|
Item 2:
|
Management’s Discussion and Analysis of Financial Condition and Results of Operations
|
Forward Looking Statements
The following discussion and
analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
This discussion contains forward-looking statements that involve risks and uncertainties that could cause our actual results to differ materially. These statements relate to future events or our future financial performance and are based on
information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,”
“should,” “except,” “plan,” “anticipate,” “intend,” “seek,” “expect,” “believe,” “estimate,” “predict,” “potential” or
“continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain
factors, including but not limited to, those discussed in “Risk Factors” included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 and other reports and filings made with the Securities and
Exchange Commission.
The following discussion provides additional information to the accompanying consolidated financial statements and notes to
help provide an understanding of our financial condition, changes in financial condition and results of operations. This discussion is organized as follows:
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•
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Overview
. This section provides a general description of our business, economic and industry-wide factors relevant to us and material opportunities,
challenges and risks in our business.
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|
•
|
|
Critical Accounting Policies
. This section discusses those accounting policies that contain uncertainties and require significant judgment in their
application.
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•
|
|
Results of Operations
. This section provides an analysis of our results of operations for all three years presented in the accompanying consolidated
statements of operations.
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•
|
|
Liquidity and Capital Resources
. This section provides an analysis of our sources and uses of cash, capital expenditures and the amount of financial
capacity available to fund our future commitments.
|
Overview
We are an outsourcing solutions provider for the education community. Under the “VarsityBooks” and “Campus Outfitters” brands, we provide textbooks, uniforms and school supplies to private K-12
schools, colleges, and distance and continuing education markets. Through our textbook and uniform outsource solutions, schools are released from the operational and financial challenges associated with managing highly seasonal retail operations and
are free to focus on their core educational mission. Parents and students benefit from the increased convenience and value associated with our comprehensive textbook and uniform programs.
We were incorporated in December 1997 and began offering books for sale on our website on August 10, 1998. Prior to 2005, our revenues consisted primarily of sales
of new textbooks. In May 2005, we acquired Campus Outfitters, a retailer of school uniforms to the private K-12 school marketplace, and introduced school uniforms as a second revenue stream into our business. To date, the primary channel for
textbook sales has been through online eCommerce transactions, while the majority of uniform sales have been recognized through retail stores and on-campus sales events.
Our original sales model focused on building a broad consumer brand, offering promotions and deeply discounted textbook prices to entice college students to visit our website and purchase their textbooks from us.
However, during 2000 we began to focus resources on the growth and development of our eduPartners program, whereby we became a provider of new textbooks and learning materials to private middle and high school, college, distance, and continuing
education markets. This model represents the overwhelming majority of our textbook business today.
Within our textbook solution, we create a customized
virtual bookstore for each partner school which is hosted on our website, www.varsitybooks.com. This site contains the required and optional educational materials and supplies selected by the school organized by grade, academic discipline and course
name. Students and parents from each of our partner schools access their customized bookstore to place their orders via a direct link from their school’s homepage or by searching for their school bookstore by region and state on our homepage.
Once an order has been submitted, it is typically picked, packed and shipped within one business day from one of three distribution centers nationwide.
Member schools leverage our textbook solution to lower their operating overhead by outsourcing their bookstore operation while delivering a more efficient and flexible bookstore solution to their community. In addition, our partner schools
have access to our unique program administration website that provides them with sales and inventory reports, among other valuable features. Student and parent customers value the convenience of our online shopping experience and take comfort in the
knowledge that
13
our posted booklists have been reviewed for content and accuracy and approved by their school. As a further convenience to parents, students and school
officials, to the extent any of our partner schools adopt textbooks to be used in the next school term, we will typically offer parents and students several options to sell back their textbooks to us at the end of the school year, helping to lower
their total cost of textbook ownership. These used textbooks are offered for sale the following school year providing our student and parent customers lower cost pricing alternatives.
