SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
Amendment No. 1 to
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED: APRIL 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________________ to _____________________
Commission File number: 0-028176
Whitehall Jewellers, Inc.
(Exact name of registrant as specified in its charter)
Delaware 36-1433610
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
155 N. Wacker Drive, Suite 500, Chicago, IL 60606
(Address of principal executive offices) (zip code)
312/782-6800
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal
year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
The number of shares of the Registrant's common stock, $.001 par value
per share, outstanding as of June 6, 2003 was 14,206,561 and the number of
shares of the Registrant's Class B common stock, $1.00 par value per share,
outstanding as of June 6, 2003 was 142.
EXPLANATORY NOTE
RESTATEMENT OF PRIOR FINANCIAL INFORMATION
As described in Note 12 to the financial statements contained in the
Form 10-Q for the quarterly period ended October 31, 2003 filed by Whitehall
Jewellers, Inc. (the "Company") with the Securities and Exchange Commission on
December 22, 2003, the Company restated previously issued financial statements
to record adjustments resulting from various accounting matters described below.
The Company restated financial statements for the three-month periods ended
April 30, 2003 and 2002, the three and six month periods ended July 31, 2003 and
2002 and the three-month and nine-month periods ended October 31, 2002.
Adjustments to restate the financial statements are summarized into the
following four categories:
A. Merchandise inventory valuation adjustments
In prior periods, the Company entered into certain contemporaneous
agreements to both purchase merchandise and return substandard
merchandise inventory to vendors, outside of the normal
contractual return privileges. Additionally, in fiscal 2001, the
Company entered into a barter arrangement for approximately
$250,000 of merchandise inventory that involved the exchange of
merchandise inventory for barter credits. These arrangements
involved receiving vendor allowances at an amount greater than the
merchandise inventory fair market value in exchange for purchases
of merchandise inventory at a date in the future. The Company has
restated the financial statements to write-down the substandard
merchandise inventory to fair market value and record the
consideration received in excess of the fair market value of the
substandard inventory as a vendor allowance, which is a reduction
to inventory. This vendor allowance reduces the cost of inventory
and as the inventory is sold, the Company will recognize lower
cost of sales.
In periods prior to February 1, 2000, the Company had written down
substandard inventory to fair market value and did not exchange
such inventory with vendors.
B. Software development costs and amortization
The financial statements have been restated to capitalize certain
costs associated with software development that were expensed in
the six-months ended July 31, 2003, in accordance with Statement
of Position 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use". In addition, the Company
amortized certain capitalized software development costs prior to
the project being placed in service and has reversed such
amortization in the restated financial statements.
C. Vendor advertising/promotion credits
Certain vendor consideration, primarily related to co-op
advertising and program sponsorships, was received in the
six-months ended July 31, 2003, which should have reduced the
carrying value of merchandise inventory, in accordance with EITF
02-16. The adjustments reflected in the Statement of Operations
relate to reversing the reimbursements received and recording the
benefit as an adjustment of the inventory
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carrying value, which benefits cost of sales in the inventory
turnover period.
D. Tax effect of the adjustments
As a result of the restatement adjustments, income tax provisions
were revised in the Statement of Operations.
The Company recommends this report to be read in conjunction with the
Company's reports filed subsequent to June 6, 2003.
Amended Items
The Company hereby amends the following items, financial statements,
exhibits or other portions of its Quarterly Report on Form 10-Q for the quarter
ended April 30, 2003, as set forth herein:
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
The financial information of the Company is amended to read in its
entirety as set forth herein.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The information set forth in "Item 2. Management's Discussion and
Analysis of Financial Condition and Results of Operations" is amended to read in
its entirety as set forth herein.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The information set forth in "Item 3. Quantitative and Qualitative
Disclosure About Market Risk" is amended to read in its entirety as set forth
herein.
Item 4. Controls and Procedures
The information set forth in "Item 4. Controls and Procedures" is
amended to read in its entirety as set forth herein.
Part II - OTHER INFORMATION
Item 5. Forward Looking Statements
The information set forth in "Item 5. Forward Looking Statements" is
amended to read in its entirety as set forth herein.
Item 6(a). Exhibits
The list of exhibits set forth by the Company is amended to read in its
entirety as set forth herein.
3
PART I - FINANCIAL INFORMATION
Item 1- Financial Statements
Whitehall Jewellers, Inc.
Statements of Operations
for the three months ended April 30, 2003 and 2002
(unaudited)
(in thousands, except per share data)
Three months ended
------------------
April 30, 2003 April 30, 2002
(Restated - (Restated -
Note 12) Note 12)
-------------- --------------
Net sales $ 69,149 $ 74,588
Cost of sales (including buying and occupancy expenses) 46,038 47,494
-------- --------
Gross profit 23,111 27,094
Selling, general and administrative expenses 26,770 25,627
-------- --------
(Loss) income from operations (3,659) 1,467
Interest expense 908 1,012
-------- --------
(Loss) income before income taxes (4,567) 455
Income tax (benefit) expense (1,780) 162
-------- --------
Net (loss) income $ (2,787) $ 293
======== ========
Basic earnings per share:
Net (loss) income $ (0.20) $ 0.02
======== ========
Weighted average common shares and common share equivalents 14,206 14,667
======== ========
Diluted earnings per share:
Net (loss) income $ (0.20) $ 0.02
======== ========
Weighted average common shares and common share equivalents 14,206 15,382
======== ========
The accompanying notes are an integral part of the financial statements.
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Whitehall Jewellers, Inc.
Balance Sheets
As of April 30, 2003, January 31, 2003 and April 30, 2002
(unaudited, in thousands, except share data)
April 30, 2003 January 31, 2003 April 30, 2002
(Restated - (Restated - (Restated -
Note 12) Note 12) Note 12)
-----------------------------------------------------
ASSETS
Current Assets:
Cash $ 1,302 $ 2,048 $ 2,131
Accounts receivable, net 719 1,621 1,811
Merchandise inventories 205,020 196,694 174,931
Current income tax benefit 2,251 --- 403
Other current assets 2,281 1,470 1,341
Deferred financing costs 510 510 511
Deferred income taxes, net 2,638 2,627 2,741
--------- --------- ---------
Total current assets 214,721 204,970 183,869
Property and equipment, net 63,655 61,634 64,097
Goodwill 5,662 5,662 5,662
Deferred financing costs 161 213 595
--------- --------- ---------
Total assets $ 284,199 $ 272,479 $ 254,223
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolver loan $ 88,559 $ 94,490 $ 52,627
Current portion of long-term debt 3,640 4,500 5,500
Accounts payable 49,088 26,784 52,543
Customer deposits 3,635 3,454 4,077
Accrued payroll 4,583 3,282 4,313
Income taxes payable --- 3,303 ---
Other accrued expenses 12,581 11,380 12,504
--------- --------- ---------
Total current liabilities 162,086 147,193 131,564
Term loan --- --- 3,000
Subordinated debt --- 640 640
Deferred income taxes, net 3,753 3,607 1,901
Other long-term liabilities 3,216 3,138 2,784
--------- --------- ---------
Total liabilities 169,055 154,578 139,889
Commitments and contingencies
Stockholders' equity:
Common stock 18 18 17
Class B common stock --- --- ---
Additional paid-in capital 105,755 105,795 104,653
Accumulated earnings 45,238 48,025 38,624
--------- --------- ---------
151,011 153,838 143,294
Less:
Treasury stock, at cost (3,817,742, 3,822,637 and 3,199,628 shares,
respectively) (35,867) (35,937) (28,960)
--------- --------- ---------
Total stockholders' equity, net 115,144 117,901 114,334
--------- --------- ---------
Total liabilities and stockholders' equity
$ 284,199 $ 272,479 $ 254,223
========= ========= =========
The accompanying notes are an integral part of the financial statements.
