Description
Filed with the SEC from June 28 to July 4:
Tuesday Morning (TUES)
Small-cap-focused investment firm Becker Drapkin Management disclosed that it owns 2,379,632 shares (5.7%) after its purchase of 280,000 shares from June 27 through June 29 at prices in a range from $4.18 to $4.22 per share. Becker Drapkin said it entered into an agreement with Tuesday Morning that will put two Becker Drapkin representatives on the board, limit Becker Drapkin's stake to no more than 19.99%, and prevent it from making additional activist proposals.
BUSINESS OVERVIEW
Overview
We are a leading closeout retailer of upscale decorative home accessories, housewares, and famous-maker gifts in the United States. We opened our first store in 1974 and operated 861 stores in 43 states as of June 30, 2011. Our stores are generally open seven days a week and focus on periodic "sales events," that occur in each month except January and July, which historically have been weaker months for retailers. Our stores are normally closed for up to one week during the months of January and July as we conduct physical inventories at all of our stores. We purchase first quality, brand name merchandise at closeout pricing and, in turn, sell it at prices significantly below those generally charged by department stores and specialty and catalog retailers. We do not sell seconds, irregulars, refurbished or factory rejects.
We believe that our well recognized, first quality brand name merchandise and value-based pricing have enabled us to establish and maintain strong customer loyalty. Our customers, who are predominantly women from middle to upper-income households, are brand savvy, value-conscious customers seeking quality products at discount pricing. While we offer our customers consistent merchandise categories, each sales event features limited quantities of new and appealing products within these categories, creating a "treasure hunt" atmosphere in our stores.
We believe that our customers are attracted to our stores not by location, but by our advertising and direct or electronic mail programs that emphasize the limited quantities of first quality, brand name merchandise which we offer at attractive prices. This has allowed us to open our stores in secondary locations of major suburban markets, such as strip malls, near our middle and upper-income customers. We are generally able to obtain favorable lease terms because of our flexibility in site selection and our no-frills format, which allow us to use a wide variety of space configurations. Additionally, we offer selected items for sale at our retail website at shop.tuesdaymorning.com .
On April 30, 2007, our Board of Directors approved a change in our fiscal year end from December 31 to June 30, effective June 30, 2007. As a result of this change, this Form 10-K includes financial information for the six-month transition periods ended June 30, 2007, and 2006, and for the twelve-month periods ended June 30, 2011, 2010, 2009, and 2008, and December 31, 2006. The twelve-month period ended June 30, 2011 is hereinafter referred to as fiscal 2011.
Key Operating Strengths
Our success is based on the following operating strengths:
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Unique Event-Based Format. We distinguish ourselves from other retailers with a unique "event-based" selling strategy, creating the excitement of multiple "grand openings" and "closeout sales" each year. Merchandise is available in limited quantities and specific items are generally not replenished during a sales event, however, stores continue to receive new merchandise throughout a sales event. We believe that the limited quantities of specific items intensify customers' sense of urgency to buy our merchandise. Accordingly, we have historically generated a majority of an event's sales in the week of the event. We intend to continue to adhere to this strategy, and continue shipments to our stores of new and different merchandise during the later stages of sales events in order to encourage new and repeat customer visits.
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Strong Sourcing Capabilities and Purchasing Flexibility. We have developed strong sourcing capabilities that allow us to gain favorable access to first quality, brand name merchandise at attractive prices. In many cases, we believe we are the retailer of choice to liquidate inventory due to our ability to make purchasing decisions quickly and to rapidly sell both large and small
quantities of merchandise without disrupting the manufacturers' traditional distribution channels or compromising their brand image. Our flexible purchasing strategy allows us to pursue new products and merchandise categories from vendors as opportunities arise. We employ an experienced buying team with an average of over 28 years of retail experience per buyer. Our buyers and our reputation as a preferred, reliable closeout retailer have enabled us to establish long-term relationships with a diverse group of top-of-the-line vendors. We believe we will continue to obtain sufficient merchandise to accommodate our existing store base and planned future growth.
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Loyal Customer Base of Brand Savvy and Value-Conscious Consumers. We have a loyal customer base consisting primarily of women ranging in age from 35 to 65 from middle and upper-income households with a median annual family income of approximately $70,000. In addition to making purchase decisions based on brand names and product quality, our customers are also value-conscious. We believe our value-based pricing, which enables our customers to realize significant savings of up to 50% to 80% over competing department store retail prices, has resulted in both strong customer loyalty and satisfaction. We have developed and currently maintain a proprietary mailing and email list consisting of over 9.0 million customers. These customers have visited our stores and requested postal and/or electronic mailings to alert them of upcoming sales events, including the brand name merchandise and prices to be offered, prior to the advertising of a sales event to the general public.
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Attractive Store-level Economics. We have attractive store-level economics due to our low store operating expenses and the low initial investment required to open new stores. Our destination-oriented retail format allows us to open stores in a wide range of locations, generally resulting in lower lease rates compared to those of other retailers. In addition to our low real estate costs, we maintain low operating and depreciation costs due to our no-frills, self-service format. Because we use low-cost store fixtures and have low pre-opening costs, our new stores require a low initial investment and have historically generated a solid return on investment in their first full year.
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Disciplined Inventory and Supply Chain Management. We have developed disciplined inventory control and supply chain management procedures. Our purchasing flexibility and strong relationships with vendors allow us to coordinate the timing of purchases and receipt of merchandise closely with our sales events. Our merchandise and distribution systems allow us to quickly and efficiently process and ship merchandise from our distribution center to our stores. Our point-of-sale systems allow us to effectively manage our inventory levels and sales performance. While as of June 30, 2011, we operated 861 stores, our shipping and sorting capacity at our distribution center will accommodate approximately 1,200 to 1,250 stores.
Growth Strategy
Our growth strategy is to continue to build on our position as a leading closeout retailer of upscale home furnishings, housewares, gifts and related items in the United States by:
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Enhancing Our Store Base. We plan to pursue expansion of our store base at levels slightly greater than in fiscal 2011, as well as to continue to pursue attractive expansion and relocation opportunities in our existing store base. See Item 6—Selected Financial Data in this Form 10-K for information regarding our historical store openings and closings. We plan to close underperforming stores by allowing leases to expire where alternative locations in similar trade areas are not available at acceptable lease rates. For both new stores and relocations, we will continue to negotiate for upgraded sites. We will also evaluate expansion opportunities in select high-producing stores to increase the selling square footage, particularly in smaller stores. We believe these strategies will better position us for the long term while still maintaining a low cost
per square foot in rent expense. To that end, for the fiscal year ending June 30, 2012 we plan to add more stores than in more recent years and expand or relocate existing stores if we locate profitable opportunities to do so. We believe there is the potential for approximately 1,200 to 1,250 stores in the United States and do not anticipate any difficulties in identifying suitable additional store locations in areas with our target customer demographics.
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Enhancing Our Sales Productivity. We intend to continue to increase the number of customer transactions by refining our merchandise mix and through other operating initiatives. For example, we have continued to make shifts in our product mix to focus on functional, utilitarian items rather than purely decorative assortments. In addition, we have been selective in our seasonal merchandise purchases and remain focused on high quality, high value items. We are able to increase our merchandise offerings throughout each sales event and on a day-in, day-out basis by delivering new merchandise to the majority of our stores 40 to 47 times per year on average. We believe this attracts new customers, encourages repeat visits by existing customers and increases our average transaction value during the later stages of each sales event. We have increased staffing at some of our high volume stores in an effort to improve our customer service levels and drive our sales volumes while decreasing staffing at stores where customer traffic does not require increased staffing levels.
