UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
x
|
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended September 27, 2008
OR
¨
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from
to
Commission File Number:
000-50807
DESIGN WITHIN REACH, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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94-3314374
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(State or other jurisdiction of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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225 Bush Street, 20
th
Floor, San Francisco, CA
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94104
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(Address of principal executive offices)
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(Zip Code)
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(415) 676-6500
(Registrants telephone number, including area code)
Indicate by check mark whether the
registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
x
Yes
¨
No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. (See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act) (Check one).
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Large accelerated filer
¨
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Accelerated filer
x
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Non-accelerated filer
¨
(do not check if smaller reporting company)
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Smaller reporting company
¨
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
¨
Yes
x
No.
The number of outstanding shares of the registrants common stock, par value $0.001 per share, as of October 30, 2008 was 14,470,831.
DESIGN WITHIN REACH, INC.
FORM 10-Q QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER
27, 2008
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1.
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Financial Statements
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Design Within Reach, Inc.
Condensed Balance Sheets
(Unaudited)
(amounts in thousands,
except per share data)
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September 27,
2008
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December 29,
2007
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September 29,
2007
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ASSETS
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Current assets
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Cash and cash equivalents
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$
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5,147
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$
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5,651
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$
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5,558
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Inventory
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39,431
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37,820
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44,224
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Accounts receivable (less allowance for doubtful accounts of $172, $264 and $244, respectively)
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2,733
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1,176
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2,851
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Prepaid catalog costs
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2,196
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2,101
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1,111
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Deferred income taxes
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1,251
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1,251
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2,078
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Other current assets
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1,813
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1,986
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2,085
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Total current assets
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52,571
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49,985
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57,907
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Property and equipment, net
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24,595
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23,302
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23,633
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Deferred income taxes, net
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8,182
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8,182
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8,083
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Other non-current assets
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959
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955
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992
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Total assets
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$
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86,307
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$
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82,424
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$
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90,615
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LIABILITIES AND STOCKHOLDERS EQUITY
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Current liabilities
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Accounts payable
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$
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16,034
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$
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14,442
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$
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12,518
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Accrued expenses
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4,976
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4,500
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5,008
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Accrued compensation
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2,151
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2,765
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2,089
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Deferred revenue
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1,905
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325
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3,171
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Customer deposits and other liabilities
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3,183
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3,397
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2,675
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Borrowings under loan agreement
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6,879
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11,200
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Long-term debt, current portion
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305
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346
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323
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Total current liabilities
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35,433
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25,775
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36,984
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Deferred rent and lease incentives
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6,072
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5,976
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5,795
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Long-term debt, net of current portion
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82
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321
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320
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Total liabilities
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41,587
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32,072
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43,099
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Commitments and Contingencies
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Stockholders equity
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Preferred stock $0.001 par value; 10,000 shares authorized; no shares issued and outstanding
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Common stock $0.001 par value; authorized 30,000 shares; issued and outstanding, 14,471, 14,455 and 14,442 shares
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14
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14
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14
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Additional paid-in capital
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60,231
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59,146
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58,595
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Accumulated other comprehensive income (loss)
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(225
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)
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73
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58
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Accumulated deficit
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(15,300
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)
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(8,881
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)
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(11,151
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)
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Total stockholders equity
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44,720
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50,352
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47,516
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Total liabilities and stockholders equity
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$
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86,307
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$
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82,424
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$
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90,615
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The accompanying notes are an integral part of these condensed financial statements.
1
Design Within Reach, Inc.
Condensed Statements of Operations
(Unaudited)
(amounts in thousands, except per share data)
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Thirteen weeks ended
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Thirty-nine weeks ended
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September 27,
2008
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September 29,
2007
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September 27,
2008
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September 29,
2007
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Net sales
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$
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42,316
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$
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49,026
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$
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136,490
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$
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141,942
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Cost of sales
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24,989
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27,221
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75,052
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80,074
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Gross margin
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17,327
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21,805
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61,438
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61,868
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Selling, general and administrative expenses
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21,843
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21,301
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67,908
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65,783
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Income (loss) from operations
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(4,516
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)
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504
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(6,470
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)
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(3,915
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)
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Interest income
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40
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|
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|
90
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|
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137
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285
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Interest expense
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(84
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)
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(286
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)
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(202
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)
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(481
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)
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Other income, net
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159
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2,021
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116
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2,060
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Income (loss) before income taxes
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(4,401
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)
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2,329
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(6,419
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)
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(2,051
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)
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Income tax expense (benefit)
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1,237
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(104
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)
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(104
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)
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Net income (loss)
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$
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(5,638
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)
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$
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2,433
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$
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(6,419
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)
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$
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(1,947
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)
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Net income (loss) per share:
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|
|
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Basic
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$
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(0.39
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)
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$
|
0.17
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$
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(0.44
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)
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$
|
(0.13
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)
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Diluted
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$
|
(0.39
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)
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|
$
|
0.17
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$
|
(0.44
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)
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|
$
|
(0.13
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)
|
Weighted average shares used in calculation of net income (loss) per share:
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Basic
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14,471
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14,433
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14,462
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14,424
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Diluted
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14,471
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14,567
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14,462
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14,424
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The accompanying notes are an integral part of these condensed financial statements.
2
Design Within Reach, Inc.
Condensed Statements of Cash Flows
(Unaudited)
(amounts in thousands)
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Thirty-nine weeks ended
|
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September 27, 2008
|
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September 29, 2007
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
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|
Net loss
|
|
$
|
(6,419
|
)
|
|
$
|
(1,947
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
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|
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|
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|
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Depreciation and amortization
|
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|
4,612
|
|
|
|
5,515
|
|
Stock-based compensation
|
|
|
1,052
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|
|
|
1,714
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Impairment of leasehold improvements
|
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94
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|
|
|
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Loss on the sale/disposal of long-lived assets
|
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|
|
|
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48
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|
Provision for doubtful accounts
|
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|
(92
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)
|
|
|
(140
|
)
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
Inventory
|
|
|
(1,611
|
)
|
|
|
(10,375
|
)
|
Accounts receivable
|
|
|
(1,465
|
)
|
|
|
(197
|
)
|
Prepaid catalog costs
|
|
|
(95
|
)
|
|
|
(65
|
)
|
Other assets
|
|
|
68
|
|
|
|
278
|
|
Accounts payable
|
|
|
429
|
|
|
|
(4,512
|
)
|
Accrued expenses
|
|
|
182
|
|
|
|
275
|
|
Accrued compensation
|
|
|
(614
|
)
|
|
|
(356
|
)
|
Deferred revenue
|
|
|
1,580
|
|
|
|
1,588
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|
Customer deposits and other liabilities
|
|
|
(439
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)
|
|
|
333
|
|
Deferred rent and lease incentives
|
|
|
96
|
|
|
|
215
|
|
|
|
|
|
|
|
|
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|
Net cash used in operating activities
|
|
|
(2,622
|
)
|
|
|
(7,626
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)
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|
|
|
|
|
|
|
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Cash flows from investing activities:
|
|
|
|
|
|
|
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Purchase of property and equipment
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|
(4,514
|
)
|
|
|
(4,381
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)
|
|
|
|
|
|
|
|
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Net cash used in investing activities
|
|
|
(4,514
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)
|
|
|
(4,381
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)
|
|
|
|
|
|
|
|
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Cash flows from financing activities:
|
|
|
|
|
|
|
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Proceeds from issuance of common stock, net of expenses
|
|
|
33
|
|
|
|
32
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|
Net borrowings under loan agreement
|
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|
6,879
|
|
|
|
11,200
|
|
Repayments of long-term obligations
|
|
|
(280
|
)
|
|
|
(462
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
6,632
|
|
|
|
10,770
|
|
|
|
|
|
|
|
|
|
|
Net decrease in cash and cash equivalents
|
|
|
(504
|
)
|
|
|
(1,237
|
)
|
Cash and cash equivalents at beginning of period
|
|
|
5,651
|
|
|
|
6,795
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of the period
|
|
$
|
5,147
|
|
|
$
|
5,558
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
Cash paid during the period for:
|
|
|
|
|
|
|
|
|
Income taxes paid, net of refunds
|
|
$
|
296
|
|
|
$
|
58
|
|
Interest paid
|
|
$
|
210
|
|
|
$
|
413
|
|
Non-cash investing and financing activities:
|
|
|
|
|
|
|
|
|
Gain (Loss) on fair value of derivatives
|
|
$
|
(137
|
)
|
|
$
|
57
|
|
The accompanying notes are an integral part of these condensed financial statements.
3
Design Within Reach, Inc.
Notes to the Condensed Financial Statements
(Unaudited)
Note 1 Summary of Significant Accounting Policies
Design Within Reach, Inc. (the Company) was incorporated in California in November 1998 and reincorporated in Delaware in March 2004. The
Company is an integrated retailer of distinctive modern design products. The Company markets and sells its products to both residential and commercial customers through three integrated sales points consisting of studios, website and phone. The
Company sells its products directly to customers principally throughout the United States. The Company opened its first international studio in Canada in the first quarter 2008.
The Company operates on a 52- or 53-week fiscal year, which ends on the Saturday closest to December 31. Each fiscal year consists of four 13-week
quarters, with an extra week added onto the fourth quarter every four to six years. The Companys 2007 fiscal year ended on December 29, 2007 and the 2008 fiscal year will end on January 3, 2009. Fiscal year 2007 consisted of 52 weeks
and fiscal year 2008 consists of 53 weeks.
Quarterly information (unaudited)
The accompanying unaudited interim condensed financial statements as of and for the thirteen weeks and thirty-nine weeks ended September 27, 2008
and September 29, 2007 have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission regarding interim financial reporting. The accompanying balance sheet as of December 29, 2007 was
derived from audited statements within the Companys Annual Report on Form 10-K for the year ended December 29, 2007. Accordingly, the accompanying unaudited interim financial statements do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of America (U.S. GAAP) for complete financial statements and should be read in conjunction with the audited financial statements and related notes thereto included
in the Companys Annual Report on Form 10-K for the year ended December 29, 2007. The accompanying unaudited interim financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of
results for the interim periods presented. The results of operations for the thirteen weeks and thirty-nine weeks ended September 27, 2008 and September 29, 2007 are not necessarily indicative of the results to be expected for any future
period or the full fiscal year.
Segment Reporting
The Companys business is conducted in a single operating segment. The Companys chief operating decision maker is the Chief Executive Officer who reviews a single set of financial data that encompasses the
Companys entire operations for purposes of making operating decisions and assessing performance.
4
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
Revenue Recognition
Significant management judgments and estimates must be made and used in connection with determining net sales recognized in any accounting period. The Company recognizes revenue on the date on which it estimates that
the product has been received by the customer and retains title to items and bears the risk of loss of shipments until delivery from its warehouse. The Company recognizes shipping and handling fees charged to customers in net sales at the time
products are estimated to have been received by customers. The Company takes title to items drop shipped by vendors at the time of shipment and bears the risk of loss until delivery to customers. The Company uses third-party freight carrier
information to estimate standard delivery times to various locations throughout the United States and Canada. The Company records as deferred revenue the dollar amount of all shipments for a particular day, if based upon the Companys estimated
delivery time, such shipments, on average, are expected to be delivered after the end of the reporting period. As of September 27, 2008, December 29, 2007 and September 29, 2007, deferred revenue was $1,905,000, $325,000 and
$3,171,000, respectively, and related deferred cost of sales was $986,000, $173,000 and $1,617,000, respectively.