5
Whitehall Jewellers, Inc.
Statements of Cash Flows
for the three months ended April 30, 2003 and 2002
(unaudited, in thousands)
Three months ended
------------------
April 30, 2003 April 30, 2002
(Restated - (Restated -
Note 12) Note 12)
-----------------------------------
Cash flows from operating activities:
Net (loss) income $ (2,787) $ 293
Adjustments to reconcile net (loss) income to net cash provided
by (used in) operating activities:
Depreciation and amortization 2,919 2,744
Loss on disposition of assets 18 15
Changes in assets and liabilities:
Decrease (increase) in accounts
receivable, net 902 (622)
(Increase) in merchandise inventories, net
of gold consignment (8,326) (1,833)
(Increase) in other current
assets (811) (117)
(Increase) in current income tax benefit (2,251) (403)
Increase in deferred income taxes, net 135 177
Increase (decrease) in accounts payable 19,638 (10,022)
(Decrease) in income taxes payable (3,303) (3,257)
Increase in customer deposits 181 114
Increase (decrease) in accrued payroll 1,301 (1,957)
Increase (decrease) in accrued liabilities 1,201 (820)
Increase in other long-term liabilities 78 124
--------- ---------
Net cash provided by (used in) operating activities 8,895 (15,564)
Cash flows from investing activities:
Capital expenditures (4,831) (2,814)
--------- ---------
Net cash (used in) investing activities (4,831) (2,814)
Cash flows from financing activities:
Borrowing on revolver loan 166,804 168,318
Repayment of revolver loan (172,735) (150,968)
Outstanding checks increase 2,666 772
Repayment of term loan (1,500) (1,250)
Financing costs (75) ---
Proceeds from employee stock purchase plan 30 10
Proceeds from exercise of stock options --- 886
--------- ---------
Net cash (used) in provided by financing activities (4,810) 17,768
--------- ---------
Net change in cash and cash equivalents (746) (610)
Cash and cash equivalents at beginning of period 2,048 2,741
--------- ---------
Cash and cash equivalents at end of period $ 1,302 $ 2,131
========= =========
The accompanying notes are an integral part of the financial statements.
6
Whitehall Jewellers, Inc.
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 385 stores as of April
30, 2003, located in 38 states, operating in regional or superregional shopping
malls. The consolidated financial statements include the accounts and
transactions of the Company and its subsidiaries. Intercompany accounts and
transactions have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis for Presentation
The accompanying unaudited financial statements have been prepared in
accordance with Rule 10-01 of Regulation S-X. Consequently, they do not include
all of the disclosures required under generally accepted accounting principles
for complete financial statements. The interim financial statements reflect all
adjustments (consisting only of normal recurring accruals) which are, in the
opinion of management, necessary for a fair presentation of financial position,
results of operations and cash flows for the interim periods presented. For
further information regarding the Company's accounting policies, refer to the
financial statements and footnotes thereto included in the Whitehall Jewellers,
Inc. Annual Report on Form 10-K/A for the fiscal year ended January 31, 2003.
References in the following notes to years and quarters are references to fiscal
years and fiscal quarters.
Merchandise Inventories
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Purchase cost is reduced to reflect certain allowances
and discounts received from merchandise vendors. Periodic credits or payments
from merchandise vendors in the form of buydowns, volume or other purchase
discounts and other vendor consideration are reflected in the carrying value of
the inventory and recognized as a component of cost of sales as the merchandise
is sold. Additionally, to the extent it is not addressed by established vendor
return privileges, and if the amount of cash consideration received from the
vendor exceeds the estimated fair value of the goods returned, that excess
amount is reflected as a reduction in the purchase cost of the inventory
acquired.
To the extent the Company's agreements with merchandise vendors provide
credits for co-op advertising, the Company has historically classified such
credits as a reduction to advertising expense in selling, general and
administrative expenses. Emerging Issues Task Force Issue No. 02-16, "Accounting
by a Customer (Including a Reseller) for Certain Consideration Received from a
Vendor" ("EITF 02-16"), which was effective for all arrangements entered into
after December 31, 2002, requires certain merchandise vendor allowances to be
classified as a reduction to inventory cost unless evidence exists supporting an
alternative classification. The Company has recorded such merchandise vendor
allowances as a reduction of inventory cost. The total amount of these
allowances and other vendor consideration as of April 30, 2003, January 31, 2003
and April 30, 2002 was approximately $2,818,000, $3,254,000 and $551,000,
respectively.
7
The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations associated with holding and safekeeping such consigned inventory are
not reflected in the Company's financial statements. At the time of sale of
consigned merchandise to customers, the Company records the purchase liability
and the related consignor cost of such merchandise in cost of sales.
Goodwill
Goodwill represents the excess of cost over the fair value of assets
acquired in purchase business combinations. Under the Financial Accounting
Standards Board Statement No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets," goodwill and indefinite lived intangible assets are reviewed at least
annually (or more frequently if impairment indicators arise) for impairment. The
Company adopted SFAS 142 on February 1, 2002 and has discontinued the
amortization of goodwill.
Income Taxes
Due to the seasonal nature of the business, the Company tends to
generate a significant portion of its income in the fourth quarter. While the
39.0% effective tax rate currently estimated for the year is management's best
estimate, to the extent that income is significantly more or less than expected,
the Company's effective income tax rate for the remainder of fiscal year 2003
could vary significantly from that of the first quarter.
Stock-Based Compensation
The Financial Accounting Standards Board issued Statement No. 148
("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure," during 2002. SFAS 148 amends Statement No. 123 ("SFAS 123"),
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation and amends the disclosure requirements to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company adopted the
disclosure requirements of SFAS 148 as of January 31, 2003.
The Company accounts for stock-based compensation according to
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," which results in no charge to earnings when options are issued at
fair market value.
The following table illustrates the effect on net income and earnings
per share for the three months ended April 30, 2003 and 2002, if the Company had
applied the fair value recognition provisions of SFAS 123, as amended by SFAS
148, to stock-based employee compensation.
8
April 30, 2003 April 30, 2002
(Restated - (Restated -
Note 12) Note 12)
-------------- --------------
Net (loss) income, as reported $(2,787) $ 293
Deduct: Total stock-based employee compensation expense determined
under fair value based method, net of related tax effects 267 558
------- -------
Pro forma net (loss) $(3,054) $ (265)
======= =======
Earnings per share:
======= =======
Basic-as reported $ (0.20) $ 0.02
======= =======
Basic-pro forma $ (0.21) $ (0.02)
======= =======
======= =======
Diluted-as reported $ (0.20) $ 0.02
======= =======
Diluted-pro forma $ (0.21) $ (0.02)
======= =======
For purposes of the pro forma net income and earnings per share
calculation in accordance with SFAS 123, for each option granted during the
three months ended April 30, 2003 and 2002 the fair value is estimated using the
Black-Scholes option-pricing model. The assumptions used are as follows:
April 30, 2003 April 30, 2002
-------------- --------------
Risk-free interest rate 3.0% 4.7%
Dividend yield 0 0
Option life 5.5 years 5.5 years
Volatility 61% 62%
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that costs associated with disposal or exit
activities after December 31, 2002 be recorded at fair value in the period the
liability is incurred. The Company adopted SFAS 146 effective January 1, 2003,
which had no impact on its financial statements.