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Extending Our Customer Reach. Historically, we have used direct mailings, targeted emails, and newspaper and print advertising to attract customers to our stores. We believe that the use of direct mailing and email alerts remains our most effective marketing strategies. We also operate our "eTreasures"® program that provides our customers with an email of our newest weekly arrivals, special offers and our monthly mailer, all in the convenience of their homes or offices. We are in the early stages in utilizing online social networking and continue to gain increasing sales momentum throughout our internet sales site. We continue to explore other electronic means of communicating with new and existing customers.
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Improving Systems. We have upgraded our merchandising system and plan to upgrade our systems as required in the ongoing course of business. These improvements may include updates to our point-of-sale software and our internet sales site at shop.tuesdaymorning.com .
Industry Trends
As a closeout retailer of first quality, brand name merchandise, we benefit from attractive characteristics in the closeout industry. Closeout merchandise is generally available to closeout retailers at low prices for a variety of reasons, including the inability of a manufacturer to sell merchandise through regular channels, the discontinuance of merchandise due to a style or color change, the cancellation of orders placed by other retailers and the termination of business by a manufacturer or wholesaler. Occasionally, the closeout retailer may be able to purchase closeout merchandise because a manufacturer has excess raw materials or production capacity. Typically, closeout retailers have lower merchandise costs, capital expenditures and operating costs, which allows for the sale of merchandise at prices lower than other retailers.
In addition, we benefit from several trends in the retailing industry. The continuing increase in "just-in-time" inventory management techniques and the rise in retailer consolidation have both resulted in a shift of inventory risk from retailers to manufacturers. In response to an increasingly competitive market, manufacturers continue to introduce new products and new packaging more frequently. We believe that these trends have helped make the closeout retailer an integral part of manufacturers' overall distribution strategies. As a result, we believe manufacturers are increasingly looking for larger, more sophisticated closeout retailers, such as ourselves, that can purchase larger and more varied merchandise and can control the distribution and advertising of specific products in order to minimize disruption to the manufacturers' traditional distribution channels.
Products
We sell first quality, upscale home furnishings, housewares, gifts and related items. We do not sell seconds, irregulars, refurbished or factory rejects. Our merchandise primarily consists of lamps, rugs, furniture, kitchen accessories, small electronics, gourmet housewares, linens, luggage, bedroom and bathroom accessories, toys, stationary and silk plants as well as crystal, collectibles, silver serving pieces, men, women and children's apparel and accessories. We specialize in well-recognized, first quality, brand name merchandise, which has included, Calphalon cookware, Breville, KitchenAid and Cuisinart appliances, Peacock Alley and Sferra linens, Michael Kors bath towels, Travel Pro luggage, Reed and Barton flatware, Lenox and Denby tabletop, Waterford and Riedel crystal, Steinbach and Hummel collectibles, Madame Alexander dolls, Royal Doulton and Wedgwood china and giftware, Couristan rugs and many others.
We differ from discount retailers in that we do not stock continuing lines of merchandise. Because we offer a continuity of merchandise categories with ever-changing individual product offerings, we provide our customers a higher proportion of new merchandise items than general merchandisers. We are continually looking to add new complementary merchandise categories that appeal to our customers.
Purchasing
Since our inception, we have not experienced any significant difficulty in obtaining first quality, brand name closeout merchandise in adequate volumes and at attractive prices. We use a mix of domestic and international vendors. As industry trends such as "just-in-time" inventory management, retailer consolidation and more frequent order cancellations by retailers, place more inventory risk on manufacturers, we believe we will continue to see vendors looking for effective ways to reduce excess inventory. In addition, as we continue to increase our number of stores, maximize productive retail space and increase distribution capacity, we believe our purchasing capacity will continue to increase and enable us to acquire larger quantities of closeout merchandise from individual vendors and manufacturers. Improvements in our distribution processes allow us to stock merchandise in our stores more quickly, which increases our purchasing flexibility. As a result of these trends and initiatives, we believe we will be able to take advantage of more, and often larger, buying opportunities as well as offer an enhanced selection of products to our customers. During fiscal 2011, our top ten vendors accounted for approximately 11.5% of total purchases, with no single vendor accounting for more than 1.6% of total purchases.
Pricing
Our pricing policy is to sell all merchandise significantly below the retail prices generally charged by department and specialty stores. Prices are determined centrally and are uniform at all of our stores. Once a price is determined for a particular item, labels displaying three-tiered pricing are affixed to the product. A typical price tag displays a competitor's "regular" price, a competitor's "sale" price and our closeout price. Our management and buyers verify retail prices by reviewing prices published in advertisements and catalogues and manufacturers' suggested retail price lists and by visiting department or specialty stores selling similar merchandise. Our information systems provide daily sales and inventory information, which enables us to mark down unsold merchandise on a timely and periodic basis as dictated by sales volumes and incoming purchases, thereby effectively managing our inventory levels.
Site Selection. We continually evaluate our current store base and locations and plans regarding potential enhancement or relocation of our store locations. As a result of this ongoing evaluation, we have and intend to continue to pursue attractive expansion and relocation opportunities in our existing store base, close some stores by allowing leases to expire for underperforming stores or where alternative locations in similar trade areas are not available at acceptable lease rates, and open new stores. For both new stores and relocations, we negotiate for upgraded sites. With the expansion opportunities, we intend to work with high performing stores in an effort to increase the selling square footage. We believe that these strategies will better position us for the long-term while still maintaining a low cost per square foot in rent expense. To that end, for the fiscal year ending June 30, 2012 we plan to add more stores than in prior years and expand or relocate existing stores if we locate attractive opportunities to do so. We expect our new stores to be similar in appearance and operation to our existing stores and do not anticipate any difficulties in identifying suitable additional store locations in areas with our target customer demographics. As we continue our expansion and relocation strategy, we expect to incur minimal change in the cost of real estate for those locations.
We believe that our customers are attracted to our stores by our advertising, direct mail and email programs that emphasize the limited quantities of first quality, brand name merchandise that we offer at attractive prices, rather than by location. This has allowed us to open our stores in secondary locations of major suburban markets, such as strip malls, near our middle and upper-income customers. We are able to obtain favorable lease terms because of our flexibility in site selection and our no-frills format, which allow us to effectively use a wide variety of space configurations. As a result of this opportunistic approach to site selection, we believe our real estate costs are lower than many traditional retailers.
Store Leases. Except for one store adjacent to our distribution center, we lease our store locations under non-cancelable operating leases that include optional renewal periods. Some of our leases also provide for contingent rent based upon store sales exceeding stipulated amounts.
Our store leases typically include "kick clauses," which allow us, at our option, to exit the lease 24 to 36 months after entering into the lease if sales at the store do not reach a stipulated amount stated in the lease. These kick clauses, when combined with our inexpensive and portable store fixtures, provide us with flexibility in opening new stores and relocating existing stores by allowing us to quickly and cost-effectively vacate a site that does not meet our sales expectations. As a result, we generally do not operate locations with continued store-level operating losses where our leases provide us this flexibility.
