NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management,
the accompanying Consolidated Balance Sheets and Consolidated Statements of Operations, Shareholders Equity and Cash Flows contain all adjustments, including normal recurring adjustments, necessary to present fairly the financial position of
the Company as of January 31, 2008, and the results of operations and changes in cash flows for the nine months then ended. Because of the seasonal nature of the Companys business, revenues and earnings results for the nine months ended
January 31, 2008 are not necessarily indicative of what the results will be for the full year. The Consolidated Balance Sheet as of April 28, 2007 included in this Form 10-Q was derived from the audited consolidated financial statements of
the Company included in the Companys fiscal year 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission. Reference should be made to the Companys Form 10-K for the year ended April 28, 2007, including the
discussion of the Companys critical accounting policies. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United
States of America.
2.
|
New Accounting Pronouncements
|
SFAS
No. 141(R)
In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 141 (revised 2007), Business Combinations. SFAS No. 141(R) reiterates that business combinations must be accounted for using the acquisition method. The definition of business combination is
expanded to include transactions where an acquirer gains control by contract alone or without exchange of consideration. SFAS No. 141(R) requires the measurement and recognition of a business combination on the acquisition date and requires
acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed, and noncontrolling interests held in the acquiree, which eliminates the current cost-based purchase method. This Statement also requires an acquirer to
recognize goodwill as of the acquisition date, measured as a residual of the consideration paid plus the fair value of any noncontrollable interest in the acquiree at the acquisition date over the fair value of the identifiable net assets acquired.
SFAS No. 141(R) is effective prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period after December 15, 2008. The Company will adopt this Statement as
necessary.
SFAS No. 157
In September 2006, SFAS No. 157, Fair Value Measurements, was issued by the FASB. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements;
however, this pronouncement does not require any new fair value measurements. The effective date for SFAS No. 157 has been delayed by the FASB for nonfinancial assets and nonfinancial liabilities; the Company will adopt this portion of the
Statement for the fiscal year beginning May 3, 2009. SFAS No. 157 is effective for the Company for the fiscal year beginning May 4, 2008 for items that are recognized or disclosed at fair value in an entitys financial statements
on a recurring basis. The Company is currently evaluating the impact of this pronouncement on its consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
SFAS No. 159
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of
FASB Statement No. 115. SFAS No. 159 allows companies to irrevocably elect to recognize most financial assets and financial liabilities at fair value on an instrument-by-instrument basis. Unrealized gains and losses will be reported
in earnings at each reporting date. The cumulative effect of re-measuring such instruments to fair value at adoption is accounted for as an adjustment to the beginning balance of retained earnings. SFAS No. 159 will be effective for the
Companys fiscal year beginning May 4, 2008, and is not expected to have a significant impact on the Companys consolidated financial statements.
SFAS No. 160
In December 2007, the FASB issued SFAS No. 160, Noncontrolling
Interests in Consolidated Financial Statements, an amendment of ARB No. 51. SFAS No. 160 identifies a new term - noncontrolling interests - to replace what were previously called minority interests. This Statement clarifies that
noncontrolling interests should be classified as equity. Changes in a parents ownership interest whereby the parent still retains control of a subsidiary will also be accounted for as an equity transaction. If a change in a parents
ownership results in a loss of control of a subsidiary, the retained equity interest will be re-measured at fair value as of the deconsolidation date and any gain or loss would be recognized in net income. The Statement is currently not applicable
to the Company; the provisions of this Statement will be adopted as necessary.
FIN No. 48
In June 2006, Financial Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109, was issued by the FASB. FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax
return. FIN No. 48 also provides guidance on derecognition, classification, interest (that will be classified in the Companys financial statements as interest expense, consistent with the Companys current accounting policy) and
penalties, accounting in interim periods, disclosure and transition. Upon adoption of FIN No. 48 as of April 29, 2007, the Company increased its existing income tax reserves by $1,562,000, largely due to foreign and state income tax
matters. The increase was recorded as a cumulative effect adjustment to the opening balance of retained earnings.
As of January 31,
2008, the Company had $4,308,000 of unrecognized tax benefits. If recognized, approximately $3,443,000 would be recorded as a component of income tax expense and the additional $865,000 would be recorded as interest and penalties. In the first,
second and third quarters of fiscal 2008, the Company increased its unrecognized tax benefits by $728,000 $639,000 and $63,000, respectively, due to the addition of income tax reserves and interest on previously recorded reserves. The increase in
unrecognized tax benefits occurred mainly in the second quarter of fiscal 2008 and resulted from the reevaluation of facts and circumstances related to a tax uncertainty identified during the adoption of FIN No. 48 in the first quarter of this
fiscal year. Upon reevaluation, management determined that a reserve amount was appropriate on this tax uncertainty and accordingly, additional income tax expense of $804,000 was recorded in the second quarter of fiscal 2008. Management also
determined that this amount did not materially impact the financial results for any individual quarter or year-to-date period of this fiscal year.
With the adoption of FIN No. 48, the Company will continue to include interest expense and penalties related to income tax contingencies in income before income taxes in its Consolidated Statements of Operations.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
In many instances, the Companys uncertain positions are related to tax years that remain
subject to examination by the relevant tax authorities. The following table summarizes these open tax years by major jurisdiction as of January 31, 2008:
|
|
|
|
|
Jurisdiction
|
|
Open Tax Year
Examination
in Progress
|
|
Examination
not yet
Initiated
|
United States *
|
|
N/A
|
|
2006 2007
|
Canada *
|
|
2000 2005
|
|
2006 2007
|
United Kingdom
|
|
N/A
|
|
2004 2007
|
|
|
|
|
|
* Includes federal as well as state or provincial jurisdictions, as applicable.
|
Based on the outcome of these examinations, it is reasonably possible that the related
unrecognized tax benefits for tax positions taken regarding previously filed tax returns will materially change from those recorded as liabilities for uncertain tax positions in our financial statements. In addition, the outcome of these
examinations may impact the valuation of certain deferred tax assets (such as net operating losses and credit carryforwards) in future periods. Based on the number of tax years currently under audit by the relevant taxing authorities, the Company
anticipates that some of these audits may be finalized in the foreseeable future.
During the next 12 months, the Company expects to settle
a United States federal tax audit, a Canadian federal tax audit and a state tax audit. The settlement of these audits could reduce the unrecognized tax benefits by approximately $1,500,000.
FSP FIN No. 48-1
In May 2007,
the FASB issued FASB Staff Position (FSP) FIN No. 48-1, Definition of Settlement in FASB Interpretation No. 48. FSP FIN No. 48-1 provides guidance on how to determine whether a tax position is effectively
settled for the purpose of recognizing previously unrecognized tax benefits. FSP FIN No. 48-1 is effective retroactively to April 28, 2007. The adoption of this standard did not have a significant impact on the Companys consolidated
financial position or results of operations.
SEC Final Rule Release No. 33-8876
In December 2007, the Securities and Exchange Commission (SEC) issued Final Rule Release No. 33-8876, Smaller Reporting Company
Regulatory Relief and Simplification. The SEC eliminated the category of filers defined as small business issuers and defined a new category called smaller reporting companies. This Final Rule also expanded the number
of companies eligible for the SECs scaled disclosures for smaller reporting companies. Under these amended rules, the scaled disclosures apply to reporting companies with less than $75 million in public float or less than $50 million in
revenue if they do not have a calculable public float. For existing companies, eligibility for the smaller reporting company status is based on the last business day of the companys most recent second fiscal quarter. The Company qualified as a
Smaller Reporting Company as of October 27, 2007, the end of its most recent second fiscal quarter, and will adopt the scaled disclosures in its annual report on Form 10-K for the fiscal year ended May 3, 2008.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
3.
|
ASDA Supply Arrangements
|
Greeting Cards
During the third quarter of fiscal 2008, the Companys Handleman UK Limited (Handleman UK) subsidiary determined, in
conjunction with its customer (ASDA), that their business relationship related to the greeting cards business, which began in October 2006, would terminate effective May 2008. This decision was mainly due to the customers desire to work
directly with the greeting cards vendor to service its retail stores. Upon cessation of this greeting cards business relationship, ASDA will no longer be a customer of Handleman UK. The Company expects an improvement in operating income for
Handleman UK as a result of the termination because the gross margins related to this greeting cards business were insufficient to cover the related operating costs. Greeting card sales to ASDA represented $53,518,000, or 6%, of the Companys
consolidated revenues for the first nine months of fiscal 2008 and $39,300,000, or 3%, of consolidated revenues for fiscal 2007.
