ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

 

Bed Bath & Beyond Inc. and subsidiaries (the “Company”) operate specialty retail stores nationwide, including stores of Bed Bath & Beyond (“BBB”), Harmon Stores, Inc. (“Harmon”) and Christmas Tree Shops, Inc. (“CTS”), primarily selling better quality domestics merchandise and home furnishings. The Company’s objective is to be a customer’s first choice for products and services in the categories offered, in the markets in which the Company operates.

 

The Company’s strategy is to achieve this objective through excellent customer service, an extensive breadth and depth of assortment, everyday low prices, introduction of new merchandising offerings and development of our infrastructure.

 

Operating in the highly competitive retail industry, the Company, along with other retail companies, is influenced by a number of factors including but not limited to, general economic conditions, consumer preferences and spending habits, competition from existing and potential competitors, unusual weather patterns and the ability to find suitable locations at acceptable occupancy costs to support the Company’s expansion program.

 

For the three months ended May 28, 2005, the Company’s consolidated net sales increased by 13.0% as compared to the corresponding quarter last year.  The increase in net sales was primarily attributable to the continuing BBB store expansion program and an increase in comparable store sales of approximately 4.4% as compared with an increase of approximately 5.1% for the fiscal first quarter of 2004.  The increase in comparable store sales reflected a number of factors, including but not limited to, the continued consumer acceptance of the Company’s merchandise offerings and a strong focus on customer service with an emphasis on responding to customer feedback.

 

A store is considered a comparable store when it has been open for twelve full months following its grand opening period (typically four to six weeks).  Stores relocated or expanded are excluded from comparable store sales if the change in square footage would cause meaningful disparity in sales over the prior period.  In the case of a store to be closed, such store’s sales are not considered comparable once the store closing process has commenced.

 

For the three months ended May 28, 2005, the Company’s consolidated net earnings increased by 20.5% as compared to the corresponding quarter last year.  This increase was primarily a result of a relative increase in gross profit as a percentage of net sales and a relative decrease in selling, general and administrative expenses (“SG&A”) as a percentage of net sales.

 

10

 

Results of Operations

 

Net Sales

 

Net sales for the three months ended May 28, 2005 were approximately $1.244 billion, an increase of $143.5 million or approximately 13.0% over net sales of approximately $1.101 billion for the corresponding quarter last year.

 

Approximately 66.6% of the increase in net sales for the three months ended May 28, 2005 was attributable to an increase in the Company’s new store sales with the balance of the increase primarily attributable to the increase in comparable store sales.  The increase in comparable store sales for the first quarter of 2005 was 4.4% as compared to 5.1% for the first quarter of 2004.  As of the beginning of the fiscal third quarter of 2004, CTS is included in the calculation of comparable store sales. The increase in comparable store sales was due to a number of factors, including but not limited to, the continued consumer acceptance of the Company’s merchandise offerings and a strong focus on customer service with an emphasis on responding to customer feedback.

 

Sales of domestics merchandise accounted for approximately 48% and 50% of net sales for the three months ended May 28, 2005 and May 29, 2004, respectively.  Sales of home furnishings accounted for approximately 52% and 50% of net sales for the three months ended May 28, 2005 and May 29, 2004, respectively.

 

Gross Profit

 

Gross profit for the three months ended May 28, 2005 was $520.8 million or 41.8% of net sales, compared with $456.8 million or 41.5% of net sales for the three months ended May 29, 2004.  The increase in gross profit as a percentage of net sales was driven primarily by the reduction of inventory acquisition costs attributable to the Company’s current merchandise offerings.

 

Selling, General and Administrative Expenses

 

SG&A was $369.9 million in the first quarter of 2005, compared with $328.1 million in the corresponding quarter last year and as a percentage of net sales was 29.7% and 29.8%, respectively.  The decrease in SG&A as a percentage of net sales was primarily attributable to an improvement in payroll and payroll related items as a percentage of net sales which primarily resulted from increases in store sales.

 

Operating Profit

 

Operating profit for the three months ended May 28, 2005 increased to $150.9 million, compared to $128.7 million during the comparable period in 2004.  The improvement in operating profit was a result of the increase in net sales, a relative increase in gross profit as a percentage of net sales and a relative decrease in SG&A as a percentage of net sales, as discussed above.

 

Interest Income

 

Interest income was $7.1 million for the first quarter of 2005, compared to $3.1 million for the

 

11

 

corresponding quarter last year.  Interest income increased due to an increase in invested cash and an increase in the Company’s average investment interest rate as a result of the recent upward trend in short term interest rates.

