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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Quarter Ended May 27, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-26772
COLDWATER CREEK INC.
(Exact name of registrant as specified in its charter)
DELAWARE 82-0419266
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE COLDWATER CREEK DRIVE, SANDPOINT, IDAHO 83864
(Address of principal executive offices)
(208) 263-2266
(Registrant's 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.
YES X NO ____
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class Shares outstanding as of July 6, 2000
-------------------------------- --------------------------------------------
Common Stock ($.01 par value) 10,443,520
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INDEX TO FORM 10-Q
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PART I. FINANCIAL INFORMATION
Page
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Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets at May 27, 2000 and February 26, 2000.................................. 4
Consolidated Statements of Operations for the three month periods ended
May 27, 2000 and May 29, 1999.................................................................... 5
Consolidated Statements of Cash Flows for the three month periods ended
May 27, 2000 and May 29, 1999.................................................................... 6
Notes to Consolidated Financial Statements......................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 24
Item 2. Changes in Securities and Use of Proceeds................................................. 24
Item 3. Defaults Upon Senior Securities........................................................... 24
Item 4. Submission of Matters to a Vote of Security Holders....................................... 24
Item 5. Other Information......................................................................... 24
Item 6. Exhibits and Reports on Form 8-K.......................................................... 24
</TABLE>
This report may contain forward-looking statements that involve risks and
uncertainties. When used in this discussion, the words "anticipate," "believe,"
"estimate," "expect," and similar expressions as they relate to the Company or
its management are intended to identify such forward-looking statements. The
Company's actual results could differ materially from the results anticipated in
these forward-looking statements as a result of certain factors set forth under
"Management's Discussion and Analysis - Risk Factors" and elsewhere in this
report.
2
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PART I. FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
3
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COLDWATER CREEK INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(in thousands, except for share data)
May 27, February 26,
2000 2000
------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 19,459 $ 7,533
Receivables 4,466 5,741
Inventories 56,016 60,203
Prepaid expenses 1,459 1,319
Prepaid catalog costs 1,017 3,994
Deferred income taxes 1,728 915
-------- --------
Total current assets 84,145 79,705
Deferred catalog costs 6,459 2,817
Property and equipment, net 38,207 38,895
Executive loans 1,236 1,453
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Total assets $130,047 $122,870
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 30,577 $ 30,098
Accrued liabilities 15,104 13,549
Income taxes payable 2,737 2,140
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Total current liabilities 48,418 45,787
Deferred income taxes 513 513
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Total liabilities 48,931 46,300
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Commitments and contingencies - -
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 1,000,000
shares authorized, none issued and - -
outstanding
Common stock, $.01 par value, 15,000,000
shares authorized, 10,382,945 and
10,319,345 issued and outstanding,
respectively 104 103
Additional paid-in capital 42,529 41,579
Retained earnings 38,483 34,888
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Total stockholders' equity 81,116 76,570
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Total liabilities and stockholders' $130,047 $122,870
equity ======== ========
The accompanying notes are an integral part of these financial statements.
4
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COLDWATER CREEK INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share data)
Three Months Ended
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May 27, May 29,
2000 1999
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Net sales $86,891 $65,135
Cost of sales 42,971 30,941
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Gross profit 43,920 34,194
Selling, general and administrative expenses 38,236 31,627
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Income from operations 5,684 2,567
Interest, net, and other 219 46
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Income before provision for income taxes 5,903 2,613
Provision for income taxes 2,308 1,044
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Net income $ 3,595 $ 1,569
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Net income per share - Basic $ 0.35 $ 0.15
======= =======
Weighted average shares outstanding - Basic 10,350 10,184
Net income per share - Diluted $ 0.34 $ 0.15
======= =======
Weighted average shares outstanding - Diluted 10,707 10,386
The accompanying notes are an integral part of these financial statements.
5
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<TABLE>
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COLDWATER CREEK INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended
------------------------------
May 27, May 29,
2000 1999
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OPERATING ACTIVITIES:
Net income $ 3,595 $ 1,569
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Non-cash items:
Depreciation and amortization 2,142 1,629
Deferred income tax benefit (813) -
Other non-cash charges 166 -
Net change in current assets and liabilities:
Receivables 1,275 (584)
Inventories 4,187 5,640
Prepaid expenses (140) 278
Prepaid catalog costs 2,977 3,608
Accounts payable 479 3,900
Accrued liabilities 1,555 2,496
Income taxes payable 904 (3,625)
(Increase) decrease in deferred catalog costs (3,642) 781
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Net cash provided by operating activities $ 12,685 $ 15,692
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INVESTING ACTIVITIES:
Purchase of property and equipment $ (1,563) $ (1,574)
Repayments of loans to executives 161 -
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Net cash used in investing activities $ (1,402) $ (1,574)
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FINANCING ACTIVITIES:
Net repayments of advances under revolving line of credit $ - $ (9,938)
Net proceeds from exercises of stock options 643 38
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Net cash provided by (used in) financing activities $ 643 $ (9,900)
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Net increase in cash and cash equivalents 11,926 4,218
Cash and cash equivalents, beginning 7,533 149
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Cash and cash equivalents, ending $ 19,459 $ 4,367
======== ========
SUPPLEMENTAL CASH FLOW DATA:
Cash paid for interest $ - $ 44
Cash paid for income taxes 2,225 4,669
Tax benefit from exercises of stock options 307 -
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
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COLDWATER CREEK INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. Interim Condensed Consolidated Financial Statements
Organizational Structure and Nature of Operations
Coldwater Creek Inc. (the "Company"), a Delaware corporation headquartered
in Sandpoint, Idaho, is a multi-channel retailer of women's apparel, jewelry,
gifts and soft home accessories, primarily marketing its merchandise through
targeted catalog mailings, an interactive e-commerce web site
(www.coldwatercreek.com) and full-line retail stores.
-----------------------
Through its wholly owned subsidiary, Coldwater Creek Outlet Stores Inc.,
the Company also operates outlet stores, which along with the web site and
periodic clearance catalogs, serve as disposition vehicles for excess
merchandise inventory. This subsidiary is consolidated in these financial
statements and all material intercompany balances and transactions have been
eliminated.
Preparation of Interim Condensed Consolidated Financial Statements
The interim condensed consolidated financial statements included herein
have been prepared by the management of Coldwater Creek Inc., without audit,
pursuant to the rules and regulations of the United States Securities and
Exchange Commission, and in the opinion of management, contain all adjustments
(consisting of only normal recurring adjustments) necessary to present fairly
the Company's consolidated financial position, results of operations and cash
flows for the periods presented. Certain information and note disclosures
normally included in consolidated financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although the Company believes that the
disclosures are adequate to make the information presented not misleading. The
consolidated financial position, results of operations and cash flows for the
interim periods disclosed within this report are not necessarily indicative of
future financial results. These consolidated financial statements are condensed
and should be read in conjunction with the consolidated financial statements and
the notes thereto included in the Company's latest Annual Report on Form 10-K
which includes audited consolidated financial statements and related notes
thereto for the fiscal year ended February 26, 2000.
Use of Estimates
The preparation of condensed consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses and disclosure of contingent assets and
liabilities at the date of the condensed consolidated financial statements.
Actual results could differ from those estimates.