Management
determined that events leading up to and resulting in this separation represented a triggering event during the third quarter of fiscal 2008. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, the Company recorded a fixed asset impairment charge of $1,439,000 primarily related to the Companys warehouse facility and related assets that were used exclusively for this product line because the carrying value of
the asset group associated with the greeting card business exceeded its fair value. This amount was recorded in the third quarter of fiscal 2008 and was included in Selling, general and administrative expenses in the Companys
Consolidated Statements of Operations. In the greeting card business model, Handleman UK does not own the greeting card product until the product is shipped from its facility. Accordingly, no inventory markdown to liquidation value is required. In
the UK, there is a statutory obligation for companies to pay severance, upon termination, to employees who will neither be transferred to a new organization (if applicable) under the Transfer of Undertakings (Protection of Employment) regulations,
nor be retained by the existing company in some other capacity. This statutory requirement is the equivalent of a benefit plan and is subject to the guidance in SFAS No. 112, Employers Accounting for Postemployment Benefits, an
amendment of FASB Statements No. 5 and 43, because there is a mutual understanding between the employee and the company. It is likely that the Company will transition certain employees to other UK activities. In accordance with SFAS
No. 5, Accounting for Contingencies, the payment of severance costs is probable, but is not estimable at this time, because the Companys transition plan has not been developed. Therefore, no severance costs have been accrued
in the third quarter of fiscal 2008 related to the termination of this greeting cards business.
The Company estimates that additional
one-time costs related to the termination of this greeting cards business will approximate $600,000. In accordance with SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, shut down costs associated with
this termination will be recorded in fiscal 2009 as incurred.
Music
On May 24, 2007, the Company announced that Handleman UK and ASDA decided not to continue their music supply arrangement. Under this arrangement,
Handleman UK provided category management and distribution of music CDs and, to a limited extent, DVDs to ASDA stores. The decision not to continue the music supply arrangement was due to the inability of Handleman UK and ASDA to reach terms that
were mutually beneficial. Music and DVD sales to
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
ASDA represented $57,339,000, or 15%, of the Companys consolidated revenues for the first nine months of fiscal 2008 (through the agreed upon
termination date) and $268,000,000, or 20%, of the Companys consolidated revenues during fiscal 2007. Handleman UK provided music category management and distribution services to ASDA through August 2007.
Management determined that events leading up to and resulting in this separation represented a triggering event during the fourth quarter of
fiscal 2007. Accordingly, the Company recorded an inventory markdown in the amount of $9,000,000 in the fourth quarter of fiscal 2007, representing the Companys best estimate of the adjustment necessary to mark inventory down to liquidation
value. This amount was included in Direct product costs in the Companys fiscal 2007 Consolidated Statements of Operations. As of January 31, 2008, the Company believes no additional inventory markdown will be required. The
Company believes this inventory markdown is adequate; however, this markdown is subject to change as the Company continues to liquidate the remaining excess inventory. Handleman UK will continue to work with the music suppliers and its other
customers in the UK, as well as other retailers, to sell off its remaining music inventory. The Company anticipates that the liquidation of the remaining inventory will be completed early in fiscal 2009.
In addition, the Company recorded an impairment charge of $734,000 related to fixed assets, because the carrying value of the asset group associated with
the music category management and distribution activities exceeded its fair value. This impairment charge was also recorded in the fourth quarter of fiscal 2007 in accordance with SFAS No. 144, and was included in Selling, general and
administrative expenses in the Companys fiscal 2007 Consolidated Statements of Operations.
The Company estimates, although it
cannot make any assurances, that additional one-time costs related to the termination of its music supply agreement will not exceed $4,000,000. In accordance with SFAS No. 146, shut down costs associated with this termination will be recorded
as incurred. For the first nine months of fiscal 2008, the Company has incurred $1,960,000 in one-time costs related to the discontinuance of the ASDA business. These amounts were included in Selling, general and administrative expenses
in the Companys Consolidated Statements of Operations. In accordance with UK Transfer of Undertakings (Protection of Employment) regulations, the Company accrued severance costs of $155,000, $68,000 and $112,000 in the first, second and third
quarters of fiscal 2008, respectively, based on the ongoing development and execution of the exit plan. These amounts were included in Selling, general and administrative expenses in the Companys Consolidated Statements of
Operations.
For the first nine months of fiscal 2008, the reduction in working capital attributable to the exited ASDA music supply
activities was approximately $41,472,000.
The table below summarizes the
components of accounts receivable balances included in the Companys Consolidated Balance Sheets (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
January 31,
2008
|
|
|
April 28,
2007
|
|
Trade accounts receivable
|
|
$
|
188,072
|
|
|
$
|
248,866
|
|
Less allowances for:
|
|
|
|
|
|
|
|
|
Gross profit impact of estimated future returns
|
|
|
(8,715
|
)
|
|
|
(8,719
|
)
|
Doubtful accounts
|
|
|
(3,934
|
)
|
|
|
(4,078
|
)
|
|
|
|
|
|
|
|
|
|
Accounts receivable, net
|
|
$
|
175,423
|
|
|
$
|
236,069
|
|
|
|
|
|
|
|
|
|
|
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
5.
|
Goodwill and Intangible Assets
|
Goodwill
The Company accounts for goodwill and intangible assets in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets. Accordingly, the Company performs an annual impairment test for goodwill and other intangible assets with indefinite lives in the fourth quarter of each fiscal year or as business conditions warrant a review. The goodwill test for
impairment is conducted on a reporting unit level, whereby the carrying value of each reporting unit, including goodwill, is compared to its fair value. Fair value is estimated using the present value of free cash flows method. Due to the upcoming
discontinuance of the greeting cards business in the UK, an impairment test of goodwill related to the Handleman UK reporting unit was performed in the third quarter of this fiscal year. As a result of this test, calculated using the above described
method, no impairment charge was recorded in the third quarter ended January 31, 2008. Additionally, the Company has not recorded any goodwill impairment during the first nine months of fiscal 2008.
Goodwill represents the excess of consideration paid over the estimated fair values of net assets of businesses acquired. Goodwill included in the
Companys Consolidated Balance Sheets as of January 31, 2008 and April 28, 2007 was $36,938,000, which was net of amortization of $1,224,000 at each of these balance sheet dates. The category management and distribution operations
reporting segment had goodwill related to the Handleman UK reporting unit of $3,406,000 (which was net of amortization of $1,224,000), at each of these balance sheet dates, while the video game operations and all other reporting segments had the
remaining $26,629,000 and $6,903,000, of goodwill, respectively.
Intangible Assets
Intangible assets predominately relate to Crave Entertainment Group, Inc. (Crave) and REPS LLC (REPS). The Company performs annual
impairment analyses in the fourth quarter, or as business conditions warrant a review, comparing the carrying value of its intangible assets with the future economic benefit of these assets. Based on such analyses, the Company adjusts, as necessary,
the value of its intangible assets. The Company has not recorded any significant impairments during the first nine months of fiscal 2008.
