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EX-32.2 - SECTION 906 CFO CERTIFICATION - HSN, Inc.dex322.htm
EX-10.2 - AMENDMENT NO. 1 TO THE SECOND AMENDED AND RESTATED 2008 STOCK AND ANNUAL - HSN, Inc.dex102.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - HSN, Inc.dex312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - HSN, Inc.dex311.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - HSN, Inc.dex321.htm
EX-10.3 - EMPLOYEE STOCK PURCHASE PLAN - HSN, Inc.dex103.htm
EX-10.1 - FORM OF PERFORMANCE CASH AWARD AGREEMENT - HSN, Inc.dex101.htm
EX-4.1 - SECOND SUPPLEMENTAL INDENTURE - HSN, Inc.dex41.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2010

Or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File No. 001-34061

 

 

HSN, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   26-2590893

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

1 HSN Drive, St. Petersburg, Florida 33729

(Address of principal executive offices, including zip code)

(727) 872-1000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of August 2, 2010, the registrant had 57,539,916 shares of common stock outstanding.

 

 

 


Table of Contents

HSN, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

 

          Page

Part I—Financial Information

   3

Item 1.

  

Financial Statements (Unaudited)

   3
  

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and 2009

   3
  

Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009

   4
  

Consolidated Statements of Shareholders’ Equity for the Six Months Ended June 30, 2010 and Year Ended December 31, 2009

   5
  

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009

   6
  

Notes to Consolidated Financial Statements

   7

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   15

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   21

Item 4.

  

Controls and Procedures

   21

Part II—Other Information

   22

Item 1.

  

Legal Proceedings

   22

Item 1A.

  

Risk Factors

   22

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   22

Item 3.

  

Defaults Upon Senior Securities

   22

Item 4.

  

Removed and Reserved

   22

Item 5.

  

Other Information

   22

Item 6.

  

Exhibits

   22

Signatures

   24

 

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Table of Contents

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

HSN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  

Net sales

   $ 689,992      $ 640,083      $ 1,373,205      $ 1,269,703   

Cost of sales

     431,331        408,212        878,060        826,608   
                                

Gross profit

     258,661        231,871        495,145        443,095   
                                

Operating expenses:

        

Selling and marketing

     129,997        124,396        250,496        246,912   

General and administrative

     56,131        53,009        110,570        104,719   

Production and programming

     14,432        13,957        28,532        27,461   

Amortization of intangible assets

     141        140        282        281   

Depreciation

     9,610        9,629        19,420        19,080   
                                

Total operating expenses

     210,311        201,131        409,300        398,453   
                                

Operating income

     48,350        30,740        85,845        44,642   
                                

Other (expense) income:

        

Interest income

     165        54        247        88   

Interest expense

     (8,226     (8,799     (16,602     (17,749
                                

Total other expense, net

     (8,061     (8,745     (16,355     (17,661
                                

Income from continuing operations before income taxes

     40,289        21,995        69,490        26,981   

Income tax provision

     (15,583     (8,357     (27,116     (10,361
                                

Income from continuing operations

     24,706        13,638        42,374        16,620   

Loss from discontinued operations, net of tax

     —          (28     (15     (56
                                

Net income

   $ 24,706      $ 13,610      $ 42,359      $ 16,564   
                                

Income from continuing operations per share:

        

Basic

   $ 0.43      $ 0.24      $ 0.74      $ 0.29   

Diluted

   $ 0.42      $ 0.24      $ 0.72      $ 0.29   

Net income per share:

        

Basic

   $ 0.43      $ 0.24      $ 0.74      $ 0.29   

Diluted

   $ 0.42      $ 0.24      $ 0.72      $ 0.29   

Shares used in computing earnings per share:

        

Basic

     57,420        56,355        57,112        56,347   

Diluted

     59,430        57,171        59,239        56,976   

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

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Table of Contents

HSN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

 

     June 30,
2010
    December 31,
2009
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 279,934      $ 269,921   

Accounts receivable, net of allowance of $11,499 and $11,608, respectively

     118,929        182,746   

Inventories

     293,679        261,473   

Deferred income taxes

     21,055        21,960   

Prepaid expenses and other current assets

     57,650        47,152   
                

Total current assets

     771,247        783,252   

Property and equipment, net

     153,068        157,051   

Intangible assets, net

     260,904        261,185   

Other non-current assets

     15,483        17,162   
                

TOTAL ASSETS

   $ 1,200,702      $ 1,218,650   
                
LIABILITIES AND SHAREHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable, trade

   $ 195,293      $ 222,787   

Current maturities of long-term debt

     12,698        4,762   

Accrued expenses and other current liabilities

     174,497        222,739   
                

Total current liabilities

     382,488        450,288   

Long-term debt, net of current maturities

     321,359        333,960   

Deferred income taxes

     75,077        76,413   

Other long-term liabilities

     17,127        13,959   
                

Total liabilities

     796,051        874,620   
                

Commitments and contingencies (Note 11)

    

SHAREHOLDERS’ EQUITY:

    

Preferred stock, $0.01 par value; 25,000,000 authorized shares; no issued shares

     —          —     

Common stock, $0.01 par value; 300,000,000 authorized shares; 57,473,915 and 56,503,163 issued shares at June 30, 2010 and December 31, 2009, respectively

     575        565   

Additional paid-in capital

     2,437,945        2,419,765   

Retained deficit

     (2,033,687     (2,076,046

Accumulated other comprehensive loss

     (182     (254
                

Total shareholders’ equity

     404,651        344,030   
                

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 1,200,702      $ 1,218,650   
                

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

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Table of Contents

HSN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

(Unaudited)

 

     Preferred Stock    Common Stock    Additional Paid-in
Capital
   Retained Deficit     Accumulated Other
Comprehensive
Loss
    Total  
     Shares    Amount    Shares    Amount          

Balance as of December 31, 2008

   —      $ —      56,222    $ 562    $ 2,406,503    $ (2,148,534   $ (246   $ 258,285   

Comprehensive income:

                     

Net income

   —        —      —        —        —        72,488        —          72,488   

Foreign currency translation

   —        —      —        —        —        —          (8     (8
                           

Total comprehensive income

                        72,480   

Stock-based compensation expense for equity awards

   —        —      —        —        11,264      —          —          11,264   

Adjustment to capitalization as a result of the spin-off

   —        —      —        —        406      —          —          406   

Board of Directors deferred compensation

   —        —      —        —        127      —          —          127   

Issuance of common stock upon exercise of stock options and release of restricted stock units

   —        —      281      3      1,465      —          —          1,468   
                                                       

Balance as of December 31, 2009

   —        —      56,503      565      2,419,765      (2,076,046     (254     344,030   

Comprehensive income:

                     

Net income

   —        —      —        —        —        42,359        —          42,359   

Foreign currency translation

   —        —      —        —        —        —          72        72   
                           

Total comprehensive income

                        42,431   

Stock-based compensation expense for equity awards

   —        —      —        —        7,370      —          —          7,370   

Board of Directors deferred compensation

   —        —      —        —        65      —          —          65   

Issuance of common stock upon exercise of stock options and release of restricted stock units

