1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Whitehall Jewellers, Inc.
In our opinion, the accompanying balance sheets and the related statements of
operations, shareholders' equity, and cash flow, present fairly, in all material
respects, the financial position of Whitehall Jewellers, Inc. (the "Company") at
January 31, 2000 and 1999, and the results of its operations and its cash flows
for each of the three years in the period ended January 31, 2000, in conformity
with accounting principles generally accepted in the United States. 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 of these statements in accordance with
auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.
Chicago, Illinois
February 22, 2000
2
BALANCE SHEETS
as of January 31, 2000, and January 31, 1999 (in thousands, except for share
amounts)
2000 1999
------------ ------------
ASSETS
Current assets:
Accounts receivable, net $ 3,159 $ 3,297
Layaway receivables, net 5,638 3,514
Merchandise inventories 147,691 116,748
Other current assets 1,109 1,329
Deferred income taxes, net 2,086 1,518
Deferred financing costs 362 143
------------ ------------
Total current assets 160,045 126,549
Property and equipment, net 49,144 34,304
Goodwill, net 6,186 6,448
Deferred income taxes, net 613 926
Deferred financing costs 948 1,529
------------ ------------
Total assets $ 216,936 $ 169,756
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Outstanding checks, net $ 17,207 $ 8,003
Revolver loans 41,117 28,886
Current portion of long-term debt 3,250 2,750
Accounts payable 37,005 25,601
Income taxes 7,315 5,226
Accrued payroll 5,945 4,174
Other accrued expenses 16,868 13,431
------------ ------------
Total current liabilities 128,707 88,071
Total long-term debt, net of current portion 14,640 17,890
Other long-term liabilities 1,661 1,627
------------ ------------
Total liabilities 145,008 107,588
Commitments and contingencies
Stockholders' equity:
Common stock, ($.001 par value; 30,000,000 shares
authorized; 15,353,120 shares, 15,278,789 shares issued,
respectively) 15 15
Class B common stock, ($1.00 par value; 29,567 shares
authorized; 152 shares issued and outstanding) -- --
Additional paid-in capital 60,426 60,003
Accumulated earnings 21,484 2,150
------------ ------------
81,925 62,168
Treasury stock, 883,376 and 26 shares, respectively, at cost (9,997) --
------------ ------------
Total stockholders' equity, net 71,928 62,168
------------ ------------
Total liabilities and stockholders' equity $ 216,936 $ 169,756
============ ============
The accompanying notes are an integral part of the financial statements.
3
STATEMENTS OF OPERATIONS
for the years ended January 31, 2000, 1999 and 1998
(in thousands, except for per share data)
2000 1999 1998
--------- --------- ---------
Net sales $ 315,406 $ 238,942 $ 188,898
Cost of sales (including buying and occupancy expenses) 182,898 139,368 110,873
--------- --------- ---------
Gross profit 132,508 99,574 78,025
Selling, general and administrative expenses 95,252 72,261 55,809
--------- --------- ---------
Income from operations 37,256 27,313 22,216
Interest expense 5,819 4,123 3,806
--------- --------- ---------
Income before income taxes 31,437 23,190 18,410
Income tax expense 12,103 8,928 7,180
--------- --------- ---------
Income before extraordinary item 19,334 14,262 11,230
Extraordinary item, net -- -- (1,035)
--------- --------- ---------
Net income $ 19,334 $ 14,262 $ 10,195
========= ========= =========
Basic earnings per share:
Income before extraordinary item $ 1.33 $ 0.93 $ 0.74
Extraordinary item, net -- -- (0.07)
--------- --------- ---------
Net income $ 1.33 $ 0.93 $ 0.67
========= ========= =========
Weighted average common share and common share
equivalents 14,560 15,275 15,140
========= ========= =========
Diluted earnings per share:
Income before extraordinary item $ 1.28 $ 0.92 $ 0.73
Extraordinary item, net -- -- (0.07)
--------- --------- ---------
Net income $ 1.28 $ 0.92 $ 0.66
========= ========= =========
Weighted average common share and common share
equivalents 15,129 15,495 15,338
========= ========= =========
The accompanying notes are an integral part of the financial statements.
4
STATEMENTS OF STOCKHOLDERS' EQUITY
for the years ended January 31, 2000, 1999 and 1998
(in thousands)
Common Class B Additional Accumulated
Stock Common Stock Paid-In Capital Earnings/(Deficit) Treasury Stock
---------------------------------------------------------------------------------
Balance at January 31, 1997 $ 15 -- $ 59,799 $(22,307) --
Net income -- -- -- 10,195 --
Exercise of options -- -- 101 -- --
---------------------------------------------------------------------------------
Balance at January 31, 1998 15 -- 59,900 (12,112) --
Net income -- -- -- 14,262 --
Exercise of options -- -- 103 -- --
---------------------------------------------------------------------------------
Balance at January 31, 1999 15 -- 60,003 2,150 --
Net income -- -- -- 19,334 --
Exercise of options -- -- 423 -- --
Treasury stock repurchase -- -- -- -- (9,997)
---------------------------------------------------------------------------------
Balance at January 31, 2000 $ 15 -- $ 60,426 $ 21,484 $ (9,997)
=================================================================================
The accompanying notes are an integral part of the financial statements.
