T H I R D Q U A R T E R R E P O R T
1
The following management's discussion and analysis is prepared as at January 25,
2010, and is based primarily on the unaudited interim consolidated financial
statements of Indigo Books & Music Inc. (the "Company" or "Indigo") for the
13-week periods ended December 26, 2009 and December 27, 2008. It should
be read in conjunction with the unaudited interim consolidated financial statements
and notes contained in this Quarterly Report, the audited annual consolidated
financial statements and accompanying notes for the year ended March 28, 2009,
and Management's Discussion and Analysis ("MD&A") included in the Company's
fiscal 2009 Annual Report.The Annual Report and additional information about
the Company, including the Annual Information Form, can be found on SEDAR
at www.sedar.com.
Overview
Indigo is the nation's largest book retailer, operating stores in all 10 provinces and
one territory in Canada and offering online sales through its www.chapters.indigo.ca
website. As at December 26, 2009, the Company operated 96 superstores under
the banners Chapters, Indigo and the World's Biggest Bookstore, 151 small format stores
under the banners Coles, Indigo, Indigospirit, SmithBooks and The Book Company and
two new concept stores under the banner Pistachio. During the third quarter of
fiscal 2010, the Company opened one superstore and did not close any stores.
The Company also has a 50% interest in Calendar Club of Canada Limited
Partnership ("Calendar Club"), which operates seasonal kiosks and year-round
stores in shopping malls across Canada.
In February 2009, Indigo launched Shortcovers (www.shortcovers.com), a new
digital destination offering online and mobile service that provides instant access
to books, articles and blogs. On December 14, 2009, Indigo transferred the net
assets of Shortcovers into a new company, Kobo Inc. ("Kobo").The Shortcovers
website was renamed to www.kobobooks.com. Kobo secured $16.0 million in
funding from strategic partners, including $5.0 million from Indigo. Indigo
retained 57.7% ownership of Kobo.
Indigo operates a separate registered charity under the name Indigo Love
of Reading Foundation (the "Foundation").The Foundation provides new books
and learning material to high-needs elementary schools across the country
through donations from Indigo, its customers, suppliers and employees.
As at December 26, 2009, the number of common shares outstanding was
24,537,009 with a book value of $196.6 million. As at December 26, 2009,
Management's Discussion and Analysis
Table of Contents
1.
Management's Discussion and Analysis
19.
Consolidated Financial Statements and Notes
32.
Investor Information
I N D I G O B O O K S &
M U S I C I N C .
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T H I R D Q U A R T E R R E P O R T
3
Revenue Increase Driven by New Store Openings
Total consolidated revenues for the 13-week period ended December 26, 2009
increased $10.2 million or 3.1% to $340.2 million from $330.0 million for the
period ended December 27, 2008.The increase was attributable to the opening
of new superstores during the year and was partially offset by the closure of
small format stores. Compared to the same period last year, the Company oper-
ated six more superstores and eight fewer small format stores. Comparable store
sales for the quarter increased 3.4% in superstores primarily due to growth in
the sales of trade books, gift and paper products and decreased 1.6% in small
format stores primarily due to lower children's book and bargain book sales.
Comparable store sales are defined as sales generated by stores that have been
open for more than 12 months. It is a key performance indicator for the Company
as this measure excludes sales fluctuations due to store closings, permanent
relocation and chain expansion.
Online sales in the third quarter decreased by $0.8 million or 2.7% to
$29.3 million for the 13-week period ended December 26, 2009 from $30.1 mil-
lion in the same period last year.The decrease in the online channel was attribut-
able to the Company selectively choosing to exit certain unprofitable titles.
Revenues from other sources include revenues generated through corporate
sales, revenues from the sale of loyalty cards, the Company's proportionate rev-
enue generated through Calendar Club, gift card breakage, and revenues from
Pistachio and Kobo. Revenues from other sources increased $0.1 million from
$23.6 million in the third quarter last year to $23.7 million in the same period
this year as growth in the Company's loyalty card program, Pistachio and Kobo
were offset by declines in Calendar Club sales and gift card breakage.
On a year-to-date basis, total consolidated revenues increased $14.8 million
or 2.0% from $725.9 million last year to $740.7 million this year. Year-to-date
comparable store sales were up 1.6% for superstores and down 1.1% for small
format stores.The year-to-date increases in revenues and comparable store sales
were driven by the same factors as discussed above.