   —        —      971      10      10,745      —          —          10,755   
                                                       

Balance as of June 30, 2010

   —      $ —      57,474    $ 575    $ 2,437,945    $ (2,033,687   $ (182   $ 404,651   
                                                       

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

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Table of Contents

HSN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Six Months Ended June 30,  
   2010     2009  

Cash flows from operating activities attributable to continuing operations:

  

Net income

   $ 42,359      $ 16,564   

Less: Loss from discontinued operations, net of tax

     (15     (56
                

Income from continuing operations

     42,374        16,620   

Adjustments to reconcile income from continuing operations to net cash provided by operating activities attributable to continuing operations:

    

Depreciation

     19,420        19,080   

Amortization of intangible assets

     282        281   

Stock-based compensation expense

     9,310        5,027   

Amortization of cable and satellite distribution fees

     1,679        1,680   

Amortization of debt issuance costs

     1,285        1,271   

Loss on disposition of fixed assets

     488        305   

Deferred income taxes

     (431     (31

Bad debt expense

     8,265        8,540   

Excess tax benefits from stock-based awards

     (965     —     

Changes in current assets and liabilities:

    

Accounts receivable

     55,587        36,700   

Inventories

     (32,206     36,321   

Prepaid expenses and other current assets

     (11,686     (14,591

Accounts payable, accrued expenses and other current liabilities

     (74,472     (37,160
                

Net cash provided by operating activities attributable to continuing operations

     18,930        74,043   
                

Cash flows from investing activities attributable to continuing operations:

  

Capital expenditures

     (15,854     (19,121
                

Net cash used in investing activities attributable to continuing operations

     (15,854     (19,121
                

Cash flows from financing activities attributable to continuing operations:

  

Repayment under revolving credit facility

     —          (20,000

Repayment of long-term debt

     (4,762     (7,500

Proceeds from issuance of common stock, net of withholding taxes

     10,719        —     

Excess tax benefits from stock-based awards

     965        —     
                

Net cash provided by (used in) financing activities attributable to continuing operations

     6,922        (27,500
                

Total cash provided by continuing operations

     9,998        27,422   

Total cash provided by operating activities attributable to discontinued operations

     15        1,034   
                

Net increase in cash and cash equivalents

     10,013        28,456   

Cash and cash equivalents at beginning of period

     269,921        177,463   
                

Cash and cash equivalents at end of period

   $ 279,934      $ 205,919   
                

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

 

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Table of Contents

HSN, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1—ORGANIZATION

Company Overview

HSN, Inc. (“HSNi”) is an interactive multi-channel retailer that markets and sells a wide range of third party and private label merchandise directly to consumers through (i) television home shopping programming broadcast on the HSN television network; (ii) catalogs, which consist primarily of the Cornerstone portfolio of leading print catalogs including Frontgate, Garnet Hill, Ballard Designs, Improvements, Smith+Noble, The Territory Ahead and TravelSmith; (iii) websites, which consist primarily of HSN.com and the seven branded websites operated by Cornerstone; and (iv) retail stores. HSNi’s television home shopping business and related internet commerce is referred to herein as “HSN” and all catalog operations, including related internet commerce and retail stores, are collectively referred to herein as “Cornerstone.”

HSN offerings primarily consist of jewelry, fashion, beauty & wellness and home & other. Merchandise offered by Cornerstone primarily consists of home furnishings (including indoor/outdoor furniture, window treatments and other home related goods) and apparel & accessories.

Basis of Presentation

HSNi was incorporated in Delaware in May 2008 in connection with the spin-off of several businesses previously owned by IAC/InterActiveCorp, or IAC. The spin-off from IAC occurred August 20, 2008 concurrent with the spin-offs from IAC of Interval Leisure Group, Inc., Ticketmaster Entertainment, Inc., and Tree.com, Inc. Throughout these financial statements, the separation transaction is referred to as the “spin-off” and each of these companies as “Spincos.” Effective August 21, 2008, HSNi’s shares began trading on the NASDAQ Global Select Market under the symbol “HSNI.”

HSNi has accounted for its international subsidiaries as discontinued operations. The results of operations and cash flows of these subsidiaries have been presented as discontinued operations within the consolidated statements of operations and consolidated statements of cash flows for all periods presented.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of HSNi’s management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for a full year. The accompanying unaudited consolidated financial statements should be read in conjunction with HSNi’s audited consolidated financial statements and notes thereto for the year ended December 31, 2009. The consolidated balance sheet as of December 31, 2009 and the consolidated statement of shareholders’ equity for the year ended December 31, 2009 were derived from the audited consolidated financial statements at that date but may not include all disclosures required by GAAP. Intercompany transactions and accounts have been eliminated in consolidation.

NOTE 2—SIGNIFICANT ACCOUNTING POLICIES

Accounting Estimates

HSNi’s management is required to make certain estimates and assumptions during the preparation of its consolidated financial statements in accordance with GAAP. These estimates and assumptions impact the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. They also impact the reported amount of net earnings during any period. Actual results could differ from those estimates. In the opinion of HSNi’s management, the assumptions underlying these interim unaudited financial statements are reasonable.

Significant estimates underlying the accompanying consolidated financial statements include: the determination of the lower of cost or market adjustment for inventory; sales returns and other revenue allowances; the allowance for doubtful accounts; the recoverability of long-lived and intangible assets; the determination of deferred income taxes, including related valuation allowances; the accrual for actual, pending or threatened litigation, claims and assessments; and assumptions related to the determination of stock-based compensation.

 

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Table of Contents

NOTE 3—PROPERTY AND EQUIPMENT

The balance of property and equipment, net, is as follows (in thousands):

 

     June 30,
2010
    December 31,
2009
 

Capitalized software

   $ 199,744      $ 190,331   

Computer and broadcast equipment

     88,822        89,001   

Buildings and leasehold improvements

     85,318        81,937   

Furniture and other equipment

     68,853        66,861   

Projects in progress

     12,305        13,207   

Land and land improvements

     10,922        11,847   
                
     465,964        453,184   

Less: accumulated depreciation and amortization

     (312,896     (296,133
                

Total property and equipment, net

   $ 153,068      $ 157,051   
                

NOTE 4—SEGMENT INFORMATION

HSNi has determined to represent its operating segments and related financial information in a manner consistent with how the chief operating decision maker and executive management view the businesses, how the businesses are organized as to segment management, and the focus of the businesses with regards to the types of products or services offered or the target market. HSNi has two operating segments, HSN and Cornerstone. Entities included in discontinued operations are excluded from the schedules below. The accounting policies of the segments are the same as those described in Note 2 – Summary of Significant Accounting Policies included in HSNi’s Annual Report on Form 10-K for the year ended December 31, 2009. Intercompany accounts and transactions have been eliminated in consolidation.

