SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 1)
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended March 29, 1997
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 number 0-16930
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EGGHEAD, INC.
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(Exact name of registrant as specified in its charter)
WASHINGTON 91-1296187
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
EAST 22705 MISSION
LIBERTY LAKE, WASHINGTON 99019
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (509) 922-7031
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Securities registered pursuant to Section 12(b) of the Act: NONE
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Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK,
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$.01 PAR VALUE
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(Title of Class)
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
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K _______
To the best of Egghead, Inc.'s knowledge, the aggregate market value of the
voting stock held by non-affiliates of the registrant at May 24, 1997 was
$47,745,815.
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
OUTSTANDING AT
CLASS JULY 8, 1997
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Common Stock, $.01 par value 17,614,342 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement relating to the
Company's 1997 Annual Meeting of Shareholders are incorporated by reference into
Part III of this Form 10-K.
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EGGHEAD, INC.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . 11
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . 12
Item 4. Submission of Matters to a Vote of Security Holders. . . . 12
PART II
Item 5. Market for the Registrant's Common Equity and Related Share-
holder Matters . . . . . . . . . . . . . . . . . . . . . . 13
Item 6. Selected Financial Data. . . . . . . . . . . . . . . . . . 14
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations. . . . . . . . . . . . . . . . . 15
Item 8. Financial Statements and Supplementary Data. . . . . . . . 21
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . 21
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . 40
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . 40
Item 12. Security Ownership of Certain Beneficial Owners and
Management . . . . . . . . . . . . . . . . . . . . . . . . 40
Item 13. Certain Relationships and Related Transactions . . . . . . 40
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . 40
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PART 1
ITEM 1. BUSINESS OF EGGHEAD
GENERAL
Egghead, Inc. ("Egghead") is a national reseller of personal computer
("PC") hardware, software, peripherals and accessories through 87 retail
stores, its 1-800-EGGHEAD direct response unit and its Internet commerce
site. Egghead, a Washington corporation, was incorporated in 1988 and is the
successor to a corporation that was incorporated in Washington in 1984. In
1995, Egghead moved its corporate headquarters from Issaquah, Washington to
its current facility in Liberty Lake, Washington. Egghead is the parent
company of DJ&J Software Corporation, EH Direct, Inc. and Elekom Corporation
("ELEKOM") and participates in a 50-50 joint venture with Surplus Direct to
operate one store under the name Egghead Computer Surplus. Egghead's 87
retail stores include this joint venture store. Unless the context indicates
otherwise, references to "Egghead" include Egghead and its subsidiaries.
Egghead's primary source of revenue is sales through its retail stores.
As of March 29, 1997, Egghead operated 87 retail stores. Egghead's retail
stores offer a broad selection of PC-related products and services at
competitive prices. Egghead also operates the 1-800-EGGHEAD direct response
unit, which processes telephone, facsimile and mail orders for the same
hardware and software products that are offered in its retail stores.
1-800-EGGHEAD also allows customers access to products not ordinarily
available through its retail outlets by offering a special order service.
Egghead also maintains a site on the Internet (HTTP://WWW.EGGHEAD.COM) that
contains information about Egghead and its merchandise offerings and permits
customers to place orders for hardware and software products on-line.
On May 1, 1997, Egghead announced a definitive agreement to acquire
closely held Surplus Software, Inc. ("Surplus Direct") for up to 5,600,000
newly issued shares of Egghead Common Stock ("the Merger"). In connection
with the Merger, Egghead will repay approximately $5.6 million of Surplus
Direct's outstanding debt. Surplus Direct is a reseller of previous version
computer hardware and software and reported sales for the nine months ended
February 28, 1997 of approximately $35.0 million. Surplus Direct has a
relatively limited operating history, and, although it reported break-even to
profitable results for the three fiscal years ended May 31, 1996, 1995 and
1994, it reported a $1.2 million loss for the nine months ended February 28,
1997. Egghead believes that the Merger will create synergies through the
combination of Surplus Direct's hardware purchasing expertise, access to the
surplus PC products channel, entrepreneurial management and Internet commerce
development capabilities with Egghead's greater software product procurement
expertise and seasoned retail management. There can be no assurance that
these benefits will be achieved. The two companies participate in a 50-50
joint venture store operated under the name Egghead Computer Surplus.
Egghead's 87 retail stores include the joint venture store. The Merger is
subject to approval by Egghead's and Surplus Direct's shareholders and to
customary closing conditions, and is expected to be completed in August 1997.
MARKET OVERVIEW
Sales of PC hardware, software and related products depend on the continued
purchase and expanded use of PCs in households and businesses, the continued
development of PC software and other changes in the PC industry. The use and
acceptance of PCs has increased over the last decade due to technological
changes such as improved operating systems and hardware, the availability of
quality hardware and software products at reasonable prices and the ability to
utilize PCs to obtain information on the Internet.
Rapid technological change presents both opportunity and risk for PC
product resellers. For example, prices of microprocessor chips are
decreasing due to increased competition among computer chip manufacturers and
the introduction of newer, faster microprocessor chips. The decrease in
microprocessor chip prices has contributed to reductions in PC prices,
resulting in increased sales of PCs to businesses and individual consumers.
However, the rapid improvements in processing capability made possible by
improvements in microprocessor chips, improved operating systems and other
technological advances contribute to shorter product life cycles that may
result in reduced margins due to rapid product obsolescence.
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The availability of more sophisticated and user-friendly software at
reasonable prices has also increased demand for PC products. For example,
improvements in graphical user interfaces, the development of integrated
software packages, such as office suite products, and new interactive
educational and entertainment products encourage purchases of PC hardware, as
well as software and other PC products. New technologies, such as CD-ROM, which
provide a multimedia experience involving full-motion video and stereo sound,
enable home users to more effectively use PCs for educational and entertainment
purposes. Sales of PC hardware accessories, such as hard drives and modems,
also have increased as consumers enhance their PCs. Egghead believes that new
technologies such as these result in enhanced product offerings, generating
demand for software and hardware products as these technologies are developed
and brought to the market place.
Access to electronic communications networks, such as the Internet and
commercially available on-line services, has also become important to both
businesses and individual consumers and has increased the demand for PCs.
Egghead anticipates that such networks will provide substantial opportunities
both now and in the future for communications, commerce and the exchange of
data. Software publishers have recognized the significance of this trend and
have begun to integrate interfaces for these electronic communications networks
into their operating systems and workgroup software.
Although Egghead believes that these factors are likely to contribute to a
continued increase in demand for PC products, a long-term decline in the
purchase or use of home or business PCs, or an interruption in the continued
development of PC software, would have a material adverse effect on Egghead's
financial condition and results of operations. The number of distribution
channels for PC products has also increased, and such channels have become
extremely competitive. PC products are distributed through resellers that
include specialty retail stores, office supply super stores, electronic
superstores, merchandise clubs, mass merchandisers and direct response
businesses. In addition, Internet commerce and other means of electronic
distribution are becoming increasingly viable channels. Egghead believes,
nevertheless, that the PC product market offers significant opportunities for
resellers that can provide desired merchandise at competitive prices, supported
by extensive product knowledge and service.
PRODUCTS AND SERVICES
Through its retail outlets, its 1-800-EGGHEAD direct response unit and
its Internet commerce site, Egghead sells PC hardware, software, peripheral
devices, accessories and computer-related magazines, books and tutorials.
Egghead carries products categorized under approximately 2,000 separate
stock-keeping units in its retail stores. Customers may also order thousands
of additional products through the 1-800-EGGHEAD special order service and
Egghead's Internet commerce site.
Egghead began operations in 1984 primarily as a software reseller, but in
recent years has expanded its product offering to include a greater percentage
of hardware and other non-software products. Approximately 39% of Egghead's
revenues for the fourth quarter of the fiscal year ended March 29, 1997 were
derived from sales of hardware and other non-software products, primarily due to
Egghead's increased and continuing focus on these product offerings, and Egghead
expects that this percentage will continue to grow. Egghead has increased its
hardware offerings in an effort to respond to a broader range of customer needs
and to position itself as a one-stop shopping alternative for PC consumers.
Egghead's management also believes that the PC hardware market is attractive
because hardware products offer resellers higher dollar gross margins relative
to software products.
Egghead provides a variety of customer services in order to enhance and
support the marketing of PC products. In all of its retail stores, Egghead
employs a knowledgeable sales force and offers free product demonstrations to
assist customers in selecting PC products, with PCs available for in-store
evaluation of Egghead's hardware and software products. In addition, 31 of
Egghead's retail stores also offer computer upgrade and installation services
on a fee basis. Egghead also offers product information and customer
assistance through its 1-800-EGGHEAD direct response unit and its Internet
commerce site.
Egghead has established the Custom Updates and Eggstras ("CUE-SM-") program,
a preferred customer
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membership program that provides discounts and other benefits to Egghead's
customers. Egghead regularly sends CUE-SM- members catalogs and other
mailings that contain advance notice of sales promotions and new offerings of
PC products and other technology. CUE-SM- provides Egghead with a database
of customers, their PC equipment profiles and a history of their software
purchases.
RETAIL OPERATIONS
Egghead's retail stores offer a broad selection of computer-related
products and services at competitive prices. Its retail stores are designed
to provide a convenient shopping environment for individuals and
organizations which purchase PC hardware, software and related products for
their personal and business use. Egghead's knowledgeable sales force offers
solutions-oriented assistance to its customers. As of March 29, 1997,
Egghead operated 87 retail stores including the joint venture store, which
sells closeout and clearance merchandise.
Egghead's traditional stores contain approximately 2,500 square feet of
retail selling space and typically are located in strip shopping centers. New
store locations are extensively researched, and Egghead seeks to locate new
stores in densely populated areas with a significant concentration of PC owners
and high mean income levels. Egghead recently implemented a new merchandising
format in certain of its retail stores that offers a broader selection of
hardware and other non-software products in an expanded space that is
approximately twice the size of its traditional stores. The larger store format
provides more room for bulkier merchandise such as PC hardware. Egghead's sales
of hardware and other non-software products increased from approximately 33% of
revenue in the fourth quarter of fiscal 1996 to approximately 39% of revenue in
the fourth quarter of fiscal 1997.
Egghead believes that additional hardware and other non-software
offerings and service and upgrade capabilities will attract a broader base of
customers. The performance of these new stores has been mixed, however, and
management continues to evaluate results while refining the format. As of
March 29, 1997, Egghead operated 24 of its retail stores under this expanded
format, and as store leases expire on Egghead's traditional, smaller format
stores, Egghead may replace certain of these stores with new, larger stores.
In November 1996, Egghead and Surplus Direct opened Egghead Computer
Surplus, a joint venture retail store in Portland, Oregon, that offers
overstocked, close-out, discontinued and previous version computer hardware
and software at discounted prices, as well as installation and upgrade
services.
On January 31, 1997, Egghead announced a strategic realignment of its
business organization involving the closure of 77 of the 156 Egghead retail
stores that were open as of December 28, 1996. As of March 29, 1997, 70 of
these stores had been closed, reducing the number of geographic locations in
which Egghead operates from 54 to 26. Concurrently with the reduction in retail
stores, Egghead reduced its headquarters personnel, closed its Lancaster,
Pennsylvania distribution center and offered for sale certain real estate
assets, including its administrative headquarters building located in Liberty
Lake, Washington.
1-800-EGGHEAD AND INTERNET COMMERCE OPERATIONS
Egghead also sells PC-related products and provides additional customer
services through its 1-800-EGGHEAD direct response unit and its Internet
commerce site.
1-800-EGGHEAD. The 1-800-EGGHEAD direct response unit processes telephone,
facsimile and mail orders for the same hardware and software products that are
offered in Egghead's retail stores. 1-800-EGGHEAD also allows customers access
to products not ordinarily available through its retail outlets by offering a
special order service. The 1-800-EGGHEAD service enables customers who do not
live near an Egghead retail store, or who prefer the convenience of shopping at
home, to purchase Egghead merchandise from their homes or businesses. Orders
typically are placed from circulars containing lists and descriptions of
available merchandise that are distributed by Egghead to individuals and
organizations. Merchandise purchased through 1-800-EGGHEAD is generally shipped
directly to the customer from
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Egghead's distribution center in Sacramento, California. Customer
representatives in the 1-800-EGGHEAD direct response unit also provide customer
service support for Egghead's retail stores and refer callers who would like to
preview a particular product to one of Egghead's retail stores or its Internet
commerce site.
INTERNET AND ELECTRONIC COMMERCE. Egghead maintains a site on the Internet
(HTTP://WWW.EGGHEAD.COM) that contains information about Egghead and its
merchandise offerings and permits customers to place orders for software and
hardware products on-line. In February 1996, Egghead began offering hardware
and software products through its Internet commerce site, and in November 1996,
Egghead began offering electronic delivery of selected software products. This
service permits a customer to place an order for selected software products and
to have the products downloaded directly onto his or her PC through purely
electronic means. Egghead customers can use the Internet commerce site to
search for software titles, browse Egghead's merchandise selection and view
demonstrations of selected software programs before placing an order. In
addition, Egghead's Internet commerce site contains lists of Egghead store
locations and of manufacturers' technical support hotlines for many of the
products it offers. Customers can also use the site to make customer service
inquiries, offer suggestions and read articles and reviews regarding Egghead's
hardware and software offerings.
In November 1996, Egghead began offering electronic delivery of selected
software products. Egghead management believes that electronics software
distribution may eventually become increasingly common and that electronic
distribution may offer significant cost advantage over traditional means of
delivery.
In August 1995, Egghead formed ELEKOM to develop electronic commerce
applications and services that link customers and their suppliers. An
Internet-compatible commerce application developed by ELEKOM is designed to
provide large organizations an easy-to-use, cost-effective, secure and reliable
product ordering and order management system for goods and services. The
application permits businesses to submit purchase orders to their suppliers
electronically and allows the purchaser and supplier to establish pre-set
pricing, quantity and other specifications for such orders. Elekom is currently
testing prototypes of the application with one large organization.