5
STATEMENTS OF CASH FLOWS
for the years ended January 31, 2000, 1999 and 1998 (in thousands)
2000 1999 1998
--------- --------- ---------
Cash flows from operating activities:
Net income $ 19,334 $ 14,262 $ 10,195
Adjustments to reconcile net income to net cash
provided by operating activities:
Loss on extinguishment of debt, net of taxes -- -- 218
Depreciation and amortization 7,603 5,204 3,964
Loss on disposition of assets 380 84 41
Proceeds from accounts receivables sold, net -- 4,041 --
Changes in assets and liabilities, net of effects of acquisition:
Decrease (increase) in accounts receivable, net 138 (754) (1,178)
(Increase) in layaway receivables, net (2,124) (878) (595)
(Increase) in merchandise inventories, net of gold consignment (30,943) (28,476) (20,571)
Decrease (increase) in other current assets 220 (216) (358)
(Increase) decrease in deferred taxes, net (255) 688 4,241
(Increase) in deferred financing costs -- (1,215) (100)
Increase in accounts payable 11,404 9,076 1,819
Increase in accrued liabilities and long-term liabilities 7,331 9,193 2,712
--------- --------- ---------
Net cash provided by operating activities 13,088 11,009 388
Cash flows from investing activities:
Capital expenditures (22,199) (14,667) (10,495)
Payment for acquired jewelry stores -- (21,760) --
Proceeds from assets sold, net -- 467 --
--------- --------- ---------
Net cash used in investing activities (22,199) (35,960) (10,495)
Cash flows from financing activities:
Borrowing on revolver loan 343,362 273,930 499,529
Repayment of revolver loan (334,146) (261,885) (493,435)
Repayment of term loan (2,750) -- --
Repayment of old term loan -- (11,426) --
Repayment of subordinated debt -- -- (9,880)
Proceeds from term loan -- 20,000 11,426
Proceeds from gold consignment 3,015 5,984 --
Proceeds from exercise of stock options 423 103 101
Purchases of treasury stock (9,997) -- --
Increase (decrease) in outstanding checks, net 9,204 (1,755) 2,366
--------- --------- ---------
Net cash provided by financing activities 9,111 24,951 10,107
--------- --------- ---------
Net change in cash and cash equivalents -- -- --
Cash and cash equivalents at beginning of period -- -- --
--------- --------- ---------
Cash and cash equivalents at end of period $ -- $ -- $ --
========= ========= =========
Supplemental disclosures of cash flow information:
Interest paid during year $ 5,419 $ 3,913 $ 3,481
Income taxes paid during year 10,188 4,659 945
The accompanying notes are an integral part of the financial statements.
6
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF OPERATIONS
The financial statements of Whitehall Jewellers, Inc. (the "Company") include
the results of the Company's chain of specialty retail fine jewelry stores. The
Company operates exclusively in one business segment, specialty retail jewelry.
The Company has a national presence with 290 stores as of January 31, 2000,
located in 32 states operating in regional or super-regional shopping malls.
2. ACQUISITION
On September 10, 1998, the Company acquired substantially all of the assets of
36 jewelry stores operating under the Jewel Box name from Carlyle & Co. Jewelers
and its affiliates, headquartered in Greensboro, North Carolina. The stores are
located in eight states in the Southeastern United States. The Company purchased
all associated inventory, accounts receivable and fixed assets for approximately
$22 million (including fees and other costs) in cash (the "Acquisition"). The
Company financed the Acquisition through a term loan and revolving credit
facility under its Credit Agreement (see Note 8, Financing Arrangements). In a
related transaction, the Company sold all of the acquired Jewel Box customer
accounts receivable for cash to BancOne, N.A.
The Acquisition has been accounted for using the purchase method of accounting,
and, accordingly, the purchase price has been allocated to the assets purchased
and the liabilities assumed based upon the fair values at the date of
Acquisition. The excess of the purchase price over the fair values of the net
assets acquired was $6.6 million and has been recorded as goodwill, which is
being amortized on a straight-line basis over 25 years. Goodwill amortization
was $262,000 and $106,000 for the years ended January 31, 2000 and 1999,
respectively.
The net purchase price was allocated as follows:
- ----------------------------------------------------------
(in thousands)
- ----------------------------------------------------------
Inventory $ 9,636
- ----------------------------------------------------------
Accounts receivable 3,902
- ----------------------------------------------------------
Other current assets 121
- ----------------------------------------------------------
Fixed assets 1,861
- ----------------------------------------------------------
Other accrued expenses (315)
- ----------------------------------------------------------
Goodwill 6,555
- ----------------------------------------------------------
- ----------------------------------------------------------
Purchase price $21,760
- ----------------------------------------------------------
7
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
For the purpose of the statements of cash flows, the Company considers all
temporary cash investments purchased with a maturity of three months or less to
be cash equivalents.
OUTSTANDING CHECKS
Outstanding checks are stated net of store cash balances of approximately
$2,569,000 and $1,787,000 as of January 31, 2000 and 1999, respectively.
