulations, or our failure to comply with such laws and regulations, could increase our expenses and expose us to legal risks.
Our business is subject to a wide array of laws and regulations. Significant legislative changes that impact our relationship with our workforce (none of which is represented by unions as of the end of fiscal year 2014) could increase our expenses and adversely affect our operations. Examples of possible legislative changes impacting our relationship with our workforce include changes to minimum wage requirements and health care mandates. In addition, certain aspects of our business, such as credit card operations, are more heavily regulated than other areas. Changes in the regulatory environment regarding topics such as banking and consumer credit, privacy and information security, product safety or environmental protection, among others, could cause our expenses to increase. If we fail to comply with applicable laws and regulations, particularly wage and hour laws, we could be subject to legal risk, including governmental enforcement action and class action civil litigation, which could adversely affect our results of operations.
A failure to design, implement or maintain an adequate system of internal controls could adversely affect our ability to manage our business or detect fraud.
The Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). Internal control over financial reporting includes: maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of the financial statements; providing reasonable assurance that receipts and expenditures of our assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and timely or to detect and prevent fraud. The Company continues to refine and test its internal control over financial reporting processes.
Our results are subject to seasonal variations.
Quarterly results of operations have historically fluctuated as a result of retail consumers purchasing patterns, with the highest quarter in terms of sales and profitability being the fourth quarter. Quarterly results of operations will likely continue to fluctuate significantly as a result of such patterns and may fluctuate due to the timing of new store openings.
Our stock price may be volatile.
No assurance can be given that operating results will not vary from quarter to quarter, and any fluctuations in quarterly operating results may result in volatility in the Company’s stock price.
We are dependent on key personnel.
The development of the Company’s business is largely dependent on the efforts of its current management team headed by Richard E. Wilson and three other executive officers. The loss of the services of one or more of these officers could have a material adverse effect on the Company.
We are exposed to interest rate risks.
The Company is subject to market risk from exposure to changes in interest rates based on its financing requirements. Increases in interest rates could have a negative impact on the Company’s profitability.
If we fail to anticipate and respond quickly to changing consumer preferences, our sales, gross margin and profitability could suffer.
A substantial part of our business is dependent on our ability to make trend-right decisions in apparel, home décor, seasonal offerings and other merchandise. Failure to accurately predict constantly changing consumer tastes, preferences, spending patterns and other lifestyles decisions could lead to lost sales, increased markdowns on inventory and adversely affect our results of operations.
Interruptions in our supply chain could adversely affect our results.
We are dependent on our vendors to supply merchandise in a timely and efficient manner. If a vendor fails to deliver on its commitments, whether due to financial difficulties or other reasons, we could experience merchandise shortages that could lead to lost sales. In addition, a large portion of our merchandise is sourced, directly or indirectly, from outside the United States, with China as our single largest source. Political or financial instability, trade restrictions, tariffs, currency exchange rates, the outbreak of pandemics, labor unrest, transport capacity and costs, port security or other events that could slow port activities and impact foreign trade are beyond our control and could disrupt our supply of merchandise and adversely affect our results of operations.
Lack of availability of suitable locations in which to build new stores could slow our growth, and difficulty in executing plans for new stores, expansions and remodels could increase our costs and capital requirements.
Our future growth is dependent, in part, on our ability to build new stores and expand and remodel existing stores in a manner that achieves appropriate returns on our capital investment. We compete with other retailers and businesses for suitable locations for our stores. In addition, for many sites we are dependent on a third party developer’s ability to acquire land, obtain financing and secure the necessary zoning changes and permits for a larger project, of which our store may be one component. Turmoil in the financial markets has made it difficult for third party developers to obtain financing for new projects. Local land use and other regulations applicable to the types of stores we desire to construct may affect our ability to find suitable locations and also influence the cost of constructing, expanding and remodeling our stores.
Product safety concerns could adversely affect our sales and results of operations.
If our merchandise offerings, including food, drug and children’s products, do not meet applicable safety standards or our guests’ expectations regarding safety, we could experience lost sales, experience increased costs and be exposed to legal and reputational risk. All of our vendors must comply with applicable product safety laws, and we are dependent on them to ensure that the products we buy comply with all safety standards. Events that give rise to actual, potential or perceived product safety concerns, including food or drug contamination, could expose us to governmental enforcement action or private litigation and result in costly product recalls and other liabilities. In addition, negative customer perceptions regarding the safety of the products we sell could cause our customers to seek alternative sources for their needs, resulting in lost sales. In those circumstances, it may be difficult and costly for us to regain the confidence of our customers.
Weather conditions may have a significant impact on our financial condition.
Weather conditions have impacted our operating results. Weather conditions affect the demand for, and in some cases the supply of, products, which in turn has an impact on prices. In past years, we have experienced severe weather conditions, including snow and ice storms, flood and wind damage, tornadoes and droughts in some states. Weather conditions also directly affect the demand for seasonal products, particularly during the winter season. Therefore, the weather can have a material adverse effect on our financial condition and results of operations.
If we fail to protect the security of personal information about our customers, we could be subject to costly government enforcement actions or private litigation and our reputation could suffer.
The nature of our experience involves the receipt and storage of personal information about our customers. If we experience a data security breach, we could be exposed to governmental enforcement actions and private litigation. In addition, our customers could lose confidence in our ability to protect their personal information, which could cause them to discontinue usage of our credit card products or stop shopping at our stores altogether. Such events could lead to lost future sales and adversely affect our results of operations.
Healthcare reform legislation and regulations may negatively impact our business.
In 2010, the “Patient Protection and Affordable Care Act” and the “Health Care and Education Affordability Reconciliation Act of 2010” (the “2010 Healthcare Acts”) were signed into law. This legislation expands health care coverage to many uninsured individuals and expands coverage for those already insured. The 2010 Healthcare Acts, as well as other healthcare reform legislation being considered by Congress and state legislatures, may have a negative impact on our business. This impact could increase our employee healthcare related costs. While the costs of the 2010 Healthcare Acts will occur after 2014, due to provisions of this legislation being phased in over time, changes to our healthcare cost structure could have an adverse effect on the Company’s financial condition.
The Relocation of the Company’s corporate headquarters may negatively impact our business.
The Company relocated its corporate headquarters from Abilene, Kansas to Coppell, Texas, a suburb of Dallas, Texas during Fiscal 2014. If we do not continue to effectively execute our relocation plan, our financial performance could be adversely affected.
Recently proposed accounting pronouncements may adversely affect our financial performance.
New accounting pronouncements may adversely affect the Company’s financial statements. One pronouncement that may affect the Company is a recent exposure draft issued by the Financial Accounting Standards Board (“FASB”), together with the International Accounting Standards Board (“IASB”), which proposes a comprehensive set of changes in U.S. GAAP accounting for leases. This proposed change in its current exposure draft form would create a new accounting model for both lessees and lessors. Changes in these accounting rules or their interpretation, or changes in underlying assumptions, estimates or judgments by us could significantly change our reported or expected financial performance. The proposed accounting standard, as currently drafted, may have a material impact on the Company’s consolidated financial statements.
The Company’s current legal proceedings may negatively affect the Company’s business.
As described in Section 3 to this Form 10-K, the Company is currently a defendant in certain lawsuits brought by Company stockholders. If any of these lawsuits are adversely decided or settled by the Company, then these costs, as well as the costs associated with defending these lawsuits, may adversely affect the Company’s financial condition. There also may be negative publicity associated with this litigation that may adversely affect the Company’s reputation and business.
A security breach of the Company’s customer, employee and/or vendor information may damage the Company’s reputation and may adversely affect the Company’s financial performance.
Like most retail companies, the Company receives and stores personal information about the Company’s customers, employees and vendors. The Company maintains security policies and procedures to ensure that the Company, and any third party service providers used by the Company, properly secure personal information of customers, employees and vendors that is held by the Company. However, even with proper security measures in place, unauthorized parties may defeat the Company’s security measures through fraud, deceit, cyber-attacks, computer hacking or other illegal means. Any breach of the Company’s security measures, or a breach of the security measures of any of the Company’s third party contractors, and loss of the personal and confidential information of the Company’s customers, employees and vendors may cause the Company to incur significant financial costs. In the event the Company experienced a security breach, the Company may incur costs to protect the individuals whose personal data was compromised, to restore and make changes to the Company’s security systems, policies and procedures to protect against future security breaches, and to restore customer confidence. Furthermore, the Company may be subject to government fines and private litigation. Damage to the Company’s security systems may cause a disruption in the Company’s online operations and sales. A security breach may also negatively affect the Company’s reputation and cause an adverse effect on the Company’s revenue and financial performance.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
The Company owns two facilities in Abilene, Kansas. The first of which is the former store support center consisting of office space (approximately 35,000 square feet) and additional warehouse space adjacent to the store support center (approximately 95,500 square feet). This facility has been listed for sale. The second facility is the Distribution Center (approximately 352,000 square feet). The Company leases its new store support center in Coppell, Texas (approximately 43,000 square feet).
Five of the stores operate in buildings owned by the Company. The remaining stores operate in properties leased by the Company. As of February 2, 2014, such leases accounted for approximately 4,273,000 square feet of leased sales floor space, which expire as follows: approximately 576,000 square feet (13.5%) expire between February 3, 2014 and February 1, 2015, approximately 507,000 square feet (11.9%) expire between February 2, 2015 and January 31, 2016, and approximately 415,000 square feet (9.7%) expire between February 1, 2016 and January 29, 2017. The remaining leases expire through 2031. The majority of the leases that are about to expire have renewal options with lease terms that are the same as the existing lease.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Other than the items delineated below, the Company is not a party to any material litigation, other than routine litigation from time to time in the ordinary course of business.
The Company is a defendant in a derivative action stemming from the Company’s proposed Merger with a subsidiary of an affiliate of Argonne Capital Group, LLC as discussed below. This action arose when two separately filed stockholder actions were consolidated, discussed below. There was also a third stockholder action, discussed below, but it has been dismissed.
On July 25, 2013, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Mallard Parent, LLC, (“Parent”) and M Acquisition Corporation, (“Merger Sub”), providing for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Parent. Parent and Acquisition Sub are beneficially owned by an affiliate of Argonne Capital Group, LLC (the “Sponsor”). The merger consideration was $14.00 per share in cash, without interest, and was to be supported through financing to be obtained by the Sponsor.
Under the Merger Agreement, each share of the Company’s common stock issued and outstanding immediately prior to the effective time of the Merger (other than shares, if any, owned by Parent, Merger Sub, the Company, or any other direct or indirect wholly owned subsidiary of Parent, Merger Sub, or the Company) would have been converted into the right to receive $14.00 per share in cash, without interest.
