EXHIBIT 13
SELECTED HISTORICAL FINANCIAL AND OPERATING DATA
The following table sets forth certain financial and operating data of the
Company. The selected statement of operations data and balance sheet data as of
and for the fiscal year ended January 31, 2004 (fiscal 2003) and each of the
four prior fiscal years are derived from audited financial statements of the
Company. The selected financial information set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Company's audited financial statements
appearing elsewhere herein.
(In thousands, except per
share and selected
operating data) Fiscal 2003 Fiscal 2002 Fiscal 2001 Fiscal 2000 Fiscal 1999
- -----------------------------------------------------------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Net sales $ 344,655 $ 341,037 $ 338,911 $ 355,065 $ 315,406
Cost of sales (including
buying and occupancy
expenses) 217,622 213,242 207,227 217,344 182,898
- -----------------------------------------------------------------------------------------------------------------------
Gross profit 127,033 127,795 131,684 137,721 132,508
Selling, general and
administrative expenses (1) 114,624 104,891 108,481 112,706 91,874
Professional fees and other
charges(2) 21,874 2,899 1,494 2,894 3,378
- -----------------------------------------------------------------------------------------------------------------------
(Loss) income from
operations (9,465) 20,005 21,709 22,121 37,256
Interest expense 4,110 4,341 6,902 5,757 5,819
- -----------------------------------------------------------------------------------------------------------------------
(Loss) income before
income taxes (13,575) 15,664 14,807 16,364 31,437
Income tax (benefit)
expense (4,861) 5,970 5,153 6,103 12,103
- -----------------------------------------------------------------------------------------------------------------------
(Loss) income before
cumulative effect of
accounting change (8,714) 9,694 9,654 10,261 19,334
Cumulative effect of
accounting change, net (3) -- -- -- (3,068) --
- -----------------------------------------------------------------------------------------------------------------------
Net (loss) income $ (8,714) $ 9,694 $ 9,654 $ 7,193 $ 19,334
=======================================================================================================================
DILUTED EARNINGS PER SHARE:
(Loss) income before cumulative effect of
accounting change $ (0.62) $ 0.64 $ 0.66 $ 0.64 $ 1.28
Selected Operating Data:
Stores open at end of
period 380 370 364 348 290
Average net sales per
store (4) $ 925,000 $ 925,000 $ 952,000 $ 1,116,000 $ 1,163,000
Average net sales per
gross square foot (5) $ 1,066 $ 1,068 $ 1,093 $ 1,286 $ 1,319
Average merchandise sale $ 285 $ 302 $ 304 $ 319 $ 303
Comparable store sales
(decrease) increase (6) (0.6%) (1.9%) (10.7%) (1.7%) 11.0%
Balance Sheet Data (at end
of period)
Merchandise inventories $ 206,146 $ 196,694 $ 173,098 $ 184,185 $ 147,691
Working capital 45,678 57,777 52,658 46,074 31,338
Total assets 286,997 272,479 252,091 261,926 219,363
Total debt 80,980 99,630 45,667 61,860 59,007
Stockholders' equity, net 105,768 117,901 113,145 103,058 71,928
(1) In fiscal 2002, the Company adopted Financial Accounting Standards
Board Statement No. 142, "Goodwill and Other Intangible Assets," and has
discontinued amortization of goodwill. (See Note 7)
(2) Includes legal, accounting and consulting services expenses, litigation
charges and severance accruals.
(3) Reflects net cumulative effect in the change in accounting for layaway
sales.
(4) Average net sales per store represents the total net sales for stores
open for a full fiscal year divided by the total number of such stores.
(5) Average net sales per gross square foot represents total net sales for
stores open for a full fiscal year divided by the total square feet of such
stores.
(6) Comparable store sales are defined as net sales of stores which are
operating for the month in the current reporting period as well as open for the
same month during the prior year reporting period. Fiscal year 1999 includes
sales from the acquired Jewel Box stores from February through July 1999 and
from October through January 2000.
1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the Company's financial
statements, including the notes thereto. This section contains statements that
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. See Forward-Looking Statements
disclosure at the end of this section.
OVERVIEW The Company is a leading national retailer of fine jewelry (based on
number of stores) operating 380 stores in 38 states as of January 31, 2004. The
Company offers a selection of merchandise in the following categories: diamond,
gold, precious and semi-precious jewelry and watches, an approach oriented
toward the Company's target customer base, middle to upper-middle income men and
women over 25 years of age. Jewelry purchases are discretionary for consumers
and may be particularly affected by adverse trends in the general economy and
perceptions of such conditions affecting disposable consumer income. During the
first half of fiscal 2003, a lackluster economy, lower consumer confidence and
an unstable geopolitical environment resulted in lower comparable store sales
than in the prior fiscal year. However, general economic conditions and consumer
confidence improved in the second half of fiscal 2003 and along with increased
sales generated from new sales focused initiatives and the expansion of the
watch lines carried in inventory, comparable store sales in the last six months
of fiscal 2003 increased 5.3% over the prior year period. Comparable store sales
for the full fiscal year of 2003 decreased $1.9 million, or 0.6%, from the prior
year.
Notwithstanding the increase in sales during the second half of fiscal
2003, the Company experienced a net loss of $8.7 million for fiscal 2003, versus
net income of $9.7 million for fiscal 2002. During fiscal 2003, the Company,
among other parties, was named in several lawsuits, which allege that
Cosmopolitan Gem Corp. defrauded Capital Factors, Inc. and the Company, among
other parties, aided and abetted in the alleged fraud. The Company's fiscal 2003
net loss resulted primarily from a significant increase in expenses in the
fourth quarter of fiscal 2003, principally relating to the Capital Factors civil
litigation, investigations of the United States Attorney's Office and the
Securities and Exchange Commission (the "SEC") of the matters alleged in the
Capital Factors litigation and an internal investigation by the Company, through
outside counsel and under the direction of the Board of Directors, in connection
with these matters. Professional fees increased by approximately $8.6 million in
the fourth quarter over the prior year. While the Company expects increased
professional fees to continue, such fees have been significantly lower since the
end of fiscal 2003. In addition, as previously disclosed in a press release
furnished to the SEC under cover of a Current Report on Form 8-K dated March 23,
2004, during the fourth quarter of the fiscal year ended January 31, 2004, the
Company accrued a litigation reserve of $6.0 million in connection with the
consolidated Capital Factors actions and the United States Attorney and SEC
investigations. Since March 23, 2004, the Company has engaged in additional
settlement negotiations relating to these matters. In light of developments in
the ongoing settlement discussions, the Company has accrued an additional
reserve for the fourth quarter of the fiscal year ended January 31, 2004, in the
amount of $2.6 million, with respect to these matters. (See Note 16 to the
financial statements.) There are no assurances that the Company will be able to
reach a settlement with any of the parties to the consolidated Capital Factors
actions, or that such a settlement or settlements, as the case may be, will be
for the amount recorded as a reserve. However, the Company currently believes
that it is more likely than not that it will reach a settlement or settlements,
as the case may be, pertaining to the consolidated Capital Factors actions in
the near term. The Company is unable at this time to predict the ultimate
outcome of the consolidated Capital Factors actions or the United States
2
Attorney and SEC investigations. Lastly, the Company also recorded $1.0 million
in the fourth quarter for certain severance related costs that were governed by
existing severance agreements.
The Board of Directors of the Company has adopted corporate governance
guidelines designed to formalize existing Board practices, such as regular
meetings of the non-executive directors, and to address other governance
matters, such as criteria for Board membership. In addition, the composition of
the Board of Directors has been changed, resulting in a higher percentage of
independent directors. The Board also is considering additional measures
designed to enhance the continued independence of the Board.
As a result of the Company's internal investigation described above and
the terminations of the Company's Chief Financial Officer and Executive Vice
President, Merchandising, arising out of that investigation, the Board and
management are undertaking several changes in the Company's management
structure. In particular, the Company is in the process of conducting a search
for a Chief Operating Officer, a newly created position, who will have
significant responsibility for the day-to-day operations of the Company. In
addition, the Company plans to hire a new Executive Vice President,
Merchandising. The Company also plans to hire a General Counsel, a newly created
position, who will oversee all legal matters and serve as the Company's Chief
Corporate Compliance Officer. The Company has already hired a Director of
Internal Audit who reports directly to the Chairman of the Audit Committee of
the Board of Directors. These changes will result in an increase in the
Company's personnel costs.
During February 2004, the Company was named in several putative class
action complaints, as further described in Note 16 to the financial statements.
The Company intends to vigorously contest these complaints and exercise all of
its rights and remedies.
The Company's business is highly seasonal. During fiscal 2003, a
significant portion of the Company's sales, and net income of $4.3 million, was
generated during the fourth fiscal quarter ending January 31, 2004, as compared
to a net loss of $13.0 million experienced in the previous three quarters.
Historically, income generated in the fourth fiscal quarter ending each January
31 represents all or a majority of the income generated during the fiscal year.
The Company has historically experienced lower net sales in each of its first
three fiscal quarters and expects this trend to continue. The Company's
quarterly and annual results of operations may fluctuate significantly as a
result of factors including, among others: increases or decreases in comparable
store sales; the timing of new store openings; net sales contributed by new
stores; timing of certain holidays and Company-initiated special events; changes
in the Company's merchandise; marketing or credit programs; general economic,
industry, weather conditions and disastrous national events that affect consumer
spending as well as pricing, merchandising, marketing, credit and other programs
of competitors.
3
RESULTS OF OPERATIONS The following table sets forth for the periods indicated
certain information derived from the statements of operations of the Company
expressed as a percentage of net sales for such periods.
Percentage of net sales Fiscal 2003 Fiscal 2002 Fiscal 2001
- ---------------------------------------------------------------------------------------
Net sales 100.0% 100.0% 100.0%
Cost of sales (including buying and
occupancy expenses) 63.1 62.5 61.1
- ---------------------------------------------------------------------------------------
Gross profit 36.9 37.5 38.9
Selling, general and administrative expenses 33.3 30.8 32.0
Professional fees and other charges 6.3 0.8 0.5
- ---------------------------------------------------------------------------------------
(Loss) income from operations (2.7) 5.9 6.4
Interest expense 1.2 1.3 2.0
- ---------------------------------------------------------------------------------------
(Loss) income before income taxes (3.9) 4.6 4.4
Income tax (benefit) expense (1.4) 1.8 1.5
- ---------------------------------------------------------------------------------------
Net (loss) income (2.5%) 2.8% 2.9%
=======================================================================================
FISCAL 2003 COMPARED TO FISCAL 2002
NET SALES
Net sales increased $3.7 million, or 1.1%, to $344.7 million in fiscal 2003 from
$341.0 million in fiscal 2002. Comparable store sales decreased $1.9 million, or
0.6%, in fiscal 2003. The slower economy and lower consumer confidence had a
negative impact on sales, which was partially offset by increased sales
generated from new promotional initiatives, including semi-annual two-day events
and the enhancement of other special promotions and the expansion of the watch
lines carried in inventory. These new initiatives were introduced primarily
during the first three quarters of fiscal 2003. Comparable store sales in the
first six months of fiscal 2003 decreased 7.9% while comparable sales in the
last six months of fiscal 2003 increased 5.3%. Additionally, sales were lower by
$6.5 million due to store closings and stores closed for remodeling for limited
periods and by $1.9 million due to changes in sales returns and allowances, of
which, $0.3 million was due to fiscal 2003 reserve activity. The remaining $1.6
million change in the reserve for sales returns and allowances reflects the
historical trends in returns which are governed by the Company's return policies
and management's initiatives to ensure compliance with those policies which
resulted in a reduction in the sales returns and allowances in fiscal 2002.
These decreases were offset by sales from new store openings of $14.0
million. The Company plans to significantly reduce new store openings in fiscal
2004. The total number of merchandise units sold increased 7.7% in fiscal 2003
compared to fiscal 2002 while the average price per item sold decreased by
approximately 5.7% to $285 in fiscal 2003 from $302 in fiscal 2002. The decline
in average price per merchandise sale and the increase in the number of
merchandise units sold was primarily due to a significant increase in the number
of lower price-point advertised items sold during promotional events during
fiscal 2003 compared to fiscal 2002. The Company plans to continue these
promotional initiatives in fiscal 2004. The Company opened 21 new stores and
closed 11 stores during fiscal 2003, increasing the number of stores operated to
380 as of January 31, 2004 from 370 as of January 31, 2003.