Fiscal Periods
References to a fiscal year refer to the calendar year in which such fiscal
year commences. The Company's fiscal year ends on the Saturday immediately
preceding or following February 28, whichever is chronologically closer. The
fiscal year is generally 52 weeks, but occasionally will consist of 53 weeks, as
will be the case in the current fiscal year 2000. References to three month
periods generally refer to the respective thirteen weeks ended on the date
indicated, as is the case for the interim periods presented herein, but
occassionally will include a fourteenth week as will be the case in the fourth
quarter of fiscal year 2000.
Reclassifications
Certain amounts in the condensed consolidated financial statements for the
prior fiscal year interim period have been reclassified to be consistent with
the current fiscal year's interim presentation.
7
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COLDWATER CREEK INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Interim Condensed Consolidated Financial Statements (continued)
Recently Issued Accounting Standards Not Yet Adopted
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires that
every derivative instrument (including certain derivative instruments embedded
in other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. In June 1999, the FASB issued Statement of
Financial Accounting Standard No. 137, "Accounting for Derivative Instruments
and Hedging Activities - Deferral of the Effective Date of FASB Statement No.
133" delaying the effective date of SFAS No. 133. In June 2000, the FASB issued
Statement of Financial Accounting Standard No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities" amending certain
accounting and reporting standards of SFAS No. 133. SFAS No. 133, as amended, is
effective for the Company's fiscal 2001 financial statements. As the Company
currently is not a party to any derivative financial instruments and does not
anticipate becoming a party to any derivative instruments, management does not
currently expect the adoption of SFAS No. 133, as amended, to have a material
impact on the Company's consolidated financial statements.
In May 2000, the Emerging Issues Task Force issued EITF 00-14, "Accounting
for Certain Sales Incentives." Under the provisions of EITF 00-14, for sales
incentives that will not result in a loss on the sale of a product or service, a
vendor should recognize the "cost" of the sales incentive at the latter of the
date the related revenue is recorded by the vendor or the date the sales
incentive is offered. The reduction to or refund of the selling price of the
product or service resulting from any cash sales incentive should be classified
as a reduction of revenue. The EITF is effective for reporting periods beginning
after May 18, 2000. Management does not expect the adoption of EITF 00-14 to
have a material impact on the Company's consolidated financial statements.
2. Revolving Line of Credit
The Company maintains an aggregate $50.0 million bank credit facility,
consisting of an unsecured revolving line of credit of $47.4 million (with a
sub-limit of $7.0 million for letters of credit) and a term standby letter of
credit of $2.6 million. At the option of the Company, the interest rate is the
bank's Prime Rate or Adjusted LIBOR [i.e., rate per annum equal to the quotient
of the London Interbank Offered Rate divided by one (1) minus the Eurocurrency
Reserve Requirement for the applicable Interest Period, rounded upward, if
necessary, to the nearest one-sixteenth of one percent], increased or decreased
by a margin based upon the Company's then EBITDA Coverage Ratio, as defined.
The underlying bank credit agreement provides that the Company must satisfy
certain specified EBITDA, leverage and current ratio requirements and places
restrictions on the Company's ability to, among other things, sell assets,
participate in mergers, incur debt, pay dividends, and make investments or
guarantees. The credit facility has a maturity date of June 30, 2001. On July
10, 2000, the Company received a letter of commitment from its lead bank to
increase the aggregate borrowing capacity allowed under the above credit
facility by $30 million to $80.0 million and extending its maturity to July 31,
2003.
3. Executive Loan and Incentive Compensation Programs
Effective June 30, 1997, the Company established an Executive Loan Program
under which the Company may make, at its sole discretion and with prior
approvals from the Chief Executive Officer and the Board of Directors'
Compensation Committee, secured long-term loans to key executives other than
Dennis and Ann Pence. Each loan is secured by the executive's personal net
assets, inclusive of all vested stock options in the Company, bears interest at
three percent per annum, and becomes due and payable on the earlier of (i) the
date ten days before the date on which the vested stock options serving as
partial security expire or (ii) ninety days from the date on which the
executive's employment with the Company terminates for any reason.
During fiscal 1999, as an additional incentive to retain key executives,
the Board of Directors authorized a compensation bonus pool of up to $1.6
million. The portion of the compensation bonus pool designated to each key
executive will be payable in lump sum on September 25, 2001 provided that
certain specified performance criteria over a 24 month period have been met by
both the key executive and the Company as a whole. The Company is accruing the
related compensation expense to each key employee on a straight-line basis over
the period based on performance to date and the current expectation that the
specified performance criteria will be met by both the key employee and the
Company as a whole.
8
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COLDWATER CREEK INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. 1996 Stock Option/Stock Issuance Plan
The Company's 1996 Stock Option/Stock Issuance Plan (the "1996 Plan") was
adopted by the Board of Directors and approved by the stockholders on March 4,
1996. Since February 13, 1998, 1,461,847 shares of common stock have been
authorized for issuance under the 1996 Plan. On May 20, 2000, the Company's
Board of Directors authorized an additional 100,000 shares of common stock for
issuance under the 1996 Plan. The addition of these 100,000 shares to the 1996
Plan is subject to approval by a majority of shareholders at the Company's
annual meeting scheduled for July 15, 2000.
5. Earnings Per Share
The following is a reconciliation of the number of common shares used in
the computations of net income per basic and diluted share. Net income per basic
common share is computed by dividing net income by the weighted average number
of common shares outstanding for the period. Net income per diluted common share
reflects the potential dilution that could occur if securities or other
contracts to issue common stock (e.g., stock options) were exercised or
converted into common stock. (in thousands):
Three Months Ended
---------------------------
May 27, 2000 May 29, 1999
---------------------------
Net income $ 3,595 $ 1,569
======= =======
Average shares outstanding used to
determine net income per basic common
share 10,350 10,184
Net effect of dilutive stock options based
on the treasury stock method using
average market price (1) 357 202
-----------------------
Average shares used to determine net
income per diluted common share 10,707 10,386
=======================
(1) Anti-dilutive stock options excluded from the above computations for the
three months ended May 27, 2000 and May 29, 1999 were 217 and 754,
respectively.
6. Contingencies
The Company is involved in litigation and administrative proceedings
primarily arising in the normal course of its business. In the opinion of
management, the Company's liability, if any, under any pending litigation or
administrative proceedings would not materially affect its financial position,
results of operations or cash flows.
The Company and its subsidiary only collect sales taxes from customers
transacting purchases in states which the Company or its subsidiary have
physically based some portion of their retailing business. The Company and its
subsidiary also pay applicable corporate income, franchise and other taxes to
states in which retail or outlet stores are physically located. Various states
have attempted to collect back sales and use taxes from direct marketers whose
only contacts with the taxing state are the distribution of catalogs and other
advertisement materials through the mail, and whose subsequent delivery of
purchased goods is by mail or interstate common carriers. The U.S. Supreme
Court has held that these states, absent
9
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COLDWATER CREEK INC. AND SUBSIDIARY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. Contingencies (continued)
Congressional legislation, may not impose tax collection obligations on an out-
of-state mail order company. The Company anticipates that any legislative
changes regarding direct marketers, if adopted, would be applied only on a
prospective basis.
10
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion may contain forward-looking statements, including
statements regarding our strategies, sales trends and operations, within the
meaning of the federal securities laws which involve risks and uncertainties.
