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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the Quarterly Period Ended September 30, 2011

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  x    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		x		Accelerated filer		¨
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 October 31, 2011, the registrant had 59,057,015 shares of common stock, $0.01 par value per share, outstanding.

 

 

 

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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 Nine Months Ended September 30, 2011 and 2010			3
		Consolidated Balance Sheets as of September 30, 2011, December 31, 2010 and September 30, 2010			4
		Consolidated Statements of Shareholders’ Equity for the Nine Months Ended September 30, 2011 and Year Ended December 31, 2010			5
		Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010			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					23
Item 1.		Legal Proceedings			23
Item 1A.		Risk Factors			23
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			23
Item 3.		Defaults Upon Senior Securities			23
Item 4.		Removed and Reserved			23
Item 5.		Other Information			23
Item 6.		Exhibits			23
Signatures					25

 

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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								Nine Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Net sales		$	751,237			$	708,359			$	2,222,158			$	2,081,564
Cost of sales			478,411				458,632				1,408,797				1,336,693
Gross profit			272,826				249,727				813,361				744,871
Operating expenses:
Selling and marketing			140,245				132,404				413,869				382,899
General and administrative			61,094				58,654				178,093				169,224
Production and programming			15,556				16,165				45,727				44,697
Depreciation and amortization of intangible assets			8,734				9,707				27,339				29,408
Total operating expenses			225,629				216,930				665,028				626,228
Operating income			47,197				32,797				148,333				118,643
Other income (expense):
Interest income			80				182				325				428
Interest expense			(8,005	)			(8,280	)			(24,024	)			(24,897	)
Total other expense, net			(7,925	)			(8,098	)			(23,699	)			(24,469	)
Income before income taxes			39,272				24,699				124,634				94,174
Income tax provision			(14,968	)			(9,821	)			(48,083	)			(36,938	)
Net income		$	24,304			$	14,878			$	76,551			$	57,236
Net income per share:
Basic		$	0.41			$	0.26			$	1.31			$	1.00
Diluted		$	0.40			$	0.25			$	1.26			$	0.96
Shares used in computing earnings per share:
Basic			58,854				57,607				58,574				57,279
Diluted			60,813				59,724				60,646				59,403
Dividends declared per common share		$	0.125			$	—			$	0.125			$	—

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

 

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HSN, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)

 

		September 30,				December 31,				September 30,
		2011				2010				2010
ASSETS
Current assets:
Cash and cash equivalents		$	340,093			$	354,259			$	259,386
Accounts receivable, net of allowance of $12,877, $13,026 and $10,498, respectively			153,198				195,748				133,116
Inventories			347,801				296,390				338,378
Deferred income taxes			22,801				28,801				22,101
Prepaid expenses and other current assets			53,405				42,443				51,245
Total current assets			917,298				917,641				804,226
Property and equipment, net			154,658				154,987				153,071
Intangible assets, net			260,248				260,623				260,763
Other non-current assets			9,397				12,492				13,924
TOTAL ASSETS		$	1,341,601			$	1,345,743			$	1,231,984
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable, trade		$	205,923			$	244,301			$	209,359
Current maturities of long-term debt			69,841				5,820				19,048
Accrued expenses and other current liabilities			165,503				216,114				171,021
Total current liabilities			441,267				466,235				399,428
Long-term debt, net of current maturities			239,062				302,938				315,059
Deferred income taxes			75,259				80,203				71,516
Other long-term liabilities			20,759				19,904				18,999
Total liabilities			776,347				869,280				805,002
Commitments and contingencies (Note 10)
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; 58,909,983, 57,966,771 and 57,712,773 issued shares at September 30, 2011, December 31, 2010 and September 30, 2010, respectively			589				580				577
Additional paid-in capital			2,465,637				2,453,406				2,445,215
Retained deficit			(1,900,972	)			(1,977,523	)			(2,018,810	)
Total shareholders’ equity			565,254				476,463				426,982
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	1,341,601			$	1,345,743			$	1,231,984

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

 

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HSN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands)

(Unaudited)

 

																										Accumulated Other
		Preferred Stock								Common Stock								Additional Paid-in								Comprehensive
		Shares				Amount				Shares				Amount				Capital				Retained Deficit				Loss				Total
Balance as of December 31, 2009			—			$	—				56,503			$	565			$	2,419,765			$	(2,076,046	)		$	(254	)		$	344,030
Comprehensive income:
Net income			—				—				—				—				—				98,523				—				98,523
Foreign currency translation			—				—				—				—				—				—				254				254
Total comprehensive income																															98,777
Stock-based compensation expense for equity awards			—				—				—				—				16,491				—				—				16,491
Issuance of common stock from stock-based compensation awards, including related tax benefit of $2,064			—				—				1,464				15				17,150				—				—				17,165
Balance as of December 31, 2010			—				—				57,967				580				2,453,406				(1,977,523	)			—				476,463
Comprehensive income			—				—				—				—				—				76,551				—				76,551
Stock-based compensation expense for equity awards			—				—				—				—				14,367				—				—				14,367
Cash dividend declared on common stock			—				—				—				—				(7,360	)			—				—				(7,360	)
Issuance of common stock from stock-based compensation awards, including related tax benefit of $5,133			—				—				943				9				5,224				—				—				5,233
Balance as of September 30, 2011			—			$	—				58,910			$	589			$	2,465,637			$	(1,900,972	)		$	—			$	565,254