4
GROSS PROFIT
Gross profit decreased $0.8 million, or 0.6%, to $127.0 million in fiscal 2003,
from $127.8 million in fiscal 2002. As a percentage of net sales, gross profit
decreased to 36.9% in fiscal 2003 from 37.5% in fiscal 2002. The gross profit
rate was negatively impacted by an increase in the cost of gold and an increase
mix in watch sales, which carry a lower margin than other categories, a decrease
in the mix of diamond and gold merchandise sales which carry a higher gross
margin, as well as the competitive pricing environment. These declines in gross
margin were partially offset by lower inventory cost associated with higher
vendor discounts and allowances compared to the same period in the prior year.
Store occupancy and buying expenses, which increased at a higher rate than the
increase in sales, also contributed to the reduction in gross profit percentage.
In response to the increased cost of gold, beginning in March 2004, the Company
has increased prices of certain items, primarily in gold merchandise categories,
which may result in gross profit rate improvements. The Company expects higher
watch sales to have a continued negative impact on gross profit rate.
EXPENSES
Selling, general and administrative expenses, excluding professional fees and
other charges, in fiscal 2003 increased $9.7 million, or 9.3%, to $114.6 million
from $104.9 million in fiscal 2002. As a percentage of net sales, selling,
general and administrative expenses increased to 33.3% in fiscal 2003 from 30.8%
in fiscal 2002. Higher personnel expense ($3.6 million), higher other expense
($3.9 million), and higher advertising expense ($2.5 million) were partially
offset by lower credit expense ($0.5 million). These dollar increases primarily
related to operating costs associated with new store openings. During fiscal
2003, the Company opened 21 new stores, as compared 17 new stores in the prior
year. Payroll costs increased primarily due to the increased number of stores
and the addition of support office positions and enhancing the hiring
requirements and compensation associated with new personnel in fiscal 2003. The
increase in other expense is primarily due to the increase in the number of
stores, increases in insurance expense ($0.9 million) and increases in accruals
for state and local taxes ($0.6 million). Advertising expense increased due to
new promotional initiatives in 2003 and the impact of the adoption of 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") as of
the beginning of this fiscal year. 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. 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. During fiscal
year 2003, the Company received $2.7 million of vendor allowances for
advertising. Credit expense decreased due to lower historical experience in
fiscal 2003 associated with exposures for chargebacks on credit card receivables
that have already been collected. The decrease in credit expense was partially
offset by higher credit card discounts due to increased credit card sales.
Professional fees and other charges increased by $19.0 million to $21.9
million in fiscal 2003 from $2.9 million in fiscal 2002, primarily associated
with the Capital Factors matters described in Note 16 in the financial
statements. As required by Financial Accounting Standards Board Statement No. 5,
"Accounting for Contingencies," the Company determines whether an estimated loss
from a loss contingency should be accrued by assessing whether a
5
loss is deemed probable and can be reasonably estimated. As previously disclosed
in a press release furnished to the SEC under cover of a Current Report on Form
8-K dated March 23, 2004, during the fourth quarter of the fiscal year ended
January 31, 2004, the Company accrued a litigation reserve of $6.0 million for
the consolidated Capital Factors actions and the United States Attorney and SEC
investigations. Since March 23, 2004, the Company has engaged in additional
settlement negotiations relating to these matters. In light of developments in
the ongoing settlement discussions, the Company has accrued an additional
reserve for the fourth quarter of the fiscal year ended January 31, 2004, of
$2.6 million, with respect to these matters. See Note 16 to the financial
statements. There are no assurances that the Company will be able to reach a
settlement with any of the parties to the consolidated Capital Factors actions
or that such a settlement or settlements, as the case may be, will be for the
amount recorded as a reserve. However, the Company currently believes that it is
more likely than not that it will reach a settlement or settlements, as the case
may be, pertaining to the consolidated Capital Factors actions in the near term.
Given the amounts sought in the consolidated Capital Factors actions, and the
inherent unpredictability of litigation, it is possible that an adverse outcome
in excess of the amount recorded could occur and could have a material adverse
effect on the Company's results of operations, financial condition or liquidity.
The Company is unable at this time to predict the ultimate outcome of the
consolidated Capital Factors actions or the United States Attorney and SEC
investigations. Professional fees of approximately $9.6 million incurred as a
result of the consolidated Capital Factors actions, the United States Attorney
and SEC investigations, and the Company's internal investigation, have been
expensed through January 31, 2004. The Company also recorded approximately $1.0
million for certain severance related costs that were governed by existing
severance agreements.
(LOSS) INCOME FROM OPERATIONS
As a result of the factors discussed above, loss from operations was $9.5
million in fiscal 2003 compared to income from operations of $20.0 million in
fiscal 2002. As a percentage of net sales, loss from operations was 2.7% in
fiscal 2003 as compared to income from operations in fiscal 2002 of 5.9%.
INTEREST EXPENSE
Interest expense decreased $0.2 million, or 5.3%, to $4.1 million in fiscal 2003
from $4.3 million in fiscal 2002. The decrease in interest expense resulted from
lower average interest rates, which were partially offset by higher average
outstanding borrowings and the write-off of deferred loan costs associated with
the prior credit facility.
INCOME TAX (BENEFIT) EXPENSE
Income tax effective rate decreased in fiscal 2003 to 35.8% from 38.1% in fiscal
2002. The income tax benefit associated with the loss in fiscal 2003 was
partially offset by a change in the Company's valuation allowance with respect
to the Company's current expected ability to use certain state income tax net
operating loss carry forwards, resulting in a decrease in the effective tax
rate.
6
FISCAL 2002 COMPARED TO FISCAL 2001
NET SALES
Net sales increased $2.1 million, or 0.6%, to $341.0 million in fiscal 2002 from
$338.9 million in fiscal 2001. Comparable store sales decreased $6.4 million, or
1.9%, in fiscal 2002. Additionally, sales were lower by $5.8 million due to
store closings and stores closed for remodeling for limited periods. These
decreases were offset by sales from new store openings of $12.5 million and a
reduction in the reserve for sales returns and allowances of $1.6 million. The
total number of merchandise units sold slightly increased compared to fiscal
2001, while the average price per merchandise item sold decreased by
approximately 0.7% to $302 in fiscal 2002 from $304 in fiscal 2001, reflecting a
continued reduction in consumer demand for higher priced items. Comparable store
sales decreased in fiscal 2002 primarily due to the recession and lower consumer
confidence. The reduction in the reserve for sales returns and allowances
reflects the historical trends in returns which are governed by the Company's
return policies and management's initiatives to ensure compliance with those
policies. Credit sales increased to 40.6% in fiscal 2002 from 40.1% in fiscal
2001. Higher third party credit sales resulted from more aggressive promotional
credit activities which were partially offset by lower third party finance
contract sales. The Company opened 17 new stores and closed 11 stores during
fiscal 2002, increasing the number of stores operated to 370 as of January 31,
2003 from 364 as of January 31, 2002.
GROSS PROFIT
Gross profit decreased $3.9 million, or 3.0%, to $127.8 million in fiscal 2002
from $131.7 in fiscal 2001. As a percentage of net sales, gross profit decreased
to 37.5% in fiscal 2002 from 38.9% in fiscal 2001. During fiscal 2002, gross
merchandise margin declined by approximately 100 basis points compared to fiscal
2001. This decline resulted from, among other things, an increase in promotional
pricing activity and an increase in the mix of sales of lower margin diamond
merchandise. Store occupancy and buying expenses which increased at a higher
rate than the increase in sales, also contributed to the reduction in gross
profit percentage. These declines in gross profit were somewhat offset by better
experience associated with sales returns and allowances.
In August 2002, the Company delivered gold to its banks extinguishing
all existing Company gold consignment obligations under the Credit Agreement.
This had the effect of increasing the weighted average cost of gold available
for retail sale by the Company, resulting in a higher weighted average cost of
sales in future periods. The Company then estimated that future costs of sales
would be approximately $1.5 million greater based on the effect of the
transaction on the weighted average cost of gold product in its inventory.
Approximately $725,000 of this increase in cost of sales is reflected in the
year ended January 31, 2003. This purchase increased the Company's inventory by
$20.5 million and was funded by revolver loan borrowings.
EXPENSES
The Company's continued efforts to improve its expense structure resulted in a
decrease in selling, general and administrative expenses, excluding professional
fees and other charges, of $3.6 million, or 3.3%, to $104.9 million in fiscal
2002 from $108.5 million in fiscal 2001, while opening 17 new stores. As a
percentage of net sales, selling, general and administrative expenses decreased
7
to 30.8% in fiscal 2002 from 32.0% in fiscal 2001. The dollar decrease was
primarily related to lower personnel expense ($2.0 million), lower other
expenses ($2.9 million) and lower advertising costs ($0.5 million), somewhat
offset by higher credit expense ($2.3 million). Selling, general and
administrative expense attributable to 17 stores opened in fiscal 2002 and 27
stores opened in fiscal 2001 were absorbed in developing the overall reduction
in selling, general and administrative expense and were partially offset by
greater reductions achieved in existing stores. Payroll costs decreased in
fiscal 2002 as compared to fiscal 2001 as a result of continued efforts to
reduce store payroll hours and control labor rates. The decrease in other
expenses resulted from, among other things, centralized control of the
consumption of certain supplies and services along with reductions in negotiated
rates for these items. Advertising costs decreased in fiscal 2002, as compared
to fiscal 2001, due to the Company's efforts to reduce production costs through
a competitive bidding process and increased vendor funding of promotional
initiatives.
The increase in credit expense relates to, among other things, a
significant increase in the use of one year no interest promotions for which the
Company pays a higher fee to the third party credit provider, higher credit
sales volume, and higher bad debt expense. The increase in bad debt expense
versus fiscal 2001 relates to reductions taken in the accounts receivable
reserve in fiscal 2001, which are established to address exposures to
chargebacks on credit receivables that have already been collected. These
reserves were reduced in fiscal 2001 as a result of improved credit practices,
reductions in the use of third party finance contract sales and management's
belief that the Company's exposure was diminished. The reserve calculation
assumptions remained unchanged in fiscal 2002.
Professional fees and other charges increased $1.4 million, or 94.0%,
to $2.9 million in fiscal 2002 from $1.5 million in fiscal 2001. This increase
primarily related to an additional litigation accrual related to the California
wage hour class action suit discussed in Note 16 to the financial statements.
(LOSS) INCOME FROM OPERATIONS
As a result of the factors discussed above, income from operations decreased to
$20.0 million in fiscal 2002 from $21.7 million in fiscal 2001. As a percentage
of net sales, income from operations decreased to 5.9% in fiscal 2002 from 6.4%
in fiscal 2001.
INTEREST EXPENSE
Interest expense decreased $2.6 million, or 37.1%, to $4.3 million in fiscal
2002 from $6.9 million in 2001. The decrease in interest expense resulted from
lower average outstanding borrowings and lower average interest rates.
INCOME TAX (BENEFIT) EXPENSE
Income tax effective rate increased in fiscal 2002 to 38.1% from 34.8% in fiscal
2001. The Company expects to utilize certain income tax net operating losses
over the next fifteen to twenty years.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements consist principally of funding inventory for
existing stores, capital expenditures and working capital (primarily inventory)
associated with the Company's new stores. The Company's primary sources of
8
liquidity have historically been cash flow from operations and bank borrowings
under the Company's Second Amended and Restated Revolving Credit and Gold
Consignment agreement dated July 29, 2003 (the "Credit Agreement"), as amended
effective March 23, 2004. As of January 31, 2004, the calculated revolver
borrowing base availability, pursuant to the Credit Agreement, exceeded the
maximum availability of $125.0 million. The Company had $80.3 million of
outstanding borrowings under the revolving loan facility as of January 31, 2004.
FISCAL 2003 The Company's cash flow provided by operating activities was $36.9
million in fiscal 2003 compared to cash flow used in operating activities of
$20.1 million in fiscal 2002. Increases in accounts payable ($36.1 million),
accrued expenses ($13.1 million) and accrued payroll ($1.2 million) were offset
by increases in merchandise inventories ($9.5 million), current income tax
benefit ($2.3 million) and accounts receivable ($0.9 million) and decreases in
income taxes payable ($3.3 million) and deferred income taxes ($3.1 million).
Cash used in investing activities included the funding of capital expenditures
of $11.5 million, related primarily to the opening of 21 new stores in fiscal
2003, compared to $8.6 million used for capital expenditures in 2002.