Revenues by channel are highlighted below:
13-week
13-week
period ended
period ended
Comparable
December 26,
December 27,
store sales
(millions of dollars)
2009
2008
% increase
% increase
Superstores
230.0
214.7
7.1
3.4
Small format stores
57.2
61.6
(7.1)
(1.6)
Online (including store kiosks)
29.3
30.1
(2.7)
N/A
Other
23.7
23.6
0.4
N/A
340.2
330.0
3.1
2.4
there were 2,053,211 stock options outstanding of which 945,711 were exercis-
able.The number of common shares reserved for issuance under the employee
stock option plan is 2,203,701.
Investment in Kobo
On December 14, 2009, Indigo transferred all Shortcovers assets to Kobo. Net
assets with a carrying amount of $3.9 million were exchanged for 10,000,000
Kobo common shares.This transfer was accounted for as a related-party transac-
tion at carrying value.
On December 15, 2009, Kobo secured $5.0 million of funding from
Indigo and $11.0 million of funding from unrelated investors (collectively, the
"Syndicate"). Common shares were issued to Indigo and the Syndicate at a price
of $1.00 per common share. Indigo holds a total of 15,000,000 common shares
of Kobo resulting in 57.7% ownership.The Syndicate invested a total of $11.0 mil-
lion in exchange for 11,000,000 common shares and a 42.3% ownership in
Kobo. Indigo retains control over Kobo and continues to consolidate Kobo in the
Company's financial statements. Non-controlling interest related to the Syndicate
has been recorded as a reduction to equity and due to Kobo's operating losses in
this quarter, as an increase to income.
Kobo was originally a wholly-owned subsidiary of Indigo and the issuance of
additional Kobo shares to the Syndicate diluted Indigo's ownership to 57.7% and
resulted in a dilution gain of $3.0 million for Indigo.The transaction also resulted
in a $0.9 million deemed disposition of Indigo's existing consolidated goodwill.
As part of this transaction, Indigo received a $1.0 million reimbursement of
Kobo expenses which increased the amount of the recognized dilution gain.
Results of Operations
The following table summarizes the consolidated statement of operations for
the periods indicated.The classification of financial information presented below
is specific to Indigo and may not be comparable to that of other retailers.
13-week
13-week
39-week
39-week
period ended
period ended
period ended
period ended
December 26,
%
December 27,
%
December 26,
%
December 27,
%
(millions of dollars)
2009
Revenues
2008
Revenues
2009
Revenues
2008
Revenues
Revenues
340.2 100.0%
330.0 100.0%
740.7 100.0%
725.9 100.0%
Cost of sales
184.9
54.4%
185.7
56.3%
407.4
55.0%
408.6
56.3%
Cost of operations
78.3
23.0%
76.3
23.1%
204.5
27.6%
198.6
27.4%
Selling and administrative
expenses
24.5
7.2%
21.4
6.5%
62.4
8.4%
55.3
7.6%
EBITDA
1
52.5
15.4%
46.6
14.1%
66.4
9.0%
63.4
8.7%
1
Earnings before interest, taxes, depreciation, amortization, non-controlling interest and non-recurring items. Also see "Non-GAAP Financial Measures".
I N D I G O B O O K S &
M U S I C I N C .
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T H I R D Q U A R T E R R E P O R T
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decreased by 0.1% in the third quarter as compared to the same period last year.
On a year-to-date basis, costs of operations increased by 0.2% to 27.6% of total
revenues this year from 27.4% last year primarily due to increased occupancy
and labour costs as previously discussed.
Selling and Administrative Expenses Increased due to Strategic
Investments in Kobo
Selling and administrative expenses include all marketing, head office costs and
investments in strategic initiatives such as Kobo. In absolute dollar terms, selling
and administrative expenses increased $3.1 million compared to the same quarter
last year. As a percent of total revenues, selling and administrative expenses
increased to 7.2% this quarter compared to 6.5% in the same period last year.
The Company spent $2.3 million this quarter on strategic projects such as Kobo,
Pistachio and gift and toy expansion, a $0.9 million increase from the same
quarter last year.The Company also accrued $2.2 million this quarter under the
Long Term Performance and Retention Incentive Program based on year-to-date
financial performance. On a year-to-date basis, selling and administrative expenses
increased $7.1 million due to the same factors mentioned above. As a percent of
total revenues, selling and administrative expenses increased from 7.6% last year
to 8.4% this year.