Sales are recorded net
of expected product returns by customers. The Company analyzes historical returns, current economic trends and changes in customer demand and acceptance of products when evaluating the adequacy of the sales returns and other allowances in any
accounting period. The returns allowance is recorded as a reduction to net sales for the estimated retail value of the projected product returns and as a reduction in cost of sales for the corresponding cost amount, less any reserve for estimated
scrap. The reserves for estimated product returns were $538,000, $654,000 and $655,000 as of September 27, 2008, December 29, 2007 and September 29, 2007, respectively.
Various governmental authorities directly impose taxes on sales including sales, use, value added and some excise taxes. The Company excludes such taxes
from net sales. The Company accounts for gift cards by recognizing a liability at the time a gift card is sold and recognizing revenue at the time the gift card is redeemed for merchandise.
Advertising Costs
Direct response catalog costs
consist of third-party costs, including paper, printing, postage, name acquisition and mailing costs. Such costs are capitalized as prepaid catalog costs and are amortized over their expected period of future benefit. Such amortization is based upon
weighted-average historical revenues attributed to previously issued catalogs. Based on historical data, the Company estimates that catalogs have a period of expected future benefit of approximately four months. Prepaid catalog costs were
$2,196,000, $2,101,000 and $1,111,000, as of September 27, 2008, December 29, 2007 and September 29, 2007, respectively.
Consideration received from the Companys vendors for co-operative advertising is accounted for as a reduction of selling, general and administrative expenses. Co-operative advertising amounts received from such vendors were $197,000
and $149,000 in the thirteen weeks ended September 27, 2008 and September 29, 2007, respectively, and $657,000 and $538,000 in the thirty-nine weeks ended September 27, 2008 and September 29, 2007, respectively. Apart from
amounts received from vendors for co-operative advertising, the Company does not typically receive allowances or credits from vendors. In the case of a few select vendors, the Company receives a small discount of approximately 2% for prompt payment
of invoices. These discounts were recorded as a reduction of cost of sales of $63,000 and $49,000 in the thirteen weeks ended September 27, 2008 and September 29, 2007, respectively, and $215,000 and $135,000 in the thirty-nine weeks ended
September 27, 2008 and September 29, 2007, respectively.
5
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
Inventory
Inventory consists of finished goods purchased from third-party manufacturers and estimated inbound freight costs. Inventory on hand is carried at an average cost at the lower of cost or market. The Company writes
down inventory below cost to the estimated market value when necessary, based upon assumptions about future demand and market conditions. As of September 27, 2008, December 29, 2007 and September 29, 2007, inventories were
$39,431,000, $37,820,000 and $44,224,000, respectively, net of write-downs of $1,818,000, $2,166,000 and $3,628,000, respectively.
Total
inventory includes inventory-in-transit that consists of finished goods purchased from third-party manufacturers that are in-transit from the vendor to the Company when terms are FOB shipping point and estimated inbound freight costs.
Inventory-in-transit also includes those goods that are in-transit from the Company to its customers. Inventory-in-transit is carried at cost. Inventory-in-transit was $5,258,000, $5,306,000 and $3,921,000, as of September 27, 2008,
December 29, 2007 and September 29, 2007, respectively.
Income Taxes
Income taxes are computed using the asset and liability method under FAS No. 109,
Accounting for Income Taxes
(FAS
109). Deferred income tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the currently enacted tax rates and laws currently in
effect. The Company estimates a valuation allowance on its deferred tax assets if it is more likely than not that they will not be realized.
Net Loss
per Share
Basic loss per share is calculated by dividing the Companys net loss available to the Companys common
stockholders for the period by the number of weighted average common shares outstanding for the period. Options to purchase 2,248,000 and 2,032,000 shares of common stock that were outstanding as of September 27, 2008 and September 29,
2007, respectively, have been excluded from the calculation of diluted loss per share because inclusion of such shares would be anti-dilutive.
Comprehensive Income (Loss)
The following table presents comprehensive income (loss) for the thirteen weeks and
thirty-nine weeks ended September 27, 2008 and September 29, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen weeks ended
|
|
Thirty-nine weeks ended
|
|
(amounts in thousands)
|
|
September 27,
2008
|
|
|
September 29,
2007
|
|
September 27,
2008
|
|
|
September 29,
2007
|
|
Net income (loss)
|
|
$
|
(5,638
|
)
|
|
$
|
2,433
|
|
$
|
(6,419
|
)
|
|
$
|
(1,947
|
)
|
Other comprehensive income (loss)
Net income (loss) on foreign currency cash flow hedges
|
|
|
(287
|
)
|
|
|
80
|
|
|
(298
|
)
|
|
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss)
|
|
$
|
(5,925
|
)
|
|
$
|
2,513
|
|
$
|
(6,717
|
)
|
|
|
(1,889
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
Derivative and Hedging Activities
The Company applies FAS No. 133,
Accounting for Derivative Instruments and Hedging Activities
, as amended and interpreted, for
derivative instruments and requires that all derivatives be recorded at fair value on its balance sheet, including embedded derivatives.
The Companys operations are exposed to global market risks, including the effect of changes in foreign currency exchange rates. To mitigate its foreign currency exchange rate risk, the Company purchases foreign currency contracts to
pay for merchandise purchases based on forecasted demand. The objective of the Companys foreign exchange risk management program is to manage the financial and operational exposure arising from these risks by offsetting gains and losses on the
underlying exposures with gains and losses on currency contract derivatives used to hedge those exposures. The Company maintains comprehensive hedge documentation that defines the hedging objectives, practices, procedures and accounting treatment.
The Companys hedging program and derivative positions and strategy are reviewed on a regular basis by management.
The Company
records derivatives related to cash flow hedges for foreign currency at fair value on its balance sheet, including embedded derivatives. The Company implemented a new hedging strategy in the first quarter 2007 to mitigate the impact of foreign
currency fluctuations on inventory purchases. Foreign currency contracts entered into during January 2007 through April 2007 were not designated as cash flow hedge contracts. The Company accounted for non-hedge foreign currency contracts on a
monthly basis by recognizing the net cash settlement gain or loss in other income, net and adjusting the carrying amount of open contracts to fair value by recognizing any corresponding gain or loss in other income, net. In the second quarter 2007,
the Company developed policies and procedures that met the criteria for cash flow hedge accounting. Foreign currency contracts entered into from May 2007 through September 2008 were designated as cash flow hedge contracts and were accounted for on a
monthly basis by adjusting the carrying amount of open designated contracts to fair value by recognizing any corresponding gain or loss in other comprehensive income (loss) and recognizing the net cash settlement gain or loss in other comprehensive
income (loss). Subsequently, these net cash settlement gains or losses are being recognized in cost of sales as the underlying hedged inventory is sold in each reporting period. In the condensed statements of cash flows, net cash settlement gain or
loss is included in operating cash flows as changes in other assets, or as customer deposits and other liabilities.
Management evaluates
hedges for effectiveness, and for derivatives that are deemed ineffective, the ineffective portion is reported through earnings. The fair market value of the hedged exposure is presumed to be the market value of the hedge instrument when critical
terms match. The Company did not record any amounts for ineffectiveness in the thirty-nine weeks ended September 27, 2008 and September 29, 2007.
7
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
Derivatives used to manage financial exposures for foreign exchange risks generally mature within one
year and contracts held by the Company as of September 27, 2008 mature from October 2008 to January 2009. Open hedge contracts were revalued to their fair value resulting in $86,000 in customer deposits and other liabilities as of
September 27, 2008, and $51,000 and $63,000 in other current assets as of December 29, 2007 and September 29, 2007, respectively. Approximately $139,000 in accumulated other comprehensive loss is expected to be recognized in cost of
sales during the fourth quarter 2008. The following table presents designated hedge contract activity for the thirteen weeks and thirty-nine weeks ended September 27, 2008 and September 29, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen weeks ended
|
|
Thirty-nine weeks ended
|
|
(amounts in thousands)
|
|
September 27,
2008
|
|
|
September 29,
2007
|
|
September 27,
2008
|
|
|
September 29,
2007
|
|
Increase (decrease) in carrying amount to fair value of open designated hedge contracts
|
|
$
|
(122
|
)
|
|
$
|
70
|
|
$
|
(137
|
)
|
|
$
|
57
|
|
Amount of gain (loss) recognized in other comprehensive income (loss) upon settlement of designated hedge contracts
|
|
|
(201
|
)
|
|
|
9
|
|
|
131
|
|
|
|
(8
|
)
|
Amount of (gain) loss reclassified from accumulated other comprehensive income (loss) into cost of sales
|
|
|
36
|
|
|
|
1
|
|
|
(292
|
)
|
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss)
Net income (loss) on foreign currency cash flow hedges
|
|
$
|
(287
|
)
|
|
$
|
80
|
|
$
|
(298
|
)
|
|
$
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management of the Company to make estimates and assumptions affecting the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting period. The Companys significant accounting estimates include estimates of dates on which products have been
received by customers used in determining when to recognize revenue, estimates of market value used in calculating inventory reserves to reflect inventory carried at a lower of cost or market, estimates of uncollectible accounts receivable,
estimates of fair value used in calculating the value of stock-based compensation, estimates of expected future cash flows and useful lives used in the review for impairment of long-lived assets, estimates of the Companys ability to realize
its deferred tax assets which are also used to establish whether valuation allowances are needed on those assets, estimates of projected net taxable income and deductible expenses used to calculate the income tax benefit for interim financial
reporting periods, estimates of freight costs used to calculate accrued liabilities, estimates of returns used to calculate sales returns reserves, estimates for determining inventory-in-transit, estimates for the amortization of prepaid catalog
costs, estimates for calculating certain accrued liabilities and estimates related to the recognition of hedging gains and losses in cost of sales. Actual results could differ from those estimates and such differences could affect the results of
operations reported in future periods.
8
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 157,
Fair Value Measurements
(FAS 157). This statement clarifies the definition of fair value and the methods used to measure fair value, and requires expanded financial statement disclosures about fair value measurements for assets and liabilities. The Company
adopted provisions of FAS 157 on December 30, 2007, the first day of the Companys fiscal year 2008, related to financial assets and liabilities, and other assets and liabilities carried at fair value on a recurring basis. The
adoption of FAS 157 did not have a material effect on the Companys financial condition or results of operations. The provisions of FAS 157 related to other nonfinancial assets and liabilities will be effective for the Company on
January 4, 2009, the first day of the Companys fiscal year 2009. The Company is currently evaluating the impact that these additional FAS 157 provisions will have on the Companys financial statements. See Note 4.