The Company utilized cash for financing activities in fiscal 2003
primarily to (i) decrease revolver borrowing ($14.2 million), (ii) make
principal payments on the term loan ($4.5 million), (iii) purchase 321,400
shares of common stock at an average price of $11.92 per share under the Stock
Repurchase Program ($3.8 million), (iv) pay financing costs ($1.0 million)
associated with the second amended and restated credit facility, and (v)
decrease outstanding checks ($2.3 million). Cash generated by financing
activities included proceeds from the exercise of options ($0.3 million).
Stockholders' equity decreased to $105.8 million at January 31, 2004 from $117.9
million at January 31, 2003.
FISCAL 2002 The Company's cash flow used in operating activities was $20.1
million in fiscal 2002 compared to cash flow provided by operating activities of
$45.2 million in fiscal 2001. Decreases in accounts payable ($34.4 million) in
order to gain cash discounts and increases in merchandise inventories ($3.1
million) as compared to a prior year decrease in inventory ($14.1 million) and
increase in accounts payable ($7.7 million) were the significant changes in
fiscal 2002. Cash used in investing activities included the funding of capital
expenditures of $8.6 million, related primarily to the opening of 17 new stores
in fiscal 2002 compared to $12.7 million used for capital expenditures in 2001.
Cash generated by financing activities included revolver borrowings
($59.2 million) and proceeds from the exercise of options ($1.6 million). The
Company utilized cash for financing activities in fiscal 2002 primarily to (i)
purchase gold to settle the gold consignment facility ($20.5 million), (ii) make
scheduled principal payments on the term loan ($5.3 million) and (iii)
repurchase 605,600 shares of common stock under the Stock Repurchase Program
announced July 23, 2002 ($6.5 million). Stockholders' equity increased to $117.9
million at January 31, 2003 from $113.1 million at January 31, 2002.
OTHER LIQUIDITY AND CAPITAL RESOURCES ELEMENTS During fiscal 2003, the Company
amended and restated its $166.5 million credit facility. The Company has a total
$125.0 million revolving credit facility through July 28, 2007, which includes a
gold consignment facility of up to $40.0 million. Interest rates and commitment
fees charged on the unused facility float based on the Company's quarterly
performance. Since these interest rates are determined by reference to LIBOR or
prime rates, changes in market interest rates can materially affect the
Company's interest expense. Borrowings under the revolver are limited to a
9
borrowing base determined based on the levels of the Company's inventory and
accounts receivable. Availability under the revolver is based on amounts
outstanding thereunder.
The Company amended the Credit Agreement effective March 23, 2004 in
order to, among other things, (i) add a Layaway Reserve to the Borrowing Base
(each as defined in the Credit Agreement), (ii) add and amend certain financial
covenants including, amending the Fixed Charge Coverage Ratio (as defined in the
Credit Agreement) and adding a covenant to maintain a Net Worth (as defined in
the Credit Agreement) of at least $90.0 million at January 31, 2005, (iii) cap
the borrowings under the facility to a maximum of $85.0 million for at least
thirty consecutive calendar days during the period December 15, 2004 through and
including February 15, 2005, (iv) increase the interest rate at which LIBOR
based borrowings are available under the Credit Agreement to LIBOR plus 2.5%
through April 30, 2005, (v) set the Commitment Fee Rate (as defined in the
Credit Agreement) at 0.5% through April 30, 2005, and (vi) set the Standby
Letter of Credit Fee Rate (as defined in the Credit Agreement) at 2.0% through
April 30, 2005. The Company periodically determines the value of the unused
facility based upon a formula the result of which varies with fluctuations in
inventory and receivable levels and aggregate borrowings. The peak outstanding
borrowing under the Company's revolver during fiscal 2003 and 2002 was $110.4
million and $111.9 million, respectively. The unused facility and availability
was $42.6 million as of January 31, 2004. Cash receipts are applied against the
outstanding borrowings on a daily basis in accordance with the credit facility
provisions.
On October 29, 2003, the Company entered into a letter agreement with
its lenders which clarified and supplemented the 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 Credit Agreement reserved their rights to determine that
the consolidated Capital Factors actions, the SEC investigation or the United
States Attorney's investigation constituted a breach of the Credit Agreement. As
of March 22, 2004, the Company and its lenders entered into a new letter
agreement which rescinded the October 29, 2003 letter agreement. Pursuant to the
new letter agreement, the lenders under the Credit Agreement have agreed that,
as of March 23, 2004, the consolidated Capital Factors actions, the SEC
investigation and the United States Attorney's investigation have not resulted
in a breach of the Credit Agreement. In addition, the lenders have agreed that
none of these matters will give rise to a default or event of default under the
Credit Agreement so long as the resolution of such matters does not involve the
payment by the Company of Restitution (which is defined below) in an amount in
excess of $15.0 million, or does not result in the indictment of the Company or
any of its current officers, directors or employees with principal financial or
accounting responsibilities. The new letter agreement also states that any
settlement involving the payment of Restitution in excess of $15.0 million shall
constitute a default under the Credit Agreement or any indictment of the Company
or any of the persons described above may constitute a default under the Credit
Agreement.
"Restitution" is defined as any restitution paid by the Company
(whether cash or non-cash or current or deferred consideration) arising from a
civil settlement or award and/or criminal penalties paid or payable in
connection with the Capital Factors litigation, the SEC investigation and/or the
United States Attorney investigation and any other actions or proceedings
directly related thereto; excluding, however, (i) amounts paid by the Company
for consignment inventory held on behalf of the parties involved in the Capital
Factors litigation, (ii) amounts already accrued on the books of the Company for
the purchase of merchandise from the parties involved in the Capital Factors
litigation and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors litigation.
10
At this time the Company does not expect the payment of Restitution to
exceed $15.0 million and, based on the Company's current financial plan, expects
to be in compliance with all financial covenants as set forth in the Credit
Agreement in 2004.
Subject to the contingencies identified in Note 16 to the financial
statements and other risks, including those identified in Forward-Looking
Statements, management expects that based on our current financial plan the cash
flow from operating activities and funds available under the Company's revolving
credit facilities should be sufficient to support the Company's current new
store expansion program, seasonal working capital needs and liabilities that may
arise with respect to the Capital Factors related matters and the investigations
of the United States Attorney's Office and the SEC. Additionally, the Company
intends to vigorously contest the putative class action complaints and exercise
all of its available rights and remedies. Given that these class action cases
are in their early stages, and no substantive proceedings have occurred, it is
not possible to evaluate the likelihood of an unfavorable outcome in any of
these matters, or to estimate any amount or range of potential loss, if any.
While there are many potential outcomes, an adverse outcome in these actions
could have a material adverse effect on the Company's results of operations,
financial condition or liquidity. It cannot be determined at this stage whether
these claims will be resolved in the fiscal year ending January 31, 2005.
If the Company were to trigger an event of default pursuant to the
March 22, 2004 letter agreement the Company may be required to negotiate relief
with its lenders or to seek new financing. There is no assurance that new
financing arrangements would be available on acceptable terms or at all. If the
existing lenders were to cease funding under the revolving loan facility or
require immediate repayment 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 its assets and
liabilities.
In the near term, the Company expects increased professional fees
associated with the matters discussed in Note 16 to the financial statements to
continue into fiscal 2004, thereby impacting earnings and cash flow. However,
such fees have been significantly lower since the end of fiscal 2003.
A substantial portion of the merchandise sold by the Company is carried
on a consignment basis prior to sale or is otherwise financed by vendors,
thereby reducing the Company's direct capital investment in inventory. The peak
consigned inventories from merchandise vendors were $99.0 million and $85.7
million during fiscal 2003 and 2002, respectively. The willingness of vendors to
enter into such arrangements may vary substantially from time to time based on a
number of factors, including the merchandise involved, the financial resources
of vendors, interest rates, availability of financing, fluctuations in gem and
gold prices, inflation, the financial condition of the Company, the vendors'
understanding that the Company bears risk of loss but does not possess title,
and a number of economic or competitive conditions in the jewelry business or
the general economy. Any change in these relationships could have a material
adverse effect on the Company's results of operations or financial condition.
On July 23, 2002, the Company announced that the Board of Directors had
established a Stock Repurchase Program covering up to $25.0 million of its
common stock. During fiscal 2003, the Company repurchased an additional 321,400
shares at a total cost of $3.8 million under the program. As of January 31,
2004, the Company had repurchased a total of 927,000 shares at a total cost of
$10.3 million under this program.
11
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.
INTEREST RATE RISK The Company's exposure to changes in interest rates relate
primarily to its borrowing activities to fund business operations. The Company
principally uses floating rate borrowings under its revolving credit facility.
The Company currently does not use derivative financial instruments to protect
itself from fluctuations in interest rates.
The information below summarizes the Company's interest rate risk
associated with debt obligations outstanding as of January 31, 2004. The table
presents principal cash flows and related interest rates by fiscal year of
maturity or repricing date.
(in thousands) 2004 2005 2006 Total
- ----------------------------------------------------------------------------------------------------------
Variable rate (a) $ 80,340 --- --- $ 80,340
Average interest rate 3.25% --- --- 3.25%
Fixed rate $ 640 --- --- $ 640
Average interest rate 12.15% --- --- 12.15%
- ----------------------------------------------------------------------------------------------------------
(a) All term loans are variable rate, which reprice within 2004. Interest rates
charged on the facility float based on the Company's quarterly financial
performance.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting
for Derivative Instruments and Hedging Activities" (the effective date of which
was amended in September 1999 by FASB Statement No. 137 "Accounting for
Derivative Instruments and Hedging Activities -- Deferral of the Effective Date
of FASB Statement No. 133 -- an amendment of FASB Statement No. 133"). This
Statement was further amended in June 2000 by FASB Statement No. 138 "Accounting
for Certain Derivative Instruments and Certain Hedging Activities - an amendment
of FASB Statement No. 137." SFAS 133 and the amendments found in SFAS No. 138
require that entities recognize all derivatives as either assets or liabilities
in the statement of financial position and measure those instruments at fair
value.
Effective February 1, 2001, the Company adopted SFAS 133, as amended,
with no impact on its financial statements.
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 for such items do not increase commensurately.
DIAMOND PRICE RISK Recent increases in diamond prices may have a future negative
impact on gross margin to the extent that sales prices for such items do not
increase commensurately.
INFLATION The Company believes that inflation generally has not had a material
effect on the results of its operations. There is no assurance, however, that
inflation will not materially affect the Company in the future.
12
CONTRACTUAL OBLIGATIONS The following summarizes the Company's contractual
obligations at January 31, 2004:
PAYMENTS DUE BY PERIOD
Less than More than
(in thousands) Total 1 year 1 - 3 Years 3 - 5 Years 5 years
- -----------------------------------------------------------------------------------------------------------------------
Revolver $ 80,340 $ --- $ -- $ 80,340 $ --
Accrued interest 206 206 -- -- --
Subordinated debt 640 640 -- -- --
Purchase obligations 1,547 1,547 -- -- --
Operating leases 217,150 30,065 85,275 66,975 34,835
- -----------------------------------------------------------------------------------------------------------------------
Total contractual obligations $ 299,883 $32,458 $85,275 $147,315 $ 34,835
- -----------------------------------------------------------------------------------------------------------------------
In the normal course of business, the Company issues purchase orders to
vendors for purchase of merchandise inventories. The outstanding amount of these
purchase orders is not included in the above table, as the purchase orders may
be cancelled at the option of the Company without penalty.
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. 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.
ACCOUNTS RECEIVABLE Accounts receivable consist primarily of customer credit
card charges and other non-recourse third party credit arrangements for
merchandise delivered to the customer for which the Company has not yet received
payment under the terms of the arrangements. Allowance for doubtful accounts
represents reserves established to address exposures to chargebacks on credit
receivables that have already been collected. The Company accrues an estimate of
expected chargebacks based on the Company's historical chargeback experience.
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 consignment
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. Allowances for inventory shrink, scrap and other
provisions are recorded based upon analysis and estimates by the Company.
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
13
administrative expenses. 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. In prior years, certain vendors
reimbursed the Company for certain co-op advertising costs that were incurred.
In 2003, the Company changed the terms of its Vendor Trading Agreements to
include a vendor allowance for advertising calculated as a percentage of
merchandise purchases. During fiscal year 2003, the Company received $2.7
million of vendor allowances for advertising. The Company records such
allowances as a reduction of inventory cost and as the inventory is sold, the
Company will recognize a lower cost of sales.
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.