Store Layout. Our opportunistic site selection and "no-frills" approach to presenting merchandise allow us to use a wide variety of space configurations. The size of our stores generally ranges from 4,600 to 31,800 square feet and averages approximately 9,800 square feet as of June 30, 2011. We have designed our stores to be functional, with little emphasis placed upon fixtures and leasehold improvements. We display all merchandise at each store by type and size on racks or counters, and we maintain minimum inventory in stockrooms.
Store Operations. We operate our stores during "sales events" that occur once each month except January and July. Our stores, or a portion thereof, are generally closed for up to one week during the months of January and July as we conduct physical inventories at all store locations. We continue to maintain the frequency of shipments of merchandise during a sales event, which results in improved efficiency of receiving and restocking activities at our stores. We attempt to align our part-time associates' labor hours in the stores closely with current customer demand.
Store Management. Each store has a manager who is responsible for recruiting, training and supervising store personnel and assuring that the store is managed in accordance with our established guidelines and procedures. Store managers are full-time employees. Our store managers are supported by regional field management and zone level support. Our store managers are responsible for reviewing store inventory and ensuring their store is continually stocked for sales event and non-sales event periods. The store manager is assisted primarily by part-time employees, with few exceptions who generally serve as assistant managers, cashiers, and help with merchandise stocking efforts. We believe that on-going training is a critical component to the success of our store management. Each store manager receives ongoing training beginning with new manager training upon being hired or promoted, as well as periodic attendance at one or more training sessions held in Dallas, Texas.
Members of our management visit selected stores during sales event and non-sales event periods to review inventory levels and presentation, personnel performance, expense controls, security and adherence to our procedures. In addition, regional and zone field managers periodically meet with senior management to review store policies and to discuss purchasing, merchandising and advertising strategies for future sales events.
Distribution
An important aspect of our model involves our ability to process, sort and distribute inventory quickly and efficiently. Our buying, distribution center and planning and allocation departments work closely together to ensure that our inventory flow is efficient and effective. The majority of our merchandise is received, inspected, counted, ticketed and designated for individual stores at our central distribution center in the Dallas, Texas metropolitan area. As a general rule, we carry similar products in each of our stores, but the amount of inventory each store is allocated varies depending upon size, location and sales projections for that store. Consistent with our sales event strategy, we ship most merchandise to our stores within a few weeks of its arrival at our distribution center. We generally do not replenish specific merchandise during a sales event; though we may ship new and different merchandise to stores throughout a sales event.
We make inventory deliveries to the majority of our stores 40 to 47 times per year on average, which allows us to significantly reduce the amount of inventory stored at our distribution center and maintain consistent in-store inventory levels. This number of shipments also allows our stores to process shipments effectively and stock their shelves with new merchandise during sales events. We use a bar-code locator system to track inventory from the time it is received until it is shipped to our stores. This system allows us to locate, price, sort and ship merchandise efficiently from our central distribution center.
Online customer orders are shipped either from our internet distribution facility, which is located with our other Dallas, Texas distribution facilities, or directly to the customer from our supplier. We use a bar-code locator system to track inventory from the time it is received until it is shipped to our customers. This system allows us to locate, price, sort and ship merchandise efficiently from our internet distribution center.
Management Information Systems
We have invested significant resources in computers, bar code scanners and radio frequency terminals, software programming and related equipment, technology and training, and we intend to continue updating these systems as necessary. We also have a company-wide local area network computer system, which includes purchase order processing, imports, transportation, distribution, point-of-sale and financial systems that enables us to efficiently control and process our inventory.
At the store level, we have computer-based registers that capture daily sales data at the stock-keeping unit, or "SKU" level. Sales and inventory information, open to buy and other operational data is distributed daily to designated levels of management and to the individuals or groups who have responsibility for specific aspects of the business.
Competition
We believe the principal factors by which we compete are price and product offering. We believe we compete effectively by pricing the merchandise we sell below department and specialty store prices and by offering a broad assortment of high-end, first quality, brand name merchandise. We currently compete against a diverse group of retailers, including department and discount stores, specialty, e-commerce and catalog retailers and mass merchants, which sell, among other products, home furnishings, housewares and related products. We also compete in particular markets with a substantial number of retailers that specialize in one or more types of home furnishing products that we sell. Some of these competitors have substantially greater financial resources that may, among other things, increase their ability to purchase inventory at lower costs or to initiate and sustain aggressive price competition.
CEO BACKGROUND
Bruce Quinnell, age 62, has served as a director of Tuesday Morning since December 2006. In May 2007, he was appointed Chairman of the Board. Mr. Quinnell has been a business consultant since leaving Borders Group, Inc. where he served as Vice Chairman from April 1999 to February 2002 and President and Chief Operating Officer from January 1997 to April 1999. Prior to that time, he served as President and Chief Operating Officer of Walden Book Company, Executive Vice President and Chief Administrative Officer of Pace Membership Warehouse, a membership-only retail store chain, and Vice President and Chief Financial Officer of Dollar General Corporation, a discount retail store chain. Mr. Quinnell serves as the Chairman of the Board of Hot Topic, Inc., a specialty retailer of music-related apparel and accessories. Mr. Quinnell also served as a member of the Board of Directors of Bombay, Inc., a specialty retailer that designs, sources and markets home accessories, wall decor and furniture, from 2005 to 2006, as a member of the Board of Directors of Cyber Medical Services (d/b/a TelaDoc), a telephone-based medical services organization, from 2004 to 2009, and as a member of the Board of Directors of Zoom Systems, Inc., a technology and services company that develops automated retail software and hardware for unmanned retail stores and fixtures, from 2004 to 2011. In nominating Mr. Quinnell to serve as a director of the Company, the Board of Directors considered his extensive background in the retail industry. The Board of Directors also believed that Mr. Quinnell's knowledge, experience and understanding of the Company provides valuable board-level leadership and management skills as well as financial, audit and operational expertise.
William Hunckler, III, age 58, has served as a director of Tuesday Morning since December 1997. Mr. Hunckler has been a private investor since January 2004. Mr. Hunckler was a co-founder in 1993 of Madison Dearborn Partners, LLC and served as a Managing Director until December 2003. Prior to 1993, Mr. Hunckler was with First Chicago Venture Capital for 13 years. During his tenure at First Chicago Venture Capital, Mr. Hunckler established and led the firm's consumer and retailing practice. Mr. Hunckler serves as a Trustee of the University of Chicago Medical Center and the Kravis Leadership Institute at Claremont McKenna College. In nominating Mr. Hunckler to serve as a director of the Company, the Board of Directors considered his strong background in private equity and corporate finance. Mr. Hunckler's experience as a co-founder and managing director of a large private equity firm has provided him with substantial knowledge in finance and accounting matters as well as capital structure.
Kathleen Mason, age 62, was appointed President and Chief Executive Officer of Tuesday Morning and appointed to the Board of Directors in July 2000. During 1999, Ms. Mason served as President of Filene's Basement, a department store chain. From 1997 to 1999, she was the President of Homegoods, an off-price home fashion store and a subsidiary of TJX Companies, and, from 1987 to 1996, she was the Chairman and Chief Executive Officer of Cherry & Webb, a women's specialty store. Ms. Mason also serves on the Board of Directors of Office Depot, Inc. and Genesco, Inc., a wholesale and retail marketer of footwear, headwear and accessories. In nominating Ms. Mason to serve as a director of the Company, the Board of Directors considered her position as President and Chief Executive Officer of the Company since 2000. In addition, the Board of Directors considered the various senior executive-level positions Ms. Mason has held with other large, national retail companies. Having served in a senior executive-level capacity for such companies for many years, Ms. Mason has the knowledge and experience to critically review and analyze the various business considerations that are necessary to operate a successful consumer-driven business. Ms. Mason's senior executive-level experiences also provide the Board of Directors with relevant business comparisons and a unique insight into the business issues faced by retail companies from time to time.