 

Income Taxes

 

The effective tax rate was 37.40% for the fiscal three month period of 2005 and 37.75% for the fiscal three month period of 2004.  The decrease is due to a reduction in the weighted average effective tax rate resulting from a change in the mix of the business within the taxable jurisdictions in which the Company operates.

 

Net Earnings

 

As a result of the factors described above, net earnings increased to $98.9 million for the first quarter of 2005, compared with $82.0 million for the first quarter of 2004.

 

Expansion Program

 

The Company is engaged in an ongoing expansion program involving the opening of new stores in both new and existing markets and the expansion or relocation of existing stores. As a result of this program, the Company operated 671 BBB stores, 26 CTS stores and 35 Harmon stores at the end of the fiscal first quarter of 2005, compared with 592 BBB stores, 24 CTS stores and 31 Harmon stores at the end of the corresponding quarter last year.  At May 28, 2005, Company-wide total square footage was approximately 23.2 million square feet.

 

The Company opened 11 BBB stores during the first quarter of fiscal 2005.  The Company plans to open approximately 74 additional BBB stores, in both new and existing markets, and several CTS and Harmon stores by the end of the fiscal year.

 

Liquidity and Capital Resources

 

Net cash provided by operating activities for the three months ended May 28, 2005 was $87.6 million as compared with $60.1 million in the corresponding period of fiscal 2004.  The increase in net cash provided by operating activities was primarily attributable to an increase in net income, the timing of certain liability payments, an increase in income taxes payable and an increase in the tax benefit received from the exercise of stock options, partially offset by an increase in merchandise inventories (primarily a result of new store space).

 

Inventory per square foot was $53.29 as of May 28, 2005 and $50.96 as of May 29, 2004.  The Company continues to focus on optimizing inventory productivity while maintaining appropriate in-store merchandise levels to support sales growth.

 

Net cash used in investing activities for the three months ended May 28, 2005 was $94.0 million as compared with $97.9 million in the corresponding period of fiscal 2004.  The decrease in net cash used in investing activities was attributable to a decrease in purchases of investment securities partially offset by a decrease in redemptions of investment securities and an increase in capital expenditures.  The increase in capital expenditures was primarily attributable to expenditures for

 

12

 

furniture, fixtures and leasehold improvements for the 11 new stores opened and stores under construction during the first three months of fiscal 2005, a warehouse facility expansion and information technology enhancements, compared to expenditures for furniture, fixtures and leasehold improvements for the 17 new stores opened and stores under construction in the corresponding period last year.

 

Net cash provided by financing activities for the three months ended May 28, 2005 was $8.8 million as compared with $4.0 million in the corresponding period of 2004.  The increase in net cash provided by financing activities is attributable to an increase in proceeds from the exercise of stock options in the current year.

 

For fiscal 2005, the Company believes that its current operating cash flow, working capital, and cash and cash equivalents on hand should be sufficient to meet its obligations in the ordinary course of business, including capital expenditures and new store openings.

 

Seasonality

 

The Company exhibits less seasonality than many other retail businesses, although sales levels are generally higher in August, November and December and generally lower in February and March.

 

Recent Accounting Pronouncements

 

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”) which requires companies to measure all employee stock-based compensation awards using a fair value method and record such expense in its consolidated financial statements.  In addition, the adoption of SFAS No. 123R requires additional accounting and disclosure related to income tax and cash flow effects resulting from share-based payment arrangements. The SEC delayed the effective date of adoption for SFAS No. 123R to the beginning of the first annual reporting period after June 15, 2005.  Per SFAS No. 123R, early adoption is encouraged.

 

The Company currently plans to adopt SFAS No. 123R at the beginning of its fiscal third quarter under the modified prospective application.  Under this application, the Company will record compensation expense for all awards granted after the adoption date and for a portion of previously granted awards that remain outstanding at the date of adoption. The Company estimates the impact of recording stock-based compensation expense, which includes the expense of stock options in the third and fourth quarters and restricted stock awards from the date of grant, will be approximately $0.07 per share for fiscal 2005.

 

Critical Accounting Policies

 

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires the Company to establish accounting policies and to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. The Company bases its estimates on historical experience and on other assumptions that it believes to be relevant under the circumstances, the

 

13

 

results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. In particular, judgment is used in areas such as the inventory valuation, impairment of long-lived assets, goodwill and other indefinitely lived intangible assets, income taxes and accruals for self insurance, litigation and store opening, expansion, relocation and closing costs. Actual results could differ from these estimates.