LEGAL CONTINGENCIES The Company is involved in certain legal matters and other
claims including those discussed in Note 16 to the financial statements. As
required by Financial Accounting Standards Board Statement No. 5, "Accounting
for Contingencies," the Company determines whether an estimated loss from a loss
contingency should be accrued by assessing whether a loss is deemed probable and
can be reasonably estimated. The Company analyzes its legal matters and other
claims based on available information to assess potential liability. The Company
consults with outside counsel involved in our legal matters when analyzing
potential outcomes. The reserve for these matters totaled $8.6 million at
January 31, 2004.
Based on the nature of such estimates, it is possible that future
results of operations or net cash flows could be materially affected if actual
outcomes are significantly different than management's estimates related to
these matters.
REVENUE RECOGNITION The Company recognizes revenue in accordance with the
Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements". Revenue from merchandise sales is
recognized when delivery has occurred and title and risk of loss have
transferred to the customer. The Company accrues an estimate of expected
returns, which have not yet been presented, based on its historical returns
experience, which is governed by the Company's merchandise returns policy.
Repair revenues are recognized when the service is complete and the merchandise
is delivered to the customer. The Company recognizes revenue, net of cost
reimbursed to an unrelated third party service provider, from the sale of an
extended warranty and service contract at the time the contract is executed with
the customer. The Company records revenue from layaway program sales at the time
the customer fulfills the terms of the program, including receipt of full
payment and delivery of the merchandise to the customer. The Company charges the
customer on a monthly basis to cover the costs of administration of inactive
layaways.
ACCOUNTING FOR STOCK BASED COMPENSATION The Company follows Accounting
Principles Board Opinion No. 25 ("APB No. 25") "Accounting for Stock Issued to
Employees" and the related interpretations in accounting for its stock option
plans. Since the stock option plans meet certain criteria of APB No. 25, the
Company does not recognize any compensation cost in the income statement.
Financial Accounting Standards Board Statement No. 123 ("SFAS 123"), "Accounting
for Stock-Based Compensation" issued subsequent to APB No. 25, defines a "fair
value based method" of accounting for employee stock options but allows
14
companies to continue to measure compensation cost for employee stock options
using the "intrinsic value based method" prescribed in APB No. 25.
The Company believes that applying the intrinsic value based method of
accounting for stock options prescribed by APB No. 25 is a critical accounting
policy because application of SFAS 123 would require the Company to estimate the
fair value of employee stock options at the date of the grant and record an
expense in the income statement over the vesting period for the fair value
calculated, thus reducing net income and earnings per share.
The Company has no immediate plans at this time to voluntarily change
its accounting policy to the fair value based method; however, the Company
continues to evaluate this alternative. In accordance with SFAS 123, the Company
has been disclosing in the Notes to the Financial Statements the impact on net
income and earnings per share as if the fair value based method was adopted.
ACCOUNTING FOR BUSINESS COMBINATIONS AND GOODWILL AND OTHER TANGIBLES In
accordance with the Financial Accounting Standard Board Statement No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets," the Company evaluates goodwill
for impairment on an annual basis in the fourth quarter or earlier whenever
indicators of impairment exist. SFAS 142 requires that if the carrying value of
a reporting unit for which the goodwill relates to exceeds its fair value, an
impairment loss is recognized to the extent that the carrying value of the
reporting unit goodwill exceeds the "implied fair value" of reporting unit
goodwill. As discussed in the notes to the financial statements, the Company
evaluated goodwill using discounted cash flow and a market multiple approach for
impairment and concluded that no impairment currently exists.
The Company believes that the accounting estimate related to
determining fair value is a critical accounting estimate because: (1) it is
highly susceptible to change from period to period because it requires Company
management to make assumptions about the future cash flows over several years in
the future and (2) the impact that recognizing an impairment would have on the
assets reported on our balance sheet as well as our results of operations could
be material. Management's assumptions about future cash flows requires
significant judgment and actual cash flows in the future may differ
significantly from those forecasted today.
NEW ACCOUNTING PRONOUNCEMENTS
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 fiscal 2002. This Statement
amends 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 this statement as of January 31,
2003.
ACCOUNTING FOR GUARANTEES 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," and interpretation of FASB Statements No. 5, 57 and 107 and Rescission
of FASB Interpretation No. 34. Under its bylaws, the Company has agreed to
indemnify its officers and directors for certain events or occurrences while the
officer or director is serving, or was serving, at its request in such
15
capacity. The maximum potential amount of future payments the Company could be
required to make pursuant to indemnification obligations is unlimited; however,
the Company has purchased directors and officer liability insurance that, under
certain circumstances, enables it to recover a portion of certain future amounts
paid. The Company has no liabilities recorded for these obligations as of
January 31, 2003 and 2004; however, reference should be made to Note 16 to the
financial statements with respect to legal contingencies.
TRANSACTIONS WITH AFFILIATES AND RELATED PARTIES In the past, the Company
provided certain office services to Double P Corporation, PDP Limited Liability
Company and CBN Limited Liability Company or other companies, from time to time,
which own and operate primarily mall-based snack food stores, and in which
Messrs. Hugh Patinkin, John Desjardins and Matthew Patinkin own a 52% equity
interest. A substantial portion of the remaining equity interest is owned by the
adult children and other family members of Norman Patinkin, a member of the
Board of Directors. For these services, Double P Corporation paid the Company
$700 per month. Effective February 1, 2004, the Company no longer provides these
services. Matthew Patinkin previously served as a director of Double P
Corporation and one of Norman Patinkin's adult children is a director and chief
executive officer of Double P Corporation. Messrs. Hugh Patinkin, John
Desjardins and Matthew Patinkin spend a limited amount of time providing
services to Double P Corporation, PDP Limited Liability Company and CBN Limited
Liability Company. Such services are provided in accordance with the Company's
Code of Ethics. In the case of Hugh Patinkin and John Desjardins, these services
are performed solely in their capacities as shareholders of Double P
Corporation. In the case of Matthew Patinkin, these services are performed in
his capacity as a shareholder of Double P Corporation and were previously
performed in his capacities as a director as well as a shareholder of Double P
Corporation. Messrs. Hugh Patinkin and John Desjardins receive no remuneration
for these services other than reimbursement of expenses incurred. Matthew
Patinkin receives no remuneration for these services other than the fee he
previously received for his services as a director of Double P Corporation. In
several cases, the Company and Double P Corporation agreed to divide and
separately lease contiguous mall space. The Company and Double P Corporation
concurrently negotiated separately with each landlord ("Simultaneous
Negotiations") to reach agreements for their separate locations. Since the
Company's initial public offering, its policy had required that the terms of any
such leases must be approved by a majority of the Company's outside directors.
The Company had conducted such negotiations in less than ten situations, since
the Company's initial public offering in 1996. The Company's current policy is
that it will no longer enter into such Simultaneous Negotiations.
The Company offers health insurance coverage to the members of its
Board of Directors. The health insurance policy options and related policy cost
available to the Directors are the same as those available to the Company's
senior level employees.
The Company operates a program under which executive officers and
directors, and parties introduced to the Company by its executive officers and
directors, are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. During fiscal 2003, such purchases totaled
approximately $174,000.
CORPORATE GOVERNANCE INITIATIVES As part of its on going work in connection with
the Sarbanes-Oxley Act and the related rules and regulations promulgated by the
SEC and listing standards adopted by the New York Stock Exchange, the Board of
Directors of the Company has adopted corporate governance guidelines designed to
formalize existing Board practices, such as regular meetings of the
non-executive directors, and to address other governance matters, such as
criteria for Board membership. In addition, the composition of the Board of
16
Directors has been changed, resulting in a higher percentage of independent
directors. The Board also is considering additional measures designed to enhance
the continued independence of the Board.
As a result of the Company's internal investigation described elsewhere
in this annual report and the recent terminations of the Company's Chief
Financial Officer and Executive Vice President, Merchandising arising out of
that investigation, the Board and management are undertaking several changes in
the Company's management structure. In particular, the Company is in the process
of conducting a search for a Chief Operating Officer, a newly created position,
who will have significant responsibility for the day-to-day operations of the
Company. In addition, the Company plans to hire a new Executive Vice President,
Merchandising. The Company also plans to hire a General Counsel, a newly created
position, who will oversee all legal matters and serve as the Company's Chief
Corporate Compliance Officer. The Company has already hired a Director of
Internal Audit who reports directly to the Chairman of the Audit Committee of
the Board of Directors.
FORWARD-LOOKING STATEMENTS As used herein, references to the "Company,"
"Whitehall Jewellers," "we," "us," and "our" refer to Whitehall Jewellers, Inc.
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," "may," "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 Securities
and Exchange Commission ("SEC") and United States Attorney's office
investigations, shareholder and other civil litigation, 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.
17
Whitehall Jewellers, Inc.
Statements of Operations
For the Years Ended January 31, 2004, 2003 and 2002
(in thousands, except per share data) 2004 2003 2002
- --------------------------------------------------------------------------------------------------
Net sales $ 344,655 $ 341,037 $ 338,911
Cost of sales (including buying and occupancy expenses) 217,622 213,242 207,227
- --------------------------------------------------------------------------------------------------
Gross profit 127,033 127,795 131,684
Selling, general and administrative expenses 114,624 104,891 108,481
Professional fees and other charges 21,874 2,899 1,494
- --------------------------------------------------------------------------------------------------
(Loss) income from operations (9,465) 20,005 21,709
Interest expense 4,110 4,341 6,902
- --------------------------------------------------------------------------------------------------
(Loss) income before income taxes (13,575) 15,664 14,807
Income tax (benefit) expense (4,861) 5,970 5,153
- --------------------------------------------------------------------------------------------------
Net (loss) income $ (8,714) $ 9,694 $ 9,654
- --------------------------------------------------------------------------------------------------
Basic earnings per share:
- --------------------------------------------------------------------------------------------------
Net (loss) income $ (0.62) $ 0.67 $ 0.66
- --------------------------------------------------------------------------------------------------
Weighted average common shares 14,098 14,545 14,584
- --------------------------------------------------------------------------------------------------
Diluted earnings per share:
- --------------------------------------------------------------------------------------------------
Net (loss) income $ (0.62) $ 0.64 $ 0.66
- --------------------------------------------------------------------------------------------------
Weighted average common shares and common share
equivalents 14,098 15,038 14,685
- --------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
18
Whitehall Jewellers, Inc.
Balance Sheets
As of January 31, 2004 and January 31, 2003
(in thousands, except share data) 2004 2003
- -------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash $ 1,901 $ 2,048
Accounts receivable, net 2,544 1,621
Merchandise inventories 206,146 196,694
Other current assets 875 1,470
Current income tax benefit 2,294 --
Deferred income taxes, net 5,712 2,627
Deferred financing costs 261 510
- -------------------------------------------------------------------------------------------------------
Total current assets 219,733 204,970
Property and equipment, net 60,948 61,634
Goodwill, net 5,662 5,662
Deferred financing costs 654 213
- -------------------------------------------------------------------------------------------------------
Total assets $ 286,997 $ 272,479
=======================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Revolver loans $ 80,340 $ 94,490
Current portion of long-term debt 640 4,500
Customer deposits 3,601 3,454
Accounts payable 60,538 26,784
Income taxes payable -- 3,303
Accrued payroll 4,457 3,282
Other accrued expenses 24,479 11,380
- -------------------------------------------------------------------------------------------------------
Total current liabilities 174,055 147,193
Long-term debt -- 640
Deferred income taxes, net 3,639 3,607
Other long-term liabilities 3,535 3,138
- -------------------------------------------------------------------------------------------------------
Total liabilities 181,229 154,578
Commitments and contingencies
Stockholders' equity:
Common Stock, ($.001 par value; 60,000,000 shares authorized; 18,055,008
shares and 18,020,968 shares issued, respectively)
18 18
Class B Common Stock, ($1.00 par value; 26,026 shares authorized;
142 shares issued and outstanding) -- --
Additional paid-in capital 106,091 105,795
Retained earnings 39,311 48,025
Treasury stock, (4,134,143 and 3,822,637 shares, respectively, at cost) (39,652) (35,937)
- -------------------------------------------------------------------------------------------------------
Total stockholders' equity, net 105,768 117,901
- -------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 286,997 $ 272,479
=======================================================================================================
The accompanying notes are an integral part of the financial statements.
19
Whitehall Jewellers, Inc.