In February 2007, the FASB issued Statement No. 159,
The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an
Amendment of FASB Statement No. 115
(FAS 159). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in FAS 159 are elective; however,
the amendment to FAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities
, applies to all entities with available-for-sale and trading securities. The fair value option established by FAS 159 permits all entities to
choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the
business entity does not report earnings) at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method;
(b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. FAS 159 is effective at the beginning of the first fiscal year beginning after November 15,
2007. The Company has decided not to adopt FAS 159.
In December 2007, the FASB issued Statement No. 141 (revised 2007),
Business
Combinations
(FAS 141(R)), which replaces FAS No. 141,
Business Combinations
. FAS 141(R) retains the underlying concepts of FAS 141 in that all business combinations are still required to be accounted for at fair value
under the acquisition method of accounting, but FAS 141(R) changed the method of applying the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at
fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be
expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. FAS 141(R) is effective on a prospective basis for
all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008. The Company is currently evaluating this new statement and anticipates that this statement will
not have a significant impact on the reporting of its results of operations.
9
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
In December 2007, the FASB issued Statement No. 160,
Noncontrolling Interests in Consolidated
Financial Statementsan amendment of ARB No. 51
. This statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. This statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated financial statements and that this minority interest be recorded separate from the parents equity. The amount of net income attributable to the noncontrolling interest
will be included in consolidated net income on the face of the income statement. The Company is currently evaluating this new statement and anticipates that this statement will not have a significant impact on the reporting of its results of
operations.
In March 2008, the FASB issued Statement No. 161,
Disclosures about Derivative Instruments and Hedging Activities
(FAS 161), which changes the disclosure requirements for derivative instruments and hedging activities. FAS 161 is intended to enhance the current disclosure framework in FAS 133,
Accounting for Derivative Instruments and Hedging
Activities
. FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating this new statement and as FAS 161 relates specifically to
disclosures, this standard will have no impact on the Companys financial condition or results of operations.
In April 2008, the FASB
issued FAS Staff Position FAS 142-3,
Determination of the Useful Life of Intangible Assets
(FSP FAS 142-3) which amends the list of factors an entity should consider in developing renewal or extension assumptions used
to determine the useful life of a recognized intangible asset under FAS No. 142,
Goodwill and Other Intangible Assets
. FSP FAS 142-3 is effective for financial statements issued for fiscal years and interim periods beginning
after December 15, 2008. The Company anticipates that this statement will have no impact on the reporting of its results of operations.
In May 2008, the FASB issued Statement No. 162,
The Hierarchy of Generally Accepted Accounting Principles
(FAS 162). Under FAS 162, the Generally Accepted Accounting Principles (GAAP)
hierarchy will now reside in the accounting literature established by the FASB. FAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements in conformity with
GAAP. FAS 162 is effective 60 days following the SECs approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411,
The Meaning of Present Fairly in Conformity with Generally Accepted Accounting
Principles
. The Company anticipates that this statement will not have a significant impact on the reporting of its results of operations.
Note 2 Income Taxes
No income tax benefit was recognized in the thirty-nine weeks ended September 27, 2008
because recent general economic events have indicated that more likely than not the tax benefit of the year-to-date pre-tax loss would not be realized during fiscal year 2008, and therefore, in the thirteen weeks ended September 27, 2008, the
$1,237,000 tax benefit recorded in the first half of 2008 was reversed.
In accordance with FASB Interpretation Number 48, Accounting
for Uncertainty in Income Taxes, we recorded a discrete item of $104,000 in the third quarter 2007 due to a change in judgment that resulted in a change in measurement of a tax position taken in a prior annual period. No income tax benefit was
recognized in the thirteen weeks and thirty-nine weeks ended September 29, 2007 because it was uncertain whether the tax benefit of the year-to-date pre-tax loss would be realized during fiscal year 2007.
10
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
The company has recorded a deferred tax asset of approximately $9,433,000 reflecting the benefit of
loss carryforwards of approximately $2,100,000 and $11,400,000 as of September 27, 2008 for federal and state income taxes, respectively, which expire in varying amounts between 2016 and 2027. Realization is dependent on generating sufficient
taxable income prior to expiration of the loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the deferred tax asset will be realized. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
Note 3
Notes Payable and Bank Credit Facility
On February 2, 2007, the Company entered into a Loan, Guaranty and Security Agreement with
Wells Fargo Retail Finance, LLC (the Loan Agreement) which replaced the previous loan with Wells Fargo HSBC Trade Bank, N.A. The Loan Agreement expires on February 2, 2012 and provides for an initial overall credit line up to
$20,000,000, which may be increased to $25,000,000 at the Companys option provided the Company is not in default on the Loan Agreement. The Loan Agreement consists of a revolving credit line and letters of credit up to $5,000,000. The amount
the Company may borrow at any time under the Loan Agreement is based upon a percentage of eligible inventory and accounts receivable less certain reserves. Borrowings are secured by the right, title and interest to all of the Companys personal
property, including equipment, fixtures, general intangibles, intellectual property and inventory. The Loan Agreement contains various restrictive covenants, including minimum availability, which is the amount the Company may borrow under the Loan
Agreement, less certain outstanding obligations, plus certain cash and cash equivalents, limitations on indebtedness, limitations on subordinated indebtedness and limitations on the amount of capital expenditures the Company may incur in any fiscal
year. The Company is currently in compliance with all of these restrictive covenants.
Interest on borrowings will be either at Wells
Fargos prime rate, or LIBOR plus 1.25% to 1.75% based upon average availability. The Company is charged an unused credit line fee of 0.25%. In the event of default, the Companys interest rates will be increased by two percentage points.
The interest rate on outstanding borrowings at September 27, 2008 was 5.00%. As of September 27, 2008, the Company had outstanding borrowings of $6,879,000 under the revolving credit line and $1,630,000 in outstanding letters of credit.
Advances of $11,491,000 were available under the revolving credit line as of September 27, 2008.
In June 2006, the Company financed a
portion of its new information technology project with a three-year promissory note of approximately $1,000,000 with an interest rate of approximately 2.0%. In accordance with Accounting Principals Board No. 21,
Interest on Receivables and
Payables
(APB 21), the Company discounted this note to its fair value. The discounted portion of approximately $58,000 is being amortized as interest expense over the life of the note using the effective interest method. As of
September 27, 2008, the Companys outstanding borrowings under this and other notes were $289,000 with interest rates ranging from 2% to 6.75%. Future maturities of notes payable are approximately $61,000 for the remainder of 2008 and
$228,000 for 2009.
11
Design Within Reach, Inc.
Notes to the Condensed Financial Statements (unaudited) (continued)
Note 4 Fair Value Measurements
In accordance with FAS 157, a fair value measurement is determined based on the assumptions that a market participant would use in pricing an asset
or liability. FAS 157 also established a three-tiered hierarchy that draws a distinction between market participant assumptions based on (i) observable inputs such as quoted prices in active markets (Level 1), (ii) inputs other than
quoted prices in active markets that are observable either directly or indirectly (Level 2) and (iii) unobservable inputs that require the Company to use present value and other valuation techniques in the determination of fair value (Level 3).
The following table presents information about assets and liabilities required to be carried at fair value on a recurring basis as of September 27, 2008 (amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description
|
|
Fair Value at
September 27,
2008
|
|
|
Level 1
|
|
Level 2
|
|
|
Level 3
|
Outstanding Forward Contracts
|
|
$
|
(86
|
)
|
|
$
|
|
|
$
|
(86
|
)
|
|
$
|
|
The Company primarily applies the market approach for recurring fair value measurements.
Note 5 Related Party Transactions
The Company rents studio space from an affiliate of the Chairman of the Companys Board of Directors. Rent expense, applicable to this space, was approximately $40,000 for each of the thirteen weeks ended September 27, 2008 and
September 29, 2007, and $120,000 for each of the thirty-nine weeks ended September 27, 2008 and September 29, 2007.
Note 6
Commitments
As of September 27, 2008, inventory purchase obligations related to open purchase orders were approximately
$23,745,000, commitments for furniture, fixtures, and leasehold improvements related to studios were approximately $283,000, and commitments to maintain and enhance various information technology systems and website were approximately $2,153,000.
Note 7 Subsequent Events
On
October 10, 2008, the Company closed its Las Vegas studio. The related leasehold improvements with a net value of $94,000 were deemed impaired as of September 27, 2008. Accordingly, an impairment charge of $94,000 was included in selling,
general and administrative expenses in the third quarter 2008 that reduced property and equipment, net.
In accordance with FASB Statement
No. 146,
Accounting for Costs Associated with Exit or Disposal Activities
(FAS 146), a liability for costs that will continue to be incurred under the lease agreement for the remaining term without economic benefit to the
Company shall be recognized and measured at the leases fair value at the cease-use date. The Company may record an additional charge after September 27, 2008 for future lease payments at the cease-use date in accordance with FAS 146.
12
Item 2.
|
Managements Discussion and Analysis of Financial Condition and Results of Operations
|
Caution on Forward-Looking Statements
Any statements in this report and the information
incorporated herein by reference about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. You can identify these forward-looking statements by the
use of words or phrases such as believe, may, could, will, estimate, continue, anticipate, intend, seek, plan,
expect, should or would. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial
condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions described in our Annual Report on Form 10-K for the year ended
December 29, 2007.
Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot
guarantee future results, events, levels of activity, performance or achievement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless
required by law.
The interim financial statements and this Managements Discussion and Analysis of Financial Condition and Results
of Operations should be read in conjunction with the financial statements and notes thereto for the fiscal year ended December 29, 2007 and the related Managements Discussion and Analysis of Financial Condition and Results of Operations,
both of which are contained in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 filed with the Securities and Exchange Commission on March 12, 2008.
Overview
We are a retailer of distinctive modern
design products to both residential and commercial customers. Our clients purchase through three integrated sales points. We have developed a national presence in modern design furnishings and a brand recognized for design excellence among our
customers and the design community. In the process we have created a business model that enables us to provide products to our customers in a more convenient, efficient and economical manner than was previously available to them. Our policy of
maintaining core products in stock represents a departure from the approach taken by many other modern design furnishings retailers.
In
fiscal year 2007, we introduced an extended lead-time program, allowing our clients to personalize their product to meet their unique needs. In addition, we launched an expanded offering in accessories in the fourth quarter 2007, which we call
DWR:Tools for Living. We believe this new product line will increase our presence in providing modern design solutions for our customers. We feature in this category approximately 700 products, ranging in price from under $10 to over
$2,000. The products all share good design and functionality.
13
Each DWR:Tools for Living product is unique in how it solves a problem or makes something more
comfortable or easier to use. We view this as an opportunity to offer our existing customers a solution to their everyday problems, as well as providing an introduction to DWR for new clients. If DWR:Tools for Living achieves a sufficient level of
market acceptance, we will continue to grow the product line and explore other design-driven opportunities. Our relationships with both internationally recognized and emerging designers continue to grow and allow us to offer our customers an array
of innovative and often hard-to-find merchandise.