MARKETING, ADVERTISING AND PROMOTION
Egghead's marketing, advertising and promotional efforts are designed to
position it as the PC product reseller of choice. These efforts have
established strong customer identification of Egghead's name and logo. Egghead
strives to create market awareness of its retail stores, and to create primary
demand for the products it sells, through aggressive advertising and marketing
efforts. Egghead's advertising campaigns emphasize the broad selection of
merchandise and competitive prices offered by Egghead. Egghead also advertises
to promote major new product launches.
Egghead's primary advertising medium is direct mail, which is used to
target the segment of the population that owns and/or uses PCs. In addition to
mailing to a database of more than 3.7 million CUE customers, Egghead mails its
circulars to PC owners targeted from purchased lists. Egghead also advertises
in both local and national newspapers, as well as on its Internet commerce site.
Egghead routinely enters into cooperative advertising and other promotional and
market development fund arrangements with manufacturers, publishers and
distributors.
MERCHANDISING
Egghead purchases most of its products through a central purchasing
department, which determines inventory levels and product mix based upon rates
of sale, seasonality and store demographics. Egghead also places special orders
of nonstocked PC products in response to customer requests.
Egghead purchases merchandise primarily through distributors. Egghead also
purchases hardware, software and other products directly from approximately
300 manufacturers and publishers, including Microsoft, which is Egghead's
primary vendor. In fiscal 1997, purchases from Microsoft represented
approximately 18.3% of Egghead's total net purchases.
Egghead's purchasing department seeks to take advantage of volume
discounts offered by certain manufacturers, publishers and distributors
whenever consistent with Egghead's inventory policies. The closure of
Egghead stores in connection with the strategic restructuring may adversely
affect the level of volume discounts Egghead receives from its vendors.
Egghead has historically managed its product obsolescence risk through its
vendor exchange, return and pricing
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mechanisms. Egghead's exchange and return privileges with its distributors and
vendors typically include time, volume and other limitations. Although such
exchange and return privileges add complexity and expense to Egghead's
purchasing operations, they allow Egghead to reduce the risk of loss resulting
from obsolete and defective merchandise.
DISTRIBUTION
Egghead operates a 138,000-square-foot distribution center in Sacramento,
California. Most inventory that Egghead purchases is received by this
distribution facility before it is sent to a customer or to a retail store,
although some merchandise is shipped directly from vendors or distributors to
Egghead's retail stores or customers. Egghead's distribution facility also
processes returned merchandise. During June 1996, Egghead closed its
distribution center in Wilmington, Ohio. It closed its Lancaster, Pennsylvania
distribution facility in March 1997 in connection with the restructuring of its
business.
COMPETITION
The business of selling PC software, hardware and related products is
intensely competitive. Since its inception in 1984, Egghead has witnessed a
proliferation of competing distribution outlets for PC software and hardware
products, including chains of large specialty stores, systems integrators,
manufacturers and publishers selling directly, mail-order firms and mass
merchandise retailers. In addition, electronic communications networks such
as the Internet are creating new opportunities for the distribution of
software and hardware products, and the cost savings associated with such
electronic distribution channels may eventually result in further price
reductions in the industry.
Egghead believes that the major competitive factors in its business include
price, breadth and depth of selection, customer service (including technical
support), and marketing and sales capabilities. Given the highly competitive
nature of the PC industry, there can be no assurance that Egghead can compete
successfully with respect to these factors. Egghead's financial condition and
results of operations would be materially adversely affected if its competitors
were to offer PC products at significantly lower prices or if Egghead were
unable to obtain products in a timely manner for an extended period of time.
Egghead competitors include computer and office superstores such as Comp
USA, Inc. and Office Depot, Inc., consumer electronics superstores such as
Fry's Electronics, mass merchandisers such as Wal-Mart Stores, Inc. and
warehouse membership clubs such as Sam's Club. Computer superstores typically
are very price competitive and offer a wide product selection, while office
superstores have a more limited selection. Computer superstores also offer
on-site installation of software and hardware upgrades, and some offer
training and technical services. Mass merchandisers and warehouse clubs are
price-competitive but carry relatively few software titles and a limited
selection of hardware products. In addition, direct response businesses, such
as Micro-Warehouse, Inc., and manufacturers, such as Dell Computer
Corporation, selling directly to consumers, compete directly with Egghead.
Egghead faces intense competition in the electronic commerce market on the
Internet, which is evolving rapidly. In the Internet market, Egghead competes
with companies that have established Internet commerce sites or that derive a
substantial portion of their revenue from electronic commerce. Several
companies with substantial customer bases in the computer and peripherals
catalog business, such as Micro-Warehouse, also may devote more resources to
Internet commerce in the future.
Because the PC product market is very competitive, resellers typically have
low gross margins and operating income as a percentage of sales. Increased
competition may lead to reduced profit margins on PC hardware, software and
related products, which could have a material adverse effect on Egghead's
results of operations. Therefore, Egghead's
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profitability depends heavily on effective internal operating and cost control
and the ability to adapt quickly and efficiently to changes in industry trends.
EMPLOYEES
At March 29, 1997, Egghead had approximately 1,310 employees. Egghead's
employees are not represented by a collective bargaining unit. Egghead
believes that its employee relations are generally good.
TRADEMARKS AND TRADE NAMES
"EGGHEAD-Registered Trademark-," "EGGHEAD DISCOUNT SOFTWARE-Registered
Trademark-," "EGGSPERT-Registered Trademark-," "All You Need to
Know-Registered Trademark-," the "PROFESSOR EGGHEAD-Registered Trademark-"
design and "EGGCESSORIES-Registered Trademark-" are registered in the United
States Patent and Trademark Office as service marks or trademarks of Egghead.
Egghead also does business under the trade names "Egghead Computer,"
"Egghead Software," "Egghead Discount Software" and "Mac's Place at
Egghead." In addition, Egghead is the owner of a number of common-law
trademarks and service marks, including "SOFTWARE ASSET MANAGEMENT-SM-,"
"SAM-SM-," "CUE-SM-," "EGGHEAD-Registered Trademark-EXPRESS-TM-," "EGG
CARTON-TM-," "ELEKOM-TM-," "EleTrade-TM-" and certain "EGG" combination
words. Egghead believes the strength of its trademarks and service marks
benefits its business and intends to continue to protect and promote its
registered and common-law trademarks and service marks.
CERTAIN RISK FACTORS
In addition to other information contained in this filing, the following
factors could affect the Company's actual results and could cause such results
to differ materially from those achieved in the past or expressed in the
Company's forward-looking statements. When used in this filing, the words
"expects," "believes," "anticipates," and similar expressions are intended to
identify forward-looking statements.
RESTRUCTURING AND REORGANIZATION OF EGGHEAD OPERATIONS; RECENT LOSSES.
Egghead has reported substantial losses from its continuing operations over
its last five fiscal years, including an after-tax loss of $49.0 million and
an overall net loss of $39.6 million for its fiscal year ended March 29,
1997. These losses included a $24.0 million restructuring and impairment
charge and a net noncash charge of $10.7 million for the establishment of a
deferred tax valuation allowance. Egghead has taken a number of steps
intended to reduce or eliminate its losses. These steps included divesting a
nonretail business segment, focusing its retail operations in certain
geographic markets, closing unprofitable stores, upgrading existing stores,
experimenting with new store formats, adding new nonsoftware merchandise
categories (particularly computer systems), developing electronic commerce
tools through its subsidiary Elekom and implementing a new Internet commerce
site.
For example, in May 1996, Egghead sold its Corporate, Government and
Education ("CGE") division to generate cash and to allow management to
focus on retail operations. The sale resulted in a net gain of $22.3
million, offset by a related loss from the CGE operations of $12.3 million.
During the fourth quarter of fiscal 1997, Egghead substantially restructured
and reorganized its operations by (i) closing 70 of its worst performing
retail stores, (ii) substantially reducing its headquarters personnel, (iii)
closing its Lancaster, Pennsylvania distribution center, and (iv) offering
for sale certain real estate assets, including its headquarters building
located in Liberty Lake, Washington. Egghead intends to close an additional
seven poorly performing retail stores as part of the restructuring and
reorganization. Since fiscal 1996, Egghead has also opened or remodeled
eight 5,000 square-foot stores, which are approximately twice the size of its
traditional stores, and increased its hardware product offerings in many of
its stores in an effort to improve sales.
These initiatives have achieved mixed results. Although the increased
proportion of hardware products is intended to increase Egghead's overall net
revenue and gross profits, gross margins as a percentage of net sales are
lower on such products; therefore revenue must increase at a sufficient rate
to offset the lower gross margins in order to increase gross profits. If
gross profits erode, further reductions in operating expenses may be
necessary, and Egghead may need to close additional retail stores. Results
from Egghead's new larger stores have been mixed.
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Egghead will continue to evaluate the performance of its larger format stores
and expects that further refinement of its store format will be required.
There can be no assurance that Egghead will be able to maintain the improved
results it has achieved in its upgraded stores or replicate them in other
stores. Egghead's Internet commerce site, which was activated in February
1996, did not generate significant revenues in fiscal 1997, and there can be
no assurance that this distribution method will generate significant revenues
in the future. Although ELEKOM is currently testing prototypes of its
products, Egghead's investment in ELEKOM has not resulted in any revenue to
date, and there can be no assurance that it will generate revenue in the
future. Moreover, there can be no assurance that Egghead will be able to
sell its real estate assets at a profit or in a timely manner that will avoid
additional carrying costs. Competition is intensifying in all of Egghead's
geographic markets, and prices continue to erode. Furthermore, despite the
restructuring and reorganization measures described herein, Egghead
anticipates that it will sustain additional losses in fiscal 1998 and a
modest loss in fiscal 1999 on a stand-alone basis.
Accordingly, it is not clear that Egghead has developed a business strategy
that will accomplish its goal of reducing and eliminating its losses, and there
can be no assurance that it will be able to do so. If Egghead cannot develop a
profitable strategy, and its losses continue, it will deplete its financial
resources and reduce shareholders' equity.
FLUCTUATIONS IN, AND UNCERTAINTY OF, FUTURE OPERATING RESULTS; FUTURE
LOSSES. Egghead's operating results have fluctuated in the past and are
likely to do so in the future, particularly on a quarterly basis. As with
many retailers and direct marketers, a significant portion of the company's
sales are generated in the fiscal quarter that includes the winter holiday
selling season. As a result, the annual earnings of the company will depend
heavily on the results of that quarter. Egghead's quarterly results of
operations may also fluctuate as a result of the amount of sales contributed
by new stores, the timing of costs associated with the construction and
opening of these stores and the timing of the closing of any stores. The
company's quarterly results of operations may fluctuate in response to the
overall demand for PC products, shifts in the mix of demand for hardware and
software products, the introduction of new products or upgrades and the
success of the Internet commerce site.
Egghead's operating results are also highly dependent on respective levels
of gross profit as a percentage of net sales, which fluctuate due to factors
that may be outside of their control. These factors include product mix,
competitive pricing pressures, product availability and changes in prices from
suppliers and the need to reduce prices to dispose of older inventory for which
there was less demand than anticipated.
COMPETITION. The business of selling PC software, hardware and related
products is intensely competitive. Since its inception in 1984, Egghead has
witnessed a proliferation of competing distribution outlets for PC software
and hardware products, including chains of large specialty stores, systems
integrators, manufacturers and publishers selling directly, mail-order firms
and mass merchandise retailers. In addition, electronic communication
networks such as the Internet are creating new opportunities for the
distribution of software and hardware products, which has resulted in
additional competition. The cost savings associated with such electronic
distribution channels can also be expected to result in further price
reductions in the industry.
Because the PC product market is very competitive, resellers typically
have low gross margins and operating income as a percentage of sales.
Increased competition in Egghead's business may lead to reduced profit
margins on PC hardware, software and related products, which could have a
material adverse effect on the company's results of operations. Therefore,
the company's profitability will depend heavily on effective internal
operating and cost control and the ability to adapt quickly and efficiently
to changes in industry trends. Many of Egghead's current and potential
competitors have significantly greater financial, technical, marketing and
other resources than the company. As a result, such competitors may be able
to secure merchandise from vendors on more favorable terms than those that
may be obtained by the company, and may be able to respond more quickly to
changes in customer preferences or to devote greater resources to the
development, promotion and sale of their merchandise than the company. The
company's financial condition and results of operations would be materially
adversely affected if its competitors were to offer PC products at
significantly lower prices, if the company were unable to obtain products in
a timely manner for an extended period of time or if more effective
competitors emerge.
EGGHEAD DEPENDENCE ON SUPPLY SOURCES. Egghead purchases merchandise
primarily through distributors. Egghead also purchases hardware, software and
other products directly from approximately 300 manufacturers and publishers,
including Microsoft, which is Egghead's primary vendor. In fiscal 1997,
direct purchases from Microsoft represented approximately 18.3% of Egghead's
total net purchases. Microsoft has determined that it will no longer sell
directly to retailers, however, and Egghead believes that in the future its
purchases of Microsoft products will be made through distributors. Vendors
9
which have established significant market share in the PC product market can,
to some extent, influence Egghead's merchandising policies and other aspects
of Egghead's operations. Egghead does not have long-term contracts or
arrangements with its vendors that would ensure the availability of
merchandise, and there can be no assurance that Egghead's current vendors
will continue to supply merchandise to Egghead. To the extent that Egghead
purchases from manufacturers, there is a risk that the reduction in the
volume of Egghead's purchases resulting from store closures undertaken as
part of its restructuring and reorganization will adversely affect its
ability to purchase directly from such manufacturers. Egghead's financial
performance in large part depends on the terms it obtains from its suppliers.
Such terms include unit prices, unsold product return policies, advertising
and market development allowances, freight charges and payment terms. If
Egghead is unable to maintain favorable terms with its suppliers, its results
of operations could be materially adversely affected. See "BUSINESS OF
EGGHEAD--Merchandising."
LIMITED EXPERIENCE, AND RISKS ASSOCIATED, WITH INTERNET COMMERCE.