EBITDA Increased to 15.4% of Revenues
EBITDA
, defined as earnings before interest, taxes, depreciation, amortization,
non-controlling interest and non-recurring items increased $5.9 million to
$52.5 million for the 13-week period ended December 26, 2009, compared
to $46.6 million for the 13-week period ended December 27, 2008.The increase
in EBITDA was the result of increased sales from the opening of new superstores
and lower cost of sales, as explained above. EBITDA as a percent of revenues
increased to 15.4% this quarter from 14.1% in the same quarter last year.
Amortization Increased versus Last Year
Amortization for the 13-week period ended December 26, 2009 increased by
$0.5 million to $7.3 million compared to $6.8 million last year. Capital expendi-
tures in the current quarter totalled $8.7 million and included $3.1 million on
store construction, renovations and equipment, $4.5 million on intangible assets
(primarily application software and internal development costs) and $1.1 million
on technology equipment. Of the $1.1 million expenditure in technology equip-
ment, $0.2 million was financed through capital leases.Year-to-date, the Company
has spent $32.3 million on capital expenditures including $17.7 million on store
A reconciliation between total revenues and comparable store sales is provided
below:
Superstores
Small format stores
13-week
13-week
13-week
13-week
period ended
period ended
period ended
period ended
December 26,
December 27,
December 26,
December 27,
(millions of dollars)
2009
2008
2009
2008
Total revenues
230.0
214.7
57.2
61.6
Adjustments for stores not in both
fiscal periods
(11.3)
(3.3)
(1.3)
(4.8)
Comparable store sales
218.7
211.4
55.9
56.8
Cost of Sales (as a Percent of Revenues) Showed Significant Improvement
Cost of sales include the landed cost of goods sold, online shipping costs, inven-
tory shrink and damage provision, less all vendor support programs. In absolute
dollar terms, cost of sales decreased $0.8 million to $184.9 million. As a percent
of total revenues, cost of sales decreased 1.9% to 54.4% in the third quarter,
compared to 56.3% in the same period last year. Cost of sales were lower in the
third quarter as the Company continues to benefit from the online shipping cost
improvements implemented during the third quarter of last fiscal year. In addition,
the Company increased the percentage of products processed centrally at its
distribution centre versus shipping the product directly from vendors to stores.
The Company receives better margins from its vendors on product shipped to its
distribution centre.The Company also received increased vendor support in
comparison to the same quarter last year. On a year-to-date basis, cost of sales as
a percent of total revenues decreased 1.3% from 56.3% last year to 55.0% this
year, for the same reasons outlined above.
Cost of Operations (as a Percent of Revenues) Remained Flat Compared
to Last Year
Cost of operations includes all store, online, distribution centre, Calendar Club
and Pistachio costs. Cost of operations increased $2.0 million primarily due to an
increase in occupancy, labour and transaction costs. Occupancy costs increased
$1.1 million primarily due to the operation of six additional superstores compared
to the third quarter of last year. Labour costs increased $1.5 million compared
to the same period last year as a result of higher minimum wage rates in most
provinces and the opening of the new superstores.Transaction costs increased by
$0.2 million because of higher interchange rates charged by credit card companies.
These increases were partially offset by reductions of $0.8 million in online and
Calendar Club expenses. As a percent of total revenues, cost of operations
I N D I G O B O O K S &
M U S I C I N C .
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T H I R D Q U A R T E R R E P O R T
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of this year. In the same period last year, the Company recognized an income tax
expense of $13.4 million.The decrease in income tax expense in the current year
is the result of (i) a lower combined income tax rate for the Company, and (ii)
reversal of the deferred credit arising from the prior year purchase of tax losses
from a related company. During fiscal 2009, Indigo purchased certain tax losses
from a related company. Indigo acquired a future tax asset of $7.3 million in
exchange for net cash consideration of $2.9 million.The difference of $4.4 mil-
lion between the net cash consideration and the future tax asset was recorded as
a deferred credit. As the future tax asset was utilized based on the year-to-date
net earnings, the deferred credit was recognized into income, which results in a
lower tax expense for Indigo.
Net Earnings Recorded for the Current Fiscal Quarter
The Company recognized net earnings of $34.5 million for the third quarter
or $1.41 net earnings per common share, compared to net earnings of $26.8 mil-
lion or $1.09 net earnings per common share last year.Year-to-date, the Company
recognized net earnings of $34.4 million ($1.40 net earnings per common
share), compared to net earnings of $28.7 million last year ($1.17 net earnings
per common share).The increase in net earnings was primarily due to the
increase in EBITDA, net gains from the Kobo transaction and a reduction in
income tax expense.
