UNITED STATES
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: JULY 31, 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 August 31, 2003 was 14,214,422 and the number of
shares of the Registrant's Class B common stock, $1.00 par value per share,
outstanding as of August 31, 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 to prior 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.
2
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 September 12, 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 July 31, 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 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
Whitehall Jewellers, Inc.
Statements of Operations
for the three months and six months ended July 31, 2003 and 2002
(unaudited, in thousands, except per share data)
Three months ended Six months ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
(Restated - (Restated - (Restated - (Restated -
Note 12) Note 12) Note 12) Note 12)
------------- ------------- ------------- -------------
Net sales $ 72,732 $ 76,243 $ 141,881 $ 150,831
Cost of sales (including buying and occupancy
expenses) 48,540 49,798 94,578 97,292
--------- --------- --------- ---------
Gross profit 24,192 26,445 47,303 53,539
Selling, general and administrative expenses 27,223 25,251 53,993 50,878
--------- --------- --------- ---------
(Loss) income from operations (3,031) 1,194 (6,690) 2,661
Interest expense 1,564 1,111 2,472 2,123
--------- --------- --------- ---------
(Loss) income before income taxes (4,595) 83 (9,162) 538
Income tax (benefit) expense (1,792) 29 (3,572) 191
--------- --------- --------- ---------
Net (loss) income $ (2,803) $ 54 $ (5,590) $ 347
========= ========= ========= =========
Basic earnings per share:
Net (loss) income $ (0.20) $ 0.00 $ (0.39) $ 0.02
========= ========= ========= =========
Weighted average common share and common
share equivalents 14,215 14,807 14,210 14,719
========= ========= ========= =========
Diluted earnings per share:
Net (loss) income $ (0.20) $ 0.00 $ (0.39) $ 0.02
========= ========= ========= =========
Weighted average common share and common
share equivalents 14,215 15,594 14,210 15,476
========= ========= ========= =========
The accompanying notes are an integral part of the financial statements.
4
Whitehall Jewellers, Inc.
Balance Sheets
(unaudited, in thousands, except share data)
July 31, 2003 January 31, 2003 July 31, 2002
(Restated - (Restated - (Restated -
Note 12) Note 12) Note 12)
------------- ---------------- -------------
ASSETS
Current Assets:
Cash $ 1,399 $ 2,048 $ 2,128
Accounts receivable, net 333 1,621 2,042
Merchandise inventories 204,926 196,694 168,334
Other current assets 2,127 1,470 1,493
Current income tax benefit 4,435 --- 262
Deferred financing costs 261 510 510
Deferred income taxes, net 2,522 2,627 2,869
--------- --------- ---------
Total current assets 216,003 204,970 177,638
Property and equipment, net 63,709 61,634 62,941
Goodwill 5,662 5,662 5,662
Deferred financing costs 781 213 468
--------- --------- ---------
Total assets $ 286,155 272,479 $ 246,709
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolver loan $ 86,375 $ 94,490 $ 61,694
Current portion of long-term debt 640 4,500 5,750
Accounts payable 61,078 26,784 36,890
Customer deposits 3,355 3,454 3,655
Accrued payroll 3,036 3,282 4,989
Income taxes payable -- 3,303 --
Other accrued expenses 12,023 11,380 13,402
--------- --------- ---------
Total current liabilities 166,507 147,193 126,380
Term loan -- -- 1,500
Subordinated debt -- 640 640
Deferred income taxes, net 3,879 3,607 1,868
Other long-term liabilities 3,338 3,138 2,907
--------- --------- ---------
Total liabilities 173,724 154,578 133,295
--------- --------- ---------
Commitments and contingencies
Stockholders' equity:
Common stock 18 18 18
Class B common stock -- -- --
Additional paid-in capital 105,830 105,795 105,633
Accumulated earnings 42,435 48,025 38,678
--------- --------- ---------
148,283 153,838 144,329
--------- --------- ---------
Less:
Treasury stock, at cost (3,815,900, 3,822,637 and
3,357,646 shares, respectively) (35,852) (35,937) (30,915)
--------- --------- ---------
Total stockholders' equity, net 112,431 117,901 113,414
--------- --------- ---------
Total liabilities and stockholders' equity $ 286,155 $ 272,479 $ 246,709
========= ========= =========
The accompanying notes are an integral part of the financial statements.
5
Whitehall Jewellers, Inc.