The Company, through its video game operations segment, distributes video game software that is internally developed, as well as video game software that is purchased from other developers.
Internally Developed Video Game Software
Crave, through one of its subsidiary companies, publishes video game titles under the Crave brand name. These titles support Sony, Nintendo and/or Microsoft video game platforms and are distributed by Crave. As a result, Crave incurs
obligations to contracted video game software developers and, in some cases, obligations to intellectual property right holders.
Under its
software development agreements, payments are typically based on the achievement of defined milestones, which vary by agreement. Such milestones include payments due at the signing of the agreements, design and/or technical achievements and delivery
of completed product; these advances are typically not refundable. These developed games are the property of Crave. Software development costs are recorded in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to
Be Sold, Leased, or Otherwise Marketed, which requires that these costs are capitalized once technological feasibility of a product is established and such
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
costs are determined to be recoverable. Under this guidance, technological feasibility should be evaluated on a product-by-product basis. Payments prior to
technological feasibility, or amounts otherwise related to software development that are not capitalized, should be charged immediately to research and development expense. Crave generally engages independent software developers experienced with the
current video game platforms developed by the manufacturers. Due to the experience of the software developers and the established game platform technology, technological feasibility is already proven prior to the beginning of, or occurs very early
in, the development cycle. Therefore, Crave typically does not incur any research and development costs. The Company did not incur any research and development costs for the nine months ended January 31, 2008 and January 31, 2007 because
technological feasibility related to the development of video game titles was established prior to the start of game development.
Software
development payments are classified as Intangible assets, net in the Companys Consolidated Balance Sheets. Commencing upon product release, these payments are amortized as royalty expense based upon the ratio of current revenues to
total projected revenues, generally over a period of 18 months, and included in Direct product costs in the Companys Consolidated Statements of Operations. The Company performs quarterly analyses, comparing the carrying value of
its software development costs with the expected sales performance of the specific products for which the costs relate. Managements judgments and estimates are utilized in the ongoing assessment of the recoverability of these advances. Based
on such analyses, the Company adjusts, when necessary, the value of its software development costs.
Certain software development agreements
may require Crave to make additional payments based on pre-defined sales volumes. Subject to these terms, once all advance payments to developers have been expensed, additional payments to developers may be required. These additional payments are
accrued as royalties and included in Accrued and other liabilities in the Companys Consolidated Balance Sheets.
Under
Craves intellectual property licensing agreements, payments are made to licensors in exchange for the rights to utilize intellectual properties owned by the licensors (e.g. popular animated characters, including all designs, themes and story
lines) that may be used in the development of video game software. Payments to licensors allow Crave the limited right to use these intellectual properties, and at no time does Crave take ownership of these intellectual properties. Advances under
these licensing agreements typically occur at the signing of the agreements and are not refundable. License advance payments are classified as Intangible assets, net in the Companys Consolidated Balance Sheets. Commencing upon
product release, these payments are amortized as royalty expense based upon the ratio of current revenues to total projected revenues, generally over a period of 18 months, and included in Direct product costs in the Companys
Consolidated Statements of Operations. The Company performs quarterly analyses comparing the carrying value of its license advances with the expected sales performance of the specific products to which the costs relate. Managements judgments
and estimates are utilized in the ongoing assessment of the recoverability of these advances. Based on such analyses, the Company adjusts, when necessary, the value of its license advances. Certain intellectual property licensing agreements may
require Crave to make additional payments based on sales volumes. Subject to these terms, once all advance payments to licensors have been expensed, additional payments to licensors may be required. These additional payments are accrued as royalties
and are included in Accrued and other liabilities in the Companys Consolidated Balance Sheets.
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
Purchased Video Game Software
Crave also purchases video game software from other software developers that support Sony, Nintendo and Microsoft video game platforms. As a distributor,
Crave occasionally enters into exclusive distribution agreements with these video game suppliers. Under these exclusive distribution agreements, Crave has the right to sole distribution of the agreed upon video software games. The agreements vary by
supplier, and may obligate Crave to pay minimum distribution fees or purchase a specified number of units over a designated period of time. Payments under these exclusive distribution agreements are usually made at the time the agreements are
signed, at the time of manufacturing, or in some instances, at the time of product receipt by Crave. These exclusive distribution advances are classified as Intangible assets, net in the Companys Consolidated Balance Sheets and are
amortized as royalty expense based upon sales of product purchased from these suppliers, and included in Direct product costs in the Companys Consolidated Statements of Operations. Under certain of these exclusive distribution
agreements, additional payments to these suppliers may be required if pre-defined minimum purchase volumes are exceeded. These additional payments are also classified as Intangible assets, net in the Companys Consolidated Balance
Sheets. Managements judgments and estimates are utilized in the ongoing assessment of the recoverability of these advances.
The
Companys future minimum payment commitments related to all of these agreements, as discussed above, are $8,699,000 as of January 31, 2008. Accrued royalties as of January 31, 2008 and April 28, 2007 totaled $946,000 and
$482,000, respectively.
The following information relates to intangible assets subject to amortization as of January 31, 2008 and
April 28, 2007 (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 31, 2008
|
|
April 28, 2007
|
Amortized
Intangible Assets
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
|
Gross
Carrying
Amount
|
|
Accumulated
Amortization
|
Trademarks
|
|
$
|
7,900
|
|
$
|
3,208
|
|
$
|
7,900
|
|
$
|
2,182
|
Customer relationships
|
|
|
28,100
|
|
|
11,149
|
|
|
28,100
|
|
|
7,547
|
Non-compete agreements
|
|
|
4,770
|
|
|
2,758
|
|
|
3,970
|
|
|
1,849
|
Software development costs and distribution/license advances
|
|
|
32,612
|
|
|
18,471
|
|
|
18,785
|
|
|
10,744
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
73,382
|
|
$
|
35,586
|
|
$
|
58,755
|
|
$
|
22,322
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 31, 2008
|
|
April 28, 2007
|
Amortized
Intangible Assets
|
|
Net
Amount
|
|
Weighted
Average
Amortization
Period
|
|
Net
Amount
|
|
Weighted
Average
Amortization
Period
|
Trademarks
|
|
$
|
4,692
|
|
|
180 mos.
|
|
$
|
5,718
|
|
|
180 mos.
|
Customer relationships
|
|
|
16,951
|
|
|
227 mos.
|
|
|
20,553
|
|
|
227 mos.
|
Non-compete agreements
|
|
|
2,012
|
|
|
39 mos.
|
|
|
2,121
|
|
|
41 mos.
|
Software development costs and distribution/license advances
|
|
|
14,141
|
|
|
18 mos.
|
|
|
8,041
|
|
|
17 mos.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
37,796
|
|
|
117 mos.
|
|
$
|
36,433
|
|
|
141 mos.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
Royalty expense related specifically to software development costs and licensed rights included in
Recoupment of development costs/licensed rights in the Companys Consolidated Statements of Cash Flows is as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
Nine Months Ended
|
Royalty Expense
|
|
January 31,
2008
|
|
January 31,
2007
|
Software development costs, including write down to net realizable value of $290 for fiscal year 2008 and $2,223 for fiscal
2007
|
|
$
|
3,651
|
|
$
|
4,949
|
Exclusive distribution rights
|
|
|
3,458
|
|
|
|
Licensed intellectual property rights, including write down to net realizable value of $38 for fiscal year 2008 and $354 for fiscal year 2007
|
|
|
618
|
|
|
1,065
|
|
|
|
|
|
|
|
Total
|
|
$
|
7,727
|
|
$
|
6,014
|
|
|
|
|
|
|
|
The Companys aggregate amortization expense related to all intangible assets for the first
nine months of fiscal 2008 and fiscal 2007 totaled $13,264,000 and $12,678,000, respectively. The Company estimates future aggregate amortization expense as follows (in thousands of dollars):
|
|
|
|
Fiscal Years
|
|
Amounts
|
2008
|
|
$
|
4,282
|
2009
|
|
|
15,436
|
2010
|
|
|
6,420
|
2011
|
|
|
2,771
|
2012
|
|
|
2,083
|
Thereafter
|
|
|
6,804
|
|
|
|
|
Total
|
|
$
|
37,796
|
|
|
|
|
On April 30, 2007, Handleman Company and
certain of its subsidiaries entered into two multi-year, secured credit agreements with GE Capital and Silver Point Finance. Company borrowings under the agreements are limited to $40,000,000 plus the collateral value of certain assets less
reserves, with a maximum of $250,000,000. On the same day, the Company terminated its amended and restated credit agreement dated November 22, 2005 with its lenders and repaid all amounts outstanding under that agreement. Absent a new
multi-year credit facility, the Company would have violated covenants under its previous credit agreement.