When used in this discussion, the words "anticipate," "believe," "estimate,"
"expect," and similar expressions are intended to identify such forward-looking
statements. These statements are based on our current expectations and our
actual results, performance or achievements could differ materially from the
results expressed in, or implied by, these forward-looking statements. Factors
that could cause or contribute to such differences include, among others, the
following: those associated with offering apparel merchandise such as long lead
times, increased inventory requirements, merchandise returns, and high shipping
costs; general economic and business conditions and other factors outside our
control such as customer response rates, consumer preferences, and fluctuations
in paper, postage and telecommunication costs; competition; effects of shifting
patterns of e-commerce versus catalog purchases; success of operating and
growth initiatives; development and operating costs; advertising and promotional
efforts; brand awareness; the existence or absence of adverse publicity;
availability, locations and terms of sites for store development; changes in
business strategy or development plans; quality of management; availability,
terms and deployment of capital; business abilities and judgment of personnel;
availability of qualified personnel; labor and employee benefit costs; and
construction costs; as well as those factors discussed in this Form 10-Q
Quarterly Report as well as in our most recent Form 10-K Annual Report filed
with the U.S. Securities and Exchange Commission. References to a fiscal year
refer to the calendar year in which such fiscal year commences. Our fiscal year
ends on the Saturday immediately preceding or following February 28, whichever
is chronologically closer. Our fiscal year is generally 52 weeks, but
occasionally will consist of 53 weeks, as will be the case in the current fiscal
year 2000. References to three month periods generally refer to the respective
thirteen weeks ended on the date indicated, as is the case for the interim
periods presented herein, but occassionally will include a fourteenth week as
will be the case in the fourth quarter of fiscal year 2000.
Overview
--------
Coldwater Creek (the "Company") is a retailer of women's apparel, jewelry,
gifts and soft home accessories. Our long-standing mission has been to
differentiate ourself from other retailers by offering exceptional value through
superior customer service and a merchandise assortment that reflects a relaxed
and casual lifestyle. We endeavor to continually offer unique assortments of
merchandise targeted to our core customer demographic of women between the ages
of 35 to 55 with household incomes in excess of $50,000.
Our most recently completed fiscal year ended February 26, 2000 ("fiscal
1999") was a milestone year in the sixteen year history of Coldwater Creek as we
embarked on a major program of evolution and expansion. First and foremost, we
successfully transitioned the Company from its historical roots as a single-
channel catalog retailer into a more dynamic retailer with two distinct
channels, Direct and Retail. Our Direct Channel encompasses our traditional
catalog business and rapidly growing e-commerce business whereas our Retail
Channel encompasses our expanding base of full-line retail stores.
We will in the future continue to use the competitive advantages provided
by our well-established catalog infrastructure, a resource not available to
single-channel e-commerce retailers, to generate revenues across all of our
sales channels, target new customers and introduce new merchandise lines. We
believe that our new multi-channel structure positions us well for increased
growth and market share in the future.
Recognizing early into fiscal 1999 that our targeted core demographic of
customers was beginning to enthusiastically embrace the Internet as an exciting,
convenient and secure shopping medium, we evolved our previously modest and
largely informational web site into a fully-interactive, user-friendly e-
commerce web site (www.coldwatercreek.com) where current and prospective
customers could enjoyably shop and purchase from our entire line of merchandise.
Our online sales for fiscal 1999 were profitable on a full-cost basis, unlike
those of many notable and highly touted e-commerce ventures, and contributed
$26.1 million, or 8.0% of consolidated net sales, as compared to only $400,000
for the prior fiscal year. Continuing the quarter-over-quarter sales increases
realized throughout fiscal 1999, our online sales momemtum carried beyond the
third and fourth quarters of fiscal 1999, which encompassed the holiday shopping
season, and through the first quarter of fiscal 2000. Online sales accounted for
$13.2 million, or 15.2%, of fiscal 2000 first quarter consolidated net sales as
compared to only $0.8 million of fiscal 1999 first quarter consolidated net
sales.
We have also been very pleased that, on average, a measurable percentage of
the customers patronizing our web site have had no previous history with the
Company. This indicates to us that, in addition to providing for certain
longer-term operating efficiencies, our web site is not merely redistributing
sales among our channels but is measurably contributing to our overall
consolidated sales growth.
11
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Overview (continued)
--------------------
Beginning in fiscal 1999, our web site also quickly became our most effective
and efficient promotional vehicle for the disposition of excess catalog
merchandise inventory, so much so, that we have subsequently closed two outlet
stores and are evaluating the possible closure of two or more of our remaining
eleven leased outlet stores during fiscal 2000.
Encouraged by the ongoing success of our e-commerce web site, we have
continued to implement new technologies to further enhance its appeal,
informational content, functionality, and most importantly, user friendliness.
Currently, our web site offers with a click of a mouse button product search
capabilities, detailed product specifications and care instructions, real-time
inventory availability, live Quitnus-based customer service chat assistance with
an average response time of approximately 15 - 20 seconds and e-mail customer
service inquiry with an average response time of approximately 20 minutes. In
addition to advertising our web site in various publications popular with our
targeted demographic base, we continue to actively disseminate our web site's
address (www.coldwatercreek.com) in all of our catalogs and stores. So as to
encourage further customer migration and loyalty to this more cost efficient
shopping medium, we are continuing to provide numerous incentives, most recently
being same day shipment via air delivery at no additional surcharge. We are
further supplementing this migration effort with weekly targeted e-mails using
HTML to our approximately 750,000 name e-mail database, which we currently are
expanding daily by approximately 1,000 to 2,000 e-mail addresses.
Additionally, we are embarking on an international e-commerce effort with
Japanese, German and Scandinavian web sites scheduled to come online by the
fiscal 2000 year-end. Each site will have the same capabilities as the U.S.
site and will be fully translated into the native language. In anticipation of
the Japanese site coming online, we have already executed an agreement with the
U.S. Postal Service Global Package Link to ensure delivery to Japanese customers
within three to five days of their order and have established a dedicated
Japanese return center.
Believing that the ability to occasionally "touch and feel" merchandise
will remain a coveted aspect of the American woman's shopping experience and to
provide another means by which to introduce current and prospective customers to
our catalogs and e-commerce web site, we have also embarked on a program of
selectively establishing for the first time full-line retail stores in highly-
trafficked urban areas. Just prior to the 1999 holiday shopping season, we
opened two full-line "urban" retail stores in Seattle, Washington and Kansas
City, Kansas which continue to perform above our initial expectations. These new
stores, despite being in urban settings, retain the Coldwater Creek ambience of
soft woods, natural lighting and soothing waterfalls, are in addition to our two
previously existing full-line "destination" or "resort" retail stores in
Sandpoint, Idaho and Jackson Hole, Wyoming. Based on the success we have
realized to date with our pilot "urban" retail stores in Seattle and Kansas City
and our geographic analysis of brand recognition, we have identified
approximately 80 attractive urban markets in 29 states and are currently
committed to opening at least five additional full-line "urban" retail stores
during fiscal 2000, including stores in the Cincinnati, Dallas, Denver and
Chicago metropolitan areas for which we have recently executed leases.
Additional store openings will be influenced by, among other factors, our
ability to timely procure optimum locations within major urban malls and
lifestyle centers.