In May 2005, as part of our strategy to expand the number of services and products we offer our customers, we acquired Campus Outfitters. Through the Campus Outfitters brand, Varsity Group owns and operates eight
retail locations serving private K-12 school communities as their official school uniform provider. Parents and students are also able to purchase uniforms and related items via on-campus sales events which are held at eligible schools as well as
online through customized virtual stores which are created on
www.campusoutfitters.com
for each partner school containing all required uniform components. We believe with the Campus Outfitters acquisition, we now have the opportunity to begin
cross-selling our textbook and uniform model between our combined network of existing customers.
Beginning in the second quarter of 2006, we moved
aggressively to launch service offerings outside our core book and uniform offerings. Significant costs were incurred in this effort. In November 2006, due to the financial impact of cost increases together with limited new revenue generation from
non-book/uniform service offerings, efforts to launch service offerings outside the book and uniform areas were terminated or suspended. Significant cost reductions have been implemented, and our current strategy includes only the book, uniform and
school supplies businesses. Our August 2006 partnership with Office Depot enables us to provide School Supplies solutions to parents and students and Office Supplies solutions to schools.
During our third quarter of fiscal 2007, we served fewer schools with our textbook solutions than the prior year and total dollar revenue and unit sales for the majority
of retained schools declined from the prior year. These factors caused a 16.1% decrease in textbook revenue from the prior year. Fewer schools were served with our textbook solutions primarily due to the loss of a slightly greater number of online
books schools than were acquired for 2007 plus the impact of losing the book revenue from schools served with both books and uniforms who dropped the uniform solution (and therefore the book solution as well) as a result of the difficulties in
uniform operations during 2006. The decline in total dollar revenue and unit sales for the majority of retained schools was caused primarily by consumers acquiring an increased percentage of books from sources other than us. While we are the
endorsed provider of textbooks to the schools we serve, we are not the exclusive source of textbooks for the consumers associated with the schools. We believe the cause of the decline in revenue per school retained from 2006 to 2007 relates to a
decline in the customer service experience in 2006 which impacted school satisfaction and consumer loyalty in 2007, our online retail book pricing in 2007 and finally, higher book backorder levels in 2007 than 2006. To address these issues, we
replaced our outsource customer service provider for 2007 and thereby experienced improved performance over 2006 and improved school survey responses, which we believe will result in improved school retention rates for 2008. We also intend to more
aggressively price our book product in 2008 to discourage online price shopping. We will work closely with Baker & Taylor and our schools to further refine our supply chain elements with the goal in 2008 to reduce out-of-stock situations.
As expected, uniform revenue declined in the third quarter of fiscal 2007 from the prior year mainly due to a decline in the number of schools served.
While poor performance in 2006 resulted in significant school losses for 2007, problems encountered in 2006 were largely corrected for 2007. Operational performance and school satisfaction were significantly improved in 2007, which we believe will
result in greater levels of account retention and new sales for 2008.
Our overall success and ability to maintain and increase profitability from
operations will depend, in part, upon our ability to retain our current customers, attract additional schools to our programs, provide a compelling and satisfying shopping experience to our retail customers, and manage our relationship with our
primary fulfillment partner, Baker and Taylor, Inc. (“B&T”), a leading distributor of books, videos and music products.
In view of the
rapidly evolving nature of our business and our limited operating history, we have limited experience forecasting our revenues. Therefore we believe that period-to-period comparisons of our financial results might not necessarily be meaningful and
you should not rely on them as an indication of future performance.
CRITICAL ACCOUNTING POLICIES
Pursuant to guidance published by the SEC regarding disclosure about critical accounting policies, we have identified the following accounting policies as critical to the
understanding of our financial statements.
Our consolidated financial statements are prepared in conformity with accounting principles generally accepted
in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, sales, and expenses, and related disclosure of contingent assets and
liabilities. We re-evaluate our estimates on an on-going basis. Our estimates and judgments are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ
from these estimates or judgments under different assumptions or conditions.
