EXHIBIT 13.1 FIVE-YEAR FINANCIAL SUMMARY Proffitt's, Inc. and Subsidiaries (In thousands, except per share amounts) 52 WEEKS 52 WEEKS 52 WEEKS 52 WEEKS 52 WEEKS ENDED ENDED ENDED ENDED ENDED JANUARY JANUARY JANUARY FEBRUARY FEBRUARY 28, 1995 29, 1994 30, 1993 1, 1992 2, 1991 CONSOLIDATED INCOME STATEMENT DATA: Net sales, including leased departments $617,363 $200,884 $128,262 $104,873 $98,767 Costs and expenses: Cost of sales 400,605 129,679 78,225 64,673 60,878 Selling, general, and administrative expenses (including store pre-opening expenses) 145,560 49,851 31,834 27,539 26,213 Other operating expenses 43,711 15,754 8,793 7,303 7,109 Operating income 27,487 5,600 9,410 5,358 4,567 Other income (expense): Finance charge income, net of allocation to purchaser of accounts receivable 13,653 5,964 4,457 4,030 4,005 Interest expense (15,655) (2,976) (2,881) (4,616) (5,404) Other income (expense), net 1,109 805 (109) 92 194 Income before provision for income taxes and cumulative effect of changes in accounting methods 26,594 9,393 10,877 4,864 3,362 Provision for income taxes 10,466 3,663 4,130 1,851 1,297 Income before cumulative effect of changes in accounting methods 16,128 5,730 6,747 3,013 2,065 Cumulative effect of changes in accounting methods (net of tax) 333 Net income $16,128 $6,063 $6,747 $3,013 $2,065 Earnings per common share before cumulative effect of changes in accounting methods $1.46 $.62 $1.02 $.78 $.55 Earnings per common share $1.46 $.66 $1.02 $.78 $.55 Weighted average number of common shares outstanding 9,912 9,236 6,591 3,858 3,787 JANUARY JANUARY JANUARY FEBRUARY FEBRUARY 28, 1995 29, 1994 30, 1993 1, 1992 2, 1991 CONSOLIDATED BALANCE SHEET DATA: Trade accounts receivable, less allowance for doubtful accounts $2,701 $38,652 $33,556 $22,713 $22,617 Working capital $103,139 $121,357 $48,538 $47,019 $34,621 Total assets $540,055 $259,881 $133,502 $97,941 $88,657 Senior long-term debt, less current portion $114,102 $24,968 $43,086 $27,215 $49,068 Subordinated debt $100,269 $86,250 Shareholders' equity $180,676 $124,043 $61,627 $54,467 $22,204 MANAGEMENT'S DISCUSSION AND ANALYSIS Proffitt's, Inc. is a leading regional specialty department store chain offering moderate to better brand name fashion apparel, accessories, cosmetics, and decorative home furnishings. The Company's stores are primarily anchor stores in leading regional malls. On March 31, 1994, Proffitt's, Inc. acquired all of the outstanding common stock of Macco Investments, Inc., a holding company for McRae's, Inc., a retail department store chain headquartered in Jackson, Mississippi. Proffitt's, Inc. currently operates its Proffitt's Division with 25 department stores located in Tennessee, Virginia, North Carolina, Georgia, and Kentucky and its McRae's Division with 28 department stores and one home furnishings specialty store located in Mississippi, Alabama, Louisiana, and Florida. In 1992 and 1993, Proffitt's, Inc. acquired 18 store locations from the Hess Department Store Company. These stores were renovated and opened as Proffitt's stores throughout 1992 and 1993. Income statement information for the year ended January 28, 1995 includes operations from the Proffitt's Division for the entire year and operations from the McRae's Division after March 31, 1994. The following table sets forth, for the periods indicated, certain items from the Company's Consolidated Statements of Income, expressed as percentages of net sales: 52 WEEKS 52 WEEKS 52 WEEKS ENDED ENDED ENDED JANUARY 28, JANUARY 29, JANUARY 30, 1995 1994 1993 Net sales 100.0% 100.0% 100.0% Costs and expenses: Cost of sales 64.9 64.6 61.0 Selling, general, and administrative expenses 23.6 22.3 24.7 Store pre-opening expenses 2.5 0.1 Other operating expenses: Property and equipment rentals 1.9 2.3 1.9 Depreciation and amortization 3.0 3.1 2.6 Taxes other than income taxes 2.2 2.4 2.3 Operating income 4.4 2.8 7.4 Other income (expense): Finance charge income, net of allocation to purchaser of accounts receivable 2.2 3.0 3.5 Interest expense (2.5) (1.5) (2.3) Other income (expense), net 0.2 0.4 (0.1) Income before provision for income taxes and cumulative effect of changes in accounting methods 4.3 4.7 8.5 Provision for income taxes 1.7 1.8 3.2 Income before cumulative effect of changes in accounting methods 2.6 2.9 5.3 Cumulative effect of changes in accounting methods (net of tax) 0.1 Net income 2.6% 3.0% 5.3% NET SALES Total Company net sales increased by 207%, 57%, and 22% in 1994, 1993, and 1992, respectively. The 1994 sales increase was due to revenues of $379.1 million generated from the McRae's Division acquired in March 1994, along with a comparable store sales increase of 3% and volume generated from new stores opened in 1993 not reflected in the comparable stores sales gain. The 1993 increase was attributable to a comparable store net sales increase of 14% combined with the opening of eleven stores and renovation and expansion of five other stores during the year. Net Sales 1994 $617.40 million 1993 $200.9 million 1992 $128.3 million 1991 $104.9 million 1990 $98.8 million GROSS MARGINS Gross margins were 35.1%, 35.4%, and 39.0% in 1994, 1993, and 1992, respectively. Effective January 31, 1993, the Company changed its method of accounting for inventory to a full-cost method which includes certain purchasing and distribution costs. Those costs related to obtaining merchandise and preparing it for sale were classified in selling, general, and administrative expenses in 1992 but were classified as cost of sales in 1994 and 1993, thereby lowering the 1994 and 1993 gross margin percent by 2.3% and 1.7%, respectively. Without this change, gross margin percent would have been 37.4% in 1994 and 37.1% in 1993. The decrease in gross margin percent from 39.0% in 1992 to 37.1% in 1993 and 37.4% in 1994 (before reflecting the change in accounting method) was primarily a result of excessive markdowns taken in fall 1993 and spring 1994 resulting from overstocking of new store locations in 1993 and weakness in women's apparel sales in 1993 and 1994. At January 28, 1995, management believes the Company's inventories were well balanced and appropriately assorted and therefore anticipates gross margins will continue to improve in 1995. SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES The change in accounting method relating to inventory costing (see "Gross Margins") decreased selling, general, and administrative expenses by 2.4% of sales in 1994 and by 2.1% of sales in 1993. Without this change, selling, general, and administrative expenses would have been 26.0% of sales in 1994 and 24.4% of sales in 1993 compared to 24.7% in 1992. The increase as a percentage of net sales in 1994 primarily was due to the acquisition of McRae's and additional overhead and other expenses required to operate the expanded store base. The decline as a percentage of net sales in 1993 from the 1992 level primarily resulted from increased economies of scale and the successful implementation of a Company-wide program to control operating expenses. The Company is consolidating certain administrative support areas for the Proffitt's and McRae's Divisions (accounting, credit, and management information systems) during spring 1995. The Company anticipates further leverage of selling, general, and