Seasonality and Third Quarter Results
Indigo's business is highly seasonal and follows quarterly sales and profit (loss)
fluctuation patterns, which are similar to those of other retailers that are highly
dependent on the December holiday sales season. A disproportionate amount of
revenues and profits are earned in the third quarter. As a result, quarterly per-
formance is not necessarily indicative of the Company's performance for the rest
of the year.The following table sets out revenues, net earnings (loss), basic and
diluted earnings (loss) per share for the preceding eight fiscal quarters.
Fiscal quarters
Q3
Q2
Q1
Q4
Q3
Q2
Q1
Q4
(thousands of dollars,
Fiscal
Fiscal
Fiscal
Fiscal
Fiscal Fiscal Fiscal Fiscal
except per share data)
2010
2010
2010
2009
2009
2009
2009
2008
Revenues
340,195
206,990
193,551
214,522
330,014
205,261
190,602
206,236
Net earnings (loss)
34,530
2,200
(2,304)
1,917
26,770
3,188
(1,225)
3,130
Basic earnings (loss)
per share
$
1.41
$
0.09 $
(0.09) $
0.08
$ 1.09
$ 0.13 $ (0.05) $ 0.13
Diluted earnings (loss)
per share
$
1.38
$
0.09 $
(0.09) $
0.08
$ 1.07 $ 0.13 $ (0.05) $ 0.12
construction, renovations and equipment, $10.6 million on intangible assets and
$4.0 million on technology equipment. Of these capital expenditures, $1.0 mil-
lion was financed through capital leases.
The Company wrote-off $0.5 million of capital assets relating to certain
Pistachio product design costs in the third quarter of this fiscal year. Indigo is
no longer using these product designs and therefore the assets were written-off.
No such write-off occurred during the prior year comparative period.
Net Interest Recorded in Third Quarter
The Company recognized net interest of nil in the third quarter of this year
compared to $0.3 million of interest income in the same period last year. On a
year-to-date basis, the Company also recognized net interest of nil compared to
$0.9 million last year.The decline in market interest rates caused the Company
to earn less interest income on its cash and cash equivalents in both the current
quarter and on a year-to-date basis.The Company nets interest income received
against interest expense paid on capital leases.
Transactions Relating to Kobo in the Third Quarter
The Company recognized a non-recurring $3.0 million dilution gain on the sale
of 42.3% of Kobo to the Syndicate.This dilution gain is the difference between
the underlying equity of Indigo's Kobo shares and the proceeds received by Kobo
on the issue of shares to the Syndicate. As part of this transaction, Indigo received
a $1.0 million reimbursement of Kobo expenses which increased the amount of
the recognized dilution gain.
Upon the sale of 42.3% of Kobo to the Syndicate, a deemed disposition
of goodwill occurred as Indigo was deemed to have disposed of a portion of its
existing goodwill.The deemed disposition of $0.9 million is a non-recurring
transaction.
The Company fully consolidated the results of Kobo in its financial state-
ments.The Company recorded $7.9 million in non-controlling interest as a
reduction to equity on its balance sheet.The $7.9 million reduction to equity
reflects the 42.3% of Kobo owned by the Syndicate.The Company recorded
$0.1 million in non-controlling interest to its statement of earnings as a recovery
of losses incurred by Kobo from the close of the financing until the end of the
quarter.The $0.1 million loss is the portion attributable to the 42.3% of Kobo
owned by the Syndicate.
Income Tax Expense Decreased from Last Year
The Company recognized income tax expense of $12.4 million in the third quarter
in long-term debt.The increase in accounts payable and accrued liabilities is con-
sistent with increased investment in inventories and long-term debt decreased as
the Company entered into fewer capital leases compared to last year.
Non-Controlling Interest
The Company fully consolidated the results of Kobo in its financial statements.
The Company recorded $7.9 million in non-controlling interest as a reduction
to equity on its balance sheet.The $7.9 million reduction to equity reflects the
42.3% of Kobo owned by the Syndicate.The Company recorded $0.1 million
in non-controlling interest to its statement of earnings as a recovery of losses
incurred by Kobo from the close of the financing until the end of the quarter.
The $0.1 million loss is the portion attributable to the 42.3% of Kobo owned
by the Syndicate.
