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No. of Recommendations: 9
The business

RadioShack has been a corporate presence since 1967. They are retailers of electronic products that are aimed at the home market--not professionals. They are a retailer I have actually been able to visit even living in a very small town, hundreds of miles from the nearest urban environment. Perhaps this is one reason for their longevity--their accessibility. Like everyone else, they are hurt by the incursion of Walmart, which is able to penetrate just about any market including a small town like ours.


They operate 5,121 company stores and 1,921 dealer/franchise outlets in the U.S., Puerto Rico and the U.S. Virgin Islands. The stores average 2,450 square feet and are located in major malls and strip centers, as well as individual storefronts. Each location carries an assortment of both private label and third-party branded products and include electronic parts, batteries and accessories; wireless and conventional telephones; audio and video equipment; direct-to-home ("DTH") satellite systems; personal computers; personal electronics such as home air cleaners; and toys. They also provide consumers access to third-party services such as cellular and PCS phone and DTH satellite activation, long distance telephone service, prepaid wireless airtime and extended service plans.

Retail stores and dealer/franchise outlets are supported by an established infrastructure:

*RadioShack Global Sourcing ("RSGS") - RSGS, which is owned by RadioShack serves international import/export, sourcing, evaluation, logistics and quality control needs.

*Consumer Electronics Manufacturing - They operate four manufacturing facilities in the United States and one overseas manufacturing operation in the Asia Pacific region. They make a variety of products including telephony, antennas, wire and cable products, and "hard to find" parts and accessories for consumer electronics products.

*RadioShack.com - Products, services and information are available through www.radioshack.com.

*RadioShack Customer Support - Using telephone and data networks, RadioShack Customer Support responds to more than 4.8 million phone calls and emails annually.

*RadioShack Service Centers - They maintain a service and support network to service the consumer electronics and personal computer retail industry in the U.S. They are also a vendor-authorized service provider for manufacturers such as Compaq, Sony, Hewlett-Packard, RCA/Thomson, Kyocera, Nokia, Samsung, ATC Logistics & Electronics and LG Electronics, among others.

*RadioShack Technology Services ("RSTS") -Management information system architecture is composed of a distributed, online network of computers that links all stores, customer channels, delivery locations, service centers, credit providers, distribution facilities and corporate offices into a fully integrated system. Store management can track sales and/or inventory at the product, customer or sales associate level.

*Regional Distribution Centers - Seven distribution centers ship over one million cartons each month to retail stores and dealer/franchise outlets. Two of these distribution centers also serve as fulfillment centers for our online customers.

Seasonality

As with other retailers, net sales and operating revenues, operating profits and cash flows are proportionally greater during the winter holiday season than during other periods of the year. There is a corresponding pre-seasonal inventory buildup, which requires working capital related to the anticipated increased sales volume.

Some product lines

Hewlett-Packard Company is the sole supplier of both desktop and laptop personal computers sold under the HP and Compaq names.

EchoStar Satellite Corporation and RadioShack have an incentive agreement to acquire subscribers for the multi-channel audio/video programming direct broadcast satellite services of DISH Network in the U.S.

Sprint Communications Company and Sprint PCS provides RadioShack customers access
to wireless PCS telephones and service, prepaid calling cards and long distance telephone service, as well as residential telephones and related telephony products.

Verizon Wireless permits approximately 4,300 company stores to sell products and services with a single cellular service provider. The relationship fosters training, marketing,
inventory, repair and other supply chain synergies. This is the area of RadioShack's business that holds the most promise for expansion. Verizon just posted a solid quarter and RadioShack, relying more on wireless revenue should benefit.

Order backlog

No material backlog of orders for the products or services. I am glad to see this included. At least they know it's important enough to some investors to warrant a mention.