On January 31, 2008, the
Company had borrowings of $90,000,000 under its new agreements, all of which was borrowed under its term loans. The Companys borrowings under these credit agreements, which mature in April 2012, contain subjective acceleration clauses, and
accordingly, have been classified as a current liability as of January 31, 2008, in accordance with FASB Technical Bulletin 79-3, Subjective Acceleration Clause in Long-Term Debt Agreements. The maximum borrowings allowed by the
agreements on January 31, 2008 were $95,578,000, based
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
on the collateral value of the Companys assets. The Company had borrowings of $106,897,000 as of April 28, 2007 under the old debt agreements that
were all classified as current due to the planned termination of that agreement.
The significant terms of the new credit agreements as of
January 31, 2008 are as follows:
GE Capital Credit Agreement
Handleman Company and certain subsidiaries of Handleman Company; General Electric Corporation, as Administrative Agent, Agent and Lender; and GE Capital
Markets, Inc. as Lead Arranger, entered into a Credit Agreement dated April 30, 2007 (GE Capital Credit Agreement). Pursuant to this new five-year credit agreement, Handleman may borrow up to $110,000,000 in the aggregate for the
purpose of providing (a) working capital financing for Handleman and its subsidiaries, (b) funds to repay certain existing indebtedness of Handleman and its subsidiaries, (c) funds for general corporate purposes of Handleman and its
subsidiaries, and (d) funds for other purposes permitted by the GE Capital Credit Agreement. Pursuant to the GE Capital Credit Agreement, Handleman has granted to General Electric Capital Corporation, as agent, a security interest in and lien
upon all of the Companys existing and after-acquired personal and real property.
The material terms of the GE Capital Credit
Agreement are as follows:
|
|
|
Amount
|
|
$110,000,000
|
|
|
Maturity
|
|
5 years
|
|
|
Interest Rate
|
|
Libor plus range of 150 to 200 basis points or prime rate plus 0 to 50 basis points based on the performance grid as stated in the GE Capital Credit Agreement
|
|
|
Unused Fee
|
|
.50%
|
|
|
Collateral
|
|
First priority security interest in all accounts receivable and inventory
Second priority interest in all Term Priority Collateral
|
|
|
Covenant
|
|
Restrictions on distributions and dividends, acquisitions and investments, indebtedness, prepayments, liens and affiliate transactions, capital structure and business, guaranteed indebtedness
and asset sales as stated in the GE Capital Credit Agreement
|
Silver Point Finance Credit and Guaranty Agreement
Handleman Company and certain Handleman subsidiaries, as Guarantors; certain lenders; Silver Point Finance, LLC (Silver Point), as
administrative agent for the Lenders, in such capacity as Administrative Agent, as Collateral agent and as co-lead arranger entered into a Credit and Guaranty Agreement dated April 30, 2007 (Silver Point Finance and Guaranty
Agreement). Pursuant to this new five-year agreement, Handleman may borrow up to $140,000,000 comprised of (a) $50,000,000 aggregate principal amount of Tranche A Term Loan (Term Loan A), (b) $40,000,000 aggregate
principal amount of Tranche B Term Loan (Term Loan B), and (c) up to $50,000,000 aggregate principal amount of Revolving Commitments (Revolving Facility), the proceeds of which shall be used to (i) repay the
existing indebtedness and the existing intercompany note, (ii) finance the working capital needs and general corporate purposes of Handleman and its subsidiaries, and (iii) pay fees and expenses associated with the loan transaction and
refinancing. Handleman has secured the obligations by granting liens against substantially all of its assets.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
The material terms of the Silver Point Finance Credit and Guaranty Agreement are as follows:
|
|
|
|
|
|
|
|
|
Term
Loan A
|
|
Term
Loan B
|
|
Revolving
Facility
|
Amount
|
|
$50,000,000
|
|
$40,000,000
|
|
$50,000,000
|
|
|
|
|
Maturity
|
|
5 years
|
|
5 years
|
|
5 years
|
|
|
|
|
Interest Rate
|
|
Libor plus 400 basis points or prime rate plus 300 basis points
|
|
Libor plus 600 basis points or prime rate plus 500 basis points
|
|
Libor plus 400 basis points or prime rate plus 300 basis points
|
|
|
|
|
Unused Fee
|
|
|
|
|
|
2.00%
|
|
|
|
|
Collateral
|
|
Second priority interest in all accounts receivable and inventory that secures the GE Facility on a first priority basis and second priority
interest in the Term Priority Collateral
Third priority security interest in all GE
Collateral
|
|
First priority interest in all tangible and intangible assets (including, without limitation, all owned real estate), except the GE Collateral
Third priority security interest in all GE Collateral
|
|
Second priority interest in all accounts receivable and inventory that secures the GE Facility on a first priority basis and second priority
interest in the Term Priority Collateral
Third priority security interest in all GE
Collateral
|
Optional Prepayment
Prepayment premium of 2% on or after 24 months but prior to 36 months; 1.0% prepayment premium on or after 36 months but prior to 48 months; 0% prepayment premium on or after 48 months
Covenants to Credit Agreements
Pursuant to the GE Capital Credit Agreement and the Silver Point Finance Credit and Guaranty Agreement, Handleman must maintain a minimum excess availability, which is subject to increase, in order to borrow under these agreements if the
Company does not achieve established adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) levels on a trailing twelve-month basis.
Amendments to Credit Agreements
In June 2007, the Company and its lenders entered into a waiver and
amendment to the new credit agreements. This waiver and amendment extended the due date for certain post closing matters.
In September
2007, the Company and its lenders entered into a second amendment to the new credit agreements. This amendment suspended the daily sweep of all United States (U.S.) customer receipts to GE Capital until the Company borrows from GE
Capital and extended the period that allows the Companys UK and Canadian cash balance ceiling limits to include outstanding checks.
In November 2007, the Company and its lenders entered into a third amendment to the new credit agreements. This amendment revised the agreements to reflect the merger between two of the Companys subsidiaries, Handleman Entertainment
Resources LLC and Handleman Services Company (thereafter known as Handleman Services Company). In addition, this amendment further extended the period that allows the Companys UK and Canadian cash balance ceiling limits to include outstanding
checks. This amendment also waived two instances when the Companys Canadian cash balance exceeded authorized limits and waived the delivery of copies of certain provincial and corporate tax returns sent to the lenders no later than 15 days
after their filing. These defaults were cured prior to the filing of the Companys second quarter Form 10-Q.
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
In January 2008, the Company and its lenders entered into a fourth amendment to the new credit
agreements. This amendment extended the period that allows the Handleman UKs cash balance ceiling limits to include outstanding checks.