David B. Green, age 66, has served as a director of Tuesday Morning since January 2008. Mr. Green has been a marketing consultant since leaving McDonald's Corporation where he served as Senior Vice President and Senior Marketing Officer-Global Marketing from 1998 to 2002. Mr. Green held key executive marketing positions over a 30-year career with McDonald's Corporation beginning in 1972. In nominating Mr. Green to serve as a director of the Company, the Board of Directors considered his strong marketing, advertising and brand management background as well as his management skills as a result of Mr. Green's holding such positions throughout his career.
Starlette Johnson, age 48, has served as a director of Tuesday Morning since May 2008. Ms. Johnson served as President, Chief Operating Officer, and Director of Dave and Busters, Inc., a restaurant and entertainment company, from April 2007 until September 2010. From June 2006 until April 2007, Ms. Johnson served as Senior Vice President and Chief Strategic Officer of Dave and Busters, Inc. From 2004 to June 2006, she was an independent consultant to restaurant, retail, and retail services companies. Prior to 2004, Ms. Johnson served in various capacities with Brinker International, Inc., a casual-dining restaurant company, including serving as its Executive Vice President and Chief Strategic Officer. In nominating Ms. Johnson to serve as a director of the Company, the Board of Directors considered the various senior executive-level positions she has held with retail service companies. These senior executive-level experiences have provided Ms. Johnson with significant expertise in business matters and financial analysis in addition to corporate organizational and executive management skills.
Sheldon I. Stein, age 58, has served as the President and Chief Executive Officer of Glazer's Distributors, one of the country's largest distributors of wine, spirits and malt products since July 2010. From 2008 until July 2010, Mr. Stein was a Vice Chairman of Global Investment Banking and Head of Southwest Investment Banking for Bank of America, Merrill Lynch. Before joining Merrill Lynch in 2008, Mr. Stein was with Bear Stearns for over twenty years as a Senior Managing Director running Bear Stearns' Southwest Investment Banking Group and as a member of Bear Stearns' President Advisory Council. Mr. Stein also serves on the Board of Directors of The Men's Wearhouse, Inc. In nominating Mr. Stein to serve as a director of the Company, the Board of Directors considered Mr. Stein's perspective and skill in building solid company value, his prior services as a strategic advisor to chief executive and chief financial officers of large public companies, his broad network of business and personal relationships, his experience and skills in corporate finance and mergers and acquisitions, and his service as the Chief Executive Officer at one of the 200 largest privately-held companies in the nation.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
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We sell upscale, name brand home furnishings, housewares, gifts and related items significantly below retail prices charged by department stores, specialty and catalogue retailers in 861 stores throughout 43 states. We have a unique event-based selling strategy that creates a sense of urgency and excitement for our customer base.
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Our store base grew approximately 1.1% in fiscal 2011, while it decreased by 0.6% in fiscal 2010, and grew approximately 2% and 4% over the fiscal years ended June 30, 2009, and 2008, respectively. During fiscal 2011, we increased our store base by nine stores. During the fiscal year ended June 30, 2010, we reduced our store base by five stores. During the fiscal years ended June 30, 2009, and 2008, we increased our store base by 15 and 32 stores, respectively.
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In December of 2008, we entered into a new credit agreement providing for an asset-based, five year, senior secured revolving credit facility, "Revolving Credit Facility". The agreement provides for, among other things: a maturity date of December 2013; a revolving credit commitment of $150.0 million, which was increased in January of 2009 to $180.0 million; applicable commitment fees and interest rates; and a requirement that the principal amount and outstanding letters of credit of the outstanding loans may not exceed $45.0 million for 30 consecutive days during the period from December 28 to January 31 (the "clean down limit"). On January 29, 2010, we entered into a second amendment to the Revolving Credit Facility to increase the clean down limit from $45.0 million to $65.0 million. As of June 30, 2011 and June 30, 2010, we did not have any outstanding borrowings on our Revolving Credit Facility.
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Our industry has been negatively impacted by macro-economic pressures that affect consumer spending, increased supply and competition as well as a highly competitive and promotional environment. Since 2008, we have experienced inconsistent sales trends, reporting both negative and positive comparable sales. During that time, however, we continued to generate positive operating income on an annual basis.
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Our industry has been negatively impacted by increased competition within an already highly competitive promotional environment; a trend we believe is likely to continue in the near term and potentially longer. As a closeout retailer of home furnishings and housewares, we currently compete against a diverse group of retailers, including department and discount stores, specialty and e-commerce retailers and mass merchants, which sell, among other products, home furnishing and houseware products similar and often identical to those we sell. We also compete in particular markets with a substantial number of retailers that specialize in one or more types of home furnishing and houseware products that we sell. Many of these competitors have substantially greater financial resources than we do. Our competitors' greater financial resources allow them to initiate and sustain aggressive price competition, initiate broader marketing campaigns that reach a larger customer base, fund ongoing promotional events and communicate more frequently with existing and potential customers.
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In response to increased competition in our industry, we are focused upon various strategic priorities that we believe will lessen the impact of this trend including, but not limited to, striving to provide a merchandise assortment that evolves and adapts to the changing needs and preferences of our customer base, continuing to review the individual contributions of the existing store base and making decisions about the future of individual store locations including whether to close or relocate them, seeking to improve overall supply chain efficiency including reviewing operational practices such as freight costs, vendor payment terms, distribution processes and increasing inventory turns, and striving to optimize our marketing plan by maximizing traffic, increasing comparable store sales and expanding the current customer base, while also increasing cost efficiency. We are also striving to optimize the acquisition of inventory to best match customer demand.
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Our ability to continuously attract buying opportunities for closeout merchandise and to anticipate consumer demand as closeout merchandise becomes available represents an uncertainty in our business. By their nature, specific closeout merchandise items are generally only available from manufacturers or vendors on a non-recurring basis. As a result, we do not have long-term contracts with our vendors for supply, pricing or access to products, but make individual purchase decisions, which are often for large quantities. Although we have many sources of merchandise and do not foresee any shortage of closeout merchandise in the near future, we cannot assure that manufacturers or vendors will continue to make desirable closeout merchandise available to us in quantities or on terms acceptable to us or that our buyers will continue to identify and take advantage of appropriate buying opportunities.
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The stability of our earnings is heavily influenced by macroeconomic factors. As the economy improves or worsens our business is often similarly impacted. Macroeconomic factors, such as the current conditions in the debt and housing markets, have impacted and will continue to impact our business by potentially decreasing the disposable income of our potential consumers. The decline in consumer confidence levels has had a negative impact on consumers' ability and willingness to spend discretionary income. At this time, we view the direction of the economy to be uncertain, which does not allow us a high degree of visibility or certainty in predicting our future earnings.
