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HGG Fiscal Year End March 31, 2012 Year Review

|Includes:hhgregg, Inc. (HGG)

Profile: hhgregg, Inc. operates as a specialty retailer of home appliances, televisions, computers, consumer electronics, mattresses, and related services. The company offers video products, such as flat panel televisions, Blu-ray products, and DVD players; appliances, including washers and dryers, refrigerators, cooking ranges, dishwashers, freezers, and air conditioners; computers, mobile phones, and tablets; and digital camcorders, digital cameras, gaming bundles, home theater receivers, mattresses, MP3 players, personal navigation products, speaker systems, and telephones. It also sells a suite of services, including third-party premium service plans, and third-party in-home service and repair of products, as well as delivery and installation, and in-home repair and maintenance. The company operates its stores under the name of hhgregg. As of May 23, 2012, it operated 210 stores in Alabama, Delaware, Florida, Georgia, Illinois, Indiana, Kentucky, Maryland, Mississippi, New Jersey, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, and Virginia. The company is headquartered in Indianapolis, Indiana.

Financial Overview:

Revenue - According to the latest financial results, for the fiscal year ended March 31, 2012, management estimates that the net sales for the business will result in 9% to 12% in net sales growth. Since the firm achieves sales growth both through the expansion of existing store base, and the opening of new stores, management provided additional guidance. It is estimated that HGG will deliver between -1% and 1% growth for same store sales. Relative to the major discount retailers i.e. Target, Walmart, and Sears, this figure appears to be relatively low. Historically I have observed same store sales estimates at Target of approximately 2% to 3% minimum, indicating that HGG may not be growing in line with what I would expect to see from much larger and more mature businesses. On an annualized basis, HGG has grown revenue at over 20% over the last 5 years. The reduced growth prospects estimated by management could be a result of several extraneous factors: 1) increased competition 2) demand for goods 3) supply of goods.

Expenses - For the fiscal year ended March 31, 2012, HGG Sales General, and Administrative (SG&A) expenses were reported at $498.6 million or 20.0% of sales. Management has exhibited some measure of control over their sales and administrative expenses reducing SG&A as a percentage of sales from 20.7% in 2011 and 21.1% in 2010. Additionally, management reported net advertising expense of $117.4 million or 4.7% of sales. Advertising expenses have trended upward over the last several years as management continues to operate in a highly competitive market with significant price competition. Advertising expenses were 3.8% and 4.2% of sales for the fiscal years ended March 31, 2010 and March 31, 2011 respectively. Cost of Goods Sold (COGS) expense, increased to $1.77 billion from $1.45 billion, or 71.1% of sales versus 69.7% of sales the year prior. Since 2008, COGS has increased by nearly 2% of sales, indicating either an erosion in margins or broad increase in input costs.

Balance Sheet - From March 31, 2011 to March 31, 2012, HGGs cash balance has declined to $59 million, reflecting a significant investment in inventories and increased capital spending on property, plant, and equipment. Additional reductions in the cash balance are attributable to stock repurchases. HGG increased debt free working capital from $146 million to $198 million between fiscal year end 2011 and fiscal year end 2011 (note: debt free working capital calculated as account receivable + merchandise inventory - account payable - line of credit). Based on several balance sheet calculations including receivable turnover, payable turnover, and inventory turnover, it is easier to get a much clearer picture of HGG's balance sheet health. According to the March 31, 2012, sales and receivable information, HGG collects on its receivables balance every 5.6 days or 65 days a year. This indicates that HGG sells primarily on a cash or short term credit basis, limiting the need to carry large receivable balances on their books. HGG does however, carry a significant inventory on their books, which accounts for the large net working capital balance relative to sales. According to the latest figures, HGG turns its inventory 6 times a year or once every 58 days. For a technology based retail business I would like to see this figure under 60, particularly considering the obsolescence factor of electronics inventory and price competitive nature of the business. At first glance, it appears as though HGG has a fairly healthy balance sheet with significant financial flexibility, particularly pertaining to increase leverage and working capital, however, this is not entirely accurate. HGG has several large off-balance sheet liabilities pertaining to long-term operating lease and marketing / advertising commitments. If you account for these off-balance sheet items as debt, the debt to total capital for HGG changes from 0% to 48% (note: a 10% WACC was utilized to discount leasehold cash flows).

Cash Flow - As of March 31, 2012, HGG reported a cash flow balance of -$13.55 million. The primary driver for the reduction in cash, was a $47.5 million cash flow reduction for the repurchase of stock previously issued. It is always nice to see management buy back their stock, however, it is important to constantly evaluate whether this buyback was value accretive for shareholders, or just another management mechanism for improving short term operating performance at the expense of the future. Additionally, management finished the year with an increase in inventories of $70 million. This net change is significantly larger than the increase of $10 million for the same period in 2011. From a cash flow perspective, it appears as though management is making significant capital investments in growing the business without delivering growth in the existing stores

Disclosure: I am long HGG.

Stocks: HGG