Shareholders' Equity
Shareholders' equity at December 26, 2009 increased $30.2 million compared
to December 27, 2008.The increase in shareholders' equity was primarily due
to net earnings of $36.3 million in the last four quarters. It was partially offset
by: (i) a $0.4 million decrease in share capital due to the repurchase of common
shares under the normal course issuer bid; and (ii) $7.4 million of dividend
payments. Contributed surplus increased $1.3 million due to the expensing
of employee stock options and Director's deferred stock units. Year-to-date,
$0.8 million was recorded for stock option expense and $0.3 million was
recorded for Director's deferred stock units in contributed surplus.
Working Capital and Leverage
The Company's working capital position usually declines from the end of its
fiscal year until the third fiscal quarter due to the seasonal nature of the business.
The Company relies on cash and accounts payable as two of the primary vehicles to
fund the business before generating a disproportionate amount of cash during the
December holiday season.The Company reported working capital of $126.4 mil-
lion as at December 26, 2009, compared to $96.7 million as at December 27,
2008 and $87.1 million at the end of fiscal 2009.Working capital increased due
to growth in current assets exceeding growth in current liabilities. As previously
discussed, the growth in current assets was $49.9 million due to increases in cash
and cash equivalents, inventory and capital assets while the growth in current
liabilities was $20.2 million primarily due to an increase in accounts payable and
accrued liabilities.
T H I R D Q U A R T E R R E P O R T
9
I N D I G O B O O K S &
M U S I C I N C .
Overview of Consolidated Balance Sheets
Total Assets
As at December 26, 2009, total assets were $58.3 million greater than at
December 27, 2008.The increase in assets was primarily due to increases in the
Company's cash and cash equivalents; property, plant and equipment; intangible
assets and inventory. Cash and cash equivalents increased $34.7 million primarily
due to strong seasonal sales and $11.0 million from the Kobo financing transaction.
The Company's inventory position increased $18.3 million mainly due to the
opening of new superstores and the expansion of the gift, paper and toy businesses.
Property, plant and equipment increased by $10.7 million primarily due to the
opening of new superstores. Intangible assets increased by $6.5 million primarily
due to expenditures for technology-related projects.These increases were offset
by a $9.9 million reduction to future tax assets due to the utilization of tax loss
carryforwards based on year-to-date net earnings.
On a fiscal year-to-date basis, total assets increased $136.3 million compared
to March 28, 2009.The increase in total assets was primarily due to an increase
in cash and cash equivalents and increased investment in inventories, property,
plant and equipment. Cash and cash equivalents increased by $110.6 million
primarily due to sales generated during the holiday season and the Kobo financing
transaction.The Company's inventory position increased by $24.5 million while
property, plant and equipment increased by $6.5 million compared to March 28,
2009.The increase in inventories is consistent with the seasonal nature of the
business while property, plant and equipment increased due to the opening of
new superstores.These increases were offset by a decrease of $14.9 million in
future income tax assets.
Total Liabilities
As at December 26, 2009, total liabilities were $20.2 million higher than total
liabilities at December 27, 2008.The increase in liabilities was primarily due
to a $22.0 million increase in accounts payable and accrued liabilities that is
consistent with the increase in the Company's inventory position, as noted above.
An additional $1.1 million increase in deferred revenue due to growth in the
Company's loyalty program was partially offset with a $1.6 million decrease to
income taxes payable due to payments made in the current year.
On a year-to-date basis, total liabilities increased $100.4 million compared
to March 28, 2009.The increase in total liabilities was mainly due to an increase
in accounts payable and accrued liabilities of $100.8 million and a $0.6 million
increase in deferred revenue which was partially offset by a $1.3 million reduction
8
On a year-to-date basis, net cash flows used in investing activities were
$31.3 million compared to $33.4 million last year. Capital expenditures this
year included $17.7 million in store construction, renovations and equipment,
$10.6 million on intangible assets and $3.0 million in technology-related prod-
ucts. Capital expenditures in the same period last year included $19.3 million
in store construction, renovations and equipment, $6.1 million in technology-
related projects and $8.0 million on intangible assets.
Cash Flows from Financing Activities
Net cash flows from financing activities were $7.5 million during the third
quarter compared to $3.1 million used in the same period last year.The increase
in cash flows from financing activities was primarily due to the $11.0 million
received from the Syndicate for its investment in Kobo.The increase was partially
offset by dividends of $2.5 million paid during this quarter.The Company did
not make any dividend payments in the same period last year.The increase was
further offset as the Company repurchased $0.4 million of common shares under
the normal course issuer bid in the current quarter compared to $2.4 million in
the same period last year.
On a year-to-date basis, net cash flows from financing activities were
$1.2 million, compared to $7.7 million of cash used last year.The change in
cash flow between the two years was primarily due to the Kobo financing and
dividend payments this quarter, offset by cash used for the share repurchase this
year, as explained above.