LAYAWAY RECEIVABLES, NET
Layaway receivables include those sales to customers under the Company's layaway
policies, which have not been collected fully as of the end of the year. Layaway
receivables are net of customer payments received to date, and net of an
estimate for those layaway sales, which the Company anticipates will never be
consummated. This estimate is based on the Company's historical calculation of
layaway sales that will never be completed. The Company charges the customer
to cover the costs of administration for inactive layaways. Effective
February 1, 2000, the Company will change its accounting policy for layaway
sales in consideration of guidance issued by the Securities and Exchange
Commission in accordance with Staff Accounting Bulletin 101, ("Revenue
Recognition in Financial Statements"). See Note 15, Subsequent Events.
MERCHANDISE INVENTORIES
Merchandise inventories are stated principally at the lower of average cost or
market. The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations are not reflected in the Company's financial statements. At the time
of sale, the Company records the purchase liability and the related cost of
merchandise in cost of sales.
8
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost, less accumulated depreciation and
amortization. Furniture and fixtures are depreciated on a straight-line basis
over estimated useful lives ranging from five to ten years. Software costs are
amortized on a straight-line basis over five years. Leasehold improvements are
amortized on a straight-line basis over the lesser of the remaining lease terms
or ten years.
Upon retirement or disposition of property and equipment, the applicable cost
and accumulated depreciation are removed from the accounts and any resulting
gains or losses are included in the results of operations.
LONG LIVED ASSETS
When facts and circumstances indicate potential impairment, the Company
evaluates the recoverability of long lived assets carrying values, using
estimates of undiscounted future cash flows over remaining asset lives. When
impairment is indicated, any impairment loss is measured by the excess of
carrying values over fair values.
GOODWILL
Goodwill represents the excess of cost over the fair values of assets acquired
and is amortized over 25 years using the straight-line method.
DEFERRED FINANCING COSTS
In connection with the Company's financing agreements, the Company incurred
various financing costs, which have been deferred on the Company's balance sheet
and are amortized over the terms of the agreements.
STORE PREOPENING EXPENSE
Expenses associated with the opening of new store locations are expensed in the
period such costs are incurred.
9
LEASE EXPENSE
The Company leases office facilities and all retail stores. Certain leases
require increasing annual minimum lease payments over the term of the lease.
Minimum lease expense under these agreements is recognized on a straight-line
basis over the terms of the respective leases. Virtually all leases covering
retail stores provide for additional contingent rentals based on a percentage of
sales. These costs are expensed in the period incurred.
REVENUE RECOGNITION
The Company recognizes revenue when the customer takes title to merchandise or
based upon the opening of layaway accounts. Effective February 1, 2000, the
Company will change its accounting policy for layaway sales and recognize
revenue on layaway sales upon delivery of the merchandise to the customer (see
Note 15, Subsequent Events).
EARNINGS PER SHARE
Earnings per share are calculated by dividing net income by the weighted average
common and potentially issuable shares outstanding during the period. The
Company completed a three-for-two stock split effected in the form of a stock
dividend payable on January 4, 2000 to all common shareholders of record at the
close of business on December 24, 1999. The financial statements have been
restated for all periods presented to give effect to this split.
INCOME TAXES
Deferred income taxes are recognized for the tax consequences in future years of
differences between the tax bases of assets and liabilities and their financial
reporting amounts based on enacted tax laws and statutory tax rates applicable
to the periods in which the differences are expected to affect taxable earnings.
A valuation allowance is established when necessary to reduce deferred tax
assets to the amount expected to be realized.
STOCK-BASED COMPENSATION
The Company accounts for stock based compensation under the basis of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and
will continue to do so in the future. However, the disclosure requirements of
SFAS No. 123, "Accounting for Stock-Based Compensation", have been adopted.
10
COMPREHENSIVE INCOME
The Company has adopted Statement of Financials Accounting Standards No. 130
(SFAS 130) "Reporting Comprehensive Income", for the years ended January 31,
2000, 1999 and 1998. The Company has no components of other comprehensive
income, as defined by SFAS 130, which are not contained in net income as
reported on the accompanying statements of operations.
MANAGEMENT ESTIMATES
The preparation of financial statements in conjunction 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.
RECLASSIFICATIONS
Certain amounts for the years ended January 31, 1999 were reclassified to
conform to the current year presentation.
4. ACCOUNTS RECEIVABLE, NET
The Company has charged $1,180,000, $1,278,000 and $1,182,000 for doubtful
accounts for the years ended January 31, 2000, 1999 and 1998, respectively.
2000 1999
---- ----
(in thousands)
Accounts receivable $ 3,879 $ 4,174
Less: allowance for doubtful accounts (720) (877)
------- -------
Accounts receivable, net $ 3,159 $ 3,297
======= =======
11
5. INVENTORY
As of January 31, 2000 and January 31, 1999, merchandise inventories consisted
of:
2000 1999
---- ----
(in thousands)
Raw materials $ 7,557 $ 4,177
Finished goods inventory 140,134 112,571
-------- --------
Merchandise inventories $147,691 $116,748
======== ========
Raw materials primarily consist of diamonds, precious gems, semi-precious gems
and gold. Included within finished goods inventory are allowances for inventory
shrink, scrap, and miscellaneous costs of $3,517,000 and $3,948,000 for the
years ended January 31, 2000 and 1999, respectively. As of January 31, 2000 and
1999, merchandise consignment inventories held by the Company that are not
included in its balance sheets totaled $52,620,000 and $37,778,000,
respectively. In addition, gold consignments of $24,294,000 and $21,279,000 are
not included in the Company's balance sheet at January 31, 2000 and 1999,
respectively (see Note 8, Financing Arrangements).