Business model

The RadioShack strategy is to have an extensive physical retail presence with approximately
7,000 convenient retail locations in virtually every neighborhood nationwide. This worked well for them until Walmart invaded almost every corner of the U.S. Sales of some electronics consumables have been declining. They may have an advantage in hiring specially trained sales staff capable of providing cost-effective routine electronics needs and distinct electronics wants, assisting customers with service activation, where applicable, and assisting with the selection of appropriate products and accessories. Walmart tends not to hire specialists for their departments. They are going to have to compete at a service level since no one seems to be able to compete with Walmart prices. Best Buy stated the same strategy at one point--offer knowledgeable sales staff to compete with lower prices. As far as I can tell BB has not achieved that from anecdotal reports I hear, although generally their business is growing impressively. RadioShack would do well to stick to such a plan. There is nothing more aggravating than getting little or no help from sales people, getting a piece of equipment that doesn't fit or doesn't work when you get it home and then having to go back and try to exchange it.

They lease, rather than own, most of the retail and service center facilities. They lease all of the property on which executive offices are located; one distribution center in the United States; and six administrative offices and one manufacturing plant in the Asia Pacific region. They own the other six distribution centers and all of the manufacturing facilities located in the United States. They also own land on which new corporate headquarters are being constructed. Off balance expenses in the form of lease obligations is a figure that must be considered along with long-term debt when evaluating RadioShack for future solvency.

Revenue recognition

Revenue recognition appears to be straightforward and not abusive. A lot of their revenue is cash for products and service. Revenue is recognized, net of an estimate for customer refunds and product returns,when delivery has occurred or services have been rendered, the sales price is fixed or determinable, and collectibility is reasonably assured.

Revenue from third party suppliers is paid as a commission or fee to RadioShack for obtaining the customer and that is recognized at the time of the sale. The third party will pay when billed and may also pay RadioShack a monthly residual amount depending on the arrangement between the customer and the third party.

Tickets per store and sales per ticket


2003 2002 2001
--------- --------- ---------
Average tickets per store per day 72 73 71
Average sales per ticket $30.77 $29.40 $30.41

Sales per ticket increased in 2003 by a small amount. Tickets per store are decreasing from 2002 , but up from 2001 . This does not bode well for significant growth in 2004 and beyond if the past performance is any measure. We are left to wonder if growth will have to rely on price increases and margin increases only since volume is flat.

I see the wireless segment of the business as their best hope for profitability. It is by far their biggest moneymaker and is growing. Wired communication, radio communication, home entertainment, and computers, are all losing ground. The other segments that are increasing are a smaller part of the business and the three combined almost equal wireless.


Year Ended December 31,
------------------------------------------------------
2003 2002 2001
---------------- ---------------- ----------------

Wireless communication $1,623.2 34.9% $1,419.9 31.0% $1,297.5 27.2%
Wired communication 343.7 7.4 379.7 8.3 383.5 8.0
Radio communication 114.8 2.5 120.6 2.6 132.0 2.8
Home entertainment 737.9 15.9 855.2 18.7 1,121.4 23.5
Computer 455.9 9.8 456.8 10.0 461.1 9.6
Power and technical 634.1 13.6 623.9 13.6 618.9 13.0
Personal electronics,
toys and personal audio 588.1 12.6 576.2 12.6 562.0 11.8
Retail support operations,
service plans, and other 151.6 3.3 144.9 3.2 199.3 4.1
---------------- ---------------- ----------------
Net sales and operating
revenues $4,649.3 100.0% $4,577.2 100.0% $4,775.7 100.0%

Income statement ratios

2003 2002 2001 2000 1999

gross margins 50% 49% 48% 49% 50%
operating margins 10% 9% 8% 13% 12%
net margins 6% 6% 3% 8% 7%
growth revenue 2% -4% 0% 16% --
growth gross 3% -3% -3% 14% --
growth operating 14% 18% -43% 27% --
growth net 13% 58% -55% 24% --
growth COGS 0% -6% 2% 19% --
growth SGA 1% 1% 5% 10% --
growth EPS diluted 22% 71% -54% 29% --
growth EPS cont operations 19% 70% -55% 28% --
inventory/COGS 33% 42% 38% 48% 42%
growth depreciation -3% -13% 1% 19% --
tax rate 37% 38% 43% 38% 38%
increase in interest -18% -15% -6% 45% --


*Sales increased approximately 1.6% in 2003. They had a 2% increase in comparable company store sales. These increases were primarily the result of a 14.3% increase in wireless department sales. These sales increases were possible because of an increase in average store volume--72 tickets on average increased from 71 in 2001. There was a decrease in 2003 of 40 company stores, net of store openings.