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

 

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HSN, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Nine Months Ended
		September 30,
		2011				2010
Cash flows from operating activities:
Net income		$	76,551			$	57,236
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of intangible assets			27,339				29,408
Stock-based compensation expense			19,392				15,063
Amortization of cable and satellite distribution fees			846				2,519
Amortization of debt issuance costs			1,927				1,929
Loss on disposition of fixed assets			1,348				1,208
Deferred income taxes			1,056				(4,777	)
Bad debt expense			14,632				12,981
Excess tax benefits from stock-based awards			(6,067	)			(1,383	)
Changes in current assets and liabilities:
Accounts receivable			27,807				36,763
Inventories			(51,411	)			(76,905	)
Prepaid expenses and other assets			(10,495	)			(5,156	)
Accounts payable, accrued expenses and other current liabilities			(95,709	)			(62,712	)
Net cash provided by operating activities			7,216				6,174
Cash flows from investing activities:
Capital expenditures			(27,723	)			(26,153	)
Net cash used in investing activities			(27,723	)			(26,153	)
Cash flows from financing activities:
Repayment of long-term debt			—				(4,762	)
Issuance of common stock, net of withholding taxes			274				12,823
Excess tax benefits from stock-based awards			6,067				1,383
Net cash provided by financing activities			6,341				9,444
Net decrease in cash and cash equivalents			(14,166	)			(10,535	)
Cash and cash equivalents at beginning of period			354,259				269,921
Cash and cash equivalents at end of period		$	340,093			$	259,386
Supplemental disclosure of noncash investing and financing activities:
Cash dividends on common stock declared but not yet paid		$	7,360			$	—

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

 

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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 various platforms including (i) television home shopping programming broadcast on the HSN television networks; (ii) catalogs, which consist primarily of the Cornerstone portfolio of leading print catalogs which includes Frontgate, Ballard Designs, Garnet Hill, Smith+Noble, The Territory Ahead, TravelSmith and Improvements; (iii) websites, which consist primarily of HSN.com and the eight branded websites operated by Cornerstone; (iv) retail and outlet stores; and (v) mobile devices. HSNi’s television home shopping business, related digital sales and retail and outlet stores are referred to herein as “HSN” and all catalog operations, including related digital sales and stores, are collectively referred to herein as “Cornerstone.”

HSN offerings primarily consist of jewelry, fashion (apparel & accessories), beauty & wellness, and home & other (including housewares, home fashions, electronics, culinary, fitness and 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. (now a wholly-owned subsidiary of Live Nation, 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.” In connection with the Spin-off, HSNi’s shares began trading on the NASDAQ Global Select Market under the symbol “HSNI.”

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, 2010. The consolidated balance sheet as of December 31, 2010 and the consolidated statement of shareholders’ equity for the year ended December 31, 2010 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.

Reclassifications

Certain reclassifications were made to prior period amounts in the consolidated statements of operations and cash flows to conform to the current year presentation.

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

 

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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.

NOTE 3—PROPERTY AND EQUIPMENT

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

 

		September 30,				December 31,				September 30,
		2011				2010				2010
Capitalized software		$	205,536			$	211,816			$	203,526
Computer and broadcast equipment			94,515				93,284				94,171
Buildings and leasehold improvements			93,593				90,417				88,849
Furniture and other equipment			74,954				72,726				71,741
Projects in progress			10,018				3,825				6,216
Land and land improvements			10,739				10,922				10,922
			489,355				482,990				475,425
Less: accumulated depreciation and amortization			(334,697	)			(328,003	)			(322,354	)
Total property and equipment, net		$	154,658			$	154,987			$	153,071

NOTE 4—SEGMENT INFORMATION

HSNi presents 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. 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, 2010. 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: (1) non-cash charges including: (a) stock-based compensation expense, (b) amortization of intangibles, (c) depreciation and gains and losses on asset dispositions, and (d) goodwill, long-lived asset and intangible asset impairments; (2) pro forma adjustments for significant acquisitions; and (3) 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 intangibles, depreciation, gains and losses on asset dispositions, asset impairment charges, acquisition-related accounting expenses and one-time items.

 

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

 

			00000000				00000000				00000000				00000000				00000000				00000000
		Three Months Ended September 30, 2011												Three Months Ended September 30, 2010
		HSN				Cornerstone				Total				HSN				Cornerstone				Total
Adjusted EBITDA		$	51,803			$	11,280			$	63,083			$	43,122			$	5,855			$	48,977
Stock-based compensation expense			(2,792	)			(3,317	)			(6,109	)			(4,057	)			(1,696	)			(5,753	)
Depreciation and amortization of intangible assets			(6,614	)			(2,120	)			(8,734	)			(7,601	)			(2,106	)			(9,707	)
Loss on disposition of fixed assets			(1,043	)			—				(1,043	)			(720	)			—				(720	)
Operating income		$	41,354			$	5,843				47,197			$	30,744			$	2,053				32,797
Other expense, net											(7,925	)											(8,098	)
Income before income taxes											39,272												24,699
Income tax provision											(14,968	)											(9,821	)
Net income										$	24,304											$	14,878