administrative expenses in 1995 due to these consolidations, increased sales volume, and continued expense control efforts. STORE PRE-OPENING EXPENSES The Company opened eleven new stores in 1993 and incurred significant store pre-opening expenses. Store pre-opening expenses totaled $5.0 million in 1993 and were immaterial in 1992 and 1994. Effective January 31, 1993, the Company changed its method of accounting for pre-opening costs to expensing such costs when incurred. Previously, pre-opening costs were deferred and amortized over the twelve months immediately following the store openings. OTHER OPERATING EXPENSES Other operating expenses were 7.1% of net sales in 1994, compared to 7.8% in 1993 and 6.8% in 1992. The percent decline in 1994 over 1993 resulted from leverage of these expenses over a larger sales base, primarily due to the addition of the McRae's stores. The increase in 1993 over prior year levels was primarily attributable to additional depreciation and building rent expense related to new stores placed in service throughout 1993 and 1992. FINANCE CHARGE INCOME Finance charge income was 2.2% of net sales in 1994 compared with 3.0% in 1993 and 3.5% in 1992. The decline from 1993 to 1994 was due to the allocation to the third party purchaser of accounts receivable (see "Liquidity") of finance charges of approximately $5.6 million, or 0.9% of sales for the year. There was no such allocation in prior years. For 1994, gross finance charge income (before allocation to third party) was essentially level with the prior year as a percent of sales. The decrease in 1993 from the 1992 level as a percent of sales was primarily due to increased customer usage of third party charge cards and to the underdeveloped customer charge account bases of the Company's proprietary charge cards in new markets. INTEREST EXPENSE Interest expense as a percentage of net sales was 2.5% for 1994, 1.5% for 1993, and 2.3% for 1992. Total interest expense was $15.7 million, $3.0 million, and $2.9 million in 1994, 1993, and 1992, respectively. The significant increase in interest expense in 1994 over prior year levels was attributable to higher borrowings associated with the purchase and operation of new stores in 1993 and the acquisition of McRae's in 1994. INCOME TAXES During 1994, 1993, and 1992, effective income tax rates were 39.4%, 39.0%, and 38.0%, respectively. NET INCOME Net income was $16.1 million in 1994, $6.1 million in 1993, and $6.7 million in 1992, which represents 2.6%, 3.0%, and 5.3% of net sales, respectively. Net income in 1994 rose over 1993 and 1992 levels due to additional sales and gross margin dollars primarily generated from the McRae's Division and having a complete year of operations from the new stores opened during 1993. As a percent of sales, net income was lower in 1994 and 1993 from 1992 due to gross margin and expense factors previously discussed. Net Income 1994 $16.128 million 1993 $6.063 million 1992 $6.747 million 1991 $3.013 million 1990 $2.065 million INFLATION Inflation affects the costs incurred by the Company in its purchase of merchandise and in certain components of its selling, general, and administrative expenses. The Company attempts to offset the effects of inflation through price increases and control of expenses, although the Company's ability to increase prices is limited by competitive factors in its markets. SEASONALITY The Company's business, like that of most retailers, is subject to seasonal influences, with a significant portion of net sales and net income realized during the fourth quarter of each year, which includes the Christmas selling season. In light of this pattern, selling, general, and administrative expenses are typically higher as a percentage of net sales during the first three quarters of each year, and working capital needs are greater in the last quarter of each year. The fourth quarter increases in working capital needs have typically been financed with internally generated funds and borrowings under the Company's revolving credit facility. Generally, more than 30% of the Company's net sales and over 50% of net income are generated during the fourth quarter. LIQUIDITY The Company's primary needs for liquidity are to acquire, renovate, or construct stores, to provide working capital for new and existing stores, and to repay borrowings. Net cash provided by operating activities was $111.3 million in 1994; net cash used in operating activities was $39.8 million and $1.3 million in 1993 and 1992, respectively. The net cash provided in 1994 was primarily due to the Company's profitable operations, the sale of ownership interests in the Company's accounts receivable (see below), and a reduction in inventory levels in the Company's existing store base over the prior year. The cash used in 1993 was primarily related to the building of inventories and trade receivables for newly opened stores. Net cash used in investing activities for 1994 totaled $210.3 million, of which $184.1 million was for the purchase of Macco Investments, Inc. and $24.5 million was related to store renovation and construction, management information systems enhancements, and other capital expenditures. Net cash used in investing activities for 1993 and 1992 totaled $62.6 million and $30.7 million, respectively, and was primarily for purchases of property and equipment and renovations related to the Hess locations. Net cash provided by financing activities for 1994 totaled $85.0 million which was primarily a result of proceeds from long-term borrowings and the issuance of a $30 million convertible preferred security (see below) netted against debt and capital lease payments of $29.2 million. Net cash provided by financing activities for 1993 totaled $117.0 million which was primarily from the proceeds of the $86.3 million subordinated debentures (discussed below), other long-term borrowings, and the $50.2 million public stock offering (discussed below) netted against debt repayments. Net cash provided by financing activities for 1992 totaled $23.1 million which was primarily from the net proceeds of long-term borrowings. In February and March 1993, the Company sold 2.4 million shares of Common Stock to the public. Net proceeds to the Company were approximately $50.2 million after deduction of the underwriting discount and offering expenses. In October and November 1993, the Company issued 4.75% convertible subordinated debentures due in 2003. Net proceeds to the Company were approximately $83.5 million after deduction of the underwriting discount and offering expenses. On March 31, 1994, Proffitt's, Inc. acquired all of the outstanding common stock of Macco Investments, Inc., a holding company for McRae's, Inc., a retail department store chain with 28 stores headquartered in Jackson, Mississippi. Additionally, the Company purchased four regional mall stores owned by McRae family partnerships, which were leased to McRae's. The consideration paid for the purchase of the McRae's shares consisted of $176 million in cash and $34 million in non-cash consideration, comprised primarily of $17.5 million of 7.5% junior subordinated debentures and equity-related securities. The Company also assumed $96 million in existing accounts receivable financing, long-term debt, and capital