Certain general and administrative costs are allocated to inventory. As of
January 31, 2000 and 1999, these amounts included in inventory are $2,464,000
and $1,950,000, respectively. General and administrative expenses previously
allocated to inventory which are included in cost of sales were $3,888,000,
$2,945,000, and $2,608,000 for the years ended January 31, 2000, 1999 and 1998,
respectively.
6. PROPERTY AND EQUIPMENT
Property and equipment includes the following as of January 31:
2000 1999
---- ----
(in thousands)
Furniture, fixtures and software $53,122 $39,188
Leasehold improvements 26,406 22,398
------- -------
Property and equipment 79,528 61,586
Less accumulated depreciation and amortization 30,384 27,282
------- -------
Property and equipment, net $49,144 $34,304
======= =======
Depreciation and amortization expense was $7,355,000, $4,791,000, and $3,657,000
for the years ended January 31, 2000, 1999, and 1998, respectively.
12
7. LONG-TERM LIABILITIES
Included in long-term liabilities at January 31, 2000 and 1999 are $1,661,000
and $1,627,000, respectively, of deferred lease obligations.
8. FINANCING ARRANGEMENTS
In conjunction with the Acquisition (see Note 2), the Company entered into an
Amended and Restated Revolving Credit Term Loan and Gold Consignment Agreement
(the "Credit Agreement") with its bank group to provide for a total facility of
$110.0 million through September 10, 2003. The facility provides for a $20.0
million term loan and $90.0 million revolver facility. Proceeds from the Credit
Agreement were used to repay the Company's former credit facility and to fund
the Acquisition.
Under this Credit Agreement, the banks have a collateral security interest in
substantially all of the assets of the Company including those purchased in the
Acquisition. The Credit Agreement contains certain restrictions on capital
expenditures, investments, payment of dividends, assumption of additional debt,
and mergers, acquisitions and divestitures, among others, and requires the
Company to maintain certain financial ratios based on levels of funded debt,
capital expenditures and earnings before interest, taxes, depreciation and
amortization.
REVOLVER LOAN
The revolving loan facility under the Credit Agreement is available up to a
maximum of $90.0 million, including amounts borrowed under the gold consignment
facility, and is limited by a borrowing base computed based on the value of the
Company's inventory and accounts receivable. Availability under the revolver is
based on amounts outstanding thereunder, including the value of consigned gold
which fluctuates based on current gold prices. Effective October 5, 1999 the
revolving credit facility under the Credit Agreement was increased to $100
million through December 31, 1999. Interest rates and commitment fees on the
unused facility float in a grid based on the Company's quarterly financial
performance.
Current interest rates for borrowings under this agreement are, at the Company's
option, Eurodollar rates plus 137.5 basis points or
13
the banks' prime rate. Interest is payable monthly for prime borrowings and upon
maturity for Eurodollar borrowings. The interest expense under the current and
former revolver facilities for the years ended January 31, 2000, 1999 and 1998
was $3,279,000, $2,060,000 and $1,646,000, respectively, reflecting a weighted
average interest rate of 6.9%, 7.7% and 7.4%, respectively.
TERM LOAN
The term loan facility under the Credit Agreement is available up to a maximum
of $17.3 million (originally $20.0 million, less principal repayments). Current
interest rates for these borrowings are, at the Company's option, Eurodollar
rates plus 187.5 basis points or the banks' prime rate plus 50 basis points.
Interest is payable monthly for prime borrowings and upon maturity for
Eurodollar borrowings. Interest rates and the commitment fee charged on the
unused facility float in a grid based on the Company's quarterly financial
performance. The interest expense under the current and former term loan
facilities for the years ended January 31, 2000, 1999 and 1998 for these
borrowings was $1,372,000, $1,139,000 and $75,000, respectively, reflecting a
weighted average interest rate of 7.3%, 7.8% and 7.9%, respectively.
GOLD CONSIGNMENT FACILITY
During the second quarter of 1996, the Company sold and simultaneously consigned
a total of 39,000 troy ounces of gold for $15.3 million under a gold consignment
facility. During the second quarter of 1998, the Company sold and simultaneously
consigned an additional 20,000 troy ounces of gold for $6.0 million. On March 3,
1999 the Company sold and simultaneously consigned 10,500 troy ounces of gold
for $3.0 million. The facility provides for the sale of a maximum of 115,000
troy ounces of gold or $40.0 million. Under the agreement, the Company pays
consignment fees of 175 basis points over the rate set by the bank based on the
London Interbank Bullion Rates payable monthly. A commitment fee of 50 basis
points per annum on the unused portion of the gold consignment facility is
payable monthly. Interest rates and the commitment fees charged on the unused
facility float in a grid based on the Company's quarterly financial performance.
The consignment fees totaled $699,000, $549,000 and $447,000 for the years ended
January 31, 2000, 1999 and 1998, respectively, at a weighted average rate of
3.6%, 3.5% and 3.4%, respectively. On September 10, 2003, the Company is
required to repurchase 69,500 troy ounces of gold under this agreement at the
prevailing gold rate in effect on that date, or the facility will be renewed.