Our business strategy is based upon the premise that integrated sales points improve
customer convenience, reinforce brand awareness, enhance customer knowledge of our products and produce operational benefits that ultimately improve market penetration and returns on capital. We believe most traditional retailers initially
established their presence with one sales point and subsequently added additional sales points, thereby making integration across sales points more difficult.
We have experienced significant growth in customers and sales since our founding in 1998. We began selling products through the phone and online in the second half of 1999, and we opened our first studio in November
2000. We base our decisions on where to open new studios by categorizing markets into tiers based on household population statistics and supporting sales data collected from our other sales points. Our experience indicates that studio
openings significantly improve our overall market penetration rates in the markets in which they are located.
Studios have increased in
number from one at the end of 2000 to 68 studios, one DWR:Tools for Living store and one outlet operating in 25 states, the District of Columbia and Canada as of September 27, 2008. During the first quarter 2008, we opened two new studios. On
September 19, 2008 and October 2, 2008, we opened our first DWR:Tools for Living stores. On October 10, 2008, we closed one studio.
All of our sales points utilize a single common inventory held at our Hebron, Kentucky fulfillment center. Because we dont offer a cash and carry option in our studios, we are able to more fully utilize selling space and
avoid the operational issues that often arise with stock balancing and store replenishment. We currently source our products primarily in the U.S. and Europe. In the thirty-nine weeks ended September 27, 2008, we purchased approximately 37% of
our product inventories from manufacturers in foreign countries, with 26% of our product inventory purchases being paid for in Euros. To mitigate our foreign currency exchange risk, we purchased foreign currency contracts to pay for merchandise
purchases. We expect to have an increasing amount of products being sourced from factories outside of Europe. We plan to increase our efforts to develop products internally and include more exclusive items in our mix, and in doing so, source
products from other parts of the world including Latin America and Asia where product costs are generally lower. Our product development team has worked diligently to find qualified factories in North America, Asia and elsewhere that can provide us
with the quality our clients expect but free us from the impact of fluctuations in the price of the Euro. By the end of 2009, we believe we can achieve product margin improvements from these efforts. We believe that within five years we may have
less than 20% of our product coming from European factories.
14
In the U.S., recent market and economic conditions have been unprecedented and challenging with tighter
credit conditions and slower growth through the third quarter 2008. For the thirty-nine weeks ended September 27, 2008, continued concerns about the systemic impact of inflation, energy costs, geopolitical issues, the availability and cost of
credit, the U.S. mortgage market and a declining real estate market in the U.S. have contributed to increased market volatility and diminished expectations for the U.S. economy. In the third quarter 2008, added concerns fueled by the federal
government conservatorship of the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, the declared bankruptcy of large U.S. financial institutions, the U.S. government loan provided to a major insurance company and
other federal government interventions in the U.S. credit markets led to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with volatile oil prices, declining business
and consumer confidence and increased unemployment have in recent weeks, subsequent to the end of the quarter, contributed to volatility of unprecedented levels. The purchase of our products by customers is discretionary, and therefore highly
dependent upon the level of consumer spending, particularly among affluent customers. Accordingly, sales of our products have been and may continue to be adversely affected by the recent market and economic conditions. As a result, we may be
required to take significant additional markdowns in response to the lower levels of demand for our products.
Basis of Presentation
We operate on a 52- or 53-week fiscal year, which ends on the Saturday closest to December 31. Each fiscal year consists of four 13-week quarters,
with an extra week added onto the fourth quarter every four to six years. Our 2007 fiscal year ended on December 29, 2007 and the 2008 fiscal year will end on January 3, 2009. Fiscal year 2007 consisted of 52 weeks and fiscal year 2008
consists of 53 weeks.
Results of Operations
Comparison of the thirteen weeks ended September 27, 2008 (Third Quarter 2008) to the thirteen weeks ended September 29, 2007 (Third Quarter 2007)
Net Sales.
Net sales consist of studio sales, online sales, phone sales, other sales, and shipping and handling fees, net of actual and estimated
returns by customers. Studio sales consist of sales of merchandise to customers from orders placed at our studios and floor sales at our DWR:Tools for Living store. Online sales consist of sales of merchandise from orders placed through our website.
Phone sales consist of sales of merchandise through the toll-free numbers. Other sales consist of warehouse sales and outlet sales. Warehouse sales consist of periodic clearance sales at our fulfillment center and other locations of product samples
and products that customers have returned. Outlet sales consist of sales at our outlet of product samples, returned products from our customers and, to a lesser degree, full price products. Shipping and handling fees consist of amounts we charge
customers for the delivery of merchandise.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen weeks ended
|
|
(amounts in thousands, except percentages)
|
|
September 27,
2008
|
|
% of Net
Sales
|
|
|
September 29,
2007
|
|
% of Net
Sales
|
|
|
Change
|
|
|
%
Change
|
|
Studio sales
|
|
$
|
28,812
|
|
68.1
|
%
|
|
$
|
32,094
|
|
65.5
|
%
|
|
$
|
(3,282
|
)
|
|
(10.2
|
)%
|
Online sales
|
|
|
5,205
|
|
12.3
|
%
|
|
|
7,429
|
|
15.2
|
%
|
|
|
(2,224
|
)
|
|
(29.9
|
)%
|
Phone sales
|
|
|
3,462
|
|
8.2
|
%
|
|
|
4,418
|
|
9.0
|
%
|
|
|
(956
|
)
|
|
(21.6
|
)%
|
Other sales
|
|
|
2,399
|
|
5.6
|
%
|
|
|
1,828
|
|
3.7
|
%
|
|
|
571
|
|
|
31.2
|
%
|
Shipping and handling fees
|
|
|
2,438
|
|
5.8
|
%
|
|
|
3,257
|
|
6.6
|
%
|
|
|
(819
|
)
|
|
(25.1
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
42,316
|
|
100.0
|
%
|
|
$
|
49,026
|
|
100.0
|
%
|
|
$
|
(6,710
|
)
|
|
(13.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15
Net sales decreased $6,710,000, or 13.7%, to $42,316,000 in the third quarter 2008 from $49,026,000 in
the third quarter 2007. The decrease in the combined net sales of our three sales points (studio, online and phone) is, related in part, to a decrease in the number of units of merchandise shipped. Studio sales decreased $3,282,000, or 10.2%, in the
third quarter 2008 compared to the third quarter 2007. Incremental sales of approximately $1,614,000 were generated from one new studio opened in the fourth quarter 2007, two new studios opened in the first quarter 2008 and one new DWR:Tools for
Living store opened in the third quarter 2008. We had 68 studios, one DWR:Tools for Living store and one outlet open at the end of the third quarter 2008 compared to 65 studios and one outlet open at the end of the third quarter 2007. Online sales
decreased $2,224,000, or 29.9%, and phone sales decreased $956,000, or 21.6%, in the third quarter 2008 compared to the third quarter 2007.
Other sales increased $571,000, or 31.2%, in the third quarter 2008 compared to the third quarter 2007. This increase is primarily related to an increase in warehouse sales of approximately $535,000, related to a large warehouse sales event
in the third quarter 2008 without a comparable event in the third quarter 2007. Shipping and handling fees for delivery of merchandise decreased $819,000, or 25.1%, in the third quarter 2008 compared to the third quarter 2007, primarily attributable
to the decrease in product sales and an increase in the amount of free shipping.
The purchase of our products by customers is
discretionary, and therefore highly dependent upon the level of consumer spending, particularly among affluent customers. Accordingly, sales of our products have been and may continue to be adversely affected by the recent market and economic
conditions.
Cost of Sales
. Cost of sales decreased by $2,232,000, or 8.2%, to $24,989,000 in the third quarter 2008 from
$27,221,000 in the third quarter 2007. The decrease in cost of sales is attributable to the decrease in net sales, partially offset, by a decrease in product-related margins. Cost of sales as a percentage of net sales increased 3.6 percentage points
to 59.1% in the third quarter 2008 from 55.5% in the third quarter 2007, primarily attributable to the warehouse sale event margins, which are lower than our margins for sales through our integrated sales points. We held a large warehouse sale in
the third quarter 2008, without a comparable event in the third quarter 2007, for damaged and overstock inventory that included discounted prices and disposal of certain unsold inventory. Shipping margins were negative in the third quarter 2008, in
part, due to rate increases we pay for shipping as a result of fuel surcharges.
Our performance depends on our ability to purchase our
merchandise from foreign and domestic designers, manufacturers and distributors. Merchandise vendors could cease their operations, discontinue extending credit terms to us or stop selling to us at any time. Any inability to acquire suitable
merchandise or the loss of one or more key vendors could have a negative effect on our business and operating results.
16
Selling, General and Administrative Expenses
(SG&A). Selling, general and
administrative expenses consist of studio, marketing, corporate and fulfillment center costs. Studio costs include salaries and studio occupancy costs. Marketing costs include consumer and online advertising expenses, and costs associated with
publishing our catalogs. Corporate costs include salaries, occupancy costs, computer systems and web-site related costs, and professional fees, among others. Fulfillment center costs include salaries, occupancy costs and charges for shipping
merchandise from our fulfillment center to studios, DWR:Tools for Living stores, our outlet and warehouse sales events. Our gross margins may not be comparable to those of other companies because some other companies include all of the costs related
to their distribution network in cost of sales, while other companies, including us, may exclude a portion of those costs from gross margin, including them instead in other line items, such as selling, general and administrative expenses.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirteen weeks ended
|
|
(amounts in thousands
except percentages)
|
|
September 27,
2008
|
|
% of Net
Sales
|
|
|
September 29,
2007
|
|
% of Net
Sales
|
|
|
Change
|
|
|
%
Change
|
|
Salaries and benefits
|
|
$
|
8,197
|
|
19.4
|
%
|
|
$
|
9,056
|
|
18.5
|
%
|
|
$
|
(859
|
)
|
|
(9.5
|
)%
|
Occupancy and related expense
|
|
|
6,877
|
|
16.3
|
%
|
|
|
6,614
|
|
13.5
|
%
|
|
|
263
|
|
|
4.0
|
%
|
Catalog, advertising and promotion
|
|
|
2,734
|
|
6.5
|
%
|
|
|
2,316
|
|
4.7
|
%
|
|
|
418
|
|
|
18.0
|
%
|
Other expense
|
|
|
3,681
|
|
8.7
|
%
|
|
|
2,824
|
|
5.8
|
%
|
|
|
857
|
|
|
30.3
|
%
|
Professional, accounting, legal and SOX
|
|
|
354
|
|
0.8
|
%
|
|
|
491
|
|
1.0
|
%
|
|
|
(137
|
)
|
|
(27.9
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total SG&A
|
|
$
|
21,843
|
|
51.6
|
%
|
|
$
|
21,301
|
|
43.4
|
%
|
|
$
|
542
|
|
|
2.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SG&A increased by $542,000, or 2.5%, to $21,843,000 in the third quarter 2008 from $21,301,000
in the third quarter 2007. As a percentage of net sales, SG&A increased to 51.6% in the third quarter 2008 from 43.4% in the third quarter 2007, primarily attributable to the decrease in net sales and increased expenses described below.
|
|
|
Salaries and benefits expense decreased $859,000, or 9.5%, to $8,197,000 in the third quarter 2008 from $9,056,000 in the third quarter 2007. This decrease is
primarily related to a $338,000 decrease in commission and bonus expenses, related in part, to the decrease in net sales, a $324,000 decrease in stock-based compensation expense and a $104,000 decrease in salary and contract labor expenses.