Accounting for Guarantees
In November 2002, the Financial Standards Accounting Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financials statements for the year ended January 31, 2003.
Under its bylaws, the Company has agreed to indemnify its officers and
directors for certain events or occurrences while the officer or director is, or
was serving, at its request in such capacity. The maximum potential amount of
future payments the Company could be required to make pursuant to these
indemnification obligations is unlimited; however, the Company has a directors
and officers liability insurance policy that, under certain circumstances,
9
enables it to recover a portion of any future amounts paid. As a result of its
insurance coverage, the Company believes the estimated fair value of these
indemnification obligations is minimal. The Company had no liabilities recorded
for these obligations as of April 30, 2003.
3. ACCOUNTS RECEIVABLE, NET
As of April 30, 2003, January 31, 2003 and April 30, 2002, accounts
receivable consisted of (in thousands):
April 30, 2003 January 31, 2003 April 30, 2002
-------------- ---------------- --------------
Accounts receivable $ 1,366 $ 2,165 $ 2,431
Less: allowance for doubtful accounts (647) (544) (620)
-------- -------- --------
Accounts receivable, net $ 719 $ 1,621 $ 1,811
======== ======== ========
4. INVENTORY
As of April 30, 2003, January 31, 2003 and April 30, 2002,
merchandising inventories consisted of (in thousands):
April 30, 2003 January 31, 2003 April 30, 2002
(Restated - (Restated - (Restated -
Note 12) Note 12) Note 12)
-------------- ---------------- --------------
Raw Materials $ 6,514 $ 7,657 $ 7,746
Finished Goods 198,506 189,037 167,185
-------- --------- --------
Inventory $205,020 $ 196,694 $174,931
======== ========= ========
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 $3,396,000,
$3,567,000 and $2,424,000 as of April 30, 2003, January 31, 2003 and April 30,
2002, respectively. As of April 30, 2003, January 31, 2003 and April 30, 2002,
consignment inventories held by the Company that are not included in the balance
sheets total $72,991,000, $74,924,000, and $80,967,000, respectively.
In addition, gold consignments of $23,298,000 are not included in the
Company's balance sheets as of April 30, 2002 (see Note 6, Financing
Arrangements) as the title to such gold has passed to the consignor and is
subject to the same risk of physical loss as other inventory held on consignment
by the Company. On August 22, 2002, the Company purchased 66,500 troy ounces of
gold at an average gold price of $307.56 per ounce for a total of approximately
$20.5 million. The Company delivered the gold to its banks and extinguished all
existing Company gold consignment obligations to the banks under the Credit
Agreement (See Note 6). The purchase had the effect of increasing the weighted
average cost of gold available for retail sale by the Company and will result in
a higher weighted average cost of sales in future periods. The Company estimated
subsequent cost of sales as a result of this transaction to be approximately
$1.5 million greater based on the effect of the transaction on the weighted
average cost of gold product in its inventory prior to this purchase.
Approximately $300,000 of this increase in cost of sales is reflected in the
three months ended April, 2003. This purchase
10
increased the Company's inventory by $20.5 million and was funded by revolver
loan borrowings. The total amount available to borrow under the Company's Credit
Agreement is unchanged.
Certain merchandise procurement, distribution and warehousing costs are
allocated to inventory. As of April 30, 2003, January 31, 2003 and April 30,
2003, the amounts included in inventory are $3,572,000, $3,364,000 and
$3,328,000, respectively.
5. ACCOUNTS PAYABLE
Accounts payable includes outstanding checks, which were $9,178,000,
$6,512,000 and $7,912,000 as of April 30, 2003, January 31, 2003 and April 30,
2002, respectively.
6. FINANCING ARRANGEMENTS
Effective January 31, 2003, the Company amended certain terms and
conditions within its Amended and Restated Revolving Credit, Term Loan and Gold
Consignment Agreement (the "Credit Agreement") with its bank group which
provides for a total facility of $166.5 million through June 30, 2004. Interest
rates and the commitment fee charged on the unused portion of the facility float
based upon the Company's quarterly financial performance.
Under the Credit Agreement, the banks have a collateral security
interest in substantially all of the assets of the Company. The Credit Agreement
contains certain restrictions on capital expenditures, investments, payment of
dividends, assumption of additional debt, 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. As of April 30, 2003, the most restrictive
financial covenant was total funded debt to earnings before interest, taxes,
depreciation and amortization as defined in the Credit Agreement. This financial
covenant was set at a ratio of 2.95 to 1.00, as amended, and is calculated based
on the daily outstanding average of all debt outstanding for the trailing four
quarters including borrowing under the Credit Agreement, senior subordinated
debt, capital leases and other indebtedness divided by earnings before interest,
taxes, deprecation and amortization for the trailing four quarters.
Revolver Loan
The revolving loan facility under the Credit Agreement is available up
to a maximum of $150.0 million, including amounts, if any, consigned 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 there under, including the value of
consigned gold which fluctuates based on gold prices. Interest rates and
commitment fees on the unused facility float based on the Company's quarterly
financial performance.
The interest rates for borrowings under this agreement are, at the
Company's option, based on Eurodollar rates or the banks' prime rate. Interest
is payable monthly for prime borrowings and upon maturity for Eurodollar
borrowings.
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Term Loans
The term loan under the Credit Agreement is available up to a maximum
of $3.0 million ($16.5 million, less principal repayments). The interest rates
for these borrowings are, at the Company's option, based on Eurodollar rates or
the banks' prime rate. 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 based on the Company's quarterly financial
performance.
Gold Consignment Facility
The Company has the opportunity to enter into gold consignments with
certain third party financial institutions. The Company provides the third party
financial institution with title to a certain number of troy ounces of gold held
in the Company's existing merchandise inventory in exchange for cash at the
current market price of gold. The Company then consigns the gold from the third
party financial institution, pursuant to a gold consignment agreement. This
agreement entitles the Company to use the gold in the ordinary course of its
business. The Gold Consignment Facility is a transfer of title in specified
quantities of the gold content of the Company's inventory (a non-financial
asset) to a financial institution in exchange for cash. The Company continues to
bear responsibility for damage to the inventory, as is the case in all of its
consigned inventory arrangements with its other vendors.
The Company has accounted for the transaction as a reduction in its
inventories, as it has transferred title to the gold to the financial
institution. Similar to other consigned inventories in the possession of the
Company (for which the Company bears risk of loss but does not possess title),
the value of the inventory is not included in the assets of the Company. The
terms of the Gold Consignment Agreement require the Company to deliver the
specified quantities of consigned gold back to the third party financial
institution at the end of the facility (which currently expires in 2004).