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In order to expand our store base for both new stores and relocations, we are negotiating for upgraded sites. We also intend to work with select high producing stores to increase the selling square footage. We plan to allow leases to expire for underperforming stores or where alternative locations are not available at acceptable lease rates.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of certain assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. On a recurring basis, we evaluate our significant estimates which are based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Inventory —Our inventories are stated at the lower of cost or market using the retail inventory method for store inventory and the specific identification method for warehouse inventory. Amounts are removed from inventory based on the retail inventory method which applies a cost-to-retail ratio to our various retail deductions such as sales, markdowns and shrink, to arrive at our cost of sales. Buying, distribution, freight and certain other costs are capitalized as part of inventory and are expensed as cost of sales as the related inventory is sold. The retail inventory method, which is used by a number of our competitors, involves management estimates with regard to items such as markdowns. Such estimates may significantly impact the ending inventory valuation at cost as well as the amount of gross margin recognized.
We capitalize into inventory all merchandise costs and certain costs incurred to purchase, distribute and deliver merchandise to our stores in order to more accurately match the cost of merchandise with the timing of its sale. These costs are included in cost of sales when the merchandise is sold. Other cost of sales components include merchandise markdowns, shrink and damages, which are expensed as they are incurred.
We conduct full physical inventories at all stores at June 30 and December 31 to measure quantities on hand and make appropriate adjustments to our financial statements. During periods for which physical observations do not occur, we utilize an estimate for recording shrinkage reserves based on our historical experience from the results of our physical inventories. This estimate may require a favorable or unfavorable adjustment to actual results to the extent that our subsequent actual physical inventories yield a different result. Thus, the difference between actual and estimated amounts may cause fluctuations in the quarters ending in March and September, but the difference is not a factor in the quarters ending in December and June. Since we conduct physical inventory counts twice a year, the subjective nature of our shrink percentage is reduced and our exposure to the risk of a significant error is minimized. In addition, we have loss-prevention programs that we believe minimize shrinkage. Although inventory shrinkage rates have not fluctuated significantly in recent years, if the actual rates were to differ from our estimates, then revisions to the inventory shrinkage expense could be required.
Inventory is the largest asset on our balance sheet and represented approximately 70%, 68%, and 70% of total assets at June 30, 2011, 2010, and 2009, respectively. Inventory increased 10.5%, or $25.2 million, from June 30, 2010 to June 30, 2011, primarily due to opportunistic purchases made in the second quarter of fiscal 2011 in addition to the shortfall in expected fourth quarter sales. Inventory increased 7.0%, or $15.6 million, from June 30, 2009 to June 30, 2010, primarily due to increased purchases of 8.7% in fiscal 2010 in response to increasing customer demand. On a per store basis, inventory increased 9.4% from June 30, 2010 to June 30, 2011 and increased 7.6% from June 30, 2009 to June 30, 2010.
Markdowns —We have used markdowns to promote the effective and timely sale of merchandise that allows us to consistently provide fresher merchandise to our customers. We also utilize markdowns coupled with promotional events to drive traffic and stimulate sales during non-sales event periods. Markdowns may be temporary or permanent. Temporary markdowns are for a designated period of time with markdowns recorded based on quantities sold during the period. Permanent markdowns may vary throughout the quarter or year in timing with higher markdowns traditionally recorded in the quarters ended June 30 and December 31 due primarily to seasonal merchandise.
Permanent markdowns are charged to cost of sales immediately based on the total quantities on-hand in the stores. We review all inventory each quarter to ensure all necessary pricing actions are taken to adequately value our inventory at the lower of cost or market through the retail inventory method. These actions which involve actual or planned permanent markdowns are considered by management to be the appropriate prices to stimulate demand for the merchandise. In addition to regularly reviewing inventory levels to identify slow-moving merchandise, management also considers current and anticipated demand, customer preferences, age of merchandise and seasonal trends in determining markdowns. Our markdowns, as a percentage of total sales, have been generally consistent from year to year. Beginning with the fiscal year ended June 30, 2008, we implemented a strategy to more closely monitor and control our markdowns of inventory to avoid marking down items that continued to sell through at reasonable rates. We believe this strategy contributed to overall margin by focusing our markdowns more on inventory that was truly slow moving and less on the basis of age in inventory alone. Changes in markdowns from period-to-period are discussed as a part of our Results of Operations analysis below. Actual required permanent markdowns could differ materially from management's initial estimates based on future customer demand or economic conditions. The effect of a 1.0% permanent markdown in the value of our inventory at June 30, 2011 would result in a decline in gross profit and diluted earnings per share for the fiscal year ended June 30, 2011 of $2.6 million and $0.04, respectively.
Insurance and Self-Insurance Reserves —We use a combination of insurance and self-insurance plans to provide for the potential liabilities associated with workers' compensation, general liability, property insurance, director and officers' liability insurance, vehicle liability and employee health care benefits. Our stop loss limits per claim are $500,000 for workers' compensation, $250,000 for general liability, and $150,000 for medical. Liabilities associated with the risks that are retained by us are estimated, in part, by historical claims experience, severity factors and the use of loss development factors.
The insurance liabilities we record are primarily influenced by changes in payroll expense, sales, number of vehicles, and the frequency and severity of claims; and include a reserve for claims incurred but not yet reported. Our estimated reserves may be materially different from our future actual claim costs, and, when required adjustments to our estimate reserves are identified, the liability will be adjusted accordingly in that period. During the fourth quarter of fiscal 2011, we made reductions of approximately $1.4 million to our workers' compensation liability and associated current period insurance expense due to reductions in projected actuarially determined ultimate losses resulting from improvements in claims experience. In recent years, we have enhanced our safety programs that have generated an overall decrease in workers compensation and general liability losses. Our self-insurance reserves for workers' compensation, general liability and medical were $6.9 million, $2.6 million, and $1.3 million at June 30, 2011, respectively; $9.1 million, $2.2 million, and $1.2 million at June 30, 2010, respectively; $9.1 million, $1.8 million, and $1.1 million at June 30, 2009, respectively.
We recognize insurance expenses based on the date of an occurrence of a loss including the actual and estimated ultimate costs of our claims. Claims are paid from our reserves and our current period insurance expense is adjusted for the difference in prior period recorded reserves and actual payments. Current period insurance expenses also include the amortization of our premiums paid to our insurance carriers. Expenses for workers' compensation, general liability and medical insurance were $1.7 million, $3.2 million and $9.1 million, respectively, for the fiscal year ended June 30, 2011; $3.9 million, $3.3 million and $8.5 million, respectively, for the fiscal year ended June 30, 2010; and $3.2 million, $3.0 million and $7.9 million, respectively, for the fiscal year ended June 30, 2009.
Impairment of long-lived assets —Long-lived assets, such as buildings, equipment, furniture and fixtures, and leasehold improvements, are reviewed for impairment at least annually and whenever an event or change in circumstances indicates that their carrying values may not be recoverable. If the carrying value exceeds the sum of the expected undiscounted cash flows, the assets are considered impaired. For store-level long-lived assets, expected cash flows are estimated based on the historical cashflows generated by the store and are adjusted based on management's estimates of expected future results. Impairment is measured as the amount by which the carrying value of the asset exceeds the fair value of the asset. Fair value is determined by quoted market values, discounted cash flows or internal appraisals, as applicable. Impairment, if any, is recorded in the period in which the impairment occurred. We have not recorded any material impairment charges in fiscal 2011, 2010, and 2009. As the projection of future cash flows requires the use of management's judgment and estimates, actual results may differ from our estimates. It is possible that additional charges for asset impairments may be recorded in the future.