We believe the following are the critical accounting policies which affect
our more significant judgments and estimates used in the preparation of our unaudited condensed consolidated financial statements:
14
|
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•
|
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Stock-Based Compensation Plans;
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|
•
|
|
Valuation of Inventories;
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|
•
|
|
Business Acquisition and Valuation and Impairment Review of Long-Lived Assets
|
A complete discussion of these policies is contained in our Form 10-K filed with the Securities and Exchange Commission for the period ending December 31, 2006. There were no significant changes to the
critical accounting policies discussed in the Company’s 10-K filed for December 31, 2006, except for the adoption of FIN 48 which is discussed in Note 1 to the condensed, consolidated financial statements.
Results of Operations:
The following table includes the condensed
consolidated statements of operations data for the three and nine months ended September 30, 2007 and September 30, 2006, expressed as a percentage of total net sales:
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|
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|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
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|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Textbooks
|
|
82.9
|
%
|
|
81.7
|
%
|
|
80.8
|
%
|
|
79.4
|
%
|
|
Uniforms
|
|
9.8
|
%
|
|
10.9
|
%
|
|
11.9
|
%
|
|
13.1
|
%
|
|
Solutions
|
|
0.0
|
%
|
|
0.3
|
%
|
|
0.0
|
%
|
|
0.4
|
%
|
|
Shipping
|
|
7.3
|
%
|
|
7.1
|
%
|
|
7.3
|
%
|
|
7.1
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total net sales
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses:
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|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of textbooks
|
|
55.6
|
%
|
|
55.1
|
%
|
|
53.8
|
%
|
|
53.6
|
%
|
|
Cost of uniforms
|
|
5.2
|
%
|
|
6.4
|
%
|
|
6.4
|
%
|
|
7.3
|
%
|
|
Cost of solutions
|
|
0.0
|
%
|
|
0.1
|
%
|
|
0.0
|
%
|
|
0.2
|
%
|
|
Cost of shipping
|
|
7.4
|
%
|
|
7.0
|
%
|
|
7.6
|
%
|
|
7.2
|
%
|
|
Sales and marketing
|
|
16.7
|
%
|
|
19.2
|
%
|
|
23.6
|
%
|
|
24.6
|
%
|
|
General and administrative
|
|
6.6
|
%
|
|
7.0
|
%
|
|
15.0
|
%
|
|
14.3
|
%
|
|
Amortization of acquired intangibles
|
|
0.0
|
%
|
|
0.1
|
%
|
|
0.0
|
%
|
|
0.3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
91.5
|
%
|
|
94.9
|
%
|
|
106.4
|
%
|
|
107.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
8.5
|
%
|
|
5.1
|
%
|
|
(6.4
|
)%
|
|
(7.5
|
)%
|
|
Other (expense) income, net
|
|
(0.3
|
)%
|
|
0.1
|
%
|
|
(0.4
|
)%
|
|
0.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes
|
|
8.2
|
%
|
|
5.2
|
%
|
|
(6.8
|
)%
|
|
(7.0
|
)%
|
|
Income tax expense
|
|
0.0
|
%
|
|
(38.2
|
)%
|
|
0.0
|
%
|
|
(30.3
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) income
|
|
8.2
|
%
|
|
(33.0
|
)%
|
|
(6.8
|
)%
|
|
(37.3
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Seasonality:
We experience significant seasonality in our results of operations and our peak selling period is the July/August/September back-to-school season. During fiscal 2006 and 2005, approximately 88% and 86% of our revenues, respectively, were
recognized in this period. We expect this trend to continue during 2007. While many private middle and high school institutions have an active book-buying season in December/January, the volume of purchases are typically significantly lower than the
initial back-to-school season. Historically, Campus Outfitters has experienced the same seasonality in its results of operations. Consistent with its current concentration of private elementary, middle and high schools, Campus Outfitters peak
selling season has been July/August/September back-to-school season. Part of our strategy is to extend our textbook program more deeply into the college and distance learning markets, expand our uniform model to more broadly incorporate branded
apparel and identify profitable new products or services to market to our existing customer base. This could result in more balanced revenues throughout the year. However, based upon our current program, product and school mix, we will continue to
experience significant fluctuations in quarterly operating results. Please see “
Forward-Looking Statements.