 

			00000000				00000000				00000000				00000000				00000000				00000000
		Nine Months Ended September 30, 2011												Nine Months Ended September 30, 2010
		HSN				Cornerstone				Total				HSN				Cornerstone				Total
Adjusted EBITDA		$	155,624			$	40,788			$	196,412			$	138,498			$	25,824			$	164,322
Stock-based compensation expense			(10,750	)			(8,642	)			(19,392	)			(10,098	)			(4,965	)			(15,063	)
Depreciation and amortization of intangible assets			(20,788	)			(6,551	)			(27,339	)			(22,749	)			(6,659	)			(29,408	)
Loss on disposition of fixed assets			(1,148	)			(200	)			(1,348	)			(1,148	)			(60	)			(1,208	)
Operating income		$	122,938			$	25,395				148,333			$	104,503			$	14,140				118,643
Other expense, net											(23,699	)											(24,469	)
Income before income taxes											124,634												94,174
Income tax provision											(48,083	)											(36,938	)
Net income										$	76,551											$	57,236

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

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Net sales:
HSN		$	513,013			$	493,743			$	1,521,181			$	1,479,073
Cornerstone			238,224				214,616				700,977				602,491
Total		$	751,237			$	708,359			$	2,222,158			$	2,081,564

NOTE 5—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. 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. As of September 30, 2011, there were approximately 3.2 million shares of common stock available for grants under the Plan.

HSNi can grant restricted stock units (“RSUs”), stock options, stock appreciation rights (“SARs”), dividend equivalents 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 is required to be at or above the fair market value of HSNi’s stock on the date of grant. RSUs have rights to receive dividend equivalents that vest once the requisite service has been rendered.

During the nine months ended September 30, 2011, HSNi granted approximately 328,000 RSUs and 348,000 SARs. The RSUs have a weighted average fair value of $30.28 and they primarily vest after three years. The SARs have a weighted average exercise price of $29.72, have a fair value of $12.84 and primarily vest ratably over three years. The following are the

 

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assumptions used in the Black-Scholes option pricing model to value SARs for the nine months ended September 30, 2011: volatility factor of 46.51%, risk-free interest rate of 2.33%, expected term of 5 years and a dividend yield of zero. Also during the nine months ended September 30, 2011, HSNi granted approximately 57,000 options under the HSN, Inc. 2010 Employee Stock Purchase Plan (“ESPP”) which had a weighted average fair value of $9.85. The following are the assumptions used in the Black-Scholes option pricing model to value options granted under the ESPP for the nine months ended September 30, 2011: volatility factor of 56.56%, risk-free interest rate of 0.15%, expected term of six months and a dividend yield of zero.

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 September 30, 2011, a liability of approximately $9.8 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								Nine Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Selling and marketing		$	854			$	783			$	2,639			$	2,261
General and administrative			4,989				4,694				15,912				12,050
Production and programming			266				276				841				752
Stock-based compensation expense before income taxes			6,109				5,753				19,392				15,063
Income tax benefit			(2,070	)			(1,896	)			(6,280	)			(5,293	)
Stock-based compensation expense after income taxes		$	4,039			$	3,857			$	13,112			$	9,770

As of September 30, 2011, there was approximately $21.3 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 1.8 years.

NOTE 6—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 nine months ended September 30, 2011, HSNi recorded a tax provision of $15.0 million and $48.1 million, respectively, which represents effective tax rates of 38.1% and 38.6%, respectively. For the three and nine months ended September 30, 2010, HSNi recorded a tax provision of $9.8 million and $36.9 million, respectively, which represents effective tax rates of 39.8% and 39.2%, respectively. The effective tax rates exceed the federal statutory rate of 35.0% due principally to the effect of state income taxes.

In connection with the Spin-off, HSNi entered into a Tax Sharing Agreement with IAC pursuant to 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

 

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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. 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.

The IRS has completed its review of the IAC consolidated tax returns for the years ended December 31, 2001 through 2006, which includes the operations of HSNi. The settlement for these years has not yet been submitted to the Joint Committee on Taxation for approval. The IRS began its review of the IAC consolidated tax returns for the years ended December 31, 2007 through 2009 in July 2011. The statute of limitations for the years 2001 through 2007 has been extended to December 31, 2012. 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. By virtue of the Tax Sharing Agreement with IAC, HSNi is indemnified with respect to additional tax liabilities for consolidated or combined federal and state 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 7—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 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.