Incremental salaries and benefits expense related to one new studio opened in the fourth quarter 2007, two new studios opened in the first quarter 2008 and two new DWR:Tools for Living stores opened on September 19, 2008 and October 2,
2008, including pre-opening expenses, was approximately $285,000. We may decrease headcount depending on operating requirements and cost considerations, which would affect salaries and benefits expense.
|
|
|
|
Occupancy and related expense increased $263,000, or 4.0%, to $6,877,000 in the third quarter 2008 compared to $6,614,000 in the third quarter 2007. This increase
is primarily due to a $582,000 increase in rent and related operating expenses, of which $501,000 is associated with one new studio opened in the fourth quarter 2007, two new studios opened in the first quarter 2008, one relocated studio with
increased occupancy expenses and two new DWR:Tools for Living stores opened on September 19, 2008 and October 2, 2008, including pre-opening expenses. This increase was partially offset by a $319,000 decrease in depreciation expense,
primarily attributable to a change in the estimated useful life of assets related to the early termination of a studio lease in the third quarter 2007. Occupancy and related expense is expected to increase in the fourth quarter 2008 from the prior
comparable period as the result of recently opened studios and DWR:Tools for Living stores.
|
17
|
|
|
Catalog, advertising and promotion expense increased $418,000, or 18.0%, to $2,734,000 in the third quarter 2008 from $2,316,000 in the third quarter 2007. This
increase is primarily due to a $307,000 increase in catalog expense. Direct response catalog costs are capitalized as prepaid catalog costs and are amortized over their expected period of future benefit of approximately four months. The increase in
catalog amortization expense is primarily attributable to increased paper, printing and distribution costs for our 2008 catalogs as compared to our 2007 catalogs. We expect higher catalog expense in the fourth quarter 2008 compared to the fourth
quarter 2007. In fiscal year 2009, we plan to reduce overall spending on catalogs and advertising.
|
|
|
|
Other expense increased $857,000, or 30.3%, to $3,681,000 in the third quarter 2008 compared to $2,824,000 in the third quarter 2007. The increase is partially due
to a $374,000 increase in the cost of distributing merchandise to our warehouse sales event, studios, and new DWR:Tools for Living stores, a $141,000 increase in travel-related expense and a $119,000 increase in software and website-related
expenses.
|
|
|
|
Professional, accounting, legal and SOX expense decreased $137,000, or 27.9%, to $354,000 in the third quarter 2008 compared to $491,000 in the third quarter 2007.
The decrease is primarily due to a $147,000 decrease in accounting and consulting fees directly related to SEC reporting and SOX compliance.
|
Interest Income.
Interest income decreased $50,000 to $40,000 in the third quarter 2008 compared to $90,000 in the third quarter 2007, primarily due to lower interest rates and less invested capital.
Interest Expense.
Interest expense decreased $202,000 to $84,000 in the third quarter 2008 compared to $286,000 in the third
quarter 2007, primarily due to decreased borrowings under our loan agreement and lower interest rates.
Other Income, Net
. Other
income decreased $1,862,000 to $159,000 in the third quarter 2008 compared to $2,021,000 in the third quarter 2007. Other income in the third quarter 2008 primarily consists of foreign currency exchange gains related to currency fluctuations. Other
income in the third quarter 2007 consists of a net gain of approximately $2,200,000 after related expenses as a result of the early termination of a studio lease per an agreement between the Company and the landlord, partially offset, by foreign
currency exchange losses of $187,000. We have certain liabilities from merchandise purchases denominated principally in Euros that result in gains or losses to other income or expense when the value of the dollar changes. Such gains or losses are
not offset against designated hedge contracts in which corresponding gains or losses are recognized in other comprehensive income (loss).
Income Taxes
. No income tax benefit was recognized in the thirty-nine weeks ended September 27, 2008 because recent general economic events have indicated that more likely than not the tax benefit of the year-to-date pre-tax
loss would not be realized during fiscal year 2008, and therefore, in the thirteen weeks ended September 27, 2008, the $1,237,000 tax benefit recorded in the first half of 2008 was reversed.
In accordance with FASB Interpretation Number 48, Accounting for Uncertainty in Income Taxes, we recorded a discrete item of $104,000 in the
third quarter 2007 due to a change in judgment that resulted in a change in measurement of a tax position taken in a prior annual period. No income tax benefit was recognized in the third quarter 2007 because it was uncertain whether the tax benefit
of the year-to-date pre-tax loss would be realized during fiscal year 2007.
18
|
Comparison of the thirty-nine weeks ended September 27, 2008 to the thirty-nine weeks ended September 29, 2007
|
Net Sales.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirty-nine weeks ended
|
|
(amounts in thousands,
except percentages)
|
|
September 27,
2008
|
|
% of Net
Sales
|
|
|
September 29,
2007
|
|
% of Net
Sales
|
|
|
Change
|
|
|
%
Change
|
|
Studio sales
|
|
$
|
92,743
|
|
67.9
|
%
|
|
$
|
92,498
|
|
65.2
|
%
|
|
$
|
245
|
|
|
0.3
|
%
|
Online sales
|
|
|
17,808
|
|
13.0
|
%
|
|
|
21,805
|
|
15.4
|
%
|
|
|
(3,997
|
)
|
|
(18.3
|
)%
|
Phone sales
|
|
|
11,888
|
|
8.7
|
%
|
|
|
13,644
|
|
9.6
|
%
|
|
|
(1,756
|
)
|
|
(12.9
|
)%
|
Other sales
|
|
|
5,601
|
|
4.2
|
%
|
|
|
4,940
|
|
3.4
|
%
|
|
|
661
|
|
|
13.4
|
%
|
Shipping and handling fees
|
|
|
8,450
|
|
6.2
|
%
|
|
|
9,055
|
|
6.4
|
%
|
|
|
(605
|
)
|
|
(6.7
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
136,490
|
|
100.0
|
%
|
|
$
|
141,942
|
|
100.0
|
%
|
|
$
|
(5,452
|
)
|
|
(3.8
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales decreased $5,452,000, or 3.8%, to $136,490,000 in the thirty-nine weeks ended
September 27, 2008 from $141,942,000 in the thirty-nine weeks ended September 29, 2007. The decrease in the combined net sales of our three sales points (studio, online and phone) is related, in part, to a decrease in the number of units
of merchandise shipped, partially offset, by a higher average per unit retail sales price. Studio sales increased $245,000, or 0.3%, in the thirty-nine weeks ended September 27, 2008 compared to the thirty-nine weeks ended September 29,
2007. This increase was primarily attributable to the increase in sales in the first quarter 2008 compared to the first quarter 2007, partially offset, by decreases in sales in the second and third quarters of 2008 from the prior comparable period.
Incremental sales of approximately $3,970,000 were generated from two new studios opened in fiscal year 2007 which did not operate during the entire first thirty-nine weeks of 2007, two new studios opened in the first quarter 2008 and one new
DWR:Tools for Living store opened in the third quarter 2008. Online sales decreased $3,997,000, or 18.3%, and phone sales decreased $1,756,000, or 12.9%, in thirty-nine weeks ended September 27, 2008 compared to the thirty-nine weeks ended
September 29, 2007.
Other sales increased $661,000 or 13.4%, in the thirty-nine weeks ended September 27, 2008 compared to the
thirty-nine weeks ended September 29, 2007. This increase is primarily related to an increase in sales of approximately $542,000 from our outlet and an increase in sales of approximately $59,000 from warehouse sales events. Shipping and
handling fees for delivery of merchandise decreased $605,000, or 6.7%, in the thirty-nine weeks ended September 27, 2008 compared to the thirty-nine weeks ended September 29, 2007. This decrease is partially attributable to the decreased
product sales.
The purchase of our products by customers is discretionary, and therefore highly dependent upon the level of consumer
spending, particularly among affluent customers. Accordingly, sales of our products have been and may continue to be adversely affected by the recent market and economic conditions.
Cost of Sales
. Cost of sales decreased by $5,022,000, or 6.3%, to $75,052,000 in the thirty-nine weeks ended September 27, 2008 from
$80,074,000 in the thirty-nine weeks ended September 29, 2007. Cost of sales as a percentage of net sales decreased 1.4 percentage points to 55.0% in the thirty-nine weeks ended September 27, 2008 from 56.4% in the thirty-nine weeks ended
September 29, 2007, primarily attributable to product-related margin improvements. Shipping margins were negative in the thirty-nine weeks ended September 27, 2008, in part, due to rate increases we pay for shipping as a result of fuel
surcharges.
19
Selling, General and Administrative Expenses (SG&A).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Thirty-nine weeks ended
|
|
(amounts in thousands,
except percentages)
|
|
September 27,
2008
|
|
% of Net
Sales
|
|
|
September 29,
2007
|
|
% of Net
Sales
|
|
|
Change
|
|
|
%
Change
|
|
Salaries and benefits
|
|
$
|
26,426
|
|
19.4
|
%
|
|
$
|
27,443
|
|
19.3
|
%
|
|
$
|
(1,017
|
)
|
|
(3.7
|
)%
|
Occupancy and related expense
|
|
|
19,857
|
|
14.5
|
%
|
|
|
18,982
|
|
13.4
|
%
|
|
|
875
|
|
|
4.6
|
%
|
Catalog, advertising and promotion
|
|
|
9,424
|
|
6.9
|
%
|
|
|
6,827
|
|
4.8
|
%
|
|
|
2,597
|
|
|
38.0
|
%
|
Other expense
|
|
|
10,466
|
|
7.7
|
%
|
|
|
8,740
|
|
6.2
|
%
|
|
|
1,726
|
|
|
19.7
|
%
|
Professional, accounting, legal and SOX
|
|
|
1,735
|
|
1.3
|
%
|
|
|
3,791
|
|
2.7
|
%
|
|
|
(2,056
|
)
|
|
(54.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total SG&A
|
|
$
|
67,908
|
|
49.8
|
%
|
|
$
|
65,783
|
|
46.3
|
%
|
|
$
|
2,125
|
|
|
3.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SG&A increased by $2,125,000, or 3.2%, to $67,908,000 in the thirty-nine weeks ended
September 27, 2008 from $65,783,000 in the thirty-nine weeks ended September 29, 2007. As a percentage of net sales, SG&A increased to 49.8% in the thirty-nine weeks ended September 27, 2008 from 46.3% in the thirty-nine weeks
ended September 29, 2007, primarily attributable to the decrease in net sales and increased expenses described below.