 

Inventory Valuation :  Merchandise inventories are stated at the lower of cost or market.  Inventory costs for BBB and Harmon are calculated using the retail inventory method and inventory cost for CTS is calculated using the first-in, first-out cost method.  Under the retail inventory method, the valuation of inventories at cost and the resulting gross margins are calculated by applying a cost-to-retail ratio to the retail value of inventories.

 

At any one time, inventories include items that have been written down to the Company’s best estimate of their realizable value.  Factors considered in estimating realizable value include the age of merchandise and anticipated demand.  Actual realizable value could differ materially from this estimate based upon future customer demand or economic conditions.

 

The Company estimates its reserve for shrinkage throughout the year, based on historical shrinkage.  Actual shrinkage is recorded at year-end based upon the results of the Company’s physical inventory count.  Historically, the Company’s shrinkage has not been volatile.

 

Impairment of Long-Lived Assets :  The Company reviews long-lived assets for impairment annually or when events or changes in circumstances indicate the carrying value of these assets may exceed their current fair values.  If it is determined that an impairment loss has occurred, the loss would be recognized during that period.  The impairment loss is calculated as the difference between asset carrying values and the estimated future undiscounted cash flows.  The Company has not historically had any material impairment of long-lived assets.  In the future, if events or market conditions affect the estimated cash flows generated by the Company’s long-lived assets to the extent that an asset is impaired, the Company will adjust the carrying value of these assets in the period in which the impairment occurs.

 

Goodwill and Other Indefinitely Lived Intangible Assets :  The Company reviews goodwill and other intangibles that have indefinite lives for impairment annually or when events or changes in circumstances indicate the carrying value of these assets might exceed their current fair values.  Impairment testing is based upon the best information available including estimates of fair value which incorporate assumptions marketplace participants would use in making their estimates of fair value.  The Company has not historically recorded an impairment to its goodwill and other indefinitely lived intangible assets.  In the future, if events or market conditions affect the estimated fair value to the extent that an asset is impaired, the Company will adjust the carrying value of these assets in the period in which the impairment occurs.

 

Income Taxes : The Company accounts for its income taxes using the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled.  The effect on

 

14

 

deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.

 

Judgment is required in determining the provision for income taxes and related accruals, deferred tax assets and liabilities.  In the ordinary course of business, there are transactions and calculations where the ultimate tax outcome is uncertain.  Additionally, the Company’s tax returns are subject to audit by various tax authorities.  Although the Company believes that its estimates are reasonable, actual results could differ from these estimates.

 

Self Insurance :  The Company utilizes a combination of insurance and self insurance for a number of risks including workers compensation, general liability, automobile liability and employee related health care benefits (a portion of which is paid by its employees). Liabilities associated with the risks that the Company retains are estimated by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.  Although the Company’s claims experience has not displayed substantial volatility in the past, actual experience could materially vary from its historical experience in the future.  Factors that affect these estimates include but are not limited to: inflation, the number and severity of claims and regulatory changes.  In the future, if the Company concludes an adjustment to self insurance accruals is required, the liability will be adjusted accordingly.

 

Litigation :  The Company records an estimated liability related to various claims and legal actions arising in the ordinary course of business which is based on available information and advice from outside counsel, where appropriate.  As additional information becomes available, the Company reassesses the potential liability related to its pending litigation and revises its estimates as appropriate. The Company cannot predict the nature and validity of claims which could be asserted in the future, and future claims could have a material impact on its earnings.

 

Store Opening, Expansion, Relocation and Closing Costs :  Store opening, expansion, relocation and closing costs, including estimates for markdowns, asset residual values and projected occupancy costs, are charged to earnings as incurred.  Actual costs related to store relocations and closings could differ from these estimates.

 

Forward Looking Statements

 

This Form 10-Q may contain forward looking statements.  Many of these forward looking statements can be identified by use of words such as may, will, expect, anticipate, estimate, assume, continue, project, plan, and similar words and phrases.  The Company’s actual results and future financial condition may differ materially from those expressed in any such forward looking statements as a result of many factors that may be outside the Company’s control.  Such factors include, without limitation: general economic conditions, changes in the retailing environment and consumer preferences and spending habits; demographics and other macroeconomic factors that may impact the level of spending for the types of merchandise sold by the Company; unusual weather patterns; competition from existing and potential competitors; competition from other channels of distribution; pricing pressures; the ability to find suitable locations at acceptable occupancy costs to support the Company’s expansion program; and the cost of labor, merchandise and other costs and expenses. The Company does not undertake any obligation to update its forward looking statements.

 

15

 

Available Information

 

The Company makes available as soon as reasonably practicable after filing with the SEC, free of charge, through the Investor Relations section of its website, www.bedbathandbeyond.com, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, electronically filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

16