HSNi’s primary metric is Adjusted EBITDA, which is defined as operating income excluding, if applicable: (i) stock-based compensation expense and amortization of non-cash marketing, (ii) amortization of intangibles, (iii) depreciation and gains and losses on asset dispositions, (iv) goodwill, long-lived asset and intangible asset impairments, (v) pro forma adjustments for significant acquisitions, and (vi) one-time items. Adjusted EBITDA is not a measure determined in accordance with GAAP, and should not be considered in isolation or as a substitute for operating income, net income or any other measure determined in accordance with GAAP. Adjusted EBITDA is used as a measurement of operating efficiency and overall financial performance and HSNi believes it to be a helpful measure for those evaluating companies in the retail and media industries. Adjusted EBITDA measures the amount of income generated each period that could be used to service debt, pay taxes and fund capital expenditures. Adjusted EBITDA has certain limitations in that it does not take into account the impact to HSNi’s consolidated statements of operations of certain expenses, including stock-based compensation, amortization of non-cash marketing, amortization of intangibles, depreciation, gains and losses on asset dispositions, asset impairment charges, acquisition-related accounting and one-time items.

 

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Table of Contents

The following tables reconcile Adjusted EBITDA to operating income (loss) for HSNi’s operating segments and to HSNi’s consolidated net income (in thousands):

 

     Three Months Ended June 30, 2010     Three Months Ended June 30, 2009  
     HSN     Cornerstone     Total     HSN     Cornerstone     Total  

Adjusted EBITDA

   $ 45,064      $ 18,489      $ 63,553      $ 38,355      $ 4,900      $ 43,255   

Stock-based compensation expense

     (2,771     (2,196     (4,967     (2,044     (436     (2,480

Amortization of intangible assets

     (141     —          (141     (140     —          (140

Depreciation

     (7,262     (2,348     (9,610     (7,160     (2,469     (9,629

Loss on disposition of fixed assets

     (426     (59     (485     (261     (5     (266
                                                

Operating income

   $ 34,464      $ 13,886        48,350      $ 28,750      $ 1,990        30,740   
                                    

Other expense, net

         (8,061         (8,745
                        

Income from continuing operations before income taxes

         40,289            21,995   

Income tax provision

         (15,583         (8,357
                        

Income from continuing operations

         24,706            13,638   

Loss from discontinued operations, net of tax

         —              (28
                        

Net income

       $ 24,706          $ 13,610   
                        

 

     Six Months Ended June 30, 2010     Six Months Ended June 30, 2009  
     HSN     Cornerstone     Total     HSN     Cornerstone     Total  

Adjusted EBITDA

   $ 95,378      $ 19,967      $ 115,345      $ 73,614      $ (4,279   $ 69,335   

Stock-based compensation expense

     (6,042     (3,268     (9,310     (3,999     (1,028     (5,027

Amortization of intangible assets

     (282     —          (282     (281     —          (281

Depreciation

     (14,867     (4,553     (19,420     (14,134     (4,946     (19,080

Loss on disposition of fixed assets

     (428     (60     (488     (299     (6     (305
                                                

Operating income (loss)

   $ 73,759      $ 12,086        85,845      $ 54,901      $ (10,259     44,642   
                                    

Other expense, net

         (16,355         (17,661
                        

Income from continuing operations before income taxes

         69,490            26,981   

Income tax provision

         (27,116         (10,361
                        

Income from continuing operations

         42,374            16,620   

Loss from discontinued operations, net of tax

         (15         (56
                        

Net income

       $ 42,359          $ 16,564   
                        

The net sales for each of HSNi’s reportable segments are as follows (in thousands):

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
   2010    2009    2010    2009

Net sales:

     

HSN

   $ 466,411    $ 454,227    $ 985,330    $ 929,155

Cornerstone

     223,581      185,856      387,875      340,548
                           

Total

   $ 689,992    $ 640,083    $ 1,373,205    $ 1,269,703
                           

 

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NOTE 5—COMPREHENSIVE INCOME

Comprehensive income is comprised of (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
     2010    2009     2010    2009

Net income

   $ 24,706    $ 13,610      $ 42,359    $ 16,564

Other comprehensive income (loss)

     42      (28     72      2
                            

Total comprehensive income

   $ 24,748    $ 13,582      $ 42,431    $ 16,566
                            

Accumulated other comprehensive loss included in the consolidated balance sheets at June 30, 2010 and December 31, 2009 is solely related to foreign currency translation and is recorded net of tax.

NOTE 6—STOCK-BASED AWARDS

The Second Amended and Restated 2008 Stock and Annual Incentive Plan, as amended (the “Plan”), authorizes the issuance of 8.0 million shares of HSNi common stock for new awards granted by HSNi. As of June 30, 2010, there were approximately 3.5 million shares of common stock available for grants under the Plan. The purpose of the Plan is to assist HSNi in attracting, retaining and motivating officers, employees, directors and consultants, and to provide HSNi with the ability to provide incentives more directly linked to the profitability of HSNi’s business and increases in shareholder value.

HSNi can grant restricted stock units (“RSUs”), stock options, stock appreciation rights (“SARs”) and other stock-based awards under the Plan. Stock-based awards have a maximum term of 10 years. The exercise price of options and SARs granted under the Plan are required to be priced at or above the fair market value of HSNi’s stock on the date of grant.

During the six months ended June 30, 2010, HSNi granted approximately 441,000 RSUs and 507,000 stock-settled SARs. The RSUs have a weighted average fair value of $20.80 and they primarily vest over three years. The stock-settled SARs have a weighted average exercise price of $20.30, have a fair value of $8.79 and primarily vest ratably over three years. The following are the assumptions used in the Black-Scholes option pricing model to value SARs for the six months ended June 30, 2010: volatility factor of 46.51%, risk-free interest rate of 2.39%, expected term of 5 years and a dividend yield of zero.

Additionally, during the first quarter of 2010, HSNi implemented a performance-based equity compensation program for certain key members of Cornerstone’s management. The amount payable is based on the extent to which certain pre-established performance goals for Cornerstone are achieved during the three-year period ending December 31, 2012. The amount earned pursuant to the award will be measured at the end of the requisite service period and is expected to be settled in shares of HSNi common stock. These equity awards are accounted for as liabilities which are remeasured each reporting period based on the probability of achievement of the performance conditions. As of June 30, 2010, a liability of approximately $1.9 million was recorded for these awards.

Stock-based compensation expense is included in the following line items in the accompanying consolidated statements of operations (in thousands):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  

Selling and marketing

   $ 650      $ 407      $ 1,478      $ 861   

General and administrative

     4,099        1,916        7,357        3,859   

Production and programming

     218        157        475        307   
                                

Stock-based compensation expense before income taxes

     4,967        2,480        9,310        5,027   

Income tax benefit

     (1,823     (937     (3,397     (1,930
                                

Stock-based compensation expense after income taxes

   $ 3,144      $ 1,543      $ 5,913      $ 3,097   
                                

As of June 30, 2010, there was approximately $25.6 million of unrecognized compensation cost, net of estimated forfeitures, related to all equity-based awards, which is currently expected to be recognized over a weighted average period of approximately 2.12 years.