|
|
|
Salaries and benefits expense decreased $1,017,000, or 3.7%, to $26,426,000 in the thirty-nine weeks ended September 27, 2008 from $27,443,000 in the
thirty-nine weeks ended September 29, 2007. This decrease is primarily related to a $661,000 decrease in stock-based compensation expense, a $291,000 decrease in commission and bonus expenses, related in part, to the decrease in net sales, and
a $165,000 decrease in recruiting, relocation and severance expenses. This decrease was partially offset by a $175,000 increase in salary and contract labor expenses. Incremental salaries and benefits expense related to two new studios opened in
fiscal year 2007 which did not operate during the entire first thirty-nine weeks of 2007, two new studios opened in the first quarter 2008 and two new DWR:Tools for Living stores opened on September 19, 2008 and October 2, 2008, including
pre-opening expenses, was approximately $538,000. Salaries and benefits expense is expected to increase due to benefit cost increases and headcount increases from new studios and DWR:Tools for Living stores not operating in the prior comparable
period. In addition, salaries and benefits expense will fluctuate with increased or decreased commissions related to sales increases or decreases, respectively. We may decrease headcount depending on operating requirements and cost considerations,
which would affect salaries and benefits expense.
|
|
|
|
Occupancy and related expense increased $875,000, or 4.6%, to $19,857,000 in the thirty-nine weeks ended September 27, 2008 compared to $18,982,000 in the
thirty-nine weeks ended September 29, 2007. This increase is primarily due to a $1,783,000 increase in rent and related operating expenses, of which $1,331,000 is associated with two new studios opened in fiscal year 2007 which did not operate
during the entire first thirty-nine weeks of 2007, two new studios opened in the first quarter 2008, one relocated studio with increased occupancy and relocation expenses and two new DWR:Tools for Living stores opened on September 19, 2008 and
October 2, 2008, including pre-opening expenses. The increase in occupancy and related expense was partially offset by a $906,000 decrease in depreciation expense, that included approximately $450,000 related to our information technology
system, which was fully depreciated in the first quarter 2007 and approximately $300,000 related to a change in the estimated useful life of assets upon an early termination of a studio lease in the third quarter 2007.
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20
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Catalog, advertising and promotion expense increased $2,597,000, or 38.0%, to $9,424,000 in the thirty-nine weeks ended September 27, 2008 from $6,827,000 in
the thirty-nine weeks ended September 29, 2007. This increase is primarily due to a $2,057,000 increase in catalog expense and a $314,000 increase in media and online advertising expense. Direct response catalog costs are capitalized as prepaid
catalog costs and are amortized over their expected period of future benefit of approximately four months. Of the increase in catalog amortization expense, approximately $874,000 is attributable to the number and timing of catalogs distributed prior
to December 29, 2007 and approximately $1,183,000 is primarily attributable to increased costs of our 2008 catalogs as compared to our 2007 catalogs. The increased costs of our 2008 catalogs are primarily related to increased paper, printing
and distribution costs.
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Other expense increased $1,726,000, or 19.7%, to $10,466,000 in the thirty-nine weeks ended September 27, 2008 compared to $8,740,000 in the thirty-nine weeks
ended September 29, 2007. The increase is primarily due to a $536,000 increase in the cost of distributing merchandise to our warehouse sales event, studios and new DWR:Tools for Living stores, a $308,000 increase in travel-related expense, a
$134,000 increase in software and website-related expenses, a $116,000 increase in sales-related merchant fees, and a $113,000 increase in telecommunication expense.
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Professional, accounting, legal and SOX expense decreased $2,056,000, or 54.2%, to $1,735,000 in the thirty-nine weeks ended September 27, 2008 compared to
$3,791,000 in the thirty-nine weeks ended September 29, 2007. The decrease is primarily due to a $2,131,000 decrease in accounting and consulting fees directly related to SEC reporting and SOX compliance, partially offset, by a $93,000 increase
in legal expense.
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Interest Income.
Interest income decreased $148,000 to $137,000 in the thirty-nine weeks ended
September 27, 2008 compared to $285,000 in the thirty-nine weeks ended September 29, 2007, primarily due to lower interest rates and less invested capital.
Interest Expense.
Interest expense decreased $279,000 to $202,000 in the thirty-nine weeks ended September 27, 2008 compared to $481,000 in the thirty-nine weeks ended September 29, 2007 primarily due
to decreased borrowings under our loan agreement and lower interest rates.
Other Income, Net
. Other income decreased $1,944,000 to
$116,000 in the thirty-nine weeks ended September 27, 2008 compared to $2,060,000 in the thirty-nine weeks ended September 29, 2007. Other income in the thirty-nine weeks ended September 27, 2008 primarily consists of foreign currency
exchange gains related to currency fluctuations. Other income in the thirty-nine weeks ended September 29, 2007 consists of a net gain of approximately $2,200,000 after related expenses as a result of the early termination of a studio lease per
an agreement between the Company and the landlord, partially offset, by foreign currency exchange losses of $222,000. We have certain liabilities from merchandise purchases denominated principally in Euros that result in gains or losses to other
income or expense when the value of the dollar changes. Such gains or losses are not offset against designated hedge contracts in which corresponding gains or losses are recognized in other comprehensive income.
Income Taxes
. No income tax benefit was recognized in the thirty-nine weeks ended September 27, 2008 because recent general economic events
have indicated that more likely than not the tax benefit of the year-to-date pre-tax loss would not be realized during fiscal year 2008.
In accordance with FASB Interpretation Number 48, Accounting for Uncertainty in Income Taxes, we recorded a discrete item of $104,000 in the third quarter 2007 due to a change in judgment that resulted in a change in measurement
of a tax position taken in a prior annual period. No income tax benefit was recognized in the thirty-nine weeks ended September 29, 2007 because it was uncertain whether the tax benefit of the year-to-date pre-tax loss would be realized during
fiscal year 2007.
21
Liquidity and Capital Resources
As of September 27, 2008, cash and cash equivalents were $5,147,000. Working capital was $17,138,000 and $20,923,000 as of September 27, 2008 and September 29, 2007, respectively.
Cash Flows.
Net cash provided by (used in):
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Thirty-nine weeks ended
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September 27, 2008
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September 29, 2007
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(amounts in thousands)
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Operating activities
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$
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(2,622
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)
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$
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(7,626
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)
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Investing activities
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(4,514
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)
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(4,381
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)
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Financing activities
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6,632
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10,770
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Net Cash Used in Operating Activities.
Net cash used in operating activities was $2,622,000
in the thirty-nine weeks ended September 27, 2008 compared to $7,626,000 in the thirty-nine weeks ended September 29, 2007. The improvement in cash flow was primarily attributable to a lower amount of inventory purchases. We have lowered
the amount of inventory by improving our merchandise purchasing process and increasing the use of shipments directly from our vendors to our customers.
Net Cash Used in Investing Activities.
Cash used in investing activities was primarily for the purchase of property and equipment related to our new studios and information technology systems of $4,514,000 in
the thirty-nine weeks ended September 27, 2008 compared to $4,381,000 in the thirty-nine weeks ended September 29, 2007. We opened two new studios, one replacement studio and one new DWR:Tools for Living store in the thirty-nine weeks
ended September 27, 2008 and two new studios and one replacement studio during the thirty-nine weeks ended September 29, 2007. We launched our website on a new platform on April 1, 2008, we installed a new warehousing and distribution
system at our fulfillment center on May 12, 2008, and we installed a new point of sales system at our outlet on July 27, 2008 that was also installed at our new DWR:Tools for Living stores.
For the remainder of fiscal year 2008, we anticipate that our investment in property and equipment will be between approximately $2,500,000 and
$3,500,000 primarily to implement new information technology systems, leasehold improvements and furniture and fixtures for two DWR:Tools for Living stores and remodel selected studios. Although most of the capital costs of the DWR:Tools for Living
stores opened on September 19, 2008 and October 2, 2008 are included in property and equipment at September 27, 2008, certain of those costs are included in accounts payable and accrued liabilities and will be fully reflected in net
cash used in investing activities by the fourth quarter 2008. We plan to finance these investments in fiscal year 2008 from our existing cash balances and borrowings under our revolving line of credit facility.
Net Cash Provided by Financing Activities.
Net cash provided by financing activities was $6,632,000 in the thirty-nine weeks ended
September 27, 2008 compared to $10,770,000 in the thirty-nine weeks ended September 29, 2007. Cash provided by financing activities was comprised primarily of borrowings on our bank credit facility of $6,879,000 and $11,200,000 in the
thirty-nine weeks ended September 27, 2008 and September 29, 2007, respectively. Cash used in financing activities was for the repayment of long-term obligations of $280,000 and $462,000 in the thirty-nine weeks ended September 27,
2008 and September 29, 2007, respectively.
As of September 27, 2008, we had available approximately $16,638,000 in working
capital resources for our future cash needs as follows:
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approximately $5,147,000 in cash and cash equivalents; and
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approximately $11,491,000 in availability under our working capital line of credit.
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22
Our cash and cash equivalents are held in accounts managed by third party financial institutions and
consist of invested cash and cash in our operating accounts. To date, we have experienced no loss or lack of access to our cash or cash equivalents; however, there can be no assurance that access to our cash and cash equivalents will not be impacted
by adverse conditions in the financial markets.
As a result of the challenging market and economic conditions, the cost and availability
of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets, generally, and the strength of counterparties, specifically, has led many lenders and
institutional investors to reduce, and in some cases, cease to provide funding to borrowers. In addition, many vendors in our industry have begun to provide less favorable payment terms. Continued turbulence in the U.S. and international
markets and economies may adversely affect the liquidity and financial condition of our lenders and vendors, and our access to credit from our lenders and vendors. If these market conditions continue, they may limit our ability, and the ability
of our lenders and vendors, to timely replace maturing liabilities, and access the capital markets to meet liquidity needs, resulting in an adverse effect on our liquidity, financial condition and results of operations.
Our cash from customers is primarily received through credit card processing companies. To date, we have experienced no delays or lack of access to
credit card cash receipts; however, there can be no assurance that access to our cash receipts will not be impacted by adverse conditions in the financial markets.
We are currently in compliance with all of our debt covenants. Our ability to stay in compliance with all of our debt covenants and to fund our operations and anticipated capital expenditures in the future will depend
on our future operations, performance and cash flows, and is subject to prevailing economic conditions and financial, business and other factors, some of which are beyond our control.
Commitments and Contractual Obligations
On February 2, 2007, we entered into a Loan, Guaranty
and Security Agreement with Wells Fargo Retail Finance, LLC, or the Loan Agreement, which replaced the previous loan with Wells Fargo HSBC Trade Bank, N.A. The Loan Agreement expires on February 2, 2012 and provides for an initial overall
credit line up to $20,000,000 which may be increased to $25,000,000 at our option, provided we are not in default on the Loan Agreement. The Loan Agreement consists of a revolving credit line and letters of credit up to $5,000,000. The amount we may
borrow at any time under the Loan Agreement is based upon a percentage of eligible inventory and accounts receivable less certain reserves. Borrowings are secured by the right, title and interest to all of our personal property, including equipment,
fixtures, general intangibles, intellectual property and inventory. The Loan Agreement contains various restrictive covenants, including minimum availability, which is the amount we may borrow under the Loan Agreement, less certain outstanding
obligations, plus certain cash and cash equivalents, limitations on indebtedness, limitations on subordinated indebtedness and limitations on the amount of capital expenditures we may incur in any fiscal year. We are currently in compliance with all
of these restrictive covenants.