Also, in an attempt to fulfill what we believe to be an underserved niche
of women's apparel, we introduced in February 2000 a new complementary apparel
line entitled Natural Elements which features mix and match, versatile, casual
separates in a vast array of colors and extended sizes. This complementary new
line, which we rolled-out across all of our sales channels, is in addition to
our three established merchandise lines. Our Northcountry line, first introduced
in 1985, remains the Company's core line of merchandise and features casual,
comfortable apparel, hard-to-find jewelry, distinctive artwork, gifts and items
for the home. Introduced in 1993, our recently updated Spirit of the West line
features fashionable, upscale apparel and hard-to-find jewelry and accessories.
Our Home line, a recent expansion upon our previously successful Bed & Bath line
first introduced in 1997, features unique and comfortable textiles, decorative
accessories and upscale bed and bath products. It is our current growth plan for
the balance of fiscal 2000 to maintain the consistent performance of
Northcountry, escalate our catalog circulation of
12
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Overview (continued)
--------------------
Spirit of the West and Natural Elements, and further refine the performance of
Home.
So as to alleviate certain past capacity constraints at our distribution
center in Sandpoint, Idaho, reduce shipping costs to our largest customer
concentration in the eastern United States and accommodate our current and
future growth initiatives, we opened a new 600,000 square foot East Coast
Operations Center in Mineral Wells, West Virginia during July of 1999. This new
facility immediately met our initial minimum targets for order processing, which
we attribute to our extensive planning and piloting efforts, and has
subsequently continued to realize incremental productivity improvements which we
believe will continue into the foreseeable future. With the addition of this
new facility, we now have a consolidated base of operations capable of
processing approximately 120,000 customer orders a day.
Our revenues and results of operations have fluctuated and can be expected
to continue to fluctuate on a quarterly basis as a result of a number of
factors, including, among other things, the timing of new merchandise and
related offerings, recognition of net sales and costs contributed by new
merchandise and related offerings, fluctuations in customer response rates,
fluctuations in paper, production, postage and telecommunication costs and
expenses, merchandise returns, unseasonal weather conditions affecting customer
demand, adverse weather conditions affecting distribution or shipping, shifts in
the timing of holidays and changes in our merchandise mix.
We defer the recognition of catalog development and production costs and
record them as related catalog sales are recognized. Consequently, quarter to
quarter revenue and expense comparisons will be impacted by the timing of the
mailing of our catalogs. Mailings may occur in different quarters from year to
year depending on the performance of third party couriers, the day of the week
on which certain holidays fall and our assessment of prevailing market
opportunities. Approximately three-quarters of the revenue generated by each
catalog mailing is recognized within the subsequent 30 to 45 days. A portion of
the revenue from a catalog mailing may also be recognized in the quarter after
the quarter in which the catalog was mailed and the revenue from a particular
catalog offering may be recognized in a quarter different from the quarter in
which the revenue from a similar catalog offering was recognized in the previous
year.
We have experienced, and will likely continue to experience, seasonal
fluctuations in our sales and operating results, which are typical of many
apparel retailers. Historically, each fiscal year's net sales and profits have
been heavily reliant on the November and December holiday season. In
anticipation of increased sales activity during November and December, we incur
significant additional expenses, including the hiring of a substantial number of
temporary employees to supplement our permanent, full-time staff. In addition,
due to the larger percentage of gifts and accessories offered in the second half
of the fiscal year related to holiday gift-giving, we normally expect higher
gross margins in the second half of the fiscal year than in the first half. If,
for any reason, our sales were to fall below expectations during November and
December, our financial condition, results of operations and cash flows could be
materially adversely affected.
13
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Results of Operations
---------------------
The following table sets forth certain information regarding the Company's
consolidated costs and expenses expressed as a percentage of consolidated net
sales:
<TABLE>
<CAPTION>
Three Months Ended
------------------
May 27, 2000 May 29, 1999
------------ ------------
<S> <C> <C>
Net sales 100.0% 100.0%
Cost of sales 49.5 47.5
----- -----
Gross profit 50.5 52.5
Selling, general and administrative expenses 44.0 48.6
----- -----
Income from operations 6.5 3.9
Interest, net, and other 0.3 0.1
----- -----
Income before provision for income taxes 6.8 4.0
Provision for income taxes 2.7 1.6
----- -----
Net income 4.1% 2.4%
===== =====
</TABLE>
Note: Certain of the above sub-totals and totals may vary arithmetically due to
the effects of rounding.
Three Months Ended May 27, 2000 Compared to Three Months Ended May 29, 1999
---------------------------------------------------------------------------
Our consolidated net sales for the three months ended May 27, 2000 ("fiscal
2000 first quarter") were $86.9 million, an increase of $21.8 million, or 33.4%,
from the $65.1 million in consolidated net sales realized during the three
months ended May 29, 1999 ("fiscal 1999 first quarter"). Our Direct Channel,
which encompasses our catalog and Internet businesses, contributed $83.1 million
in net sales during the fiscal 2000 first quarter, an increase of $19.5 million,
or 30.7%, from the $63.6 million in net sales contributed during the fiscal 1999
first quarter. Our rapidly growing Internet e-commerce business accounted for
$13.2 million, or 15.2%, of fiscal 2000 first quarter consolidated net sales as
compared to only $0.8 million of fiscal 1999 first quarter consolidated net
sales. Our Retail Channel, currently consisting of four full-line retail stores,
contributed $3.8 million, or 4.4%, of fiscal 2000 first quarter consolidated net
sales as compared to $1.6 million, or 2.5%, of fiscal 1999 first quarter
consolidated net sales. The fiscal 2000 first quarter growth in net sales
primarily is attributable to increased customer response across all sales
channels to our spring and summer merchandise offerings, continued rapid sales
growth from our e-commerce web site and net sales from our new Natural Elements
merchandise line and new Seattle and Kansas City retail stores.
A key element of our overall marketing strategy has been to pursue an
aggressive circulation strategy when market conditions permit. Catalog mailings
were 43.1 million during the fiscal 2000 first quarter, an increase of 6.7
million, or 18.4%, from the 36.4 million catalog mailings during the fiscal 1999
first quarter. As a result of this ongoing marketing investment in current and
future customer growth, the costs of which constitute the substantial majority
of each fiscal period's selling, general and administrative expenses, our
proprietary mailing list increased by 1.2 million names, or 15.6%, to 8.9
million names at May 27, 2000 versus 7.7 million names at May 29, 1999. Active
customers, defined as a customer who has purchased from us during the preceding
twelve months, were 2.3 million at May 27, 2000 as compared to 2.1 million names
at May 29, 1999.
Gross profit, consists of net sales less cost of sales, with cost of sales
primarily being merchandise acquisition costs, freight in, handling and storage
costs. Our fiscal 2000 first quarter consolidated gross profit was $43.9
million, an increase of $9.7 million, or 28.4%, from the $34.2 million realized
during the fiscal 1999 first quarter. Our fiscal 2000 first quarter
consolidated gross margin was 50.5% versus 52.5% in the fiscal 1999 first
quarter. The increase in consolidated gross profit dollars is primarily
attributable to
14
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Results of Operations (continued)
---------------------------------
Three Months Ended May 27, 2000 Compared to Three Months Ended May 29, 1999
---------------------------------------------------------------------------
(continued)
-----------
the sales increases outlined above. The decrease in the consolidated gross
margin rate is primarily attributable to increased distribution capacity costs
incurred in connection with the fiscal 1999 second quarter opening of our new
East Coast Operations Center, certain incremental inbound freight costs we
elected to incur to meet the above-expectations customer demand for our recently
launched Natural Elements merchandise line, and increased sales of marked down
excess inventory arising from the demand-driven increase in overall inventory
throughput.