Egghead seeks to utilize the Internet and other means of electronic commerce
to sell and distribute merchandise. Revenue generated through the company's
Internet commerce site still represents only a relatively small percentage of
the company's total net sales. Egghead established its Internet commerce
site in February 1996 and began directly downloading selected software
products to its customers' PCs in November 1996. Total net sales from
Egghead's Internet commerce site did not represent a significant portion
of its total net sales in fiscal 1997.
Demand for and market acceptance of recently introduced services and
products sold over the Internet are subject to a high level of uncertainty, and
there exist few proven services and products. The Internet is also
characterized by rapid technological change, changes in user and customer
requirements, frequent new service or product introductions and the emergence of
new industry standards and practices. In addition, as with other providers of
Internet services, Egghead must rely on an Internet service provider to connect
the Internet commerce site to the Internet, and on encryption and authentication
technology licensed from third parties to provide the security and
authentication necessary to effect secure transmission of confidential
information on the Internet. There can be no assurance that a sufficiently
broad base of customers will adopt and continue to use the Internet as a medium
of commerce, the company will be successful in using new technologies
effectively or adapting its Internet commerce sites and proprietary technology
to customer requirements or industry standards, that interruptions in the
company's Internet commerce site connections or the telecommunications access
will not occur or that compromises or breaches will not occur in the encryption
and authentication technology utilized by the company. Failure of an Internet
commerce market to develop, or the occurrence of any of the events described
above, could have a material adverse effect on the business, financial condition
and results of operations of the company.
10
ITEM 2 PROPERTIES
At March 29, 1997, Egghead operated 87 retail stores (including its joint
venture store with Surplus Direct) in 19 states and the District of Columbia.
Most of Egghead's stores are located in strip shopping centers to provide
customers convenient access. As of March 29, 1997, Egghead's retail store
locations were as follows:
NUMBER OF
LOCATION RETAIL OUTLETS
--------------------------------- ----------------
Arizona. . . . . . . . . . . . . . . . . 2
California . . . . . . . . . . . . . . . 18
Colorado . . . . . . . . . . . . . . . . 2
Connecticut. . . . . . . . . . . . . . . 2
District of Columbia . . . . . . . . . . 1
Illinois . . . . . . . . . . . . . . . . 3
Maryland . . . . . . . . . . . . . . . . 3
Massachusetts. . . . . . . . . . . . . . 8
Michigan . . . . . . . . . . . . . . . . 5
New Jersey . . . . . . . . . . . . . . . 6
New Mexico . . . . . . . . . . . . . . . 1
New York . . . . . . . . . . . . . . . . 5
North Carolina . . . . . . . . . . . . . 2
Oregon . . . . . . . . . . . . . . . . . 6
Pennsylvania . . . . . . . . . . . . . . 3
Tennessee. . . . . . . . . . . . . . . . 1
Texas. . . . . . . . . . . . . . . . . . 2
Utah . . . . . . . . . . . . . . . . . . 3
Virginia . . . . . . . . . . . . . . . . 4
Washington . . . . . . . . . . . . . . . 10
--
Total. . . . . . . . . . . . . . . . . . 87
--
--
As part of the restructuring and reorganization, Egghead intends to close
an additional seven stores. Egghead leases all of its retail stores under
leases expiring from fiscal 1998 to fiscal 2007. Egghead expects that leases
with terms expiring during fiscal 1998 will be renewable at Egghead's option
under substantially similar terms. Nearly all of Egghead's leases provide
for a minimum monthly rent that either is constant or adjusts periodically
throughout the lease term, including renewal periods.
Egghead currently leases its distribution facility in Sacramento,
California. The lease on Egghead's Sacramento distribution facility expires
in September 1998, with renewal options available. During June 1996, Egghead
closed its distribution center in Wilmington, Ohio. It closed its Lancaster,
Pennsylvania distribution facility in March 1997 in connection with the
reduction in scope of its business and plans to sublease that facility.
Egghead owns and is currently offering for sale its administrative
headquarters building in Liberty Lake, Washington. Approximately 51% of the
Liberty Lake, Washington facility currently is being leased to Software
Spectrum, Inc. pursuant to a call center lease agreement entered into by
Egghead and Software Spectrum, Inc. in connection with the sale of Egghead's
CGE division. The lease has a three-year term expiring in 1999 with an
option for renewal. Egghead's Liberty Lake facility houses its corporate
headquarters, information systems and Egghead's 1-800-EGGHEAD direct response
operation. Egghead is evaluating whether to enter into a sale and leaseback
of its existing headquarters facility or to relocate its headquarters to
another facility in the Spokane, Washington area during fiscal 1998.
11
Compliance with federal, state and local laws enacted for protection of the
environment has had no material effect on Egghead's capital expenditures,
earnings or competitive position. Egghead does not anticipate any material
adverse effects in the future based on the nature of its operations and the
current focus of such laws.
ITEM 3. LEGAL PROCEEDINGS
Various claims and lawsuits arising in the normal course of business are
pending against the Company. The subject matter of these proceedings primarily
includes commercial disputes and employment issues. The results of these
proceedings described above are not expected to have a material adverse effect
on the Company's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders in the fourth
quarter of fiscal year 1997.
12
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
MARKET AND MARKET PRICE FOR COMMON STOCK
Egghead's common stock, $0.01 par value, is traded over the counter under
the symbol EGGS and is quoted as part of the NASDAQ National Market System.
The Egghead common shares are NASDAQ quoted on the Nasdaq National
Market. The table below sets forth for the periods indicated the high and
low sale prices per Egghead common share on the Nasdaq National Market as
reported in published financial sources. For current price information, the
Egghead shareholders are urged to consult publicly available sources.
HIGH LOW
---- ---
FISCAL 1997 (ENDED MARCH 29, 1997):
Fourth Quarter . . . . . . . . . . . . . 6.00 4.38
Third Quarter. . . . . . . . . . . . . . 6.63 5.00
Second Quarter . . . . . . . . . . . . . 10.88 5.88
First Quarter. . . . . . . . . . . . . . 13.63 9.50
FISCAL 1996 (ENDED MARCH 30, 1996):
Fourth Quarter . . . . . . . . . . . . . 10.69 5.13
Third Quarter. . . . . . . . . . . . . . 8.75 5.88
Second Quarter . . . . . . . . . . . . . 13.75 7.88
First Quarter. . . . . . . . . . . . . . 13.38 8.88
HOLDERS
The approximate number of holders of record of Egghead's common stock as
recorded on the books of Egghead's Registrar and Transfer Agent as of May 24,
1997 was 1,054.
DIVIDENDS
No cash dividends were declared or paid by Egghead during any of the
periods presented above. Egghead presently does not intend to pay any cash
dividends in the foreseeable future, but intends to retain all earnings for use
in its business operations.
13
ITEM 6. SELECTED FINANCIAL DATA
1
The following selected historical financial data of Egghead have been
derived from Egghead's historical consolidated financial statements. Fiscal
1993 had 53 weeks. All other fiscal years presented had 52 weeks. All
Statement of Operations amounts reflect the CGE activities as discontinued
operations. The selected financial data presented below should be read in
conjunction with such consolidated financial statements and the notes thereto.
STATEMENT OF OPERATIONS DATA:
FISCAL YEAR
-----------------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 321,566 $ 373,510 $ 434,021 $ 403,841 $ 360,715
Cost of sales, including certain buying, occupancy and
distribution costs. . . . . . . . . . . . . . . . . . . . . 270,266 322,210 380,428 357,373 326,044
--------- --------- --------- --------- ---------
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . 51,300 51,300 53,593 46,468 34,671
Selling, general and administrative expense . . . . . . . . . 48,249 56,096 53,895 59,639 60,632
Depreciation and amortization expense, net of charge
included in cost of sales . . . . . . . . . . . . . . . . . 6,089 7,603 7,363 7,449 6,043
Restructuring and impairment charge . . . . . . . . . . . . . 858 -- -- -- 15,597
Provision for shareholder litigation . . . . . . . . . . . . . -- 1,200 -- -- --
--------- --------- --------- --------- ---------
Operating loss . . . . . . . . . . . . . . . . . . . . . . . . (3,896) (13,599) (7,665) (20,620) (47,601)
Theft insurance recovery . . . . . . . . . . . . . . . . . . . -- -- 1,650 -- --
Other (expense) income . . . . . . . . . . . . . . . . . . . . (489) (101) 618 2,469 3,428
--------- --------- --------- --------- ---------
Loss from continuing operations before income taxes. . . . . . (4,385) (13,700) (5,397) (18,151) (44,173)
Income tax benefit (provision) . . . . . . . . . . . . . . . . 1,711 5,343 2,106 7,030 (4,788)
--------- --------- --------- --------- ---------
Loss from continuing operations. . . . . . . . . . . . . . . . (2,674) (8,357) (3,291) (11,121) (48,961)
Income from discontinued operations, net of tax. . . . . . . . 9,604 7,843 5,959 376 (12,254)
Gain on disposal of discontinued operations, net of tax. . . . -- -- -- -- 22,286
--------- --------- --------- --------- ---------
Income from discontinued operations . . . . . . . . . . . . . 9,604 7,843 5,959 376 10,032
--------- --------- --------- --------- ---------
Net income (loss) before cumulative effect of change in
accounting principles . . . . . . . . . . . . . . . . . . . 6,930 (514) 2,668 (10,745) (38,929)
Cumulative effect of change in accounting principles, net of tax -- -- -- -- (711)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . --------- --------- --------- --------- ---------
Net income (loss). . . . . . . . . . . . . . . . . . . . . . . $ 6,930 $ (514) $ 2,668 $ (10,745) $ (39,640)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Earnings (loss) per share:
Continuing operations . . . . . . . . . . . . . . . . . . . $ (0.15) $ (0.49) $ (0.19) $ (0.64) $ (2.78)
Discontinued operations, net. . . . . . . . . . . . . . . . $ 0.56 $ 0.46 $ 0.34 $ 0.02 $ .57
Cumulative effect of change in accounting principle, net. . -- -- -- -- (.04)
--------- --------- --------- --------- ---------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . $ 0.41 $ (0.03) $ 0.15 $ (0.62) $ (2.25)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
OPERATING DATA:
Number of retail stores:
Open at end of period. . . . . . . . . . . . . . . . . . 205 189 169 164 86
Opened during period . . . . . . . . . . . . . . . . . . 33 3 -- 10 6
Closed during period . . . . . . . . . . . . . . . . . . 10 19 20 15 84
Weighted average number open during period(1). . . . . . 195 197 178 166 145
BALANCE SHEET DATA:
Total assets. . . . . . . . . . . . . . . . . . . . . . . . $ 263,216 $ 256,010 $ 270,141 $ 284,232 $ 175,520
Shareholders' equity. . . . . . . . . . . . . . . . . . . . 142,990 143,416 146,416 139,269 100,047
_______________
(1) Calculated by dividing the total number of store months open during the
period by 12.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Selected financial data for each quarter of fiscal years 1996 and 1997 follows
(in millions, except per share data). Each quarter consists of 13 weeks.
CONTINUING OPERATIONS
First Quarter Second Quarter Third Quarter Fourth Quarter
--------------- --------------- --------------- ----------------
1996 1997 1996 1997 1996 1997 1996 1997
------ ------ ------ ------ ------ ------ ------ ------
Net sales $ 84.7 $78.6 $100.6 $80.0 $121.7 $113.2 $96.8 $88.9
Gross margin 10.0 6.6 11.2 8.2 14.5 15.6 10.8 4.3
Selling, general, and
administrative expense 14.3 17.9 15.3 15.0 14.9 12.4 15.2 15.3
Operating income (loss) (6.1) (13.1) (5.9) (8.6) (2.2) 1.7 (6.4) (27.6)
Theft insurance recovery -- -- -- -- -- -- -- --
Income (loss) from
continuing operations
before income taxes (5.4) (12.4) (5.0) (7.6) (1.8) 2.5 (6.0) (26.6)
Income (loss) from
continuing
operations (3.3) (7.6) (3.0) (4.7) (1.1) 1.5 (3.7) (38.2)
Earnings (loss) per share
from continuing
operations $(0.19) $(0.43) $(0.17) $(0.27) $(0.06) $0.09 $(0.21) $(2.17)
DISCONTINUED OPERATIONS
Financial data for the CGE division for each quarter follows. This division
was sold May 13, 1996 and is reported as discontinued operations in the
consolidated financial statements included in this filing.
First Quarter Second Quarter Third Quarter Fourth Quarter
--------------- --------------- --------------- ----------------
1996 1997 1996 1997 1996 1997 1996 1997
------ ------ ------ ------ ------ ------ ------ ------
Net sales $ 90.0 $39.3 $ 90.6 $ -- $ 94.7 $ -- $88.0 $ --
Gross margin 9.3 (23.8) 8.6 -- 8.8 -- 10.1 --
Selling, general, and
administrative expense 8.2 -- 8.6 -- 8.0 -- 8.6 (3.7)
Operating income (loss) 0.4 (23.8) (0.6) -- 0.2 -- 0.9 3.7
Income (loss) before income
taxes 0.2 (23.8) (0.8) -- 0.3 -- 0.9 3.7
Income (loss) from
discontinued operations;
net of tax 0.1 (14.5) (0.5) -- 0.2 -- 0.6 2.3
Earnings (loss) per share
from discontinued
operations 0.01 (0.83) (0.03) -- $ 0.01 -- $ 0.03 0.13
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Egghead is a national reseller of PC hardware, software, peripherals and
accessories through 87 retail stores, its 1-800-EGGHEAD direct response unit and
its Internet commerce site. Egghead began operations in 1984 primarily as a
software reseller, but in recent years has expanded its product offerings to
include a greater percentage of hardware and other non-software products.