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

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Net income		$	24,304			$	14,878			$	76,551			$	57,236
Weighted average number of shares outstanding:
Basic			58,854				57,607				58,574				57,279
Dilutive effect of stock-based compensation awards			1,959				2,117				2,072				2,124
Diluted			60,813				59,724				60,646				59,403
Net income per share:
Basic		$	0.41			$	0.26			$	1.31			$	1.00
Diluted		$	0.40			$	0.25			$	1.26			$	0.96
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			1,207				1,577				1,272				1,835

 

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NOTE 8—LONG-TERM DEBT

The balance of long-term debt, including current maturities, is as follows (in thousands):

 

		September 30,				December 31,				September 30,
		2011				2010				2010
Secured credit agreement expiring July 25, 2013:
Term loan		$	69,841			$	69,841			$	95,238
Revolving credit facility			—				—				—
11.25% Senior Notes due August 1, 2016; interest payable each February 1st and August 1st			240,000				240,000				240,000
Unamortized original issue discount on Senior Notes			(938	)			(1,083	)			(1,131	)
Total long-term debt			308,903				308,758				334,107
Less: current maturities			(69,841	)			(5,820	)			(19,048	)
Long-term debt, net of current maturities		$	239,062			$	302,938			$	315,059

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 September 30, 2011, the term loan interest rate was equal to LIBOR plus 2.00% (2.24%). The credit agreement contains two principal financial covenants consisting of a maximum leverage ratio, as defined in the credit agreement, of 2.75x and a minimum interest coverage ratio, as defined in the credit agreement, of 3.00x, among other covenants. HSNi was in compliance with all such covenants as of September 30, 2011, with a leverage ratio of 1.08x and an interest coverage ratio of 9.86x. 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 September 30, 2011, there were $35.1 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 September 30, 2011, 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 $114.9 million. HSNi capitalized $7.3 million in financing costs related to the credit agreement and amortizes 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 9—FAIR VALUE MEASUREMENTS

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. HSNi applies the following framework for measuring fair value which is 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 our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

 

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

 

		September 30, 2011
										Fair Value Measurement Category
		Carrying Value				Fair Value				Level 1				Level 2				Level 3
Senior Notes		$	240,000			$	264,000			$	264,000			$	—			$	—
Term Loan			69,841				69,609				—				—				69,609

 

		December 31, 2010
										Fair Value Measurement Category
		Carrying Value				Fair Value				Level 1				Level 2				Level 3
Senior Notes		$	240,000			$	273,900			$	273,900			$	—			$	—
Term Loan			69,841				69,841				—				—				69,841

 

		September 30, 2010
										Fair Value Measurement Category
		Carrying Value				Fair Value				Level 1				Level 2				Level 3
Senior Notes		$	240,000			$	273,600			$	273,600			$	—			$	—
Term Loan			95,238				95,238				—				—				95,238

The fair value of the Senior Notes is based upon quoted market information (level 1 criteria) and the fair value of the term loan is 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 nine months ended September 30, 2011 and the year ended December 31, 2010, there were no assets that were required to be recorded at fair value as no impairment indicators were present.

NOTE 10—COMMITMENTS AND CONTINGENCIES

In January 2010, one of HSNi’s direct-to-consumer subsidiaries received a preliminary notification from a state taxing authority alleging that the subsidiary was required to collect and remit sales taxes for the period from September 2002 through August 2009. In October 2010, the state presented the subsidiary with an assessment relating to this matter. Additionally during 2010, the same taxing authority notified two other direct-to-consumer subsidiaries of its intent to conduct sales tax audits for the period from 2004 through 2010. HSNi does not believe that any of these subsidiaries were obligated to collect and remit such taxes, and intends to vigorously defend its position. At this time, no contingent liability has been recorded and no assurances can be given as to the outcome of this situation.

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 (including patent infringement), sales tax, regulatory compliance and other claims. HSNi has established reserves for specific legal or tax compliance matters that it has determined 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 its liquidity, results of operations, financial condition or cash flows, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future and an unfavorable resolution of such a proceeding could have such a material impact. Moreover, any claims or regulatory actions against HSNi, whether meritorious or not, could be time-consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources.

HSNi also evaluates other contingent matters, including tax contingencies, to assess the probability and estimated extent of potential loss. See Note 6 for discussion related to income tax contingencies.

 

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NOTE 11 – SHAREHOLDERS’ EQUITY

Share Repurchase Program

On September 27, 2011, HSNi’s Board of Directors approved a share repurchase program which allows HSNi to purchase 10 million shares of its common stock from time to time through privately negotiated and/or open market transactions. The timing of any repurchases and actual number of shares repurchased will depend on a variety of factors, including the stock price, corporate and regulatory requirements, restrictions under HSNi’s debt obligations and other market and economic conditions. The repurchase program may be suspended or discontinued by HSNi at any time.

Dividend Policy

On September 27, 2011, HSNi’s Board of Directors approved a cash dividend of $0.125 per common share. HSNi anticipates the cash dividend will be funded from current cash and expected future cash flows. The dividend will be paid on November 16, 2011 to HSNi’s record holders as of November 2, 2011.

NOTE 12—SUBSEQUENT EVENT

In October 2011, HSNi made a voluntary prepayment of the remaining $69.8 million balance of its term loan. The liability was reclassified as a current liability as of September 30, 2011 in the accompanying financial statements.

 

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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 certain “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 relate to expectations concerning matters that are not historical fact and 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. Although we believe our expectations are based on reasonable estimates and assumptions, they are not guarantees of performance.