The Merger was subject to the approval by at least a majority of all outstanding shares of common stock. The Merger was also subject to various other customary conditions, including the absence of any governmental order prohibiting the consummation of the transaction contemplated by the Merger Agreement, the accuracy of the representations and warranties contained in the Merger Agreement, and compliance with the covenants and agreements in the Merger Agreement in all material respects.
The Company was subject to customary “non-solicitation” provisions that limited its ability to solicit, encourage, discuss or negotiate alternative acquisition proposals from third parties or to provide non-public information to third parties. These non-solicitation provisions were subject to a “fiduciary out” provision that allows the Company to provide non-public information and participate in discussions and negotiations with respect to certain unsolicited written acquisition proposals and to terminate the Merger Agreement and enter into an alternative acquisition agreement with respect to a superior proposal in compliance with the terms of the Merger Agreement, provided that the Company’s Board of Directors has concluded that the failure to do so would be inconsistent with its fiduciary obligations under applicable law.
The Merger Agreement contained certain termination rights, including the Company’s right to terminate the Merger Agreement to accept a superior proposal, and provided that, upon termination of the Merger Agreement by the Company under specified conditions, a termination fee would have been payable by the Company. In such circumstances, the Company would have been required to pay Sponsor $2.25 million. Subject to approval by at least a majority of all outstanding shares of common stock, the proposed Merger was expected to close before the end of the 2013 calendar year.
On October 30, 2013, the Company held a special meeting of its stockholders to vote on the proposal to adopt the Merger Agreement. The proposal to adopt the Merger Agreement did not receive approval from more than a majority of the outstanding share of the Company’s common stock, and therefore was not approved by the Company’s Stockholders. As a result of the failure to receive such stockholder approval, on October 30, 2013, the Company delivered to parent and Merger Sub a written notice (the “Termination Notice”) terminating the Merger Agreement in accordance with Section 7.2(b) of the Merger Agreement. As a result of the Termination Notice, the Merger Agreement was terminated and the merger contemplated was abandoned. Because the Termination Notice was delivered because of the failure of the Company’s stockholders to approve the Merger Agreement, no termination fee was paid by either party.
Merger related costs for the fifty-two weeks ended February 2, 2014,3 included in SG&A Expenses from Continuing Operations, were $2.4 million, and include special compensation fees paid to the Company’s Board of Directors, in the amount of $0.3 million, for merger related activities.
On September 5, 2013, Advanced Advisors, a Company stockholder, filed a class action petition in the District Court of Shawnee County, Kansas (case no. 13C001007) citing, among other parties, the Company and the Company’s directors, Royce Winsten, Terrence Babilla, Dennis Logue, Lolan Mackey, and Richard Wilson, as defendants. The petition challenged the defendants’ actions in causing the Company to enter into the Merger Agreement under which the Sponsor was to purchase all of the outstanding shares of the Company. The allegations against the defendants included breaches of fiduciary duties and the aiding and abetting of breaches of fiduciary duties. The amount of the damages was unspecified.
On September 23, 2013, Paul Hughes, an individual Company stockholder, filed a class action petition in the District Court of Shawnee County, Kansas (case no. 13C001096) citing, among other parties, the Company and the Company’s directors, Royce Winsten, Terrence Babilla, Dennis Logue, Lolan Mackey, and Richard Wilson, as defendants. The petition challenged the defendants’ actions in causing the Company to enter into the Merger Agreement under which the Sponsor was to purchase all of the outstanding shares of the Company. The allegations against the defendants included breaches of fiduciary duties and the aiding and abetting of breaches of fiduciary duties. The amount of the damages was unspecified. On March 20, 2014, Plaintiffs filed a notice of dismissal without prejudice. On April 10, 2014, the court entered a dismissal order and removed the case from the active docket.
On September 27, 2013, Jeffery R. Geygan, an individual Company stockholder, filed a class action petition in the District Court of Shawnee County, Kansas (case no. 13C001120) citing, among other parties, the Company and the Company’s directors, Royce Winsten, Terrence Babilla, Dennis Logue, Lolan Mackey, and Richard Wilson, as defendants. The petition challenged the defendants’ actions in causing the Company to enter into the Merger Agreement under which the Sponsor was to purchase all of the outstanding shares of the Company. The allegations against the defendants included breaches of fiduciary duties and the aiding and abetting of breaches of fiduciary duties. The amount of the damages was unspecified.
On November 21, 2013, the parties filed a joint motion to consolidate the Geygan case and the Advanced Advisors case, discussed above. On December 18, 2013, the court granted the consolidation motion, and the cases were consolidated under case no. 13C1007. On January 9, 2014, the Plaintiffs filed their consolidated and verified derivative petition, citing, among other parties, the Company and the Company’s directors, Royce Winsten, Terrence Babilla, Dennis Logue, Lolan Mackey, and Richard Wilson, as defendants. The petition challenges the defendants’ actions in causing the Company to enter into the Merger Agreement under which the Sponsor was to purchase all of the outstanding shares of the Company. The allegations against the defendants include breaches of fiduciary duties and the aiding and abetting of breaches of fiduciary duties. The amount of the damages is unspecified.
On January 30, 2014, the Company filed a motion to dismiss the Plaintiffs’ consolidated and verified derivative petition. The court set a July 18, 2014 hearing for the Company’s motion to dismiss.
The Company intends to vigorously defend itself in all of the legal proceedings discussed above.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Common Stock of the Company is quoted on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol “ALCS”. The following table sets forth the range of high and low closing price of the Company’s Common Stock for each quarter of fiscal years 2014 and 2013.
As of April 28, 2014, there were 666 holders of record of the Common Stock of the Company. The Company has not paid cash dividends on its Common Stock during the last five fiscal years. The terms of the Security Agreement, dated as of July 21, 2011 between the Company and Wells Fargo Bank, National Association, (“Wells Fargo”), allow for the payment of dividends unless certain loan covenants are triggered.
On October 12, 2012, subsequent to a trade confirmation executed October 10, 2012 whereby the Company repurchased shares of its common stock, the Company notified Wells Fargo that immediately after giving effect to the share repurchase, the Consolidated Fixed Charge Coverage Ratio would not be greater than the required ratio per Section 7.06(c) of the Facility. On October 12, 2012, Wells Fargo issued its consent of the repurchase; provided that their consent automatically terminated in the event the repurchase was not consummated within 90 days of the date of consent.
On February 6, 2013, the Board of Directors of the Company unanimously approved a First Amendment (the “Amendment”) to its Credit Agreement with Wells Fargo, amending Section 7.06(c) of the Credit Agreement to permit the Company, subject to certain conditions set forth in the Amendment, to repurchase, redeem or otherwise acquire Equity Interests issued by the Company not to exceed $1,000,000 in the aggregate in each Fiscal Year. Under the Credit Agreement, “Equity Interests” is defined as all of the shares of the capital stock of a person and all of the other warrants, options or other rights of a person to purchase capital stock of such person. Such amendment was announced on Form 8-K filed by the Company with the Securities and Exchange Commission on February 12, 2013 and a copy of the Amendment is attached to such 8-K. Except to the extent specifically set forth in Wells Fargo’s Consent, no other consent, waiver of, or change in any of the terms, provisions or conditions of the Credit Agreement is intended or implied.
Company Repurchases of Common Stock
On July 27, 2012, the Company entered into a new Rule 10b5-1 and Rule 10b-18 Stock Repurchase Agreement with William Blair and Company, LLC (the “Stock Repurchase Agreement”) whereby the Company authorized the repurchase of up to 175,000 shares of the Company’s Common Stock under the Company’s stock repurchase program (the “Program”). The Stock Repurchase Agreement has expired without any additional shares having been repurchased.
The Program was initially authorized by the Company on March 23, 2006, whereby the Board of Directors of the Company authorized the repurchase of 200,000 shares of the Company's Common Stock, and the Company repurchased 3,337 shares of Common Stock under the Program. The Company's Board of Directors reinstated the Program on August 13, 2008 and the Company repurchased 22,197 shares of Common Stock under the Program during such period of reinstatement. The Board of Directors of the Company approved the reinstatement of the Program again on January 6, 2012 and the Company repurchased an additional 34,407 shares of Common Stock during such reinstatement. On April 25, 2012, the Board of Directors of the Company authorized the Company to repurchase an additional 500,000 shares of Common Stock for a total of 700,000 shares of Common Stock authorized for repurchase under the Program. The Stock Repurchase Agreement only authorizes William Blair and Company, LLC to repurchase a portion of the total shares available for repurchase under the Program as stated above. Under the terms of the Program, the Company can terminate the proposed buy back at any time.
During fiscal 2013, the Company repurchased a total of 584,928 shares of Common Stock under the Program. All shares were repurchased at market prices and the Company’s policy is to apply the excess of purchase price over par value to additional paid-in capital, resulting in a decrease to additional paid-in capital of $4.0 million. As of February 3, 2013, the Company repurchased a total of 610,462 shares under the Program since it was initially approved in 2006. Therefore, there were 89,538 shares of Common Stock available to be repurchased by the Company, as of February 3, 2013.
The Company had not repurchased additional shares, subsequent to February 3, 2013.
The Company closely monitors IRS Section 382 regarding technical change of control. This particular section of the tax code would place an annual limit on the Company’s right to use its net operating loss carry-forwards (“NOLs”) should the aggregate shift in 5% shareholders be more than 50% in the preceding three-year testing period or as a result of certain reorganizations (“Tripping Event”). The annual limitation approximates 3% of the Company’s market capitalization just prior to the Tripping Event. In the event of a Tripping Event, it is management’s belief the Company would still be able to utilize its NOLs prior to their expiration, albeit over a longer period of time.
Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities
The Company did not sell any equity securities during fiscal 2014 that were not registered under the Securities Act.
Securities Authorized For Issuance Under Equity Compensation Plans
See the information provided in the “Equity Compensation Plan Information” section of the Proxy Statement for our fiscal 2014 Annual Meeting of Stockholders, which information is incorporated herein by reference.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Overview
Economic conditions: The lingering economic slowdown has caused disruptions and significant volatility in financial markets, increased rates of mortgage loan default and personal bankruptcy, and declining consumer and business confidence, which has led to decreased customer traffic and reduced levels of consumer spending, particularly on discretionary items. The continuing economic recession has impacted the Company’s customers, whom the Company believes to be primarily on a fixed or low income, and has negatively affected their ability to shop in our stores and buy our products. This decline in consumer and business confidence and the decreased levels of customer traffic and consumer spending have negatively impacted our business. We cannot predict how long the current economically challenging conditions will persist and how such conditions might affect us and our customers. Decreased customer traffic and reduced consumer spending, particularly on discretionary items, would, however, over an extended period of time negatively affect our financial condition, operating performance, revenues and income. In addition, we cannot predict how current or worsening economic conditions will affect our critical suppliers and distributors and any negative impact on our critical suppliers or distributors may also have an adverse impact on our business results or financial condition.