On March 11, 2008, the Company and its lenders entered into a fifth amendment to its credit agreements. This amendment waives a default of an affirmative covenant that relates to a recurring certificate the Company provides its
lenders. This certificate affirms that the Companys collateral assets are sufficient to support its outstanding debt. As of February 16, 2008, collateral value of the Companys assets, as defined by the credit agreements, totaled
$109.9 million; the collateral value of assets to support the Companys $90.0 million of outstanding debt, as required by the terms of the credit agreements, was $117.9 million, which did not include cash on hand of approximately $55.2 million.
The fifth amendment waives the affirmative covenant default, and reduces the amount of collateral assets the Company must maintain in order
to borrow against the credit agreements. Other significant terms within the amendment include daily collateral and accounts payable reporting; providing a rolling 13-week liquidity forecast on a weekly basis; allowing the lenders to syndicate a
portion of their credit commitment; an increase in interest rates for the Term A Loan debt and Revolving Debt Facility by 2.0% and the Term B Loan debt by 3.0%; a LIBOR and base interest rate floor of 4.5% and 7.5%, respectively; allowing for lower
levels of cash in tri-party blocked accounts in Canada and the United Kingdom; suspension of the springing EBITDA test when excess collateral reaches certain defined levels; reduction of the authorized level for capital expenditures, license
advances and required rights, and exclusive distribution advances; and the addition of a requirement that the Companys fiscal 2009 budget be completed by March 30, 2008. As consideration for the fifth amendment, the Company incurred
amendment fees of $2.5 million, payable when the amendment expires or a longer-term amendment is reached, whichever occurs first. The Company will not incur additional amendment fees associated with the negotiation of a longer-term credit amendment
with its lenders. Further, as a result of the default, the lenders, pursuant to the terms of the agreements, exercised its right to control the Companys cash effective March 4, 2008. As a result, the Company was required to pay $20.0
million of its Term A Loan debt on March 4, 2008 based on the amount of its cash balances as of that date. A prepayment premium associated with this early debt repayment in the amount of $1.6 million was incurred on March 4, 2008.
By March 30, 2008, the Company expects to complete its fiscal 2009 budget and projected cash flows, which the Company will use in attempting to
negotiate longer-term credit amendment. While Handleman intends to revise the terms of its credit agreements based on its fiscal 2009 budget, the Company cannot make any assurances that it will reach an agreement with its lenders. If the Company
cannot reach an agreement with its lenders and the lenders exercise their rights to accelerate the payment of the outstanding loan balance, then the Company will not have sufficient liquidity to fund its day-to-day operations.
7.
|
Derivatives and Market Risk
|
Derivative
Financial Instruments
In the normal course of business, Handleman Company is exposed to market risk associated with changes in interest
rates and foreign currency exchange rates. To manage a portion of these inherent risks, the Company may purchase certain types of derivative financial instruments, from time to time, based on managements judgment of the trade-off between risk,
opportunity and cost. The Company does not hold or issue derivative financial instruments for trading or speculative purposes.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
Currency Forward Contracts
The Companys business is primarily denominated in U.S. dollars. The Company typically does not enter into any contracts to hedge foreign currency
risk.
The Company has two qualified defined
benefit pension plans (pension plans) that cover substantially all full-time U.S. and Canadian employees. In addition, the Company has a nonqualified defined benefit plan, the Canadian Supplemental Executive Retirement Plan
(SERP), which covers select employees.
During the third quarter of fiscal 2008, the Company paid $4,200,000 in lump sum
payments to certain U.S. SERP executive and non-executive participants from the U.S. SERP Rabbi Trust. These payments represented final distribution of the plan assets and the U.S. SERP is no longer in existence at January 31, 2008.
Accordingly, a settlement loss of $135,000 was recorded in the third quarter of fiscal 2008, in accordance with SFAS No. 88, Employers Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination
Benefits.
During the first quarter of fiscal 2008, the Company paid $495,000 in lump sum payments to certain non-executive active and
terminated employees from the U.S. SERP Rabbi Trust. Accordingly, a settlement loss of $260,000 was recorded in the first quarter of fiscal 2008. In accordance with SFAS No. 88, the Company calculated the settlement losses and remeasured the
plan assets and benefit obligations resulting from the lump sum payments to the plan participants. As a result of remeasurement, the Company recorded an increase of $101,000 to the unfunded status of the U.S. SERP in the first quarter of fiscal
2008.
During the first quarter of fiscal 2007, the Companys Board of Directors approved amendments to freeze the Companys U.S.
pension plan and U.S. SERP. Accordingly, during the first quarter of fiscal 2007, the Company recorded non-cash curtailment charges of $680,000 and $384,000 related to the Companys U.S. pension plan and U.S. SERP, respectively. These charges
were calculated in accordance with SFAS No. 88, using actuarial assumptions as of July 29, 2006. SFAS No. 88 requires curtailment accounting if an event eliminates, for a significant number of employees, the accrual of defined
benefits for some or all of their future services. In the event of a curtailment, a loss must be recognized for the unrecognized prior service cost associated with years of service no longer expected to be rendered.
During the third quarter of fiscal 2007, the Company paid $1,737,000 in lump sum payments to certain non-executive active employees from the U.S. SERP.
The payments were made from the U.S. SERP trust. Accordingly, in accordance with SFAS No. 88, settlement loss of $215,000 was recorded during the third quarter of fiscal 2007.
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
The information below, for all periods presented, combines U.S. and Canadian pension plans and U.S.
and Canadian SERPs. Components of net periodic benefit cost are as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Plans
|
|
|
SERPs
|
|
|
Three Months Ended
|
|
|
Three Months Ended
|
|
|
January 31,
2008
|
|
|
January 31,
2007
|
|
|
January 31,
2008
|
|
January 31,
2007
|
Service cost
|
|
$
|
120
|
|
|
$
|
453
|
|
|
$
|
5
|
|
$
|
117
|
Interest cost
|
|
|
828
|
|
|
|
834
|
|
|
|
60
|
|
|
128
|
Expected return on plan assets
|
|
|
(1,853
|
)
|
|
|
(1,089
|
)
|
|
|
|
|
|
|
Amortization of unrecognized prior service cost, actuarial loss and other
|
|
|
8
|
|
|
|
34
|
|
|
|
9
|
|
|
5
|
Settlement/curtailment loss
|
|
|
|
|
|
|
|
|
|
|
135
|
|
|
215
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost
|
|
$
|
(897
|
)
|
|
$
|
232
|
|
|
$
|
209
|
|
$
|
465
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Plans
|
|
|
SERPs
|
|
|
Nine Months Ended
|
|
|
Nine Months Ended
|
|
|
January 31,
2008
|
|
|
January 31,
2007
|
|
|
January 31,
2008
|
|
January 31,
2007
|
Service cost
|
|
$
|
326
|
|
|
$
|
1,349
|
|
|
$
|
14
|
|
$
|
351
|
Interest cost
|
|
|
2,575
|
|
|
|
2,519
|
|
|
|
207
|
|
|
405
|
Expected return on plan assets
|
|
|
(3,615
|
)
|
|
|
(3,294
|
)
|
|
|
|
|
|
|
Amortization of unrecognized prior service cost, actuarial loss and other
|
|
|
53
|
|
|
|
223
|
|
|
|
24
|
|
|
81
|
Settlement/curtailment loss
|
|
|
|
|
|
|
680
|
|
|
|
395
|
|
|
599
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic benefit cost
|
|
$
|
(661
|
)
|
|
$
|
1,477
|
|
|
$
|
640
|
|
$
|
1,436
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended January 31, 2008, contributions to the Companys defined
benefit pension plans were $404,000. The Company anticipates contributing an additional $124,000 to the pension plans in the remainder of fiscal 2008, for a total contribution of $528,000. These amounts represent contributions to the Canadian
pension plan only. The Company does not expect to contribute to either the U.S. pension plan or Canadian SERP in fiscal 2008.