Selling, general and administrative expenses ("SG&A") primarily consist of
marketing, distribution and general and administrative expenses. The marketing
expense component primarily consists of catalog production and postage costs.
Production costs primarily consist of paper, printing, computer services and
list rental costs (net of list rental revenue). Our consolidated SG&A expenses
increased by $6.6 million, or 20.9%, to $38.2 million during the fiscal 2000
first quarter from $31.6 million in the fiscal 1999 first quarter. In contrast,
our consolidated SG&A expenses significantly decreased as a percentage of
consolidated net sales to 44.0% during the fiscal 2000 first quarter, an
improvement of 456 basis points from our 48.6% rate in the fiscal 1999 first
quarter. The increase in our consolidated SG&A expenses primarily is the result
of the incremental variable marketing costs incurred to achieve the
aforementioned 33.4% increase in consolidated net sales whereas the substantial
decrease in our consolidated SG&A expense rate was primarily attributable to
increased sales leveraging of fixed infrastructure costs, and to a lesser
extent, productivity improvements realized at our new East Coast Operations
Center.
As a result of the foregoing, our consolidated income from operations
increased by $3.1 million, or 121.4%, to $5.7 million for the fiscal 2000 first
quarter from $2.6 million for the fiscal 1999 first quarter. Expressed as a
percentage of consolidated net sales, our consolidated income from operations
was 6.5% for the fiscal 2000 first quarter versus 3.9% in fiscal 1999 first
quarter.
As a result of our higher average cash and cash equivalents throughout the
fiscal 2000 first quarter, we realized consolidated net interest and other
income of $0.2 million during the fiscal 2000 first quarter versus consolidated
net interest and other income of $46,000 during the fiscal 1999 first quarter.
Our consolidated provision for income taxes increased $1.3 million, or
121.1%, to $2.3 million during the fiscal 2000 first quarter from $1.0 million
during the fiscal 1999 first quarter. This increase was relatively consistent
with the 125.9% increase in fiscal 2000 first quarter consolidated pre-tax
income over the fiscal 1999 first quarter. Slightly reducing our effective
income tax rate for the fiscal 2000 first quarter, as compared to the fiscal
1999 first quarter, were the favorable effects of certain West Virginia tax
credits.
We completed the fiscal 2000 first quarter realizing consolidated net
income of $3.6 million (net income per basic and diluted share of $0.35 and
$0.34, respectively) versus $1.6 million (net income per basic and diluted share
of $0.15 and $0.15, respectively) for the fiscal 1999 first quarter, an
improvement of $2.0 million or 129.1%.
15
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Liquidity and Capital Resources
-------------------------------
We have historically funded our growth through a combination of funds
generated from operations, trade credit arrangements and short-term bank credit
facilities. As our working capital requirements generally precede the
realization of sales, we routinely draw on our revolving line of credit to
produce catalogs and increase inventory levels in anticipation of future sales
realization. Our standard trade credit arrangements for purchased inventory and
services typically require the net amount due to be paid by us within sixty days
of the invoice date.
We maintain an aggregate $50.0 million bank credit facility, consisting of
an unsecured revolving line of credit of $47.4 million (with a sub-limit of $7.0
million for letters of credit) and a term standby letter of credit of $2.6
million. At our option, the interest rate is the bank's Prime Rate or Adjusted
LIBOR [i.e., rate per annum equal to the quotient of the London Interbank
Offered Rate divided by one (1) minus the Eurocurrency Reserve Requirement for
the applicable Interest Period, rounded upward, if necessary, to the nearest
one-sixteenth of one percent], increased or decreased by a margin based upon our
then EBITDA Coverage Ratio, as defined. The underlying agreement provides that
we must satisfy certain specified EBITDA, leverage and current ratio
requirements and places restrictions on our ability to, among other things, sell
assets, participate in mergers, incur debt, pay dividends, and make investments
or guarantees. The credit facility has a maturity date of June 30, 2001. On July
10, 2000, the Company received a letter of commitment from its lead bank to
increase the aggregate borrowing capacity allowed under the above credit
facility by $30 million to $80.0 million and extending its maturity to July 31,
2003.
Consolidated operating activities generated $12.7 million of positive cash
flow during the fiscal 2000 first quarter as compared to $15.7 million of
positive cash flow during the fiscal 1999 first quarter. On a comparative
quarter-to-quarter basis, the fiscal 2000 first quarter decrease primarily
reflects the positive cash flow effects of our higher net income, increased
income tax liabilities and non-cash depreciation being more than offset by the
negative cash flow effects of increased deferred catalog costs, inventories and
prepaid catalog costs and decreased accounts payable and accrued liabilities.
The fiscal 2000 first quarter net positive operating cash flow of $12.7
million, as well as $0.6 million in net proceeds from the exercise of employee
stock options, primarily were utilized to increase our cash and cash equivalents
balance by $11.9 million and to fund $1.6 million of capital equipment
expenditures. The fiscal 1999 first quarter net positive operating cash flow of
$15.7 million primarily was utilized to fully repay our $9.9 million revolving
line of credit balance and to fund $1.6 million of capital equipment
expenditures.
Consolidated investing activities consumed $1.4 million and $1.6 million of
cash in the fiscal 2000 and fiscal 1999 first quarters, respectively, with cash
outlays consisting principally of capital expenditures. The fiscal 2000 first
quarter capital expenditures primarily reflect the cost of various computer
hardware and software upgrades and additions. The fiscal 1999 first quarter
capital expenditures primarily reflect the cost of material handling,
telecommunication and information systems for the added East Coast operations,
and to a lesser degree, hardware and software upgrades to corporate systems.
Consolidated financing activities provided $0.6 million of cash during the
fiscal 2000 first quarter whereas financing activities used $9.9 million of cash
during the fiscal 1999 first quarter. The fiscal 2000 first quarter solely
reflects net proceeds from exercises of stock options. The fiscal 1999 first
quarter substantially reflects the full repayment of our $9.9 million revolving
line of credit balance. The Company continues to have no outstanding short- or
long-term bank debt at May 27, 2000.
As a result of the foregoing, we had $35.7 million in consolidated working
capital at May 27, 2000 as compared to $33.9 million consolidated in working
capital at February 26, 2000 and $27.0 million in consolidated working capital
at May 29, 1999. Our consolidated current ratio was 1.7 at May 27, 2000 as
compared to 1.7 at February 26, 2000 and 1.8 at May 29, 1999.
16
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Liquidity and Capital Resources (continued)
-------------------------------------------
As previously discussed, we opened in July of 1999 our new 600,000 square
foot East Coast Operations Center. We will incur annual lease expense of
approximately $2.5 million over the twenty year lease term. The lease allows us,
at our option, to (i) purchase the underlying land and facility at a then
determined fair market value or (ii) exercise up to four successive five-year
extensions.
In February 2000, we entered into a build-to-suit, sale-lease agreement for
the construction of a new 60,000 square foot customer service call center in
Coeur d'Alene, Idaho to replace our currently leased 45,000 square foot facility
there which is not able to sufficiently accommodate the future technology and
space requirements of our Direct Channel. Construction of the new facility is
scheduled to be completed during the summer of 2000. We will incur annual lease
expense of approximately $0.7 million during the first three years of the
fifteen year lease term with subsequent annual lease payments adjusted based
upon the Northwest region's consumer price index.