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 those described under “Risk Factors,” included in HSNi’s Annual Report on Form 10-K for the year ended December 31, 2010 and the following: the continued impact of the current macroeconomic environment on consumer confidence and spending levels; whether national economic stimulus initiatives and measures 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 digital sales growth; changes in our relationships with pay television operators, vendors, manufacturers and other third parties; changes in product delivery costs particularly if we are unable to offset them; our ability to offer new or alternative products and services in a cost effective manner and consumer acceptance of these products and services; any technological or regulatory developments that could negatively impact the way we do business, including regulations regarding state and local sales and use taxes; HSNi’s business prospects and strategy, including whether HSNi’s initiatives will be effective; and the loss of any key member of our senior management team. 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. Such forward-looking statements speak only to the date such statements are made and we do not undertake 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, including shipping and handling fees, 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 policy allows customers to return virtually all merchandise for a full refund or exchange, subject to pre-established time restrictions.

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
HSN		$	513,013				4	%		$	493,743			$	1,521,181				3	%		$	1,479,073
Cornerstone			238,224				11	%			214,616				700,977				16	%			602,491
Total net sales		$	751,237				6	%		$	708,359			$	2,222,158				7	%		$	2,081,564

HSNi net sales in the third quarter of 2011 increased 6%, or $42.9 million, compared to the prior year due to a 4% increase at HSN and an 11% increase at Cornerstone. The number of units shipped in the third quarter of 2011 increased 3% to 13.5 million and the average price point increased 4% to $63.82. Digital sales as a percentage of HSNi’s total net sales for the quarter increased 220 basis points to 41.0% compared to 38.8% in the prior year.

 

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HSNi net sales in the nine months ended September 30, 2011 increased 7%, or $140.6 million, compared to the prior year due to a 3% increase at HSN and a 16% increase at Cornerstone. The number of units shipped in 2011 increased 3% to 39.5 million and the average price point increased 6% to $64.95. Digital sales as a percentage of total net sales increased 250 basis points to 40.8% in 2011 compared to 38.3% in the prior year.

HSN

Net sales for HSN in the third quarter of 2011 increased 4%, or $19.3 million, compared to the prior year driven by strength in the electronics, beauty and wellness categories. Digital sales grew 10% with penetration increasing 190 basis points to 32.8%, up from 30.9% in the prior year. Average price point increased 3% and units shipped increased 4%. The return rate increased to 20.3% from 19.2% primarily due to changes in product mix.

Net sales for HSN in the nine months ended September 30, 2011 increased 3%, or $42.1 million, compared to the prior year. The sales growth was driven by a 9% increase in digital sales and growth in the electronics, culinary and beauty categories, partially offset by lower sales in fitness. Digital sales penetration grew 190 basis points to 32.9%, up from 31.0% in the prior year. Shipped units increased 1% to 29.3 million and average price point increased by 5% to $62.44.

Divisional product mix at HSN is provided in the table below:

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Jewelry			15.0	%			16.3	%			14.8	%			15.5	%
Fashion (apparel & accessories)			15.2	%			15.7	%			14.5	%			14.3	%
Beauty & wellness			18.1	%			16.4	%			18.2	%			18.1	%
Home & other (including housewares, home fashions, electronics, culinary, fitness and other)			51.7	%			51.6	%			52.5	%			52.1	%
Total			100.0	%			100.0	%			100.0	%			100.0	%

Cornerstone

Net sales for Cornerstone in the third quarter of 2011 increased 11%, or $23.6 million, compared to the prior year. Digital sales grew 15% with penetration increasing 180 basis points to 58.7%. Average price point increased 7% and units shipped increased 2%. The return rate decreased to 14.3% from 15.9% primarily due to a $2.5 million sales provision recorded in the prior year for a voluntary product recall. Catalog circulation increased 22% compared to the prior year.

Net sales for Cornerstone in the nine months ended September 30, 2011 increased 16%, or $98.5 million, compared to the prior year. The sales growth is primarily attributable to strength at Cornerstone’s three largest brands, Frontgate, Ballard Designs and Garnet Hill; as well as investment in catalog circulation and digital marketing. Digital sales grew 20% with penetration increasing 180 basis points to 58.1%. Average price point and units shipped each increased 7% in 2011. Catalog circulation increased 13% compared to the prior year.

Cost of Sales and Gross Profit

Cost of sales consists primarily of the cost of products sold, shipping and handling costs and compensation and other employee-related costs for personnel engaged in warehouse functions. Cost of products sold includes merchandise cost, inbound freight and duties and certain allocable general and administrative costs, including certain warehouse costs.

 

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		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
Gross profit:		(Dollars in thousands)												(Dollars in thousands)
HSN		$	178,543				5	%		$	169,935			$	529,381				5	%		$	503,733
HSN gross profit margin			34.8	%			40 bp				34.4	%			34.8	%			70 bp				34.1	%
Cornerstone		$	94,283				18	%		$	79,792			$	283,980				18	%		$	241,138
Cornerstone gross profit margin			39.6	%			240 bp				37.2	%			40.5	%			50 bp				40.0	%
HSNi		$	272,826				9	%		$	249,727			$	813,361				9	%		$	744,871
HSNi gross profit margin			36.3	%			100 bp				35.3	%			36.6	%			80 bp				35.8	%

 

bp = basis points

HSN

Gross profit for HSN in the third quarter of 2011 increased 5%, or $8.6 million, compared to the prior year. Gross profit margin improved 40 basis points to 34.8% compared to 34.4%. The margin increase was primarily attributable to lower outbound shipping costs and improvements in our supply chain management, partially offset by an increase in clearance activity and changes in product mix.