Egghead's profitability over its early operating history was mixed;
however, over its last five fiscal years, Egghead has reported increasing
losses from continuing operations. Egghead's losses over the last five
fiscal years are attributable primarily to an increased number of competitors
selling PC products through a greater variety of channels, severe price
competition among PC product resellers, a trend toward lower margins on
computer and related software products, Egghead's relatively high
headquarters expenses and other factors described in more detail under "RISK
FACTORS." Egghead has taken a number of steps intended to reduce or
eliminate its losses. These steps include divesting a nonretail business
segment, focusing its retail operations in certain geographic markets,
closing unprofitable stores, upgrading existing stores, experimenting with
new store formats, adding new nonsoftware merchandise categories
(particularly computer systems), developing electronic commerce tools through
its ELEKOM subsidiary and implementing a new Internet commerce site.
For example, in May 1996, Egghead sold its CGE division to generate cash
and to allow management to focus on retail operations. The sale resulted in
a net gain of $22.3 million, offset by a related loss from the CGE operations
of $12.3 million. During the fourth quarter of fiscal 1997, Egghead
substantially restructured and reorganized its operations by (i) closing 70
of its worst performing retail stores, (ii) substantially reducing its
headquarters personnel, (iii) closing its Lancaster, Pennsylvania
distribution center, and (iv) offering for sale certain real estate assets,
including its headquarters building located in Liberty Lake, Washington.
Egghead intends to close an additional seven poorly performing retail stores
as part of the restructuring and reorganization. The restructuring and
reorganization concentrated Egghead's retail stores into 26 geographic
markets and is expected to reduce headquarters and distribution expenses for
continuing operations to approximately $17.0 million on an annualized basis
from $32.0 million in fiscal 1997. Since fiscal 1996, Egghead has also
opened or remodeled eight 5,000 square foot stores, which are approximately
twice the size of its traditional stores, and increased its hardware product
offerings in many of its stores in an effort to improve sales. Egghead
currently operates 24 of these larger format stores, 12 of which were
existing stores that have been open for more than one year and were expanded,
remodeled or relocated. In fiscal 1997, Egghead generated comparable store
sales and operating profit increases of 17% and 28%, respectively, from these
12 stores. In November 1996, Egghead opened one Egghead Computer Surplus
store, operated as a joint venture with Surplus Direct, to participate in a
new retail channel for surplus PC products.
These initiatives have achieved mixed results. Although the increased
proportion of hardware products is intended to increase Egghead's overall net
revenues and gross profits, gross margins as a percentage of net sales are
lower on such products; therefore revenue must increase at a sufficient rate
to offset the lower gross margins in order to increase gross profits. If
gross profits erode, further reductions in operating expenses may be
necessary. Closure of poorly performing stores should improve retail store
operating performance and inventory turn ratios for the remaining stores, but
results from its new larger stores have been mixed. Egghead will continue to
evaluate the performance of its larger format stores and expects that further
refinement of its store format will be required. There can be no assurance
that Egghead will be able to maintain the improved results it has achieved in
its upgraded stores or replicate them in other stores. Egghead's Internet
commerce site, which was activated in February 1996, did not generate
significant amounts of revenue and there can be no assurance that this
distribution method will generate significant revenue in the future.
Although ELEKOM is currently testing prototypes of its products, Egghead's
investment in ELEKOM has not resulted in any revenue to date, and there can
be no assurance that it will generate revenue in future periods.
Accordingly, it is not yet clear that Egghead has developed a business
strategy that will accomplish the goal of further reducing and eliminating its
losses, and there can be no assurance that it will be able to do so. If Egghead
cannot develop a profitable strategy, and its losses continue, Egghead will
deplete its financial resources and reduce shareholders' equity.
15
On May 1, 1997, Egghead announced a definitive agreement (the "Merger
Agreement") to acquire closely held Surplus Direct for up to 5.6 million
newly issued shares of Egghead Common Stock. The transaction includes
repayment of $5.6 million of Surplus Direct debt. Surplus Direct, a reseller
of previous version computer hardware and software, had sales for the nine
months ended February 28, 1997 of approximately $35.0 million. Surplus
Direct has a relatively limited operating history, and, although it reported
break-even to profitable results for the three fiscal years ended May 31,
1996, 1995 and 1994, it reported a $1.2 million loss for the nine months
ended February 28, 1997. Although Egghead does not expect any significant
cost savings or economic efficiencies to result from the combination of the
companies, Egghead believes that it will benefit from the combination of
Surplus Direct's hardware purchasing expertise, access to the surplus PC
products channel, entrepreneurial management and Internet commerce
development capabilities with Egghead's greater software product procurement
expertise and seasoned retail management. Nevertheless, there can be no
assurance that these benefits will be realized. The transaction is subject
to approval by Egghead's and Surplus Direct's shareholders and customary
closing conditions, and is expected to be completed in August 1997.
In connection with the signing of the Merger Agreement, Egghead and
Surplus Direct entered into a Bridge Loan Agreement, dated April 30, 1997,
pursuant to which Egghead loaned Surplus Direct $2.0 million to finance its
working capital needs pending completion of the Merger (the "Bridge Loan").
The Bridge Loan bears interest at the prime rate (as quoted by Seattle-First
National Bank) plus 5.0% per annum and is due on December 31, 1997 in the
event that the Merger does not occur. The Bridge Loan is subordinated to up
to $4.5 million of senior indebtedness (the "Bank Debt") of Surplus Direct
under a credit facility with its principal bank (the "Bank") and ranks pari
passu with $2.0 million of Surplus Direct debt under a subordinated note (the
"SV Capital Note") payable to SV Capital Partners, L.P., which is a
substantial shareholder of Surplus Direct ("SV Capital Partners"). The
Bridge Loan and the SV Capital Note are secured by a second lien (behind the
Bank Debt) on the principal assets of Surplus Direct. Egghead has agreed to
repay the Bank Debt and the SV Capital Note at the Closing and the Bank and
SV Capital Partners have agreed not to accelerate their loans prior to the
closing of the Merger, except under specified circumstances.
Egghead uses a 52/53-week fiscal year ending on the Saturday nearest
March 31. Each fiscal quarter consists of 13 weeks. Information contained
in this report excludes, unless otherwise stated, any data relative to the
discontinued operations of the CGE division.
RESULTS OF OPERATIONS
OVERVIEW
Egghead reported a total net loss for fiscal 1997 of $39.6 million compared
to a total net loss of $10.7 million for fiscal 1996 and net income of
$2.7 million for fiscal 1995. On a pre tax basis, the loss from continuing
operations for fiscal 1997 was $44.2 million ($20.2 million excluding a
restructuring and impairment charge) compared to losses of $18.2 million for
fiscal 1996 and $5.4 million for fiscal 1995. In addition to the restructuring
and impairment charge, the total net loss for fiscal 1997 included a net
noncash charge of $10.7 million for the establishment of a deferred tax
valuation allowance and a $36.5 million gain on the sale of the CGE division,
partially offset by the related loss from discontinued operations of
$20.1 million.
The restructuring and impairment charge totaled $24.0 million before
income taxes was recorded during the fourth quarter of fiscal 1997. The
charge included $6.5 million in gross margin expenses, $5.8 million for
settlement of store and warehouse leases, $4.3 million for fixed asset
dispositions, professional fees and miscellaneous expenses, $3.3 million in
store closing costs and related fixed asset dispositions, $1.3 million for the
impairment and disposition of real estate and $2.8 million for severance and
related benefits.
The pretax loss during fiscal 1996 was due primarily to a decrease in sales
compared to fiscal 1995 resulting from a reduction in the average number of
stores in full operation during the year, as well as one-time costs of
approximately $4.6 million associated with the relocation of Egghead's corporate
headquarters, costs of rolling out its larger format retail stores, and its
investment of approximately $1.1 million in ELEKOM. Fiscal 1995 pretax
income was primarily
16
attributable to increases from fiscal 1994 in hardware and accessory sales and
included a one-time theft insurance recovery of $1.7 million, pretax, related
to inventory stolen from retail stores in prior years.
Egghead has determined that its deferred tax assets no longer meet the
realization criteria of SFAS No. 109 ("SFAS 109"). Under SFAS 109, the
realization of the deferred tax assets depends on generating future taxable
income. Based on Egghead's recent losses and the fact that it anticipates
that it will sustain additional losses in fiscal 1998 and a modest loss in
fiscal 1999 on a stand-alone basis, Egghead management has determined that
it is more likely than not that the deferred tax assets could not currently
be realized. Accordingly, Egghead recorded a net noncash charge in fiscal
1997 of $10.7 million for the establishment of a deferred tax valuation
allowance in accordance with SFAS 109. Egghead's net operating losses can be
recovered over a 15-year period for tax purposes if Egghead achieves
profitability. Until Egghead has determined that all of its existing net
operating losses are realizable, it will not record a tax charge or benefit
for future operating results. For comparative purposes Egghead's results of
operations are discussed below on a pretax basis.
CONTINUING OPERATIONS
PRETAX LOSS. Loss before income taxes includes the results of Egghead's
retail stores, 1-800-EGGHEAD direct response unit, Internet commerce operations
and ELEKOM, as well as the selling, general and administrative expenses related
to these operations. The following table shows the relationship of certain
items relating to continuing operations included in Egghead's Consolidated
Statement of Operations, including the restructuring and impairment charge,
expressed as a percentage of net sales:
FISCAL YEAR
-------------------------
1995 1996 1997
----- ----- -----
Net sales. . . . . . . . . . . . . . . . . . . . . 100.0% 100.0% 100.0%
Cost of sales, including certain buying, occupancy
and distribution costs. . . . . . . . . . . . . 87.7 88.5 90.4
----- ----- -----
Gross margin . . . . . . . . . . . . . . . . . . . 12.3 11.5 9.6
Selling, general and administrative expense. . . . 12.4 14.8 16.8
Depreciation and amortization expense, net of
amounts included in cost of sales . . . . . . . 1.7 1.8 1.7
Restructuring and impairment charge. . . . . . . . -- -- 4.3
----- ----- -----
Operating loss . . . . . . . . . . . . . . . . . . (1.8) (5.1) (13.2)
Other income, net. . . . . . . . . . . . . . . . . 0.5 0.6 1.0
----- ----- -----
Loss before income taxes . . . . . . . . . . . . . (1.3)% (4.5)% (12.2)%
----- ----- -----
----- ----- -----
NET SALES. Sales through Egghead's retail stores constitute the
principal component of Egghead's net sales. Although Egghead commenced sales
of PC products through the Internet in February 1996, Internet commerce sales
did not represent a significant percentage of net sales in fiscal 1997.
Sales through Egghead's retail stores are primarily related to the number of
such stores in operation during the fiscal period, the size of those stores,
the number of new retail stores and the performance of comparable retail
stores during the period. Net sales are also affected by new PC product
releases, competition from other resellers and a variety of other factors.
As is the case with many retailers, a significant portion of Egghead's sales
are generated in the fiscal quarter that includes the winter holiday selling
season. As a result, Egghead's fiscal year results will be heavily dependent
on the results for that quarter. See BUSINESS OF EGGHEAD--Certain Risk
Factors--Fluctuations in, and Uncertainty of, Future Operating Results;
Future Losses" and "--Competition."
During fiscal 1997, Egghead opened seven stores, remodeled two stores and
closed 84 stores, operating a total of 87 stores at March 29, 1997, including
the Egghead Computer Surplus store. This compares to the 164 stores open at
fiscal year-end 1996 and the 169 stores open at fiscal year-end 1995.
Egghead intends to close an additional seven stores in connection with the
restructuring and reorganization. Of the 87 stores open at the end of fiscal
1997, 24, not including the Egghead Computer Surplus Store, were
approximately twice the size of Egghead's traditional stores. Twelve of the
24 larger stores are existing stores that have been open for more than one
year and were expanded, remodeled or relocated. In fiscal 1997, Egghead
generated comparable store sales and operating profit
17
increases of 17% and 28%, respectively, from these 12 stores. Nevertheless, the
overall performance of the larger format stores has been mixed. Egghead will
continue to evaluate the performance of its larger format stores and expects
that further refinement of its store format will be required.
Net sales for fiscal 1997 were $360.7 million, a decrease of 11% from the
$403.8 million in the prior year. The decrease in sales is attributable
primarily to the closure of 84 stores during fiscal 1997 and a decrease in
overall sales volume. Egghead closed 70 stores during the fourth quarter of
fiscal year 1997. Sales for fiscal 1997 from the 87 Egghead stores that were
open at the end of fiscal 1997 accounted for $238.4 million or 66% of Egghead's
fiscal year retail store revenue. Net sales in fiscal 1996 were $403.8 million,
a decrease of $30.2 million or 7% from net sales of $434.0 million in fiscal
1995. Fiscal 1996 sales decreases resulted primarily from the reduction in the
average number of stores in full operation during the year. Fiscal 1995 sales
increased $60.5 million or 16% from fiscal 1994 sales of $373.5 million. Fiscal
1995 increases primarily resulted from an increase in hardware and related
accessories sales, a full year of sales from a direct mail company acquired by
Egghead in 1994 and broad product price reductions initiated in 1994.
Comparable retail store sales measure sales for stores that were open in
both periods being evaluated. Comparable store sales decreased 9.5% during
fiscal 1997 due to a general sales decrease in fiscal 1997 and to Microsoft's
launch of Windows 95 in fiscal 1996, which increased sales in fiscal 1996.
Of the 87 retail stores that were open at the end of fiscal 1997, Egghead
expects that 80 stores will be retained after completion of the restructuring
and reorganization. These 80 stores recorded a 1.6% decrease in comparable
store sales for fiscal 1997 compared to the decrease of 9.5% in comparable
store sales for the entire company. In the fourth quarter of fiscal 1997,
these stores generated a comparable store increase of 6.0% over the fourth
quarter of fiscal 1996. These stores also contributed store operating
profits (before distribution, marketing and corporate overhead expenses) in
excess of total year-to-date retail store operating profits. The increases
in comparable retail store sales for fiscal 1996 and 1995 were 0.1% and
21.0%, respectively, over the prior periods. Comparable store sales for
fiscal 1996 were flat compared to fiscal 1995, despite the release of Windows
95 in fiscal 1996, due to an overall decrease in sales of other products. As
discussed above, fiscal 1995 comparable store sales benefited primarily from
price reductions initiated in fiscal 1994.