 

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NOTE 7—INCOME TAXES

HSNi calculates its interim income tax provision in accordance with the accounting guidance for income taxes in interim periods. At the end of each interim period, HSNi makes its best estimate of the annual expected effective tax rate and applies that rate to its ordinary year-to-date income or loss. The tax or benefit related to significant, unusual, or extraordinary items that will be separately reported or reported net of their related tax effect are individually computed and recognized in the interim period in which those items occur.

In addition, the effect of changes in enacted tax laws or rates, tax status, or judgment on the realizability of a beginning-of-the-year deferred tax asset in future years is recognized in the interim period in which the change occurs.

The computation of the annual expected effective tax rate at each interim period requires certain estimates and assumptions including, but not limited to, the expected operating income for the year, permanent and temporary differences, and the likelihood of recovering deferred tax assets generated in the current year. The accounting estimates used to compute the provision for income taxes may change as new events occur, more experience is acquired, additional information is obtained or the tax environment changes. To the extent that the estimated annual effective tax rate changes during a quarter, the effect of the change on prior quarters is included in tax expense for the current quarter.

For the three and six months ended June 30, 2010, HSNi recorded a tax provision from continuing operations of $15.6 million and $27.1 million, respectively, which represents effective tax rates of 38.7% and 39.0%, respectively. For the three and six months ended June 30, 2009, HSNi recorded a tax provision from continuing operations of $8.4 million and $10.4 million, respectively, which represents effective tax rates of 38.0% and 38.4%, respectively. The effective tax rates exceed the federal statutory rate of 35.0% due principally to state income taxes.

As a result of the spin-off, HSNi entered into a Tax Sharing Agreement with IAC in which, among other things, each of the Spincos has indemnified IAC and the other Spincos for any taxes resulting from the spin-off of such Spinco (and any related interest, penalties, legal and professional fees, and all costs and damages associated with related shareholder litigation or controversies) to the extent such amounts result from (i) any act or failure to act by such Spinco described in the covenants in the Tax Sharing Agreement, (ii) any acquisition of equity securities or assets of such Spinco or a member of its group, and (iii) any breach by such Spinco or any member of its group of any representation or covenant contained in the separation documents or in the documents relating to the Internal Revenue Service (“IRS”) private letter ruling and/or tax opinions. Additionally, under the Tax Sharing Agreement, with respect to the consolidated federal income tax return of IAC and its subsidiaries for any taxable year that includes HSNi, IAC shall determine in its sole discretion whether to elect ratable allocation under applicable U.S. Treasury Regulations. HSNi shall, and shall cause each member of its group to, take all actions necessary to give effect to such election. In the event an adjustment with respect to a pre-spin-off period for which IAC is responsible results in a tax benefit to HSNi in a post-spin-off period, HSNi will be required to pay such tax benefit to IAC. In general, IAC controls all audits and administrative matters and other tax proceedings relating to the consolidated federal income tax return of the IAC group and any other tax returns for which the IAC group is responsible. The provisions set forth in the Tax Sharing Agreement could subject HSNi to future tax contingencies.

HSNi is routinely under audit by federal, state, local and foreign tax authorities. These audits include questioning the timing and the amount of deductions and the allocation of income among various tax jurisdictions. Income taxes payable include amounts considered sufficient to pay assessments that may result from examination of prior year returns; however, the amount paid upon resolution of issues raised may differ from the amount provided. Differences between the reserves for tax contingencies and the amounts owed by HSNi are recorded in the period they become known.

The IRS is currently examining the IAC consolidated tax returns for the years ended December 31, 2001 through 2006, which includes the operations of HSNi. The statute of limitations for these years has been extended to December 31, 2010. Various IAC consolidated tax returns filed with state, local and foreign jurisdictions are currently under examination, the most significant of which are California, New York and New York City, for various tax years after December 31, 2003. These examinations are expected to be completed by 2011. By virtue of the Tax Sharing Agreement with IAC, HSNi is indemnified with respect to additional tax liabilities for consolidated or combined federal tax returns prepared and filed by IAC prior to the spin-off, but is liable for any additional tax liabilities for HSNi separately filed state income tax returns.

NOTE 8—EARNINGS PER SHARE

HSNi computes basic earnings per share using the weighted average number of common shares outstanding for the period. HSNi computes diluted earnings per share using the treasury stock method or as if converted method, as applicable, which includes the weighted average number of common shares outstanding for the period plus the potential dilution that could occur if various equity awards to issue common stock were exercised or restricted equity awards were vested resulting in the issuance of common stock that could share in HSNi’s earnings.

 

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The following table presents HSNi’s basic and diluted earnings per share (in thousands, except per share data):

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010    2009     2010     2009  

Net income:

         

Continuing operations

   $ 24,706    $ 13,638      $ 42,374      $ 16,620   

Discontinued operations

     —        (28     (15     (56
                               

Net income

   $ 24,706    $ 13,610      $ 42,359      $ 16,564   
                               

Weighted average number of shares outstanding:

         

Basic

     57,420      56,355        57,112        56,347   

Dilutive effect of stock-based compensation awards

     2,010      816        2,127        629   
                               

Diluted

     59,430      57,171        59,239        56,976   
                               

Net income per share—basic:

         

Continuing operations

   $ 0.43    $ 0.24      $ 0.74      $ 0.29   

Discontinued operations

     —        (0.00     (0.00     (0.00
                               

Net income

   $ 0.43    $ 0.24      $ 0.74      $ 0.29   
                               

Net income per share—diluted:

         

Continuing operations

   $ 0.42    $ 0.24      $ 0.72      $ 0.29   

Discontinued operations

     —        (0.00     (0.00     (0.00
                               

Net income

   $ 0.42    $ 0.24      $ 0.72      $ 0.29   
                               
Unexercised employee stock options and stock appreciation rights and unvested restricted stock units excluded from the diluted EPS calculation because their effect would have been antidilutive      1,570      4,964        1,964        5,649   
                               

NOTE 9—LONG-TERM DEBT

 

     June 30,
2010
    December 31,
2009
 

Secured credit agreement expiring July 25, 2013:

    

Term loan

   $ 95,238      $ 100,000   

Revolving credit facility

     —          —     

11.25% Senior Notes due August 1, 2016; interest payable each February 1st and August 1st which commenced February 1, 2009

     240,000        240,000   

Unamortized original issue discount on Senior Notes

     (1,181     (1,278
                

Total long-term debt

     334,057        338,722   

Less: current maturities

     (12,698     (4,762
                

Long-term debt, net of current maturities

   $ 321,359      $ 333,960   
                

On July 25, 2008, HSNi entered into a secured credit agreement with a syndicate of banks relating to a $150 million term loan and a $150 million revolving credit facility, each having a five-year maturity. Certain HSNi subsidiaries have unconditionally guaranteed HSNi’s obligations under the credit agreement, which is secured by substantially all of HSNi’s assets. The credit agreement bears interest based on HSNi’s financial leverage and, as of June 30, 2010, the term loan interest rate was equal to LIBOR plus 2.00% (2.35%). The credit agreement contains two principal financial covenants consisting of a maximum leverage ratio of 2.75x and a minimum interest coverage ratio of 3.00x, among other covenants. HSNi was in compliance with all such covenants