Statements of Stockholders' Equity
For the Years Ended January 31, 2004, 2003 and 2002
Class B Additional
Common Common Paid-in Retained Treasury
(in thousands) Stock Stock Capital Earnings Stock
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 2001 $ 17 $ -- $103,341 $ 28,677 $(28,977)
Net income -- -- -- 9,654 --
Exercise of options -- -- 426 -- --
Stock issued under Employee Stock Purchase Plan -- -- -- -- 7
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 2002 17 -- 103,767 38,331 (28,970)
Net income -- -- -- 9,694 --
Exercise of options 1 -- 2,028 -- (459)
Treasury stock repurchase -- -- -- -- (6,548)
Stock issued under Employee Stock Purchase Plan -- -- -- -- 40
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at January 31, 2003 18 -- 105,795 48,025 (35,937)
Net loss -- -- -- (8,714) --
Exercise of options -- -- 296 -- 40
Treasury stock repurchase -- -- -- -- (3,831)
Stock issued under Employee Stock Purchase Plan -- -- -- -- 76
===================================================================================================================================
Balance at January 31, 2004 $ 18 $ -- $106,091 $ 39,311 $(39,652)
===================================================================================================================================
The accompanying notes are an integral part of the financial statements.
20
Whitehall Jewellers, Inc.
Statements of Cash Flows
For the Years Ended January 31, 2004, 2003 and 2002
(in thousands) 2004 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net (loss) income $ (8,714) $ 9,694 $ 9,654
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization 12,209 11,216 10,715
Store closing impairment charge -- -- 822
Loss on disposition of assets 435 146 74
Write-off of deferred loan cost 516 -- --
Changes in assets and liabilities:
(Increase) decrease in accounts receivable, net (923) (432) 217
(Increase) decrease in merchandise inventories, net of gold
consignment (9,452) (3,143) 14,098
Decrease (increase) in other current assets 595 (246) (536)
(Increase) in current income tax benefit (2,294) -- --
(Decrease) increase in deferred taxes, net (3,053) 1,997 2,327
Increase (decrease) in accounts payable 36,100 (34,381) 7,695
Increase (decrease) customer deposits 147 (509) (251)
(Decrease) increase in income taxes payable (3,303) 46 384
Increase (decrease) in accrued payroll 1,175 (2,988) 1,100
Increase (decrease) in other accrued expenses 13,099 (1,944) (1,638)
Increase in other long-term liabilities 397 478 532
- --------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 36,934 (20,066) 45,193
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (11,509) (8,571) (12,695)
- --------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (11,509) (8,571) (12,695)
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Borrowing on revolver loan 1,007,773 1,065,170 1,043,464
Repayment of revolver loan (1,021,923) (1,005,957) (1,055,407)
Repayment of term loan (4,500) (5,250) (4,250)
Purchase of gold to settle gold consignment -- (20,453) (6,118)
Proceeds from gold consignment -- -- 3,107
Financing costs (1,117) -- (348)
Proceeds from exercise of stock options 296 1,570 426
Proceeds from stock issued under the Employee Stock Purchase Plan 76 40 7
Purchase of treasury stock (3,831) (6,548) --
(Decrease) in outstanding checks (2,346) (628) (13,564)
- --------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (25,572) 27,944 (32,683)
- --------------------------------------------------------------------------------------------------------------------------
Net change in cash and cash equivalents (147) (693) (185)
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period 2,048 2,741 2,926
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 1,901 $ 2,048 $ 2,741
- --------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Interest paid during year $ 2,962 $ 2,515 $ 6,372
Income taxes paid during year $ 3,813 $ 3,809 $ 2,274
- --------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
21
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 380 and 370 stores located in 38 states
operating in regional or super-regional shopping malls as of January 31, 2004
and January 31, 2003, respectively. The consolidated financial statements
include the accounts and transactions of the Company and its subsidiaries.
Intercompany accounts and transactions have been eliminated.
(2) Common stock repurchase program
On July 23, 2002, the Company announced that the Board of Directors had
established a stock repurchase program covering up to $25.0 million of its
common stock. During fiscal 2003, the Company repurchased 321,400 shares of
common stock under the stock repurchase program at a total cost of approximately
$3.8 million. As of January 31, 2004, the Company had repurchased a total of
927,000 shares of common stock under the stock repurchase program at a total
cost of approximately $10.4 million. Shares repurchased by the Company reduce
the weighted average number of shares of Common Stock outstanding for basic and
diluted earnings per share calculations.
(3) Summary of significant accounting policies
CASH AND CASH EQUIVALENTS For purposes of the statements of cash flows, the
Company considers any temporary cash investments purchased with an original
maturity of three months or less to be cash equivalents.
ACCOUNTS RECEIVABLE Accounts receivable consists primarily of customer credit
card charges and other non-recourse third party credit arrangements for
merchandise delivered to the customer for which the Company has not yet received
payment under the terms of the arrangements. Allowance for doubtful accounts
represents reserves established to address exposures to chargebacks on credit
receivables that have already been collected. The Company accrues an estimate of
expected chargebacks based on the Company's historical chargeback experience.
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 consignment
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. Allowances for inventory shrink, scrap and other
provisions are recorded based upon analysis and estimates by the Company.
To the extent the Company's agreements with merchandise vendors provide
credits for co-op advertising, the Company has historically classified such
22
credits as a reduction to 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" 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. In prior years, certain vendors
reimbursed the Company for certain co-op advertising costs that were incurred.
In 2003, the Company changed the terms of its Vendor Trading Agreements to
include a vendor allowance for advertising calculated as a percentage of
merchandise purchases. During fiscal year 2003, the Company received $2.7
million of vendor allowances for advertising. The Company records such
allowances as a reduction of inventory cost and as the inventory is sold, the
Company will recognize a lower cost of sales.
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.
PROPERTY AND EQUIPMENT Property and equipment are carried at cost, less
accumulated depreciation and amortization. Furniture and fixtures are
depreciated on a straight-line basis over estimated useful lives ranging from
five to ten years. Software costs are amortized on a straight-line basis over
five years. Leasehold improvements are amortized on a straight-line basis over
the lesser of the remaining lease term or ten years.
Upon retirement or disposition of property and equipment, the applicable
cost and accumulated depreciation are removed from the accounts and any
resulting gains or losses are included in the results of operations.
LONG-LIVED ASSETS When facts and circumstances indicate potential impairment,
the Company evaluates the recoverability of long-lived asset carrying values,
using projections of undiscounted future cash flows over remaining asset lives.
When impairment is indicated, any impairment loss is measured by the excess of
carrying values over fair values.
GOODWILL Goodwill represents the excess of cost over the fair 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 annually
in the fourth quarter (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. The Company reviewed goodwill for
impairment as of January 31, 2004 and determined that no impairment existed.
DEFERRED FINANCING COSTS In connection with the Company's financing agreements,
the Company incurred various financing costs, which have been deferred on the
Company's balance sheet and are amortized over the terms of the agreements and
included in interest expense.
ACCOUNTS PAYABLE Accounts payable include outstanding checks which were
$4,166,000 and $6,512,000 as of January 31, 2004 and 2003, respectively.
23
ADVERTISING AND MARKETING EXPENSE The Company expenses the production costs of
advertising the first time the advertising takes place, except for
direct-response advertising, which is capitalized and amortized over the
expected period of future benefit. Advertising expense was $8.5 million and $6.0
million for fiscal year 2003 and 2002, respectively.
Direct-response advertising consists primarily of special offers,
fliers and catalogs that include value off coupons for the merchandise.
STORE PRE-OPENING EXPENSE Expenses associated with the opening of new store
locations are expensed in the period such costs are incurred.
LEASE EXPENSE The Company leases the premises for its office facilities and all
of its retail stores. Certain leases require increasing annual minimum lease
payments over the term of the lease. Minimum lease expense under these
agreements is recognized on a straight-line basis over the terms of the
respective leases. Virtually all leases covering retail stores provide for
additional contingent rentals based on a percentage of sales. These costs are
expensed in the period incurred.
SELF-INSURANCE The Company self-insures or retains a portion of the exposure for
losses related to workers compensation and general liability costs. It is the
Company's policy to record self-insurance reserves, as determined actuarially,
based upon claims filed and an estimate of claims incurred but not yet reported.
REVENUE RECOGNITION The Company recognizes revenue in accordance with the
Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements". Revenue from merchandise sales is
recognized when delivery has occurred and title and risk of loss have
transferred to the customer. The Company accrues an estimate of expected
returns, which have not yet been presented, based on its historical returns
experience, which is governed by the Company's merchandise returns policy.
Repair revenues are recognized when the service is complete and the merchandise
is delivered to the customer. The Company recognizes revenue, net of cost
reimbursed to an unrelated third party service provider, from the sale of an
extended warranty and service contract at the time the contract is executed with
the customer. The Company records revenue from layaway program sales at the time
the customer fulfills the terms of the program, including receipt of full
payment and delivery of the merchandise to the customer. The Company charges the
customer on a monthly basis to cover the costs of administration of inactive
layaways.
EARNINGS PER SHARE Basic earnings per share are computed by dividing net
earnings available to holders of common stock by the weighted average number of
shares of common stock outstanding. Diluted earnings per share are computed
assuming the exercise of all dilutive stock options. Under these assumptions,
the weighted average number of common shares outstanding is increased
accordingly.
INCOME TAXES Deferred income taxes are recognized for the tax consequences in
future years of differences between the tax basis of assets and liabilities and
their financial reporting amounts based on enacted tax laws and statutory tax
rates applicable to the periods in which the differences are expected to affect
taxable earnings. A valuation allowance is established when necessary to reduce
deferred tax assets to the amount expected to be realized.
STOCK BASED COMPENSATION The Financial Accounting Standards Board issued
Statement No. 148 ("SFAS 148"), "Accounting for Stock-Based
24
Compensation-Transition and Disclosure," during 2002. This Statement amends
Financial Accounting Standards Board 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 this statement 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 fiscal years ended January 31, 2004, 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:
(in thousands, except per share amounts) 2004 2003 2002
- ---------------------------------------------------------------------------------------------------------
Net (loss) income, as reported $ (8,714) $ 9,694 $ 9,654
Deduct: Total stock-based employee compensation expense
determined under fair value based method, net of related
tax effects (921) (1,951) (2,459)
- ---------------------------------------------------------------------------------------------------------
Pro forma net (loss) income $ (9,635) $ 7,743 $ 7,195
- ---------------------------------------------------------------------------------------------------------
Earnings per share:
Basic-as reported $ (0.62) $ 0.67 $ 0.66
Basic-pro forma $ (0.68) $ 0.53 $ 0.49
Diluted-as reported $ (0.62) $ 0.64 $ 0.66
Diluted-pro forma $ (0.68) $ 0.51 $ 0.49
For purposes of pro forma net income and earnings per share
calculations in accordance with SFAS 123, for each option granted during the
years ended January 31, 2004, 2003 and 2002 the fair value is estimated using
the Black-Scholes option-pricing model. The assumptions used are as follows:
2004 2003 2002
- -----------------------------------------------------------------------------
Risk-free interest rate 3.3% 4.1% 5.1%
Dividend yield 0 0 0
Option life 5.5 years 5.5 years 7 years
Volatility 60% 62% 44%
MANAGEMENT ESTIMATES The preparation of financial statements in conjunction with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Valuation reserves for inventory, accounts
receivable, sales returns and deferred tax assets are significant examples of
the use of such estimates. Actual results could differ from those estimates.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"), as amended by Statement of Financial
Accounting Standards No. 137 "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of Statement No. 133 - an amendment
of FASB Statement No. 133", was required to be adopted by the Company for its
fiscal year beginning after December 1, 2000. SFAS 133 requires
25
disclosures of the objectives for holding or issuing derivative instruments, the
context to understand the objectives and the strategies for achieving the
objectives and disclosures related to the impact of derivatives as reflected in
the statement of comprehensive income and requires that all derivative
instruments be recognized as either assets or liabilities in the balance sheet
and measured at their fair values. SFAS 133 also requires changes in the fair
value of derivatives to be recorded in each period in current earnings or
comprehensive income, depending on the intended use of the derivatives. The
Company adopted SFAS 133, as amended, effective February 1, 2001, which had no
impact on its financial statements.
ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS In August 2001,
the Financial Accounting Standards Board issued Statement No. 144 ("SFAS 144"),
"Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144
establishes accounting requirements for impaired long-lived assets to be held
and used, long-lived assets to be disposed of other than by sale and long-lived
assets to be disposed of by sale. The Company adopted SFAS 144 effective
February 1, 2002, which had no impact on its financial statements.