GROSS MARGIN. Gross margin consists of net sales minus cost of sales,
including certain buying, occupancy and distribution costs. Gross margin is
primarily affected by sales volume and the mix of PC products sold, as well as
vendor rebates and freight and obsolescence charges. Gross margin as a
percentage of net sales may also be significantly affected by industry-wide
pricing pressure related to both competitors' pricing and vendors' pricing.
Beginning in fiscal 1996, Egghead began to increase the percentage of hardware
and other non-software products offered. Such products typically generate
higher gross margins in absolute dollars, though not necessarily as a percentage
of sales.
Gross margin for fiscal 1997 was $34.7 million, or 9.6% of net sales,
compared to $46.5 million, or 11.5% of net sales, for fiscal 1996. The
decrease in 1997 gross margin was primarily attributable to the inventory
liquidation associated with the closure of 70 stores in connection with the
reorganization and restructuring. Excluding the $6.5 million gross margin
restructuring charge, gross margin in fiscal 1997 would have been $41.2
million, or 11.7% of net sales. The store closures in 1997 will
substantially reduce the quantity of merchandise purchased by Egghead and may
adversely affect Egghead's ability to obtain volume discounts in the future.
Gross margin as a percentage of net sales was also reduced by increased sales
of hardware and other non-software products, which represented approximately
36% of net sales in fiscal 1997, compared to approximately 34% in fiscal
1996. Sales of hardware and other non-software related products represented
39% of net sales in the fourth quarter of fiscal 1997 compared to 33% in the
fourth quarter of 1996, and Egghead expects sales of such products to
increase as a proportion of net sales.
As a percentage of net sales, gross margin was 11.5% in fiscal 1996 compared
to 12.3% in fiscal year 1995. Fiscal 1996 gross margin was negatively affected
by the pricing and promotion terms relating to the sale of Microsoft Windows 95
and a clearance sale during the last quarter of the fiscal year. Fiscal 1995
gross margin reflects a full year of broad price reductions initiated in the
middle of 1994.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE ("SG&A"). SG&A expense
consists primarily of operating expense, excluding occupancy for retail,
1-800-EGGHEAD and Internet operations and headquarters expense, and excludes
18
product procurement and marketing. Such operating expense includes payroll and
benefits for headquarters and distribution support functions,
telecommunications, credit card processing costs and supplies.
SG&A expense as a percentage of net sales was 16.8% in fiscal 1997,
compared to 14.8% in the prior fiscal year. The increase was
primarily due to reduced sales and to restructuring and reorganization costs of
$1.9 million. These costs consist primarily of payroll and other costs relating
to the closure of the 70 stores announced in January.
In fiscal 1996, SG&A expense as a percentage of net sales was 14.8%
compared to 12.4% in fiscal 1995. The increased expense in fiscal 1996
includes $4.6 million incurred in connection with the relocation of Egghead's
corporate headquarters to Liberty Lake and $1.1 million related to
development of products by ELEKOM. SG&A expense as a percentage of net sales
not including relocation expense and ELEKOM expenditures would have been
13.3% in fiscal 1996 and 12.3% in fiscal 1995. The improvement in the fiscal
1995 SG&A expense as a percentage of net sales compared to fiscal 1994 was
due mainly to sales increasing at a faster rate than expenses during the
period.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense, net
of amounts included in cost of sales, primarily includes depreciation of
Egghead's headquarters facility and capital equipment. The expense of
$6.0 million for fiscal 1997 declined compared to $7.4 million for the prior
year, primarily due to the disposition of fixed assets related to the sale of
the CGE division. Depreciation and amortization expense, net of amounts
included in cost of sales, of $7.4 million in fiscal 1996 was consistent with
fiscal 1995.
Assuming consummation of the Merger, depreciation and amortization expense
will increase in fiscal 1998 and subsequent periods as a result of the
amortization of goodwill resulting from the Merger. See "Pro Forma Condensed
Financial Statements."
OTHER INCOME, NET. Interest income in fiscal 1997, 1996 and 1995 was
$3.4 million, $2.2 million and $0.8 million, respectively. Increases in
interest income are primarily due to the increases in cash balances discussed
under "--Liquidity and Capital Resources." In addition, fiscal 1995 included
theft insurance recovery of $1.7 million, representing settlement of an
insurance claim, net of expenses, for inventory stolen by members of a
multistate shoplifting ring from numerous retail stores during fiscal
1991, 1992 and 1993.
DISCONTINUED OPERATIONS
All results for the operations of the CGE division are reported as a
discontinued operation. Certain general, administrative and distribution areas
have traditionally supported all of Egghead's business lines. The expenses
included in the results of the discontinued operations reflect only those
activities directly related to the CGE division.
Gain on the disposition of the discontinued operation during fiscal 1997
was $36.5 million ($22.3 million after tax). The sales price for the CGE
division was $45.0 million cash, which did not include the accounts
receivable, which were collected during fiscal 1997. The reported gain is
net of fixed assets and lease write-offs of $1.2 million, transaction, legal
and accounting fees of $2.0 million, transition period employment costs of
$1.8 million and costs of $3.4 million related to the fulfillment of
post-sale obligations.
Loss from the discontinued operation was $20.1 ($12.3 million net of tax)
for fiscal 1997. The major components of the loss were inventory write-offs
of $6.9 million, accounts receivable write-offs of $5.1 million, fixed asset
dispositions and equipment lease buyouts of $3.2 million, warehouse closing
costs of $1.9 million and operating losses, severance and other costs of $3.0
million.
Net sales for the discontinued operations of CGE declined $65.2 million,
or 15.2% from $428.5 million in fiscal 1995 to $363.3 million in fiscal 1996,
due primarily to disruptions in sales efforts related to the consolidation of
Egghead's regional sales offices and its headquarters relocation to Liberty
Lake, Washington. Gross margin for CGE as a percentage of net sales was
10.1% in fiscal 1996, compared to 11.3% in fiscal 1995.
The increase in SG&A expense as a percentage of net sales was 9.2% in
fiscal 1996, compared to 8.6% in fiscal 1995. The increase is primarily
attributable to the sales shortfall.
19
LIQUIDITY AND CAPITAL RESOURCES
In recent fiscal years, Egghead has funded its operations through cash
provided by operations, bank lines of credit and the proceeds of the sale of the
CGE division. Egghead elected not to renew its bank line of credit after the
line expired in April 1996 because it had sufficient cash to fund operations.
Egghead had no outstanding borrowings under the line at the expiration date.
Cash and cash equivalents increased $33.9 million from $49.6 million at the
end of fiscal 1996 to $83.5 million at March 29, 1997. The increase in the cash
balance was primarily due to the sale of the CGE division, the collection of
related accounts receivable and a liquidation of merchandise inventories, offset
by a reduction in accounts payable. Egghead expects these cash balances will be
adequate to meet future cash requirements for operations.
Net property and equipment decreased $9.8 million from $29.5 million at the
end of fiscal 1996 to $19.7 million at March 29, 1997. The decrease is
principally due to the sale of the CGE division, the disposition of assets
related to the restructuring and reorganization and normal depreciation. Net
property and equipment increased $7.6 million from $21.9 million at the end of
fiscal 1995 to $29.5 million at March 30, 1996. The increase is principally due
to the addition or remodel of the larger format stores, as well as improvements
to the corporate headquarters building in Liberty Lake, offset by depreciation
expense.
Capital expenditures in fiscal 1997 totaled $5.1 million, primarily for
new stores and computer hardware. Capital expenditures in fiscal 1996
totaling $16.2 million included leasehold improvements, fixtures, computer
hardware, software and communications equipment, principally due to the
remodel or addition of 19 larger format stores and the relocation of
Egghead's corporate headquarters. Capital expenditures in fiscal 1995
totaling approximately $14.7 million included land and a building in Liberty
Lake, Washington for the corporate headquarters, computer software and
communications equipment.
NEW ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." This new standard requires that
long-lived assets and certain identifiable intangible assets be evaluated to
determine whether the carrying amount is recoverable based on estimated
future cash flows expected from the use of the assets and cash to be received
upon disposal of the assets. Egghead adopted this standard at the beginning
of the first quarter of fiscal 1997. The cumulative effect of the change in
accounting principle, which was recognized in the first quarter of fiscal
1997, was a charge of $0.7 million, after tax, or $0.04 per share. This
charge represents the write down of Egghead's property held for sale in
Kalispell, Montana and the related goodwill. In connection with its adoption
of SFAS No. 121 Egghead also recorded a pretax charge of approximately $0.1
million related to retail assets, the carrying amounts of which were not
likely to be recovered through future cash flows. In connection with Egghead's
fourth quarter restructuring and reorganization and the corresponding
impairment of certain other real estate assets that became properly
classified as held for sale, Egghead recorded an additional $1.0 million charge
in the fourth quarter of fiscal 1997.
In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." This new standard requires entities to choose either a fair
value-based method or an intrinsic value-based method of accounting for all
employee stock compensation plans. Egghead adopted the standard during fiscal
1997 and has historically and will in the future use the intrinsic value-based
method, which requires no compensation cost to be recognized at the date of the
stock compensation grant if the option is granted at the current market price.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
("SFAS 128"). SFAS 128 establishes new standards for computing and
presenting earnings per share and supersedes Accounting Principles Board
Opinion No. 15, "Earnings Per Share." Egghead will adopt this new standard
in the third quarter of fiscal 1998. Egghead does not anticipate that the
adoption of this new standard would have a material effect on loss per share
for fiscal 1997, 1996 and 1995 as currently reported.
20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Egghead, Inc.:
We have audited the accompanying consolidated balance sheets of Egghead,
Inc. (a Washington corporation) and subsidiaries as of March 29, 1997 and
March 30, 1996, and the related statements of operations, shareholders' equity
and cash flows for each of the three fiscal years in the period ended March 29,
1997. These financial statements are the responsibility of Egghead's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Egghead, Inc. and
subsidiaries as of March 29, 1997 and March 30, 1996, and the results of their
operations and their cash flows for each of the three fiscal years in the period
ended March 29, 1997, in conformity with generally accepted accounting
principles.