Based on the gold rate as of January 31, 2000, the market value of the gold
consigned was $19.8 million.
14
SUBORDINATED NOTES
Series A Senior Subordinated Notes due 2004 (the "Series A Notes") totaling
$12,000,000 bear interest at 12.15% per annum payable in cash, with interest
payments due quarterly. The Series B Senior Subordinated Notes due 2004 (the
"Series B Notes") totaling $8,000,000 bear interest at 15% per annum increasing
1% per annum beginning May 1, 1998, payable in cash, with interest payments due
quarterly.
The Series A Notes subsequently were exchanged for the Series C Notes which are
identical in all material respects to the Series A Notes, except that the Series
C Notes have been registered under the Securities Act of 1933, as amended. The
Series B Notes subsequently were exchanged for the Series D Notes which are
identical in all material respects to the Series B Notes, except that the Series
D Notes have been registered under the Securities Act of 1933, as amended.
In conjunction with the Company's Common Stock offering in November 1996, the
Series D Notes were redeemed at a premium. In January 1998, $1,480,000 of the
Series C Notes were redeemed for a total of $1,554,000. In January 1998, the
Company completed a tender offer to purchase $9,880,000 of the Series C Notes at
a premium of $1,087,000. Interest expense was $78,000 for the years ended
January 31, 2000 and 1999, respectively.
As of January 31, 2000 and 1999, the current portion and noncurrent portion of
long-term debt consisted of the following:
2000 1999
---- ----
(in thousands)
Current portion of long-term debt:
Term loan $ 3,250 $ 2,750
------- -------
Total $ 3,250 $ 2,750
======= =======
Long-term debt, net of current portion:
Term loan $ 4,000 $17,250
Subordinated debt 640 640
------- -------
Total $14,640 $17,890
======= =======
15
Future scheduled maturities under the loan agreements, excluding the revolver,
for January 31, 2000, are as follows:
TERM SUBORDINATED NOTES TOTAL
---- ------------------ -----
(in thousands)
January 31, 2001 $ 3,250 --- $ 3,250
January 31, 2002 4,250 --- 4,250
January 31, 2003 5,250 --- 5,250
January 31, 2004 4,500 --- 4,500
April 30, 2004 --- 640 640
------------- ----------------------- -----------------
Total $ 17,250 $ 640 $ 17,890
============= ======================= =================
The carrying amount of the Company's borrowings under the Credit Agreement and
other long-term borrowings approximate fair value.
DEFERRED FINANCING COSTS
In conjunction with the Company's recapitalization of its financing arrangements
in fiscal year 1997 and the establishment of the Credit Agreement in fiscal year
1998, the Company incurred $2,503,000 and $1,100,000, respectively, in deferred
financing costs. These costs are being amortized over the term of the Credit
Agreement. Amortization expense in the years ended January 31, 2000, 1999 and
1998 was $362,000, $303,000 and $308,000, respectively.
In the fourth quarter of fiscal 1997, the Company recorded an extraordinary loss
of $1.0 million, net of $0.7 million tax in connection with the tender offer to
purchase Series C notes. The loss consisted of $1.3 million of costs associated
with the extinguishment of debt and $0.4 million write-off of deferred financing
costs.
16
9. INCOME TAXES
The temporary differences between the tax basis of assets and liabilities and
their financial reporting amounts that give rise to a significant portion of the
deferred tax asset and deferred tax liability and their approximate tax effects
are as follows, as of January 31:
2000 1999
---- ----
(in thousands)
Temporary Tax Effect Temporary Tax Effect
Difference Difference
-------------------- ------------------- ------------------- -----------------
Merchandise inventories $ 1,402 $ 554 $ 665 $ 263
Property and equipment, net 103 40 994 393
Accrued rent 1,862 736 1,627 642
Accounts receivable 985 389 1,077 425
Sales returns 1,229 485 691 273
Other 1,665 658 1,309 518
-------------------- ------------------ ------------------ ---------------
Total deferred tax asset 7,246 2,862 6,363 2,514
------------------- ------------------ ------------------ ---------------
Other liability 413 163 177 70
-------------------- ------------------ ------------------ ---------------
Total deferred tax liability (413) (163) (177) (70)
------------------- ------------------ ------------------ ----------------
Net deferred tax asset $ 6,883 $ 2,699 $ 6,186 $ 2,444
=================== ================== ================== ===============
The net current and non-current components of deferred income taxes recognized
in the balance sheet at January 31 are as follows:
2000 1999
---- ----
(in thousands)
Net current assets $ 2,086 $ 1,518
Net non-current assets 613 926
------------------ ----------------
$ 2,699 $ 2,444
================= ================
The income tax expense for the years ended January 31, consists of the
following:
2000 1999 1998
---- ---- ----
(in thousands)
Current expense $ 12,559 $ 8,162 $ 2,456
Deferred tax expense (456) 766 4,063
------------------- ------------------ -----------------
Total income tax expense $ 12,103 $ 8,928 $ 6,519
=================== ================== =================
17
The provision for income taxes on income differs from the statutory tax expense
computed by applying the federal corporate tax rate of 35% for the years ended
January 31, 2000, and 1999 and 34% for the year ended January 31, 1998.