Physical delivery can be made from the Company's inventory or from gold acquired
by the Company in the open market. As an alternative to physical delivery of
these specific troy ounces of gold, the Company can elect to purchase the
consigned quantities at the end of the consignment facility at the current
market price for gold on that date.
As of April 30, 2002, the Company sold and simultaneously consigned
66,500 troy ounces of gold for $23.3 million under the gold consignment
facility. The facility provides for the sale of a maximum 115,000 troy ounces or
$40.0 million. Under the agreement, the Company pays consignment fees based on
the London Interbank Bullion Rates payable monthly. Consignment rates and
commitment fees on the unused portion of the gold consignment facility float
based upon the Company's quarterly financial performance. On August 22, 2002,
the Company purchased 66,500 troy ounces of gold at an average gold price of
$307.56 per ounce for a total of $20.5 million. The Company delivered gold to
its banks and extinguished all existing Company gold obligations under the
Credit Agreement.
12
7. DILUTIVE SHARES THAT WERE OUTSTANDING DURING THE PERIOD
The following table summarizes the reconciliation of the numerators and
denominators for the basic and diluted earnings per share ("EPS") computations
at April 30, 2003 and 2002.
Three months ended
April 30, 2003 April 30, 2002
(Restated - (Restated -
Note 12) Note 12)
-------------- ---------------
(in thousands, except share amounts)
Net (loss) income $ (2,787) $ 293
Weighted average shares for basic EPS 14,206 14,667
Incremental shares upon conversions:
Stock options ---- 715
Weighted average shares for diluted EPS 14,206 15,382
Stock options excluded from the calculation of diluted earnings per
share for the three months ended April 30, 2003 and 2002, were 2,434,263, and
362,845 respectively, due to their antidilutive effect on the calculations.
8. RECLASSIFICATION
Certain Balance Sheet amounts from prior periods were reclassified to
conform to the current year presentation. These reclassifications had no impact
on earnings.
9. COMMITMENT AND CONTINGENCIES
The Company entered into a three-year purchase agreement with one of
its merchandise inventory vendors in February 2003. Under the terms of the
agreement, the Company is committed to future minimum purchases of $16,000,000
in 2003, and $8,000,000 for each of the next two calendar years but only to the
extent the Company returns and the vendor accepts merchandise inventory from the
Company in specified proportions to the purchase commitment. In exchange for
this purchase agreement, the vendor agreed to accept from the Company $5,000,000
of merchandise inventory, some of which was damaged. As of April 30, 2003, the
Company had purchased approximately $4,500,000 and returned approximately
$2,800,000 of merchandise inventory under this agreement.
On July 25, 2002, the Company was named a defendant in a wage hour
class action suit filed in California by three former store managers. The case
is based principally upon the allegation that store managers employed by the
Company in California should have been classified as non-exempt for overtime
purposes. The plaintiffs seek recovery of allegedly unpaid overtime wages for
the four-year period preceding the filing date, along with certain penalties,
interest and attorneys fees. The purported class includes all current and former
store managers employed by the Company in California for the four-year period
preceding the filing of the complaint. The Company denied liability and asserted
that its managers were properly classified. In April 2003, the parties reached a
preliminary agreement to settle the matter resulting in a pre-tax charge of
$1,000,000, inclusive of the plaintiffs' attorneys' fees,
13
interest, penalties, administrative costs and other Company costs. This
settlement covers the period from July 25, 1998 through the date of settlement
approval. Completion of the settlement is subject to, among other things, the
successful negotiation and execution of a written settlement agreement, opt out
and other potential contingencies in the settlement agreement, court approval
and administration of the claims process. The parties are in the process of
negotiating the specific settlement terms. See Note 10, Subsequent Events.
The Company is subject to other claims and litigation in the normal
course of business. It is the opinion of management that additional liabilities,
if any, resulting from these other claims and litigation are not expected to
have a material adverse effect on the Company's financial condition or results
of operations.
10. SUBSEQUENT EVENTS
The Company has received and accepted a proposal from LaSalle Bank,
N.A. and ABN/AMRO Bank N.V. to lead a transaction that will refinance the
Company's credit facility. The proposed facility would be a revolving credit and
gold consignment agreement totaling $125 million. The Company expects this
facility will be in place in the second quarter resulting in a charge for
unamortized deferred financing fees of approximately $550,000 at that time.
Effective July 29, 2003, the Company entered into a Second Amended and Restated
Revolving Credit, Term Loan and Gold Consignment Agreement with certain members
of its prior bank group, with LaSalle Bank, N.A. and ABN/AMRO Bank as the lead
agent, which provides for a total facility of up to $125.0 million through July
28, 2007.
On July 25, 2002, the Company was named a defendant in a wage hour
class action suit filed in California by three former store managers. The case
was based principally upon the allegation that store managers employed by the
Company in California should have been classified as non-exempt for overtime
purposes. In April 2003, the parties reached a preliminary agreement to settle
the matter resulting in a pre-tax charge of $1,000,000, inclusive of the
plaintiffs' attorneys' fees, interest, penalties, administrative costs and other
Company costs. This settlement covers the period from July 25, 1998 through the
date of final settlement approval by the court. The court granted final approval
to the settlement on December 11, 2003.
The Company was named a defendant in a wage hour suit filed in
California by a former employee on May 6, 2003. The case was based principally
upon the allegation that the amount of overtime paid to certain California
employees was less than the amount actually earned. The suit asserts a claim for
$1,000,000. In December 2003, the parties reached a settlement of the suit for
an amount that is not significant in relation to the Company's financial
statements.
In August 2003, the Company was named as one of 14 defendants in a
lawsuit originally filed in the United States District Court for the Southern
District of New York, now pending in New York State Supreme Court, Commercial
Division. The case is brought by Capital Factors, Inc. ("Capital Factors"),
which provided financing to defendant Cosmopolitan Gem Corp. ("Cosmopolitan"),
an entity with which the Company has certain consignment and other commercial
arrangements. The complaint alleges that Cosmopolitan defrauded Capital Factors
into advancing funds to Cosmopolitan by misrepresenting Cosmopolitan's finances
and the profitability of its operations, and that the Company, along with other
persons and entities, including other jewelry retailers, aided and abetted or
participated in the alleged fraud. The complaint asserts against the defendants,
including the Company, claims under common law and the
14
Racketeer Influenced and Corrupt Organizations Act ("RICO"). Capital Factors
seeks aggregate damages from all of the defendants, including the Company, of
$30,000,000, plus unspecified punitive damages, interest and fees. Damages,
excluding punitive damages, awarded pursuant to claims asserted under RICO, as
well as interest on such damages, are subject to trebling, within the discretion
of the court.
The Company has also been named as one of 13 defendants in an amended
complaint filed on December 2, 2003 by International Diamonds, L.L.C.
("International") and its affiliate, Astra Diamonds Manufacturers, Ltd.