*Sales decreased in 2002 primarily as the result of a 38.7% decline in sales to dealer/franchise outlets in 2002. Sluggish sales in DTH (Echo Star dishes and service) were the main culprit. There was a 1% decrease in comparable company store sales due primarily to the decline of DTH unit sales and desktop computers, but sales increased in wireless handsets and related accessories. Retail support operations, service plans and other sales decreased 26.2% from 2001 to 2002 primarily as a result of a $19.1 million decrease in 2002 domestic manufacturing sales due to large Verizon fixture sales in 2001 and a $15.2 million decrease in RSIS sales as a result of their exit from the national commercial installation business at the end of 2001.

*Sales in the wireless communication department, which is made up of wireless handsets (including related services), accessories, and wireless services such as prepaid airtime and bill payments, increased 14.3% in dollars and increased as a percentage of total sales to 34.9% in 2003 compared to 31.0% in 2002. This sales increase was due primarily to an increase in the average selling price of wireless handsets, resulting from a continued emphasis on national carrier service and product offerings with desirable product features and content,such as color screens and cameras. In addition, sales increases in both wireless services and accessories contributed to this increase. RadioShack plans to roll out new technologies, sales promotions, and carrier compensation models that may result in wireless sales increases for 2004. Wireless is key to their success.

*Sales in the home entertainment department, which consists of all home audio and video end-products and accessories, including DTH hardware and installation, decreased 13.7% in dollars and decreased as a percentage of total sales to 15.9% in 2003 compared to 18.7% in 2002. These decreases were primarily attributable to a decline in sales of satellite dishes and their related installation services, as well as a decrease in home entertainment accessory sales. They are predicting further declines and do not see any catalyst to growth in this highly competitive area. Not only are there competing satellite services(DirecTV and Voom) but they have to compete with Best Buy and Walmart in the home entertainment electronic equipment arena. I don't see this as a growth area for them.


*Sales in the computer department, which includes desktop, laptop, handheld computers and related accessories, in addition to digital cameras and home networking products, decreased slightly in dollars and decreased as a percentage of total sales to 9.8% in 2003 compared to 10.0% in 2002. These decreases were primarily the result of a planned decrease in sales of desktop CPUs and monitors, substantially offset by increased sales of digital cameras, camcorders and related accessories, as well as home networking products and computer accessories. They expect that sales in the computer department will increase in 2004, compared to 2003.


*Gross profit for 2003 was $2,315.7 million or 49.8% of net sales and operating
revenues. The increase in gross profit over 2002 was primarily due to a $40.0 million in benefit from a supply chain vendor and strategic pricing initiatives.

*They have also managed to improve the merchandise mix within departments by increasing the sales mix for many of the higher margin products, while managing the mix down for many lower margin products.

Income statement quarterly ratios

June 04 Mar 04 Dec 03 Sep 03

growth revenue -4% -27% 40% 4%
growth gross income -2% -25% 38% 2%
growth EBIT -3% -44% 135% -4%
growth net income 0% -46% 123% -1%
growth EPS 2% -46% 124% 0%
gross margin 51% 51% 49% 50%
gross operating 11% 11% 14% 8%
gross net 6% 6% 9% 5%
growth COGS -5% -29% 42% 5%
growth SGA -3% -18% 20% 4%

The December quarter is the best quarter the store has and revenues tend to drift down from there. Looking at 4 years of quarterly income confirms this. Expenses decrease appropriately as income decreases