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 exit or disposal activities after December
31, 2002 be recorded at fair value in the period in which the liability is
incurred. The Company adopted SFAS 146 effective January 1, 2003, which had no
impact on its financial statements.
ACCOUNTING FOR GUARANTEES 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," and interpretation of FASB Statements No. 5, 57 and 107 and Rescission
of FASB Interpretation No. 34. Under its bylaws, the Company has agreed to
indemnify its officers and directors for certain events or occurrences while the
officer or director is serving, 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 purchased directors and officers liability insurance that, under
certain circumstances, enables it to recover a portion of certain future amounts
paid. The Company has no liabilities recorded for these obligations as of
January 31, 2004, however, reference should be made to Note 16 to the financial
statements with respect to legal contingencies.
(4) Accounts receivable, net
Accounts receivable, net included the following as of January 31:
(in thousands) 2004 2003
- ---------------------------------------------------------------------------------------
Accounts receivable $ 3,082 $ 2,165
Less: allowance for doubtful accounts (538) (544)
- ---------------------------------------------------------------------------------------
Accounts receivable, net $ 2,544 $ 1,621
- ----------------------------------------------------------------------------------------
The Company has charged bad debt expense of $973,000, $1,686,000 and $577,000
for doubtful accounts for the years ended January 31, 2004, 2003 and 2002,
respectively.
26
(5) Merchandise inventories
Merchandise inventories consisted of the following as of January 31:
(in thousands) 2004 2003
- ------------------------------------------------------------------------------------------------
Raw materials $ 9,827 $ 7,657
Finished goods inventory 196,319 189,037
- ------------------------------------------------------------------------------------------------
Merchandise inventories $ 206,146 $ 196,694
================================================================================================
Raw materials consist primarily of diamonds, precious gems,
semi-precious gems and gold. Included within finished goods inventory are
allowances for inventory shrink, scrap and miscellaneous costs of $3,731,000 and
$3,567,000 for the years ended January 31, 2004 and 2003, respectively. As of
January 31, 2004 and 2003, merchandise consignment inventories held by the
Company that are not included in its balance sheets total $91,635,000 and
$74,924,000, respectively.
Certain merchandise procurement, distribution and warehousing costs are
allocated to inventory. As of January 31, 2004 and 2003, these amounts included
in inventory are $3,500,000 and $3,364,000, respectively. The amounts comprising
the overhead pool of capitalizable costs were $5,521,000, $5,566,000 and
$5,211,000 for the years ended January 31, 2004, 2003 and 2002, respectively.
(6) Property and equipment, net
Property and equipment included the following as of January 31:
(in thousands) 2004 2003
- -------------------------------------------------------------------------------------------------------
Furniture and fixtures, and software $ 86,506 $ 77,614
Leasehold improvements 35,098 36,407
- -------------------------------------------------------------------------------------------------------
Property and equipment 121,604 114,021
Accumulated depreciation and amortization (60,656) (52,387)
- -------------------------------------------------------------------------------------------------------
Property and equipment, net $ 60,948 $ 61,634
- -------------------------------------------------------------------------------------------------------
Depreciation expense was $11,760,000, $10,704,000 and $9,955,000 for the
years ended January 31, 2004, 2003, and 2002, respectively.
The Company has recognized impairment charges included in costs of sales,
measured as the excess of net book value of furniture, fixtures and leasehold
improvements over their fair values, associated with management's decision to
close stores. As of January 31, 2004 the Company has completed the closure of
eleven stores without requiring significant adjustment to the originally
recorded charges and continues to pursue the closure of the remainder. The
Company did not record any impairment charges for the fiscal year ended January
31, 2004 and January 31, 2003. The Company recorded $822,000 in impairment
charges for the year ended January 31, 2002.
The amount of internally developed software capitalized during the year
ending January 31, 2004 and 2003 was $115,000 and $53,000, respectively, and is
included in furniture, fixtures and software. Amortization of capitalized
software for the year ended January 31, 2004 and 2003, was $50,000 and $69,000,
respectively. The remaining unamortized costs of internally developed software
included in property and equipment as of January 31, 2004 and 2003 was $229,000
and $164,000, respectively.
27
(7) Goodwill, net
On September 10, 1998, the Company acquired substantially all of the assets of
36 jewelry stores operating under the Jewel Box name from Carlyle & Co. Jewelers
and its affiliates, headquartered in Greensboro, North Carolina. The Company
purchased all associated inventory, accounts receivable and fixed assets for
approximately $22 million (including fees and other costs) in cash (the
"Acquisition"). The Acquisition has been accounted for using the purchase method
of accounting, and, accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based upon the fair values at the
date of Acquisition. The excess of the purchase price over the fair values of
the net assets acquired was $6.6 million and has been recorded as goodwill.
The Company adopted the provisions of SFAS 142 effective February 1, 2002
and has discontinued the amortization of goodwill. The Company has no other
separately identifiable intangible assets. Pursuant to this standard, the
Company has completed an assessment of the categorization of its existing
goodwill. In addition, the Company completed an analysis of the fair value using
both a discounted cash flow analysis and a market multiple approach and has
determined that no impairment of goodwill should be recorded. The carrying
amount of goodwill as of January 31, 2004 and January 31, 2003 was $5,662,000.
The table below shows income before income taxes, net income and earnings per
share for the years ended January 31, 2004, 2003 and 2002, adjusted to add back
goodwill amortization and related tax effects.
(in thousands, except per share data) 2004 2003 2002
- -----------------------------------------------------------------------------------------
Reported (loss) income before income taxes $ (13,575) $ 15,664 $ 14,807
Add back: Goodwill amortization -- -- 262
- -----------------------------------------------------------------------------------------
Adjusted (loss) income before income taxes $ (13,575) $ 15,664 $ 15,069
=========================================================================================
Reported net (loss) income $ (8,714) $ 9,694 $ 9,654
Add back: After tax impact of goodwill
amortization -- -- 171
- -----------------------------------------------------------------------------------------
Adjusted (loss) net income $ (8,714) $ 9,694 $ 9,825
=========================================================================================
Basic earnings per share:
Reported net (loss) income $ (0.62) $ 0.67 $ 0.66
After tax impact of goodwill amortization -- -- 0.01
- -----------------------------------------------------------------------------------------
Adjusted (loss) net income $ (0.62) $ 0.67 $ 0.67
=========================================================================================
Diluted earnings per share:
Reported net (loss) income $ (0.62) $ 0.64 $ 0.66
After tax impact of goodwill amortization -- -- 0.01
- -----------------------------------------------------------------------------------------
Adjusted (loss) net income $ (0.62) $ 0.64 $ 0.67
=========================================================================================
(8) Other long-term liabilities
Included in long-term liabilities at January 31, 2004 and 2003 are $3,535,000
and $3,138,000 respectively, of deferred lease costs.
(9) 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 to provide for a total
facility of $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. The Company amended
the Credit Agreement effective March 23, 2004 in order to, among other things,
(i) add a Layaway Reserve to the Borrowing Base (each as defined in the Credit
28
Agreement), (ii) add and amend certain financial covenants including, amending
the Fixed Charge Coverage Ratio (as defined in the Credit Agreement) and adding
a covenant to maintain a Net Worth (as defined in the Credit Agreement) of at
least $90.0 million at January 31, 2005, (iii) cap the borrowings under the
facility to a maximum of $85.0 million for at least thirty consecutive calendar
days during the period December 15, 2004 through and including February 15,
2005, (iv) increase the interest rate at which LIBOR based borrowings are
available under the Credit Agreement to LIBOR plus 2.5% through April 30, 2005,
(v) set the Commitment Fee Rate (as defined in the Credit Agreement) at 0.5%
through April 30, 2005, and (vi) set the Standby Letter of Credit Fee Rate (as
defined in the Credit Agreement) at 2.0% through April 30, 2005.
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, payments 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.
As of January 31, 2004, the calculated revolver availability, pursuant to the
Credit Agreement, exceeded the maximum availability of $125.0 million. The
Company had $80.3 million of outstanding borrowings under the revolving loan
facility as of January 31, 2004.
On October 29, 2003, the Company entered into a letter agreement with
its lenders which clarified and supplemented the 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 Credit Agreement reserved their rights to determine that
the consolidated Capital Factors actions, the SEC investigation or the United
States Attorney's investigation constituted a breach of the Credit Agreement. As
of March 22, 2004, the Company and its lenders entered into a new letter
agreement which rescinded the October 29, 2003 letter agreement. Pursuant to the
new letter agreement, the lenders under the Credit Agreement have agreed that,
as of March 23, 2004, the consolidated Capital Factors actions, the SEC
investigation and the United States Attorney's investigation have not resulted
in a breach of the Credit Agreement. In addition, the lenders have agreed that
none of these matters will give rise to a default or event of default under the
Credit Agreement so long as the resolution of such matters does not involve the
payment by the Company of Restitution (which is defined below) in an amount in
excess of $15.0 million or does not result in the indictment of the Company or
any of its current officers, directors or employees with principal financial or
accounting responsibilities. The new letter agreement also states that any
settlement involving the payment of Restitution in excess of $15.0 million shall
constitute a default under the Credit Agreement or any indictment of the Company
or any of the persons described above may constitute a default under the Credit
Agreement.
"Restitution" is defined as any restitution paid by the Company
(whether cash or non-cash or current or deferred consideration) arising from a
civil litigation settlement or award and/or criminal penalties paid or payable
in connection with the Capital Factors litigation, the SEC investigation, and/or
the United States Attorney investigation and any other actions or proceedings
directly related thereto; excluding however, (i) amounts paid by the Company for
consignment inventory held on behalf of the parties involved in the Capital
Factors litigation, (ii) amounts already accrued on the books of the Company for
the purchase of merchandise from the parties involved in the Capital Factors
litigation and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors litigation.
29
At this time, the Company does not expect the payment of Restitution to
exceed $15.0 million and, based on the Company's current financial plan, expects
to be in compliance with all financial covenants as set forth in the Credit
Agreement in 2004.
Subject to the contingencies identified in Note 16 to the financial
statements and other risks, including those identified in Forward-Looking
statements, management expects that based on our current financial plan the cash
flow from operating activities and funds available under the Company's revolving
credit facilities should be sufficient to support the Company's current new
store expansion program, seasonal working capital needs and liabilities that may
arise with respect to the Capital Factors related matters and the investigations
of the United States Attorney's Office and the SEC. Additionally, the Company
intends to vigorously contest the putative class action complaints and exercise
all of its available rights and remedies. Given that these class action cases
are in their early stages, and no substantive proceedings have occurred, it is
not possible to evaluate the likelihood of an unfavorable outcome in any of
these matters, or to estimate any amount or range of potential loss, if any.
While there are many potential outcomes, an adverse outcome in these actions
could have a material adverse effect on the Company's results of operations,
financial condition or liquidity. It cannot be determined at this stage whether
these claims will be resolved in the fiscal year January 31, 2005.
If the Company were to trigger an event of default pursuant to the
March 22, 2004 letter agreement the Company may be required to negotiate relief
with its lenders or to seek new financing. There is no assurance that new
financing arrangement would be available on acceptable terms or at all. If the
existing lenders were to cease funding under the revolving loan facility or
require immediate repayment 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 its assets and
liabilities.
In the near term, the Company expects increased professional fees
associated with the matters discussed in Note 16 to the financial statements to
continue into fiscal 2004, thereby impacting earnings and cash flow. However,
such fees have been significantly lower since the end of fiscal 2003.
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.
The interest rates for borrowings under the Credit Agreement are, at
the Company's option, based on LIBOR rates or the United States banks' prime
rate. Interest is payable monthly for prime borrowings and upon maturity for
LIBOR borrowings.
The interest expense under the revolver facility for the years ended
January 31, 2004, 2003 and 2002 was $2,900,000, $3,008,000 and $4,650,000,
respectively, reflecting a weighted average interest rate of 3.2%, 4.2% and
6.4%, respectively.
TERM LOAN In connection with the Credit Agreement, the Company paid the term
loan amount due under the prior credit agreement, totaling $4.5 million during
fiscal 2003. Interest rates for these borrowings were, at the Company's option,
30
based on LIBOR rates or the United States banks' prime rate. Interest was
payable monthly for prime borrowings and upon maturity for LIBOR borrowings.