("Astra"). Astra is an Israeli diamond wholesaler that supplied diamonds to
Cosmopolitan; International is a joint venture formed by Cosmopolitan and Astra
to sell high quality finished diamond jewelry in the United States. The amended
complaint, consolidated with the Capital Factors action described above (the
"consolidated Capital Factors actions"), alleges that the Company, along with
other jewelry retailers and business affiliates of Cosmopolitan, participated in
Cosmopolitan's fraudulent scheme to defraud Capital Factors, and thus injured
International and Astra. The complaint asserts claims under common law and RICO,
seeking aggregate damages from all of the defendants, including the Company, of
$6,800,000, plus interest and fees. Damages awarded pursuant to claims under
RICO, as well as interest on such damages, are subject to trebling, within the
discretion of the court. In addition, the complaint alleges claims against the
Company for breach of contract for approximately $2,520,000 in goods delivered
and invoiced to the Company, for which International has not received payment.
In connection with the consolidated Capital Factors actions in New York
state court, the Company has filed an interpleader action for declaratory
relief, asking the Court to determine the proper parties to whom the Company
must pay amounts and deliver goods that are not in dispute related to goods
received from Cosmopolitan and certain other entities. In its answer to the
interpleader, Capital Factors has asserted that Whitehall owes Cosmopolitan
$8,600,000 in accounts receivable on invoices assigned to Capital Factors. This
amount may be included in the $30,000,000 of losses that Capital Factors seeks
in its RICO claims, although the Company is not certain at this time. The
Company is not currently aware of any accounts payable due and owing to any of
the claimants in this action that are not already reflected in the Company's
accounts payable and accrued liabilities.
In these consolidated Capital Factors actions, no depositions have been
taken and the Company has not answered either the Capital Factors complaint or
the amended International complaint. The Company intends to defend these
lawsuits vigorously.
The United States Attorney for the Eastern District of New York is
conducting a criminal investigation regarding matters that include those alleged
in the consolidated Capital Factors actions. The Company, among others, is a
subject of such criminal investigation and is cooperating fully with the United
States Attorney.
In addition, subsequent to the filing of the complaint by Capital
Factors and as previously disclosed, the SEC initiated an informal inquiry into
matters that are the subject of the consolidated Capital Factors actions. On
November 3, 2003, the Company received a subpoena issued by the SEC as a part of
a formal investigation by the SEC with respect to such matters. In connection
with this formal investigation, the SEC has requested that the Company produce
certain additional documents relating to the matters that are the subject of the
consolidated Capital Factors actions. The Company is cooperating fully with the
SEC in connection with this formal investigation.
15
As previously announced, the Company has conducted an internal
investigation in connection with the consolidated Capital Factors actions and
the related investigations by the United States Attorney for the Eastern
District of New York and the SEC. As a result of this internal investigation, as
previously announced, the Company terminated the employment of its Chief
Financial Officer who had been on leave.
Because these matters are still in their early stages, the Company is
unable at this time to predict the outcome of this contingency or the potential
exposure associated with the consolidated Capital Factors actions or the United
States Attorney and SEC investigations or to estimate the impact of this
reasonably possible contingent liability on the Company's results of operations,
financial condition or liquidity. Given the amounts sought in the consolidated
Capital Factors actions, and the inherent unpredictability of litigation, an
adverse outcome in these actions could have a material adverse effect on the
Company's results of operations, financial condition or liquidity, as further
described below.
On October 29, 2003, the Company entered into a letter agreement with
its lenders which clarified and supplements the existing provisions of the
Second Amended and Restated Revolving Credit, Term Loan and Gold Consignment
Agreement dated July 29, 2003 (the "Second Amended and Restated Credit
Agreement") with respect to the consolidated Capital Factors actions, the SEC
investigation and the investigation by the United States Attorney. Pursuant to
the letter agreement, the lenders under the Second Amended and Restated Credit
Agreement have reserved their rights to determine that the consolidated Capital
Factors actions, the SEC inquiry or the United States Attorney's investigation
constitutes a breach of the Second Amended and Restated Credit Agreement. If the
required lenders were to make such a determination, they would have the right to
declare an event of default and cease funding under the revolving loan facility
under the Second Amended and Restated Credit Agreement, among other things. If
the existing lenders were to cease funding under the revolving loan facility,
the Company would be required to seek new financing. There is no assurance that
new financing would be available on acceptable terms or at all. If the existing
lenders were to cease funding under the revolving loan facility and if the
Company were not able to arrange new financing on acceptable terms, this would
have a material adverse effect on the Company, which could affect the underlying
valuation of assets and liabilities. The accompanying financial statements have
been prepared assuming that the Company will continue as a going concern and do
not include any adjustments that might result from the occurrence of the
previously mentioned uncertainties.
In the course of the Company's internal investigation, as previously
announced, the Company discovered that its Executive Vice President,
Merchandising, violated a Company policy with respect to Company documentation
regarding the age of certain store inventory. Following that discovery, the
Company placed the executive on leave pending further investigation. Since then,
the Company discovered additional irregularities with respect to the
classification of inventory for the year ending January 31, 2001 and for the
quarter ending April 30, 2001, and for certain prior periods. These
irregularities resulted in inventory and accounts payable being equally
understated by approximately $6,300,000 for the period ending January 31, 2001
and approximately $2,500,000 for the period ending April 30, 2001. Such
irregularities had no effect on the Company's balance sheet for any subsequent
periods, including the years ending January 31, 2002 and January 31, 2003. The
matters referred to above did not have any income statement effects. As a result
of these matters, the Company terminated the employment of its Executive Vice
President, Merchandising.
16
11. RELATED PARTY TRANSACTIONS
The Company operates a program under which executive officers and
directors are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. For the first three months of fiscal 2003,
such purchases by executive officers and directors totaled approximately
$26,000.
12. RESTATEMENT
The accompanying interim financial statements for the three-month
interim periods ended April 30, 2003 and 2002 have been restated. Adjustments to
restate the financial statements are summarized into the following four
categories:
A. Merchandise inventory valuation adjustments
In prior periods, the Company entered into certain contemporaneous
agreements to both purchase merchandise and return substandard
merchandise inventory to vendors, outside of the normal
contractual return privileges. Additionally, in fiscal 2001, the
Company entered into a barter arrangement for approximately
$250,000 of merchandise inventory that involved the exchange of
merchandise inventory for barter credits. These arrangements
involved receiving vendor allowances at an amount greater than the
merchandise inventory fair market value in exchange for purchases
of merchandise inventory at a date in the future. The Company has
restated the financial statements to write-down the substandard
merchandise inventory to fair market value and record the
consideration received in excess of the fair market value of the
substandard inventory as a vendor allowance, which is a reduction
to inventory. This vendor allowance reduces the cost of inventory
and as the inventory is sold the Company will recognize lower cost
of sales.
In periods prior to February 1, 2000, the Company had written down
substandard inventory to fair market value and did not exchange
such inventory with vendors.
B. Software development costs and amortization
The financial statements have been restated to capitalize certain
costs associated with software development that were expensed in
the six-months ended July 31, 2003, in accordance with Statement
of Position 98-1 "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use". In addition, the Company
amortized certain capitalized software development costs prior to
the project being placed in service and has reversed such
amortization in the restated financial statements.
C. Vendor advertising/promotion credits
Certain vendor consideration, primarily related to co-op
advertising and program sponsorships, was received in the
six-months ended July 31, 2003, which should have reduced the
carrying value of merchandise inventory, in accordance with EITF
02-16. The adjustments reflected in the Statement of Operations
relate to reversing the reimbursements received and recording the
benefit as an adjustment of the inventory carrying value, which
benefits cost of sales in the inventory turnover period.