 

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as of June 30, 2010, with a leverage ratio of 1.33x and an interest coverage ratio of 8.11x. The amount available to HSNi under the credit agreement is reduced by the amount of commercial and standby letters of credit issued under the revolving credit facility portion of the agreement. As of June 30, 2010, there were $34.3 million of outstanding commercial and standby letters of credit issued under the revolving credit facility. The ability to draw funds under the revolving credit facility is dependent upon meeting the aforementioned financial covenants, which may limit HSNi’s ability to draw the full amount of the facility. As of June 30, 2010, the additional amount that could be borrowed under the revolving credit facility, in consideration of the financial covenants and outstanding letters of credit, was approximately $115.7 million. HSNi capitalized $7.3 million in financing costs related to the credit agreement and will amortize these costs to interest expense over the credit agreement’s five-year life. The annual fee to maintain the revolving credit facility is 50 basis points on the revolving credit facility portion of the credit agreement.

On July 28, 2008, HSNi issued $240 million of 11.25% senior notes due 2016 (the “Senior Notes”). The Senior Notes are unsecured and subordinated to all of HSNi’s secured debt. The Senior Notes were issued at a discount of $1.6 million which, along with other issuance expenses of $7.3 million, are being amortized to interest expense over the eight-year term of the Senior Notes.

NOTE 10—FAIR VALUE MEASUREMENTS

Fair value accounting, as prescribed by GAAP, defines fair value and establishes a framework for measuring fair value based on a three-level hierarchy:

Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Valuations based on unobservable inputs reflecting HSNi’s own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate fair value because of the short maturity of these items. The following table summarizes the fair value of HSNi’s financial assets and liabilities which are carried at cost (in millions):

 

     June 30, 2010
               Fair Value Measurement Category
     Carrying
Value
   Fair Value    Level 1    Level 2    Level 3

Senior Notes

   $ 240.0    $ 268.8    $ 268.8    $ —      $ —  

Term Loan

     95.2      91.0      —        —        91.0

 

     December 31, 2009
               Fair Value Measurement Category
     Carrying
Value
   Fair Value    Level 1    Level 2    Level 3

Senior Notes

   $ 240.0    $ 264.0    $ 264.0    $ —      $ —  

Term Loan

     100.0      96.1      —        —        96.1

The fair value of the Senior Notes was based upon quoted market information (level 1 criteria) and the fair value of the term loan was based upon discounted cash flows (level 3 criteria).

HSNi measures certain assets, such as intangible assets and property and equipment, at fair value on a non-recurring basis. These assets are recognized at fair value if they are deemed to be impaired. During the six months ended June 30, 2010 and 2009, there were no assets that were required to be recorded at fair value since no impairment indicators were present.

 

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NOTE 11—COMMITMENTS AND CONTINGENCIES

HSNi received a preliminary assessment notification from a state alleging that one of HSNi’s subsidiaries was required to collect and remit sales tax to the state. HSNi does not believe that its subsidiary is obligated to collect and remit these taxes, and intends to vigorously defend its position if the state’s notification results in an assessment. At this time, no assurances can be given as to the outcome nor can a reasonable estimate of liability, if any, be made.

In the ordinary course of business, HSNi is a party to various audits and lawsuits. These audits or litigation may relate to claims involving property, personal injury, contract, intellectual property, sales tax, regulatory compliance and other claims. HSNi establishes reserves for specific legal or tax compliance matters when it determines that the likelihood of an unfavorable outcome is probable and the loss is reasonably estimable. Management has also identified certain other legal matters where it believes an unfavorable outcome is not probable and, therefore, no reserve is established. Although management currently believes that an unfavorable resolution of claims against HSNi, including claims where an unfavorable outcome is reasonably possible, will not have a material impact on the liquidity, results of operations, or financial condition of HSNi, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future. HSNi also evaluates other contingent matters, including tax contingencies, to assess the probability and estimated extent of potential loss. See Note 7 for discussion related to income tax contingencies.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward-Looking Information

This quarterly report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), which are based on management’s exercise of business judgment, as well as assumptions made by and information currently available to management. When used in this document, the words “may,” “will,” “anticipate,” “believe,” “estimate,” “expect,” “intend,” and words of similar import, are intended to identify any forward-looking statements. These forward-looking statements include, among other things, statements relating to the following: HSNi’s future financial performance, HSNi’s business prospects and strategy, anticipated trends and prospects in the various markets in which HSNi’s businesses operate and other similar matters. These forward-looking statements are based on management’s current expectations and assumptions about future events, which are inherently subject to uncertainties, risks and changes in circumstances that are difficult to predict.

Should one or more of these uncertainties, risks or changes in circumstances materialize, or should underlying assumptions prove incorrect, our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could cause or contribute to such differences include but are not limited to the following: the impact of the continued macroeconomic environment on consumer confidence and spending levels; whether national economic stimulus initiatives and measures to stabilize financial institutions and the economy will be successful in achieving their objectives within the expected timeframes; other changes in political, business and economic conditions, particularly those that affect consumer confidence, consumer spending or internet growth; any technological or regulatory developments that could negatively impact the way we do business; changes in the interest rate environment and developments in the overall credit markets; HSNi’s business prospects and strategy, including whether HSNi’s initiatives will be effective; changes in our relationships with pay television operators, vendors, manufacturers and other third parties; the loss of any key member of our senior management team; our ability to offer new or alternative products and services in a cost effective manner and consumer acceptance of these products and services; and changes in product delivery costs. Certain of these and other risks and uncertainties are discussed in HSNi’s filings with the SEC, including the “Risk Factors” section in our Annual Report on Form 10-K filed with the SEC on March 4, 2010. Other unknown or unpredictable factors that could also adversely affect HSNi’s business, financial condition and results of operations may arise from time to time.

You should not place undue reliance on these forward-looking statements. We undertake no obligation, and do not intend, to update, revise or otherwise publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof, or to reflect the occurrence of any unanticipated events. Although we believe that our expectations are based on reasonable assumptions, we can give no assurance that our expectations will materialize. Historical results should not be considered an indication of future performance.

Results of Operations

Net Sales

Net sales primarily relate to the sale of merchandise and are reduced by incentive discounts and actual and estimated sales returns. Revenue is recorded when delivery to the customer has occurred. Delivery is considered to have occurred when the customer takes title and assumes the risks and rewards of ownership, which is generally on the date of shipment. HSNi’s sales policies allow customers to return virtually all merchandise for a full refund or exchange, subject to pre-established time restrictions and, in some cases, restocking fees.