Stock-based compensation —The Compensation Committee of our Board of Directors and, through express consent of the Compensation Committee, our CEO, are authorized to grant stock options and restricted stock awards from time to time to eligible employees and directors. Those awards may be service or performance based. We grant options with exercise prices equal to the market price of our common stock on the date of the option grant as determined in accordance with the terms of our equity incentive plans. The majority of the options granted prior to June 30, 2008 vest daily over periods of four to five years and expire ten years from the date of grant. Options granted after June 30, 2008, typically vest over periods of one to three years with equal portions of the grant vesting on an annual basis and expire ten years from the date of grant. In accordance with U.S. generally accepted accounting principles, we recognize compensation expense at an amount equal to the fair value of share-based payments granted under compensation arrangements. We calculate the fair value of stock options using the Black-Scholes option pricing model. Determining the fair value of share-based awards at the grant date requires judgment in developing assumptions, which involve a number of variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, the expected dividend yield and expected stock option exercise behavior. In addition, we also use judgment in estimating the number of share-based awards that are expected to be forfeited.
Year Ended June 30, 2011 Compared to Year Ended June 30, 2010
Net sales decreased $7.1 million, or 0.9%, to $821.2 million in fiscal 2011 from $828.3 million in fiscal 2010, primarily due to a decrease in sales from comparable stores (stores open at least one year) of 1.2%. The decrease in comparable store sales was comprised of a decrease in comparable store transactions of 1.7%, offset by an increase in comparable store average ticket of 0.5%.
Gross profit for fiscal 2011 was $313.3 million, almost flat compared to $314.0 million in gross profit for fiscal 2010. The change in gross profit was attributable to a decline in net sales offset by an increase in our gross profit percentage. As a percentage of net sales, gross profit increased to 38.2% in fiscal 2011 compared with 37.9% in the same period last year. This increase of 0.3% in gross profit percentage was attributed to a 0.2% decline due to improved product pricing from our vendors, 0.2% decline in markdowns, offset with a 0.1% increase in shrink.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Business Overview
The retail home furnishings industry has been negatively impacted by increased supply and competition within an already highly competitive promotional environment, a trend we believe is likely to continue in the near term and potentially longer. As a closeout retailer of home furnishings, we currently compete against a diverse group of retailers, including department and discount stores, specialty, catalogue and e-commerce retailers and mass merchants, which sell, among other products, home furnishing and related products similar and often identical to those we sell. We also compete in particular markets with a substantial number of retailers that specialize in one or more types of home furnishing and houseware products that we sell. Some of these competitors have substantially greater financial resources than we do. Our competitors’ greater financial resources allow them to initiate and sustain aggressive price competition, initiate broader marketing campaigns that reach a larger customer base, fund ongoing promotional events and communicate more frequently with existing and potential customers.
In response to the ongoing competition in the retail home furnishings and housewares industries, we continue to focus internally on various strategic initiatives that we believe have and will continue to offset the impact of this trend including, but not limited to:
• evaluating our monthly direct mail advertising vehicle to create more excitement surrounding each monthly event and draw more customer traffic to our stores;
• focusing on our Internet business to more effectively utilize this channel to increase sales to our existing customers as well as attract new customers;
• continuing to review the individual contributions of the existing store base and making decisions about the future of individual store locations, including whether to close or relocate them;
• striving to provide a merchandise assortment that evolves and adapts to the changing needs and preferences of our customer base;
• seeking to improve overall supply chain efficiency, including an ongoing review of operational practices such as freight costs, vendor payment terms, distribution processes and increasing inventory turns;
• expanding the current customer base;
• increasing cost efficiency; and
• striving to optimize our purchasing of inventory to best match customer demand.
We also continue to closely monitor and control our markdowns of inventory to avoid marking down items that continue to sell through at reasonable rates. Markdowns during the third quarter of fiscal 2012 were 4.9% of sales versus 4.8% of sales for the same period last year. We believe this strategy has contributed and will continue to contribute to overall margin by focusing our markdowns on inventory that is truly slow moving and not marking down items on the basis of age in inventory alone. This strategy is designed to exclude markdowns on opportunistic buys which are too large for us to sell through in one year. However, if our sales forecasts are not achieved, we may be required to record additional markdowns that could exceed historical levels. The effect of a 0.5% markdown in the value of our inventory at March 31, 2012 would result in a decline in gross profit and loss per share for the third quarter of fiscal 2012 of $1.3 million and $0.02, respectively. Under current economic conditions, forecasts can vary significantly from the actual results we achieve.
Our ability to continuously attract buying opportunities for closeout merchandise, and to anticipate consumer demand as closeout merchandise becomes available, represents an uncertainty in our business. By their nature, specific closeout merchandise items are generally only available from manufacturers or vendors on a non-recurring basis. As a result, we do not have long-term contracts with our vendors for supply, pricing or access to products, but make individual purchase decisions, which are often for large quantities. Although we have many sources of merchandise and do not foresee any shortage of closeout merchandise in the near future, we cannot assure that manufacturers or vendors will continue to make desirable closeout merchandise available to us in quantities or on terms acceptable to us or that our buyers will continue to identify and take advantage of appropriate buying opportunities. Since this uncertainty is a by-product of our business, we expect it to be an ongoing risk.
The stability of our earnings is also heavily influenced by macroeconomic factors. As the economy improves or worsens our business is often similarly impacted. Macroeconomic factors, such as the current conditions in the debt and housing markets and unemployment, have impacted and will continue to impact our business by decreasing the disposable income of our existing and potential customers. A decline in consumer confidence levels also has a negative impact on consumers’ ability and willingness to spend discretionary income. At this time, we view the direction of the economy to be uncertain, which does not allow us a high degree of visibility or certainty with respect to our future earnings.
Net sales for the third quarter of fiscal 2012 were approximately $172.7 million, a decrease of 0.9% compared to the same period last year. Comparable store sales for the quarter ended March 31, 2012, decreased by 3.2% compared to the same period last year which was primarily due to a 1.8% decrease in traffic and a 1.4% decrease in average ticket. Net loss for the quarter was $4.2 million and loss per share was $0.10.
We continue to remain focused on our long-term growth and profitability. The home furnishings and high end decorative sectors of the U.S. economy continue to be challenged by the highly competitive promotional environment and weakness in the housing and debt markets.
Nine Months Ended March 31, 2012
Compared to the Nine Months Ended March 31, 2011
During the nine months ended March 31, 2012, net sales decreased to $616.4 million from $626.4 million, a decrease of $10.0 million, or 1.6%, compared to the nine months ended March 31, 2011. The decrease was primarily due to a 4.1% decrease in comparable store sales. The decrease in comparable sales for the first nine months of fiscal 2012 was comprised of a 3.5% decrease in traffic and a 0.6% decrease in average ticket, partially offset by new store sales.
Gross profit decreased $5.3 million, or 2.2%, to $235.4 million for the nine months ended March 31, 2012 as compared to $240.7 million for the same nine month period last year. The decrease in gross profit dollars was primarily due to lower net sales. In the nine month period ended March 31, 2012, our gross profit percentage decreased to 38.2% from 38.4% for the same period last year. This decrease of 0.2% in gross profit percentage was primarily due to slightly higher markdowns and freight costs offset by somewhat higher product margins.