Contingencies
The Company has a contingent liability with a certain state taxing authority related to the filing and payment of franchise taxes. The Company feels it
has filed and paid these taxes appropriately and has filed a protest with this taxing authority. The outcome of this matter is unknown. The Company believes its potential exposure is in the range of zero to $2,800,000. However, because no
determination can be made as to the resolution of this unresolved issue, as they are neither probable nor estimable, no accrual has been recorded for this item.
The Company had the following contingent liabilities related to its acquisition of Crave during fiscal 2006: (i) up to $21,000,000 in earn out payments that were payable based upon Craves adjusted EBITDA
for the calendar years 2005, 2006 and 2007, as those figures were calculated for each year; and (ii) up to $2,000,000 to be paid on or about January 2, 2008, if three certain Crave employees remained with that entity through
December 31, 2007. In the third quarter of fiscal 2007, one of the three previously mentioned Crave employees departed, thereby reducing the
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
$2,000,000 contingent liability to $1,500,000. The Company accrued this liability over 25 months with the related expense included in Selling, general
and administrative expenses in the Companys Consolidated Statements of Operations. An adjustment in the third quarter of fiscal 2007, in the amount of $260,000, was recorded to reflect the reduction in this contingent liability. In
January 2008, the Company paid this contingent liability totaling $1,500,000. No earn out payments were achieved by Crave for calendar years 2005, 2006 or 2007.
During fiscal 2006, the Company recorded investment income of approximately $4,300,000 related to a gain on the sale of an investment in PRN, a company that provides in-store media networks. Under the terms of the
sale agreement, the Company received additional proceeds of $957,000 that were recorded in investment income during the first quarter of fiscal 2008 and may receive an additional $400,000 through September 2009, subject to general and tax
indemnification claims.
On May 22, 2007, Handleman Companys Compensation Committee adopted Handleman Companys Key Employee
Retention Plan (KERP) for executive officers and certain other employees. Management identified 53 key employees for the KERP based on (i) a high risk of the employee terminating his/her employment relationship with Handleman;
(ii) the employee being critical to Handlemans success; (iii) the employees job performance rating of good or better; (iv) the difficulty for management to replace the knowledge, skills and abilities the
employee provides Handleman; and (v) the impact suffered by Handleman as a result of the employee terminating his/her employment relationship with Handleman exceeding the cost of retaining the employee. Management determined each
employees total KERP potential payout by taking a percentage, ranging from 20% to 75%, of the employees base salary as of May 22, 2007. The key employees received 25% of the total payout if the employee was employed by Handleman up
to and on December 15, 2007; and the remaining 75% of the total payout will be paid if the employee is employed by Handleman up to and on March 15, 2009. On December 17, 2007, $764,000 was paid out to eligible employees. As of
January 31, 2008, 45 of the 53 employees originally identified remain employed by the Company. The cost associated with the second KERP installment payment to remaining key employees would total $1,980,000. The Company is accruing this
liability over the vesting period with the related expense included in Selling, general and administrative expenses in the Companys Consolidated Statements of Operations.
On November 28, 2007, Handleman announced that Mr. Albert Koch will serve as Handlemans President and Chief Executive Officer through
Handlemans engagement of AP Services, LLC. AP Services is affiliated with AlixPartners, a financial advisory firm, where Mr. Koch is Vice Chairman, Managing Director and Partner. In addition to an hourly rate and time commitment for
services, Handleman has also agreed to pay AP Services a success fee that is equal to 5% of the increase in shareholder market capitalization from the inception of the agreement through the payment due date upon the completion of the engagement. The
market capitalization on the inception date shall be determined by the number of outstanding shares (20,460,000 shares) multiplied by the average of the closing prices for the five trading days ending on November 28, 2007, which totals
$47,140,000. The minimum success fee shall be an amount equal to 20% of the AP Services billing for Mr. Kochs time from the inception of the contract through the payment due date provided that such minimum shall not exceed 20% of the
increase in market capitalization.
Litigation
The Company is not currently involved in any legal proceedings that are material or for which it does not believe it has adequate reserves. Any other legal proceedings in which the Company is involved are routine
legal matters that are incidental to the business and the ultimate outcome of
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
which is not expected to be material to future results of consolidated operations, financial position and cash flows. The Company establishes reserves for
all claims and legal proceedings based on its best estimate of the amounts it expects to pay.
10.
|
Comprehensive (Loss) Income
|
Comprehensive loss is
summarized as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
January 31,
2008
|
|
|
January 31,
2007
|
|
|
January 31,
2008
|
|
|
January 31,
2007
|
|
Net income (loss)
|
|
$
|
2,405
|
|
|
$
|
4,229
|
|
|
$
|
(31,188
|
)
|
|
$
|
(15,951
|
)
|
Changes in: Foreign currency translation adjustments, net of tax
|
|
|
(3,271
|
)
|
|
|
1,269
|
|
|
|
823
|
|
|
|
4,222
|
|
Employee benefit related adjustments, net of tax
|
|
|
297
|
|
|
|
|
|
|
|
103
|
|
|
|
|
|
Minimum pension liability, net of tax
|
|
|
|
|
|
|
(268
|
)
|
|
|
|
|
|
|
(209
|
)
|
Interest rate swap, net of tax
|
|
|
|
|
|
|
75
|
|
|
|
|
|
|
|
(41
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive (loss) income, net of tax
|
|
$
|
(569
|
)
|
|
$
|
5,305
|
|
|
$
|
(30,262
|
)
|
|
$
|
(11,979
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The table below summarizes the components of accumulated other comprehensive income included in
the Companys Consolidated Balance Sheets (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
January 31,
2008
|
|
|
April 28,
2007
|
|
Foreign currency translation adjustments
|
|
$
|
23,477
|
|
|
$
|
22,654
|
|
Employee benefit plan related adjustments
|
|
|
(5,137
|
)
|
|
|
(5,240
|
)
|
|
|
|
|
|
|
|
|
|
Total accumulated other comprehensive income
|
|
$
|
18,340
|
|
|
$
|
17,414
|
|
|
|
|
|
|
|
|
|
|
Effective with the second
quarter of fiscal 2008, the Company has changed its reportable segments to reflect how the business is managed. A segment is a component of an enterprise that has discrete financial information that is regularly reviewed by the chief operating
decision maker in deciding how to allocate resources and assess performance. The Companys REPS LLC subsidiary is now being disclosed as a separate reporting segment as it does not meet the quantitative and qualitative criteria defined in SFAS
No. 131, Disclosures about Segments of an Enterprise and Related Information, to allow it to be aggregated with another segment for reporting purposes. Prior period results have been reclassified to conform to the new reporting
segment structure.
The reportable segments of the Company are category management and distribution operations, video game operations and
all other.
Within the category management and distribution operations business segment, the Companys revenues can be categorized as
follows: (i) Category Management Revenues sales to customers who receive the full suite of category management services included with their purchase of Handleman-owned tangible products (primarily music); this suite of services includes
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
assortment management utilizing the Companys category management systems and processes, product warehousing, ticketing, direct to store shipments,
in-store field service and customer returns management; (ii) Greeting Cards Revenues sales to customers who receive only certain category management services with the purchase of Handleman-owned greeting cards, including assortment
management on replenishment orders, product warehousing, direct to store shipments, in-store field service and customer returns management; (iii) Fee-for-Services Revenues revenues generated from the sale of services performed by the
Company such as in-store field service and/or warehousing and distribution of customer-owned product; in these arrangements, the customer does not purchase tangible product from Handleman Company. For the nine months ended January 31, 2008,
revenues generated from full category management, greeting cards and fee-for-services represented 67%, 6% and 4% of the Companys consolidated revenues, respectively.