The economic slowdown also affects the Company’s business environment. Due to lower discretionary spending by consumers and a high demand for lower cost goods, the discount retail industry has become highly competitive. This competitive environment impacts the Company because lower prices and greater markdowns on inventory are necessary to keep the Company’s position in the industry and these factors may result in lower margins and profitability.
Another factor that continues to impact the Company is severe weather. We have experienced severe weather conditions, including snow and ice storms, flood and wind damage, tornadoes and droughts in some states that have slowed consumer confidence and customer traffic.
Operations. The Company is a regional broad line retailer operating in 23 states.
The Company’s fiscal year ends on the Sunday closest to January 31. Fiscal years 2014 and 2013 consisted of 52 weeks and 53 weeks, respectively. For purposes of this management’s discussion and analysis of financial condition and results of operations, the financial numbers are presented in thousands.
Strategy. The Company’s overall business strategy involves identifying and opening stores in locations that will provide the Company with the highest return on investment. The Company believes that co-locating near or next to grocery stores provides a positive overall impact to the results of the ALCO stores. The Company also competes for retail sales with other entities, such as mail order companies, specialty retailers, stores, manufacturer’s outlets and the internet. The Company initiated a transactional web site during November 2011. In July 2012, the Company expanded the product selection on its website which now includes more than 20,000 items of high-quality merchandise. Products offered on the ALCOstores.com website include video games and electronics, housewares, appliances and furniture, health & beauty aids, baby goods, office supplies, automotive and sporting goods, and much more. As in traditional ALCO stores, consumers can choose from a wide range of well-known brand names. In addition, the website includes brands not found in the Company’s retail stores.
The Company uses a variety of broad-based targeted marketing and advertising strategies to reach consumers. These strategies include full-color photography advertising circulars of eight to 20 pages distributed through newspaper insertion or, in the case of inadequate newspaper coverage, through direct mail. During fiscal 2014, these circulars were distributed 47 times in ALCO markets. During fiscal 2015, the Company will distribute approximately 47 circulars in the Company’s markets. The Company also uses in-store marketing. The Company’s merchandising and marketing teams work together to present the products in an engaging and innovative manner, which is coordinated so that it is consistent with the current print advertisements. The Company regularly changes its banners and in-store promotions, which are advertised throughout the year, to attract consumers to the stores, to generate strong customer frequency and to increase average sales per customer. Net marketing and promotion costs represented approximately 1.6% and 1.1% of net sales in fiscal years 2014 and 2013, respectively. Management believes it has developed a comprehensive marketing strategy, intended to increase customer traffic and same-store sales. The Company continues to operate as a high-low retailer and has included in many of its marketing vehicles cross departmental products. For example, the Company has used an Elder Care page with over-the-counter products, “as seen on TV” items, and dry meals-all targeting customers who have reached retirement age. The Company believes that by providing the breadth of these key items to this targeted audience we can serve our customers’ needs more efficiently and garner a greater share of the purchases made by this demographic. The Company’s stores offer a broad line of merchandise consisting of approximately 35,000 items, including automotive, consumables and commodities, crafts, domestics, electronics, furniture, hardware, health and beauty aids, housewares, jewelry, ladies’, men’s and children’s apparel and shoes, pre-recorded music and video, sporting goods, seasonal items, stationery and toys. The Company is constantly evaluating the appropriate mix of merchandise to improve sales and gross margin performance. Corporate merchandising is provided to each store to ensure a consistent Company-wide store presentation. To facilitate long-term merchandising planning, the Company divides its merchandise into three core categories: primary, secondary, and convenience. The primary core receives management’s primary focus, with a wide assortment of merchandise being placed in the most accessible locations within the stores and receiving significant promotional consideration. The secondary core consists of categories of merchandise for which the Company maintains a strong assortment that is easily and readily identifiable by its customers. The convenience core consists of categories of merchandise for which the Company maintains convenient (but limited) assortments, focusing on key items that are in keeping with customers’ expectations for a broad line retail store. Secondary and convenience cores include merchandise that the Company feels is important to carry, as the target customer expects to find them within a broad line retail store and they ensure a high level of customer traffic. The Company continually evaluates and ranks all product lines, shifting product classifications when necessary to reflect the changing demand for products. In addition, the Company’s merchandising systems are designed to integrate the key retailing functions of seasonal merchandise planning, purchase order management, merchandise distribution, sales information and inventory maintenance and replenishment. All of the Company’s stores have point-of-service computer terminals that capture sales information and transmit such information to the Company’s data processing facilities where it is used to drive management, financial, and supply chain functions.
Recent Events.
· On April 17, 2014, Tom L. Canfield, Jr. resigned from his position as Senior Vice President-Logistics and Administration of the Company, effective May 31, 2014.
· On April 22, 2014, the Board of Directors of the Company unanimously resolved to set the date of the 2014 annual meeting of the Company’s stockholders as Wednesday, July 30, 2014 and determined that the close of business on June 25, 2014 is to be fixed as the record date for the determination of stockholders entitled to notice and to vote at such annual meeting.
Key Financial Items in Fiscal 2014.
The Company measures itself against a number of financial metrics to assess its performance. Some of the important financial items, from continuing operations, during fiscal 2014 were:
· Net sales from continuing operations during the 52 weeks of fiscal 2014 decreased 1.6% to $474.1 million, compared to net sales during the 53 weeks of fiscal 2013 of $481.8 million. Excluding the 53rd week of fiscal 2013, net sales from continuing operations during fiscal 2014 decreased 0.3%, compared to net sales during the 52 weeks of fiscal 2013 of $475.4 million. During fiscal 2014, the Company opened three ALCO stores and closed eight stores. The Company also initiated the closing of fourteen additional stores, which closing will be completed in the first quarter of fiscal 2015.
· Gross margin percentage is a key measure of the Company’s ability to maximize profit on the purchase and subsequent sale of merchandise, while minimizing promotional and clearance markdowns, shrinkage, damage and returns. Gross margin percentage is defined as net sales less cost of sales, expressed as a percentage of net sales.
Gross margin, as a percentage of net sales, was 28.6% during fiscal 2014, compared to 30.3% during fiscal 2013.
· Selling, general and administrative expenses (“SG&A”) are a measure of the Company’s ability to manage and control its expenses to purchase, distribute and sell merchandise.
SG&A expenses were 29.7% of sales during fiscal 2014 compared to 27.3% during fiscal 2013. Included in fiscal 2014 SG&A are costs associated with the Company’s merger activity in the amount of $2.4M and costs associated with the relocation of the corporate office to Coppell, TX in the amount of $1.1M.
· During fiscal 2014, the Company recorded a non-cash charge of $9.8 million attributable to a valuation allowance on the Company’s cumulative net deferred tax asset. The establishment of a valuation allowance does not have any impact on cash, nor does such an allowance preclude the Company from utilizing its loss carryforwards in the future.
· Earnings per share (“EPS”) is an indicator of the returns generated for the Company’s stockholders.
Net loss per diluted share for fiscal 2014 was $8.11, compared to net income per diluted share of $0.36 during fiscal 2013.
· Return on average equity (“ROE”) is a measure of the operating results produced on the average equity of the Company.
Negative ROE was 34.7% during fiscal 2014, compared to ROE of 1.0% for fiscal 2013.
Results of Operations. The following table sets forth, for the fiscal years indicated, the components of the Company’s statements of operations expressed as a percentage of net sales:
______________________________________
Fiscal 2014 Compared to Fiscal 2013
Net sales from continuing operations, including the Company’s transactional website, during the 52 weeks of fiscal 2014 decreased 1.6% to $474.1 million, compared to net sales during the 53 weeks of fiscal 2013 of $481.8 million. Excluding the 53rd week of fiscal 2013, net sales from continuing operations during fiscal 2014 decreased 0.3%, compared to net sales during the 52 weeks of fiscal 2013 of $475.4 million. During fiscal 2014, the Company opened three ALCO stores and closed eight stores. The Company also initiated the closing of fourteen additional stores, which closing will be completed in the first quarter of fiscal 2015.
Net sales from same-stores, excluding the Company’s two fuel center locations, during the 52 weeks of fiscal 2014 decreased 4.5%, or $21.5 million, compared to net sales during the 53 weeks of fiscal 2013. Excluding the 53rd week of fiscal 2013, net sales from same-stores during fiscal 2014 decreased 3.2%, or $15.2 million. The decrease in same-store sales was primarily due to a 7.4% decrease in customer transactions occurring at a same-store and partially offset by a 3.0% increase in the average sale per customer transaction occurring at a same-store.
Net sales from non-same stores during the 52 weeks of fiscal 2014 increased $15.2 million and net sales from the Company’s two fuel center locations during the 52 weeks of fiscal 2014 decreased $1.4 million. Excluding the 53rd week of fiscal 2013, net sales from non-same stores during the 52 weeks of fiscal 2014 increased $15.4 million and net sales from the Company’s two fuel center locations during the 52 weeks of fiscal 2014 decreased $1.3 million.
Net sales from the Company’s transactional website during the 52 weeks of fiscal 2014 were $0.3 million, an increase of $0.1 million compared to the 53 weeks of fiscal 2013. The increase was primarily attributable to the expanded product selection that includes more than 20,000 items of high-quality merchandise
Gross margin from continuing operations for fiscal 2014 decreased $10.3 million, or 1.7%, to $135.8 million compared to $146.1 million in fiscal 2013. As a percentage of net sales, gross margin was 28.6% during fiscal 2014, compared to 30.3% during fiscal 2013. During the third quarter of fiscal 2014 and concluding within the fourth quarter of fiscal 2014, the Company initiated an inventory reduction strategy which allowed the Company to end fiscal 2014 with approximately $4.0 million less inventory, compared to fiscal 2013. The inventory reduction strategy negatively impacted gross margin during the third and fourth quarters of fiscal 2014.
Selling, general and administrative expenses (SG&A) increased $9.7 million, or 7.4%, to $141.0 million during the 52 weeks of fiscal 2014 compared to $131.3 million during the 53 weeks of fiscal 2013. The increase is primarily attributable to SG&A associated with merger activity ($2.4 million) and the relocation of the Company’s corporate office ($1.1 million), SG&A from new stores ($2.5 million), increase in net advertising costs ($2.0 million), increase in utilities due to prolonged winter conditions ($1.0 million), and an increase in corporate overhead ($1.3 million); partially offset by a decrease in warehouse overhead ($0.6 million). As a percentage of net sales, SG&A expenses were 29.7% during fiscal 2014, as compared to 27.2% during fiscal 2013. Excluding share-based compensation and loss on sale of assets, fiscal years 2014 and 2013 SG&A expenses, as a percent of net sales, were 29.7% and 27.1%, respectively.