”
15
Net Sales:
Net sales decreased 17.2%, or $8.1 million, to $39.1 million, and decreased 17.4%, or $8.9 million, to $42.4 million for the three and nine-month periods ended September 30, 2007, respectively, compared to the same periods in 2006. The
decrease during the three and nine-month periods was primarily the result of a decrease in both number of schools served and sales per school for the textbook business and decrease in the number of schools served by the uniform business.
Operating Expenses:
Cost of Textbooks -
Cost of
textbooks consists of the cost of textbooks and related education materials sold to customers. Cost of textbooks decreased 16.4%, or approximately $4.3 million, to approximately $21.7 million, and decreased 17.0%, or approximately $4.7 million, to
approximately $22.8 million, for the three and nine months ended September 30, 2007, respectively, compared to the same periods in 2006. This decrease in absolute dollars was attributable to our decreased sales volume. Expressed as a percentage
of related revenue, cost of textbooks was 67.2% and 67.5% for the three months ended September 30, 2007 and 2006, respectively, and 66.6% and 67.8% for the nine months ended September 30, 2007 and 2006, respectively. The improved margins
in the three and nine months ended September 30, 2007 were the result of improvements in product sourcing and inventory management, and an increase in the sale of used textbooks in proportion to new textbooks over the prior year period.
Improved margins were partially offset by approximately $0.5 million in benefits provided by Baker and Taylor resulting from prompt payment discounts we could not fully take advantage of due to lower cash balances over the prior year period and
lower volume discounts due to lower sales as compared to the prior year periods. Cost of textbooks varies with textbook revenue and we expect these costs to increase in absolute dollars as our customer base and number of partner schools served
expands. Please see “Forward-Looking Statements.”
The following table sets forth online textbook sales for the three and nine months ended
September 30, 2007 and 2006 (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Total online unit sales:
|
|
|
|
|
|
|
|
|
|
New textbooks sold
|
|
893
|
|
1,002
|
|
941
|
|
1,047
|
|
Used textbooks sold
|
|
107
|
|
104
|
|
116
|
|
110
|
|
|
|
|
|
|
|
|
|
|
|
Total textbooks sold
|
|
1,000
|
|
1,106
|
|
1,057
|
|
1,157
|
|
|
|
|
|
|
|
|
|
|
Cost of Uniforms
- Cost of uniforms consists of the cost of uniforms and apparel sold to customers. Cost of
uniforms decreased approximately $1.0 million, or 32.9%, to approximately $2.0 million, and decreased approximately $1.0 million, or 27.8%, to approximately $2.7 million for the three and nine months ended September 30, 2007, respectively.
Expressed as a percentage of related revenue, cost of uniforms was 52.7% and 58.5% for the three months ended September 30, 2007 and 2006, respectively, and 53.4% and 55.4% for the nine months ended September 30, 2007 and 2006,
respectively.
The improved margins in the three and nine month periods ended September 30, 2007 were largely attributable to decreased sales volume
and integration issues related to the acquisition of Campus Outfitters in fiscal 2006 that did not recur in fiscal 2007. Before our acquisition of Campus Outfitters in May 2005, Campus had been privately owned and operated. In order to accommodate
the Campus acquisition, we began in fiscal 2006 upgrading virtually all aspects of its transaction processing systems, including order management, cash and credit card processing, purchasing, inventory management and shipping. While many of the
systems were upgraded in time, we did experience delays in fiscal 2006 in the release of our new order management and inventory management software systems, which contributed to operational difficulties and caused increased cost of uniforms during
our quarter ended September 30, 2006. These difficulties were largely overcome for fiscal 2007, contributing to a reduced cost of uniforms and apparel sold to customers in 2007.