Selling, general and administrative expenses during the nine months ended March 31, 2012 increased $3.5 million, or 1.6%, to $224.5 million from $221.0 million for the nine months ended March 31, 2011. As a percentage of net sales, selling, general and administrative expenses increased 1.1% to 36.4% in the first nine months of fiscal 2012 from 35.3% in the same period last year. The increase was primarily due to the loss of expense leverage on lower sales volume in addition to higher rent expense from having more stores this year. An increase in square footage in certain new and relocated stores during the trailing 12 months also contributed to the higher rent expense. On a per store basis, selling, general and administrative expenses remained flat year over year.
The income tax expense for the nine month periods ended March 31, 2012 and 2011 was $3.3 million and $6.8 million, respectively, reflecting an effective tax rate of 35.5% and 38.3%, respectively. The effective tax rate was lower in the nine months ended March 31, 2012 as compared to the nine months ended March 31, 2011 due to an increase tax credits for fiscal year 2012.
Liquidity and Capital Resources
We have financed our operations with funds generated from operating activities and borrowings under our Revolving Credit Facility. Our borrowings have historically peaked during October as we build inventory levels prior to the holiday selling season. Given the seasonality of our business, the amount of borrowings under our revolving credit facility may fluctuate materially depending on various factors, including the time of year, our needs and the opportunity to acquire merchandise inventory. We have no off-balance sheet arrangements or transactions with unconsolidated, limited purpose or variable interest entities, nor do we have material transactions or commitments involving related persons or entities.
Net cash provided by operating activities for the nine months ended March 31, 2012 was $50.1 million whereas net cash used in operating activities for the nine months ended March 31, 2011 was $11.3 million. The $50.1 million of cash provided by operating activities for the nine months ended March 31, 2012 was primarily due to a decrease in inventory of $2.2 million, a decrease in prepaid assets of $2.5 million, an increase in accounts payable of $25.1 million, and net income, excluding depreciation and amortization of $17.6 million. There were no significant changes to our vendor payment policy during this time.
Capital expenditures are primarily associated with new store openings or relocations, existing store maintenance, or enhancements to warehouse and office equipment and systems, and totaled $9.5 million and $17.0 million for the nine months ended March 31, 2012 and 2011, respectively. The decrease in capital expenditures was primarily related to merchandise systems implementations that occurred during fiscal 2011 that did not reoccur in fiscal 2012. We expect to spend approximately $5.5 million for additional capital expenditures during the remainder of fiscal 2012, which will primarily include systems improvements, the opening of new stores, relocations of existing stores, enhancements of selected stores, fixtures for existing stores and purchases of equipment for our distribution center and corporate office.
On August 22, 2011, the Company’s Board of Directors adopted a share repurchase program pursuant to which the Company is authorized to repurchase from time to time shares of Common Stock, up to a maximum of $5.0 million in aggregate purchase price for all such shares (the “Repurchase Program”). On January 20, 2012, the Company’s Board of Directors increased the authorization for stock repurchases under the Repurchase Program from $5.0 million to a maximum of $10.0 million. The Repurchase Program does not have an expiration date and may be suspended or discontinued at any time. The Board will evaluate the Repurchase Program each year and there can be no assurances as to the number of shares of Common Stock the Company will repurchase. During the nine-month period ended March 31, 2012, 1,657,094 shares were repurchased under the Repurchase Program at an average cost of $3.51 per share and for a total cost (excluding commissions) of approximately $5.9 million. All such shares were purchased by the Company in open-market transactions.
We have a credit agreement providing for an asset-based, five-year senior secured Revolving Credit Facility (the “Revolving Credit Facility”) in the amount of up to $180.0 million. Our indebtedness under the credit facility is secured by a lien on substantially all of our assets. On November 17, 2011, we entered into a third amendment to the Revolving Credit Facility. This amendment, among other things, extended the maturity date of the Revolving Credit Facility from December 15, 2013 to November 17, 2016 and removed the “clean down” provision. The Revolving Credit Facility contains certain restrictive covenants, which affect, among others, our ability to incur liens or incur additional indebtedness, sell assets or merge or consolidate with any other entity. In addition, we are currently required to maintain availability under the Revolving Credit Facility of not less than $18.0 million. As of March 31, 2012, we were in compliance with all required covenants. Interest expense of $0.4 million for the quarter ended March 31, 2012 was due primarily to commitment fees of $0.2 million, and the amortization of financing fees of $0.2 million.
At March 31, 2012, we had no outstanding amounts under the Revolving Credit Facility, $8.3 million of outstanding letters of credit and availability of $120.9 million under the Revolving Credit Facility subject to minimum availability requirements as discussed above. Letters of credit under the Revolving Credit Facility are primarily for self-insurance purposes. We incur commitment fees of 0.375% on the unused portion of the Revolving Credit Facility. Any borrowing under the Revolving Credit Facility incurs interest at LIBOR or the prime rate, depending on the type of borrowing, plus an applicable margin. These rates are increased or reduced as our average daily availability changes.
Recent Accounting Pronouncements
In June 2011, an accounting standard update was issued that eliminates the option to present the components of other comprehensive income in the statement of equity and requires the presentation of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. This update does not change the items that must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. This accounting standard update is not effective for the Company until July 1, 2012 and will be applied retrospectively. This update will not have an impact on our financial condition, results of operations or cash flows.
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. This standard amends the disclosure guidance with respect to fair value measurements for both interim and annual reporting periods. Specifically, this standard requires separate disclosure of significant transfers of assets or liabilities between Level 1 and Level 2 fair value measurements, and separate disclosures of fair value measurements for purchases, sales, issuances and settlements that use unobservable inputs (Level 3), and more robust disclosure of the valuation techniques and inputs used to measure recurring and nonrecurring fair value measurements (e.g., Level 2 and Level 3 measurements). These more robust disclosures and separate disclosure of significant transfers of assets or liabilities between Level 1 and Level 2 fair value measurements was effective for us as of December 15, 2009. The separate disclosures of fair value measurements for purchases, sales and settlements that use unobservable inputs (Level 3) was effective beginning with our fiscal year beginning July 1, 2011. However, at this time, the Company does not have any material Level 1, 2 or 3 assets or liabilities that require disclosure.
In April 2011, the FASB issued Accounting Standards Update No. 2011-04: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The Amendments change the wording used to describe the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. Specifically, the amendments clarify the intent around applying existing fair value measurements and disclosure requirements, as well as, those that change a particular principle or requirement for measuring fair value or disclosing information about fair value measurements. These amendments are to be applied prospectively for annual periods beginning after December 15, 2011, and early application is not permitted. Due to the level of immateriality of the Level 1, 2 and 3 assets and liabilities that are addressed with these amendments, the Company does not believe that any of these amendments will have a material effect on its consolidated financial statements.
CONF CALL
Lorie Pete
Thank you for joining us. I'd like to welcome you all to the Tuesday Morning Corporation's second quarter fiscal year 2009 conference call. Today you will hear from Tuesday Morning President and Chief Executive Officer, Kathleen Mason; Executive Vice President and Chief Operating Officer, Mike Marchetti; and Executive Vice President and Chief Financial Officer, Stephanie Bowman.
We are here to discuss the company's second quarter results which were reported this morning. If you have not yet received a copy of today's release please call Lorie Pete and Associates at 214-871-8787. This morning's call will begin with formal remarks by management. When they have concluded a question-and-answer period will follow. The operator will instruct you on procedure at that time.
I'd also like to remind participants that remarks made by management during the course of this call may contain certain forward-looking statements within the meaning of the Federal Securities laws and the Private Securities Litigation Reform Act of 1995 which are based on management's current expectations, estimates, and projections. Words such as: expect, anticipate, intend, plan, believe, estimate and variations of such words and similar expressions are intended to identify such forward-looking statements.