17
D. Tax effect of the adjustments
As a result of the restatement adjustments, income tax provisions
were revised in the Statement of Operations.
The following tables set forth the effects of the restatement
adjustments discussed above on the restated components of the
Statement of Operations for the three-month interim periods ended
April 30, 2003 and 2002 (unaudited, in thousands, except per share
data):
Three months ended Three months ended
April 30, 2003 April 30, 2002
As previously As previously
reported Restated reported Restated
------------- -------- ------------- --------
Cost of sales (including buying and
occupancy expenses) $ 46,052 $ 46,038 $ 47,376 $ 47,494
Gross profit 23,097 23,111 27,212 27,094
Selling, general and administrative
expenses 26,692 26,770 25,627 25,627
(Loss) income from operations (3,595) (3,659) 1,585 1,467
(Loss) income before income taxes (4,503) (4,567) 573 455
Income tax (benefit) expense (1,755) (1,780) 204 162
Net (loss) income (2,748) (2,787) 369 293
Earnings per share:
Basic $ (0.19) $ (0.20) $ 0.03 $ 0.02
Diluted $ (0.19) $ (0.20) $ 0.02 $ 0.02
18
The following table sets forth the effects of the restatement
adjustments discussed above on the restated components of the Balance Sheets at
April 30, 2003, January 31, 2003 and April 30, 2002 (unaudited, in thousands):
BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------------------
April 30, 2003 January 31, 2003 April 30, 2002
As As As
previously previously previously
reported Restated Restated Restated reported Restated
---------- -------- ---------- --------- ---------- ---------
Merchandise inventories $ 206,276 205,020 $ 197,859 $ 196,694 $ 175,882 $ 174,931
Current income tax benefit 2,293 2,251 -- -- 438 403
Deferred income taxes, net 2,158 2,638 2,172 2,627 2,370 2,741
Total current assets 215,307 214,721 205,680 204,970 184,252 183,869
Total assets 284,758 284,199 273,189 272,479 254,606 254,223
Income taxes payable 3,261 3,303
Total current liabilities 147,151 147,193
Total liabilities 154,536 154,578
Accumulated earnings 46,029 45,238 48,777 48,025 39,239 38,624
Total stockholders'
equity, net 115,935 115,144 118,653 117,901 114,949 114,334
Total liabilities and
stockholders' equity 284,758 284,199 273,189 272,479 254,606 254,223
The following table sets forth the effects of the restatement
adjustments discussed above on the Statement of Operations for the three months
ended April 30, 2003 and 2002 (unaudited, in thousands, except per share data):
Three months Three months
ended ended
April 30, 2003 April 30, 2002
-------------- --------------
Net (loss) income
As previously reported $ (2,748) $ 369
Reduced/(additional) expense:
Merchandise inventory valuation adjustments (4) (118)
Software development costs and amortization 27 --
Vendor advertising/promotion credits (87) --
Tax effects of items above 25 42
--------- --------
As restated $ (2,787) $ 293
========= ========
Basic (loss) income per share
As previously reported $ (0.19) $ 0.03
As restated $ (0.20) $ 0.02
Weighted average common Shares 14,206 14,667
Diluted (loss) income per share
As previously reported $ (0.19) $ 0.02
As restated $ (0.20) $ 0.02
Weighted average common shares and common
share equivalents 14,206 15,382
19
PART I - FINANCIAL INFORMATION
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations
Restatements of Prior Results
In December 2003, the Company restated previously issued financial
statements to record adjustments resulting from various accounting matters
described in Note 12 to the financial statements. In connection with the
process, the Company restated its financial statements for the three-month
periods ended April 30, 2003 and 2002. Accordingly, the financial statements
included in Management's Discussion and Analysis are discussed as adjusted by
the restatement of prior periods discussed in Note 12. .
Results of Operations
Net sales for the first quarter of fiscal 2003 decreased $5.4 million,
or 7.3%, to $69.1 million from $74.6 million in the first quarter of fiscal
2002. New store sales accounted for an increase in sales of $2.4 million.
Comparable store sales decreased $6.3 million, or 8.7%, in the first quarter of
fiscal 2003 from the first quarter of fiscal 2002. These sales changes were
impacted by a sales decrease of $1.5 million related to closed stores.
Comparable store sales were significantly affected by the economy and, more
particularly, a dramatic sales drop off in late February and throughout March
which management believes related in large measure to the War in Iraq and the
heightened concerns about terrorism. The total number of merchandise units sold
increased by approximately 9.8% in the first quarter of fiscal 2003 from the
first quarter of fiscal 2002, while the average price per merchandise sale
decreased to $277 in the first quarter of fiscal 2003 from $309 in the first
quarter of fiscal 2002. Credit sales as a percentage of net sales remained
constant at 40.5% in the first quarter of fiscal 2003 compared to the first
quarter of fiscal 2002. The Company opened 16 new stores and closed one store in
the first quarter of fiscal 2003, increasing the number of stores to 385 as of
April 30, 2003 compared to 373 as of April 30, 2002.
Gross profit decreased $4.0 million, or 14.7%, to $23.1 million from
$27.1 million in the first quarter of fiscal 2003 compared to the same period in
fiscal 2002. Gross profit as a percentage of sales decreased to 33.4% in the
first quarter of fiscal 2003 compared to 36.3% in the first quarter of fiscal
2002. The decrease in gross profit rate was driven by price promotions,
principally on diamond merchandise, and the de-leveraging of occupancy and
buying expenses as a result of lower sales. The decrease was partially offset by
the cost of goods sold impact of the turnover of benefit from vendor discounts
and co-op allowances recorded in compliance with the adoption of EITF 02-16.
Due to the adjustments resulting from the restatement, for the first quarter of
fiscal 2003, gross profit as a percent of net sales remained unchanged at
33.4%, and for the first quarter of fiscal 2002, gross profit as a percent of
net sales decreased twenty basis points to 36.3% from 36.5%.
Selling, general and administrative expenses increased $1.2 million, or
4.5%, to $26.8 million from $25.6 million in the first quarter of fiscal 2003
compared to the same period in fiscal 2002. Selling, general and administrative
expense as a percent of sales increased to 38.7% versus 34.4% in first quarter
2002. The dollar increase primarily related to higher other expense ($0.4
million), higher advertising expense ($0.3 million) and higher personnel expense
($0.5 million) which were partially offset by lower credit expense ($0.1
million). The increase in other expenses is primarily due to the increase in the
number of stores and increases in professional fees, but was partially offset by
lower expenses in existing stores resulting from centralized control of the
consumption of supplies and services along with reductions in negotiated rates
for those items. Advertising expense increased due to a new promotional
initiative in April 2003. Payroll costs increased
20
primarily due to the increased number of stores, but were offset by expense
reductions to reduce payroll hours and control labor rates in existing stores.
Due to the adjustments resulting from the restatement, selling, general and
administrative expenses as a percent of net sales increased ten basis points to
38.7% from 38.6%
Interest expense decreased approximately $0.1 million to $0.9 million
in the first quarter of fiscal 2003 from $1.0 million in the first quarter of
fiscal 2002. The decrease resulted from lower interest rates partially offset by
higher average borrowings.