Cost of uniforms varies with uniform revenue and we expect these costs to increase in absolute dollars as our customer base expands. Please see “Forward-Looking Statements.”
Cost of Shipping.
Cost of shipping consists of outbound shipping to our customers. Cost of shipping decreased $0.4 million, or 12.3%, to $2.9 million, and
decreased approximately $0.4 million, or 12.0%, to approximately $3.2 million for the three and nine months ended September 30, 2007, respectively. Expressed as a percentage of related revenue, cost of shipping was 101.1% and 98.5% for the
three months ended September 30, 2007 and 2006, respectively, and 103.7% and 100.4% for the nine months ended September 30, 2007 and 2006, respectively. This cost decrease was largely attributable to decreased sales volume.
16
Sales and Marketing:
Sales and marketing expense consists primarily of promotional expenditures, credit card processing fees, travel expense, expenses associated with contracting with our textbook partner schools, expenses associated with our Campus Outfitters
retail locations and road shows, seasonal overhead associated with performing inventory purchases at textbook programs schools, and payroll and related expenses for personnel engaged in sales and marketing, account management, and our textbook,
uniform and solutions operations. Sales and marketing expense decreased approximately $2.5 million, or 28.1%, to approximately $6.5 million, and decreased approximately $2.6 million or 20.5%, to approximately $10 million for the three and nine
months ended September 30, 2007, respectively.
The following table sets forth sales and marketing expense for the three and nine months ended
September 30, 2007 and 2006 (in thousands):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
September 30,
|
|
|
Nine months ended
September 30,
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
|
Variable sales and marketing expense
|
|
$
|
4,303
|
|
|
$
|
5,296
|
|
|
$
|
4,692
|
|
|
$
|
5,738
|
|
|
Percentage of total revenue
|
|
|
11.0
|
%
|
|
|
11.2
|
%
|
|
|
11.1
|
%
|
|
|
11.2
|
%
|
|
Other sales and marketing expense
|
|
$
|
2,212
|
|
|
$
|
3,768
|
|
|
$
|
5,343
|
|
|
$
|
6,879
|
|
|
Percentage of total revenue
|
|
|
5.7
|
%
|
|
|
8.0
|
%
|
|
|
12.6
|
%
|
|
|
13.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing expense, as reported
|
|
$
|
6,515
|
|
|
$
|
9,064
|
|
|
$
|
10,035
|
|
|
$
|
12,617
|
|
|
Percentage of total revenue
|
|
|
16.7
|
%
|
|
|
19.2
|
%
|
|
|
23.7
|
%
|
|
|
24.7
|
%
|
Variable sales and marketing expense consists of credit card expenses, certain expenses associated with
contracting with our textbook and apparel program schools, and sales expenses associated with our agreement with B&T. Variable sales and marketing expense decreased by approximately $1.0 million and $1.1 million, respectively, for the three and
nine months ended September 30, 2007 due to the decreased sales volume discussed earlier. We expect that variable sales and marketing expense will increase during our peak selling period in each July/August/September back-to-school season.
Please see “Forward-Looking Statements.”
Other sales and marketing expense consists of primarily payroll and related expenses for personnel
engaged in sales and marketing, account management, textbook, uniform and solutions operations, travel expense, expenses associated with our Campus Outfitters retail locations and road shows and seasonal overhead associated with performing inventory
purchases at textbook program schools. Other sales and marketing expense decreased 39.3%, or approximately $1.5 million, to approximately $2.3 million, and decreased 21.2%, or approximately $1.5 million, to approximately $5.4 million for the three
and nine months ended September 30, 2007, respectively. The decrease in the three and nine months ended September 30, 2007 was largely attributable to the termination or suspension of all non-textbook / uniforms / school supply service
offerings in our fourth quarter of fiscal 2006. Please see “Forward-Looking Statements.”