Also, as previously discussed, we embarked on a program during fiscal 1999
of selectively establishing for the first time full-line retail stores in highly
trafficked urban areas. Just prior to the 1999 holiday shopping season, we
opened two full-line "urban" retail stores in Seattle, Washington and Kansas
City, Kansas which continue to perform above our initial expectations. These
"urban" stores are in addition to our two previously existing full-line
"destination" or "resort" retail stores in Sandpoint, Idaho and Jackson Hole,
Wyoming. Based on the success we have realized to date with these two pilot
"urban" retail stores, we have identified through our marketing database
approximately 80 attractive urban markets in 29 states and are currently
committed to opening at least five additional full-line "urban" retail stores
during fiscal 2000, including stores in the Cincinnati, Dallas, Denver and
Chicago metropolitan areas for which we have recently executed leases. We
currently estimate that each such retail store will be leased, as are our
existing stores, with an average initial cash investment per store being limited
to leasehold improvements and inventory in the approximate range of $1.5 million
to $2.0 million depending upon size and design elements. Additional store
openings will be influenced by, among other factors, our ability to timely
procure optimum locations within major urban malls and lifestyle centers.
We currently estimate between $16 million and $22 million in total capital
expenditures during the balance of fiscal 2000 primarily consisting of leasehold
improvements for the planned five new retail store locations and a new point-of-
sale computer system to accommodate this expansion, and to a lesser extent,
other corporate technology additions and upgrades. These expenditures are
expected to be primarily funded from operating cash flows, and to the extent
necessary, our existing bank credit facility.
We believe that cash flow from operations and borrowing capacity under our
$80.0 million bank credit facility will be sufficient to support operations and
future growth for the foreseeable future. Thereafter, we may be required to seek
additional sources of funds for continued or accelerated growth and there can be
no assurance that such funds will be available on satisfactory terms. Failure to
obtain such financing could delay or prevent our planned growth, which could
adversely affect our business, financial position, results of operations and
cash flows.
Other Matters
-------------
Year 2000 Compliance
--------------------
As a result of our planning and preparation efforts over the past two
years, we experienced no significant problems at the turn of the century with
either our own technology or that of our infrastructure providers. Contingency
plans to manage all identified areas of perceived risk will remain in place
throughout 2000. The costs incurred by us in connection with our Year 2000
compliance program have been and are expected to remain immaterial to our
financial position, results of operations and cash flows.
17
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Other Matters (continued)
-------------------------
Recently Issued Accounting Standards Not Yet Adopted
----------------------------------------------------
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires
that every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either an asset
or liability measured at its fair value. In June 1999, the FASB issued
Statement of Financial Accounting Standard No. 137, "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133" delaying the effective date of SFAS No. 133. In June 2000,
the FASB issued Statement of Financial Accounting Standard No. 138, "Accounting
for Certain Derivative Instruments and Certain Hedging Activities" amending
certain accounting and reporting standards of SFAS No. 133. SFAS No. 133, as
amended, is effective for our fiscal 2001 financial statements. As we currently
are not a party to any derivative financial instruments and do not anticipate
becoming a party to any derivative instruments, we do not currently expect the
adoption of SFAS No. 133, as amended, to have a material impact on our
consolidated financial statements.
In May 2000, the Emerging Issues Task Force issued EITF 00-14, "Accounting
for Certain Sales Incentives." Under the provisions of EITF 00-14, for sales
incentives that will not result in a loss on the sale of a product or service, a
vendor should recognize the "cost" of the sales incentive at the latter of the
date the related revenue is recorded by the vendor or the date the sales
incentive is offered. The reduction to or refund of the selling price of the
product or service resulting from any cash sales incentive should be classified
as a reduction of revenue. The EITF is effective for reporting periods beginning
after May 18, 2000. Management does not expect the adoption of EITF 00-14 to
have a material impact on the Company's consolidated financial statements.
Risk Factors
------------
Continued Dependence On and Risks Associated with Our Catalog Operations
------------------------------------------------------------------------
Our success as a Company for the foreseeable future will depend
significantly on the future success of our established Catalog Sales Channel. We
believe that the future success of our Catalog Sales Channel will be predicated
upon the efficient targeting of our catalog mailings, a high volume of prospect
catalog mailing, appropriate shifts in our merchandise mix and our ability to
achieve adequate response rates to our catalog mailings. Catalog mailings entail
substantial paper, postage, merchandise acquisition and human resource costs,
including costs associated with catalog development and increased inventories,
virtually all of which are incurred prior to the mailing of each catalog. As a
result, we are not able to adjust the costs being incurred in connection with a
particular catalog mailing to reflect the actual performance of the catalog. If,
for any reason, we were to experience a significant shortfall in anticipated
revenue from a particular catalog mailing, and thereby not recover the costs
associated with that catalog mailing, our financial condition, results of
operations and cash flows could be materially adversely affected. In addition,
response rates to our catalog mailings and, as a result, revenues generated by
each catalog mailing can be affected by factors such as consumer preferences,
economic conditions, the timing and mix of catalog mailings and changes in the
merchandise mix, several of which factors may be outside our control. Further,
we have historically experienced fluctuations in the response rates to our
catalog mailings. Any inability we have to accurately target the appropriate
segment of the consumer catalog market or to achieve adequate response rates
could result in lower sales, significant markdowns or write-offs of inventory,
increased merchandise returns, and lower margins, which could have a material
adverse effect on our financial condition, results of operations and cash flows.
Our New Internet and Retail Sales Channels are Untested and Extremely Difficult
-------------------------------------------------------------------------------
to Evaluate
-----------
Although we have been in the catalog business for many years and certain of
our senior vice presidents gained significant retail experience with previous
employers, we have had had only limited experience with our Internet and Retail
Sales Channels. Our approaches in these new sales channels are untested as a
business matter, and we cannot be sure that these approaches will provide the
value to us that we expect. Furthermore, our management does not have
significant experience operating in these new sales channels and our future
success will depend on recent and future additions to our management team.
Additionally, because the Internet is constantly changing, we will likely need
to correspondingly alter our business in the future. Frequent changes could
impose significant burdens on our management and our employees and could result
in loss of productivity or even increased employee attrition. Any investment in
us must be considered in light of the problems frequently encountered by
companies at this stage of development in new and rapidly evolving markets. We
cannot be certain that our business strategy will be successful or that we will
successfully address the risks and challenges associated with the Internet.
18
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
------------------------
Risks Associated with Our Growth Strategy
-----------------------------------------
Our growth strategy primarily includes the following components: (i)
further development of our Catalog, Internet and Retail Sales Channels, (ii)
introduction of new merchandise lines, (iii) expansion of our existing
merchandise selection, and (iv) increased catalog circulation and response
rates. Our growth strategy involves various risks, including a reliance on a
high degree of prospect mailings, which may lead to less predictable response
rates, and increased patronage of our Web site. Our failure to successfully
implement any or all of our growth strategies would likely have a material
adverse effect on our financial condition, results of operations and cash flows.
We believe our growth has been attributable in large part to our success in
meeting the merchandise, timing and service demands of an expanding customer
base with certain demographic characteristics. There can be no assurance that we
will be able to continually identify and offer new merchandise that appeals to
our customer base or that the introduction of new merchandise categories or new
marketing or distribution strategies, such as the sale of our merchandise in
retail stores or through new catalog titles, will be successful or profitable,
or that any such efforts will achieve sustainable acceptance in the marketplace.