Depreciation and amortization expense from continuing operations increased $1.7 million, or 19.2%, to $10.4 million in fiscal 2014 compared to $8.7 million in fiscal 2013. The increase in depreciation is primarily attributable to the impairment of previously announced store closures ($1.4 million) not finalized during fiscal 2014 and depreciation attributable to new stores.
Operating results from continuing operations decreased $26.4 million to a net operating loss of $24.5 million in fiscal 2014 compared to net income of $1.9 million in fiscal 2013. Operating results from continuing operations as a percentage of net sales was a loss of 5.2% for fiscal 2014 compared to operating income of 0.4% for fiscal 2013.
Interest expense increased $0.4 million, or 10.3%, to $3.8 million in fiscal 2014 compared to $3.5 million in fiscal 2013. Excluding interest on capital lease obligations and amortization of debt financing costs, interest expense was $2.4 million in fiscal 2014 compared to $2.1 million in fiscal 2013.
Income tax expense on continuing operations was $5.0 million in fiscal 2014 compared to $0.6 million in fiscal 2013. Included in fiscal 2014 is a non-cash charge of $9.8 million attributable to a valuation allowance on the Company’s cumulative net deferred tax asset. The establishment of a valuation allowance does not have any impact on cash, nor does such an allowance preclude the Company from utilizing its loss carryforwards in the future. The Company’s effective tax rate was -23.5% in fiscal 2014 and 19.2% in fiscal 2013.
Loss from discontinued operations, was $1.9 million in fiscal 2014, compared to $0.6 million in fiscal 2013. Loss from discontinued operations for fiscal 2013 was net of income tax benefit of $0.4 million. Eight stores were closed during fiscal 2014, whereas four stores were closed during fiscal 2013.
SG&A Detail; Certain Financial Matters
The Company has included Adjusted SG&A and Adjusted EBITDA, non-U.S. GAAP performance measures, as part of its disclosure as a means to enhance its communications with stockholders. Certain stockholders have specifically requested this information to assist them in comparing the Company to other retailers that disclose similar non-U.S. GAAP performance measures. Further, management utilizes these measures in internal evaluation, review of performance and to compare the Company’s financial measures to those of its peers. Adjusted EBITDA differs from the most comparable U.S. GAAP financial measure (earnings (loss) from continuing operations) in that it does not include certain items, as does Adjusted SG&A. These items are excluded by management as they are non-recurring and/or not relevant to analysis of ongoing business operations and to better evaluate normalized operational cash flow and expenses excluding unusual, inconsistent and non-cash charges. To compensate for the limitations of evaluating the Company’s performance using Adjusted SG&A and Adjusted EBITDA, management also utilizes U.S. GAAP performance measures such as gross margin, return on investment, return on equity and cash flow from operations. As a result, Adjusted SG&A and Adjusted EBITDA may not reflect important aspects of the results of the Company’s operations.
______________________________________
(1) Store support center includes gain (loss) on disposal of fixed assets and costs associated with office relocation and merger activity.
(2) Same-stores are those stores which were open at the end of the reporting period, had reached their fourteenth month of operation, and include store locations, if any, that had experienced a remodel, an expansion, or relocation. Same-stores also include the Company’s transactional website.
(3) Non same-stores are those stores which have not reached their fourteenth month of operation.
(4) Average selling square feet is calculated as beginning square feet plus ending square feet divided by 2
(5) Adjusted EBITDA per average selling square foot is calculated as Adjusted EBITDA divided by average selling square feet
(6) Average store level merchandise inventory is calculated as beginning inventory plus ending inventory divided by 2
(7) Excludes inventory for unopened stores
Store support center SG&A for fiscal 2014 increased $4.8 million, or 23.9%. The net increase was primarily attributable to costs associated with merger activity ($2.4 million), the relocation of the Company’s corporate office ($1.1 million), and increases in payroll and benefits ($0.5 million).
SG&A expenses attributable to same-stores increased $2.9 million or 2.8% during fiscal 2014 compared to fiscal 2013. The net increase was primarily attributable to increase in net advertising costs ($2.0 million) and increase in utilities due to prolonged winter conditions ($1.0 million).
SG&A expenses attributable to non same-stores increased $2.6 million during fiscal 2014 compared to fiscal 2013.
Reconciliation and Explanation of Non-U.S. GAAP Financial Measures
The following table shows the reconciliation of Adjusted EBITDA to net earnings (loss):
______________________________________
Seasonality and Quarterly Results
The following table sets forth the Company’s net sales, gross margin, income from operations and net earnings during each quarter of fiscal years 2014 and 2013:
______________________________________
(1) Earnings per share amounts are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share in fiscal years 2014 and 2013 may not equal the total computed for the year.
See Note 11 of Notes to Financial Statements for quarterly earnings per share information.
The Company’s business is subject to seasonal fluctuations. The Company’s highest sales levels occur in the fourth quarter of its fiscal year which includes the Christmas holiday selling season. The Company’s results of operations in any one quarter are not necessarily indicative of the results of operations that can be expected for any other quarter or for the full fiscal year. The Company’s results of operations may also fluctuate from quarter to quarter as a result of the amount and timing of sales contributed by new stores and the integration of the new stores into the operations of the Company, as well as other factors. The addition of a large number of new stores can, therefore, significantly affect the quarterly results of operations.
Inflation
Management does not believe that its merchandising operations have been materially affected by inflation over the past few years. Future inflationary pressure, however, may reduce our profitability. The Company will continue to monitor costs, take advantage of vendor incentive programs, selectively buy from competitive vendors and adjust merchandise prices based on market conditions.
Liquidity and Capital Resources
At the end of fiscal 2014, working capital (defined as current assets less current liabilities) was $135.6 million compared to $133.6 million at the end of fiscal 2013.
The Company’s primary sources of funds are cash flow from operations, borrowings under its revolving loan credit facility, and vendor trade credit financing. Short-term trade credit represents a significant source of financing for inventory to the Company. Trade credit arises from the willingness of the Company’s vendors to grant payment terms for inventory purchases.
Net cash used in operating activities during fiscal 2014 aggregated $18.2 million as compared to net cash provided of $9.4 million during fiscal 2013. The $27.6 million decrease in cash from operating activities resulted primarily from a net loss of $26.4 million during fiscal 2014 as compared to net income of $1.3 million in fiscal 2013.
Net cash used in investing activities during fiscal 2014 was $11.2 million as compared to net cash used during fiscal 2013 in the amount of $15.4 million. Net cash used consisted primarily of capital expenditures. The Company’s long-range strategy is to grow its store count, and it intends to continue to invest in technology and migrate various system applications during the next 36 months. During fiscal 2014, the Company opened three stores and closed eight stores. During fiscal 2013, the Company opened five stores and closed four stores.
On July 21, 2011, the Company entered into a five-year revolving Credit Agreement (the “Facility”) with Wells Fargo and Wells Capital Finance, LLC. The $120.0 million Facility replaced the Company’s previous $120.0 million credit facility with Bank of America, N.A. and Wells Fargo Retail Finance, LLC, and expires July 20, 2016.The Company uses its revolving loan credit facility and vendor trade credit financing to fund the buildup of inventories periodically during the year for its peak selling seasons and to meet other short-term cash requirements.
Under the Facility, the Company can request an increase of up to $25.0 million. On November 22, 2013, pursuant to Section 2.16 of the Facility, the Board of Directors unanimously approved a request to increase the revolving credit commitments of the Company by $10.0 million (the “Commitment Increase”); thereby, increasing the overall Facility from $120.0 million to $130.0 million. Except for the Commitment Increase, the Facility remains unchanged and in full force and effect.
Including the Commitment Increase, the revolving loan credit facility provides up to $130 million of financing in the form of notes payable. The loan agreement expires July 20, 2016. The revolving loan note payable of $89.5 million together with outstanding letters of credit at February 4, 2014, resulted in an available line of credit at that date of approximately $18.2 million, subject to a borrowing base calculation. Loan advances are secured by a security interest in the Company’s inventory and credit card receivables. The loan agreement contains various restrictions that are applicable when outstanding borrowings exceed $110.5 million, including limitations on additional indebtedness, prepayments, acquisition of assets, granting of liens, certain investments and payments of dividends. The Company’s loan agreement contains various covenants including limitations on additional indebtedness and certain financial tests, as well as various subjective acceleration clauses. The balance sheet classification of the borrowings under the revolving loan credit facility has been determined in accordance with ASC 470-10-45, Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include both a Subjective Acceleration Clause and a Lock-Box Arrangement. Accordingly, this obligation has been classified as a long-term liability in the accompanying balance sheet.
On July 27, 2012, the Company entered into a new Rule 10b5-1 and Rule 10b-18 Stock Repurchase Agreement with William Blair and Company, LLC (the “Stock Repurchase Agreement”) whereby the Company authorized the repurchase of up to 175,000 shares of the Company’s Common Stock under the Company’s stock repurchase program (the “Program”).
The Program was initially authorized by the Company on March 23, 2006, whereby the Board of Directors of the Company authorized the repurchase of 200,000 shares of the Company's Common Stock, and the Company repurchased 3,337 shares of Common Stock under the Program. The Company's Board of Directors reinstated the Program on August 13, 2008 and the Company repurchased 22,197 shares of Common Stock under the Program during such period of reinstatement. The Board of Directors of the Company approved the reinstatement of the Program again on January 6, 2012 and the Company repurchased an additional 34,407 shares of Common Stock during such reinstatement. On April 25, 2012, the Board of Directors of the Company authorized the Company to repurchase an additional 500,000 shares of Common Stock for a total of 700,000 shares of Common Stock authorized for repurchase under the Program. The Stock Repurchase Agreement only authorizes William Blair and Company, LLC to repurchase a portion of the total shares available for repurchase under the Program as stated above. Under the terms of the Program, the Company can terminate the proposed buy back at any time.
During fiscal 2013, the Company repurchased a total of 584,928 shares of Common Stock under the Program. All shares were repurchased at market prices and the Company’s policy is to apply the excess of purchase price over par value to additional paid-in capital, resulting in a decrease to additional paid-in capital of $4.0 million. As of February 3, 2013, the Company repurchased a total of 610,462 shares under the Program since it was initially approved in 2006. Therefore, there were 89,538 shares of Common Stock available to be repurchased by the Company, as of February 3, 2013.
The Company had not repurchased additional shares, subsequent to February 3, 2013.
Net cash provided by financing activities during fiscal 2014 was $28.4 million as compared to net cash provided during fiscal 2013 in the amount of $6.7 million. Net cash provided by financing activities during fiscal 2014 consisted of net borrowings under the revolving Credit Agreement. Net cash provided by financing activities during fiscal 2013 also consisted of net borrowings under the revolving Credit Agreement and was partially offset by payments for repurchase of Company stock. As such, stock repurchases were funded by increases in the amount outstanding under the Company’s revolving credit agreement. In fiscal 2013, the Company had net cash borrowings of $11.4 million on its revolving credit facility, made cash payments of $0.8 million to reduce its capital lease obligations, and made cash payments of $4.0 million to repurchase shares of Company stock.