Interest rates and the commitment fee charged on the unused facility float based
on the Company's quarterly financial performance. The interest expense under the
term loan facility for the years ended January 31, 2004, 2003 and 2002 was
$72,000, $353,000 and $841,000, respectively reflecting a weighted average
interest rate of 3.9%, 4.4% and 6.7%, respectively.
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. In the event of
a consignment of gold, 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 gold consignment transactions 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.
In August 2002, the Company delivered gold to its banks extinguishing
all existing Company gold consignment obligations under the Credit Agreement.
The purchase had the effect of increasing the weighted average cost of gold
available for retail sale by the Company and resulted in a higher weighted
average cost of sales in subsequent 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 $798,000 and
$725,000 of this increase in cost of sales is reflected in the year ended
January 31, 2004 and 2003, respectively. This purchase increased the Company's
inventory by $20.5 million and was funded by revolver loan borrowings. The
Company currently has no gold consignment obligations to the banks under the
Credit Agreement.
The consignment fees totaled $0, $354,000 and $804,000 for the years
ended January 31, 2004, 2003 and 2002, respectively, at a weighted average rate
of 0.0%, 3.0% and 3.7%, respectively.
31
SUBORDINATED NOTES As of January 31, 2004 and 2003, the Company had Series C
Senior Subordinated Notes due 2004 (the "Series C Notes") totaling $640,000
which bear interest at 12.15% per annum payable in cash, with interest payments
due quarterly. Interest expense was $78,000 for each of the years ended January
31, 2004, 2003 and 2002, respectively.
As of January 31, 2004 and 2003, the current portion and noncurrent
portion of long-term debt consisted of the following:
(in thousands) 2004 2003
- -------------------------------------------------------------
Current portion of long-term debt:
Term loan $ -- $4,500
Subordinated debt 640 --
- -------------------------------------------------------------
Sub total $ 640 $4,500
- -------------------------------------------------------------
Long-term debt, net of current portion:
Subordinated debt $ -- $ 640
- -------------------------------------------------------------
Total $ 640 $5,140
- -------------------------------------------------------------
The final scheduled maturity of the subordinated notes totaling $640,000
is on October 31, 2004.
The carrying amount of the Company's borrowings under the Credit
Agreement and other long-term borrowings approximates fair value based on
current market rates.
(10) 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 and included in interest
expense in fiscal 2003. Costs associated with the second amended and restated
credit facility totaling approximately $1.0 million are being amortized over the
term of the Credit Agreement. Amortization expense in the years ended January
31, 2004, 2003 and 2002 was $926,000, $511,000 and $487,000, respectively.
32
(11) Income taxes
The temporary differences between the tax basis of assets and liabilities and
their financial reporting amounts that give rise to a significant portion of the
deferred tax asset and deferred tax liability and their approximate tax effects
are as follows, as of January 31:
2004 2003
------------------------ ------------------------
Temporary Temporary
(in thousands) Difference Tax Effect Difference Tax Effect
- ---------------------------------------------------------------------------------------------
Merchandise inventories $ 1,988 $ 775 $ 1,699 $ 664
Accrued rent 3,798 1,481 3,412 1,331
Accounts receivable 872 340 935 365
Sales returns 920 359 709 276
Vacation pay 1,154 450 1,132 441
Severance 900 351 -- --
Litigation reserve 8,572 3,342 1,000 390
Workers' compensation reserve 774 302 -- --
State and local government fees 1,926 752 937 365
State closing payables 121 47 225 88
Other 4 1 183 72
Net operating loss carryforward 1,971 769 858 334
AMT credit carryforward 53 21 -- --
- ---------------------------------------------------------------------------------------------
Total deferred tax asset 23,053 8,990 11,090 4,326
- ---------------------------------------------------------------------------------------------
Property and equipment, net 14,181 5,530 12,446 4,854
Goodwill 1,584 618 1,160 452
Valuation allowance 1,971 769 -- --
- ---------------------------------------------------------------------------------------------
Total deferred tax liability (17,736) (6,917) (13,606) (5,306)
- ---------------------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 5,317 $ 2,073 $ (2,516) $ (980)
- ---------------------------------------------------------------------------------------------
The net current and non-current components of deferred income taxes
recognized in the balance sheet at January 31 are as follows:
(in thousands) 2004 2003
- --------------------------------------------------------------------------------------------------------
Net current assets $ 5,712 $ 2,627
Net non-current (liability) (3,639) (3,607)
- --------------------------------------------------------------------------------------------------------
Net deferred tax asset (liability) $ 2,073 $ (980)
- --------------------------------------------------------------------------------------------------------
At January 31, 2004, the Company also had a state net operating loss of
$21,593,000. This net operating loss will expire in tax years 2006 to 2023. A
valuation allowance of $769,000 has been established to reflect management's
belief that based on the nature of the net operating losses, the jurisdictions
involved and consideration of current tax planning strategies, it is currently
unlikely that the deferred tax associated with the net operating loss
carryforward will be fully realized prior to expiration.
The income tax expense for the years ended January 31, consists of the
following:
(in thousands) 2004 2003 2002
- ----------------------------------------------------------------------------------------------------------
Current (benefit) expense $ (1,636) $ 3,795 $ 3,548
Deferred tax (benefit) expense (3,225) 2,175 1,605
- ----------------------------------------------------------------------------------------------------------
Total income tax (benefit) expense $ (4,861) $ 5,970 $ 5,153
- ----------------------------------------------------------------------------------------------------------
33
The provision for income taxes on income differs from the statutory tax
expense computed by applying the federal corporate tax rate of 34%, 35% and 34%
for the years ended January 31, 2004, 2003 and 2002, respectively.
(in thousands) 2004 2003
- ---------------------------------------------------------------------------
Taxes computed at statutory rate $(4,616) $ 5,482
State income tax (benefit) expense, net of federal
tax effect (1,032) 499
Valuation expense 769 --
Other 18 (11)
- ---------------------------------------------------------------------------
Total income tax (benefit) expense $(4,861) $ 5,970
- ---------------------------------------------------------------------------
(12) Common stock
Following are the number of shares issued and outstanding for each of the
Company's classes of Common Stock as of January 31:
Class B
Common Stock Common Stock Treasury
(in thousands) (par value $.001) (par value $1.00) Stock
- ---------------------------------------------------------------------------------------------
Balance at January 31, 2001 17,733,387 148 (3,200,876)
Conversion of Class B Common Stock 213 (6) --
Exercise of Options/Restricted Shares 76,230 -- --
Issuance of Stock -- -- 667
- ---------------------------------------------------------------------------------------------
Balance at January 31, 2002 17,809,830 142 (3,200,209)
Exercise of Options/Restricted Shares 211,138 -- (21,418)
Purchase of Treasury Stock -- -- (605,600)
Issuance of Stock -- -- 4,590
- ---------------------------------------------------------------------------------------------
Balance at January 31, 2003 18,020,968 142 (3,822,637)
Exercise of Options/Restricted Shares 34,040 -- --
Purchase of Treasury Stock -- -- (321,400)
Issuance of Stock -- -- 9,896
- ---------------------------------------------------------------------------------------------
Balance at January 31, 2004 18,055,008 142 (4,134,141)
- ---------------------------------------------------------------------------------------------
Each share of Class B Common Stock is exchangeable into common stock on
a 35.4 for 1 basis. Each share of Common Stock is entitled to one vote, and each
share of Class B Common Stock is entitled to 35.4 votes on each matter submitted
to stockholders for vote.
(13) Earnings per common share
Basic earnings per share are computed by dividing net earnings available to
holders of common stock by the weighted average number of shares of common stock
outstanding. Diluted earnings per share are computed assuming the exercise of
all dilutive stock options. Under these assumptions, the weighted average number
of common shares outstanding is increased accordingly.
34
The following table reconciles the numerators and denominators of the
basic and diluted earnings per share ("EPS") computations for the years ended
January 31:
2004 2003 2002
-------------------------------------------------------------------------
(in thousands, except per share amounts) Basic Diluted Basic Diluted Basic Diluted
- --------------------------------------------------------------------------------------------------------------------
EPS Numerator:
Net (loss) income $ (8,714) $ (8,714) $ 9,694 $ 9,694 $ 9,654 $ 9,654
EPS Denominator:
Average common shares outstanding: 14,098 14,098 14,545 14,545 14,584 14,584
Effect of dilutive securities:
Stock options -- -- -- 493 -- 101
- ---------------------------------------------------------------------------------------------------------------------
Total shares 14,098 14,098 14,545 15,038 14,584 14,685
- ---------------------------------------------------------------------------------------------------------------------
Earnings per share $ (0.62) $ (0.62) $ 0.67 $ 0.64 $ 0.66 $ 0.66
- ---------------------------------------------------------------------------------------------------------------------
Stock options excluded from the
calculation of diluted earnings per
share (due to their antidilutive
effect on the calculation) -- 1,240 -- 606 -- 1,133
- ---------------------------------------------------------------------------------------------------------------------
(14) Employee benefit plans
Effective October 1, 2001, the Company established an Employee Stock Purchase
Plan ("ESPP") for the benefit of substantially all employees. Employees become
eligible to participate in the ESPP after six consecutive months of employment
and the employee's customary employment is more than 20 hours per week. Through
employee contributions to the ESPP, the employee can purchase common stock of
the Company at 90% of the market value.
Effective October 1, 1997, the Company established a 401(k) Plan (the
"Plan") for the benefit of substantially all employees, the assets of which are
not commingled with Company funds. Employees become eligible to participate in
the Plan after one year of service, which is defined as at least one year of
employment and 1,000 hours worked in that year. The Company may make
discretionary contributions to the Plan. No such discretionary contributions
have been made since inception.
In 1988, the Company established an Employee Stock Ownership Plan (the
"ESOP"), which is a noncontributory plan established to acquire shares of the
Company's Class B Common Stock for the benefit of all employees. In conjunction
with completion of the Company's initial public offering and recapitalization of
its financing arrangements, the Company restructured the ESOP. As of January 31,
1998, all remaining shares had been released to participants. As long as the
stock is publicly traded the Company is not required to repurchase shares from
ESOP participants. However, if the Company were to cease being public, the
Company's shares held by the ESOP would be subject to redemption at market
value. As of January 31, 2004 and 2003, there were approximately 425,000 and
470,000 Company shares with a market value of approximately $3.9 million and
$4.7 million held by ESOP, respectively. The only remaining activity of the ESOP
is to make distributions to existing participants or beneficiaries.
(15) Stock plans
In April 1996, the Company approved the 1996 Long-Term Incentive Plan (the "1996
Plan"). Under the 1996 Plan, the Company may grant incentive stock options
("ISOs") within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended, or nonqualified stock options.
35
In addition, the Company may grant stock appreciation rights ("SARs"),
bonus stock awards which are vested upon grant, stock awards which may be
subject to a restriction period and specified performance measures and
performance shares. Performance shares are rights, contingent upon the
attainment of the performance measures within a specified performance period, to
receive one share of common stock, which may be restricted, or the fair market
value of such performance share in cash. No compensatory options have been
granted under the 1996 Plan during fiscal 2003. A total of 1,156,784 shares of
common stock have been reserved for issuance under the 1996 Plan. Grants may be
made under the 1996 Plan during the ten years after its effective date. Options
granted under the 1996 Plan generally vest in four equal annual installments and
expire ten years after the date of grant. Options and shares granted under the
plans are subject to forfeiture based on, among other things, the nature and
timing of the termination of employment.
The Company approved the 1997 Long-Term Incentive Plan (the "1997 Plan")
on February 24, 1997 and the stockholders adopted the 1997 Plan on June 5, 1997.
On June 8, 1999, June 1, 2000 and June 11, 2002, the stockholders adopted
amendments to the 1997 Plan to increase the common stock reserved for issuance
under the 1997 Plan. Under the 1997 Plan, the Company may grant ISOs or
nonqualified stock options. The 1997 Plan also provides for the grant of SARs,
bonus stock awards which are vested upon grant, stock awards which may be
subject to a restriction period and specified performance measures, and
performance shares. Performance shares are rights, contingent upon the
attainment of performance measures within a specified performance period, to
receive one share of common stock, which may be restricted, or the fair market
value of such performance share in cash. No compensatory options have been
granted under the 1997 Plan during fiscal 2003. A total of 2,500,000 shares of
Common Stock have been reserved for issuance under the 1997 Plan. Grants may be
made under the 1997 Plan during the ten years after its effective date. Options
granted under the 1997 Plan generally vest in three or four equal annual
installments and expire ten years after the date of grant.