 

     Three Months Ended June 30,    Six Months Ended June 30,
     2010    %
Change
  2009    2010    %
Change
  2009
     (Dollars in thousands)    (Dollars in thousands)

HSN

   $ 466,411    3%   $ 454,227    $ 985,330    6%   $ 929,155

Cornerstone

     223,581    20%     185,856      387,875    14%     340,548
                               

Total net sales

   $ 689,992    8%   $ 640,083    $ 1,373,205    8%   $ 1,269,703
                               

HSNi net sales for the three months ended June 30, 2010 increased 8%, or $49.9 million, as compared to the prior year due to a 3% increase at HSN and a 20% increase at Cornerstone. The number of units shipped in the second quarter of 2010 increased 8% to 12.7 million as compared 11.7 million in the prior year and the average price point was relatively flat at $60.53 as compared to $60.60 in the prior year. Internet sales as a percentage of total net sales for the quarter represented 38.5% of HSNi net sales compared to 35.8% in the prior year.

 

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HSNi net sales for the six months ended June 30, 2010 increased 8%, or $103.5 million, as compared to the same period in 2009 due to a 6% increase at HSN and a 14% increase at Cornerstone. The number of units shipped in the first half of 2010 increased 7% to 25.3 million from 23.6 million and the average price point increased 1% to $60.16 from $59.53. Internet sales as a percentage of total net sales continued to grow in the first half of 2010 representing 38.1% of HSNi net sales as compared to 36.3% in the prior year.

HSN

HSN merchandise categories primarily consist of jewelry, fashion (including apparel & accessories), beauty & wellness and home & other (including housewares, home fashions, electronics, fitness and other). Divisional product mix at HSN is provided in the table below:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2010     2009     2010     2009  

Jewelry

   16.1   17.7   15.0   16.3

Fashion (apparel & accessories)

   14.0   10.2   13.2   10.8

Beauty & wellness

   20.6   20.6   19.8   19.6

Home & other

   49.3   51.5   52.0   53.3
                        

Total

   100.0   100.0   100.0   100.0
                        

Net sales for HSN for the second quarter of 2010 increased 3% to $466.4 million compared to $454.2 million in the prior year. Due primarily to a strategic shift in product mix towards the fashion and wellness categories, units shipped increased 6% and the average price point decreased 2% compared to the prior year. HSN.com sales grew 10% over the prior year representing 30.4% of HSN’s net sales, up from 28.4% in the prior year.

Net sales for HSN for the six months ended June 30, 2010 increased 6% to $985.3 million from $929.2 million in the prior year. Shipped units increased by 6% and the average price point increased by 1% to $58.03 compared to the same period in the prior year. HSN.com net sales grew 13% over the prior year representing 31.0% of HSN’s total net sales, up from 29.2% in the prior year.

Cornerstone

Net sales for Cornerstone for the second quarter of 2010 increased 20% to $223.6 million compared to the prior year. The sales growth is attributable to an increase in demand for luxury and outdoor products, the execution of strategic merchandising and marketing initiatives and our investment in catalog circulation in Cornerstone’s three largest brands, Frontgate, Ballard Designs and Garnet Hill. The number of units shipped increased 16% and the average price point increased 2% to $71.81 compared to the prior year. Internet sales penetration increased 140 basis points and represents 55.4% of Cornerstone’s net sales.

Net sales for Cornerstone for the six months ended June 30, 2010 increased 14% to $387.9 million compared to $340.5 million in the prior year. As discussed previously, the increase is attributable to the increase in consumer demand for luxury and outdoor products, the execution of strategic merchandising and marketing initiatives and our investment in catalog circulation in Cornerstone’s three largest brands, Frontgate, Ballard Designs and Garnet Hill. The average price point and units shipped increased 1% and 11%, respectively, in the first half of 2010 as compared to the prior year. Internet sales represented 55.9% of net sales in 2010 as compared to 55.5% in 2009.

Cost of Sales and Gross Profit

Cost of sales consists primarily of the cost of products sold, shipping and handling costs, compensation and other employee-related costs (including stock-based compensation) for personnel engaged in warehouse functions and certain warehousing and fulfillment costs.

 

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     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

Gross profit:

    

HSN

   $ 162,189      6%   $ 152,773      $ 333,798      10%   $ 304,742   

HSN gross profit margin

     34.8   120 bp     33.6     33.9   110 bp     32.8

Cornerstone

   $ 96,472      22%   $ 79,098      $ 161,347      17%   $ 138,353   

Cornerstone gross profit margin

     43.1   50 bp     42.6     41.6   100 bp     40.6

HSNi

   $ 258,661      12%   $ 231,871      $ 495,145      12%   $ 443,095   

HSNi gross profit margin

     37.5   130 bp     36.2     36.1   120 bp     34.9

 

bp = basis points

HSN

Gross profit for HSN for the second quarter of 2010 increased 6% to $162.2 million compared to $152.8 million in the prior year. Gross profit margin improved 120 basis points to 34.8% compared to 33.6% in the prior year. The improvement in gross profit margin was mainly driven by the product mix shift towards fashion and wellness which typically carry lower price points and higher margins.

Gross profit for HSN for the six months ended June 30, 2010 increased 10% to $333.8 million from $304.7 million in the prior year. Gross profit margin improved 110 basis points to 33.9% from 32.8% in the prior year. The improvement in gross profit margin was mainly driven by the product mix shift towards fashion and wellness and improved product margins due to less promotional activity.

Cornerstone

Gross profit for Cornerstone increased 22% to $96.5 million in the second quarter of 2010 compared to $79.1 million in the prior year. Gross profit margin improved 50 basis points to 43.1% from 42.6% and was attributable to reduced promotional activity and leverage over warehousing costs due to the revenue growth and warehouse efficiencies.

Gross profit for Cornerstone for the six months ended June 30, 2010 increased 17% to $161.3 million compared to $138.4 million in the prior year. Gross profit margin improved 100 basis points to 41.6% from 40.6%. The margin improvement was attributable to reduced promotional activity and leverage over warehousing costs due to the revenue growth and warehouse efficiencies.

Selling and Marketing Expense

Selling and marketing expense consists primarily of advertising and promotional expenditures, compensation and other employee-related costs (including stock-based compensation) for personnel engaged in customer service, sales and merchandising functions and on-air distribution costs. Advertising and promotional expenditures primarily include catalog production and distribution costs and online marketing, including fees paid to search engines and third party distribution partners.

 

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     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

HSN

   $ 66,872      4%   $ 64,478      $ 137,668      4%   $ 132,039   

As a percentage of HSN net sales

     14.3   10 bp     14.2     14.0   (20 bp)     14.2

Cornerstone

   $ 63,125      5%   $ 59,918      $ 112,828      (2%)   $ 114,873   

As a percentage of Cornerstone net sales

     28.2   (400 bp)     32.2     29.1   (460 bp)     33.7

HSNi

   $ 129,997      5%   $ 124,396      $ 250,496      1%   $ 246,912   

As a percentage of HSNi net sales

     18.8   (60 bp)     19.4     18.2   (120 bp)     19.4

HSNi’s selling and marketing expense for the second quarter of 2010 increased $5.6 million to $130.0 million and represents 18.8% of net sales as compared to 19.4% in the prior year. The increase in expense is primarily due to an increase in compensation and other employee-related costs due to increased headcount and an increase in Cornerstone’s catalog costs associated with a 16% increase in circulation.