2000 1999 1998
---- ---- ----
(in thousands)
Taxes computed at statutory rate $ 11,002 $ 8,116 $ 5,683
State tax expense, net of federal benefit 1,395 943 743
Other (294) (131) 93
------------ ----------- -----------
Total income tax expense $ 12,103 $ 8,928 $ 6,519
============ =========== ===========
10. COMMON STOCK
Following are the number of shares issued for each of the Company's classes of
Common Stock as of January 31:
Common Stock Class B
(Par value $.001) Common Stock Treasury Stock
(par value $1.00)
----------------------------------------------------------
Balance at January 31, 1997 15,091,739 152 (26)
----------------------------------------------------------
Exercise of Options 131,815 --- ---
----------------------------------------------------------
Balance at January 31, 1998 15,223,554 152 (26)
----------------------------------------------------------
Exercise of Options 55,235 --- ---
----------------------------------------------------------
Balance at January 31, 1999 15,278,789 152 ---
Exercise of Options/Restricted Shares 74,331 --- ---
Purchase of Treasury Stock --- --- (883,350)
----------------------------------------------------------
Balance at January 31, 2000 15,353,120 152 (883,376)
==========================================================
Each share of Class B Common Stock is exchangeable into common stock on a 35.4
for 1 basis. Each share of Common Stock is entitled to one vote, and each share
of Class B Common Stock is entitled to 35.4 votes on each matter submitted to
stockholders for vote.
11. EARNINGS PER COMMON SHARE
The Company adopted SFAS No. 128, "Earnings Per Share," in fiscal year 1998.
This accounting pronouncement eliminates the measure of performance called
"primary" earnings per share and replaces it with "basic" earnings per share.
The essential difference between the two calculations is that the dilutive
effects of stock options outstanding are not considered in the basic
computation. As a result, basic earnings per share tend to be slightly higher
than primary earnings per share. The pronouncement also changed the measure
previously reported as "fully diluted" earnings per share to "diluted" earnings
per share. All prior periods have been restated.
18
Basic earnings per share is computed by dividing net earnings available to
holders of common stock by the weighted average number of shares of common stock
outstanding. Diluted earnings per share is computed assuming the exercising of
all stock options that are profitable to the recipients. Under these
assumptions, the weighted average number of common shares outstanding is
increased accordingly.
The following table reconciles the numerators and denominators of the basic and
diluted earnings per share computations:
- ------------------------------------------------------------------------------------------------------------------------------------
2000 1999 1998
---- ---- ----
- ------------------------------------------------------------------------------------------------------------------------------------
Basic Diluted Basic Diluted Basic Diluted
----- ------- ------ ------- ------ -------
- ------------------------------------------------------------------------------------------------------------------------------------
EPS Numerator:
- ------------------------------------------------------------------------------------------------------------------------------------
Income before extraordinary item $ 19,334 $ 19,334 $ 14,262 $ 14,262 $ 11,230 $ 11,230
- ------------------------------------------------------------------------------------------------------------------------------------
EPS Denominator:
- ------------------------------------------------------------------------------------------------------------------------------------
Average common shares outstanding: 14,560 14,560 15,275 15,275 15,140 15,140
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of dilutive securities:
- ------------------------------------------------------------------------------------------------------------------------------------
Stock options --- 569 --- 220 --- 198
- ------------------------------------------------------------------------------------------------------------------------------------
Total shares 14,560 15,129 15,275 15,495 15,140 15,338
- ------------------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings per share before extraordinary item $1.33 $1.28 $0.93 $0.92 $0.74 $0.73
- ------------------------------------------------------------------------------------------------------------------------------------
On February 19, 1999, the Company announced that its Board of Directors had
authorized the repurchase of up to $10.0 million of its Common Stock. Shares
repurchased by the Company will reduce the weighted average number of common
shares outstanding for basic and diluted earnings per share calculations. As of
January 31, 2000, the Company has repurchased 883,350 shares at a total cost of
approximately $10.0 million.
12. EMPLOYEE BENEFIT PLAN
Effective October 1, 1997, the Company established a 401(k) Plan (the "Plan")
for the benefit of substantially all employees. Employees become eligible to
participate in the Plan after one year of service which is defined as at least
one year of employment and 1,000 hours worked in that year. The Company may make
discretionary contributions to the Plan. No such contributions have been made.
19
In 1988, the Company established an Employee Stock Ownership Plan (the "ESOP"),
which is a noncontributory plan established to acquire shares of the Company's
Class B Common Stock for the benefit of all employees. In conjunction with
completion of the Company's initial public offering and recapitalization of its
financing arrangements, the Company restructured its ESOP. As of January 31,
1998, all remaining shares had been released to participants. As long as the
Company's stock is publicly traded, the Company is not required to repurchase
shares from ESOP participants. The only remaining activity of the ESOP is to
make distributions to existing participants or beneficiaries.
13. STOCK PLANS
On September 28, 1995, the Company authorized options for the equivalent of
1,039,647 shares under the Incentive Stock Option Plan (the "1995 Plan") to be
granted to certain members of the Company's management. Options for the
equivalent of 1,032,342 shares were issued at exercise prices ranging from $0.60
to $0.66 per share. These prices were greater than or equal to the fair market
value at the date of grant, as determined by an independent third party
valuation. The options allow the holders to purchase Common Stock within a
period ranging from five years to five years and eight months, at a fixed price.