Seattle, Washington
May 13, 1997
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
21
EGGHEAD, INC. AND SUBSIDIARIES
- -------------------------------------------------------------------------------
Consolidated Balance Sheets
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ASSETS
March 30, March 29,
1996 1997
-------- --------
Current assets:
Cash and cash equivalents $ 49,590 $ 83,473
Accounts receivable, net of allowance for
doubtful accounts of $2,098 and $5,319, respectively 24,079 13,917
Receivable from Joint Venture - 4,000
Merchandise inventories, net 84,712 49,087
Prepaid expenses and other current assets 9,455 4,116
Current deferred income taxes 4,859 -
Property held for sale 1,725 7,692
Discontinued operations - net current assets 74,473 -
-------- --------
Total current assets 248,893 162,285
-------- --------
Property and equipment, net 27,770 12,018
Non-current deferred income taxes 4,221 -
Other assets 1,621 1,217
Discontinued operations - net long-term assets 1,727 -
-------- --------
$284,232 $175,520
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $119,341 $ 43,027
Accrued liabilities 16,112 12,996
Liabilities related to disposition of CGE division 8,327 7,754
Reserves and liabilities related to restructuring - 11,258
-------- --------
Total current liabilities 143,780 75,035
-------- --------
Other long-term liabilities 1,183 438
-------- --------
Total liabilities 144,963 75,473
-------- --------
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value: 10,000,000 authorized - -
no shares issued and outstanding
Common stock, $.01 par value: - -
50,000,000 shares authorized; 17,546,548 and
17,591,087 shares issued and outstanding, respectively 176 176
Additional paid-in capital 124,104 124,457
Retained earnings (deficit) 14,989 (24,586)
-------- --------
Total shareholders' equity 139,269 100,047
-------- --------
$284,232 $175,520
-------- --------
-------- --------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
22
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Operations
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
1995 1996 1997
-------- -------- --------
Net sales $434,021 $403,841 $360,715
Cost of sales, including certain buying,
occupancy and distribution costs 380,428 357,373 326,044
-------- -------- --------
Gross margin 53,593 46,468 34,671
Selling, general and administrative expense 53,895 59,639 60,632
Depreciation and amortization expense,
net of amounts included in cost of sales 7,363 7,449 6,043
Restructuring and impairment charges - - 15,597
-------- -------- --------
Operating loss (7,665) (20,620) (47,601)
-------- -------- --------
Other income, net 2,268 2,469 3,428
-------- -------- --------
Loss from continuing operations
before income taxes (5,397) (18,151) (44,173)
Income tax (expense) benefit 2,106 7,030 (4,788)
-------- -------- --------
Net loss from continuing operations
before discontinued operations and
change in accounting principle (3,291) (11,121) (48,961)
-------- -------- --------
Discontinued operations:
Gain on disposal of discontinued operations,
net of tax expense of $14,249 - - 22,286
Income (loss) from discontinued
operations, net of tax (benefit) expense of
$3,811, $241 and $(7,833), respectively 5,959 376 (12,254)
-------- -------- --------
Net income (loss) before cumulative effect of change
in accounting principle 2,668 (10,745) (38,929)
Cumulative effect of change in accounting principle,
net of tax of $451 - - (711)
-------- -------- --------
Net income (loss) $ 2,668 $(10,745) $(39,640)
-------- -------- --------
-------- -------- --------
Earnings (loss) per share:
Continuing operations $ (0.19) $ (0.64) $ (2.78)
Discontinued operations:
Gain on disposal of discontinued operations - - 1.27
Income (loss) from discontinued operations 0.34 0.02 (0.70)
Change in accounting principle - - (0.04)
-------- -------- --------
Earnings (loss) per share $ 0.15 $ (0.62) $ (2.25)
-------- -------- --------
-------- -------- --------
Weighted average common shares outstanding 17,281 17,437 17,581
-------- -------- --------
-------- -------- --------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
23
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows
(DOLLARS IN THOUSANDS)
1995 1996 1997
-------- -------- --------
Cash flows from operating activities:
Net loss from operations $ 2,668 $(10,745) $(39,640)
-------- -------- --------
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 10,468 10,721 7,099
Deferred rent (108) (411) (465)
Deferred income taxes 1,084 (729) 10,750
(Gain) loss on disposition of property
and equipment 187 (55) 2,490
Gain on sale of CGE division - - (36,535)
Restructuring charges - - 23,000
Provisions for asset impairment - - 2,343
Changes in assets and liabilities:
Accounts receivable, net 1,089 (3,585) 10,162
Merchandise inventories 13,558 13,831 30,495
Prepaid expenses & other current assets (574) (5,410) 3,669
Other assets (245) 128 (658)
Discontinued operations, net (6,881) 3,005 67,101
Accounts payable 13,401 14,916 (76,373)
Accrued liabilities (2,528) (903) (7,268)
-------- -------- --------
Total adjustments 29,451 31,508 35,810
-------- -------- --------
Net cash provided by (used in)
operating activities 32,119 20,763 (3,830)
-------- -------- --------
Cash flows from investing activities:
Additions to property and equipment (14,741) (16,174) (5,091)
Proceeds from sale of property and equipment 103 86 1,757
Advances to Joint Venture - - (4,000)
Proceeds from sale of CGE division - - 45,000
Discontinued operations, net (520) (788) -
-------- -------- --------
Net cash provided by (used in)
investing activities (15,158) (16,876) 37,666
-------- -------- --------
Cash flows from financing activities:
Proceeds from stock issuances 286 3,536 353
Payments made on capital lease obligations (308) (487) (306)
-------- -------- --------
Net cash provided by (used in)
financing activities (22) 3,049 47
-------- -------- --------
Effect of exchange rates on cash (24) 62 -
-------- -------- --------
Net increase in cash and cash equivalents 16,915 6,998 33,883
Cash and cash equivalents at beginning of period 25,677 42,592 49,590
-------- -------- --------
Cash and cash equivalents at end of period $ 42,592 $ 49,590 $ 83,473
-------- -------- --------
-------- -------- --------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
24
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows (CONTINUED)
(DOLLARS IN THOUSANDS)
1995 1996 1997
------ ------ ------
SUPPLEMENTAL DISCLOSURES OF CASH PAID
DURING THE YEAR :
Interest $ 39 $ 77 $ 30
Income taxes $ 668 $ 334 $ -
SUPPLEMENTAL DISCLOSURE OF NON-CASH
INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations totaling $0.2 million and $0.7 million were recorded
in fiscal 1995 and 1996 respectively, when Egghead acquired new equipment.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
25
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Consolidated Statements of Shareholders' Equity
(AMOUNTS IN THOUSANDS)
Common Stock Additional Retained
--------------------- Paid-in Earnings
Shares Amount Capital (Deficit) Total
------ ------ ---------- -------- --------
Balance, April 2, 1994 17,121 $171 $120,287 $22,958 $143,416
Stock issued for cash, pursuant to
employee stock purchase plan 42 1 258 - 259
Stock issued for cash, pursuant to stock
option plan 3 - 27 - 27
Translation adjustment - - - 46 46
Net income - - - 2,668 2,668
------ ---- -------- -------- --------
Balance, April 1, 1995 17,166 172 120,572 25,672 146,416
Stock issued for cash, pursuant to
employee stock purchase plan 46 1 286 - 287
Stock issued for cash, pursuant to
stock option plan 335 3 3,246 - 3,249
Translation adjustment - - - 62 62
Net loss - - - (10,745) (10,745)
------ ---- -------- -------- --------
Balance, March 30, 1996 17,547 176 124,104 14,989 139,269
Stock issued for cash, pursuant to
employee stock purchase plan 17 - 161 - 161
Stock issued for cash, pursuant to stock
option plan 27 - 192 - 192
Translation adjustment - - - 65 65
Net loss - - - (39,640) (39,640)
------ ---- -------- -------- --------
Balance, March 29, 1997 17,591 $176 $124,457 $(24,586) $100,047
------ ---- -------- -------- --------
------ ---- -------- -------- --------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
26
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
All references herein to fiscal 1995, 1996 and 1997 relate to the fiscal years
ended April 1, 1995, March 30, 1996, and March 29, 1997, respectively.
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Egghead, Inc. sells personal computer software, hardware and related
products through its wholly owned subsidiaries, DJ&J Software Corporation
(DJ&J, d/b/a Egghead Software) and Eggspert Software, Ltd. (Eggspert, a
Canadian subsidiary), EH Direct, Inc. (EH Direct), Egghead International,
Inc. (Egghead International), and ELEKOM Corporation (ELEKOM). References
to "Egghead" include Egghead, Inc., its predecessors, and its subsidiaries.
Eggspert and Egghead International became inactive subsidiaries on May 13,
1996 following the sale of the corporate, government, and education (CGE)
division to Software Spectrum, Inc. (SSI). SEE NOTE 10.
CONSOLIDATION
The consolidated financial statements include the accounts of Egghead, Inc.
and its wholly owned subsidiaries, DJ&J, Eggspert, EH Direct, Egghead
International, and ELEKOM, and include all such adjustments and
reclassifications necessary to eliminate the effect of significant
intercompany accounts and transactions. Operating results for Eggspert and
Egghead International are included in discontinued operations. SEE NOTE
10.
ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates. The most significant estimates with regard to these financial
statements are the restructure and reorganization reserves and liabilities
and the discontinued operations reserves and liabilities.
CASH AND CASH EQUIVALENTS
Egghead considers all highly liquid investments with a maturity of three
months or less at the time of purchase to be cash equivalents. The
carrying amount of cash equivalents approximates fair value because of the
short-term maturity of those instruments.
ACCOUNTS RECEIVABLE AND REVENUE RECOGNITION
Certain advertising and promotional expenditures are reimbursable from
suppliers under cooperative advertising and other promotional and market
development fund arrangements. Amounts qualifying for reimbursement are
recorded as receivables from the suppliers and as a corresponding reduction
of net advertising expense in the period the promotion occurs. Also
included in accounts receivable are credit card receivables and amounts due
from vendors for returned inventory and other programs. Egghead records a
provision for uncollectible vendor receivables based upon historical
experience.
Egghead sales made on credit generally have terms of net 30 days. The
sales and corresponding trade receivables for inventoried product are
recorded upon merchandise shipment. Egghead records provisions for
doubtful accounts and sales returns and allowances based upon historical
experience.
27
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MERCHANDISE INVENTORIES
Merchandise inventories are accounted for using the moving weighted average
cost method and are stated at the lower of cost or market. Egghead
maintains reserves for the obsolescence of merchandise inventory. These
reserves totaled approximately $6.7 million and $3.7 million at March 30,
1996 and March 29, 1997, respectively. Management has developed a plan to
dispose of this obsolete inventory and believes the reserve is adequate to
cover any losses on disposition. Inventories on the balance sheet are
shown net of reserves.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, net of accumulated depreciation.
Depreciation of equipment, furniture and fixtures is provided using the
straight-line method over their estimated useful lives ranging from two to
seven years. Depreciation of buildings is provided using the straight-line
method over their estimated useful lives of up to 30 years. Amortization of
leasehold improvements is provided using the straight-line method over the
lesser of the lease term or the assets' estimated useful lives.
PROPERTY HELD FOR SALE
Property held for sale is stated at the lower of carrying value or
estimated net realizable value.
GOODWILL
Net assets of organizations acquired in purchase transactions are recorded
at fair value at date of acquisition. Unidentified intangibles are
amortized on a straight line basis over the estimated lives of the
remaining long-term assets acquired. Unidentified intangibles at March 30,
1996 were $998,000, net of accumulated amortization of $993,000.
Unidentified intangibles at March 29, 1997 were fully amortized.
ACCOUNTS PAYABLE
Outstanding checks included in accounts payable were $9.0 million and $7.0
million at March 30, 1996 and March 29, 1997, respectively.
DEFERRED RENT
Certain store lease agreements provide for scheduled rent increases or for
rent payments to commence at a date later than the date of occupancy. In
these cases, Egghead recognizes the aggregate rent expense on a
straight-line basis over the lease term beginning when the store opens.
INCOME TAXES
Egghead determines its income tax accounts in accordance with Statement of
Financial Accounting Standards No. 109. Deferred income taxes result
primarily from temporary differences in the recognition of certain items
for income tax and financial reporting purposes.
EARNINGS (LOSS) PER SHARE
Earnings (loss) per share amounts are computed using the weighted average
number of common shares and dilutive common equivalent shares outstanding
during each period using the treasury stock method. Common equivalent
shares result from the assumed exercise of stock options and from the
conversion of cash related to the employee stock purchase plan into common
shares based upon the terms of the plan which would have a dilutive effect
in years where there are earnings. Common equivalent shares had no
material effect on the computation in fiscal 1995, 1996 or 1997.
28
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECENT ACCOUNTING PRONOUNCEMENTS
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." This new standard requires that long-lived assets and certain
identifiable intangible assets be evaluated to determine whether the
carrying amount is recoverable based on estimated future cash flows
expected from the use of the assets and cash to be received upon disposal
of the assets. Egghead adopted this standard at the beginning of the first
quarter of fiscal 1997. The cumulative effect of the change in accounting
principle, which was recognized in the first quarter of fiscal 1997, was a
charge of $0.7 million, after tax, or $0.04 per share. This charge
represents the write down of Egghead's property held for sale in
Kalispell, Montana and the related goodwill. In connection with its
adoption of SFAS No. 121, Egghead also recorded a pretax charge of
approximately $0.1 million related to retail assets, the carrying amounts
of which were not likely to be recovered through future cash flows. In
connection with Egghead's fourth quarter restructuring and reorganization
and the corresponding impairment of certain other real estate assets
that became properly classified as held for sale, Egghead recorded an
additional $1.0 million charge in the fourth quarter of fiscal 1997.
See Note 10.
In October 1995, the FASB issued Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation." This new
standard requires entities to choose either a fair value-based or intrinsic
value-based method of accounting for all employee stock compensation plans.
Egghead adopted the standard during fiscal 1997 and has historically, and
will in the future, use the intrinsic value-based method, which requires no
compensation cost to be recognized at the date of the stock compensation
grant if the option is granted at the current market price.
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 128 (SFAS 128), "Earnings Per Share." SFAS 128 establishes
new standards for computing and presenting earnings per share and
supersedes Accounting Principles Board Opinion No. 15, "Earnings Per
Share." SFAS 128 will be adopted by Egghead in the third quarter of fiscal
1998. Management does not believe the adoption of this new standard would
have a material effect on earnings (loss) per share for fiscal 1995, 1996
or 1997, as currently reported.
FISCAL YEARS
Egghead uses a 52/53-week fiscal year, ending on the Saturday nearest
March 31. Fiscal quarters are such that the first three quarters
consist of 13 weeks and the fourth quarter consists of the remaining
13/14 weeks. Fiscal 1995, 1996 and 1997 each had 52 weeks.
29
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 2 PROPERTY AND EQUIPMENT
The components of property and equipment at March 30, 1996 and March 29,
1997 were as follows (in thousands):
March 30, March 29,
1996 1997
-------- --------
Land and buildings, net $ 7,000 $ -
Equipment 38,814 16,937
Leasehold improvements 13,700 6,078
Furniture and fixtures 7,080 8,399
-------- --------
66,603 31,414
Less accumulated depreciation and
amortization (38,833) (19,396)
-------- --------
Property and equipment, net $ 27,770 $ 12,018
-------- --------
-------- --------
Property held for sale at March 29, 1997 includes Egghead's headquarters
building in Liberty Lake, Washington and property in Kalispell, Montana.
30
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 3 INCOME TAXES
The provision (benefit) for income taxes from continuing operations is comprised
of the following (in thousands):
Fiscal year
-----------
1995 1996 1997
------- -------- -------
Current:
Federal $(2,048) $ (4,383) $-
State (896) (1,917) -
------- -------- -------
(2,944 (6,300) -
------- -------- -------
Deferred:
Federal 730 (404) 4,170
State 108 (326) 618
------- -------- -------
838 (730) 4,788
------- -------- -------
Total $(2,106) $ (7,030) $ 4,788
------- -------- -------
------- -------- -------
During fiscal 1995 and fiscal 1996, tax expense of $3,811 and $241,
respectively, was recorded against income from discontinued operations. During
fiscal 1997, Egghead also recorded income tax expense on the sale of the
discontinued CGE operations of $14,249 and income tax benefits against the loss
from discontinued operations and cumulative effect of change in accounting
principle of $7,833 and $451, respectively.
Deferred income taxes result primarily from temporary differences in certain
items for income tax and financial reporting purposes. The tax effects of
temporary differences giving rise to the deferred tax assets are as follows:
March 30, March 29,
1996 1997
------- -------
Accounts receivable $ 857 $ 2,695
Merchandise inventories 2,651 1,595
Property and equipment 3,625 3.008
Net operating loss carryforwards - 5,000
Reserves and liabilities related to
restructure - 4,391
Accrued liabilities and other 1,947 4,623
------- -------
Total deferred tax assets 9.080 21,312
Less valuation allowance - (21,312)
------- -------
Net deferred tax assets $ 9,080 -
------- -------
Given its recent losses, Egghead determined that its deferred tax assets no
longer meet the realization criteria of Statement of Financial Accounting
Standards No. 109 (SFAS 109). Under SFAS 109, the realization of the deferred
tax assets depends on generating future taxable income. Egghead management has
determined that it is more likely than not that the deferred tax assets could
not be currently realized. Accordingly, Egghead recorded a net noncash charge
in fiscal 1997 of $10.7 million for the establishment of a deferred tax
valuation allowance in accordance with SFAS 109. The charge is included in
continuing operations as a component of income tax expense. Egghead's net
operating loss carryforwards can be recovered over a 15-year period and begin to
expire in 2011.