HSNi’s selling and marketing expense for the six months ended June 30, 2010 increased $3.6 million to $250.5 million and represents 18.2% of net sales as compared to 19.4% in the prior year. The increase in the expense is primarily due to an increase in compensation and other employee-related costs due to increased headcount and an increase in HSN’s on-air distribution costs associated with additional subscribers in certain markets, partially offset by a decrease in Cornerstone’s catalog costs. The decrease in catalog costs was primarily attributable to the timing of the catalog mailings as catalog costs are amortized over the expected future revenue stream.

General and Administrative Expense

General and administrative expense consists primarily of compensation and other employee-related costs (including stock-based compensation) for personnel engaged in finance, legal, tax, human resources, information technology and executive management functions, bad debts, facilities costs and fees for professional services.

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

HSN

   $ 39,019      2%   $ 38,287      $ 78,691      4%   $ 75,925   

As a percentage of HSN net sales

     8.4   0 bp     8.4     8.0   (20 bp)     8.2

Cornerstone

   $ 17,112      16%   $ 14,722      $ 31,879      11%   $ 28,794   

As a percentage of Cornerstone net sales

     7.7   (20 bp)     7.9     8.2   (30 bp)     8.5

HSNi

   $ 56,131      6%   $ 53,009      $ 110,570      6%   $ 104,719   

As a percentage of HSNi net sales

     8.1   (20 bp)     8.3     8.1   (10 bp)     8.2

HSNi’s general and administrative expense for the second quarter of 2010 increased 6% to $56.1 million compared to $53.0 million in the prior year. This increase is primarily attributable to compensation expense related to performance-driven incentives and stock-based compensation for performance-based awards.

HSNi’s general and administrative expense for the six months ended June 30, 2010 increased 6% to $110.6 million compared to $104.7 million in the prior year. This increase is primarily due to compensation expense related to performance-driven incentives and stock-based compensation for performance-based awards.

Production and Programming Expense

Production and programming expense includes costs related to the production of HSN’s television network. These costs consist primarily of compensation and other employee-related costs (including stock-based compensation) for personnel engaged in production and programming at HSN. Expenses associated with on-air distribution of HSN, including expenses relating to pay television operators, are included in selling and marketing expense.

 

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     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

Production and programming expense

   $ 14,432      3%   $ 13,957      $ 28,532      4%   $ 27,461   

As a percentage of HSN net sales

     3.1   0 bp     3.1     2.9   (10 bp)     3.0

Production and programming expense for the second quarter of 2010 increased 3% to $14.4 million compared to $14.0 million in the prior year. As a percentage of HSN’s net sales, production and programming expense was 3.1% for the three months ended June 30, 2010 and 2009, respectively.

Production and programming expense for the six months ended June 30, 2010 increased 4% to $28.5 million compared to $27.5 million in the prior year. As a percentage of HSN’s net sales, production and programming expense was 2.9% compared to 3.0% in the prior year period.

Depreciation

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

HSN

   $ 7,262      1%   $ 7,160      $ 14,867      5%   $ 14,134   

Cornerstone

     2,348      (5%)     2,469        4,553      (8%)     4,946   
                                    

HSNi

   $ 9,610      (0%)   $ 9,629      $ 19,420      2%   $ 19,080   
                                    

As a percentage of HSNi net sales

     1.4   (10 bp)     1.5     1.4   (10 bp)     1.5

HSNi’s depreciation for the second quarter of 2010 and 2009 was $9.6 million. Depreciation for the six months ended June 30, 2010 was $19.4 million compared to $19.1 million in the prior year and represents 1.4% of net sales compared to 1.5% in the prior year.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP measure and is defined in Note 4 of Notes to Consolidated Financial Statements.

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

HSN

   $ 45,064      17%   $ 38,355      $ 95,378      30%   $ 73,614   

As a percentage of HSN net sales

     9.7   130 bp     8.4     9.7   180 bp     7.9

Cornerstone

   $ 18,489      277%   $ 4,900      $ 19,967      567%   $ (4,279

As a percentage of Cornerstone net sales

     8.3   570 bp     2.6     5.1   640 bp     (1.3 %) 

HSNi

   $ 63,553      47%   $ 43,255      $ 115,345      66%   $ 69,335   

As a percentage of HSNi net sales

     9.2   240 bp     6.8     8.4   290 bp     5.5

HSNi’s Adjusted EBITDA for the second quarter of 2010 increased 47% or $20.3 million from 2009 and represents 9.2% of net sales compared to 6.8% in the prior year. The increase in Adjusted EBITDA is primarily due to the increase in net sales and the 130 basis point improvement in gross profit margin, offset slightly by increases in compensation and employee-related costs and investments in Cornertone’s catalog circulation.

HSNi’s Adjusted EBITDA for the six months ended June 30, 2010 increased 66% or $46.0 million from 2009 and represents 8.4% of net sales as compared to 5.5% in the prior year. The increase in Adjusted EBITDA is primarily due to the increase in net sales and the 120 basis point improvement in gross profit margin, offset slightly by increases in compensation and employee-related costs and HSN’s on-air distribution costs.

 

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Operating Income (Loss)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

HSN

   $ 34,464      20%   $ 28,750      $ 73,759      34%   $ 54,901   

As a percentage of HSN net sales

     7.4   110 bp     6.3     7.5   160 bp     5.9

Cornerstone

   $ 13,886      598%   $ 1,990      $ 12,086      218%   $ (10,259

As a percentage of Cornerstone net sales

     6.2   510 bp     1.1     3.1   610 bp     (3.0 %) 

HSNi

   $ 48,350      57%   $ 30,740      $ 85,845      92%   $ 44,642   

As a percentage of HSNi net sales

     7.0   220 bp     4.8     6.3   280 bp     3.5

HSNi’s operating income for the second quarter of 2010 increased 57% or $17.6 million to $48.4 million compared to $30.7 million in the prior year. The operating margin in 2010 improved to 7.0% compared 4.8% in 2009. The improvement is due to the increase in net sales and the 130 basis point increase in gross profit margin, offset slightly by increases in compensation and employee-related costs, including stock-based compensation, and investments in Cornerstone’s catalog circulation.

HSNi’s operating income for the six months ended June 30, 2010 increased 92% or $41.2 million to $85.8 million as compared to $44.6 million in the prior year. The operating margin in 2010 improved to 6.3% compared to 3.5% in 2009. The increase is primarily due to the increase in net sales and the 120 basis point increase in gross profit margin, offset slightly by increases in compensation and employee-related costs, including stock-based compensation, and HSN’s on-air distribution costs.