Liquidity and Capital Resources
The Company has a highly seasonal business which generates the majority of its
revenues and cash flows during the December holiday season. Indigo has minimal
accounts receivable, as its customers pay largely by cash or credit card, and it
purchases products on trade terms with the right to return a significant portion
of its products. Indigo's main sources of capital are cash flow generated from
operations and long-term debt. Indigo invests its cash in highly liquid assets.
The Company does not invest in asset-backed commercial paper.The Company
previously had a revolving line of credit which expired on October 15, 2009 and
was not renewed.
Based on the Company's liquidity position and cash flow forecast, the Board
of Directors approved the payment of a quarterly cash dividend of $0.10 per
common share or $0.40 per common share annually, starting in the first quarter
of the current fiscal year. Based on current operating levels, management expects
cash flow generated from operations to be sufficient to meet its working capital
T H I R D Q U A R T E R R E P O R T
11
I N D I G O B O O K S &
M U S I C I N C .
The Company's leverage position (defined as Total Liabilities to Total
Shareholders' Equity) remained stable at 1.4:1 at the end of the current quarter
compared to 1.5:1 last year.The Company's leverage position increased slightly
from 1.1:1 as at March 28, 2009 due to the increases in total liabilities exceeding
increases in shareholders' equity, as mentioned above.
Overview of Consolidated Statements of Cash Flows
Cash and cash equivalents increased $123.7 million from the second to the third
quarter of fiscal 2010 compared to an increase of $98.1 million last year. Year-to-
date, cash and cash equivalents increased $110.6 million compared to an increase
of $112.2 million for the same period last year.
Cash Flows from Operating Activities
Cash flows generated from operating activities were $124.7 million in the third
quarter this year compared to $117.6 million in the same period last year, an
improvement of $7.1 million. Cash flows in the current quarter were primarily
generated from net earnings of $34.5 million, reductions in accounts payable
of $86.8 million and non-cash items of $20.1 million.These cash flows from
operating activities were offset by a $12.1 million investment in inventory and a
$7.8 million increase in accounts receivable which have not yet been received
due to the timing of quarter end.
On a year-to-date basis, cash flows generated from operating activities
were $140.8 million. Increases in accounts payable and accrued liabilities
totalling $100.8 million were the primary driver of cash flows generated from
operating activities. Similar to the third quarter, cash flows generated from
accounts payable were offset by $24.5 million of cash used to purchase inventory
and a $6.3 million increase in accounts receivable. Over the same period last
year, cash generated from operating activities was $153.3 million.
Cash Flows Used in Investing Activities
In the third quarter, net cash flows used in investing activities were $8.5 million
compared to $16.5 million used in the same quarter last year.The Company
spent $8.5 million of cash on capital projects in the current quarter, including
$3.1 million in store construction, renovations and equipment, $4.5 million on
intangible assets (primarily application software and internal development costs)
and $0.9 million in technology-related projects. During the third quarter last
year, the Company spent $16.5 million on capital projects including $8.3 million
for store and head office construction, renovations and equipment, $3.1 million
on intangible assets and $5.1 million for technology-related projects.
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T H I R D Q U A R T E R R E P O R T
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I N D I G O B O O K S &
M U S I C I N C .
needs, debt service requirements and dividend payments for the current fiscal
year. In addition, Indigo has the ability to reduce capital spending to fund debt
requirements if necessary; however a long-term decline in capital expenditures
may negatively impact revenues and profit growth. Future declaration of quarterly
dividends and the establishment of future record and payment dates are subject
to the final determination of the Company's Board of Directors. Dividends may
be reduced or eliminated if required to maintain appropriate capital resources.
There can be no assurance that operating levels will not deteriorate over the
ensuing fiscal year, which could result in the Company being unable to meet its
current working capital and debt service requirements. In addition, other factors
not presently known to management could materially and adversely affect Indigo's
future cash flows. In such events, the Company would be required to obtain
additional capital as is necessary to satisfy its working capital and debt service
requirements from other sources. Alternative sources of capital could result in
increased dilution to shareholders and may be on terms that are not favourable
to the Company.