The following table sets forth the average revolver balance outstanding, the maximum amount outstanding at end of the fiscal periods, and amounts outstanding for each borrowing type:
On October 12, 2012, subsequent to a trade confirmation executed October 10, 2012 whereby the Company repurchased shares of its common stock, the Company notified Wells Fargo that immediately after giving effect to the share repurchase, the Consolidated Fixed Charge Coverage Ratio would not be greater than the required ratio per Section 7.06(c) of the Facility. On October 12, 2012, Wells Fargo issued its consent of the repurchase; provided that their consent automatically terminated in the event the repurchase was not consummated within 90 days of the date of consent.
On February 6, 2013, the Board of Directors of the Company unanimously approved a First Amendment (the “Amendment”) to its Credit Agreement with Wells Fargo amending Section 7.06(c) of the Credit Agreement to permit the Company, subject to certain conditions set forth in the Amendment, to repurchase, redeem or otherwise acquire Equity Interests issued by the Company not to exceed $1,000,000 in the aggregate in each Fiscal Year. Under the Credit Agreement, “Equity Interests” is defined as all of the shares of the capital stock of a person and all of the other warrants, options or other rights of a person to purchase capital stock of such person. Such amendment was announced on Form 8-K filed by the Company with the SEC on February 12, 2013 and a copy of the Amendment is attached to such 8-K. Except to the extent specifically set forth in Wells Fargo’s Consent, no other consent, waiver of, or change in any of the terms, provisions or conditions of the Credit Agreement is intended or implied.
Expansion Plans
The continued growth of the Company is dependent, in large part, upon the Company’s ability to open and operate new stores on a timely and profitable basis. In addition, the Company continually reviews underperforming stores to determine potential closures. During fiscal 2015, the Company expects to open no less than three stores, is currently in process of closing 14 stores, and does not anticipates additional closures of underperforming stores will occur during fiscal 2015. While the Company believes that adequate sites are currently available, the rate of new store openings is subject to various contingencies, many of which are beyond the Company’s control. These material contingencies include:
· the Company’s ability to hire, train, and retain qualified personnel
· the availability of adequate capital resources for us to purchase inventory, equipment, and fixtures and make other capital expenditures necessary for store expansion
· the ability of our landlords and developers to find appropriate financing in the current credit market to develop property to be leased by the Company
Historically, we have been able to hire, train, and retain qualified personnel and we anticipate being able to do so in the future. In order to address this contingency, the Company has initiated an Assistant Manager Training Program whereby the Company provides general management training to manager candidates at monthly seminars held at the Company’s corporate offices. We anticipate that this program will increase our ability to train and retain qualified personnel. We currently believe that we will have the capital resources necessary to purchase the inventory, equipment, and fixtures, and to fund the other capital expenditures necessary for the store expansions. If we lack such capital resources, however, it would limit our expansion plans and negatively impact our operations going forward. The Company has been working closely with multiple developers and landlords that the Company believes have the financial resources to develop property to be leased by the Company and hold such property as a long-term investment in their portfolios. If such developers and landlords do not have, and cannot obtain, the financial resources to develop and hold such property, it would limit our expansion plans and negatively impact our operations going forward.
Off-Balance Sheet Arrangements
The Company has not provided any financial guarantees as of February 2, 2014.
The Company has not created and is not party to, any special-purpose or off-balance sheet entities for the purpose of raising capital, incurring debt or operating the business. The Company does not have any arrangements or relationships with entities that are not into the financial statements that are reasonably likely to materially affect the Company’s liquidity or the availability of capital resources.
Critical Accounting Policies
Our analysis of operations and financial condition is based on our financial statements, prepared in accordance with U.S. GAAP. Preparation of these financial statements requires us to make estimates and assumptions affecting the reported amounts of assets and liabilities at the date of the financial statements, reported amounts of revenues and expenses during the reporting period and related disclosures of contingent assets and liabilities. In the Notes to Financial Statements, we describe our significant accounting policies used in preparing the financial statements. Our estimates are evaluated on an ongoing basis and are drawn from historical experience and other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from these estimates. The following items in our financial statements require significant estimation or judgment:
Inventories: Inventories are stated at the lower of cost or net realizable value. The first-in, first-out (FIFO) method is used for all merchandise.
Insurance: The Company retains significant deductibles on its insurance policies for workers compensation, general liability, medical claims and prescriptions. Due to the fact that it often takes more than one year to determine the actual costs, these costs are estimated based on the Company’s historical loss experience and estimates from the insurance carriers and consultants. The Company completes an actuarial evaluation of its loss experience each year. In between actuarial evaluations, management monitors the cost and number of claims and compares those results to historical amounts. The Company’s actuarial method is the fully developed method. The Company records its reserves on an undiscounted basis. The Company’s prior estimates have varied from actual results due to differences related to actual claims versus estimated ultimate loss calculations. Current and future estimates could be affected by changes in those same assumptions and are reasonably likely to occur.
Consideration received from vendors: Cost of sales and SG&A expenses are partially offset by various forms of consideration received from our vendors. This “vendor income” is earned for a variety of vendor-sponsored programs, such as volume rebates, markdown allowances, promotions, warehouse cost reimbursement and advertising. Consideration received, to the extent that it reimburses specific, incremental and identifiable costs incurred to date, is recorded in selling, general and administrative expenses in the same period as the associated expenses are incurred. Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date are recognized as a reduction to the cost of the merchandise purchased and are reflected in costs of sales as the merchandise is sold. The Company establishes a receivable for the vendor income that is earned but not yet received. Based on provisions of the agreements in place, this receivable is computed by estimating when the Company has completed its performance and the amount has been earned. The majority of year-end receivables associated with these activities are collected within the following fiscal quarter.
Analysis of long-lived assets for impairment: The Company reviews assets for impairment at the lowest level for which there are identifiable cash flows, usually at the store level. The carrying amount of assets is compared with the expected undiscounted future cash flows to be generated by those assets over their estimated remaining economic lives. If the undiscounted cash flows are less than the carrying amount of the asset, the asset is written down to fair value. Factors that could result in an impairment review include, but are not limited to, a current period cash flow loss combined with a history of cash flow losses or a projection that demonstrates continuing losses associated with the use of a long-lived asset, or significant changes in a manner of use of the assets due to business strategies or competitive environment. Additionally, when a commitment is made to close a store in a period beyond the quarter in which the closure commitment is made, it is reviewed for impairment and depreciable lives are adjusted. The impairment evaluation is based on the estimated cash flows from continuing use until the expected disposal date plus the expected terminal value. Actual results could vary from management estimates.
Income Taxes: ASC Topic 740 prescribes a recognition threshold and a measurement standard for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The recognition and measurement of tax benefits is often highly judgmental. Determinations regarding the recognition and measurement of a tax benefit can change as additional developments occur relative to the issue. Accordingly, the Company’s future results may include favorable or unfavorable adjustments to our liability for uncertain tax positions.
The Company records valuation allowances against our deferred tax assets, when necessary. Realization of deferred tax assets (such as net operating loss carryforwards) is dependent on future taxable earnings and is therefore uncertain. The Company will assess the likelihood that our deferred tax assets in each of the jurisdictions in which it operates will be recovered from future taxable income. Deferred tax assets are reduced by a valuation allowance to recognize the extent to which, more likely than not, the future tax benefits will not be realized.
During fiscal 2014, the Company recorded a non-cash charge of $9.8 million attributable to a valuation allowance on the Company’s cumulative net deferred tax asset. The establishment of a valuation allowance does not have any impact on cash, on the Facility nor does such an allowance preclude the Company from utilizing its loss carryforwards in the future.
Share-Based Compensation: The Company has a share-based compensation plan, which includes non-qualified stock options and nonvested share awards. See Note 1, Summary of Significant Accounting Policies, and Note 10, Share-based Compensation, to the Notes to Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, for a complete discussion of our stock-based compensation programs. We determine the fair value of our non-qualified stock option awards at the date of grant using option-pricing models. We determine the fair value of our share awards at the date of grant using generally accepted valuation techniques. Management reviews its assumptions and the valuations to determine the fair value of share-based compensation awards.
Customer Loyalty Program: The Company has a customer loyalty program which allows members to earn points for each purchase completed at any of our stores. Points earned enable members to receive a certificate that may be redeemed on future purchases at our stores. The value of points earned by our customer loyalty program members is included in accrued liabilities, based on the value of points that are projected to be redeemed, and recorded as a reduction in revenue at the time the points are redeemed.
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS OF OPERATIONS, FINANCIAL CONDITION OR BUSINESS
Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact may constitute “forward-looking statements” within the meaning of Section 21E of the Exchange Act. These statements are subject to risks and uncertainties, as described below. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, income or loss, earnings or loss per share, capital expenditures, store openings, store closings, payment or non-payment of dividends, capital structure and other financial items, (ii) statements of plans and objectives of the Company’s management or Board of Directors, including plans or objectives relating to inventory, store development, marketing, competition, business strategy, store environment, merchandising, purchasing, pricing, distribution, transportation, store locations and information systems, (iii) statements of future economic performance, and (iv) statements of assumptions underlying the statements described in (i), (ii) and (iii). Forward-looking statements can often be identified by the use of forward-looking terminology, such as “believes,” “expects,” “may,” “will,” “should,” “could,” “intends,” “plans,” “estimates”, “projects” or “anticipates,” variations thereof or similar expressions.
Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. The Company’s future results of operations, financial condition and business operations may differ materially from the forward-looking statements or the historical information stated in this Annual Report on Form 10-K. Stockholders and investors are cautioned not to put undue reliance on any forward-looking statement.
There are a number of factors and uncertainties that could cause actual results of operations, financial condition or business contemplated by the forward-looking statements to differ materially from those discussed in the forward-looking statements made herein or elsewhere orally or in writing, by, or on behalf of, the Company, including those factors described in “Item 1A. Risk Factors” above. Other factors not identified herein could also have such an effect.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
AND FINANCIAL STATEMENT SCHEDULES
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
ALCO Stores, Inc.
We have audited the accompanying balance sheets of ALCO Stores, Inc. (a Kansas corporation) (the “Company”) as of February 2, 2014 and February 3, 2013, and the related statements of operations, changes in shareholders’ equity, and cash flows for each of the two years in the period ended February 2, 2014 and February 3, 2013. These financial statements 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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ALCO Stores, Inc. as of February 2, 2014 and February 3, 2013, and the results of its operations and its cash flows for each of the two years in the period ended February 2, 2014 and February 3, 2013 in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Kansas City, Missouri
May 5, 2014
ALCO Stores, Inc.