General and Administrative:
General and administrative expense consists of payroll and related expenses for executive, administrative, and our development and systems personnel, facilities
expenses, costs associated with our agreement with SchoolOne which is developing our new technology and providing services and support for our processes and systems, costs associated with the upgrade and maintenance of our website, outside
consultant and professional services expenses, travel, and other general corporate expenses. General and administrative expense, reported net of $0.2 million and $0.3 million of costs capitalized for software developed or purchased for internal use
during the three months ended September 30, 2007 and 2006, respectively, decreased 20.7% or approximately $0.7 million, to approximately $2.6 million. General and administrative expense, reported net of $0.7 million and $1.4 million of costs
capitalized for software developed or purchased for internal use during the nine months ended September 30, 2007 and 2006, respectively, decreased 14.4% or approximately $1.0 million, to approximately $6.4 million for the nine months ended
September 30, 2007. These decreases were primarily attributable to the termination or suspension of all non-textbook / uniforms / school supply service offerings in our fourth quarter of fiscal 2006. Included in the three and nine month periods
ended September 30, 2007 were approximately $0.3 million of lease expense related to the sublease of our space in our former headquarters in Washington, D.C., and estimated lease termination expenses of our space in Akron, OH. Please see
“Forward-Looking Statements.”
17
We are capitalizing development costs in accordance with American Institute of Certified Public Accountants
(“AICPA”) Statement of Position No. 98-1 (“SOP 98-1”), “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Please see “Forward-Looking Statements.”
Amortization of Acquired Intangibles
Our
acquisitions of Campus Outfitters in May 2005 and IQ Digital in May 2006 were accounted for under the purchase method of accounting. As a result, we recorded intangible assets at their applicable fair values of the net tangible assets acquired.
Intangible assets are amortized over periods ranging from one to ten years. Amortization of acquired intangibles was approximately $66,000 and $163,000 during the three and nine months ended September 30, 2006. During our fourth quarter 2006,
we recorded impairment charges against all of our acquired intangibles except for the IQ Digital trademark. As a result, future amortization for acquired intangibles is immaterial. Please see “Forward-Looking Statements.”
Other (expense) income, net
Other (expense) income, net
consists primarily of interest income on our cash and cash equivalents and investments, and interest expense related to our outstanding margin loan and line of credit. Other expense was approximately $(85,000) and $(0.2) million for the three and
nine months ended September 30, 2007, respectively, compared to other income of $40,000 and $0.3 million for the three and nine months ended September 30, 2006, respectively. The decrease was due to lower average invested cash and
increasing borrowings under the revolving line of credit during the three and nine months ended September 30, 2007 as compared to the prior year periods and a recognized loss of approximately $41,000 during the nine months ended
September 30, 2007 due to the sale of a long-term security before its maturity date.
Income Taxes
During the three months and nine months ended September 30, 2006, the Company recorded income tax benefits of $18.0 million and $15.6 million, respectively. In the
third quarter of 2006, we determined that deferred tax assets would not be realized and we ceased recording income tax benefits. For the three months and nine months ended September 30, 2007, all income tax benefits were fully reserved.
In July 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income taxes by prescribing the minimum recognition threshold
a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting for interim periods and disclosures for
uncertain tax positions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company’s adoption of FIN 48 on January 1, 2007, did not result in the recording of any previously unrecognized tax positions
and did not have an effect on its financial position or results of operations.
The Company files a U.S. federal income tax return and returns in various
state jurisdictions. The Company is subject to U.S. federal tax and state tax examinations for the tax years 2003 to 2006. The Company is subject to certain state tax examinations for the tax years 2002 to 2006 for those states with longer
statutes of limitation than the Federal three-year statute. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months.
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax positions as a component of income tax expense. As of the date of
adoption of FIN 48, the Company did not have any accrued interest or penalties associated with any unrecognized tax positions, and there was no related interest or penalties recognized during the three months and nine months ended
September 30, 2007.