Statements of Cash Flows
for the six months ended July 31, 2003 and 2002
(unaudited, in thousands)
Six months ended
--------------------------------
July 31, 2003 July 31, 2002
(Restated (Restated
- Note 12) - Note 12)
------------- -------------
Cash flows from operating activities:
Net (loss) income $ (5,590) $ 347
Adjustments to reconcile net (loss) income
to net cash provided by (used in) operating activities:
Depreciation and amortization 5,923 5,544
Loss on disposition of assets 409 24
Write-off of deferred loan cost 516 --
Changes in assets and liabilities:
Decrease(increase)in accounts receivable, net 1,288 (853)
(Increase) decrease in merchandise
inventories, net of gold consignment (8,232) 4,764
(Increase) in other current assets (657) (269)
(Increase) in current income tax benefit (4,435) (262)
Increase in deferred income taxes, net 377 16
(Decrease) in customer deposits (99) (308)
Increase(decrease) in accounts payable 23,382 (21,193)
(Decrease) in accrued payroll (246) (1,281)
(Decrease) in income taxes payable (3,303) (3,257)
Increase(decrease) in accrued liabilities 643 (1,417)
Increase in other long-term liabilities 200 247
--------- ---------
Net cash provided by (used in) operating activities 10,176 (17,898)
Cash flows from investing activities:
Capital expenditures (8,125) (4,339)
--------- ---------
Net cash used in investing activities (8,125) (4,339)
Cash flows from financing activities:
Borrowing on revolver loan 363,810 439,385
Repayment of revolver loan (371,925) (412,968)
Repayment of term loan (4,500) (2,500)
Proceeds from exercise of stock options 75 1,407
Proceeds under employee stock purchase plan 45 10
Financing costs (1,117) --
Increase(decrease) in outstanding checks, net 10,912 (3,710)
--------- ---------
Net cash (used in) provided by financing activities (2,700) 21,624
--------- ---------
Net change in cash and cash equivalents (649) (613)
Cash and cash equivalents at beginning of period 2,048 2,741
--------- ---------
Cash and cash equivalents at end of period $ 1,399 $ 2,128
========= =========
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 383 stores as of July
31, 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 July 31, 2003, January 31, 2003
and July 31, 2002 was approximately $2,542,000, $3,254,000 and $1,540,000,
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 six months of fiscal 2003.
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 and six months ended July 31, 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
Three months ended Six months ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
(Restated - Note 12) (Restated - Note 12) (Restated - Note 12) (Restated - Note 12)
--------------------------------------------------------------------------------------------
(in thousands, except for per share amounts)
--------------------------------------------------------------------------------------------
Net (loss) income, as reported $ (2,803) $ 54 $ (5,590) $ 347
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method, net of related tax
effects 265 508 532 1,077
------------------------------- -----------------------------------
Pro forma net (loss) $ (3,068) $ (454) $ (6,122) $ (730)
=============================== ===================================
Earnings per share:
Basic-as reported $ (0.20) $ 0.00 $ (0.39) $ 0.02
=============================== ===================================
Basic-pro forma $ (0.22) $ (0.03) $ (0.43) $ (0.05)
=============================== ===================================
Diluted-as reported $ (0.20) $ 0.00 $ (0.39) $ 0.02
=============================== ===================================
Diluted-pro forma $ (0.22) $ (0.03) $ (0.43) $ (0.05)
=============================== ===================================
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 and six months ended July 31, 2003 and 2002 the fair value is estimated
using the Black-Scholes option-pricing model. The assumptions used are as
follows:
For the three months ended For the six months ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
------------------------------------ ------------------------------------
Risk-free interest rate 3.0% 4.4% 3.0% 4.6%
Dividend yield 0 0 0 0
Option life 5.5 years 5.5 years 5.5 years 5.5 years
Volatility 60% 62% 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.
During the six months ended July 31, 2003, the Company closed 6 stores
resulting in a charge of $24,000 related to closing costs, net of reversal of
$225,000 in prior period accruals for store closing costs and minimum rent. In
addition, the Company recorded $374,000 of accelerated depreciation expense in
connection with these store closings.
Accounting for Guarantees
In November 2002, the Financial Standards Accounting Board issued FASB
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
9
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,
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 July 31, 2003.