Balance sheet ratios

2003 2002 2001 2000 1999

current ratio 1.9 2.0 2.0 1.4 1.5
quick ratio 0.7 0.5 0.4 0.1 0.1
AR growth -11% -25% -41% 62% --
DSO 14.3 16.4 21.1 35.3 25.3
inventory days 119.8 151.5 139.8 175.2 153.9
growth in payables -4% 51% -12% 0% --
growth in inventory -21% 2% -18% 35% --
CCC 87.2 119.2 130.5 175.2 137.2
ROE 39% 36% 21% 42% 36%
ROA 13% 12% 7% 14% 14%
ROIC 22% 19% 14% 23% 23%
debt/equity 80.4% 86.2% 86.2% 88.8% 61.2%
debt/capital 45% 46% 46% 47% 38%
book value 4.7 4.2 4.4 4.7 4.3
cash/share $3.90 $2.60 $2.27 $0.70 $0.86
NC WC 251.2 468.2 592 933.7 502.4
change in NC WC -217 -123.8 -341.7 431.3 502.4
increase in LT debt -50 25.9 262.5 -16.5 319.4
increase/decrease total shares -9.1 -5.1 -9 -4.9 190.7
payable days outstanding 46.9 48.7 30.4 35.3 41.9

*accounts receivable provided $17.2 million in cash, compared to $68.2 million in the prior year. Cash provided by accounts receivable in 2003 and 2002 was the result of reductions of vendor and service provider receivables and dealer/franchise receivables, due to increased collections and lower sales of satellite television hardware. Accounts receivable growth is down and they seem to have made collections more efficient.

*During 2003, changes in inventory provided $202.3 million in cash, compared to a $21.4 million cash usage during 2002. The decrease in inventory since December 31, 2002, was primarily the result of supply chain initiatives, including a greater focus on reducing weeks-of-supply. Inventory growth is down--days inventory is in stock has decreased by a month. They are doing a good job of tightening up operations and improving the balance sheet and cash flow.

*the cash conversion cycle has improved significantly

*ROE, ROA and ROIC are all high.

*high levels of debt are decreasing. They have some large payments coming due in 2011. They attempt to use rate swaps to hedge rates. They now pay the variable end of the swap and get paid the fixed. If rates climb quickly, this may prove to be a bad swap.

*cash requirements for pre-seasonal inventory buildup range between $200.0 million and $400.0 million. The funding required for this buildup comes primarily from cash on hand and cash generated from net sales and operating revenues. The cash per share may decline until after Christmas. Their 4th quarter is normally much higher revenue than the preceding three quarters.

* Capital expenditures for 2003 were primarily due to the construction of a new corporate campus, while capital expenditures for both 2002 and 2001 were primarily for retail store expansions and remodels and upgrades of information systems. They anticipate capital expenditure requirements for 2004 will be approximately $300.0 million and be related to new corporate headquarters. Store remodels and relocations and updated information systems account for the almost half of the balance of anticipated 2004 capital expenditures.

Cash flow statement ratios

2003 2002 2001 2000 1999
growth in operating cash flow 25% -33% 566% -79% --
operating cash/revenue 14% 11% 16% 2% 14%
operating cash/net income 218% 198% 465% 32% 189%
operating cash/debt+interest 5.7 6.5 4.9 0.2 2.4
growth capex 78% -23% 16% 17% --
capex/operating cash 29% 20% 18% 103% 18%
free cash flow* 462.3 414.8 636.6 -3.1 459.2
common shares 162.6 171.7 176.8 185.8 190.7
free cash flow/share $2.84 $2.42 $3.60 $(0.02) $2.41

*calculated as (operating cash-capex)

*Cash used in financing activities was $274.8 million in 2003, compared to $377.5 million and $502.8 million in 2002 and 2001, respectively. They used $286.2 million for the repurchase of common stock in 2003 and $329.9 million and $308.3 million for the repurchase of common and preferred stock in 2002 and 2001, respectively. the number of outstanding shares is dropping every year since 1999.

*$32.3 million recorded in 2002 was from the sale and lease-back of corporate technology center building during the second quarter. This transaction was recorded as a financing obligation.

*dividends paid, net of tax, in 2003, 2002 and 2001 amounted to $40.8 million, $39.8 million and $43.7 million, respectively and increased in 2003.