leases. The purchase price for the four stores owned by the McRae family partnerships totaled $18 million. The financing of the transaction and the combined business included a $175 million facility with a financial institution for the sale of ownership interests in accounts receivable ("Accounts Receivable Facility"), a $125 million revolving credit facility with several banks ("Revolver"), and $20 million of mortgage financing on certain Proffitt's and McRae's properties. The Accounts Receivable Facility requires that a portion of finance charges earned be allocated to the purchaser of the ownership interests in the accounts receivable, sufficient to cover the yield on commercial paper utilized by the purchaser to finance the transaction, plus fees and expenses. The Revolver provides various borrowing options, including prime rate and LIBOR-based rates. Book Value Per Common Share 1994 $15.23 million 1993 $13.35 million 1992 $9.48 million 1991 $8.45 million 1990 $5.86 million Several of the Company's financing agreements limit the Company's additional borrowing and capital lease obligations and require the maintenance of, among other things, various financial ratios and minimum levels of net worth. The agreements also restrict capital expenditures and purchases of Common Stock. To further strengthen the balance sheet of the combined Company, concurrent with the closing of the acquisition, Proffitt's, Inc. issued a privately placed, $30 million, 6.5% convertible preferred security. As of March 15, 1995, the interest rate on the $175 million Accounts Receivable Facility was 6.7%. As of March 15, 1995, $125.1 million was drawn on the Accounts Receivable Facility. The maximum drawn on the Accounts Receivable Facility during 1994 totaled $143.9 million. Amounts drawn on the Accounts Receivable Facility are limited to between 94% and 96% of total accounts receivable. As of March 15, 1995, the interest rate on the $125 million Revolver was 7.4%. Borrowings on the Revolver are limited to 50% of merchandise inventories. As of March 15, 1995, the Company had borrowings totaling $58.8 million outstanding under the Revolver and unused availability of $29.5 million. The maximum amount outstanding under the Revolver during 1994 was $87.4 million. At that time, the Company had unused availability on the Revolver of $37.6 million. At January 28, 1995, total debt was 57% of total capitalization. Excluding the subordinated debentures, which the Company considers permanent capital, senior debt was 33% of total capitalization. The Company estimates total capital expenditures for the combined organization in 1995 will be approximately $25 million, primarily for the relocation of one store, the renovation of several other stores, and enhancements in point-of-sale equipment and management information systems. On March 7, 1995, the Company acquired the majority interest (50.1%) of Parks-Belk Company ("Parks-Belk"), the owner and operator of four department stores in northeast Tennessee. Specific terms of the transaction were not disclosed, but consideration was paid in Proffitt's Common Stock and cash and was less than $10 million. The Company currently is negotiating to purchase the remaining stock of Parks-Belk. The Company estimates capital expenditures for renovations to these store locations will be immaterial. The Company anticipates its capital expenditures and working capital requirements relating to planned new and existing stores will be funded through cash provided by operations, borrowings, and cash reserves. The Company expects to generate adequate cash flows from operating activities to sustain current levels of operations. The Company maintains favorable banking relations and anticipates the necessary credit agreements will be extended or new agreements will be entered into in order to provide future borrowing requirements as needed. RECENT ACCOUNTING PRONOUNCEMENTS There are no recent accounting pronouncements that will have a significant impact on the Company's financial statements. Shareholder's Equity 1994 $180.5 million 1993 $124.0 million 1992 $61.6 million 1991 $54.5 million 1990 $22.2 million MARKET INFORMATION The Company's Common Stock trades on the NASDAQ Stock Market under the symbol PRFT. As of March 15, 1995, there were approximately 630 shareholders of record. Below is a summary of the high and low bid quotations for the Company's Common Stock for each quarterly period for the prior two years. The source of these quotations is the Monthly Statistical Report of the National Association of Securities Dealers, Inc. These quotations represent inter-dealer prices for actual transactions, without adjustment for retail markup, markdown, or commission. The Company presently follows the policy of retaining earnings to provide funds for the operation and expansion of the business and has no present intention to declare cash dividends in the foreseeable future. Future dividends, if any, will be determined by the Board of Directors of the Company in light of circumstances then existing, including the earnings of the Company, its financial requirements, and general business conditions. The Company declared no dividends to common shareholders in either 1994 or 1993. FISCAL YEAR ENDED JANUARY 28, 1995 JANUARY 29, 1994 PRICE RANGE PRICE RANGE QUARTER HIGH LOW HIGH LOW First 25 3/4 16 1/2 26 1/2 21 1/2 Second 19 3/4 14 3/4 27 1/4 21 3/4 Third 21 3/4 14 3/4 36 3/4 23 1/2 Fourth 25 1/4 17 3/4 35 1/2 18 1/4 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors Proffitt's, Inc. We have audited the accompanying consolidated balance sheets of Proffitt's, Inc. and subsidiaries as of January 28, 1995 and January 29, 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended January 28, 1995. These financial statements are the responsibility of the Company'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 consolidated financial position of Proffitt's, Inc. and subsidiaries at January 28, 1995 and January 29, 1994 and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 28, 1995, in conformity with generally accepted accounting principles. As described in Note M to the financial statements, the Company changed its method of costing inventory, accounting for store pre- opening expenses and accounting for income taxes in the year ended January 29, 1994 and changed its method of valuing inventory in the year ended January 28, 1995. COOPERS & LYBRAND L.L.P. Knoxville, Tennessee March 17, 1995 REPORT OF INDEPENDENT ACCOUNTANTS Our report on the consolidated financial statements of Proffitt's, Inc. has been incorporated by reference in this Form 10-K from page 26 of the 1994 Annual Report to Shareholders of Proffitt's, Inc. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in Item 14(a)2 of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. Knoxville, Tennessee March 17, 1995 CONSOLIDATED STATEMENTS OF INCOME (in thousands, except per share amounts) Proffitt's, Inc. and Subsidiaries YEAR ENDED JANUARY 28, JANUARY 29, JANUARY 30, 1995 1994 1993 NET SALES $617,363 $200,884 $128,262 COSTS AND EXPENSES Cost of sales 400,605 129,679 78,225 Selling, general, and administrative expenses 145,560 44,871 31,728 Store pre-opening expenses 4,980 106 Other operating expenses: Property and equipment rentals 11,616 4,638 2,480 Depreciation and amortization 18,397 6,290 3,401 Taxes other than income taxes 13,698 4,826 2,912 OPERATING INCOME 27,487 5,600 9,410 OTHER INCOME (EXPENSE) Finance charge income - Note C 13,653 5,964 4,457 Interest expense (15,655) (2,976) (2,881) Other income (expense), net 1,109 805 (109) INCOME BEFORE PROVISION FOR INCOME TAXES AND CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING METHODS 26,594 9,393 10,877 Provision for income taxes 10,466 3,663 4,130 INCOME BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING METHODS 16,128 5,730 6,747 Cumulative effect of changes in accounting methods (net of tax) - Note M: Inventory costing 702 Store pre-opening (369) NET INCOME 16,128 6,063 6,747 Preferred stock dividends 1,694 NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 14,434 $ 6,063 $ 6,747 Earnings per common share before cumulative effect of changes in accounting methods $ 1.46 $ 0.62 $ 1.02 Cumulative effect of changes in accounting methods: Inventory costing .08 Store pre-opening (.04) Earnings per common share - Note A $ 1.46 $ 0.66 $ 1.02 Weighted average common shares 9,912 9,236 6,591 The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) Proffitt's, Inc. and Subsidiaries JANUARY 28, JANUARY 29, 1995 1994 ASSETS CURRENT ASSETS Cash and cash equivalents $ 1,133 $ 15,200 Trade accounts receivable, less allowance for doubtful accounts of $2,411 in 1994 and $1,195 in 1993 - Note C 2,701 38,652 Accounts receivable - other 7,648 7,278 Merchandise inventory 162,080 73,102 Prepaid supplies and expenses 5,827 1,534 Refundable income taxes 2,429 Deferred income tax asset - Note D 171 1,591 TOTAL CURRENT ASSETS 179,560 139,786 PROPERTY & EQUIPMENT, net of depreciation - Notes B, E, and F 300,285 115,706 GOODWILL, net of amortization - Note B 44,624 OTHER ASSETS Note receivable from related party - Note I 500 500 Other assets 15,086 3,889 TOTAL ASSETS $540,055 $259,881 JANUARY 28, JANUARY 29, 1995 1994 LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Trade accounts payable $ 34,587 $ 6,963 Accrued expenses 21,436 6,468 Accrued compensation and related items 4,980 1,641 Income taxes payable - Note D 149 Current portion of long-term debt and capital lease obligations - Notes F and G 15,269 3,357 TOTAL CURRENT LIABILITIES 76,421 18,429 REAL ESTATE AND MORTGAGE NOTES - Note F 64,726 20,968 NOTES PAYABLE - Note F 47,621 4,000 NOTES PAYABLE TO RELATED PARTY - Note I 1,755 CAPITAL LEASE OBLIGATIONS - Note G 11,319 DEFERRED INCOME TAXES - Note D 54,830 6,191 OTHER LONG-TERM LIABILITIES 2,438 SUBORDINATED DEBENTURES - Note H 98,632 86,250 SUBORDINATED DEBENTURES TO RELATED PARTY - Note H 1,637 COMMITMENTS - Note G SHAREHOLDERS' EQUITY Preferred Stock, $1.00 par value, 10,000 total shares authorized: Series A - 600 shares authorized, issued, and outstanding, $50 per share liquidation preference 28,850 Series B - 33 shares authorized, no shares issued Common Stock, $.10 par value, 100,000 shares authorized, 9,971 and 9,293 shares issued and outstanding at January 28, 1995 and January 29, 1994, respectively 997 929 Additional paid-in capital 113,996 100,715 Retained earnings 36,833 22,399 TOTAL SHAREHOLDERS' EQUITY 180,676 124,043 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $540,055 $259,881 The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in thousands of dollars) Proffitt's, Inc. and Subsidiaries PREFERRED STOCK SERIES A SERIES B Balance at February 1, 1992 $ - $ - Net income Issuance of Common Stock Balance at January 30, 1993 Net income Issuance of Common Stock Income tax benefits related to exercised stock options Balance at January 29, 1994 Net income Issuance of shares - Note B 28,850 3,296 Conversion of Series B Preferred Stock (3,296) Preferred dividends Balance at January 28, 1995 $28,850 $ - (TABLE CONTINUED) ADDITIONAL TOTAL COMMON PAID-IN RETAINED SHAREHOLDERS' STOCK CAPITAL EARNINGS EQUITY Balance at February 1, 1992 $644 $ 44,234 $ 9,589 $ 54,467 Net income 6,747 6,747 Issuance of Common Stock 6 407 413 Balance at January 30, 1993 650 44,641 16,336 61,627 Net income 6,063 6,063 Issuance of Common Stock 279 55,611 55,890 Income tax benefits related to exercised stock options 463 463 Balance at January 29, 1994 929 100,715 22,399 124,043 Net income 16,128 16,128 Issuance of shares - Note B 52 10,001 42,199 Conversion of Series B Preferred Stock 16 3,280 Preferred dividends (1,694) (1,694) Balance at January 28, 1995 $997 $113,996 $36,833 $180,676 The accompanying notes are an integral part of these consolidated financial statements. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands of dollars) Proffitt's, Inc. and Subsidiaries YEAR ENDED JANUARY JANUARY JANUARY 28, 1995 29, 1994 30, 1993 OPERATING ACTIVITIES Net income $ 16,128 $ 6,063 $ 6,747 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Cumulative effect of changes in accounting methods, before income taxes (547) Depreciation and amortization 19,102 6,556 3,510 Deferred income taxes 3,850 1,652 230 Other 289 490 520 Changes in operating assets and liabilities: Trade accounts receivable 65,577 (10,134) (5,805) Merchandise inventory 15,230 (36,407) (10,473) Prepaid expenses and other current assets 1,356 (4,952) (982) Other assets (146) (43) Accounts payable, accrued expenses, and income taxes payable (10,223) (2,332) 5,017 NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 111,309 (39,757) (1,279) INVESTING ACTIVITIES Purchases of property and equipment, net (24,505) (64,095) (24,735) Expenditure for acquired receivables (10,857) Collections of acquired receivables 5,038 5,819 Acquisition of Macco Investments, Inc. (184,067) Other (1,761) (3,541) (921) NET CASH USED IN INVESTING ACTIVITIES (210,333) (62,598) (30,694) FINANCING ACTIVITIES Issuance of convertible subordinated debentures 86,250 Payments of deferred financing fees (2,895) (229) Proceeds from long-term borrowings 85,679 63,395 25,053 Payments on long-term debt and capital lease obligations (29,244) (80,596) (2,111) Proceeds from issuance of stock 29,410 50,862 356 Dividends paid to preferred shareholders (888) NET CASH PROVIDED BY FINANCING ACTIVITIES 84,957 117,016 23,069 (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (14,067) 14,661 (8,904) Cash and cash equivalents at beginning of year 15,200 539 9,443 Cash and cash equivalents at end of year $ 1,133 $ 15,200 $ 539 Noncash investing and financing activities are described in Notes B, D, and F. The accompanying notes are an integral part of these consolidated financial statements. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except per share amounts) Proffitt's, Inc. and Subsidiaries NOTE A - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS At January 28, 1995, the Company operated twenty-five Proffitt's specialty retail department stores located in Tennessee, Georgia, North Carolina, Kentucky, and Virginia; twenty-eight McRae's specialty department stores located in Mississippi, Alabama, Florida, and Louisiana; and one specialty home store. The Company's fiscal year ends on the Saturday nearest January 31 and consisted of 52 weeks for the years ended January 28, 1995, January 29, 1994, and January 30, 1993. CONSOLIDATION The financial statements include the accounts of the Company and its wholly-owned subsidiaries. On March 31, 1994, the Company acquired Macco Investments, Inc., the parent company of McRae's, Inc. (collectively McRae's). The operations of McRae's and its subsidiaries are included after March 31, 1994 (see Note B). REVENUES Retail sales are recorded on the accrual basis, and profits on installment sales are recognized in full when the sales are recorded. Sales are net of returns. TRADE ACCOUNTS RECEIVABLE Trade accounts consist of revolving charge accounts with terms which, in some cases, provide for payments exceeding one year. In accordance with usual industry practice, such receivables are included in current assets. Finance charge income is accrued monthly as a percentage of uncollected customer account balances. Beginning in April 1994, a portion of finance charge income is earned by a financial institution in connection with the sale of interests in accounts receivable (see Note C). INVENTORIES Inventories are valued at the lower of cost or market as determined by the retail inventory method applied on the last-in, first-out (LIFO) method for approximately 76% of the inventories at January 28, 1995 and on the first-in, first-out (FIFO) method for the balance. Prior to the fiscal year ended January 28, 1995, the Company used the FIFO method for all inventories. As of January 28, 1995, the carrying value of inventory approximated its current replacement costs. Prior to January 31, 1993, inventory costs consisted only of "direct costs," principally invoice cost plus freight. Effective January 31, 1993, the Company adopted the "full cost" method. Under the full cost method, inventory costs include the direct costs plus certain purchasing and distribution costs. The impact of this change is further discussed in Note M. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is computed using the straight-line method for financial reporting purposes over the estimated useful lives of the assets, which are 45 years for buildings and range from 4 to 20 years for fixtures, leasehold improvements, and equipment. CASH EQUIVALENTS The Company considers all highly liquid investments purchased with maturities of three months or less to be cash equivalents. LEASED DEPARTMENT SALES The Company includes leased department sales as part of net sales. Leased department sales were $21,775, $3,308, and $2,562 for the years ended January 28, 1995, January 29, 1994, and January 30, 1993, respectively. STORE PRE-OPENING EXPENSES Prior to January 31, 1993, new store pre-opening costs were deferred and amortized over the 12 months immediately following the individual store openings. Effective January 31, 1993, the Company changed its method to expense such costs when incurred. The impact of this change is further discussed in Note M. INCOME TAXES Prior to January 31, 1993, deferred income taxes were provided under the "deferred method" to reflect the tax consequences of timing differences between amounts reported for financial accounting purposes and income tax purposes. Effective January 31, 1993, the Company adopted the "asset and liability method" which recognizes deferred tax assets and liabilities for the differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. The impact of this change is further discussed in Note M. EARNINGS PER COMMON SHARE Earnings per common share have been computed based on the weighted average number of common shares outstanding, including common stock equivalents, after recognition of preferred stock dividends of $1,694 for the year ended January 28, 1995. There were no preferred dividends in prior years. The weighted average number of common shares outstanding was 9,912 for the year ended January 28, 1995, 9,236 for the year ended January 29, 1994, and 6,591 for the year ended January 30, 1993. The Company's 4.75% convertible subordinated debentures issued in October 1993 and 7.5% junior subordinated debentures issued in March 1994 are not common stock equivalents, and therefore, shares issuable upon their conversion are included only in the computation of fully diluted earnings per share. The difference between primary and fully diluted earnings per share was not significant in any year. GOODWILL In connection with the March 31, 1994 acquisition of McRae's, the Company has classified as goodwill the cost in excess of fair value of the net assets acquired. Goodwill is being amortized on a straight-line method over 40 years, and the Company recognized amortization charges of $949 during 1994. At each balance sheet date, the Company evaluates the realizability of goodwill based upon expectations of nondiscounted cash flows and operating income. Based upon its most recent analysis, the Company believes that no material impairment of goodwill exists at January 28, 1995. NOTE B - ACQUISITION On March 31, 1994, the Company acquired all of the common stock of Macco Investments, Inc. (Macco), a privately held corporation and the parent company of McRae's, Inc. (McRae's). The total acquisition price of approximately $212 million consisted of a cash payment of $176 million and the issuance of (i) 436 shares of Proffitt's, Inc. Common Stock, (ii) the Company's 7.5% Junior Subordinated Debentures due March 31, 2004 in an aggregate face amount equal to $17.5 million, (iii) 33 shares of Series B Cumulative Junior Perpetual Preferred Stock, (iv) the Company's promissory notes to certain of the Macco shareholders for $2 million, and (v) transaction costs of approximately $6 million. In addition and in connection with the acquisition, the Company purchased four regional mall stores owned by McRae family partnerships and leased to McRae's for $18.5 million. McRae's was a privately-owned regional specialty department store company, offering moderate to upper-moderate brand name and private label fashion apparel, shoes, accessories, cosmetics, and home furnishings. McRae's operates 28 department stores in Mississippi, Alabama, Louisiana, and Florida. The Company now operates two divisions: the Proffitt's Stores Division and the McRae's Stores Division. The financing of the acquisition included a $175 million accounts receivable financing program through a financial institution; a $125 million bank revolving credit facility; $20 million of mortgage financing on certain Proffitt's and McRae's properties; and a private sale of $30 million Series A Cumulative Convertible Exchangeable Preferred Stock. The following unaudited pro forma summary presents the consolidated results of operations as if the acquisition had occurred at the beginning of the years presented and do not purport to be indicative of what would have occurred had the acquisition been made as of these dates or of results which may occur in the future. Pro forma: (Unaudited) YEAR ENDED JANUARY 28, JANUARY 29, 1995 1994 Net sales $680,405 $619,665 Income before cumulative effect of changes in accounting methods $ 17,909 $ 20,214 Net income $ 17,909 $ 20,547 Earnings per common share before cumulative effect of changes in accounting methods $ 1.60 $ 1.86 Earnings per common share $ 1.60 $ 1.90 The allocation of the purchase price was as follows: Working capital $ 68,396 Property and equipment 176,907 Goodwill 45,574 Other assets 10,409 Long-term debt (32,877) Capital lease obligations (11,695) Deferred income taxes (42,432) Other long-term liabilities (2,484) $ 211,798 NOTE C - SALE OF ACCOUNTS RECEIVABLE On April 1, 1994, the Company sold an ownership interest in its accounts receivable. The Company recognized no gain or loss on this transaction. Under the agreement with the purchaser, which expires March 1996, the purchaser's share of collections on accounts may be remitted to the purchaser, or the Company, at its option, may substitute newly created receivables and retain the collections. The Company may obtain additional proceeds by increasing the ownership interest transferred to the purchaser, or reduce the purchaser's interest by remitting a portion of the collections to the purchaser. The ownership interest which may be transferred to the purchaser is limited to $175 million and is further restricted on the basis of the level of eligible receivables and a minimum ownership interest to be maintained by the Company. The Company sold $333,473 of its accounts receivable during 1994, and the ownership interest transferred to the purchaser, which is reflected as a reduction of accounts receivable, was $138,740 at January 28, 1995. Finance charges to the Company's customers on the purchaser's portion of receivables are used to cover the purchaser's borrowing costs (the yield on commercial paper issued by the purchaser), fees related to the level of the purchaser's investment, and related expenses, including fees paid to the Company to service the receivables. The balance of finance charges is retained by the Company. Finance charges retained by the purchaser were $5,567 in 1994. The Company is contingently liable for the collection of the receivables sold. Management believes that the allowance for doubtful accounts of $2,411 at January 28, 1995 is adequate for losses under this recourse provision. The agreement contains certain covenants requiring the maintenance of various financial ratios. If these covenants are not met or if an event of default was to occur, the purchaser could be entitled to terminate the agreement. NOTE D - INCOME TAXES The components of income tax expense were as follows: YEAR ENDED JANUARY 28, JANUARY 29, JANUARY 30, 1995 1994 1993 Current: Federal $ 5,109 $ 1,964 $ 3,281 State 1,507 260 619 6,616 2,224 3,900 Deferred: Federal 3,348 1,375 216 State 502 277 14 3,850 1,652 230 $ 10,466 $ 3,876 $ 4,130 The primary sources of significant timing differences for 1992 which gave rise to deferred taxes included depreciation expense, inventory capitalization, deferred costs, and bad debts. Components of the net deferred tax asset or liability recognized in the consolidated balance sheets as of January 28, 1995 and January 29, 1994 were as follows: JANUARY 28, JANUARY 29, 1995 1994 Current: Deferred tax assets: Allowance for doubtful accounts $ 809 $ 326 Other current assets 99 Tax credits 423 412 Accrued expenses 1,250 853 2,581 1,591 Deferred tax liabilities: Inventory (2,410) Net deferred tax asset $ 171 $ 1,591 Noncurrent: Deferred tax assets: Capital leases $ 837 Other long-term liabilities 951 1,788 Deferred tax liabilities: Property and equipment (49,855) $ (6,134) Other assets (5,406) (57) Junior subordinated debentures (1,357) (56,618) (6,191) Net deferred tax liability $(54,830) $ (6,191) Income tax expense varies from the amount computed by applying the statutory federal income tax rate to income before taxes. The reasons for this difference were as follows: YEAR ENDED JANUARY 28, JANUARY 29, JANUARY 30, 1995 1994 1993 Statutory rate 35.0% 34.0% 34.0% State income taxes, net of federal benefit 3.0 4.0 4.0 Other items, net 1.4 1.0 Effective rate 39.4% 39.0% 38.0% During the year ended January 29, 1994, certain incentive and nonqualified stock options (for income tax purposes) were exercised. The difference between the purchase price of the stock established at the date of grant and the fair value at date of exercise was deducted as compensation for income tax purposes without a corresponding expense recorded for financial reporting purposes. The tax benefit of $463 relating to such was credited to additional paid-in capital. There were no material amounts of such options exercised during the years ended January 28, 1995 and January 30, 1993. The Company made income tax payments, net of refunds received, of $9,764, $5,870, and $3,292 during the years ended January 28, 1995, January 29, 1994, and January 30, 1993, respectively. NOTE E - PROPERTY AND EQUIPMENT A summary of property and equipment at January 28, 1995 and January 29, 1994 was as follows: JANUARY 28, JANUARY 29, 1995 1994 Land and land improvements $ 38,848 $ 7,358 Buildings 123,319 43,547 Leasehold improvements 40,786 22,333 Fixtures and equipment 128,898 66,447 Construction in progress 9,265 341,116 139,685 Accumulated depreciation (40,831) (23,979) $300,285 $115,706 NOTE F - SENIOR LONG-TERM DEBT A summary of senior long-term debt at January 28, 1995 and January 29, 1994 was as follows: JANUARY 28, JANUARY 29, 1995 1994 Real estate and mortgage notes, interest ranging from 3.75% to 10.375%, maturing 1995 to 2008, collateralized by property and equipment with a carrying amount of approximately $110,977 at January 28, 1995 $ 73,791 $ 22,825 Subordinated notes payable to individuals, interest at 12.00%, maturing 1997, callable by the holders with written notice six months prior to payment date 5,266 Notes payable, interest ranging from 10.36% to 13.00%, maturing 1995 to 1998 4,888 5,500 Revolving credit agreement, interest at 7.01% at January 28, 1995 45,000 128,945 28,325 Current portion (14,843) (3,357) $114,102 $ 24,968 Real estate and mortgage notes include a note payable of $1,803 at January 28, 1995, which is subject to call at any time after February 1, 1997. Also, included are notes payable of $3,288 at January 28, 1995, which are subject to call (with six months notification) at any time after November 3, 1996. In conjunction with a real estate mortgage note having a balance of $7,650 at January 28, 1995, the Company entered into an interest rate swap agreement for the management of interest rate exposure. The differential to be paid or received is included in interest expense. The agreement swaps the variable rate for a fixed rate of 5.7%. This agreement extends to June 30, 2003. The Company continually monitors its position and the credit rating of the interest rate swap counterparty. While the Company may be exposed to credit losses in the event of nonperformance by the counterparty, it does not anticipate such losses. At January 28, 1995, the Company owed $45 million under a revolving credit agreement (Revolver) with banks. Borrowings under the Revolver are limited to 50% of merchandise inventories up to a maximum borrowing of $125 million, and interest rate options are based on the LIBOR rate and prime rate. The agreement expires in 1997 and subject to mutual agreement, can be extended for up to two additional periods of one year each. In addition to certain general requirements, the credit agreement requires the Company to meet specific covenants related to current ratio, fixed charges, funded debt, capitalization, and tangible net worth. Certain other note agreements also impose restrictions and financial maintenance requirements. Maturities of long-term debt for the next five years, giving consideration to lenders' call privileges, are as follows: FISCAL YEAR END 