Forward-looking statements are subject to risk and uncertainties which could cause actual results to differ materially from those projected or implied in the forward-looking statements. Such risk and uncertainties include the success of new store openings, competitive factors, access to merchandise and unanticipated changes in consumer demand and economic trends, as well as other risk detailed in the company's filings with the Securities and Exchange Commission including form 8-K, 10-Q, 10-K and 10-KT.
We will start with Kathleen Mason's overall comments on the quarter and year-to-date results. Then move to Stephanie Bowman for financial details, and finally we'll open the call for your questions. Mike Marchetti will answer operational questions. Kathleen, please begin.
Kathleen Mason
Thank you for joining us today. As reported this morning, net sales for the second quarter ended December 31, 2008 were $272.7 million as compared to $308.7 million for the quarter ended December 31, 2007, a decrease of 11.7 % or $36 million.
Comparable store sales for the quarter decreased 14.9%. Net income for the second quarter of fiscal 2009 was $12.7 million or $0.31 per diluted share compared to net income of $20.5 million or $0.50 for the same quarter in 2008.
With the six months ended December 31, 2008, net sales were $446.1 million versus $510.3 million for the same period ended December 31, 2007, a decrease of 12.6%.
Comparable store sales decreased by 15.8% during the six months period ended December 31, 2008 compared to the same period last year. Decreases in traffic of 11.4%, and average ticket of 4.4% comprised the comparable store sales decline.
For the six months period ended December 31, 2008, net income was $8.4 million or $0.20 per diluted share compared with net income of $21.7 million or $0.52 per diluted share for the period ended December 31, 2007.
The impact of lower sales for the second quarter was partially offset by reductions in SG&A cost of 4.4% on a per store basis.
For the six months period, SG&A cost were reduced by 4.8% on a per store basis. It is well documented that this is one of the worst economic environment that we have seen in decades. The downturn in the home furnishing sector, as a result of the housing and credit crisis, has impacted our results in particular.
The shorter holiday selling season, a highly promotional liquidation environment and the weakest consumer confident reports on record produced less traffic and lower average baskets than in previous seasons.
Our customer has drastically reduced discretionary spending. The regions with the largest decline continue to be the areas most affected by housing such as Florida, California, Nevada and Arizona.
In December, we secured a new credit facility which provides us with greater flexibility than our previous facility.
We believe the new facility represents a significant advantage in this challenging retail environment and should give greater confidence to our shareholders and vendor partners that we are well positioned to weather the current economic storm.
We are focused on generating positive cash flow, managing inventories and maintaining our strong balance sheet. We ended the second quarter with inventory of $260.9 million compared to inventory of $259.3 million at December 31, 2007 which was a 3.3% decrease on a per store basis. Markdowns were taken to address aged and slow moving inventory.
We operated 860 stores in 45 states as of December 31, 2008. During the second quarter of fiscal year 2009, we opened nine stores, relocated six stores and expanded one store. We do not expect to add additional stores or square footage for the balance of fiscal 2009, which ends on June 30, 2009.
We believe relocating and expanding stores in our existing store base will improve the overall portfolio and performance of our store. The flexibility in our execution will better position us for the long-term while maintaining a low cost per square foot and rent expense.
I'll now turn the call over to Stephanie, who will discuss our financial results in more detail.
Stephanie Bowman
Thank you Kathleen, and good morning everyone. This morning, I will discuss the financial results for the second quarter of fiscal 2009.
Net sales for the second quarter of fiscal 2009 were $272.7 million compared to $308.7 million for the quarter ended December 31, 2007, a decline of 11.7%.
A drop in comparable store sales of 14.9% offset by sales of non-comparable stores was the reason for the variance. Comparable store sales were comprised of decreases in traffic of 9.6% and average ticket of 5.3%.
Gross Profit for the second quarter was $100.9 million and gross margin was 37.1% compared to a gross profit of $114.9 million and a gross margin of 37.2% for the same period in 2007.
The primary reasons for the drop in gross margins percentage were a slight increase in capitalized inventory cost as a percent of sales, partially offset by slight declines in shrink, merchandise cost and markdowns.
SG&A expense for the quarter was $80.3 million or 29.5% of sales versus $80.7 million or 26.1% of sales last year.
We were able to lower cost on a per store basis by 4.4%. Our operating income for the quarter was $20.6 million compared to operating income of $34.2 million in the prior year with operating margins of 7.6% for 2008 and 11.1% for 2007.
Net interest expense decreased to $0.5 million, due to lower average daily borrowings under our revolving credit facility in 2008 versus 2007. At December 31, 2008 borrowings were lower by $5 million versus 2007.
Net income for the second quarter ended December 31, 2008 was $12.7 million or $0.31 per diluted share compared to net income of $20.5 million or $0.50 per diluted share last year.
For the six months ended December 31, 2008, net sales were $446.1 million compared to $510.3 million for the period ended December 31, 2007, a decrease of 12.6%. A drop in the comparable store sales of 15.8% offset by sales of non-comparable stores was the reason for the variance.
Comparable store sales were comprised of decreases in traffic of 11.4% and average ticket of 4.4%.
Gross profit for the six month period was $165.1 million and gross margin was 37% compared to a gross profit of $190.6 million and a gross margin of 37.3% for the same period in 2007.
The primary reasons for the drop in gross margin percentage was a slight increase in capitalized inventory cost as a percent of sales.
SG&A expense for the six months was $151.2 million or 33.9% of sales versus $153.2 million or 30% of sales last year. We were able to lower cost on a per store basis by 4.8% for the six month period.
Our operating income for the quarter was $13.8 million compared to operating income of $37.4 million in the prior year with operating margins of 3.1% for 2008 and 7.3% for 2007.
Net interest expense decreased to $0.9 million due to lower average sale in borrowings under our revolving credit facility, during the six month in 2008 versus 2007. At December 31, 2008, borrowings were lower by $5 million versus 2007.
Net income for the six months ended December 31, 2008 was $8.4 million or $0.20 per diluted share compared to net income of $21.7 million or $0.52 per diluted share last year.
Inventory as of December 31, 2008 was $260.9 million versus $259.3 million at December 31, 2007. Our inventory levels per store decreased 3.3% year-over-year. We had $2 million outstanding under the revolving credit facility versus $7 million at December 31, 2007. At December 31, 2008 we had outstanding letters of credit of $12.8 million primarily for insurance program.
We are in compliance with all debt covenants at December 31, 2008. Our accounts payable balance at December 31, 2008 increased to $73.3 million from $59.6 million at December 31, 2007, primarily a result of the timing of inventory purchases.
We invested $3.4 million for the quarter and $7 million for the six month period in capital expenditure.
For the fiscal year ending June 30, 2009, our guidance remains, net sales in the range of $800 million to $810 million. Comparable stores sales in the low negative double-digits, diluted earnings per share in the range of zero to $0.05 and capital expenditures are projected to be approximately $10 million.
At this point, I'll turn the call back over to you, Kathleen.
Kathleen Mason
Thank you, Stephanie. We reaffirm our commitment to generating positive cash flow, maintaining our strong balance sheet and to match expenses and inventories with revenues. We firmly believe that our strong balance sheet, flexible format and ability to generate those positive cash flows will place us in a position to weather the current economic environment.
And now, I'd like to open the call for questions.
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Fund Letters