Interest on borrowings will be either at Wells Fargos prime rate, or LIBOR plus 1.25% to 1.75% based
upon average availability. We are charged an unused credit line fee of 0.25%. In the event of default, our interest rates would increase by two percentage points. The interest rate on outstanding borrowings at September 27, 2008 was 5.00%. As
of September 27, 2008, we had outstanding borrowings of $6,879,000 under the revolving credit line and $1,630,000 in outstanding letters of credit. Advances of $11,491,000 were available under the revolving credit line as of September 27,
2008.
23
We have various other notes payable, which consist primarily of unsecured equipment financing loans. In
June 2006, we financed a portion of our new information technology project with a three-year promissory note of approximately $1,000,000 with an interest rate of approximately 2.0%. In accordance with APB Opinion No. 21
Interest on
Receivables and Payables,
or APB 21, we discounted this note to its fair value. The discounted portion of approximately $58,000 is being amortized as interest expense over the life of the note using the effective interest method. As of
September 27, 2008, outstanding borrowings under these notes were $289,000 with interest rates ranging from 2% to 6.75%. These notes mature in 2009.
We entered into equipment leases during fiscal year 2007 with remaining capitalized lease obligation payments of $124,000 as of September 27, 2008.
As of September 27, 2008, inventory purchase obligations related to open purchase orders were approximately $23,745,000, commitments for furniture,
fixtures, and leasehold improvements related to studios were approximately $283,000, and commitments to maintain and enhance various information technology systems and website were approximately $2,153,000.
Critical Accounting Estimates
Our financial
statements have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts
of assets, liabilities, sales and expenses. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are set forth below
and in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007, in the Notes to Financial Statements and Critical Accounting Policies and Estimates section.
Revenue Recognition
We recognize revenue on the date on which we estimate that the product has been
received by the customer. We retain title to items and bear the risk of loss of shipments until delivery from our warehouse. We take title to items drop shipped by vendors at the time of shipment and bear the risk of loss until delivery to
customers. We use third-party freight carrier information to estimate standard delivery times to various locations throughout the United States and Canada. We record as deferred revenue the dollar amount of all shipments for a particular day, if
based upon our estimated delivery time, such shipments, on average, are expected to be delivered after the end of the reporting period. As of September 27, 2008, December 29, 2007 and September 29, 2007, deferred revenue was
$1,905,000, $325,000 and $3,171,000, respectively, and related deferred cost of sales was $986,000, $173,000 and $1,617,000, respectively.
Sales are recorded net of expected returns by customers. Significant management judgments and estimates must be made and used in connection with determining net sales recognized in any accounting period. Our management must make estimates
of potential future product returns related to current period revenue. We analyze historical returns, current economic trends and changes in customer demand and acceptance of products when evaluating the adequacy of the sales returns and other
allowances in any accounting period. The returns allowance is recorded as a reduction to net sales for the estimated retail value of the projected product returns and as a reduction in cost of sales for the corresponding cost amount less any reserve
for estimated scrap. The reserves for estimated product returns were $538,000, $654,000 and $655,000 as of September 27, 2008, December 29, 2007 and September 29, 2007, respectively.
24
Item 3.
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Quantitative and Qualitative Disclosures About Market Risk
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Foreign Currency Exchange Risk
In the thirty-nine weeks ended September 27, 2008, we generated
approximately 98% of our net sales in U.S. dollars, but we purchased approximately 37% of our product inventories from manufacturers in foreign countries, with 26% of our product inventory purchases being paid for in Euros. Increases and decreases
in the U.S. dollar relative to the Euro result in fluctuations in the cost to us of merchandise sourced from Europe. As a result of such currency fluctuations, we have experienced and may continue to experience fluctuations in our operating results
on an annual and a quarterly basis going forward. Specifically, as the value of the U.S. dollar declines relative to the Euro, the effective cost for our product increases. As a result, declines in the value of the U.S. dollar relative to the Euro
and other foreign currencies would increase our cost of sales and decrease our gross margin. Although our hedging strategy described below may mitigate this risk in the short term, currency fluctuations in the long term will not be mitigated by
hedging because we do not hedge our currency risks beyond a year.
In the thirty-nine weeks ended September 27, 2008, the value of the
dollar increased approximately 1% relative to the Euro. We implemented a new hedging strategy in the first quarter 2007 to mitigate the impact of foreign currency fluctuations on inventory purchases. Foreign currency contracts entered into from
January 2007 to April 2007 were not designated as cash flow hedge contracts. We accounted for non-hedge foreign currency contracts on a monthly basis by recognizing the net cash settlement gain or loss in other income, net and adjusting the carrying
amount of open contracts to fair value by recognizing any corresponding gain or loss in other income, net. In the second quarter 2007, we developed policies and procedures that met the criteria for cash flow hedge accounting. Foreign currency
contracts entered into from May 2007 through September 2008 were designated as cash flow hedge contracts and were accounted for on a monthly basis by adjusting the carrying amount of open designated contracts to fair value by recognizing any
corresponding gain or loss in other comprehensive income (loss) and recognizing the net cash settlement gain or loss in other comprehensive income (loss). Subsequently, these net cash settlement gains or losses are being recognized in cost of sales
as the underlying hedged inventory is sold in each reporting period. In the condensed statements of cash flows, net cash settlement gain or loss is included in operating cash flows as changes in other assets, and as customer deposits and other
liabilities. Our derivative positions were used only to manage identified exposures. If our hedging strategy does not help reduce fluctuations in our cost of goods and mitigate the impact of the strengthening of the Euro relative to the U.S. dollar,
we will continue to have difficulties in accurately predicting our costs of sales and our cost of sales may increase, adversely impacting our gross margin. A hypothetical 1% increase or decrease in the Euro exchange rate with the dollar on
December 30, 2007 would have resulted in a $104,000 change to cost of sales in the thirty-nine weeks ended September 27, 2008 and $158,000 change to cost of sales on an annualized basis.
Interest Rate Risk
We have interest payable on our
revolving line of credit. Amounts borrowed under this line of credit bear interest at an annual rate equal to the lenders prime lending rate or LIBOR plus 1.25% to 1.75% based upon average availability. The extent of this risk is not
quantifiable or predictable because of the variability of future interest rates and the future financing requirements. As of September 27, 2008, we had $6,879,000 of outstanding borrowings under the revolving credit line at an interest rate of
5.00%. A hypothetical increase or decrease in interest rates by one percentage point on December 30, 2007 would have resulted in a $30,000 change to our interest expense in the thirty-nine weeks ended September 27, 2008 and $40,000 on
an annualized basis.
25
Item 4.
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Controls and Procedures
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(a)
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Evaluation of Disclosure Controls and Procedures
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Management, including our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, evaluated the effectiveness of our disclosure controls and procedures, as of the end of the period covered by this report, in accordance with
Rules 13a-15(b) and 15d-15(b) of the Exchange Act. Based on that evaluation, our CEO and CFO concluded that control deficiencies which constituted material weaknesses at December 29, 2007 as discussed in subsection (b) below,
continued to exist in our internal control over financial reporting as of the end of the period covered by this report. As a result of these material weaknesses, our CEO and CFO concluded that our disclosure controls and procedures were not
effective as of the end of the period covered by this report at the reasonable assurance level. In light of the material weaknesses described below, we performed additional analyses and other post-closing procedures to determine that our financial
statements included in this report were prepared in accordance with U.S. GAAP. Accordingly, management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of
operations and cash flows for the periods presented.
The certifications of our principal executive officer and principal financial officer
required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 are attached as exhibits to this Quarterly Report on Form 10-Q. The disclosures set forth in this Item 4 contain information concerning the evaluation of our
disclosure controls and procedures, internal control over financial reporting and changes in internal control over financial reporting referred to in those certifications. Those certifications should be read in conjunction with this Item 4 for
a more complete understanding of the matters covered by the certifications.
(b)
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Managements Report on Internal Control Over Financial Reporting
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Management is responsible for establishing and maintaining adequate internal control over our financial reporting. Internal control over financial reporting refers to the process designed by, or under the supervision
of, our CEO and CFO, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in
accordance with U.S. GAAP, and includes those policies and procedures that:
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1)
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pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
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2)
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provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that our receipts and
expenditures are being made only in accordance with the authorization of our management and directors; and
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3)
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provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the
financial statements.
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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.
26
Management assessed the effectiveness of our internal control over financial reporting as of the end of
the period covered by this report. In making this assessment, management used the framework set forth in the report entitled
Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway
Commission, or COSO. The COSO framework summarizes each of the components of a companys internal control system, including (i) the control environment, (ii) risk assessment, (iii) control activities, (iv) information and
communication, and (v) monitoring.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over
financial reporting such that there is a reasonable possibility that a material misstatement of the companys annual or interim financial statements will not be prevented or detected on a timely basis. Management identified the following
material weaknesses during its assessment of our internal control over financial reporting as of the end of fiscal year 2007 and determined that such weaknesses continued to exist as of the end of the period covered by this report.
Control Activities
We had an entity
level material weakness related to ineffective controls over the initiation, authorization, review, documentation and recording of the financial impact of material contracts. Specifically, we do not have a contract tracking system for material
contracts entered into other than for purchase orders related to inventory commitments. This material weakness could impact selling, general and administrative expenses and capital expenditures.
Monitoring
We had an entity level
material weakness related to insufficient oversight procedures performed by management of our internal controls. We did not maintain processes to verify that internal controls over financial reporting and regulatory filings were performed correctly
or in a timely and consistent basis.
As a result of this conclusion, management performed significant additional substantive review of
those areas described above where it identified material weaknesses to gain assurance that the financial statements as included herein are fairly stated in all material respects.
(c)
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Managements Remediation Initiatives
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We
continue to evaluate the deficiencies that were identified in 2007. We continue to remediate the remaining deficiencies.
To facilitate
some of the improvements in the internal control environment, we continue to implement a new ERP system. This new ERP system should replace the majority of our existing legacy systems. We expect the new system to allow us to leverage more automated
controls which will help remediate some of the deficiencies.
Our management has discussed the material weaknesses described above and
other deficiencies with our Audit Committee. In an effort to remediate the identified material weaknesses and other deficiencies, we have initiated and/or taken action to remediate material weaknesses related to the following areas:
Control Activities
We are
continuing to develop a process to emphasize the importance of internal controls and verify that all process owners are involved with performance of internal controls. We continue to provide training to all process owners on the appropriate
requirements to document and perform internal control procedures.
27
We are continuing to develop a process whereby, on a periodic basis, process owners will perform
self-assessment testing and report results to management. Periodic independent testing also will be performed to evaluate the adequacy of design and effectiveness of internal control procedures.