Income tax benefit of $1.8 million in the first quarter of 2003
compared to an income tax expense of $0.2 million in the first quarter of 2002,
reflects an expected annual effective tax rate of 39.0% for fiscal 2003. The
Company's annual effective tax rate was 38.1% for fiscal 2002. The expected
increase in effective annual tax rate for fiscal 2003 reflects statutory changes
in a number of states in which the Company operates stores.
Net loss of $2.8 million in the first quarter of fiscal 2003, compared
to net income of $0.3 million in the first quarter of fiscal 2002, primarily
resulted from the factors discussed individually above.
Liquidity and Capital Resources
The Company's cash requirements consist principally of funding
inventory at existing stores, capital expenditures and working capital
(primarily inventory) associated with the Company's new stores. The Company's
primary sources of liquidity have been cash flow from operations and bank
borrowings under the Company's revolver.
The Company's inventory levels and working capital requirements have
historically been highest in advance of the Christmas season. The Company has
funded these seasonal working capital needs through borrowings under the
Company's revolver and increases in trade payables and accrued expenses. As of
April 30, 2003, the maximum availability under the credit facility was $37.9
million based on the borrowing base formula. The credit facility covenants also
require the Company to attain certain operating results.
The Company's cash flow provided by operating activities was $8.9
million in the first quarter of 2003 compared to $15.6 million used in operating
activities in the first quarter of fiscal 2002. Depreciation and amortization
($2.9 million) and increases in accounts payable ($19.6 million), outstanding
checks ($2.7 million), accrued payroll ($1.3 million), accrued liabilities ($1.2
million) and decreases in accounts receivable ($0.9 million) were partially
offset by increases in merchandise inventories ($8.3 million) and current income
tax benefit ($2.3 million) and a decrease in income taxes payable ($3.3 million)
and loss from operations ($2.8 million). The increase in accounts payable in
fiscal 2003 reflects the impact of timing of vendor payments resulting from the
Company's strategy to pay certain accounts payable in advance in the fourth
quarter of fiscal 2002 in order to earn additional cash discounts. The increase
in merchandise inventories primarily related to inventory for new store
openings, including anticipated store openings in the second quarter of fiscal
2003 and the 16 completed new store openings in the first quarter of fiscal
2003.
The Company utilized cash in the first quarter of 2003 primarily to pay
down revolver borrowings of $5.9 million, to fund capital expenditures of $4.8
million, primarily related to the opening of 16 new stores in the first quarter
of 2003, and to repay a portion of the term loan ($1.5 million).
Management expects that cash flow from operating activities and funds
available under its revolving credit facility should be sufficient to support
the Company's current new store expansion program and seasonal working capital
needs for the foreseeable future.
21
Contractual Obligations and Contingencies
The Company disclosed contractual obligations in the Management's
Discussion and Analysis of Financial Conditions and Results of Operations in the
Form 10-K/A filing for the fiscal year ended January 31, 2003.
Refer to Notes 9 and 10 of the April 30, 2003 financial statements
filed in this Form 10-Q/A with respect to commitments and contingencies.
Critical Accounting Policies and Estimates
The Company's critical accounting policies and estimates, including the
assumptions and judgments underlying them, are disclosed in the notes to the
Financial Statements and Managements Discussion and Analysis of Financial
Condition and Results of Operations in the Form 10-K/A filing for the year ended
January 31, 2003. These policies have been consistently applied in all material
respects and address such matters as revenue recognition, inventory valuation,
depreciation methods and asset impairment recognition. While the estimates and
judgments associated with the application of these policies may be affected by
different assumptions or conditions, the Company believes the estimates and
judgments associated with the reported amounts are appropriate in the
circumstances. Management has discussed the development and selection of these
critical accounting estimates with the audit committee of our Board of
Directors.
Due to the seasonal nature of the business, the Company tends to
generate nearly all of its income in the fourth quarter. While the 39% effective
tax rate currently estimated for the year is management's best estimate, to the
extent that income is significantly more or less than expected, the Company's
effective income tax rate for the fourth quarter and the full year could vary
significantly from that of the previous quarters.
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Cost is reduced to reflect certain allowances and
discounts received from vendors. Periodic payments from vendors in the form of
buydowns, volume or other purchase discounts that are evidenced by signed
agreements are reflected in the carrying value of the inventory when earned and
as a component of cost of sales, buying and occupancy as the merchandise is
sold. Additionally, to the extent it is not addressed by established vendor
return privileges, and if the amount of cash consideration received from the
vendor exceeds the estimated fair value of the goods returned, that excess
amount is reflected as a reduction in the purchase cost of the inventory
acquired. To the extent the Company's agreements with vendors specify co-op
advertising, the Company has historically classified such credits as a reduction
to advertising expense in selling, general and administrative expenses. Emerging
Issues Task Force ("EITF") Issue No. 02-16, "Accounting by a Customer (Including
a Reseller) for Certain Consideration Received from a Vendor" ("EITF 02-16"),
which was effective for all arrangements entered into after December 31, 2002,
requires vendor allowances to be classified as a reduction to cost of sales
unless evidence exists supporting an alternative classification.
The Company also obtains merchandise from vendors under various
consignment agreements. The consigned inventory and related contingent
obligations associated with holding and safekeeping such consigned inventory are
not reflected in the Company's financial statements. At the time of sale of
consigned merchandise to customers, the Company records the purchase liability
and the related consignor cost of such merchandise in cost of sales.
22
Transactions with Affiliates and Related Parties
The Company operates a program under which executive officers and
directors are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. For the first three months of fiscal 2003,
such purchases by executive officers and directors totaled approximately
$26,000.
Inflation
Management believes that inflation generally has not had a material
effect on the Company's results of operations.
Accounting for Costs Associated with Exit or Disposal Activities
In June 2002, the Financial Accounting Standards Board issued Statement
No. 146 ("SFAS 146"), "Accounting for Costs Associated with Exit or Disposal
Activities." SFAS 146 requires that costs associated with disposal or exit
activities after December 31, 2002 be recorded at fair value in the period the
liability is incurred. The Company adopted SFAS 146 effective January 1, 2003,
which had no impact on its financial statements.
Accounting by a Customer for Certain Consideration Received from a Vendor
Merchandise inventories are stated principally at the lower of weighted
average cost or market. Purchase cost is reduced to reflect certain allowances
and discounts received from merchandise vendors. Periodic credits or payments
from merchandise vendors in the form of buy downs, volume or other purchase
discounts and other vendor consideration are reflected in the carrying value of
the inventory and recognized as a component of cost of sales as the merchandise
is sold. Additionally, to the extent it is not addressed by established vendor
return privileges, and if the amount of cash consideration received from the
vendor exceeds the estimated fair value of the goods returned, that excess
amount is reflected as a reduction in the purchase cost of the inventory
acquired.
To the extent the Company's agreements with vendors provide credits for
co-op advertising, the Company has historically classified such credits as a
reduction to advertising expense in selling, general and administrative
expenses. Emerging Issues Task Force Issue No. 02-16, "Accounting by a Customer
(Including a Reseller) for Certain Consideration Received from a Vendor" ("EITF
02-16"), which was effective for all arrangements entered into after December
31, 2002, requires certain merchandise vendor allowances to be classified as a
reduction to inventory cost unless evidence exists supporting an alternative
classification. The Company has recorded such merchandise vendor allowances as a
reduction of inventory cost. The total amount of these allowances and other
vendor consideration earned as of April 30, 2003, January 31, 2003, and April
30, 2002 was approximately $2,818,000, $3,254,000 and $551,000, respectively.