Other (Expense) Income

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2010     %
Change
  2009     2010     %
Change
  2009  
     (Dollars in thousands)     (Dollars in thousands)  

Interest income

   $ 165      206%   $ 54      $ 247      181%   $ 88   

Interest expense

     (8,226   7%     (8,799     (16,602   6%     (17,749
                                    

Other (expense) income, net

   $ (8,061   8%   $ (8,745   $ (16,355   7%   $ (17,661
                                    

As a percentage of HSNi net sales

     (1.2 %)    (20 bp)     (1.4 %)      (1.2 %)    (20 bp)     (1.4 %) 

Interest expense primarily relates to the $240 million of Senior Notes and the five-year term loan. The decrease in interest expense for the three and six months ended June 30, 2010 compared to 2009 is due to the repayment of the term loan and a decrease in the average interest rate of the term loan.

Income Tax Provision

For the three and six months ended June 30, 2010, HSNi recorded a tax provision from continuing operations of $15.6 million and $27.1 million, respectively, which represents effective tax rates of 38.7% and 39.0%, respectively. For the three and six months ended June 30, 2009, HSNi recorded a tax provision from continuing operations of $8.4 million and $10.4 million, respectively, which represents effective tax rates of 38.0% and 38.4%, respectively. The effective tax rates for all periods presented are higher than the federal statutory rate of 35% due principally to state income taxes.

Liquidity and Capital Resources

As of June 30, 2010, HSNi had $279.9 million of cash and cash equivalents, up from $269.9 million as of December 31, 2009.

Net cash provided by operating activities attributable to continuing operations for the six months ended June 30, 2010 was $18.9 million compared to $74.0 million in the same period last year, a decrease of $55.1 million. This variance is principally due to an increase in inventories to support sales growth and increased payments of trade payables and income taxes, partially offset by the improved operating performance and collection of accounts receivables at HSN.

 

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Net cash used in investing activities attributable to continuing operations for the six months ended June 30, 2010 of $15.9 million resulted from capital expenditures. The capital expenditures were for investments in information technology, campus renovations and broadcasting-related investments. Net cash used in investing activities attributable to continuing operations in 2009 of $19.1 million was primarily at HSN and was for investments in high-definition television programming, campus renovations and other information technology and broadcasting-related investments.

Net cash provided by financing activities attributable to continuing operations for the six months ended June 30, 2010 was $6.9 million due to cash proceeds of $10.7 million received from the issuance of common stock pursuant to stock-based awards, net of withholding taxes, partially offset by the repayment of $4.8 million of long-term debt. As of June 30, 2010, $95.2 million was outstanding under the term loan and no amounts were outstanding under the revolving credit facility, except for letters of credit. Net cash used in financing activities attributable to continuing operations in 2009 was $27.5 million due to repayments of $20.0 million for the revolving credit facility and $7.5 million of long-term debt.

The credit agreement contains two principal financial covenants consisting of a maximum leverage ratio of 2.75x and a minimum interest coverage ratio of 3.00x, among other covenants. HSNi was in compliance with all such covenants as of June 30, 2010, with a leverage ratio of 1.33x and an interest coverage ratio of 8.11x. The amount available under the credit agreement is reduced by the amount of commercial and standby letters of credit issued under the revolving credit facility portion of the agreement. As of June 30, 2010, there were $34.3 million of outstanding commercial and standby letters of credit issued under the revolving credit facility. The ability to draw funds under the revolving credit facility is dependent upon meeting the aforementioned financial covenants, which may limit HSNi’s ability to draw the full amount of the facility. As of June 30, 2010, the additional amount that could be borrowed under the revolving credit facility, in consideration of the financial covenants and outstanding letters of credit, was approximately $115.7 million.

HSNi does not currently have any material commitments for capital expenditures; however, management does anticipate that HSNi will need to make capital and other expenditures in connection with the development and expansion of its operations. HSNi’s ability to fund its cash and capital needs will be affected by its ongoing ability to generate cash from operations, the overall capacity and terms of its financing arrangements as discussed above, and access to the capital markets. HSNi believes that its cash on hand, its anticipated operating cash flows, its available unused portion of the revolving credit facility and its access to capital markets will be sufficient to fund its operating needs, capital, investing and other commitments and contingencies for the foreseeable future.

Seasonality

HSNi is affected by seasonality, although historically our business has exhibited less seasonality than many other retail businesses. Our sales levels are generally higher in the fourth quarter.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

For a description of HSNi’s market risks, see “Item 7A. Quantitative and Qualitative Disclosures about Market Risk” in HSNi’s Annual Report on Form 10-K for the year ended December 31, 2009. No material changes have occurred in HSNi’s market risks since December 31, 2009.

Item 4. Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) promulgated under the Exchange Act) as of June 30, 2010. Based on that evaluation, management has concluded that the disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to ensure that information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2010 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of business, we are involved in various legal matters arising out of our operations. These matters may relate to claims involving property, personal injury, contract, intellectual property, sales tax, regulatory compliance and other claims. At August 4, 2010, we are not a party to any legal proceedings that are reasonably expected to have a material adverse effect on our business, results of operations, financial condition or cash flows. The results of these matters cannot be predicted with certainty and an unfavorable resolution of one or more of these matters could have a material adverse effect on our business, results of operations, financial condition or cash flows.

Rules of the SEC require the description of material pending legal proceedings, other than ordinary, routine litigation incident to the company’s business, and advise that proceedings ordinarily need not be described if they primarily involve damage claims for amounts (exclusive of interest and costs) not exceeding 10% of the current assets of the company and its subsidiaries on a consolidated basis. In the judgment of management, none of the pending litigation matters which HSNi and its subsidiaries are defending involves or is likely to involve amounts of that magnitude.

Item 1A. Risk Factors

See Part I, Item 1A., “Risk Factors,” of HSNi’s Annual Report on Form 10-K for the year ended December 31, 2009, for a detailed discussion of the risk factors affecting HSNi. There have been no material changes from the risk factors described in the annual report.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Removed and Reserved

Item 5. Other Information

None

Item 6. Exhibits

 

Exhibit
Number

  

Description

  

Location

  4.1    Second Supplemental Indenture dated as of January 1, 2010 between HSN, Inc., as Issuer, and The Bank of New York Mellon, as Trustee    Filed herewith
10.1    Form of Performance Cash Award Agreement *    Filed herewith
10.2    Amendment No. 1 to the Second Amended and Restated 2008 Stock and Annual Incentive Plan dated as of February 24, 2010 *    Filed herewith
10.3    Employee Stock Purchase Plan    Filed herewith
31.1    Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act.    Filed herewith

* Reflects management contracts and management and director compensation plans.

 

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31.2

   Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act.    Filed herewith

32.1

   Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act.    Filed herewith

32.2

   Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act.    Filed herewith

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: August 4, 2010

 

HSN, INC.
By:  

/s/ JUDY A. SCHMELING

  Judy A. Schmeling Executive Vice President and Chief Financial Officer

 

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