We have developed a process to review material contracts for appropriate financial statement treatment and disclosure and are in the process of
implementing it.
Monitoring
We are implementing formal policies and procedures over performance of internal controls, including monitoring functions. We are performing a top-down risk-based approach to identify those accounts, financial statement assertions, business
processes and locations which have a higher likelihood of resulting in a material misstatement to our financial statements and to accordingly adjust the nature, timing and extent of control monitoring efforts.
We have tasked an internal resource to monitor compliance with internal control requirements, including the performance of self-testing by process
owners. During this quarter, we began monitoring compliance with internal control requirements, which included self-testing.
(d)
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Changes in Internal Control over Financial Reporting
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We installed a new point of sales system at our outlet on July 27, 2008 that was also installed at our new DWR:Tools for Living stores. Other than these implementations, the improvements in our control environment over the last
thirteen weeks and the internal control implementation currently underway as discussed above, there have been no changes in our internal control over financial reporting during our fiscal quarter ended September 27, 2008 that have materially
affected, or are reasonably likely to materially affect, our internal control over financial reporting.
28
PART II OTHER INFORMATION
Item 1.
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Legal Proceedings
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None.
In addition to the other information
set forth in this report, you should carefully consider the factors described below, as well as those discussed in Part I, Item 1A, Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007,
which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks and uncertainties facing us. Additional risks and uncertainties not currently known to us
or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Our
business depends, in part, on factors affecting consumer spending that are not within our control.
Our business depends on consumer
demand for our products and, consequently, is sensitive to a number of factors that influence consumer spending, including general economic conditions, turmoil in the credit markets, disposable consumer income, levels of employment, salaries and
wage rates, consumer confidence, recession and fears of recession, stock market volatility, war and fears of war, acts of terrorism, inclement weather, consumer debt, interest rates, sales tax rates and rate increases, inflation, and consumer
perceptions of personal well-being and security generally. The purchase of our products by customers is discretionary, and therefore highly dependent upon the level of consumer spending, particularly among affluent customers. Adverse changes in
factors affecting discretionary consumer spending could reduce consumer demand for our products, thus reducing our net sales and adversely affecting our operating results. The recent downturn in the housing market, increases in energy prices, the
turmoil in the credit markets, the decrease in consumer confidence and uncertainties in general economic conditions including the possibility of a recession, may adversely affect our sales. In addition, fewer customers may shop at our studios, our
website or through the catalog. Any of these factors would likely cause us to delay or slow our expansion plans, result in lower net sales and hamper our ability to raise prices in line with costs and also could result in excess inventories, which
could, in turn, lead to increased merchandise markdowns, promotional expenses and impairment charges, adversely affecting our profitability. In addition, promotional and/or prolonged periods of deep discount pricing by our competitors could have a
material adverse effect on our business.
Recent turmoil in the credit markets and the financial services industry may negatively impact our business,
results of operations, financial condition, liquidity or market price of our common stock.
Recently, general worldwide economic
conditions have experienced a downturn due to the sequential effects of the subprime lending crisis, general credit market crisis, collateral effects on the finance and banking industries, volatile energy costs, concerns about inflation, slower
economic activity, decreased consumer confidence, reduced corporate profits and capital spending. We cannot predict the timing or duration of any economic slowdown or the timing or strength of a subsequent economic recovery, worldwide or in the
retail industry, specifically. While the ultimate outcome of these events cannot be predicted, they may have a material adverse effect on our liquidity and financial condition if our ability to borrow money to finance our operations from our
existing lenders under our loan agreements or obtain credit under our revolving line of credit were to be impaired. The recent economic crisis could adversely impact our customers discretionary spending. Because consumer purchases of
discretionary items, such as our products, tend to decline during recessionary periods, when disposable income is lower, our sales have been and will continue to be adversely affected by the downturn in economic conditions. Additionally, our stock
price could decrease if investors have concerns that our business, financial condition and results of operations will be negatively impacted by a worldwide macroeconomic downturn.
29
We are subject to various risks and uncertainties that might affect our ability to procure quality merchandise from
our vendors or receive favorable payment terms from our vendors.
Our performance depends on our ability to procure quality merchandise
from our vendors. Our vendors are subject to certain risks, including availability of raw materials, labor disputes, union organizing activity, inclement weather, natural disasters, and general economic and political conditions that might limit
their ability to provide us with quality merchandise on a timely basis. For these or other reasons, one or more of our vendors might not adhere to our quality control standards, and we might not identify the deficiency before merchandise is shipped
to us or our customers. Our vendors failure to manufacture or import quality merchandise could reduce our net sales, damage our reputation and have an adverse effect on our financial condition. In addition, the global credit crisis may affect
the liquidity and viability of our vendors and may cause them to provide less favorable payment terms. Any such changes could require us to seek different vendors from which to purchase products and could require us to borrow additional funds
under our revolving credit line to finance the purchase of our products.
We may need additional financing and may not be able to obtain additional
financing on favorable terms or at all, which could increase our costs, limit our ability to grow and dilute the ownership interests of existing stockholders.
On February 2, 2007, we entered into a Loan, Guaranty and Security Agreement with Wells Fargo Retail Finance, LLC (the Loan Agreement) which replaced the loan with Wells Fargo HSBC Trade Bank, N.A.
The Loan Agreement expires on February 2, 2012 and provides for an initial overall credit line up to $20.0 million, which may be increased to $25.0 million at our option, provided we are not in default on the Loan Agreement. The Loan Agreement
consists of a revolving credit line and letters of credit up to $5.0 million. The amount we may borrow at any time under the Loan Agreement is based upon a percentage of eligible inventory and accounts receivable less certain reserves. Borrowings
are secured by the right, title and interest to all of our personal property, including equipment, fixtures, general intangibles, intellectual property and inventory. The Loan Agreement contains various restrictive covenants, including minimum
availability, which is the amount we may borrow under the Loan Agreement, less certain outstanding obligations, plus certain cash and cash equivalents, limitations on indebtedness, limitations on subordinated indebtedness and limitations on the
amount of capital expenditures we may incur in any fiscal year. The current disruptions in the capital markets have caused banks and other credit providers to restrict availability of new credit facilities and require more collateral and higher
pricing upon renewal or increase of existing credit facilities, if such facilities are renewed at all.
Other than the Loan Agreement, we
do not have any significant available credit, bank financing or other external sources of liquidity. We may need to raise additional capital in the future to fund our working capital requirements, open additional studios, to facilitate long-term
expansion, to respond to competitive pressures or to respond to unanticipated financial requirements. The amount of financing that we will require for these efforts will vary depending on our financial results, our ability to generate cash from
internal operations, and the number and speed at which we open additional studios. There is no assurance that we will be able to raise the additional capital required to meet our objectives. Our access to additional financing will depend on a
variety of factors such as market conditions, the general availability of credit, the volume of trading activities, the overall availability of credit to our industry, our credit ratings and credit capacity, as well as the possibility that customers
or lenders could develop a negative perception of our long- or short-term financial prospects. Our financial circumstances at the time of any future financing transaction may make the terms, conditions and cost of any available capital relatively
unfavorable. If additional debt or equity capital is not readily available, we will be forced to scale back, or fail to address opportunities for expansion or enhancement of, our operations.
30
Item 2.
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
None.
Item 3.
|
Defaults Upon Senior Securities
|
None.
Item 4.
|
Submission of Matters to a Vote of Security Holders
|
A.
|
Our Annual Meeting of stockholders was held on August 5, 2008 (the Annual Meeting).
|
B.
|
At the Annual Meeting, stockholders voted on three matters: (i) the election of three Directors for a term of three years expiring in 2011; (ii) the approval of an
amendment to the Amended and Restated 2004 Equity Incentive Award Plan to increase the number of shares issuable under the plan by 900,000 shares to 3,000,000 shares; and (iii) the ratification of the appointment of Grant Thornton LLP as our
independent registered public accounting firm for the fiscal year ending January 3, 2008. The stockholders approved all matters, and the voting results were as follows:
|
|
I.
|
Election of three Directors:
|
|
|
|
|
|
|
|
|
|
John Hansen
|
|
For
|
|
13,843,844
|
|
Withheld
|
|
69,420
|
Hilary Billings
|
|
For
|
|
13,499,175
|
|
Withheld
|
|
414,089
|
James Peters
|
|
For
|
|
13,847,943
|
|
Withheld
|
|
65,321
|
|
II.
|
Amendment to the Amended and Restated 2004 Equity Incentive Award Plan to increase the number of shares issuable under the plan by 900,000 shares to 3,000,000 shares:
|
|
|
|
|
|
|
|
For 4,790,697
|
|
Against 2,677,636
|
|
Abstain 359,618
|
|
Broker non-votes 6,085,313
|
|
III.
|
Ratification of the appointment of Grant Thornton LLP as our independent registered public accounting firm for the fiscal year ending December 29, 2007:
|
|
|
|
|
|
For 13,893,876
|
|
Against 15,229
|
|
Abstain 4,159
|
Item 5.
|
Other Information
|
None.
31
|
|
|
Exhibit
Number
|
|
Exhibit Title
|
|
|
3.01(1)
|
|
Amended and Restated Certificate of Incorporation
|
|
|
3.02(2)
|
|
Amended and Restated Bylaws
|
|
|
3.03(3)
|
|
Certificate of Designations for Series A Junior Participating Preferred Stock of Design Within Reach, Inc.
|
|
|
4.01(3)
|
|
Form of Specimen Common Stock Certificate
|
|
|
4.02(3)
|
|
Rights Agreement, dated as of May 23, 2006, among Design Within Reach, Inc. and American Stock Transfer and Trust Company, N.A., as Rights Agent, including the form of Certificate of
Designations of the Series A Junior Participating Preferred Stock of Design Within Reach, Inc. as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C
|
|
|
4.03(4)
|
|
First Amendment dated December 13, 2007 to Rights Agreement dated May 23, 2006 between Design Within Reach, Inc. and American Stock Transfer and Trust Company
|
|
|
31.1
|
|
Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
|
|
|
31.2
|
|
Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934
|
|
|
32*
|
|
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|
|
|
(1)
|
|
Incorporated by reference to the Registration Statement on Form S-1 (No. 333-113903) filed on March 24, 2004, as amended.
|
(2)
|
|
Incorporated by reference to Amendment No. 2 to Registration Statement on Form S-1 (No. 333-113903) filed on June 1, 2004, as amended.
|
(3)
|
|
Incorporated by reference to Design Within Reachs Current Report on Form 8-K filed on May 25, 2006.
|
(4)
|
|
Incorporated by reference to Design Within Reachs Current Report on Form 8-K filed on December 14, 2007.
|
*
|
These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18
of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Design Within Reach, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.
|
32
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
|
|
Dated: November 6, 2008
|
|
DESIGN WITHIN REACH, INC.
|
|
|
|
|
/s/ John D. Hellmann
|
|
|
John D. Hellmann
|
|
|
Vice President, Chief Financial Officer and Secretary
|
|
|
(Authorized Officer and Principal Financial Officer)
|
33
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