Gross profit for HSN in the nine months ended September 30, 2011 increased 5%, or $25.6 million, compared to the prior year. Gross profit margin improved 70 basis points to 34.8% from 34.1%. The margin increase was primarily attributable to lower outbound shipping costs and improvements in our supply chain management.

Cornerstone

Gross profit for Cornerstone in the third quarter of 2011 increased 18%, or $14.5 million, compared to the prior year. Gross profit margin improved 240 basis points to 39.6% from 37.2%. The margin increase was primarily attributable to improved outbound shipping margins; lower inbound freight costs in the home brands; and the impact of a $2.5 million sales provision for a voluntary product recall recorded in the prior year.

Gross profit for Cornerstone in the nine months ended September 30, 2011 increased 18%, or $42.8 million, compared to the prior year. Gross profit margin improved 50 basis points to 40.5% from 40.0%. The margin increase was primarily attributable to improved outbound shipping margins and leverage over fixed warehousing costs, partially offset by increased promotional activity to drive sales demand.

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.

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
HSN		$	72,106				(1	%)		$	72,849			$	214,393				2	%		$	210,517
As a percentage of HSN net sales			14.1	%			(70 bp	)			14.8	%			14.1	%			(10 bp	)			14.2	%
Cornerstone		$	68,139				14	%		$	59,555			$	199,476				16	%		$	172,382
As a percentage of Cornerstone net sales			28.6	%			90 bp				27.7	%			28.5	%			(10 bp	)			28.6	%
HSNi		$	140,245				6	%		$	132,404			$	413,869				8	%		$	382,899
As a percentage of HSNi net sales			18.7	%			0 bp				18.7	%			18.6	%			20 bp				18.4	%

HSNi’s selling and marketing expense in the third quarter of 2011 increased 6%, or $7.8 million, compared to the prior year and was 18.7% of net sales in both periods. The increase in expense is primarily due to investments in Cornerstone’s catalog circulation.

 

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HSNi’s selling and marketing expense in the nine months ended September 30, 2011 increased 8%, or $31.0 million, and was 18.6% of net sales compared to 18.4% in the prior year. The increase in expense is primarily due to investments in Cornerstone’s catalog circulation, an increase in on-air distribution costs primarily due to HSN2 and investments in digital marketing.

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 debt expense; facilities costs; and fees for professional services.

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
HSN		$	42,914				1	%		$	42,576			$	125,535				4	%		$	121,267
As a percentage of HSN net sales			8.4	%			(20 bp	)			8.6	%			8.3	%			10 bp				8.2	%
Cornerstone		$	18,180				13	%		$	16,078			$	52,558				10	%		$	47,957
As a percentage of Cornerstone net sales			7.6	%			10 bp				7.5	%			7.5	%			(50 bp	)			8.0	%
HSNi		$	61,094				4	%		$	58,654			$	178,093				5	%		$	169,224
As a percentage of HSNi net sales			8.1	%			(20 bp	)			8.3	%			8.0	%			(10 bp	)			8.1	%

HSNi’s general and administrative expense for the third quarter of 2011 increased 4%, or $2.4 million, and was 8.1% of net sales compared to 8.3% in the prior year. The increase in expense is primarily attributable to an increase in compensation and other employee-related costs and an increase in insurance costs, partially offset by a decrease in legal costs due to a $2.5 million settlement recorded in the prior year.

HSNi’s general and administrative expense in the nine months ended September 30, 2011 increased 5%, or $8.9 million, and was 8.0% of net sales compared to 8.1% in the prior year. The increase in expense is primarily due to increases in compensation and other employee-related costs including $3.9 million of additional stock-based compensation, insurance costs and bad debt expense due to higher usage of our Flexpay extended payment program. These expenses were partially offset by a decrease in legal costs due to a $2.5 million settlement recorded in the prior year.

Production and Programming Expense

Production and programming expense consists 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.

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
Production and programming expense		$	15,556				(4	%)		$	16,165			$	45,727				2	%		$	44,697
As a percentage of HSN net sales			3.0	%			(30 bp	)			3.3	%			3.0	%			0 bp				3.0	%

Production and programming expense in the third quarter of 2011 decreased 4%, or $0.6 million, compared to the prior year. As a percentage of HSN’s net sales, production and programming expense was 3.0% for the third quarter of 2011, compared to 3.3% in the prior year. The decrease in expense was primarily related to marketing events that occurred in the prior year.

Production and programming expense in the nine months ended September 30, 2011 increased 2%, or $1.0 million, compared to the prior year. As a percentage of HSN’s net sales, production and programming expense was 3.0%, consistent with the prior year. The increase in expense is primarily due to an increase in compensation and employee-related costs, partially offset by a decrease in expense related to prior year marketing events.