Any substantial inability on our part to further develop and grow our Catalog,
Internet and Retail Sales Channels, to maintain our current average order size
and response rates, and leverage the success of existing catalog titles to new
merchandise lines, catalogs, web site and retail stores would likely have a
material adverse effect on our financial condition, results of operations and
cash flows. As part of our Retail Sales Channel strategy, we are currently
establishing for the first time in the Company's history a base of full-line
"urban" retail stores. We have currently identified a total of 80 attractive
urban markets in 29 states where we may establish full-line retail stores over
the next several years. Recently, we have executed leases for four full-line
"urban" retail stores in Cincinnati, Dallas, Denver and Chicago. These stores
will be in addition to the full-line "urban" retail stores we currently operate
in Seattle and Kansas City. We have had limited experience operating retail
stores and, other than operating our Jackson Hole, Wyoming retail store since
1997, we have had no significant experience operating stores outside the
vicinity of our headquarters. In addition, retail store operations entail
substantial fixed costs, including costs associated with real estate, inventory
maintenance and staffing. There can be no assurance that these stores will be
opened, will be opened in a timely manner, or, if opened, that these stores will
be profitable. Failure to successfully implement this store-based strategy could
result in significant write-offs of inventory and fixtures and would likely have
a material adverse effect on our financial condition, results of operations and
cash flows. We may need to raise additional funds in order to support greater
expansion, develop enhanced services, respond to competitive pressures, acquire
complementary businesses or respond to unanticipated or seasonal requirements.
In addition, various elements of our growth strategies, including our aggressive
catalog-mailing program, our aggressive Internet growth strategy, our plans to
introduce new merchandise and our plans to broaden existing merchandise lines,
may require additional capital. There can be no assurance that funds will be
available to us on terms satisfactory to us when needed.
Risks Affecting Our Ability to Fulfill Orders
---------------------------------------------
Our ability to provide superior customer service, effectively and
efficiently target our merchandise offerings, and fulfill customer orders
depends, to a large degree, on the efficient and uninterrupted operation of our
two customer service call centers, two distribution centers, management
information systems and on the timely performance of third parties such as
shipping companies and the United States Postal Service. Although we believe we
have built redundancy into our telephone and management information systems and
maintain relationships with several different shipping companies, any material
disruption or slowdown in our order processing or fulfillment systems resulting
from strikes or labor disputes, telephone down times, electrical outages,
mechanical problems, human error or accidents, fire, natural disasters or
comparable events could cause delays in our ability to receive and distribute
orders and may cause orders to be lost or to be shipped or delivered late. As a
result, customers may cancel orders or refuse to receive goods on account of
late shipments which would result in a reduction of net sales and could mean
increased administrative and shipping costs. Excess call volume could result in
telephone answer delays and delays in placing orders. There can be no assurance
that telephone call volumes will not
19
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
------------------------
Risks Affecting Our Ability to Fulfill Orders (continued)
---------------------------------------------------------
exceed present telephone system capacity and that, as a result, telephone answer
delays and delays in placing orders will not occur. We believe that our success
to date has been based in part on our reputation for levels of customer service
substantially superior to the standards in the catalog industry, any impairment
of our superior customer service reputation could have a material adverse effect
on our business. Any material disruption in or destruction of part or all of
our distribution centers caused by strike, fire or natural disaster would likely
have a material adverse effect on our ability to provide the timely delivery of
merchandise and on our financial condition, results of operations and cash
flows.
Risks Associated with System Disruptions
----------------------------------------
Our ability to attract and retain users and customers to our e-commerce web
site depends on the performance, reliability and availability of our web site
and network infrastructure. We have periodically experienced service
interruptions caused by temporary problems in our own systems or software or in
the systems or software of third parties. While we continue to implement
procedures to improve the reliability of our systems, these interruptions may
continue to occur from time to time. Third parties may not be liable to us for
any damage or loss they may cause to our business, and we may be unable to seek
reimbursement from them for losses that they cause. Our users also depend on
third party Internet service providers for access to our web site. These
entities have experienced significant outages in the past, and could experience
outages, delays and other difficulties due to system failures in the future
which are unrelated to our systems, but which could nonetheless adversely affect
our business.
We May Face Potential Business-Related Liabilities and Expenses
---------------------------------------------------------------
As a result of doing business through our catalogs, e-commerce web site and
retail stores, we may be exposed to legal risks and uncertainties, including
potential liabilities to consumers of such products. Some of the risks that may
result from doing business via any of our three sales channels include:
. product liability or other tort claims relating to goods;
. claims of consumer fraud and false or deceptive advertising or
sales practices;
. breach of contract claims relating to merchant transactions; and
. claims relating to any failure to appropriately collect and remit
sales or other taxes arising from electronic commerce
transactions.
Even to the extent that such claims do not result in material liability,
investigating and defending such claims could have a material adverse effect on
our business, financial condition, results of operations and cash flows.
Quarterly and Seasonal Fluctuations
-----------------------------------
Our revenue and results of operations have fluctuated and can be expected
to continue to fluctuate on a quarterly basis as a result of a number of
factors, including, among other things, the timing of new merchandise and
catalog offerings, recognition of costs or net sales contributed by new
merchandise and catalog offerings, fluctuations in response rates, fluctuations
in paper, production and postage costs and expenses, merchandise returns,
adverse weather conditions that affect distribution or shipping, shifts in the
timing of holidays and changes in our merchandise mix. In addition, we maintain
a common industry policy of deferring the recognition of the costs of catalog
development and production until sales are realized on each mailing and
recognize such costs as sales are realized. Consequently, quarter to quarter
revenue and expense comparisons will be impacted by the timing of the mailing of
our catalogs. Catalog mailings may occur in different quarters from year to year
depending on the performance of third party
20
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
------------------------
Quarterly and Seasonal Fluctuations (continued)
-----------------------------------------------
couriers, the day of the week on which certain holidays fall and our assessment
of prevailing market opportunities. A portion of the revenue from a catalog
mailing may be recognized in the quarter after the quarter in which the catalog
was mailed and the revenue from a particular catalog offering may be recognized
in a quarter different from the quarter in which the revenue from a similar
offering was recognized in the previous year. We have experienced, and may
continue to experience, seasonal fluctuations in our sales and operating
results, which is typical of many apparel retailers. In past fiscal years, our
net sales and profits have been heavily reliant on the November and December
holiday season. We believe that in the future this seasonality will continue.
In anticipation of increased sales activity during November and December, we
incur significant additional expenses, including the hiring of a substantial
number of temporary employees to supplement our permanent, full-time staff.
If, for any reason, our sales were to fall below our expectations during
November and December, our financial condition, results of operations and cash
flows would likely be materially adversely affected.
Merchandise Returns
-------------------
As part of our customer service commitment, we maintain a liberal
merchandise return policy which allows customers to return any merchandise,
virtually at any time and for any reason, and regardless of merchantable
condition. We make allowances in our financial statements for anticipated
merchandise returns based on historical return rates and our future
expectations. While we believe our allowances are adequate, there can be no
assurance that actual merchandise returns will not exceed our allowances. In
addition, there can be no assurance that the introduction of new merchandise
through our various channels, changes in the merchandise mix or other factors
will not cause actual returns to exceed return allowances. Any significant
increase in merchandise returns or merchandise returns that exceed our
allowances could materially adversely affect our financial condition, results of
operations and cash flows.