Balance Sheets
(dollars in thousands, except share and per share amounts)
______________________________________
See accompanying notes to financial statements.
ALCO Stores, Inc.
Statements of Operations
Fiscal Years ended February 2, 2014 and February 3, 2013
(dollars in thousands, except per share amounts)
______________________________________
See accompanying notes to financial statements.
ALCO Stores, Inc.
Statements of Stockholders’ Equity
Fiscal Years ended February 2, 2014 and February 3, 2013
(dollars in thousands, except share amounts)
______________________________________
See accompanying notes to financial statements.
ALCO Stores, Inc.
Statements of Cash Flows
Fiscal Years ended February 2, 2014 and February 3, 2013
(dollars in thousands)
______________________________________
Supplemental cash flow information:
See accompanying notes to financial statements.
ALCO STORES, INC.
Notes to Financial Statements
February 2, 2014 and February 3, 2013
(dollars in thousands, except for share and per share amounts)
1. Summary of Significant Accounting Policies
(a) Nature of Business
The Company is engaged in the business of retailing general merchandise throughout the central portion of the United States of America through broad line department store outlets. Merchandise is purchased for resale from many vendors. The Company has a partnership with Associated Wholesale Grocer, (“AWG”), whereby the Company purchases several categories of product through AWG.
(b) Basis of Presentation
The Company’s fiscal year ends on the Sunday nearest to January 31. Fiscal years 2014 and 2013 consisted of 52 weeks and 53 weeks, respectively.
(c) Inventories
Inventories are stated at the lower of cost or net realizable value. The first-in, first-out (FIFO) method is used for all inventories.
(d) Property and Equipment
Depreciation is computed on a straight-line basis over the estimated useful lives of the assets. Amortization of capital leases is computed on a straight-line basis over the terms of the lease agreements. Major improvements are capitalized, while maintenance and repairs that do not extend the useful life of the asset are charged to expense as incurred. Estimated useful lives are as follows:
For fiscal years 2014 and 2013 depreciation and amortization was $10.5 million and $8.9 million, respectively. The fiscal 2014 increase in depreciation includes impairment charges of $1.4 million related to planned store closures.
(e) Operating Leases
The Company accounts for operating leases over the initial lease term without regard to available renewal options. The Company considers free rent periods and scheduled rent increases in determining total rent expense for the initial lease term. Total rent expense is recognized on a straight-line basis over that term.
(f) Insurance
The Company retains significant deductibles on its insurance policies for workers’ compensation, general liability, medical claims and prescriptions. Due to the fact that it could take more than one year to determine the actual costs, these costs are estimated based on the Company’s historical loss experience and estimates from the insurance carriers and consultants. The Company completes an actuarial evaluation of its loss experience each year. During the periods between actuarial evaluations, management monitors the cost and number of claims and compares those results to historical amounts. The Company’s actuarial method is the fully developed method. The Company records its reserves on an undiscounted basis.
The Company’s prior estimates have varied based on changes in assumptions related to actual claims versus estimated ultimate loss calculations based on historical claim activity. Current and future estimates could be affected by changes in those same assumptions.
(g) Income Taxes
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company reflects changes in estimates related to prior period income taxes as a component of current period income tax expense.
(h) Net Sales
Sales are recorded when title and risk of loss are transferred to the customer, which occurs at the point of sale. The Company excludes sales taxes from revenue. The Company has established a sales returns allowance based on the historical returns pattern experienced by the Company.
(i) Net Earnings (Loss) Per Share
Basic net earnings (loss) per share is computed by dividing net earnings (loss) by the weighted average number of shares outstanding. Diluted net earnings (loss) per share reflects the potential dilution that could occur if contracts to issue securities (such as stock options) were exercised, unless their effect is anti-dilutive. See Note 9.
(j) Use of Estimates
Management of the Company has made certain estimates and assumptions in determining the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses to prepare these financial statements in conformity with U.S. GAAP. Actual results could differ from those estimates used to record various assets and liabilities, such as allowances for doubtful accounts, valuation of merchandise inventory, reserves for self-insurance, and the effective tax rate.
(k) Long-lived Assets
Whenever events and circumstances indicate that the carrying value of certain long-lived assets may be impaired, the Company reviews such assets for impairment at the lowest level for which there are identifiable cash flows, usually at the store level. The carrying amount of certain assets is compared with the expected undiscounted future cash flows to be generated by those assets over their estimated remaining economic lives. If the undiscounted cash flows are less than the carrying amount of the assets, the assets are written down to fair value. Factors that could result in an impairment review include, but are not limited to, a current period cash flow loss combined with a history of cash flow losses or a projection that demonstrates continuing losses associated with the use of a long-lived asset, or significant changes in a manner of use of the assets due to changes in business strategies or competitive environment. Additionally, when a commitment is made to close a store in a period beyond the quarter in which the closure commitment is made, it is the long-lived assets associated with the store are reviewed for impairment and depreciable lives are adjusted. The impairment evaluation is based on the estimated cash flows from continuing use until the expected disposal date plus the expected terminal value. Actual results could vary from management estimates. During fiscal 2014, an asset impairment of $1.4 million was recorded attributable to previously announced store closures, not finalized as of February 2, 2014.
The Company had $0.6 million classified as excess land held for sale as of both February 2, 2014 and February 3, 2013. These properties are recorded at their estimated net realizable value, net of disposal costs. Management believes the assets held for sale could be sold within the next 12 months.
(l) Store Closings and Discontinued Operations
A provision for store closure expense is recorded when the Company discontinues using the facility. There was no liability for store closure expense for fiscal years 2014 and 2013.
The Company has determined that generally each store is a component of the entity and that for each closed store (i) the operations and cash flows of the component have been eliminated from the ongoing operations of the entity and (ii) the entity will not have any significant continuing involvement in the operations of the component after the store is closed. This is a result of the Company’s stores being geographically dispersed. The results of operations for stores that have been closed by the Company (8 and 4 in fiscal years 2014 and 2013, respectively) have been reclassified to discontinued operations in the accompanying statements of operations for all periods presented. The Company does not allocate interest expense to discontinued operations. The liability recognized for costs associated with store closing is primarily related to future lease costs (net of estimated sublease income), and is accrued and charged to income when the Company ceases to use the leased location.
(m) Consideration Received from Vendors
Cost of sales and selling, general and administrative expenses are partially offset by various forms of consideration received from our vendors. This “vendor income” is earned for a variety of vendor-sponsored programs, such as volume rebates, markdown allowances, promotions, warehouse cost reimbursement and advertising. Consideration received, to the extent that it reimburses specific, incremental, and identifiable costs incurred to date, is recorded in selling, general and administrative expenses in the same period as the associated expenses are incurred. Reimbursements received that are in excess of specific, incremental and identifiable costs incurred to date are recognized as a reduction to the cost of the merchandise purchased and are reflected in costs of sales as the merchandise is sold. The Company establishes a receivable for the vendor income that is earned but not yet received. This receivable is computed based on provisions of the agreements in place and reflects management’s expectations about when and whether the Company will have completed its performance and the amount will be earned. The Company performs detailed analyses to determine the appropriate level of the receivable in the aggregate. The majority of year-end receivables associated with these activities are collected within the following fiscal quarter.
(n) Advertising Costs
The Company expenses advertising costs as incurred. The Company records payments from vendors representing reimbursements of specific identifiable costs as a reduction of that cost. Advertising expenses of $11.1 million and $11.6 million in fiscal 2014 and 2013, respectively, are included in selling, general and administrative expenses in the statements of operations. Advertising reimbursements from vendors, partially offset advertising expenses, were $3.5 million and $6.2 million for fiscal years 2014 and 2013, respectively. The costs of production and distribution of newspaper circulars made up the majority of our advertising costs in both years.
(o) Share-based Compensation
The Company currently sponsors share-based employee benefit plans and stock option plans. The Company recognizes compensation expense for its share-based payments based on the fair value of the awards on the date of the grant. Share-based payments include stock option awards issued under the Company’s employee stock option and director stock option plans. See Note 10 for further information concerning these plans.
(p) Fair Value of Financial Instruments
The financial instruments of the Company consist of cash, short-term receivables and accounts payable, accrued expenses and long-term debt instruments, including capital leases. For notes payable under revolving loan, fair value approximates the carrying value due to the variable interest rate. For all other financial instruments, including cash, short-term receivables, accounts payable and accrued expenses, the carrying amounts approximate fair value due to the short maturity of those instruments.
(q) Pre-opening Costs
The costs of start-up activities, including organization costs and new store openings, are expensed as incurred.
2. Inventories
Inventories are stated at the lower of cost or net realizable value. The first-in, first-out (FIFO) method is used for all inventories.
3. Credit Arrangements, Notes Payable and Long-term Debt
On July 21, 2011, the Company entered into a five-year revolving Credit Agreement (the “Facility”) with Wells Fargo and Wells Capital Finance, LLC. The $120.0 million Facility replaced the Company’s previous $120.0 million credit facility with Bank of America, N.A. and Wells Fargo Retail Finance, LLC, and expires July 20, 2016.The Company uses its revolving loan credit facility and vendor trade credit financing to fund the buildup of inventories periodically during the year for its peak selling seasons and to meet other short-term cash requirements.
Under the Facility, the Company can request an increase of up to $25.0 million. On November 22, 2013, pursuant to Section 2.16 of the Facility, the Board of Directors unanimously approved a request to increase the revolving credit commitments of the Company by $10.0 million (the “Commitment Increase”); thereby, increasing the overall Facility from $120.0 million to $130.0 million. Except for the Commitment Increase, the Facility remains unchanged and in full force and effect.
Including the Commitment Increase, the revolving loan credit facility provides up to $130 million of financing in the form of notes payable. The loan agreement expires July 20, 2016. The revolving loan note payable of $89.5 million together with outstanding letters of credit at February 4, 2014, resulted in an available line of credit at that date of approximately $18.2 million, subject to a borrowing base calculation. Loan advances are secured by a security interest in the Company’s inventory and credit card receivables. The loan agreement contains various restrictions that are applicable when outstanding borrowings exceed $110.5 million, including limitations on additional indebtedness, prepayments, acquisition of assets, granting of liens, certain investments and payments of dividends. The Company’s loan agreement contains various covenants including limitations on additional indebtedness and certain financial tests, as well as various subjective acceleration clauses. The balance sheet classification of the borrowings under the revolving loan credit facility has been determined in accordance with ASC 470-10-45, Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include both a Subjective Acceleration Clause and a Lock-Box Arrangement. Accordingly, this obligation has been classified as a long-term liability in the accompanying balance sheet.