Within the video game operations business segment, the Company generates revenues from the sale and distribution of Handleman-owned video game hardware, software and accessories. Product is shipped directly to
individual stores. For the first nine months of fiscal 2008, revenues generated from the video game operations represented 22% of the Companys consolidated revenues.
The all other segment primarily represents the Companys REPS LLC operating segment. REPS provides in-store merchandising for home entertainment and consumer product brand owners at mass merchant, warehouse club
and specialty retailers. Prior to the second quarter of fiscal 2008, the operating results for REPS were included in the category management and distribution operations reporting segment. For the first nine months of fiscal 2008, revenues generated
with external customers from the all other segment represented 1% of the Companys consolidated revenues.
The accounting policies of
the segments are the same as those described in Note 1, Accounting Policies, contained in the Companys Form 10-K for the year ended April 28, 2007. The Company evaluates performance of its segments and allocates resources to
them based on income before corporate allocations, interest expense, investment (loss) income and income taxes (segment income).
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
The tables below present information about reported segments for the three months ended
January 31, 2008 and January 31, 2007 (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended January 31, 2008:
|
|
Category
Management
and
Distribution
Operations
|
|
Video
Game
Operations
|
|
|
All
Other
|
|
Total
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Category management music, video and other revenues
|
|
$
|
207,554
|
|
$
|
|
|
|
$
|
|
|
$
|
207,554
|
Greeting cards revenues
|
|
|
20,289
|
|
|
|
|
|
|
|
|
|
20,289
|
Fee-for-services revenues external customers
|
|
|
17,800
|
|
|
|
|
|
|
5,440
|
|
|
23,240
|
Fee-for-services revenues intersegment
|
|
|
|
|
|
|
|
|
|
9,000
|
|
|
9,000
|
Video game related distribution revenues
|
|
|
|
|
|
95,807
|
|
|
|
|
|
|
95,807
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment revenues
|
|
|
245,643
|
|
|
95,807
|
|
|
|
14,440
|
|
|
355,890
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,799
|
|
|
1,451
|
|
|
|
517
|
|
|
3,767
|
Segment income
|
|
|
25,175
|
|
|
5,313
|
|
|
|
2,149
|
|
|
32,637
|
Capital expenditures
|
|
|
1,694
|
|
|
33
|
|
|
|
21
|
|
|
1,748
|
|
|
|
|
|
Three Months Ended January 31, 2007:
|
|
Category
Management
and
Distribution
Operations
|
|
Video
Game
Operations
|
|
|
All
Other
|
|
Total
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Category management music, video and other revenues
|
|
$
|
369,399
|
|
$
|
|
|
|
$
|
|
|
$
|
369,399
|
Greeting cards revenues
|
|
|
20,494
|
|
|
|
|
|
|
|
|
|
20,494
|
Fee-for-services revenues external customers
|
|
|
1,624
|
|
|
|
|
|
|
4,994
|
|
|
6,618
|
Fee-for-services revenues intersegment
|
|
|
|
|
|
|
|
|
|
8,693
|
|
|
8,693
|
Video game related distribution revenues
|
|
|
|
|
|
88,514
|
|
|
|
|
|
|
88,514
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment revenues
|
|
|
391,517
|
|
|
88,514
|
|
|
|
13,687
|
|
|
493,718
|
|
|
|
|
|
Depreciation and amortization
|
|
|
1,409
|
|
|
1,763
|
|
|
|
593
|
|
|
3,765
|
Segment income (loss)
|
|
|
42,713
|
|
|
(188
|
)
|
|
|
538
|
|
|
43,063
|
Capital expenditures
|
|
|
12,027
|
|
|
(73
|
)
|
|
|
7
|
|
|
11,961
|
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
The tables below present information about reported segments for the nine months ended
January 31, 2008 and January 31, 2007 (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended January 31, 2008:
|
|
Category
Management
and
Distribution
Operations
|
|
Video
Game
Operations
|
|
|
All
Other
|
|
Total
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Category management music, video and other revenues
|
|
$
|
623,769
|
|
$
|
|
|
|
$
|
|
|
$
|
623,769
|
Greeting cards revenues
|
|
|
53,518
|
|
|
|
|
|
|
|
|
|
53,518
|
Fee-for-services revenues external customers
|
|
|
40,680
|
|
|
|
|
|
|
12,658
|
|
|
53,338
|
Fee-for services revenues intersegment
|
|
|
|
|
|
|
|
|
|
22,007
|
|
|
22,007
|
Video game related distribution revenues
|
|
|
|
|
|
205,978
|
|
|
|
|
|
|
205,978
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment revenues
|
|
|
717,967
|
|
|
205,978
|
|
|
|
34,665
|
|
|
958,610
|
|
|
|
|
|
Depreciation and amortization
|
|
|
6,121
|
|
|
4,381
|
|
|
|
1,549
|
|
|
12,051
|
Segment income
|
|
|
71,115
|
|
|
5,619
|
|
|
|
1,383
|
|
|
78,117
|
Capital expenditures
|
|
|
4,098
|
|
|
58
|
|
|
|
72
|
|
|
4,228
|
Total assets
|
|
|
339,880
|
|
|
123,329
|
|
|
|
16,359
|
|
|
479,568
|
|
|
|
|
|
Nine Months Ended January 31, 2007:
|
|
Category
Management
and
Distribution
Operations
|
|
Video
Game
Operations
|
|
|
All
Other
|
|
Total
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Category management music, video and other revenues
|
|
$
|
854,480
|
|
$
|
|
|
|
$
|
|
|
$
|
854,480
|
Greeting cards revenues
|
|
|
20,494
|
|
|
|
|
|
|
|
|
|
20,494
|
Fee-for-services revenues external customers
|
|
|
3,068
|
|
|
|
|
|
|
13,429
|
|
|
16,497
|
Fee-for services revenues intersegment
|
|
|
|
|
|
|
|
|
|
22,942
|
|
|
22,942
|
Video game related distribution revenues
|
|
|
|
|
|
164,469
|
|
|
|
|
|
|
164,469
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment revenues
|
|
|
878,042
|
|
|
164,469
|
|
|
|
36,371
|
|
|
1,078,882
|
|
|
|
|
|
Depreciation and amortization
|
|
|
5,345
|
|
|
5,371
|
|
|
|
1,774
|
|
|
12,490
|
Segment income (loss)
|
|
|
100,074
|
|
|
(7,132
|
)
|
|
|
456
|
|
|
93,398
|
Capital expenditures
|
|
|
21,788
|
|
|
214
|
|
|
|
51
|
|
|
22,053
|
Total assets
|
|
|
465,350
|
|
|
124,880
|
|
|
|
19,212
|
|
|
609,442
|
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
A reconciliation of total segment revenues to consolidated revenues, total segment depreciation and
amortization expense to consolidated depreciation and amortization expense, total segment income to consolidated income (loss) before income taxes, total segment capital expenditures to consolidated capital expenditures and total segment assets to
consolidated assets as of and for the three and nine months ended January 31, 2008 and January 31, 2007 is as follows (in thousands of dollars):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
January 31,
2008
|
|
|
January 31,
2007
|
|
|
January 31,
2008
|
|
|
January 31,
2007
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment revenues
|
|
$
|
355,890
|
|
|
$
|
493,718
|
|
|
$
|
958,610
|
|
|
$
|
1,078,882
|
|
Elimination of intersegment revenues
|
|
|
(9,000
|
)
|
|
|
(8,693
|
)
|
|
|
(22,007
|
)
|
|
|
(22,942
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated revenues
|
|
$
|
346,890
|
|
|
$
|
485,025
|
|
|
$
|
936,603
|
|
|
$
|
1,055,940
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and Amortization Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment depreciation and amortization expense
|
|
$
|
3,767
|
|
|
$
|
3,765
|
|
|
$
|
12,051
|
|
|
$
|
12,490
|
|
Corporate depreciation and amortization expense
|
|
|
1,722
|
|
|
|
1,965
|
|
|
|
5,774
|
|
|
|
5,948
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated depreciation and amortization expense
|
|
$
|
5,489
|
|
|
$
|
5,730
|
|
|
$
|
17,825
|
|
|
$
|
18,438
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (Loss) Before Income Taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment income
|
|
$
|
32,637
|
|
|
$
|
43,063
|
|
|
$
|
78,117
|
|
|
$
|
93,398
|
|
Interest expense
|
|
|
(3,488
|
)
|
|
|
(2,671
|
)
|
|
|
(9,862
|
)
|
|
|
(5,947
|
)
|
Investment (loss) income
|
|
|
(195
|
)
|
|
|
929
|
|
|
|
(1,886
|
)
|
|
|
1,405
|
|
Corporate expenses
|
|
|
(24,617
|
)
|
|
|
(35,250
|
)
|
|
|
(94,728
|
)
|
|
|
(113,357
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated income (loss) before income taxes
|
|
$
|
4,337
|
|
|
$
|
6,071
|
|
|
$
|
(28,359
|
)
|
|
$
|
(24,501
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital Expenditures
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment capital expenditures
|
|
$
|
1,748
|
|
|
$
|
11,961
|
|
|
$
|
4,228
|
|
|
$
|
22,053
|
|
Corporate capital expenditures
|
|
|
580
|
|
|
|
347
|
|
|
|
1,727
|
|
|
|
1,180
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated capital expenditures
|
|
$
|
2,328
|
|
|
$
|
12,308
|
|
|
$
|
5,955
|
|
|
$
|
23,233
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment assets
|
|
|
|
|
|
|
|
|
|
$
|
479,568
|
|
|
$
|
609,442
|
|
Corporate assets
|
|
|
|
|
|
|
|
|
|
|
54,997
|
|
|
|
68,758
|
|
Elimination of intercompany receivables and payables
|
|
|
|
|
|
|
|
|
|
|
(50,760
|
)
|
|
|
(38,940
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated assets
|
|
|
|
|
|
|
|
|
|
$
|
483,805
|
|
|
$
|
639,260
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
12.