Liquidity and Capital Resources
As of September 30, 2007, we had approximately $2.1 million of cash, cash equivalents, and restricted cash and our net working capital was approximately $8.2 million compared to approximately $2.6 million of cash, cash equivalents and
short-term investments and net working capital of approximately $6.5 million at December 31, 2006. As of September 30, 2007, we did not have any cash invested in long-term investments compared to approximately $3.9 million at
December 31, 2006. The decrease in cash, cash equivalents, restricted cash and short-term investments during the nine months ended September 30, 2007 was primarily attributable to cash payments for our school partner incentive accruals,
used textbooks we acquired during our fiscal 2007 buyback campaign and cash used to fund operating losses. This decrease was partially offset by the collection of certain receivables due from B&T.
As of September 30, 2007, our principal commitments consisted of borrowings under our line of credit agreement with Bank of America, obligations outstanding under
operating leases, our service agreement with SchoolOne, and accounts payable. Beginning in the second quarter of 2006, we moved aggressively to launch service offerings outside our core book and uniform offerings. Significant costs and cash
expenditures were incurred in this effort. In November 2006, due to the financial impact of cost increases together with limited new revenue generation from non-book/uniform service offerings, efforts to launch service
18
offerings outside the book and uniform areas were terminated or suspended. Significant cost reductions have been implemented, and our current strategy
includes only the book, uniform and school supplies businesses. As a result, we anticipate a reduction in cash used in fiscal 2007. However, the seasonal nature of our business requires that we manage our liquidity carefully in advance of the fall
selling season. Please see “Forward-Looking Statements.”
Net cash used in operating activities was approximately $2.2 million for the nine
months ended September 30, 2007 compared to net cash used in operating activities of approximately $1.3 million for the nine months ended September 30, 2006. The change was primarily due to an increase in payments made against accounts
payable and accrued expenses, and a smaller decrease in other current assets related to year-end rebates received from B&T compared to the prior year period. This was partially offset by a decrease in cash expended for inventory and a decreased
net loss in the nine months ended September 30, 2007.
Investing activities consist of acquisitions of businesses, capitalization of software
developed for internal use, purchases of property, plant and equipment, purchases of software, purchases and sales of short-term and long-term investments and restricted cash, and proceeds from sales of property plant and equipment. Net cash
provided by investing activities was approximately $3.7 million for the nine months ended September 30, 2007 compared to net cash used in investing activities of approximately $0.4 million for the nine months ended September 30, 2006.
During the nine months ended September 30, 2007 we had sales of short-term and long-term investments of approximately $6.4 million, which we used to payoff our margin loan outstanding as of December 31, 2006, and to purchase a restricted
cash investment with BOA to use as collateral against our line of credit, compared to net sales of short-term and long-term investments of $3.4 million during the comparable reporting period. Total purchases of property, equipment and software,
including capitalization of software, was approximately $0.7 million during the nine months ended September 30, 2007, a decrease of approximately $1.8 million over the comparable period in 2006. During fiscal 2006, we made significant
investments in our people, processes and systems to accelerate the growth of our business, including approximately $1.3 million for payments of acquisitions during the nine months ended September 30, 2006. As a result, we expect our total
fiscal 2007 expenditures for property, equipment and software, including capitalization of software, to be significantly lower in fiscal 2007. Also during the nine months ended September 30, 2007, we received cash proceeds of approximately $0.1
million resulting from sales of fixed assets no longer in service due to the closure of our iQ Digital Studios office in Akron, Ohio.
Net cash used in
financing activities was approximately $1.9 million for the nine months ended September 30, 2007 compared to net cash provided by financing activities of approximately $0.7 for the nine months ended September 30, 2006. During the nine
months ended September 30, 2007, we made a full payment of approximately $4.2 million against our margin loan outstanding as of December 31, 2006. This was offset by actual cash borrowings of approximately $1.5 million under our line of
credit agreement with Bank of America as well as prospective cash borrowings of approximately $0.6 million to cover outstanding checks at September 30, 2007.