Based on the Company’s average excess availability, the amount advanced to the Company on any Base Rate Loan (as such term is defined in the Facility) bears interest at the highest of (a) the rate of interest in effect for such day as publicly announced from time to time by Wells Fargo as its “prime rate”; (b) the Federal Funds Rate for such day, plus 1.0%; and (c) the LIBO Rate for a 30 day interest period as determined on such day, plus 2.0%. Amounts advanced with respect to any LIBO Borrowing for any Interest Period (as those terms are defined in the Facility) shall bear interest at an interest rate per annum (rounded upwards, if necessary, to the next 1/16 of one percent) equal to (a) the LIBO Rate for such Interest Period multiplied by (b) the Statutory Reserve Rate (as defined in the Facility). The Facility contains various restrictions that are applicable when outstanding borrowings reach certain thresholds, including limitations on additional indebtedness, prepayments, acquisition of assets, granting of liens, certain investments and payment of dividends.
On October 12, 2012, subsequent to a trade confirmation executed October 10, 2012 whereby the Company repurchased shares of its common stock, the Company notified Wells Fargo that immediately after giving effect to the share repurchase, the Consolidated Fixed Charge Coverage Ratio would not be greater than the required ratio per Section 7.06(c) of the Facility. On October 12, 2012, Wells Fargo issued its consent of the repurchase; provided that their consent automatically terminated in the event the repurchase was not consummated within 90 days of the date of consent.
On February 6, 2013, the Board of Directors of the Company unanimously approved a First Amendment (the “Amendment”) to its Credit Agreement with Wells Fargo National Association, amending Section 7.06(c) of the Credit Agreement to permit the Company, subject to certain conditions set forth in the Amendment, to repurchase, redeem or otherwise acquire Equity Interests issued by the Company not to exceed $1,000,000 in the aggregate in each Fiscal Year. Under the Credit Agreement, “Equity Interests” is defined as all of the shares of the capital stock of a person and all of the other warrants, options or other rights of a person to purchase capital stock of such person. Such amendment was announced on Form 8-K filed by the Company with the Securities and Exchange Commission on February 12, 2013 and a copy of the Amendment is attached to such 8-K.. Except to the extent specifically set forth in Wells Fargo’s Consent, no other consent, waiver of, or change in any of the terms, provisions or conditions of the Credit Agreement is intended or implied.
Notes payable outstanding at February 4, 2014 and February 3, 2013 under the revolving loan credit facility aggregated $89.5 million and $63.4 million, respectively. The lender had also issued letters of credit aggregating $9.1 million and $8.6 million, respectively, at such dates on behalf of the Company. The interest rates on the outstanding borrowings at February 4, 2014 were 2.1875% on $72.0 million of the outstanding balance and 4.25% on the remaining $17.5 million. The Company had additional borrowings available at February 4, 2014 under the revolving loan credit facility amounting to approximately $18.2 million.
Interest expense on notes payable and long-term debt, excluding capital lease obligations, aggregated $2.5 million and $2.2 million during fiscal years 2014 and fiscal 2013, respectively.
4. Employee Benefits
Effective November 1, 2010, the Company’s Board of Directors elected to suspend the Company match of employees 401(K) contributions. Historically, the Company matched employee contributions up to half of the first 4% of compensation contributed by the employee. Contributions by the Company vest with the participants over a seven-year period.
5. Self-Insurance Claim Reserves
Changes to the self-insurance reserves for fiscal years 2014 and 2013 are as follows:
6. Leases
The Company is lessee under long-term capital leases expiring at various dates. The components of property under capital leases as of February 2, 2014 and February 3, 2013 are as follows:
The Company also has non-cancelable operating leases, primarily for buildings, that expire at various dates.
Future minimum lease payments under all non-cancelable leases, together with the present value of the net minimum lease payments pursuant to capital leases, as of February 2, 2014 are as follows:
Minimum payments do not include contingent rentals, which may be paid under certain store leases on the basis of percentage of sales in excess of stipulated amounts. There were no contingent rentals applicable to capital leases for fiscal years 2014 and 2013.
The interest on capital lease obligations was $1.3 million for both fiscal years 2014 and 2013.
The following schedule presents the composition of total rent expense for all operating leases for fiscal 2014 and 2013:
7. Income Taxes
The Company’s income tax expense (benefit) consists of the following for fiscal years 2014 and 2013:
Income tax expense (benefit) attributable to continuing operations for fiscal years 2014 and 2013 consists of:
Income tax expense attributable to continuing operations was $5.0 million and $0.7 million for fiscal years 2014 and 2013, respectively, and differs from the amounts computed by applying the Federal statutory income tax rate of 34% as a result of the following:
The Company’s effective income tax rate from continuing operations for February 2, 2014 and February 3, 2013 is (25.8)% and 24.2%, respectively. The fiscal 2014 effective tax rate differs from the federal statutory rate, due primarily to federal employment credits, state income taxes and the recording of a valuation allowance.
The Company recorded the valuation allowance on its net deferred tax assets as a result of losses from operations, to the extent the Company was in a cumulative loss position for the three year period ending February 2, 2014. Based on this assessment, the Company could not support the realization of its net deferred tax assets in future periods, and the remaining net deferred tax assets were written off. Management will continue to evaluate all of the positive and negative evidence in the future and will make a determination as to whether it is more likely than not that its net deferred tax assets will be realized in future periods. The establishment of a valuation allowance does not have any impact on cash, nor does such an allowance preclude the Company from using its loss carryforwards or utilizing other deferred tax assets in the future.
The fiscal 2013 effective tax rate differs from the federal statutory rate due primarily to federal employment credits and state income taxes. The Company had no valuation allowance as of February 3, 2013 due to history of earnings and cumulative income in recent years.
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at February 2, 2014 and February 3, 2013 are presented below:
______________________________________
At February 2, 2014, the Company has total federal and state net operating loss carryforwards of $25.2 million and $28.7 million, respectively, which are available to offset future taxable income. The federal net operating loss carryforwards will begin expiring in fiscal 2031. The state net operating loss carryforwards have various expiration dates beginning in fiscal 2016. The Company also has federal credits available in the amount of $3.8 million to offset future federal income tax. Approximately $3.5 million of these credits will begin to expire in fiscal year 2029, and the remaining credits have no expiration.
In assessing the need for a valuation allowance, the Company considered both positive and negative evidence related to the likelihood of realization of the deferred tax assets. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. Accounting guidance states that a cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome in determining whether a valuation allowance is not needed against deferred tax assets. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses.
As of February 2, 2014 and February 3, 2013 the Company did not have any unrecognized tax benefits. Interest and penalties, if any, accrued on the unrecognized tax benefits are reflected as interest expense. No interest or penalties were recognized in the current period.
The statute of limitations for the Company’s federal income tax returns is open for fiscal 2011 through fiscal 2014. The Company files in numerous state jurisdictions with varying statutes of limitation. The Company’s state returns are subject to examination by the taxing authority for fiscal 2010 through 2014 or fiscal 2011 through fiscal 2014, depending on each state’s statute of limitations.
On September 13, 2013, the IRS and United States Treasury Department released final and re-proposed tangible property regulations regarding the deduction and capitalization of expenditures related to tangible property, including the tax treatment of, among other things, materials and supplies, dispositions of property under the Modified Accelerated Cost Recovery System, general asset accounts and the determination of whether expenditures with respect to tangible property are a deductible repair or must be capitalized. The regulations are generally effective for tax years beginning on or after January 1, 2014, but may be adopted in earlier years under certain circumstances. On January 24, 2014, the IRS issued transition guidance that provides the procedures for taxpayers to change their method of accounting to comply with the regulations. We intend to adopt the guidance effective February 3, 2014. We do not expect the adoption of the regulations to have a material impact on our consolidated financial statements.
8. Stockholders’ Equity
On July 27, 2012, the Company entered into a new Rule 10b5-1 and Rule 10b-18 Stock Repurchase Agreement with William Blair and Company, LLC (the “Stock Repurchase Agreement”) whereby the Company authorized the repurchase of up to 175,000 shares of the Company’s Common Stock under the Company’s stock repurchase program (the “Program”).
The Program was initially authorized by the Company on March 23, 2006, whereby the Board of Directors of the Company authorized the repurchase of 200,000 shares of the Company's Common Stock, and the Company repurchased 3,337 shares of Common Stock under the Program. The Company's Board of Directors reinstated the Program on August 13, 2008 and the Company repurchased 22,197 shares of Common Stock under the Program during such period of reinstatement. The Board of Directors of the Company approved the reinstatement of the Program again on January 6, 2012 and the Company repurchased an additional 34,407 shares of Common Stock during such reinstatement. On April 25, 2012, the Board of Directors of the Company authorized the Company to repurchase an additional 500,000 shares of Common Stock for a total of 700,000 shares of Common Stock authorized for repurchase under the Program. The Stock Repurchase Agreement only authorizes William Blair and Company, LLC to repurchase a portion of the total shares available for repurchase under the Program as stated above. Under the terms of the Program, the Company can terminate the proposed buy back at any time.
During fiscal 2013, the Company repurchased a total of 584,928 shares of Common Stock under the Program. All shares were repurchased at market prices and the Company’s policy is to apply the excess of purchase price over par value to additional paid-in capital, resulting in a decrease to additional paid-in capital of $4.0 million. As of February 3, 2013, the Company repurchased a total of 610,462 shares under the Program since it was initially approved in 2006. Therefore, there were 89,538 shares of Common Stock available to be repurchased by the Company, as of February 3, 2013.
The Company had not repurchased additional shares, subsequent to February 3, 2013.
9. Earnings Per Share
The following is a reconciliation of the outstanding shares utilized in the computation of earnings per share:
The anti-dilutive effect of 397,500 and 346,000 stock options has been excluded from diluted weighted average shares outstanding for the fiscal years ended February 2, 2014 and February 3, 2013, respectively.
10. Share-Based Compensation
Share-based payments consist of stock option grants. The benefits of tax deductions in excess of recognized compensation expense are reported as a financing cash flow.
Total share-based compensation (a component of selling and general and administrative expenses) is summarized as follows:
Forfeitures are estimated at the time of valuation and reduce expense ratably over the vesting period. This estimate is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate. The Company grants awards to a limited number of key employees and officers, thus, actual forfeitures can vary significantly from estimated amounts.