1996 $ 14,843 1997 14,667 1998 57,600 1999 4,602 2000 21,434 The Company made interest payments of $13,090, $2,743, and $2,842 during the years ended January 28, 1995, January 29, 1994, and January 30, 1993, respectively. Capitalized interest was $303 and $787 for the years ended January 28, 1995 and January 29, 1994, respectively. No material amount of interest was capitalized for the year ended January 30, 1993. NOTE G - LEASES The Company is committed under long-term leases primarily for the rentals of certain retail stores. The leases generally provide for minimum annual rentals (including executory costs such as real estate taxes and insurance) and contingent rentals based on a percentage of sales in excess of stated amounts. Generally, the leases have primary terms ranging from 20 to 30 years and include renewal options ranging from 5 to 15 years. At January 28, 1995, minimum rental commitments under capital leases and operating leases with terms in excess of one year are as follows: FISCAL YEAR END CAPITAL LEASES OPERATING LEASES 1996 $ 2,179 $ 7,267 1997 2,179 7,006 1998 2,179 6,861 1999 2,179 6,472 2000 2,165 6,080 Thereafter 21,219 41,226 Total minimum rental commitments 32,100 $ 74,912 Estimated insurance, taxes, maintenance, and utilities (7,863) Net minimum rental commitments 24,237 Imputed interest (rates ranging from 8.00% to 17.80%) (12,492) Present value of net minimum rental commitments 11,745 Less current installments of capital lease obligations (426) Capital lease obligations, excluding current installments $ 11,319 Contingent rentals on capital leases were $213 in 1994. Total rental expense for operating leases was as follows: YEAR ENDED JANUARY 28, JANUARY 29, JANUARY 30, 1995 1994 1993 Buildings: Minimum rentals $ 8,549 $ 3,570 $ 1,684 Contingent rentals 2,244 953 721 Equipment 823 115 75 $11,616 $ 4,638 $ 2,480 NOTE H - SUBORDINATED DEBENTURES In October 1993, the Company issued $86,250 of 4.75% convertible subordinated debentures, due November 1, 2003, with interest due semi-annually. The debentures are convertible into the Company's Common Stock at any time prior to maturity, unless previously redeemed, at a conversion price of $42.70 per share. The debentures are redeemable for cash at any time on or after November 15, 1996, at the option of the Company at specified redemption prices. In March 1994, the Company issued 7.50% junior subordinated debentures with a face value of $17,500. The debentures were discounted to reflect their fair value and have an accreted carrying value of $14,019 at January 28, 1995. A Director of the Company owns $1,637 of these debentures. During the year ended January 29, 1994, a $5,000 convertible subordinated debenture was converted into Common Stock at a conversion price of $16 per share. NOTE I - RELATED PARTY TRANSACTIONS In February 1989, the Company entered into an agreement with the Chairman of the Board and Chief Executive Officer for an unsecured $500 interest-free loan due January 31, 1999. The loan was made as a supplement to this individual's base compensation, and interest was imputed on this loan at 5.54% for 1994. The Company is obligated under 6.50% second mortgage real estate notes to a Director of the Company in the amount of $1,755. NOTE J - STOCK OPTIONS The Company's 1987 Stock Option Plan, as amended, provided for the granting of options of Common Stock not to exceed 490 shares to officers, key employees, and Directors. No additional options are to be granted under the 1987 Plan. On March 1, 1994, the Company's Board of Directors adopted the Proffitt's, Inc. 1994 Long-Term Incentive Plan pursuant to which stock options, stock appreciation rights, restricted shares of Common Stock, and performance units may be awarded to officers, key employees, and Directors. This Plan has available for grant 1,200 shares of Common Stock of the Company. Stock option activity was as follows: SHARES STOCK OPTION PRICE RANGE Balance at February 1, 1992 295 $ 5.250 $ 8.125 Granted 78 12.000 Exercised (53) 5.250 12.000 Balance at January 30, 1993 320 5.250 12.000 Granted 199 23.625 28.500 Exercised (81) 5.250 12.000 Balance at January 29, 1994 438 5.250 28.500 Granted 660 18.250 24.500 Exercised (70) 5.250 23.625 Cancelled (9) 12.000 23.625 Balance at January 28, 1995 1,019 5.250 28.500 At January 28, 1995, incentive stock options and nonqualified stock options for 380 shares were exercisable. NOTE K - STOCK TRANSACTIONS In February and March 1993, the Company sold 2,395 shares of Common Stock at $22.25 per share in a public offering. Net proceeds to the Company were approximately $50.2 million after the underwriting discount and offering expenses. On March 31, 1994, the Company issued 600 shares of Series A Cumulative Convertible Exchangeable Preferred Stock in a private offering. Net proceeds to the Company were approximately $28.5 million after offering expenses. Dividends are cumulative and are paid in March and September at $3.25 per annum per share (6.50%). The Preferred Stock is convertible into Common Stock at a price of $21.10 per share and has a liquidation preference of $50 per share. The Company may redeem the stock, in whole or in part, at $52.50 per share after two years based on certain conditions, and in any event after four years. The stock is exchangeable at the Company's option in whole on any dividend payment date on the basis of $50 of 6.50% Exchange Debentures for each share. The stock gains voting rights when three semi-annual dividends are in arrears, and at that time, the shareholder may appoint one representative to the Company's Board of Directors. NOTE L - ASSET PURCHASES From October 1992 to July 1993, the Company purchased certain real and personal property and assumed certain operating leases of eighteen store locations from Hess's Department Stores, Inc. (Hess) and Crown American Corporation. The acquired locations were in Tennessee, Virginia, Kentucky, and Georgia. The total purchase price for the acquired property was approximately $24 million which was financed through the Company's revolving credit facility. The Company did not acquire the merchandise inventories of the locations. These stores were renovated and placed in service as Proffitt's stores between November 1992 and November 1993. Also, in October 1992, in a related but separate transaction, the Company purchased from Citicorp Retail Services, Inc. a portion of the trade accounts receivable generated by the proprietary credit card program of Hess for the trade areas related to the property purchased. The total purchase price for the trade accounts receivable was $10.9 million which was financed through the Company's revolving credit facility. NOTE M - CHANGES IN ACCOUNTING METHODS Effective January 31, 1993, the Company changed its method of accounting for inventory to include certain purchasing and distribution costs. Previously, these costs were charged to expense in the period incurred rather than in the period in which the merchandise was sold. The Company believes this new method is preferable because it provides a better matching of the full cost of obtaining merchandise and preparing it for sale with the related revenues. The cumulative effect of this change for periods prior to January 31, 1993 of $702 (net of income taxes of $449) is shown