|
Common Stock Basic and Diluted Shares
|
A
reconciliation of the weighted average shares used in the calculation of basic and diluted shares is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
|
January 31,
2008
|
|
January 31,
2007
|
|
January 31,
2008
|
|
January 31,
2007
|
Weighted average shares during the period basic
|
|
20,357
|
|
20,163
|
|
20,315
|
|
20,102
|
Additional shares from assumed exercise of stock-based compensation
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares adjusted for assumed exercise of stock-based compensation diluted
|
|
20,357
|
|
20,201
|
|
20,315
|
|
20,102
|
|
|
|
|
|
|
|
|
|
Options to purchase 613,761 shares of common stock were outstanding as of January 31, 2008,
but were not included in the computation of diluted earnings per share because the options exercise prices were greater than the average market price of the common shares.
The effective income tax rates for
the third quarters of fiscal 2008 and 2007 were 44.5% and 30.3%, respectively. The effective income tax rates for the first nine months of fiscal 2008 and 2007 were (10.0)% and 34.9%, respectively. No income tax benefit was recorded on operating
losses incurred during the third quarter and first nine months of fiscal 2008 due to the Companys uncertainty as to whether these benefits would be realized in the future. The Company does not receive an income tax benefit from operating
losses incurred in certain taxing jurisdictions. The income tax expense recorded in the third quarter and first nine months of this fiscal year resulted from income taxes related to taxable income in certain foreign taxing jurisdictions and an
additional valuation allowance recorded on deferred tax assets. The additional valuation allowance was driven by the Companys filing of its fiscal 2007 income tax return in the third quarter of this fiscal year, because it determined that it
insufficiently estimated timing differences when preparing the income tax provision for the fiscal year ended April 28, 2007. As a result, additional income tax expense of $376,000 was recorded in the third quarter of this fiscal year.
Management also determined that this amount did not materially impact the financial results for any individual quarter or year-to-date period within fiscal 2008 or fiscal 2007.
The Company has a 23.6% equity
investment in a start-up venture that offered online music distribution that linked right holders (artists, record labels and media companies) directly with retailers and consumers. Although this investment satisfied the requirements for
classification as a variable interest entity (VIE) in accordance with the guidance in FIN No. 46 (revised December 2003), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, the Company
determined that it was not the primary beneficiary, therefore the operating results of this VIE were not consolidated with those of the Company. As a result, the Company recorded this investment under the equity method of accounting.
On November 30, 2007, the VIE defaulted on its first installment on a loan repayment to the Company in the amount of approximately $768,000. This
default, coupled with other events
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
occurring in the second quarter of this year, including the loss of a major customer by the VIE and a request by the VIE for additional cash funding from the
Company to finance ongoing operations, were deemed triggering events, indicating that the Companys carrying value of its investment in this VIE may exceed its fair value. Therefore, an impairment test was performed in accordance
with the guidance in Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, that resulted in an impairment charge in the second quarter of fiscal 2008 in the amount of
$3,454,000. This charge was included in Investment (loss) income in the Companys Consolidated Statements of Operations.
Further, the loan receivable from the VIE in the amount of $3,167,000 was written off in the second quarter of this year because the Company believed the VIE could not generate sufficient cash flows from its operations to fund its debt
repayments to the Company in consideration of the events occurring in the second quarter of this fiscal year, as described above. This loan receivable write-off was included in Selling, general and administrative expenses in the
Companys Consolidated Statements of Operations.
This VIE had been in discussions with potential investors to secure funding. During
the third quarter of fiscal 2008, it was determined that the additional funding would not be secured and that the VIE would be unable to finance ongoing operations. Accordingly, the remaining investment of $351,000 was deemed impaired in the third
quarter, written off and included in Investment (loss) income in the Companys Consolidated Statements of Operations.
On February 18, 2008,
Handleman Company announced that it accepted the resignation of Mr. Thomas C. Braum, Jr. from his position as Handlemans Executive Vice President and Chief Financial Officer and that Mr. Khaled Haram will serve as
Handlemans Senior Vice President and Chief Financial Officer. Mr. Haram has been with Handleman Company since April 2006 when he was hired as Senior Vice President and Chief Information Officer. In 2007, he assumed the responsibility for
Handleman United Kingdom. The Information Technology division will continue to report to Mr. Haram in his new role.
On March 11,
2008, the Company entered into a fifth amendment to its new credit agreements. See Note 6 of Notes to Consolidated Financial Statements for more information.
The Companys financial
statements have been presented on the basis that it is a going concern, which contemplates the continuity of operations, realization of assets and the satisfaction of liabilities in the ordinary course of business. In preparing its consolidated
financial statements, the Company considered its ability to continue as a going concern due to its results of operations, borrowing availability under its credit agreements and its ability to successfully negotiate a longer-term credit amendment
with its lenders to replace the fifth amendment to its credit agreements.
The Company has some ability to reduce or delay its capital
expenditures and manage working capital to improve cash generated from operations. The Companys current projections indicate that it will have sufficient cash flow to support its operations, fund working capital and capital expenditures, and
satisfy debt service requirements through fiscal 2009, if it remains in compliance with its credit agreements and if its vendors do not significantly change vendor terms.
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
Absent a revised longer-term amendment, the Company would not comply with the terms of its credit
agreements beyond May 31, 2008, and the lenders could accelerate repayment of the Companys debt. If the Company is unable to generate additional funds through the sale of assets, subsidiaries or securities, or is unable to secure
alternative financing, then its ability to continue as a going concern would be in doubt.
27