* free cash flow, defined as cash flows from operating activities less dividends paid and capex was $421.5 million in 2003, compared to $375.0 million in 2002. This increase in free cash flow was the result of supply chain initiatives, including a greater focus on reducing inventory weeks-of-supply as noted on the discussion of the balance sheet. The increase was partially offset by the increase in capital
expenditures related to the new corporate campus.

* they expect free cash flow to be approximately $70.0 million in 2004. The decrease from 2003 is based primarily on the timing of capital expenditures for new corporate headquarters; the majority of which was intended to be included in 2003 capital expenditures. The major portion of new corporate campus expenditures will now be part of 2004 capital expenditures. After 2004, free cash flow should return to a more historical free cash flow level of $200.0 million to $250.0 million,annually.

* free cash flow will be targeted to fund share repurchases, repay maturing debt,change dividend payments or fund other uses of capital that management believes will enhance shareholder value.

More discussion of debt and swaps

Debt is considered investment grade by the rating agencies. On May 20, 2003, Fitch changed senior unsecured debt from "A-" to "BBB+." Below are the agencies' latest ratings by category

Standard
Category Moody's and Poor's Fitch
-------- ------- ---------- -----
Senior unsecured debt Baa1 A- BBB+
Commercial paper P-2 A-2 F2


Senior unsecured debt primarily consists of two issuances of 10-year long-term notes and an issuance of medium-term notes. During the third quarter of 2001, they entered into several interest rate swap agreements with notional amounts totaling $150.0 million and maturities ranging from 2004 to 2007. In June and August 2003,they entered into additional interest rate swap agreements with underlying notional amounts of debt of $100.0 million and $50.0 million, respectively, with maturities in May 2011. These were entered into in order to convert a portion of long-term fixed rate debt to a variable rate. The effect of these agreements was a reduction in interest expense of $7.8 million during 2003, when compared to the fixed rates. At current interest rates, they expect this favorable condition to reoccur in 2004.

Options

Fair value of $9.63 Black-Scholes


Summary of Stock Option Transactions (Share amounts in thousands)

2003 2002 2001
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Share Price Shares Price


Outstanding 22,816 $ 34.32 22,869 $ 34.34 15,179 $ 34.33
Grants 3,541 21.31 1,515 28.80 9,384 34.42
Exercised (755) 20.72 (525) 17.50 (378) 19.84
Forfeited (1,713) 33.85 (1,043) 35.23 (1,316) 38.93

Outstanding 23,889 $ 32.85 22,816 $ 34.32 22,869 $ 34.34

shares outstanding 160.5 million
Total dilution 14.9%
Value total $230.2 million
Value per share $1.43

Exercised 755,000 value= $15.6 million
Net income would be $282.9 million
EPS would be $1.76 per share instead of $1.77

The number of options outstanding is high. The number actually exercised is not abusive. The impact if it had been deducted as an expense against net income would be a penny per share.

Comparison of four years quarterly income

March June September December
2003
Net sales and operating revenues $1,070.3 $1,025.0 $1,063.6 $1,490.4
Net income $ 56.6 $ 57.5 $ 57.1 $ 127.3
Diluted $ 0.33 $ 0.34 $ 0.34 $ 0.77

2002
Net sales and operating revenues $1,034.4 $ 998.1 $1,047.0 $1,497.7
Net income $ 57.6 $ 51.8 $ 44.9 $ 109.1
Diluted $ 0.31 $ 0.28 $ 0.25 $ 0.63

2001
Net sales and operating revenues $ 1,139.5 $ 1,039.5 $ 1,080.9 $ 1,515.8
Net income $ 46.5 $ 41.2 $ 43.8 $ 35.2
Diluted $ 0.23 $ 0.21 $ 0.23 $ 0.18

2000
Net sales and operating revenues $ 1,047.3 $ 1,023.3 $ 1,140.4 $ 1,583.7
Net income $ 69.7 $ 75.4 $ 77.1 $ 145.8

Diluted $ 0.35 $ 0.38 $ 0.39 $ 0.74


*Note the increase every year in December
*2002 was one of their worst years in the past four with some improvement in 2003. The improvement is mostly in the wireless segment.