Accounting Policies
Critical Accounting Estimates
The discussion and analysis of Indigo's operations and financial condition are
based upon the unaudited interim consolidated financial statements, which have
been prepared in accordance with Canadian generally accepted accounting
principles ("GAAP").The preparation of these consolidated financial statements
requires the Company to estimate the effect of several variables that are inherently
uncertain.These estimates and assumptions can affect the reported amounts of
assets, liabilities, revenues and expenses. Indigo bases its estimates on historical
experience and other assumptions which the Company believes to be reasonable
under the circumstances.The Company also evaluates its estimates on an ongoing
basis.The significant accounting policies of the Company are described in Note 2
of the consolidated financial statements in the fiscal 2009 Annual Report, and the
Company's critical accounting estimates are disclosed in the MD&A section of its
fiscal 2009 Annual Report.
In the third quarter of fiscal 2010, there were no significant changes to the
provisions for slow-moving and damaged products and for gift and paper products
that have been marked down. Furthermore, the method of determining gift card
breakage is consistent with that used in previous periods.
12
The provision for future tax assets was reduced by $14.9 million due to
the utilization of tax loss carryforwards.The carrying value of goodwill was also
reduced by $0.9 million due to the deemed disposal which occurred upon the
sale of 42.3% of Kobo to the Syndicate.The methods of calculating future tax
assets and goodwill are consistent with that used in previous periods.
New Accounting Pronouncements
The following accounting standards will be adopted by the Company in the future.
Business Combinations
Section 1582 of the CICA Handbook, "Business Combinations", replaces the
existing Section 1580, "Business Combinations." The CICA also issued Section
1601, "Consolidated Financial Statements" and Section 1602, "Non-Controlling
Interests", which replaces Section 1600, "Consolidated Financial Statements."
These new sections are based on the International Accounting Standards Board's
("IASB") International Financial Reporting Standard 3, "Business Combinations"
and will replace the existing guidance on business combinations and consolidated
financial statements.The objective of the new standards is to harmonize Canadian
accounting for business combinations with the international and U.S. accounting
standards.The three new standards have to be adopted concurrently and will
apply to interim and annual consolidated financial statements relating to fiscal
years beginning on or after January 1, 2011. Assets and liabilities that arose from
business combinations whose acquisition dates preceded the application of the
new standards will not be adjusted upon application of these new standards.
Section 1602 should be applied retrospectively except for certain items.The
Company is currently assessing whether it will apply the new accounting standards
at the beginning of its fiscal 2012 year or elect to early adopt.
International Financial Reporting Standards
In February 2008, the Canadian Accounting Standards Board confirmed its plan
to converge with IFRS.The Company must prepare interim and annual financial
statements in accordance with IFRS for fiscal years beginning on or after January 1,
2011.The Company's launch of its IFRS conversion project began in 2008 where
it established an internal project team and engaged an external consultant to
conduct a preliminary diagnosis and scoping exercise.To date, the project team
has completed a detailed assessment of each standard, including identifying the
T H I R D Q U A R T E R R E P O R T
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I N D I G O B O O K S &
M U S I C I N C .
14
differences between the Company's current policies and those under IFRS, and
determined the financial implications that result from the adoption of these new
standards.The team, with the assistance of its external consultant, has prepared
a sample of the Company's historical financial statements using IFRS. Project
plans are being developed to address the information technology and data
system impacts, disclosure controls and procedures and internal controls over
financial reporting.
The Company continues to monitor and assess the impact of evolving differ-
ences between Canadian GAAP and IFRS, since the IASB is expected to continue
issuing new accounting standards during the transition period. As a result, the
final impact of IFRS on the Company's consolidated financial statements can only
be measured once all the applicable IFRS at the conversion date are known.
Risks and Uncertainties
The risks and uncertainties faced by the Company are substantially the same as
those disclosed in the MD&A section of its fiscal 2009 Annual Report, except
for the below.
Foreign Exchange Risk
The Company's foreign exchange risk is largely limited to currency fluctuations
between the Canadian and U.S. Dollars. However, the strategic partnerships
entered into by Kobo are anticipated to result in sales to American, Asian and
Australian consumers and therefore, foreign exchange risk is expected to
increase as Kobo expands its operations. Kobo is currently in the start-up phase
of operations and its current impact on foreign exchange risk is not significant.
Disclosure Controls & Procedures
Management is responsible for establishing and maintaining a system of disclosure
controls and procedures to provide reasonable assurance that all material infor-
mation relating to the Company is gathered and reported on a timely basis to
senior management, including the Chief Executive Officer ("CEO") and Chief
Financial Officer ("CFO"), so that appropriate decisions can be made by them
regarding public disclosure.