 

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Depreciation and Amortization of Intangible Assets

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
HSN		$	6,614				(13	%)		$	7,601			$	20,788				(9	%)		$	22,749
Cornerstone			2,120				1	%			2,106				6,551				(2	%)			6,659
HSNi		$	8,734				(10	%)		$	9,707			$	27,339				(7	%)		$	29,408
As a percentage of HSNi net sales			1.2	%			(20 bp	)			1.4	%			1.2	%			(20 bp	)			1.4	%

HSNi’s depreciation in the third quarter of 2011 decreased 10%, or $1.0 million, and was 1.2% of net sales compared to 1.4% in the prior year. Depreciation for the nine months ended September 30, 2011 decreased 7%, or $2.1 million, and was 1.2% of net sales compared to 1.4% in the prior year. The decrease in depreciation is primarily due to certain fixed assets becoming fully depreciated during the period.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP measure. The definition of Adjusted EBITDA and its reconciliation to operating income for HSNi’s operating segments and to HSNi’s consolidated net income are in Note 4 of Notes to Consolidated Financial Statements.

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
HSN		$	51,803				20	%		$	43,122			$	155,624				12	%		$	138,498
As a percentage of HSN net sales			10.1	%			140 bp				8.7	%			10.2	%			80 bp				9.4	%
Cornerstone		$	11,280				93	%		$	5,855			$	40,788				58	%		$	25,824
As a percentage of Cornerstone net sales			4.7	%			200 bp				2.7	%			5.8	%			150 bp				4.3	%
HSNi		$	63,083				29	%		$	48,977			$	196,412				20	%		$	164,322
As a percentage of HSNi net sales			8.4	%			150 bp				6.9	%			8.8	%			90 bp				7.9	%

HSNi’s Adjusted EBITDA in the third quarter of 2011 increased 29%, or $14.1 million, and was 8.4% of net sales compared to 6.9% in the prior year. These results are primarily due to a 6% increase in net sales and a 100 basis point improvement in gross profit margin, partially offset by a 4% increase in operating expenses (excluding non-cash charges). HSN’s Adjusted EBITDA increased 20%, or $8.7 million, primarily due to a 4% increase in net sales and a 40 basis point improvement in gross profit margin. Cornerstone’s Adjusted EBITDA increased 93%, or $5.4 million, primarily due to an 11% increase in net sales and a 240 basis point improvement in gross profit margin, partially offset by a 12% increase in operating expenses (excluding non-cash charges), particularly catalog production and distribution costs.

HSNi’s Adjusted EBITDA in the nine months ended September 30, 2011 increased 20%, or $32.1 million, and was 8.8% of net sales compared to 7.9% in the prior year. The increase in Adjusted EBITDA is primarily due to a 7% increase in net sales and an 80 basis point improvement in gross profit margin, partially offset by a 6% increase in operating expenses (excluding non-cash charges). HSN’s Adjusted EBITDA increased 12%, or $17.1 million, primarily due to a 3% increase in net sales and an 70 basis point improvement in gross profit margin, partially offset by an increase in operating expenses for HSN’s on-air distribution costs and compensation and employee-related costs. Cornerstone’s Adjusted EBITDA increased 58%, or $15.0 million, primarily due to a 16% increase in net sales and a 50 basis point improvement in gross profit margin, partially offset by a 13% increase in operating expenses (excluding non-cash charges), particularly for investments in catalog circulation and compensation and employee-related costs.

 

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Operating Income

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
HSN		$	41,354				35	%		$	30,744			$	122,938				18	%		$	104,503
As a percentage of HSN net sales			8.1	%			190 bp				6.2	%			8.1	%			100 bp				7.1	%
Cornerstone		$	5,843				185	%		$	2,053			$	25,395				80	%		$	14,140
As a percentage of Cornerstone net sales			2.5	%			150 bp				1.0	%			3.6	%			130 bp				2.3	%
HSNi		$	47,197				44	%		$	32,797			$	148,333				25	%		$	118,643
As a percentage of HSNi net sales			6.3	%			170 bp				4.6	%			6.7	%			100 bp				5.7	%

HSNi’s operating income in the third quarter of 2011 increased 44%, or $14.4 million, and was 6.3% of net sales compared to 4.6% in the prior year. The increase is primarily due to a 6% growth in net sales and a 100 basis point improvement in gross profit margin, partially offset by a 4% increase in operating expenses primarily for investments in Cornerstone’s catalog circulation and compensation and employee-related costs, partially offset by a decrease in legal fees due to a settlement recorded in the prior year.

HSNi’s operating income in the nine months ended September 30, 2011 increased 25%, or $29.7 million, and was 6.7% of net sales compared to 5.7% in the prior year. The increase is primarily due to a 7% increase in net sales and an 80 basis point increase in gross profit margin, partially offset by an increase in operating expenses primarily for investments in Cornerstone’s catalog circulation, compensation and employee-related costs and on-air distribution costs at HSN.

Other Income (Expense)

 

		Three Months Ended September 30,												Nine Months Ended September 30,
		2011				Change				2010				2011				Change				2010
		(Dollars in thousands)												(Dollars in thousands)
Interest income		$	80				(56	%)		$	182			$	325				(24	%)		$	428
Interest expense			(8,005	)			(3	%)			(8,280	)			(24,024	)			(4	%)			(24,897	)
Other expense, net		$	(7,925	)			(2	%)		$	(8,098	)		$	(23,699	)			(3	%)		$	(24,469	)
As a percentage of HSNi net sales			(1.1	%)			0 bp				(1.1	%)			(1.1	%)			(10 bp	)			(1.2	%)

Interest expense primarily relates to the $240 million of Senior Notes and the five-year term loan. The decreases in interest expense for the three and nine months ended September 30, 2011 compared to the prior periods are due to the partial repayments of the term loan in 2010 and a decrease in the average interest rate of the term loan.