3. ACCOUNTS RECEIVABLE, NET
As of July 31, 2003, January 31, 2003 and July 31, 2002, accounts
receivable consisted of:
July 31, 2003 January 31, 2003 July 31, 2002
------------- ---------------- -------------
(in thousands)
Accounts receivable $ 805 $ 2,165 $ 2,682
Less: allowance for
doubtful accounts (472) (544) (640)
------- ------- -------
Accounts receivable, net $ 333 $ 1,621 $ 2,042
======= ======= =======
4. INVENTORY
As of July 31, 2003, January 31, 2003 and July 31, 2002, merchandise
inventories consisted of:
July 31, 2003 January 31, 2003 July 31, 2002
------------- ---------------- -------------
(Restated - (Restated - (Restated -
Note 12) Note 12) Note 12)
------------- ---------------- -------------
(in thousands)
Raw Materials $ 11,171 $ 7,657 $ 6,846
Finished Goods 193,755 189,037 161,488
--------- --------- ---------
Merchandise Inventories $ 204,926 $ 196,694 $ 168,334
========= ========= =========
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 $2,899,000,
$3,567,000, and $3,411,000 as of July 31, 2003, January 31, 2003 and July 31,
2002, respectively. As of July 31, 2003, January 31, 2003 and July 31, 2002,
consignment inventories held by the Company that were not included in the
balance sheets total $76,777,000, $74,924,000, and $68,520,000, respectively.
In addition, gold consignments of $23,298,000 are not included in the
Company's balance sheets as of July 31, 2002 (see Note 6, Financing
10
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 $282,000 and $562,000 of this increase in cost of sales is
reflected in the three and six months ended July 31, 2003, respectively. This
purchase 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
were allocated to inventory. As of July 31, 2003, January 31, 2003 and July 31,
2002, the amounts included in inventory were $3,608,000, $3,364,000 and
$3,302,000, respectively.
5. ACCOUNTS PAYABLE
Accounts payable includes outstanding checks, which were $17,424,000,
$6,512,000 and $3,430,000 as of July 31, 2003, January 31, 2003 and July 31,
2002, respectively.
6. FINANCING ARRANGEMENTS
Effective July 29, 2003, the Company entered into a Second Amended and
Restated Revolving Credit, Term Loan and Gold Consignment Agreement (the "Credit
Agreement") with certain members of its prior bank group which provides for a
total facility of up to $125.0 million through July 28, 2007. Interest rates and
the commitment fee charged on the unused portion of the facility float based
upon the Company's financial performance as calculated quarterly.
Under this Credit Agreement, the banks have a collateral security
interest in substantially all of the assets of the Company. The Credit Agreement
contains certain restrictions, including restrictions on investments, payment of
dividends, assumption of additional debt, acquisitions and divestitures. The
Credit Agreement also requires the Company to maintain a specified ratio of the
sum of earnings before interest, taxes, depreciation and amortization plus
minimum store rent to the sum of minimum store rent plus cash interest expense
if the Company's borrowing availability drops below a certain level.
Revolver Loan
The revolving loan facility under the Credit Agreement is available up
to a maximum of $125.0 million, including amounts 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 receivables. Availability under
the revolver is based on amounts outstanding thereunder, 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.
11
The interest rates for borrowings under the Credit 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.
Gold Consignment Facility
The Company has the opportunity to enter into gold consignments with
certain third party financial institutions. At this time the Company has no
obligations under the gold consignment facility. 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 2007).
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 current market price for gold on that date.
As of July 31, 2002, the Company sold and simultaneously consigned
66,500 troy ounces of gold for $20.3 million under the gold consignment facility
based upon the market price of gold. 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.
7. DEFERRED FINANCING COSTS
In conjunction with the Company's refinancing of its prior credit
agreement with certain members of its prior bank group, deferred financing costs
of $516,000 related to the prior credit facility were written off in the second
quarter of fiscal 2003. Costs associated with the second amended and restated
credit facility totaling $1.0 million are being amortized over the term of the
Credit Agreement.
12
8. 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 July 31, 2003 and 2002.