The following table provides an overview or our aggregate contractual obligations as of September 30, 2007, and the effect these obligations are expected to have on our liquidity and cash flows for the remainder of fiscal 2007 and in
future periods are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Obligations
|
|
2007
|
|
|
2008
|
|
|
2009
|
|
|
2010
|
|
|
2011
|
|
Thereafter
|
|
Total
|
|
|
Capital lease obligations & other
|
|
$
|
4
|
|
|
$
|
10
|
|
|
$
|
8
|
|
|
$
|
8
|
|
|
$
|
8
|
|
$
|
—
|
|
$
|
38
|
|
|
Line of credit obligations
|
|
|
—
|
|
|
|
1,585
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
1,585
|
|
|
SchoolOne (1)
|
|
|
532
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
—
|
|
|
532
|
|
|
Operating lease obligations (2)
|
|
|
775
|
|
|
|
1,370
|
|
|
|
1,213
|
|
|
|
802
|
|
|
|
398
|
|
|
738
|
|
|
5,296
|
|
|
Sub lease income (3)
|
|
|
(86
|
)
|
|
|
(585
|
)
|
|
|
(621
|
)
|
|
|
(319
|
)
|
|
|
—
|
|
|
—
|
|
|
(1,611
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,225
|
|
|
$
|
2,380
|
|
|
$
|
600
|
|
|
$
|
491
|
|
|
$
|
406
|
|
$
|
738
|
|
$
|
5,840
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Second amended agreement signed in August 2007 for services from July 2007 through December 2007.
|
|
(2)
|
As of the date of this filing we currently lease approximately 92,000 square feet pursuant to leases that are month-to-month or are schedule to expire between October 2007 and May
2015. We are currently trying to sublease our space in Akron, OH (former headquarters of iQ Digital) and in Ft. Lauderdale, Fl. Remaining contractual obligations for these spaces as of September 30, 2007 are approximately $0.3 million through
April 2011 and $0.6 million through December 2011, respectively.
|
|
(3)
|
Sub lease income to be received from our former headquarters space in Washington, D.C.
|
Our business is presently highly seasonal, with the vast bulk of our revenues from the sale of books and apparel being earned during the back to school season in the third quarter of each year. In addition, beginning
in the second quarter of 2006, we moved aggressively to launch service offerings outside our core book and uniform offerings. We experienced significant cash expenditures in this effort. In November 2006, due to the financial impact of cost
increases and cash expenditures together with
19
limited new revenue generation from non-book/uniform service offerings, efforts to launch service offerings outside the book and uniform areas were
terminated or suspended. Significant cost reductions have been implemented, and our current strategy includes only the book and uniform businesses, however, as a result of this, our net cash and investments position was approximately $9.8 million
lower as of December 31, 2006 compared to December 31, 2005. In March 2007, we entered into a Revolving Line of Credit Loan Agreement and Security Agreement with Bank of America, N.A. (“BOA”) in which BOA will lend up to a
maximum amount of $5 million to assist in funding the Company’s seasonal cash requirements. The Company may also issue letters of credit under the facility. Borrowing ceiling levels are established monthly utilizing a borrowing base formula
based on percentages of month-end inventory, receivable and investment collateral values. A $2 million restricted cash investment is required to be maintained at all times as the investment collateral portion of the borrowing base. The facility is
secured by substantially all of our assets. The agreement terminates on April 30, 2008.
We presently believe that our cash, cash equivalents and
investments may not be sufficient to fund our operating needs until the 2008 back to school season. We are in discussions with BOA regarding expansion of and other changes to the credit facility, considering additional spending reductions
and considering additional external financings to meet our liquidity needs. In order to meet out liquidity needs we will need to obtain capital from one of these sources. Please see “Forward-Looking Statements.”