No expense was recorded in connection with these options. On September 28, 1995,
the Company granted the equivalent of 759,222 shares of Restricted Stock to
certain members of the Company's management. During fiscal 1995, the Company
recognized $461,000 in compensation expense relating to the issuance of these
shares. This amount represented the fair market value of the shares at the grant
date, as determined by an independent third party valuation.
In April 1996, the Company approved the 1996 Long-Term Incentive Plan (the "1996
Plan"). Under the 1996 Plan, the Company may grant incentive stock options
("ISOs") within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended, or nonqualified stock options. In addition, the Company may grant
stock appreciation rights, bonus stock awards which are vested upon grant, stock
awards which may be subject to a restriction period and specified performance
measures, and performance shares. Performance shares are rights, contingent upon
the attainment of the performance measures within a specified performance
period, to receive one share of Common Stock, which may be restricted, or the
fair market value of such performance share in cash. A total of 1,156,784 shares
of Common Stock have been reserved for issuance under the 1996 Plan. Grants may
be made under the 1996 Plan
20
during the ten years after its effective date. Options granted under the 1996
Plan generally vest in four equal annual installments and expire ten years after
the date of grant. Options and shares granted under the plans are subject to
forfeiture based on, among other things, the nature and timing of the
termination of employment.
The Company approved the 1997 Long-Term Incentive Plan (the "1997 Plan") on
February 24, 1997 and the stockholders adopted the 1997 Plan on June 5, 1997. On
June 8, 1999 the stockholders adopted an amendment to the 1997 Plan to increase
the Common Stock reserved for issuance under the 1997 Plan. Under the 1997 Plan,
the Company may grant ISOs or nonqualified stock options. The 1997 Plan also
provides for the grant of stock appreciation rights ("SARs"), bonus stock awards
which are vested upon grant, stock awards which may be subject to a restriction
period and specified performance measures, and performance shares. Performance
shares are rights, contingent upon the attainment of performance measures within
a specified performance period, to receive one share of Common Stock, which may
be restricted, or the fair market value of such performance share in cash. A
total of 1,500,000 shares of Common Stock have been reserved for issuance under
the 1997 Plan. Grants may be made under the 1997 Plan during the ten years after
its effective date. Options granted under the 1997 Plan expire ten years after
the date of grant and generally vest in (i) four equal annual installments or
(ii) after nine years, subject to acceleration in the first, second and third
years after the date of grant based on the Company's performance.
In December 1997, the Company adopted the 1998 Non-Employee Director Stock
Option Plan (the "1998 Plan"), effective February 1, 1998. Under the 1998 Plan,
non-employee directors may elect to receive all or a designated amount of their
directors' fee in the form of stock options. A total of 37,500 shares have been
reserved for issuance under the 1998 Plan. Grants may be made during the ten
years after its effective date. Options granted under the 1998 Plan vest at the
end of the quarter in which the date of grant occurs and expire ten years after
the date of grant. As of January 31, 2000, options covering 27,830 shares had
been granted under the 1998 Plan.
21
Option activity for the years ended January 31, 1998, 1999 and 2000 was as
follows:
- ---------------------------------------------------------------------------------------------------------------------
Shares Weighted-Average Options
Exercise Price Excercisable
- ---------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1997 1,337,376 $ 7.85 194,802
- ---------------------------------------------------------------------------------------------------------------------
Options granted 283,725 7.70
- ---------------------------------------------------------------------------------------------------------------------
Options exercised (131,816) 0.63
- ---------------------------------------------------------------------------------------------------------------------
Options canceled (16,724) 6.45
- ---------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1998 1,472,561 $ 8.49 348,636
- ---------------------------------------------------------------------------------------------------------------------
Options granted 171,140 11.37
- ---------------------------------------------------------------------------------------------------------------------
Options exercised (55,235) 2.13
- ---------------------------------------------------------------------------------------------------------------------
Options canceled (32,363) 9.45
- ---------------------------------------------------------------------------------------------------------------------
Balance at January 31, 1999 1,556,103 $ 9.02 659,057
- ---------------------------------------------------------------------------------------------------------------------
Options granted 711,751 12.96
- ---------------------------------------------------------------------------------------------------------------------
Options exercised (74,331) 6.15
- ---------------------------------------------------------------------------------------------------------------------
Options cancelled (21,902) 10.93
- ---------------------------------------------------------------------------------------------------------------------
Balance at January 31, 2000 2,171,621 $ 10.38 980,663
- ---------------------------------------------------------------------------------------------------------------------
The weighted-average fair value of the options covering 711,751, 171,140, and
283,725 shares granted was $12.97, $5.34, and $4.18, for the years ended January
31, 2000, 1999 and 1998, respectively.