Three months ended Six Months Ended
July 31, 2003 July 31, 2002 July 31, 2003 July 31, 2002
(Restated - (Restated - (Restated - (Restated -
Note 12) Note 12) Note 12) Note 12)
------------- ------------- ------------- -------------
(in thousands, except per share amounts)
Net (loss) income $ (2,803) $ 54 $ (5,590) $ 347
Weighted average shares for
basic EPS 14,215 14,807 14,210 14,719
Incremental shares upon
conversions:
Stock options -- 787 -- 757
Weighted average shares for
diluted EPS 14,215 15,594 14,210 15,476
Stock options excluded from the
calculation of diluted earnings
per share due to their
antidilutive effect on the
calculations 1,408 356 2,412 354
9. RECLASSIFICATIONS
Certain Balance Sheet amounts from prior periods were reclassified to
conform to the current year presentation. These reclassifications had no impact
on earnings.
10. COMMITMENTS 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 July 31, 2003, the
Company had purchased approximately $9,000,000 and returned approximately
$3,100,000 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. 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 final settlement agreement
was preliminarily approved on August 1, 2003 and notices have been sent to class
members. Class members have until October 17, 2003 to opt out of the settlement.
See Note 13, Subsequent Events.
13
The Company was named a defendant in a wage hour suit filed in
California by a former employee on May 6, 2003. The case is 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. The Company intends to defend the case vigorously. The Company is
unable to predict the outcome or potential exposure of this case, if any, at
this time. See Note 13, Subsequent Events.
The Company has been named as one of 14 defendants in a lawsuit filed
August 13, 2003 in the United States District Court for the Southern District of
New York, styled Capital Factors, Inc. v. Cosmopolitan Gem Corp., et al., No. 03
Civ. 6097. The case is brought by Capital Factors, Inc. ("Capital"), 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 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 Company
claims under common law and the Racketeer Influenced and Corrupt Organizations
Act ("RICO"). Subsequent to the filing of the complaint, the Company was
informed by the SEC that it is seeking information from a number of parties,
including the Company, relating to this matter. Capital seeks aggregate damages
from the defendants of $30,000,000, with trebling under RICO, plus unspecified
punitive damages. The Company intends to defend the lawsuit vigorously. The
Company is unable to predict the outcome or potential exposure of this case, if
any, at this time. Subsequent to the filing of the complaint, the Company was
informed by the SEC that it has opened an informal inquiry into the allegations
contained in the lawsuit and is seeking information from a number of parties,
including the Company, relating to this matter. The Company intends to cooperate
fully with any request for information it may receive from the SEC. See Note 13,
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.
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 six months of fiscal 2003,
such purchases by executive officers and directors totaled approximately
$129,000.
12. RESTATEMENT
The accompanying interim financial statements for the three and six
month interim periods ended July 31, 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
14
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.
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 and six month interim
periods ended July 31, 2003 and 2002 (unaudited, in thousands,
except per share data):
15
Three months ended Three months ended
July 31, 2003 July 31, 2002
As previously As previously
reported Restated reported Restated
------------- -------- ------------- --------
Cost of sales (including buying and
occupancy expenses) $ 48,623 $ 48,540 $49,703 $49,798
Gross profit 24,109 24,192 26,540 26,445
Selling, general and administrative expenses 27,251 27,223 25,251 25,251
(Loss) income from operations (3,142) (3,031) 1,289 1,194
(Loss) income before income taxes (4,706) (4,595) 178 83
Income tax (benefit) expense (1,835) (1,792) 64 29
Net (loss) income (2,871) (2,803) 114 54
Earnings per share:
Basic $ (0.20) $ (0.20) $ 0.01 $ 0.00
Diluted $ (0.20) $ (0.20) $ 0.01 $ 0.00
Six months ended Six months ended
July 31, 2003 July 31, 2002
As previously As previously
reported Restated reported Restated
-------------- -------- ------------- --------
Cost of sales (including buying and occupancy
expenses) $ 94,675 $ 94,578 $ 97,079 $ 97,292
Gross profit 47,206 47,303 53,752 53,539
Selling, general and administrative expenses
53,943 53,993 50,878 50,878
(Loss) income from operations (6,737) (6,690) 2,874 2,661
(Loss) income before income taxes
(9,209) (9,162) 751 538
Income tax (benefit) expense (3,590) (3,572) 268 191
Net (loss) income (5,619) (5,590) 483 347
Earnings per share:
Basic $ (0.40) $ (0.39) $ 0.03 $ 0.02
Diluted $ (0.40) $ (0.39) $ 0.03 $ 0.02
16
The following table sets forth the effects of the restatement
adjustments discussed above on the restated components of the Balance Sheets at
July 31, 2003, January 31, 2003 and July 31, 2002 (unaudited, in thousands):
BALANCE SHEETS
- -------------------------------------------------------------------------------------------------------------------------
July 31, 2003 January 31, 2003 July 31, 2002
As As As
previously Restated previously previously
reported reported Restated reported Restated
-----------------------------------------------------------------------------------------
Merchandise inventories $ 206,149 204,926 $197,859 $196,694 $169,380 $168,334
Current income tax benefit 4,477 4,435 --- --- 300 262
Deferred income taxes, net 2,085 2,522 2,172 2,627 2,461 2,869
Total current assets 216,683 216,003 205,680 204,970 178,086 177,638
Total assets 286,730 286,155 273,189 272,479 247,157 246,709
Income taxes payable 3,261 3,303
Total current liabilities 147,151 147,193
Total liabilities 154,536 154,578
Accumulated earnings 43,158 42,435 48,777 48,025 39,354 38,678
Total stockholders' equity,
net 113,154 112,431 118,653 117,901 114,090 113,414
Total liabilities and
stockholders' equity 286,730 286,155 273,189 272,479 247,157 246,709
The following table sets forth the effects of the restatement
adjustments discussed above on the Statement of Operations for the three and six
months ended July 31, 2003 and 2002 (unaudited, in thousands, except per share
data):
Three months ended Three months ended
July 31, 2003 July 31, 2002
------------------ ------------------
Net (loss) income
As previously reported $ (2,871) $ 114
Reduced/(additional) expense:
Merchandise inventory valuation adjustments 6 (95)
Software development costs and amortization 78 ---
Vendor advertising/promotion credits 27 ---
Tax effects of items above (43) 35
-------- --------
As restated $ (2,803) $ 54
======== ========
Basic (loss) income per share
As previously reported $ (0.20) $ 0.01
As restated $ (0.20) $ 0.00
Weighted average common Shares 14,215 14,807
Diluted (loss) income per share
As previously reported $ (0.20) $ 0.01
As restated $ (0.20) $ 0.00
Weighted average common shares and common share
equivalents 14,215 15,594
17
Six months ended Six months ended
July 31, 2003 July 31, 2002
---------------- ----------------
Net (loss) income
As previously reported $ (5,619) $ 483
Reduced/(additional) expense:
Merchandise inventory valuation adjustments 2 (213)
Software development costs and amortization 105 ---
Vendor advertising/promotion credits (60) ---
Tax effects of items above (18) 77
-------- --------
As restated $ (5,590) $ 347
======== ========
Basic (loss) income per share
As previously reported $ (0.40) $ 0.03
As restated $ (0.39) $ 0.02
Weighted average common shares 14,210 14,719
Diluted (loss) income per share
As previously reported $ (0.40) $ 0.03
As restated $ (0.39) $ 0.02
Weighted average common shares and common share
equivalents 14,210 15,476
13. SUBSEQUENT EVENTS
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 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.
18
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.
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.
19
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.
20
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 and
six-month periods ended July 31, 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 for the Three Months Ended July 31, 2003
Net sales for the second quarter of fiscal 2003 decreased $3.5 million,
or 4.6%, to $72.7 million from $76.2 million in the second quarter of fiscal
2002. Comparable store sales decreased $5.3 million, or 7.2%, in the second
quarter of fiscal 2003 from the second quarter of fiscal 2002. Additionally,
there was a sales decrease of $1.3 million related to closed stores. These
decreases were partially offset by sales from new stores of $3.1 million. The
total number of merchandise units sold decreased by approximately 2.5% in the
second quarter of fiscal 2003 from the second quarter of fiscal 2002 while the
average price per merchandise sale declined to $285 in fiscal 2003 from $291 in
fiscal 2002. The slower economy and lower consumer confidence contributed to a
negative impact on sales. Credit sales as a percentage of net sales increased
slightly in the second quarter of fiscal 2003 compared to the second quarter of
fiscal 2002. The Company opened three new stores and closed five stores in the
second quarter of fiscal 2003 increasing the number of stores open to 383 as of
July 31, 2003 compared to 374, as of July 31, 2002.
Gross profit for the second quarter of fiscal 2003 decreased $2.2
million, or 8.5%, to $24.2 million from $26.4 million in the same period in
fiscal 2002. Gross profit as a percentage of net sales decreased to 33.3% in the
second quarter of fiscal 2003 from 34.7% in the second quarter of fiscal 2002.