Accounting for Stock-Based Compensation
The Financial Accounting Standards Board issued Statement No. 148
("SFAS 148"), "Accounting for Stock-Based Compensation-Transition and
Disclosure," during 2002. SFAS 148 amends Statement No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation and amends the disclosure requirements to require
prominent disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
23
method used on reported results. The Company adopted the disclosure requirements
of SFAS 148 as of January 31, 2003.
Accounting for Guarantees
In November 2002, the Financial Standards Accounting Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others," an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FASB Interpretation No. 34. The Company has adopted the guidance of FIN 45
and has reflected the required disclosures in its financial statements
commencing with the financial statements for the year ended January 31, 2003.
Under its bylaws, the Company has agreed to indemnify its officer and
directors for certain events or occurrences while the officer or director is, or
was serving, at its request in such capacity. The maximum potential amount of
future payments the Company could be required to make pursuant to these
indemnification obligations is unlimited; however, the Company has a directors
and officer liability insurance policy that, under certain circumstances,
enables it to recover a portion of any future amounts paid. As a result of its
insurance policy coverage, the Company believes the estimated fair value of
these indemnification obligations is minimal. The Company had no liabilities
recorded for these obligations as of April 30, 2003.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
The Company's exposure to changes in interest rates relates primarily
to its borrowing activities to fund business operations. The Company principally
uses floating rate borrowings under its revolving credit and term loan
facilities. The Company's private label credit card provider charges the Company
varying discount rates for its customers' credit program purchases. These
discount rates are sensitive to significant changes in interest rates. The
Company currently does not use derivative financial instruments to protect
itself from fluctuations in interest rates.
Gold Price Risk
The Company does not hedge gold price changes. Current increases in
gold prices have had and may have a future negative impact on gross margin to
the extent sales prices do not increase commensurately.
Item 4. - Controls and Procedures
The Company's management, with the participation of our Chief Executive
Officer and our Chief Financial Officer, carried out an evaluation of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures (as defined in Rule 13a-15(e) promulgated under the Securities
Exchange Act of 1934, as amended). Based upon this evaluation, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective as of April 30, 2003 to
provide reasonable assurance that information required to be disclosed by the
Company in reports filed or submitted under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported, within the time
periods specified in the SEC's rules and forms. There were no changes in the
Company's internal control over financial reporting that occurred during the
Company's fiscal quarter ended April 30, 2003 that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.
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As previously reported in the Company's Form 10-Q for the quarterly
period ended October 31, 2003, in the course of performing its review of the
interim financial statements of the Company for the period ended October 31,
2003, PricewaterhouseCoopers advised the Company's audit committee and
management that the Company had internal control deficiencies in its cash
disbursements and merchandise areas that PricewaterhouseCoopers considered
collectively to be a "material weakness" under standards established by the
American Institute of Certified Public Accountants. These deficiencies had no
impact on the Company's results of operations or financial condition for and as
of the three-month period ended April 30, 2003 and the fiscal year ended January
31, 2003. During the third quarter of 2003, the Company (1) implemented a policy
requiring that each check disbursement be accompanied by a remittance advice
identifying the invoices and credit memos covered by such disbursement and (2)
formally adopted and internally promulgated a policy detailing procedures for
accounts payable disbursements.
Following the end of the third quarter of 2003, the Company has already
or will shortly undertake a number of additional measures in respect of its
internal control over financial reporting. Among these measures, the Company:
(1) commenced a search for an internal audit director, who will report directly
to the audit committee of the Board of Directors; (2) is in the process of
instituting a compliance program, as part of which the Company has adopted a
Code of Business Conduct and Ethics and has appointed a Chief Corporate
Compliance Officer; (3) implemented improvements in the process by which monthly
statements from vendors of outstanding invoices and credits are reconciled to
the Company's records; and (4) implemented additional procedures for approving
purchases by the Company of items previously provided to the Company on
consignment.
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PART II - OTHER INFORMATION
Item 5. Forward Looking Statements
This report contains certain forward-looking statements (as such term
is defined in Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934) and information relating to the Company that
are based on the current beliefs of management of the Company as well as
assumptions made by and information currently available to management including
statements related to the markets for our products, general trends and trends in
our operations or financial results, plans, expectations, estimates and beliefs.
In addition, when used in this report, the words "anticipate," "believe,"
"estimate," "expect," "intend," "plan," "predict" and similar expressions and
their variants, as they relate to the Company or our management, may identify
forward-looking statements. Such statements reflect our judgment as of the date
of this report with respect to future events, the outcome of which is subject to
certain risks, including the factors described below, which may have a
significant impact on our business, operating results or financial condition.
Investors are cautioned that these forward-looking statements are inherently
uncertain. Should one or more of these risks or uncertainties materialize, or
should underlying assumptions prove incorrect, actual results or outcomes may
vary materially from those described herein. Whitehall Jewellers undertakes no
obligation to update forward-looking statements. The following factors, among
others, may impact forward-looking statements contained in this report: (1) a
change in economic conditions or the financial markets which negatively impacts
the retail sales environment and reduces discretionary spending on goods such as
jewelry; (2) reduced levels of mall traffic caused by economic or other factors;
(3) our ability to execute our business strategy and the related effects on
comparable store sales and other results; (4) the extent and results of our
store expansion strategy and associated occupancy costs, and access to funds for
new store openings; (5) the high degree of fourth quarter seasonality of our
business; (6) the extent and success of our marketing and promotional programs;
(7) personnel costs and the extent to which we are able to retain and attract
key personnel; (8) the effects of competition; (9) the availability and cost of
consumer credit; (10) relationships with suppliers; (11) our ability to maintain
adequate information systems capacity and infrastructure; (12) our leverage and
cost of funds and changes in interest rates that may increase such costs; (13)
our ability to maintain adequate loss prevention measures; (14) fluctuations in
raw material prices, including diamond, gem and gold prices; (15) developments
relating to the consolidated Capital Factors actions and the related SEC and
U.S. Attorney's office investigations, including the impact of such developments
on our results of operations and financial condition and relationship with our
lenders or with our vendors; (16) regulation affecting the industry generally,
including regulation of marketing practices; (17) the successful integration of
acquired locations and assets into our existing operations; and (18) the risk
factors identified from time to time in our filings with the SEC.
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Item 6. - Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description
- ----------- -----------
10.1 2003 Special Bonus Program (previously filed)
31.1 Certification of the Chief Executive Officer pursuant to Rule
13a - 14(a) of the Securities Exchange Act of 1934.
31.2 Certification of the Chief Financial Officer pursuant to Rule
13a - 14(a) of the Securities Exchange Act of 1934.
32.1 Certification of the Chief Executive Officer pursuant to 18
United States Code Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
33.2 Certification of the Chief Financial Officer pursuant to 18
United States Code Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WHITEHALL JEWELLERS, INC.
(Registrant)
Date: January 21, 2004 By: /s/ John R. Desjardins
----------------------------
John R. Desjardins
Executive Vice President;
Chief Financial Officer and
Treasurer
(Duly authorized officer and
principal financial officer)
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