31
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 3 INCOME TAXES (CONTINUED)
Egghead's income tax provision (benefit) differs from the amount computed by
applying the statutory federal tax rate to loss from continuing operations
before taxes as follows:
Fiscal year
-----------
1995 1996 1997
------ ------ ------
Statutory Federal tax rate (34.0)% (34.0)% (34.0)%
State taxes, net of Federal benefit (4.0) (4.6) (4.0)
Tax exempt interest income (3.3) (1.8) (1.4)
Other, net 2.3 1.7 2.0
Change in valuation allowance - - 48.2
----- ----- -----
(39.0)% (38.7)% 10.8%
----- ----- -----
----- ----- -----
NOTE 4 STOCK OPTION AND STOCK PURCHASE PLANS
EMPLOYEE STOCK PURCHASE PLAN
The Egghead, Inc. 1989 Employee Stock Purchase Plan (the 1989 Plan)
currently provides options to acquire the Common Stock of Egghead to
substantially all full-time and certain other employees at the lesser
of 85% of the fair market value of the Common Stock on August 1 of the
first and second plan years and July 1 thereafter, or 85% of the fair
market value on the following July 31 of the first plan year and June 30
of each plan year thereafter. Under the 1989 Plan, a maximum of 650,000
shares were reserved for issuance. As of March 29, 1997, there were
323,844 shares available for future issuance.
THE 1993 STOCK OPTION PLAN
In September 1993, Egghead's shareholders approved the 1993 Stock Option
Plan (the 1993 Plan and together with the 1989 Plan, the Plans), under
which 2,000,000 shares of Egghead's Common Stock were reserved for
issuance. The 1993 Plan replaced the 1986 Combined Incentive and
Non-Qualified Stock Option Plan (the 1986 Combined Plan) under which
2,000,000 shares were originally reserved for issuance. The number of
shares reserved for issuance under the 1993 Plan was increased by the
shares reserved for issuance under the 1986 Combined Plan that were not
subject to outstanding stock options. Shares presently subject to
outstanding stock options under the 1986 Combined Plan, which subsequently
are canceled or will expire, will increase the number of shares reserved
for issuance under the 1993 Plan. No additional stock options will be
granted under the 1986 Combined Plan. Options granted under the 1993 Plan
vest annually over three years and terminate after 10 years, unless
otherwise noted.
32
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 4 STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
Egghead accounts for these plans under the intrinsic value-based method of
accounting, under which no compensation cost has been recognized. Had
compensation cost for these plans been determined consistent with Statement
of Financial Accounting Standards No. 123 (SFAS 123), Egghead's net income
and earnings per share (EPS) would have been reduced to the following pro
forma amounts:
Fiscal Year
1996 1997
---- ----
Net Loss As Reported $(10,745) $(39,640)
Pro Forma (11,846) (40,800)
Loss per share As Reported $(0.62) $(2.25)
Pro Forma (0.68) (2.32)
The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future amounts. SFAS 123 does not apply to options granted
prior to April 1, 1995, and additional grants in future years are
anticipated.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model, with the following
assumptions used for grants in fiscal 1996 and 1997:
Fiscal Year
-----------
1996 1997
------ ------
Dividend yield 0% 0%
Volatility 67% 67%
Risk-free interest rate 5.91% 5.61%
Expected stock option life 4.4 yrs. 4.4 yrs.
Using these assumptions, the weighted average fair value of options granted
was $6.17 and $3.67 in fiscal 1996 and 1997, respectively.
33
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 4 STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
Options granted, exercised, and canceled under the Plans are
summarized as follows:
Fiscal year
1995 1996 1997
------------------------ ------------------------ ------------------------
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
Outstanding, beginning
of year 702,322 $11.88 1,513,089 $ 8.63 1,372,887 $9.33
Options granted(1) 1,140,900 6.49 621,100 10.67 1,444,200 6.80
Options exercised (2,625) 10.25 (55,395) 6.47 (27,891) 7.01
Options canceled (327,508) 7.45 (705,907) 8.94 (605,668) 9.50
--------- --------- ---------
Outstanding, end of year 1,513,089 8.63 1,372,887 9.33 2,183,528 7.75
--------- --------- ---------
--------- --------- ---------
Exercisable, end of year 293,139 $13.18 359,277 $10.85 837,156 $8.19
--------- --------- ---------
--------- --------- ---------
Available for grant in
future years 1,776,066 1,860,873 1,022,341
--------- --------- ---------
--------- --------- ---------
(1) One million options granted during fiscal 1997 vest over a period of 18
months, with 294,400 vested as of March 29, 1997. The remaining 705,600
options vest monthly at a rate of 44,100 until all options are vested
The following table summarizes information regarding all stock options
outstanding at March 29, 1997:
Options Outstanding Options Exercisable
-------------------------------------- ------------------------
Remaining
Contractual Exercise Exercise
Range of Exercise Prices Number Life Price Number Price
------------------------ --------- ----------- -------- --------- --------
$5.375 - $8.125 1,686,668 8.97 years $ 5.97 670,386 $ 6.57
$9.00 - $10.75 591,501 4.64 years 10.52 477,809 10.46
$10.8125 - $16.00 976,716 4.85 years 12.72 602,818 13.79
$17.00 - $20.00 312,467 2.39 years 18.10 312,467 18.10
--------- ---------
$5.375 - $20.00 3,567,352 6.55 years $9.63 2,063,480 $11.33
--------- ---------
--------- ---------
OPTION REPRICING
On April 23, 1997, the Compensation Committee of the Egghead Board approved
a plan pursuant to which certain executive officers were offered an
opportunity to exchange options having exercise prices in excess of the
then current fair market value of new options having an exercise price of
$4.375 per Egghead Common Share. Recipients of the repriced replacement
options received credit for vesting under the original options, but cannot
exercise the new options for a one-year period following the date of grant
of the new options. The Compensation Committee approved a similar option
repricing for employees other than executive officers on April 4, 1997.
34
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 4 STOCK OPTION AND STOCK PURCHASE PLANS (CONTINUED)
THE NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
In September 1993, Egghead's shareholders approved the Non-employee
Director Stock Option Plan, and in August 1995, Egghead's shareholders
approved amendments thereto (as amended, the Director Plan) under which
450,000 shares of Egghead's Common Stock were reserved for issuance.
Options granted under the Director Plan vest annually over three years and
terminate after 10 years. As of March 29, 1997, 162,500 shares were
available for grant and 287,500 shares were subject to outstanding options,
which have been granted at prices ranging from $5.88 to $13.75 per share.
As of March 29, 1997, options for 130,000 shares were vested.
THE EXECUTIVE PLAN
In February 1989, the Board of Directors approved four-year employment
agreements and stock option agreements for three executive officers who are
no longer with Egghead, whereby the officers' compensation was based on
equity incentives. Each drew an annual salary of $1 per year during his
term of employment. Options to acquire up to 1,700,000 shares of Common
Stock are authorized under the Executive Plan. As of March 29, 1997,
325,000 options approved under the Executive Plan were never granted and
1,096,324 were subject to outstanding options, which have been granted to
such executive officers of Egghead at prices ranging from $10.38 to $20.00
per share. All outstanding options are vested and expire in February 1999.
As of March 29, 1997, 278,676 of the options had been exercised at $10.38
per share. The Executive Plan is no longer active and no further options
will be granted under the Executive Plan, which will terminate on
February 22, 1999.
NOTE 5 401(k) PLAN
Egghead has a 401(k) retirement plan for the benefit of its employees.
After six months of full-time employment (more than 1,000 hours), an
employee is eligible to participate in the plan. Employee contributions
are matched by Egghead at 50% of the employee's contribution up to 4% of
their compensation. Egghead contributions are fully vested upon the
completion of two years of service. Egghead contributions were
approximately $446,000, $228,000 and $466,000 in fiscal 1995, 1996
and 1997, respectively. Subsequent to March 29, 1997, Egghead discontinued
the guaranteed matching of employee contributions. Egghead may, however,
make voluntary contributions in the future.
35
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 6 COMMITMENTS AND CONTINGENCIES
SIGNIFICANT SUPPLIERS
In fiscal 1996 and 1997, three supplier/distributors in the aggregate
accounted for approximately 40% and 33%, respectively, of Egghead's
purchases. The loss of these suppliers could have a material adverse
effect on Egghead's operating results and financial condition.
LEASES
Egghead leases retail stores and a distribution facility under operating
leases with remaining lives on most leases ranging from one to five years.
Some leases contain renewal options of one to five years which Egghead may
exercise at the end of the initial lease term. The leases generally
require Egghead to pay taxes, insurance and certain common area maintenance
costs.
Aggregate rental expense, including common area maintenance charges, for
all operating leases for fiscal 1995, 1996 and 1997 was approximately $16.8
million, $16.0 million and $15.4 million, respectively. As of March 29,
1997, future minimum rental payments under noncancelable operating leases
for continuing retail stores and the distribution facility, and equipment
consisted of the following (in thousands):
Operating
Fiscal Year Leases
----------- ---------
1998 $ 6,215
1999 4,036
2000 2,318
2001 1,532
Thereafter 2,007
-------
Total minimum payments $16,108
-------
-------
36
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 7 THEFT INSURANCE RECOVERY
Theft insurance recovery of $1.65 million included in other income, net, in
fiscal 1995 represents settlement of an insurance claim, net of expenses,
for inventory stolen from numerous retail stores during fiscal 1991, 1992
and 1993 by members of a multi-state shoplifting ring.
NOTE 8 JOINT VENTURE
Effective November 22, 1996, Egghead invested $250,000 for a 50% interest
in a limited liability company joint venture (the JV). The other principal
shareholder of the JV is Surplus Software, Inc. (Surplus Direct). The JV
operates a retail outlet for surplus computer hardware, software and
related accessories and services. As of March 29, 1997, Egghead had
loaned the JV $4.0 million at a variable rate of 1/2% above the prime
interest rate as published by Seattle-First National Bank (8.5% at
March 29, 1997).
Egghead accounts for this investment under the equity method and any income
or loss is reflected in other income. Summary financial information of the
JV's revenue, expenses, assets and liabilities as of and for the period
ended March 29, 1997 are as follows (in thousands):
Revenue $4,477
Expenses 4,660
------
Loss before income taxes $ 183
------
------
Assets $4,723
Liabilities 4,656
------
$ 67
------
------
During fiscal 1997, Egghead had gross sales of $2.1 million to the JV.
Sales to this related party are transacted based on current market prices
and are typically at or below the original cost to Egghead. Egghead
records any markdowns on merchandise sold to the JV as a component of cost
of sales.
NOTE 9 RESTRUCTURING AND REORGANIZATION
In the fourth quarter of fiscal 1997, Egghead recorded a $24.0 million
restructuring and impairment charge to reorganize its operations as
announced on January 31, 1997. This plan involves among other things,
closing 70 of the 156 Egghead stores, which reduced the number of
geographic locations in which Egghead operated stores from 54 to 26, a
significant reduction in its headquarters staff and the closure of its
Lancaster, Pennsylvania distribution center. This charge includes
$6.5 million of gross margin expense, $5.8 million in settlement of
store and warehouse leases, $3.3 million of store closing
costs and related fixed asset dispositions, $1.3 million in disposition
and impairment of real estate, and $7.1 million of severance payments,
other fixed asset dispositions, professional fees and other expenses
associated with the restructuring plan. Egghead anticipates that the sale
of real estate, the closure of all activities and stores and the settlement
of all leases and claims related to the restructuring will be completed by
the end of fiscal 1998.
37
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 10 DISCONTINUED OPERATIONS
Effective May 13, 1996, Egghead sold its CGE division to SSI, a Texas
corporation, for $45.0 million in cash pursuant to the terms of an
asset purchase agreement entered into on March 23, 1996. The asset
purchase agreement required Egghead to provide SSI with certain support
services for a period not to exceed 120 days on Egghead's behalf, SSI's
collection of Egghead's CGE-related accounts receivable for a period
not to exceed 150 days and a lease to SSI for a period of three years of
a portion of Egghead's Spokane facility.
Gain on the disposition of the discontinued operation was $36.5 million
($22.3 million after tax). The sales price for the CGE division was $45.0
million, which did not include the accounts receivable, which were
collected during the fiscal year. The reported gain is net of fixed assets
and lease write-offs of $1.2 million, transaction, legal and accounting
fees of $2.0 million, transition period employment costs of $1.8 million
and costs of $3.4 million related to the fulfillment of post-sale
obligations as noted above.
The net assets and liabilities relating to discontinued operations have
been segregated on the consolidated balance sheet from their historic
classifications to separately identify them as being related to the
discontinued operations. Liabilities related to the disposition of the
CGE division at March 29, 1997 consisted of liabilities relating to CGE
activities and additional reserves deemed necessary to complete the
disposition of remaining CGE assets, including the settlement of remaining
claims. The balance at March 30, 1996 consisted of liabilities to be
assumed by SSI upon completion of the sale.
The income from discontinued operations for fiscal 1995, 1996, and 1997 is
comprised of the following (in millions):
Fiscal year
-----------
1995 1996 1997
------- ------- -------
Net sales $ 428.5 $ 363.3 $ 39.3
Costs and expenses 418.7 362.7 59.4
------- ------- -------
Income (loss) before provision
for income taxes 9.8 0.6 (20.1)
Income tax expense (benefit) 3.8 0.2 (7.8)
------- ------- -------
Income (loss) from
discontinued operations $ 6.0 $ 0.4 $(12.3)
------- ------- -------
------- ------- -------
NOTE 11 SUBSEQUENT EVENTS
On May 1, 1997, Egghead announced a definitive agreement to acquire closely
held Surplus Direct for up to 5,600,000 newly issued shares of Egghead
Common Stock in a transaction valued at $31.5 million based on Egghead's
share price as of April 30, 1997. The transaction includes repayment of
$5.6 million of Surplus Direct debt. Surplus Direct, engaged in the
direct marketing of previous version computer hardware and software,
had sales for the nine months ended February 28, 1997 of approximately
$35 million. The transaction is subject to shareholder approval and
customary closing conditions, including normal governmental approval,
and is expected to be completed in August 1997.