The following table summarizes the status of outstanding stock options as of
January 31, 2000:
Shares Covered By
Outstanding Options Options Exercisable
Number of Shares Weighted Average
Range of Covered By Remaining Weighted-Average Number of Options Weighted-Average
Exercise Prices Outstanding Options Contractual Life Exercise Price Exercisable Exercise Price
- --------------------- --------------------------------------------------------------------------------------------------------------
$0.60 - $0.60 5,110 1.33 $0.60 5,110 $0.60
$6.75 - $9.33 1,331,654 6.46 8.92 926,403 9.01
$9.42 - $11.46 645,447 9.21 11.29 21,247 10.27
$11.54 - $26.63 189,410 9.09 17.75 27,903 12.57
- ------------------------------------------------------------------------------------------------------------------------------------
$0.60 - $26.63 2,171,621 7.50 $10.38 980,663 $9.10
====================================================================================================================================
22
Had the Company elected to apply the provisions of SFAS No. 123, "Accounting for
Stock Based Compensation", regarding recognition of compensation expense to the
extent of the calculated fair value of stock options granted during the years
ended January 31, 2000, 1999, and 1998, reported net income and earnings per
share would have been reduced as follows:
2000 1999 1998
(in thousands, except per share amounts)
Net income, as reported $ 19,334 $ 14,262 $ 10,195
Pro forma net income 17,037 12,641 8,782
Earnings per share, as reported 1.28 0.92 0.66
Pro forma earnings per share 1.13 0.82 0.57
For purposes of pro forma net income and earnings per share calculation in
accordance with SFAS No. 123, for each option granted under the 1995 Plan during
the year ended January 31, 1996, the fair value is estimated as of the date of
grant using the Minimum Value method using a weighted-average assumption of 6.1%
risk-free interest rate and 5.5 year option life. For each option granted during
the years ended January 31, 2000, 1999, and 1998, the fair value is estimated
using the Black-Scholes option-pricing model. The assumptions used are as
follows:
-------------------------------------------------------------------------------------------------------
2000 1999 1998
---- ---- ----
Risk-free interest rate 5.3% 5.3% 6.4%
-------------------------------------------------------------------------------------------------------
Dividend yield 0 0 0
-------------------------------------------------------------------------------------------------------
Option life 6 years 6 years 6 years
-------------------------------------------------------------------------------------------------------
Volatility 39% 40% 47%
-------------------------------------------------------------------------------------------------------
23
14. COMMITMENTS
The Company leases office facilities and all retail stores, generally under
noncancelable agreements for periods ranging from 7 to 13 years. Most leases
require the payment of taxes, insurance and maintenance costs. Future minimum
rentals under noncancelable operating leases as of January 31, 2000 are as
follows:
Years ending January 31, Amount
(in thousands)
---------------------
2001 $ 20,336
2002 19,879
2003 19,322
2004 18,930
2005 17,846
thereafter 64,758
---------------------
$ 161,071
=====================
Total rental expense for all operating leases for the years ended January 31, is
as follows:
2000 1999 1998
---- ---- ----
Rental expense:
Minimum $ 17,950 $ 13,517 $ 10,748
Rentals based on sales 2,520 2,015 1,746
------------------------ ------------------------- -------------------------
$ 20,470 $ 15,532 $ 12,494
======================== ========================= =========================
24
15. SUBSEQUENT EVENTS
ACCOUNTING CHANGE
On December 3, 1999 the SEC issued certain accounting guidance in Staff
Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101, among other things, indicates that revenue from layaway sales
should only be recognized upon delivery of merchandise to the customer. In
consideration of this guidance, the Company will implement a change in
accounting in the first quarter of fiscal year 2000.
The Company has recorded a charge of approximately $5.0 million, $3.0
million net of tax, which will be presented as a cumulative effect of this
accounting change on February 1, 2000.
REGISTRATION STATEMENT (UNAUDITED)
On January 27, 2000, the Company filed with the SEC a registration
statement on Form S-3 for the offer and sale by the Company of 2,300,000 shares
of its common stock and by selling stockholders of 625,000 shares of the
Company's common stock. Net proceeds from the offering are intended to pay down
bank debt, and for working capital and other general corporate purposes.
25
16. UNAUDITED QUARTERLY RESULTS
The Company's results of operations fluctuate on a quarterly basis. The
following table sets forth summary unaudited financial information of the
Company for each quarter in fiscal 1999 and fiscal 1998. In the opinion of
management, this quarterly information has been prepared on a basis consistent
with the Company's audited financial statements appearing elsewhere in this
annual report, and reflects adjustments, consisting of normal recurring
adjustments, necessary for a fair presentation of such unaudited quarterly
results when read in conjunction with the audited financial statements and notes
thereto.
1999 Quarters Ended
------------------------------------------------------------------------------
April 30, 1999 July 31, 1999 October 31, 1999 January 31, 2000
-------------- ------------- ---------------- ----------------
(in thousands, except per share amounts)
Net Sales $ 58,935 $ 65,886 $ 62,933 $ 127,652
Gross profit 22,987 26,623 25,039 57,859
Income from operations 3,157 5,080 3,434 25,585
Net income 1,168 2,268 1,085 14,813
Diluted earnings per share:
Net income $ 0.08 $ 0.15 $ 0.07 $ 0.97
1998 Quarters Ended
------------------------------------------------------------------------------
April 30, 1998 July 31, 1998 October 31, 1998 January 31, 1999
-------------- ------------- ---------------- ----------------
(in thousands, except per share amounts)
Net Sales $ 41,584 $ 46,849 $ 48,483 $ 102,026
Gross profit 16,139 18,762 19,030 45,643
Income from operations 1,946 3,574 2,193 19,600
Net income 702 1,681 609 11,270
Diluted earnings per share:
Net income $ 0.05 $ 0.11 $ 0.04 $ 0.73