separately in the consolidated statement of income. The effect of this change on the fiscal year ended January 29, 1994 was to increase net income before the cumulative effect by $461, or $.05 per common share. Effective January 31, 1993, the Company also changed its method of accounting for store pre-opening costs to expensing such costs when incurred. Previously, these costs were amortized over the 12 months immediately following the individual store openings. The Company believes this new method is preferable because it is more conservative and is more prevalent in the industry. The cumulative effect of this change for periods prior to January 31, 1993 of $369 (net of income taxes of $236) is shown separately in the consolidated statement of income. The effect of this change on the fiscal year ended January 29, 1994 was to decrease net income before cumulative effect by $1,665, or $.18 per common share. In 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes, which requires a change from the deferred method to the asset and liability method of accounting for income taxes. The Company adopted the new accounting standard effective January 31, 1993. Adoption of the new standard had no effect on the Company's financial position or results of operations. There would have been no impact on 1992 had the standard been applied retroactively. The pro forma net income and earnings per common share, if the accounting changes for inventories and store pre-opening costs had been retroactively applied, were as follows: YEAR ENDED JANUARY 30, 1993 Pro forma: Net income $ 6,538 Earnings per common share $ .99 Historical: Net income $ 6,747 Earnings per common share $ 1.02 Effective January 30, 1994, the Company changed its method of accounting for inventory to the last-in, first-out (LIFO) method for approximately 76% of its inventories. Previously, all inventories were valued using the first-in, first-out (FIFO) method. The Company believes this new method is preferable because it more accurately matches costs with revenues and is more prevalent in the industry. At January 28, 1995, inventories costed under LIFO approximated FIFO. The cumulative effect of this change is not presented because it is not determinable. NOTE N - FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instrument: The fair values of cash and cash equivalents, accounts receivable, and short-term debt approximates cost due to the immediate or short-term maturity of these instruments. For variable rate notes that reprice frequently, fair value approximates carrying value. The fair values of fixed rate notes are estimated using discounted cash flow analyses with interest rates currently offered for loans with similar terms and credit risk. The fair values of convertible subordinated debentures are based on quoted market prices. For junior subordinated debentures, the fair values are estimated using discounted cash flow analyses with interest rates currently offered for financial instruments with similar terms and credit risk. The fair value of the Preferred Stock, which was issued in a private placement, is estimated at carrying value as such stock is not traded in the open market and a market price is not readily available. The fair values of the Company's aforementioned financial instruments at January 28, 1995 were as follows: CARRYING ESTIMATED AMOUNT FAIR VALUE Cash and cash equivalents $ 1,133 $ 1,133 Accounts receivable 2,701 2,701 Fixed rate notes payable 10,154 10,723 Variable rate notes payable 45,000 45,000 Fixed rate real estate and mortgage notes 41,781 41,369 Variable rate real estate and mortgage notes 32,010 32,010 Convertible subordinated debentures 86,250 65,119 Junior subordinated debentures 14,019 14,019 Convertible exchangeable Preferred Stock 28,850 28,850 NOTE O - SUBSEQUENT EVENT On March 7, 1995, the Company acquired a majority interest (50.1%) of Parks-Belk Company, the owner and operator of four department stores in northeast Tennessee. Specific terms of the transaction were not disclosed, but consideration was paid in Proffitt's, Inc. Common Stock and cash and was less than $10 million. The Company is negotiating to purchase the remaining interest. REPORTS REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors Proffitt's, Inc. We have audited the accompanying consolidated balance sheets of Proffitt's, Inc. and subsidiaries as of January 28, 1995 and January 29, 1994, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended January 28, 1995. These financial statements are the responsibility of the Company'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 consolidated financial position of Proffitt's, Inc. and subsidiaries at January 28, 1995 and January 29, 1994 and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 28, 1995, in conformity with generally accepted accounting principles. As described in Note M to the financial statements, the Company changed its method of costing inventory, accounting for store pre-opening expenses and accounting for income taxes in the year ended January 29, 1994 and changed its method of valuing inventory in the year ended January 28, 1995. Knoxville, Tennessee March 17, 1995 REPORT OF MANAGEMENT The accompanying consolidated financial statements, including the notes thereto, and the other financial information presented in the Annual Report have been prepared by management. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts that are based upon our best estimates and judgements. Management is responsible for the consolidated financial statements, as well as the other financial information in this Annual Report. The Company maintains an effective system of internal accounting control. We believe that this system provides reasonable assurance that transactions are executed in accordance with management authorization and that they are appropriately recorded in order to permit preparation of financial statements in conformity with generally accepted accounting principles and to adequately safeguard, verify, and maintain accountability of assets. Reasonable assurance is based on the recognition that the cost of a system of internal control should not exceed the benefits derived. The consolidated financial statements and related notes have been audited by independent certified public accountants. Management has made available to them all of the Company's financial records and related data and believes all representations made to them during their audits were valid and appropriate. Their reports provide an independent opinion upon the fairness of the financial statements. The Audit Committee of the Board of Directors is composed of three outside Directors. The Committee is responsible for recommending the independent certified public accounting firm to be retained for the coming year, subject to shareholder approval. The Audit Committee meets periodically with the independent auditors, as well as with management, to review accounting, auditing, internal accounting control, and financial reporting matters. The independent auditors have unrestricted access to the Audit Committee. /s/ R. Brad Martin /s/ James E. Glasscock R. Brad Martin James E. Glasscock Chairman of the Board and Executive Vice President, Chief Chief Executive Officer Financial Officer, and Treasurer