The reduction in gross profit margin was primarily impacted by store occupancy
expense, including store-closing costs ($0.4 million), which increased at a rate
higher than the increase in sales. Gross profit rate was also negatively
impacted by an increase mix of watch sales which carry a lower margin than
certain other merchandise categories as well as the competitive pricing
environment. Due to the adjustments resulting from the restatement, for the
second quarter of fiscal 2003, gross profit as a percent of net sales increased
twenty basis points to 33.3% from 33.1%, and for the second quarter of fiscal
2002, gross profit as a percent of net sales decreased ten basis points to 34.7%
from 34.8%.
Selling, general and administrative expenses for the second quarter of
fiscal 2003 increased $1.9 million, or 7.8%, to $27.2 million from $25.3 million
in the second quarter of fiscal 2002. As a percentage of net sales, selling,
general and administrative expenses increased to 37.4% in the second quarter of
fiscal 2003 from 33.1% in the second quarter of fiscal 2002. The dollar increase
was primarily related to higher other expense ($1.6 million), higher advertising
expense ($0.4 million) and higher personnel expense ($0.3 million) which were
partially offset by lower credit expense ($0.3 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 2003. Prior to the
adoption of EITF 02-16, management had expected that the impact of the
promotional initiatives would be offset by advertising co-op allowances. Payroll
costs increased primarily due to the increased number of stores, but were offset
by measures taken to reduce payroll hours and control labor rates in existing
stores. Due to the adjustments resulting from the restatement, for the second
quarter of fiscal 2003, selling, general and administrative expenses as a
percent of net sales decreased ten basis points to 37.4% from 37.5%.
21
Interest expense increased $0.5 million to $1.6 million in the second
quarter of fiscal 2003 from $1.1 million in the second quarter of fiscal 2002,
resulting from the write off of $516,000 of deferred financing fees related to
the refinancing of the prior credit facility with certain members of the prior
bank group and higher average borrowings partially offset by lower average
interest rates.
Income taxes decreased $1.8 million resulting in a benefit of $1.8
million in the second quarter of fiscal 2003 compared to an expense of $29,000
in the second quarter of fiscal 2002, reflecting an effective annual tax rate of
39.0% and 34.9% in the second quarter of fiscal 2003 and 2002, respectively. The
Company's annual effective tax rate was 38.1% for fiscal 2002.
Net loss of $2.8 million in the second fiscal quarter of 2003, compared
to net income of $0.1 million in the second quarter of fiscal 2002, primarily
resulted from the factors discussed individually above.
Results of Operations for the Six Months Ended July 31, 2003
Net sales for the six months ended July 31, 2003 decreased $9.0
million, or 5.9%, to $141.9 million from $150.8 million in the six months ended
July 31, 2002. Comparable store sales decreased $11.7 million, or 7.9%, in the
first six months of fiscal 2003 from the same period in fiscal 2002. These
decreases were partially offset by sales from new stores of $5.5 million.
Additionally, there were sales decreases of $2.8 million primarily related to
closed stores. The total number of merchandise units sold increased slightly in
the first six months of fiscal 2003 from the first six months of fiscal 2002 and
the average price per merchandise sale declined to $281 in fiscal 2003 from $300
in fiscal 2002. The slower economy and lower consumer confidence had a negative
impact on sales. Credit sales as a percentage of net sales increased slightly in
the first six months of fiscal 2003 compared to the first six months of fiscal
2002. The Company opened 19 new stores and closed six stores in the first six
months of fiscal 2003 increasing the number of stores open to 383 as of July 31,
2003 compared to 374 as of July 31, 2002.
Gross profit for the first six months of fiscal 2003 decreased $6.2
million, or 11.6%, to $47.3 million from $53.5 million compared to the same
period in fiscal 2002. Gross profit as a percentage of sales decreased to 33.3%
from 35.5% in the same period of fiscal 2002. The reduction in gross profit
margin was primarily impacted by store occupancy expense, including
store-closing costs ($0.4 million), which increased at a rate higher than the
increase in sales. Gross profit rate was also negatively impacted by an increase
mix of watch sales which carry a lower margin than certain other merchandise
categories as well as the competitive pricing environment. Due to the
adjustments resulting from the restatement, for the first six months of fiscal
2003, gross profit as a percent of net sales increased ten basis points to 33.3%
from 33.2%, and for the first six months of fiscal 2002, gross profit as a
percent of net sales decreased ten basis points to 35.5% from 35.6%.