Ability to Manage Expanding Operations
--------------------------------------
Our growth has resulted in an increased demand on our managerial,
operational and administrative resources. However, in order to manage currently
anticipated levels of future demand, we will be required to continue, among
other things, to (i) improve and integrate our management information systems
and controls, including inventory management, (ii) adjust our distribution
capabilities and (iii) attract and retain qualified personnel, including middle
management. In addition, there can be no assurance that any upgrades,
improvements and expansions in our overall infrastructure and operations will
increase the productivity or efficiency of our operations or that the same will
be adequate to meet our present or future needs. Continued growth could result
in a strain on our management, financial, merchandising, marketing, distribution
and other resources and we may experience operating difficulties, including
difficulties in training and managing an increasing number of employees,
difficulties in obtaining sufficient materials and manufacturing capacity from
vendors to produce our merchandise, problems in upgrading our management
information systems and delays in production and shipments. There can be no
assurance that we will be able to manage future growth effectively and any
failure to manage growth effectively could have a material adverse effect on our
financial condition, results of operations and cash flows. Our inability to
respond to and manage these changing business conditions could have a material
adverse effect on our financial condition, results of operations and cash flows.
Competition
-----------
The markets for our merchandise are highly competitive, and the recent
growth in these markets has encouraged the entry of many new competitors as well
as increased competition from established companies. Although we believe that we
do not compete directly with any single company with respect to our entire range
of merchandise, within each merchandise category we have significant competitors
and may face new competition from new entrants or existing competitors who focus
on market segments
21
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
------------------------
Competition (continued)
-----------------------
currently served by us. These competitors include large retail operations,
including some with catalog and e-commerce operations, and other catalog and
direct marketing companies and international competitors. With respect to the
apparel merchandise offered by us, we are in direct competition with more
established catalog, Internet and retail operations, some with substantially
greater experience in selling apparel merchandise and which may focus on
prospective customers sharing some of the demographic characteristics of our
customers. Any failure on our part to successfully market our apparel
merchandise or compete effectively against such competitors would likely have a
material adverse effect on our growth and could adversely affect our financial
condition, results of operations and cash flows. Many of these competitors are
larger and have significantly greater financial, marketing and other resources
than us. Increased catalog mailings by our competitors may adversely affect
response rates to our own catalog mailings. In addition, because we source a
significant percentage of our merchandise from suppliers and manufacturers
located in the United States, where labor and production costs may be higher
than in foreign countries, there can be no assurance that our merchandise will
or can be competitively priced when compared to merchandise offered by other
retailers. While we believe that we have been able to compete successfully
because of our brand recognition, the exclusivity and broad range and quality of
our merchandise, including our private label merchandise offerings, and our
superior customer service policies, there can be no assurance that we will be
able to maintain or increase our market share in the future. Our failure to
compete successfully would likely have a material adverse effect our financial
condition, results of operations and cash flows.
Changing Consumer Preferences; General Economic Conditions
----------------------------------------------------------
Although we believe that our business has benefited from increasing
consumer interest in merchandise that reflects a casual and relaxed lifestyle,
there can be no assurance that this belief is correct or that such trends will
continue. Any change in these trends could have a material adverse effect on our
financial condition, results of operations and cash flows. In addition, although
we believe that the sale of our merchandise historically has not been primarily
driven by fashion trends, all of our merchandise is subject to changing consumer
preferences. A shift in consumer preferences away from the merchandise which we
offer could have a material adverse effect on financial condition, results of
operations and cash flows. Our future success depends in part on our ability to
anticipate and respond to changes in consumer preferences and there can be no
assurance that we will respond in a timely or commercially appropriate manner to
such changes. Failure to anticipate and respond to changing consumer preferences
could lead to, among other things, lower sales of our products, significant
markdowns or write-offs of inventory, increased merchandise returns, and lower
margins, which would likely have a material adverse effect on our financial
condition, results of operations and cash flows. Our business is sensitive to
regional changes in customers' spending and discretionary income patterns which,
in turn, are controlled to a large extent by prevailing economic conditions.
Adverse economic conditions in one or more regions in which we have significant
sales could have a material adverse effect on sales of our merchandise and, as a
result, on our financial condition, results of operations and cash flows.
Dependence on Key Personnel
---------------------------
Our success depends largely on the efforts of our key personnel, including
Dennis and Ann Pence, our founders. In the past, Dennis and Ann Pence have been
involved in all aspects of our business, including marketing, merchandising and
operations. Recently, they have primarily focused on our long-term strategic
positioning. The loss of either of their services would likely have a material
adverse effect on our financial condition, results of operations and cash flows.
In addition, several other key employees, including Georgia Shonk-Simmons (Chief
Merchant and President of Catalog & Retail Sales Division), Don Robson (Senior
Vice President and Chief Financial Officer), Tom Scott (Senior Vice President,
Chief Operations Officer and Chief Information Officer) and Tom Bosch (Senior
Vice President of Retail) occupy critical positions and continue to be
increasingly responsible for policy making and day-to-day
22
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
------------------------
Dependence on Key Personnel(continued)
--------------------------------------
operations. The loss of any of such key employee could have a material adverse
effect on our financial condition, results of operations and cash flows. Other
operational, marketing and merchandising personnel are important to our
financial condition, results of operations and cash flows. Our ability to
attract and retain well-qualified key personnel, including, but not limited to,
the above-named individuals, is crucial to our successful continued operations
and expansion, in particular with respect to our new sales channels. In
addition, our relatively remote location may make it more difficult to replace
key employees who leave us, or to add the employees required to manage our
further growth.
Possible Volatility of Our Stock Price
--------------------------------------
The market price for our common stock may be significantly affected by such
factors as our quarterly operating results, changes in any earnings estimates
publicly announced by us or by analysts, announcements of new merchandise
offerings by us or our competitors, seasonal effects on sales and various
factors affecting the economy in general. In addition, the Nasdaq National
Market has experienced a high level of price and volume volatility and market
prices for the stock of many companies have experienced wide price fluctuations
not necessarily related to the operating performance of such companies.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Coldwater Creek is not exposed to financial market risks from changes in
foreign currency exchange rates and is only minimally impacted by changes in
interest rates. Borrowings under the Company's bank credit facility are at a
variable rate of interest and, based on the current level of borrowings, the
Company experiences only modest changes in interest expense when market interest
rates change. However, in the future, the Company may enter into transactions
denominated in non-U.S. currencies or increase the level of its borrowings,
which could increase the Company's exposure to these market risks. The Company
has not used, and currently does not contemplate using, any derivative financial
instruments.
23
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PART II
Item 1. Legal Proceedings
There are no material legal proceedings presently pending to which Coldwater
Creek Inc. or its subsidiary is a party or of which any of their properties are
the subject.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
NUMBER DESCRIPTION OF DOCUMENT
------------------------------
27.1 Financial Data Schedule
There were no reports filed on Form 8-K during the three months ended May 27,
2000.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Sandpoint,
State of Idaho, on this 11th day of July 2000.
COLDWATER CREEK INC.
By: /s/ Donald A. Robson
-----------------------------------------------
Donald A. Robson
Senior Vice President, Chief Financial Officer
and Treasurer (Principal Financial and
Accounting Officer)
24