Income Tax Provision

For the three and nine months ended September 30, 2011, HSNi recorded a tax provision of $15.0 million and $48.1 million, respectively, which represents effective tax rates of 38.1% and 38.6%, respectively. For the three and nine months ended September 30, 2010, HSNi recorded a tax provision of $9.8 million and $36.9 million, respectively, which represents effective tax rates of 39.8% and 39.2%, respectively. The effective tax rates exceed the federal statutory rate of 35.0% due principally to the effect of state income taxes.

Liquidity and Capital Resources

As of September 30, 2011, HSNi had $340.1 million of cash and cash equivalents compared to $354.3 million as of December 31, 2010 and $259.4 million as of September 30, 2010.

Net cash provided by operating activities for the nine months ended September 30, 2011 was $7.2 million, compared to $6.2 million in the same period last year. The change was primarily due to the improved operating performance offset by the timing of payments of trade payables.

Net cash used in investing activities for the nine months ended September 30, 2011 was $27.7 million resulting primarily from capital expenditures for investments in information technology and headquarters renovations. Net cash used in investing activities in 2010 of $26.2 million was primarily for investments in information technology, headquarters renovations and broadcasting-related investments.

 

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Net cash provided by financing activities for the nine months ended September 30, 2011 was $6.3 million and was primarily due to excess tax benefits from stock-based awards. Net cash provided by financing activities in 2010 was $9.4 million primarily due to the issuance of common stock, net of withholding taxes, of $12.8 million, partially offset by the repayment of long-term debt of $4.8 million.

The credit agreement contains two principal financial covenants consisting of a maximum leverage ratio, as defined in the credit agreement, of 2.75x and a minimum interest coverage ratio, as defined in the credit agreement, of 3.00x, among other covenants. With a leverage ratio of 1.08x and an interest coverage ratio of 9.86x, HSNi was in compliance with the two principal financial covenants as well as the other covenants as of September 30, 2011. 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. The amount available under the credit agreement is also reduced by the amount of commercial and standby letters of credit issued under the revolving credit facility portion of the agreement. As of September 30, 2011, there were $35.1 million of outstanding commercial and standby letters of credit issued under the revolving credit facility. As of September 30, 2011, 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 $114.9 million.

In October 2011, HSNi made a voluntary prepayment of the remaining $69.8 million balance of its term loan.

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; as well as capital, investing and other commitments and contingencies for the foreseeable future.

On September 27, 2011, HSNi’s Board of Directors approved a share repurchase program which allows HSNi to purchase 10 million shares of its common stock from time to time through privately negotiated and/or open market transactions. The timing of any repurchases and actual number of shares repurchased will depend on a variety of factors, including the stock price, corporate and regulatory requirements, restrictions under HSNi’s debt obligations and other market and economic conditions. The repurchase program may be suspended or discontinued by HSNi at any time. HSNi has not yet purchased any common stock under this program.

On September 27, 2011, HSNi’s Board of Directors approved a cash dividend of $0.125 per common share. We anticipate the cash dividend will be funded from current cash and expected future cash flows. The dividend will be paid on November 16, 2011 to HSNi’s record holders as of November 2, 2011.

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, 2010. No material changes have occurred in HSNi’s market risks since December 31, 2010.

 

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 September 30, 2011. 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.

 

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There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2011 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 (including patent infringement), sales tax, regulatory compliance and other claims. As of the date of this filing, 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; however, litigation matters are subject to inherent uncertainties and the results of these matters cannot be predicted with certainty. 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. Moreover, any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time and result in the diversion of significant operational resources.

See Part I. Item 1. Financial Statements – Note 10 – Commitments and Contingencies, for additional information regarding legal matters in which we are involved.

 

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, 2010, 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

On September 27, 2011, HSNi’s Board of Directors approved a share repurchase program which allows HSNi to purchase 10 million shares of its common stock from time to time through privately negotiated and/or open market transactions, including pursuant to a trading plan in accordance with Rule 10b5-1 and Rule 10b-18 under the Securities Exchange Act of 1934, as amended, or by any combination of such methods. The timing of any repurchases and actual number of shares repurchased will depend on a variety of factors, including the stock price, corporate and regulatory requirements, restrictions under HSNi’s debt obligations and other market and economic conditions. The repurchase program may be suspended or discontinued by HSNi at any time. HSNi has not yet purchased any common stock under this program.

 

Item 3.

Defaults Upon Senior Securities

None

 

Item 4.

Removed and Reserved

 

Item 5.

Other Information

None

 

Item 6.

Exhibits

 

Exhibit Number		Description		Location
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
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

 

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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
101		The following financial information from HSNi’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2011, formatted in XBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010, (ii) Consolidated Balance Sheets as of September 30, 2011, December 31, 2010 and September 30, 2010, (iii) Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2011 and 2010, and (iv) Notes to the Consolidated Financial Statements, tagged as blocks of text.			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: November 2, 2011

 

 

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