Valuation

A two stage free cash flow to equity valuation was used with the following inputs

Cost of equity 9.7%
Beta 1.1
Retention ratio 87%
ROIC 22% high growth/20% stable growth
5 years of growth at 6%
Stable growth 3%
Growth calculated from fundamentals=15% of 100%
Growth calculated from historical growth 5% of 100%
Growth from outside estimate of 6% was 80% of formula
capex exceeds depreciation by 100%

Intrinsic value= $32.18
Adjusted for options $30.75

Lease obligations
Bond spread BBB+ =164
30 year 5.14%
cost of debt=5.14+1.64=6.83


debt obligation with leases increases to $1.5 billion from $618 million--why calculate this? It gives an idea of what the company is obligated to pay in the future. Lease obligations can be just as binding as debt and will be a continuing expense that the company will be expected to meet. This is especially true for a company like RadioShack that leases locations rather than owns them. At present, with the company paying down debt the figure seems in line. If they started taking on increasing levels of debt, that would be concerning. Since the DCF model uses the free cash flow to equity, the reclassified debt does not affect the calculation.


WACC= 10.7*(0.554)+6.8*(1-0.37)*(0.446)= 7.8
ROIC-WACC=14.2 making money for shareholders, not consuming it.

RadioShack is a shareholder friendly corporation, with the exception of a few too many options outstanding. Management pay is reasonable and bonuses are not excessive. The 10K was transparent and had more information that a shareholder might want than I normally find. They discuss in a fair amount of detail their swaps, their business strategy and even mention they don't have a backlog. They seem to anticipate all the things that might be of interest.

They are attempting a reorganization of sorts. They are down by 40 stores and do not have capital slated for new openings. They are tinkering with the product mix. The low margin items are being relegated to second place as they go for emphasis on sales of higher margin items. I want to see them really push wireless. Most of their other segments are declining. Several segments are making small gains. If they can't reorganize and minimize the impact of the declining segments, they will begin a decline and slide into obsolescence.

Declining business segments:

Wired communication 343.7 7.4 379.7 8.3 383.5 8.0
Radio communication 114.8 2.5 120.6 2.6 132.0 2.8
Home entertainment 737.9 15.9 855.2 18.7 1,121.4 23.5
Computer 455.9 9.8 456.8 10.0 461.1 9.6

They return a lot of value to the investor. Dividends have been increasing and common shares are decreasing as they make a commitment to continue buybacks which actually decrease outstanding shares and don't just offset options grants.

ROE,ROA and ROIC are high.

The only question is how ae they going to continue to grow. No new store openings are planned and they have to find a niche between Best Buy and Walmart. They have to rely on service and have those little bits and pieces of electronics gear that you may not be able to find anywhere else. They have to convince the public they are not obsolete.

Current growth is coming from increasing margins and a tight grip on inventory and expenses. They are doing a beautiful job. The only question concerns what can we expect for future growth? I have given them a very conservative 6% growth for 5 years and 3% stable growth. At the current price of around $25 they are trading at a discount. In the current market environment, it might not be wrong to wait for another 10% to 20% just to account for the downward drift of the market as a whole in this slightly bearish environment. There will be a boost in interest in RadioShack when the December sales figures arrive. If they have a blowout Christmas, I would expect prices to improve.

Some other numbers
 
Market Cap (intraday):4.26 B
Enterprise Value (5-Aug-04):4.54B
Trailing P/E :13.68
Forward P/E :11.64
PEG Ratio (5 yr expected): 1.19
Price/Sales (ttm):0.93
Price/Book (mrq):5.27
Enterprise Value/EBITDA : 7.23

Return on Assets (ttm): 14.73%
Return on Equity (ttm): 41.54%

Diluted EPS (ttm): 1.94
Earnings Growth: 13.30%
Free Cashflow: 355.40M

52-Week High (19-Feb-04): 36.24
52-Week Low (7-Aug-03): 25.37
50-Day Moving Average: 28.93
200-Day Moving Average: 30.85

Annual Dividend: 0.25
Dividend Yield: 0.92%
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