Internal Control over Financial Reporting
Management is also responsible for establishing and maintaining adequate internal
control over financial reporting to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of consolidated financial
statements for external purposes in accordance with Canadian generally accepted
accounting principles.
All internal control systems, no matter how well designed, have inherent
limitations.Therefore, even those systems determined to be effective can provide
only reasonable assurance with respect to consolidated financial statement prepara-
tion and presentation. Additionally, management is necessarily required to use
judgment in evaluating controls and procedures.
Changes in Internal Control over Financial Reporting
Management has evaluated whether there were changes in the Company's internal
control over financial reporting that occurred during the period beginning on
September 27, 2009 and ending on December 26, 2009 which have materially
affected, or are reasonably likely to materially affect, the Company's internal
control over financial reporting.
The Kobo financing transaction in December 2009 has resulted in material
changes to the Company's internal control over financial reporting.The issuance
of Kobo shares to third-party investors in exchange for financing has led to a
reduction in the Company's percentage ownership of Kobo to 57.7%.This
transaction results in the requirement to record a non-controlling interest in
Kobo and to mitigate the risk of an error in its consolidated financial reporting,
management of the Company has implemented controls around the calculation
and recording of entries used to consolidate ownership of Kobo.
Cautionary Statement Regarding Forward-Looking Statements
The above discussion includes forward-looking statements. All statements other
than statements of historical facts included in this discussion that address activities,
events or developments that the Company expects or anticipates will or may
occur in the future are forward-looking statements.These statements are based
on certain assumptions and analysis made by the Company in light of its experi-
ence, analysis and its perception of historical trends, current conditions and
expected future developments as well as other factors it believes are appropriate
in the circumstances. However, whether actual results and developments will
conform with the expectations and predictions of the Company is subject to a
T H I R D Q U A R T E R R E P O R T
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I N D I G O B O O K S &
M U S I C I N C .
16
number of risks and uncertainties, including the general economic, market or
business conditions; competitive actions by other companies; changes in laws
or regulations; and other factors, many of which are beyond the control of the
Company. Consequently all the forward-looking statements made in this discus-
sion are qualified by these cautionary statements and there can be no assurance
that results or developments anticipated by the Company will be realized or,
even if substantially realized, that they will have the expected consequences to,
or effects on, the Company.
Non-GAAP Financial Measures
The Company prepares its consolidated financial statements in accordance with
Canadian generally accepted accounting principles. In order to provide additional
insight into the business, the Company has also provided non-GAAP data, includ-
ing comparable store sales and EBITDA, in the discussion and analysis section
above. Neither measure has a standardized meaning prescribed by GAAP, and
is therefore specific to Indigo and may not be comparable to similar measures
presented by other companies.
Comparable stores sales and EBITDA are key indicators used by the
Company to measure performance against internal targets and prior period
results. Both measures are commonly used by financial analysts and investors to
compare Indigo to other retailers. Comparable store sales are defined as sales
generated by stores that have been open for more than 12 months. It is a key
performance indicator for the Company as this measure excludes sales fluctua-
tions due to store closings, permanent relocation and chain expansion. EBITDA
is defined as earnings before interest, taxes, depreciation and amortization.
EBITDA
also excludes non-controlling interest and the non-recurring dilution
gain, deemed disposition of goodwill and capital assets write-off because they
affect the comparability of Indigo's financial results.The method of calculating
EBITDA
is consistent with that used in prior periods.
A reconciliation between comparable store sales and revenues (the most
comparable GAAP measure) was included earlier in this report. A reconciliation
between EBITDA and earnings before income taxes (the most comparable GAAP
measure) is provided below:
Reconciliation of EBITDA to earnings before income taxes
13-week
13-week
39-week
39-week
period ended
period ended
period ended
period ended
December 26,
December 27,
December 26,
December 27,
(millions of dollars)
2009
2008
2009
2008
EBITDA
52.5
46.6
66.4
63.4
Amortization of property, plant
and equipment
5.1
5.3
14.9
16.9
Amortization of intangible assets
2.2
1.4
6.1
4.0
Write-off of capital assets
0.5
0.0
0.5
0.0
Non-controlling interest
(0.1)
0.0
(0.1)
0.0
Kobo dilution gain
(3.0)
0.0
(3.0)
0.0
Deemed disposition of goodwill
0.9
0.0
0.9
0.0
Interest on long-term debt and
financing charges
0.1
0.1
0.2
0.2
Interest income on cash and
cash equivalents
(0.1)
(0.3)
(0.2)
(1.1)
Earnings before income taxes
46.9
40.1
47.1
43.4