Equity Incentive Plan
On June 27, 2012, the Company's stockholders approved the Company's 2012 Equity Incentive Plan (the "Plan"), which is administered by the Compensation Committee of the Company's Board of Directors. Under the Plan, the Company may grant up to 500,000 shares of Company stock in the form of stock options, awards and rights to officers, key employees and consultants of the Company; provided however, the Company's directors are not permitted to be participants in the Plan. According to the terms of the Plan, the per share exercise price of stock options granted shall not be less than the fair market value of the stock on the date of grant and such options will expire no later than ten years from the date of grant. The stock options, awards and rights granted under the Plan vest over a certain period of time, as determined by the Compensation Committee in its sole discretion, beginning from the grant date unless certain Company events occur as further provided under the terms of the Plan. In the case of a stockholder owning more than 10% of the outstanding voting stock of the Company, the exercise price of an incentive stock option may not be less than 110% of the fair market value of the stock on the date of grant and such options will expire no later than five years from the date of grant. Also, the aggregate fair market value of the stock with respect to which incentive stock options are exercisable on a tax deferred basis for the first time by an individual in any calendar year may not exceed $100,000. In the event that the foregoing results in a portion of an option exceeding the $100,000 limitation, such portion of the option in excess of the limitation shall be treated as a non-qualified stock option. No more than 100,000 shares of the Company's stock may be awarded in a single calendar year to any individual participating in the Plan. At February 2, 2014, the Company had 392,500 remaining shares authorized for future option grants. The 2012 Plan will expire on June 27, 2022.
Under our 2003 Incentive Stock Option Plan, options may be granted to officers and key employees, not to exceed 500,000 shares. According to the terms of the plan, the per share exercise price of options granted shall not be less than the fair market value of the stock on the date of grant and such options will expire no later than five years from the date of grant. The options vest in equal amounts over a four year requisite service period beginning from the grant date unless certain Company events occur. In the case of a stockholder owning more than 10% of the outstanding voting stock of the Company, the exercise price of an incentive stock option may not be less than 110% of the fair market value of the stock on the date of grant and such options will expire no later than five years from the date of grant. Also, the aggregate fair market value of the stock with respect to which incentive stock options are exercisable on a tax deferred basis for the first time by an individual in any calendar year may not exceed $100. In the event that the foregoing results in a portion of an option exceeding the $100 limitation, such portion of the option in excess of the limitation shall be treated as a nonqualified stock option. At February 2, 2014, the Company had 275,875 remaining shares authorized for future option grants. Upon exercise, the Company issues these shares from the unissued shares authorized.
Under our Non-Qualified Stock Option Plan for Non-Management Directors, options may be granted to Directors of the Company who are not otherwise officers or employees of the Company, not to exceed 200,000 shares. According to the terms of the plan, the per share exercise price of options granted shall not be less than the fair market value of the stock on the date of grant and such options will expire five years from the date of grant. The options vest in equal amounts over a four year requisite service period beginning from the grant date unless certain Company events occur. All options under the plan shall be non-qualified stock options. As of February 2, 2014, the Company had 76,457 shares remaining to be issued under this plan. Upon exercise, the Company will issue these shares from the unissued shares authorized.
The fair value of each option grant is separately estimated. The fair value of each option is amortized into share-based compensation on a straight-line basis over the requisite service period as discussed above. We have estimated the fair value of all stock option awards as of the date of the grant by applying a modified Black-Scholes pricing valuation model. The application of this valuation model involves assumptions that are judgmental and highly sensitive in the determination of share-based compensation, including expected stock price volatility. The assumptions used in determining the fair value of options granted in the last two fiscal years and a summary of the methodology applied to develop each assumption are as follows:
EXPECTED PRICE VOLATILITY - This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company uses actual historical changes in the market value of its stock to calculate expected price volatility because management believes that this is the best indicator of future volatility. The Company calculates monthly market value changes from the date of grant over a past period to determine volatility. An increase in the expected volatility will increase share-based compensation.
RISK-FREE INTEREST RATE - This is the applicable U.S. Treasury rate for the date of the grant over the expected term. An increase in the risk-free interest rate will increase share-based compensation.
EXPECTED LIVES - This is the period of time over which the options granted are expected to remain outstanding and is based on management’s expectations in relation to the holders of the options. Options granted have a maximum term of ten years. An increase in the expected life will increase share-based compensation.
DIVIDEND YIELD - The Company has not made any dividend payments nor does it have plans to pay dividends in the foreseeable future. An increase in the dividend yield will decrease share-based compensation.
A summary of stock option activity for the Company’s most recent fiscal year is as follows:
The Company recognizes expense for its share-based payments based on the fair value of the awards at grant date. The aggregate intrinsic values in the table above represent the total difference between the Company’s closing stock price on February 2, 2014 and the option respective exercise price, multiplied by the number of in-the-money options as of February 2, 2014. As of February 2, 2014, total estimated unrecognized share-based compensation related to non-vested stock options is $0.5 million with a weighted average recognition period of 2.4 years.
Other information relative to option activity during the fiscal years ended February 2, 2014 and February 3, 2013 is as follows:
11. Seasonality and Quarterly Results (Unaudited)
The following table sets forth the Company’s net sales, gross margin, earnings (loss) from continuing operations and net earnings (loss) during each quarter of fiscal years 2014 and 2013:
______________________________________
(1) Earnings per share amounts are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share in fiscal years 2014 and 2013 may not equal the total computed for the year.
12. Business Operations
The Company’s business activities consist of the operation of retail stores. The Company initiated a transactional web site during November 2011. Based on its insignificant results of operation, the transactional website has been aggregated with the operating results of the Company’s ALCO stores.
The Company has many suppliers with which it conducts business. The Company has a partnership with AWG, whereby the Company purchases several categories of product through AWG.
For fiscal 2014, AWG comprised approximately 26% of the Company’s total purchases, as compared to approximately 27% during fiscal 2013. The Company believes that its relationships with its suppliers are good, but a change in the relationship with AWG would potentially cause the Company to incur increases in its cost of certain merchandise.
For fiscal years 2014 and 2013 the percentages of sales by product category were as follows:
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
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report, to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Management’s Report on Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining internal control over financial reporting as defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934, as amended. The Company’s internal control system is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. GAAP. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of February 2, 2014 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). As a result of this assessment, management concluded that the Company’s internal control over financial reporting was effective as of February 3, 2013.
(c) Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during fiscal 2014 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.
(d) Report of Independent Registered Pubic Accounting Firm
Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF THE REGISTRANT
For information with respect to the Company’s Directors, the Board of Directors’ Audit Committee, the Board of Directors’ Nominating Committee and the written code of ethics, see the information provided in the “Proposal One - Election of Directors”, “Information About Directors Nominees”, “Information about the Nominating Committee”, “Code of Ethics” and “Certain Information Concerning the Board and Its Committees” sections of the Proxy Statement for the 2014 Annual Meeting of Stockholders, which information is incorporated herein by reference. For information with respect to Section 16 reports, see the information provided in the “Section 16(a) Beneficial Ownership Reporting Compliance” section of the Proxy Statement for the 2013 Annual Meeting of Stockholders, which information is incorporated herein by reference.
The Company’s executive officers as of May 5, 2014, are as follows:
Except as set forth below, all of the executive officers have been associated with the Company in their present position or other capacity for more than the past five years. There are no family relationships among the executive officers of the Company.
Richard E. Wilson has served as President and Chief Executive Officer of the Company since February 15, 2010. From December, 2007 until he joined the Company, Mr. Wilson served as Principal of Corporate Alliance Group, a management consulting company specializing in marketing, product development, planning, strategy and brand management for the retail and wholesale trade. Prior to forming Corporate Alliance Group, Mr. Wilson was Senior Vice President, General Merchandise, for BJ’s Wholesale Club from May, 2005 to February, 2007. From August, 2003 to April, 2005, Mr. Wilson was Senior Vice President, Home Furnishings for the Macy’s division of Federated Department Stores, Inc., the parent company of department stores such as Macy’s and Bloomingdales. Mr. Wilson has also previously served as an executive with the Filene’s division of May Department Stores.
Wayne S. Peterson, joined the Company as its Senior Vice President-Chief Financial Officer on September 20, 2010. Mr. Peterson served as Chief-Financial Officer of Minyard Foods, Inc., a privately-held regional supermarket retailer, which operates a total of 60 stores in the Dallas/Fort-Worth area from 2006 until he joined the Company. From 2002-2005, Mr. Peterson served as the Executive Vice President, Chief Financial Officer, Secretary, and Director of Copeland’s Enterprises, Inc., a privately held regional specialty retailer of sporting goods. Mr. Peterson has also previously served as an executive with Homeland Holdings Corporation, and Buttrey Food and Drug Stores Company and has approximately 33 years of retail experience.
Tom L. Canfield, Jr. has served as Senior Vice President - Logistics/Administration Officer since 2006. From, 1973 to 2006, Mr. Canfield served in various capacities with the Company. Mr. Canfield has approximately 40 years of experience in the retail industry.
Brent A. Streit was promoted to Senior Vice President, Marketing & Ecommerce July 6, 2012. Mr. Streit joined the Company in 2001 as a buyer and has held increasingly responsible positions in supply chain management, marketing and business development. Mr. Streit has more than 20 years of retail experience.
Ricardo Clemente was promoted to Senior Vice President of Store Operations, Loss Prevention, and Human Resource May 30, 2013. Mr. Clemente joined the Company on February 28, 2011 as a District Manager and held increasingly responsible positions in Operations and Human Resources. Mr. Clemente has more than 20 years of experience in retailing.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The Registrant’s Proxy Statement to be used in connection with the 2014 Annual Meeting of Stockholders contains under the caption “Executive Compensation and Other Information” the information required by Item 11 of Form 10-K, and such information is incorporated herein by this reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Registrant’s Proxy Statement to be used in connection with the 2014 Annual Meeting of Stockholders, contains under the caption “Security Ownership of Certain Beneficial Owners, Directors and Management” the information required by Item 12 of Form 10-K and such information is incorporated herein by this reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The Registrant’s Proxy Statement to be used in connection with the 2014 Annual Meeting of Stockholders, contains under the captions “Related Party Transactions” and “Certain Information Concerning the Board and Its Committees” the information required by Item 13 of Form 10-K and such information is incorporated herein by this reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Registrant’s Proxy Statement to be used in connection with the 2014 Annual Meeting of Stockholders, contains under the caption “Ratification of Selection of Independent Public Accountants” the information required by Item 14 of Form 10-K and such information is incorporated herein by this reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as part of this report
(1) Financial Statements
The financial statements are listed in the index for Item 8 of this Form 10-K.
(2) Financial Statement Schedules
All schedules are omitted because they are inapplicable, not required, or the information is included elsewhere in the Financial Statements or the notes thereto.
(3) Exhibits
The exhibits filed with or incorporated by reference in this report are listed below:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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 and Title
Date
/s/ Richard E. Wilson
May 5, 2014
Richard E. Wilson
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Wayne S. Peterson
May 5, 2014
Wayne S. Peterson
Senior Vice President - Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ Terrence M. Babilla
May 5, 2014
Terrence M. Babilla
Director
/s/ Dennis E. Logue
May 5, 2014
Dennis E. Logue
Director
/s/ Lolan C. Mackey
May 5, 2014
Lolan C. Mackey
Director
/s/ Royce L. Winsten
May 5, 2014
Royce L. Winsten
Director - Chairman of Board