38
EGGHEAD, INC. AND SUBSIDIARIES
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements (CONTINUED)
NOTE 11 SUBSEQUENT EVENTS (CONTINUED)
In connection with the signing of the agreement, Egghead and Surplus Direct
entered into a Bridge Loan Agreement, dated April 30, 1997, pursuant to
which Egghead loaned Surplus Direct $2.0 million to finance its working
capital needs pending completion of the merger (the Bridge Loan). The
Bridge Loan bears interest at the prime rate (as quoted by Seattle-First
National Bank) plus 5.0% per annum and is due on December 31, 1997 in the
event that the merger does not occur. The Bridge Loan is subordinated to
up to $4.5 million of senior indebtedness (the Bank Debt) of Surplus Direct
under a credit facility with its principal bank (the Bank) and ranks pari
passu with $2.0 million of Surplus Direct debt under a subordinated note
(the SV Capital Note) payable to SV Capital Partners, L.P., which is a
substantial shareholder of Surplus Direct (SV Capital Partners). The
Bridge Loan and the SV Capital Note are secured by a second lien (behind
the Bank Debt) on the principal assets of Surplus Direct. Egghead has
agreed to repay the Bank Debt and the SV Capital Note at the closing of
the Merger and the Bank and SV Capital Partners have agreed not to
accelerate their loans prior to the closing of the transaction, except
under specified circumstances.
39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Part III, Item 10, is incorporated by reference
from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1997
Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A
within 120 days of March 29, 1997.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Part III, Item 11, is incorporated by reference
from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1997
Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A
within 120 days of March 29, 1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Part III, Item 12, is incorporated by reference
from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1997
Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A
within 120 days of March 29, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Part III, Item 13, is incorporated by reference
from Egghead, Inc.'s definitive Proxy Statement relating to Egghead, Inc.'s 1997
Annual Meeting of Shareholders, which will be filed pursuant to Regulation 14A
within 120 days of March 29, 1997.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents filed as a part of this report:
1. Financial Statements -- The Consolidated Financial
Statements, Notes thereto, Financial Statement Schedules
(none), and Accountants' Report thereon are included in
Part II, Item 8 of this report.
2(a) Exhibits
(i) 3.1 Restated Articles of Incorporation of Egghead, Inc.
(vii) 3.2 Restated Bylaws of Egghead, Inc.
(x) 10.1* Microsoft 1995/1996 Channel Agreement dated July 1, 1995,
as amended through January 1, 1996.
10.2X* Amendment No. 1 to the Microsoft 1995/1996 Channel
Agreement, with attached addendums and amendments to the
addendums of such Agreement, through June 30, 1997.
10.3X** Form of Change of Control Agreements
10.4X** Executive Deferred Compensation Plan and related
documents effective July 1, 1996
10.5 Intentionally left blank
10.6 Intentionally left blank
40
10.7 Intentionally left blank
10.8 Intentionally left blank
(v) 10.9* Reseller Agreement with WordPerfect Corporation dated
April 1, 1994.
(vi) 10.10* Microsoft 1994/1995 Channel Agreement dated July 1, 1994.
(vi) 10.11* Addendum to the Microsoft 1994/1995 Channel Agreement
dated July 1, 1994.
(vii) 10.11a Amendment No. 1 to the Addendum to the Microsoft 1994/1995
Channel Agreement (appointment as a Large Account
Reseller) dated July 1994.
(vi) 10.12* Follow-up letter dated August 2, 1994, from Microsoft
regarding Microsoft 1994/1995 Channel Agreement dated
July 1, 1994.
(vii) 10.13* Addendum to the 1994/1995 Microsoft Channel Agreement
dated January 1995.
10.14 Intentionally left blank.
10.15 Lease, as amended, dated June 9, 1988, between Sammamish
Park Place I Limited Partnership as Landlord and DJ&J
Software Corporation as Tenant regarding registrant's
administrative headquarters. (Previously filed with
registrant's Form 10-K for the fiscal year ended April 1,
1989, as Exhibit 10.46.)
10.16 First Amendment to June 9, 1988 Lease between Sammamish
Park Place I Limited Partnership and DJ&J Software
Corporation dated October 4, 1989. (Previously filed with
registrant's Form 10-K for the fiscal year ended March 31,
1990, as Exhibit 10.46a.)
10.17 Lease dated March 23, 1992 between Sammamish Park Place II
Limited Partnership as Landlord and DJ&J Software
Corporation as Tenant regarding registrant's
administrative headquarters. (Previously filed with
registrant's Form 10-K for the fiscal year ended March 28,
1992, as Exhibit 10.47.)
10.18 Lease Termination and Rent Payment Agreement between
Sammamish Park Place II Limited Partnership as Landlord
and DJ&J Software Corporation as Tenant regarding
registrant's administrative headquarters. (Previously
filed with registrant's Form 10-Q for the quarter ended
July 2, 1994.)
(vi) 10.18a First Amendment to Lease Termination and Rent Payment
Agreement between Sammamish Park Place II Limited
Partnership as Landlord and DJ&J Software Corporation as
Tenant.
(vi) 10.18b Second Amendment to Lease Termination and Rent Payment
Agreement between Sammamish Park Place II Limited
Partnership as Landlord and DJ&J Software Corporation as
Tenant.
(iii) 10.19 Lease dated March 23, 1989, between The CHY Company as
Landlord and DJ&J Software Corporation as Tenant regarding
registrant's Sacramento distribution facility.
(iii) 10.20 First amendment to lease between The CHY Company as
Landlord and
41
DJ&J Software as Tenant regarding registrant's Sacramento
distribution facility.
10.21X Lease dated May 15, 1995 between Central Valley Limited
Liability Company as Lessor and DJ&J Software Corporation
d/b/a Egghead Software as Lessee, regarding Registrant's
Sacramento distribution facility, with attached Exercise
of Option extending lease term date to September 30, 1998.
(i) 10.22 Lease Agreement dated January 7, 1988 with Granite
Properties, a limited partnership, as Landlord and DJ&J
Software Corporation, as Tenant, regarding registrant's
Lancaster distribution facility.
10.23 Intentionally left blank
10.24 Intentionally left blank
(viii) 10.25 Asset Purchase Agreement by and among Software Spectrum,
Inc., Egghead, Inc. and DJ&J Software Corporation dated as
of March 23, 1996 with Exhibits 4.11 and 4.12 thereto.
10.26 Intentionally left blank.
10.27 Form of Indemnification Agreement between registrant and
its directors. (Previously filed with registrant's
Form 10-Q for the quarter ended December 31, 1994 as same
exhibit number.)
10.28 Form of Indemnification Agreement between DJ&J Software
Corporation and its directors. (Previously filed with
registrant's Form 10-Q for the quarter ended December 31,
1994 as same exhibit number.)
(vi) 10.29 Revolving Loan Agreement dated September 30, 1994, among
Seattle-First National Bank and U.S. Bank of Washington,
National Association, Egghead, Inc. and DJ&J Software
Corporation.
10.30 Revolving Loan Agreement dated September 30, 1993 among
Seattle-First National Bank and U.S. Bank of Washington,
National Association, Egghead, Inc. and DJ&J Software
Corporation. (Previously filed with registrant's
Form 10-Q for the quarter ended October 16, 1993, as same
exhibit number.)
10.31 Intentionally left blank.
10.32 Intentionally left blank.
10.33** Executive employment agreement between Egghead, Inc. and
Terence M. Strom dated June 28, 1993. (Previously filed
with registrant's Form 10-Q for the quarter ended October
16, 1993, as Exhibit 10.34.)
(ii) 10.34** Egghead, Inc. 1989 Executive Retention Incentive Stock
Option Plan.
(ii) 10.35** Egghead, Inc. 1989 Executive Retention Incentive Stock
Option Agreement between Egghead, Inc. and Stuart M. Sloan
dated February 23, 1989.
(ii) 10.36** Egghead, Inc. 1989 Executive Retention Non-Qualified Stock
Option Agreement between Egghead, Inc. and Stuart M. Sloan
dated February 23, 1989.
(iii) 10.36a** Amendment No. 1 to Egghead, Inc. 1989 Executive Retention
Non-Qualified Stock Option Agreement between Egghead, Inc.
and Stuart M. Sloan dated April 17, 1991.
42
10.37 Intentionally left blank.
10.38 Intentionally left blank.
(ii) 10.39** Egghead, Inc. 1989 Executive Retention Incentive Stock
Option Agreement between Egghead, Inc. and Ronald A.
Weinstein dated February 23, 1989.
(iii) 10.39a** Amendment No. 1 to Egghead, Inc. 1989 Executive Retention
Incentive Stock Option Agreement between Egghead, Inc. and
Ronald A. Weinstein dated April 17, 1991.
(ii) 10.40** Egghead, Inc. 1989 Executive Retention Non-Qualified Stock
Option Agreement between Egghead, Inc. and Ronald A.
Weinstein dated February 23, 1989.
(iii) 10.40a** Amendment No. 1 to Egghead, Inc. 1989 Executive Retention
Non-Qualified Stock Option Agreement between Egghead, Inc.
and Ronald A. Weinstein dated April 17, 1991.
10.41 Intentionally left blank.
10.42 Intentionally left blank.
(ii) 10.43** Egghead, Inc. 1989 Executive Retention Incentive Stock
Option Agreement between Egghead, Inc. and Matthew J.
Griffin dated February 23, 1989.
(ii) 10.44** Egghead, Inc. 1989 Executive Retention Non-Qualified Stock
Option Agreement between Egghead, Inc. and Matthew J.
Griffin dated February 23, 1989.
(iii) 10.44a** Egghead, Inc. 1989 Executive Retention Non-Qualified Stock
Option Agreement between Egghead, Inc. and Matthew J.
Griffin dated April 17, 1991.
10.45 Intentionally left blank.
10.46 Intentionally left blank.
10.47 Intentionally left blank.
10.48** Egghead, Inc. 1989 Employee Stock Purchase Plan.
(Previously filed with registrant's Form S-8 dated
June 23, 1990, as Exhibit 10.)
10.49** Egghead, Inc. 1993 Stock Option Plan. (Previously filed
with registrant's Form 10-Q dated for the quarter ended
October 16, 1993, as Exhibit 10.31.)
(x) 10.50** Egghead, Inc. Restated Nonemployee Director Stock Option
Plan.
10.51X** Resignation & Release Agreement between Peter F.
Grossman and Egghead Inc. and DJ&J Software Corporation
effective April 29, 1997.
10.52X** Resignation & Release Agreement between Ronald J.
Smith and Egghead Inc. and DJ&J Software Corporation
effective February 15, 1997.
10.53X** Resignation & Release Agreement between Terrence M. Strom
and Egghead Inc. and DJ&J Software Corporation effective
February 15, 1997.
21.1X List of subsidiaries of Egghead, Inc.
23.1X Consent of Arthur Andersen LLP.
24.1X Power of Attorney (contained on signature page).
27.1X Financial Data Schedule
* See attached
_____________
X Filed herewith.
(i) Previously filed with registrant's Registration Statement on Form S-1,
Registration No. 33-21472, as same exhibit number.
43
(ii) Previously filed with registrant's Form 8-K dated February 23,
1989, as Exhibits 10.1 to 10.13.
(iii) Previously filed with registrant's Form 10-K for the fiscal year
ended March 29, 1992, as same exhibit number.
(iv) Previously filed with registrant's Form 10-K for the fiscal year
ended April 3, 1993, as same exhibit number.
(v) Previously filed with registrant's Form 10-K for the fiscal year
ended April 2, 1994, as same exhibit number.
(vi) Previously filed with registrant's Form 10-Q for the quarter ended
October 1, 1994.
(vii) Previously filed with registrant's Form 10-K for the fiscal year
ended April 1, 1995, as same exhibit number.
(viii) Previously filed with registrant's Form 8-K dated March 23, 1996,
as Exhibit 2.1.
(x) Previously filed with registrant's Form 10-K for the fiscal year
ended March 30, 1996, as same exhibit number.
* Confidential portions of this exhibit have been omitted and filed
separately with the Securities and Exchange Commission pursuant to
an Application for Confidential Treatment under Rule 24b-2 under
the Securities Exchange Act of 1934, as amended. Each exhibit has
been marked to identify the confidential portions that are
omitted.
** Designates management contract or compensatory plan or
arrangement.
2b. Form 8-K
Egghead, Inc. filed one report on Form 8-K, dated April 30, 1997, during
the fourth quarter of its fiscal year ended March 29, 1997, which reported
on Item 5 of Form 8-K.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of Liberty
Lake, State of Washington, on June 20, 1997.
EGGHEAD, INC.
By /s/ George P. Orban
----------------------------------------------------
George P. Orban
Chief Executive Officer, Chairman of the Board
EGGHEAD, INC.
By /s/ Brian W. Bender
----------------------------------------------------
Brian W. Bender
Chief Accounting Officer, Chief Financial Officer
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes
George P. Orban and Brian W. Bender, or either of them, as attorneys-in-fact
with full power of substitution, to execute in the name and on behalf of each
person, individually and in each capacity stated below, and to file, any and all
amendments to this report, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that said attorneys-in-fact, of their
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on June 20, 1997, on behalf of
the Registrant and in capacities indicated.
Signature Title
- --------- -----
/s/ George P. Orban
- ------------------------------------ Chairman of the Board
George P. Orban
/s/ Richard P. Cooley
- ------------------------------------ Director
Richard P. Cooley
/s/ Steven E. Lebow
- ------------------------------------ Director
Steven E. Lebow
/s/ Linda Fayne Levinson
- ------------------------------------ Director
Linda Fayne Levinson
/s/ Eric P. Robison
- ------------------------------------ Director
Eric P. Robison
45
/s/ Terence M. Strom
- ------------------------------------ Director
Terence M. Strom
/s/ Samuel N. Stroum
- ------------------------------------ Director
Samuel N. Stroum
/s/ Melvin A. Wilmore
- ------------------------------------ Director
Melvin A. Wilmore
46