Selling, general and administrative expenses for the six months ended
increased $3.1 million, or 6.1% to $54.0 million from $50.9 million for the
first six months of fiscal 2002. As a percentage of net sales, selling, general
and administrative expenses increased to 38.1% in the first half of fiscal 2003
from 33.7% in the first half of fiscal 2002. The dollar increase was primarily
related to higher other expense ($1.9 million), higher advertising expense ($0.8
million) and higher personnel expense ($0.8 million), which were partially
offset by lower credit expense ($0.4 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
22
consumption of supplies and services along with reductions in negotiated rates
for those items. Advertising expense increased due to a new promotional
initiative in 2003. Prior to the adoption of EITF 02-16, management had expected
that the impact of the promotional initiatives would be offset by advertising
co-op allowances. Payroll costs increased primarily due to the increased number
of stores, but were offset by measures taken to reduce payroll hours and control
labor rates in existing stores. Due to the adjustments resulting from the
restatement, for the first six months of fiscal 2003, selling, general and
administrative expenses as a percent of net sales increased ten basis points to
38.1% from 38.0%.
Interest expense increased $0.4 million to $2.5 million in the first
six months of fiscal 2003 from $2.1 million in the first six months of fiscal
2002, resulting from the write-off of $516,000 of deferred financing fees
related to the refinancing of the prior credit facility with certain members of
the prior bank group and higher average borrowings partially offset by average
lower interest rates.
Income taxes decreased $3.8 million resulting in a benefit of $3.6
million in the first half of fiscal 2003 compared to an expense of $0.2 million
in the prior period, reflecting an effective annual tax rate of 39.0% and 35.5%,
respectively. The Company's annual effective tax rate was 38.1% for fiscal 2002.
Net loss of $5.6 million in the six months ended July 31, 2003,
compared to net income of $0.3 million in the six months ended July 31, 2002,
primarily resulted from the factors discussed individually above.
Liquidity and Capital Resources
The Company's cash requirements consist principally of funding
inventory for existing stores, capital expenditures and working capital
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
July 31, 2003, the maximum availability under the new credit facility was $125.0
million based on the borrowing base formula, and the Company had $86.4 million
of outstanding borrowings under this credit facility.
The Company's cash flow provided by operating activities was $10.2
million in the first six months of 2003 compared to $17.9 million used in
operating activities in the first six months of fiscal 2002. Depreciation and
amortization ($5.9 million) and increases in accounts payable ($23.4 million),
outstanding checks ($10.9 million), accrued liabilities ($0.6 million), and
decreases in accounts receivable ($1.3 million) were partially offset by
increases in merchandise inventories ($8.2 million), and current income tax
benefit ($4.4 million) and decreases in income tax payable ($3.3 million), and
loss from operations ($5.6 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 fiscal 2002 in
order to earn additional cash discounts. The increase in merchandise inventories
primarily related to inventory for 19 new store openings completed in the first
six months of fiscal 2003.
The Company utilized cash in the first six months of 2003 primarily to
pay down revolver borrowings ($8.1 million), fund capital expenditures ($8.1
million) related to the opening of 19 new stores in the first six months of
2003, to repay the term loan ($4.5 million) and to pay financing costs ($1.0
million) associated with the second amended and restated credit facility.
23
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.
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 10 and 13 of the July 31, 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.
24
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.
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 six months of fiscal 2003,
such purchases by executive officers and directors totaled approximately
$129,000.
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 significant 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 July 31, 2003, January 31, 2003, and July 31,
2002 was approximately $2,542,000, $3,254,000 and $1,540,000, respectively.
25
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
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 July 31, 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 customer's 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
26
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 July 31, 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 July 31, 2003 that have materially affected, or
are reasonably likely to materially affect, the Company's internal control over
financial reporting.
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 and six-month periods ended July 31, 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.
27
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 Number Description
-------------- -----------
10.1 Second Amended and Restated Revolving Credit and Gold
Consignment Agreement, dated as of July 29, 2003,
among the Company, the Banks listed therein, LaSalle
Bank National Association, ABN AMRO Bank N.V., and JP
Morgan Chase Bank (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 Chief Executive Officer pursuant to
18 United States Code Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification of Chief Financial Officer pursuant to
18 United States Code Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
29
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)
30