In December 1998, the Company adopted the 1998 Non-Employee Director
Stock Option Plan (the "1998 Plan"), effective February 1, 1998. Under the 1998
Plan, non-employee directors may elect to receive all or a designated amount of
their directors' fee in the form of stock options. A total of 37,500 shares have
been reserved for issuance under the 1998 Plan. Grants may be made during the
ten years after its effective date. Options granted under the 1998 Plan vest at
the end of the quarter in which the date of grant occurs and expire ten years
after the date of grant. During fiscal 2003 and fiscal 2002, no options had been
granted under the 1998 Plan.
36
Option activity for the years ended January 31, 2002, 2003 and 2004 was as
follows:
Weighted-Average Options
Shares Exercise Price Exercisable
- ----------------------------------------------------------------------------
Balance at January 31, 2001 2,497,417 $12.29 1,460,575
- ----------------------------------------------------------------------------
Options granted 469,849 8.03
Options exercised (76,230) 11.75
Options canceled (120,318) 19.39
- ----------------------------------------------------------------------------
Balance at January 31, 2002 2,770,718 $11.36 1,567,816
- ----------------------------------------------------------------------------
Options granted 423,486 13.50
Options exercised (211,138) 8.87
Options canceled (27,062) 14.16
- ----------------------------------------------------------------------------
Balance at January 31, 2003 2,956,004 $11.81 2,105,510
- ----------------------------------------------------------------------------
Options granted 80,862 10.27
Options exercised (36,806) 8.12
Options canceled (254,462) 11.20
- ----------------------------------------------------------------------------
Balance at January 31, 2004 2,745,598 $11.88 2,338,574
- ----------------------------------------------------------------------------
The weighted-average fair value of 80,862, 423,486 and 469,849 options
granted was $5.31, $7.17 and $4.28 for the years ended January 31, 2004, 2003
and 2002, respectively.
The following table summarizes the status of outstanding stock options
as of January 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------------------------------------------
Weighted
Number of Average Weighted- Number of Weighted-
Options Remaining Average Options Average
Range of Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------------------------------------------------------------------------------------------------------------------------------
$6.753 - $8.876 442,849 6.49 $ 7.955 299,113 $ 7.885
$8.915 - $9.333 1,008,466 2.43 9.327 988,483 9.332
$9.525 - $12.360 697,619 5.89 11.142 617,634 11.282
$12.563 - $24.250 596,664 6.82 19.948 433,344 21.656
- ------------------------------------------------------------------------------------------------------------------------------
$6.753 - $24.250 2,745,598 4.92 $ 11.875 2,338,574 $ 11.946
- ------------------------------------------------------------------------------------------------------------------------------
(16) Commitments and contingencies
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. The
parties reached an agreement to settle the matter resulting in a pre-tax charge
of $1,000,000, inclusive of the plaintiff's attorneys' fees, interest,
penalties, administrative costs and other Company costs, which was approved by
the court on December 11, 2003. This settlement covers the period from July 25,
1998 through the date of final settlement approval by the court. The Company has
made payments totaling approximately $1,000,000, per the terms of the settlement
agreement, as of January 31, 2004.
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. The parties have reached a settlement of the suit for an amount that
is not significant in relation to the Company's financial statements.
The Company has been 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
37
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.
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 asserted
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 the Company owes Cosmopolitan
$8,600,000 in accounts receivable on invoices assigned to Capital Factors. This
amount is included in the $30,000,000 of losses that Capital Factors seeks in
its RICO claims. In addition, Ultimo, Inc. ("Ultimo"), a jewelry supplier, is a
defendant in the International action and in the interpleader action. Ultimo
provided certain items of jewelry to the Company on a consignment basis and
asserts that: (1) the Company has sold approximately $450,000 worth of such
items, the proceeds of which it claims remain in the Company's possession; and
(2) the Company continues to possess approximately $1,780,000 worth of its
consignment goods. Ultimo asserts that it should receive these consignment
proceeds and goods. Capital Factors and International also have asserted claims
to these proceeds and goods. The Company plans to place the remaining
consignment goods into escrow, and the New York State Supreme Court has
announced that it will hold a hearing as early as May 2004 to determine the
proper distribution of these consignment goods. The consignment proceeds already
have been placed in the Company's outside counsel's escrow account pending court
determination of the proper recipient. 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.
38
In these consolidated Capital Factors actions, document discovery has
begun, but depositions have been stayed until April 19, 2004 upon consent of the
parties. In addition, the Company has filed motions to dismiss both the Capital
Factors and International/Astra complaints. The motions are currently pending
before the court.
As previously disclosed, 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 this 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 the matters that are the
subject of the consolidated Capital Factors actions. The Company produced
documents to the SEC in response to the SEC's subpoena and information
requests. The Company is cooperating fully with the SEC in connection with this
formal investigation.
In accordance with Financial Accounting Standards Board Statement No.
5, "Accounting for Contingencies," the Company determines whether an estimated
loss from a loss contingency should be accrued by assessing whether a loss is
deemed probable and can be reasonably estimated. As previously disclosed in a
press release furnished to the SEC under cover of a Current Report on Form 8-K
dated March 23, 2004, during the fourth quarter of the fiscal year ended January
31, 2004, the Company accrued a litigation reserve of $6.0 million for the
consolidated Capital Factors actions and the United States Attorney and SEC
investigations. Since March 23, 2004, the Company has engaged in additional
settlement negotiations relating to these matters. In light of developments in
the ongoing settlement discussions, the Company has accrued an additional
reserve for the fourth quarter of the fiscal year ended January 31, 2004, in the
amount of $2.6 million, with respect to these matters. There are no assurances
that the Company will be able to reach a settlement with any of the parties to
the consolidated Capital Factors actions or that such a settlement or
settlements, as the case may be, will be for the amount recorded as a reserve.
However, the Company currently believes that it is more likely than not that it
will reach a settlement or settlements, as the case may be, pertaining to the
consolidated Capital Factors actions in the near term. Given the amounts sought
in the consolidated Capital Factors actions, and the inherent unpredictability
of litigation, it is possible that an adverse outcome in excess of the amount
recorded could occur and these actions could have a material adverse effect on
the Company's results of operations, financial condition or liquidity. The
Company is unable at this time to predict the ultimate outcome of the
consolidated Capital Factors actions or the United States Attorney and SEC
investigations. Professional fees of approximately $9.6 million incurred as a
result of the consolidated Capital Factors actions, the United States Attorney
and SEC investigations, and the Company's internal investigation, have been
expensed through January 31, 2004.
On October 29, 2003, the Company entered into a letter agreement with
its lenders which clarified and supplemented the 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 Credit Agreement reserved their rights to determine that
the consolidated Capital Factors actions, the SEC investigation or the United
States Attorney's investigation constituted a breach of the Credit Agreement. As
of March 22, 2004, the Company and its lenders entered into a new letter
agreement which rescinded the October 29, 2003 letter agreement. Pursuant to the
new letter agreement, the lenders under the Credit Agreement have agreed that,
39
as of March 23, 2004, the consolidated Capital Factors actions, the SEC
investigation and the United States Attorney's investigation have not resulted
in a breach of the Credit Agreement. In addition, the lenders have agreed that
none of these matters will give rise to a default or event of default under the
Credit Agreement so long as the resolution of such matters does not involve the
payment by the Company of Restitution (which is defined below) in an amount in
excess of $15.0 million, or does not result in the indictment of the Company or
any of its current officers, directors or employees with principal financial or
accounting responsibilities. The new letter agreement also states that any
settlement involving the payment of Restitution in excess of $15.0 million shall
constitute a default under the Credit Agreement or any indictment of the Company
or any of the persons described above may constitute a default under the Credit
Agreement.
"Restitution" is defined as any restitution paid by the Company
(whether cash or non-cash or current or deferred consideration) arising from a
civil settlement or award and/or criminal penalties paid or payable in
connection with the Capital Factors litigation, the SEC investigation and/or the
United States Attorney investigation and any other actions or proceedings
directly related thereto; excluding, however, (i) amounts paid by the Company
for consignment inventory held on behalf of the parties involved in the Capital
Factors litigation and (ii) amounts already accrued on the books of the Company
for the purchase of merchandise from the parties involved in the Capital Factors
litigation and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors litigation.
At this time the Company does not expect the payment of Restitution to
exceed $15.0 million and, based on the Company's current financial plan, expects
to be in compliance with all financial covenants as set forth in the Credit
Agreement in 2004.
On February 12, 2004, a putative class action complaint captioned
Greater Pennsylvania Carpenters Pension Fund, et al. v. Whitehall Jewellers,
Inc. et al., Case No. 04 C 1007, was filed in the United States District Court
for the Northern District of Illinois against the Company and certain of the
Company's current and former officers. The complaint makes reference to the
litigation filed by Capital Factors Inc. above and to the Company's November 21,
2003 announcement that it had discovered violations of Company policy by the
Company's Executive Vice President, Merchandising, with respect to Company
documentation regarding the age of certain store inventory. The complaint
further makes reference to the Company's December 22, 2003 announcement that it
would restate results for certain prior periods. The complaint purports to
allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 ("1934 Act") and Rule 10b-5 promulgated thereunder, and alleging that the
Company and its officers made false and misleading statements and falsely
accounted for revenue and inventory during the putative class period of November
19, 2001 to December 10, 2003.
On February 18, 2004, a putative class action complaint captioned
Michael Radigan, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C
1196, was filed in the United States District Court for the Northern District of
Illinois against the Company and certain of the Company's current and former
officers, charging violations of Sections 10(b) and 20(a) of the 1934 Act and
Rule 10b-5 promulgated thereunder, and alleging that the Company and its
officers made false and misleading statements and falsely accounted for revenue
and inventory during the putative class period of November 19, 2001 to December
10, 2003. The factual allegations of this complaint are similar to those made in
the Greater Pennsylvania Carpenters Pension Fund complaint discussed above.
On February 20, 2004, a putative class action complaint captioned
Milton Pfeiffer, et al., v. Whitehall Jewellers, Inc. et al., Case No. 04 C
1285, was filed in the United States District Court for the Northern District of
40
Illinois against the Company and certain of the Company's current and former
officers, charging violations of Sections 10(b) and 20(a) officers, charging
violations of Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5
promulgated thereunder, and alleging that the Company and its officers made
false and misleading statements and falsely accounted for revenue, accounts
payable, inventory, and vendor allowances during the putative class period of
November 19, 2001 to December 10, 2003. The factual allegations of this
complaint are similar to those made in the Greater Pennsylvania Carpenters
Pension Fund complaint discussed above.
On April 6, 2004, the District Court in the Greater Pennsylvania
Carpenters case, No. 04 C 1107 consolidated the Pfeiffer and Radigan complaints
with the Greater Pennsylvania Carpenters complaint, and on April 14, 2004,
granted the plaintiffs up to 60 days to file an amended consolidated complaint.
The Company intends to vigorously contest these putative class action
complaints and exercise all of its available rights and remedies. Given that
these cases are in their early stages, and no substantive proceedings have
occurred, it is not possible at this preliminary stage to evaluate the
likelihood of an unfavorable outcome in any of these matters, or to estimate any
amount or range of potential loss, if any. While there are many potential
outcomes, an adverse outcome in any of these actions could have a material
adverse effect on the Company's results of operations, financial condition or
liquidity. It cannot be determined at this stage whether these claims will be
resolved in the fiscal year ending January 31, 2005.
On January 16, 2004, the Company was named as a defendant in a
copyright infringement lawsuit filed in the United States District Court for the
District of Minnesota by Janel Russell Designs, Inc. ("Janel Russell Designs").
Janel Russell Designs asserts that the Company is infringing its copyright in a
jewelry design by selling infringing merchandise. Janel Russell Designs seeks
unquantified damages. Two of the allegedly infringing pieces are supplied to the
Company by Samuel Aaron Inc. and one is supplied by Princess Pride Creations.
Each of the suppliers has also been sued by Janel Russell Designs in separate
lawsuits. Pursuant to language in certain Vendor Trading Agreements the Company
entered into with each supplier, the Company tendered the defense of the cases
to Samuel Aaron and Princess Pride and demanded indemnification. Both vendors,
through counsel, have indicated they will defend and indemnify the Company. The
Company filed its answer on March 3, 2004.
The Company is subject to other claims and litigation in the normal
course of business. Although there can be no certainty, 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.
The Company leases the premises for its office facilities and all of its
retail stores, and certain office and computer equipment generally under
noncancelable agreements for periods ranging from two to 13 years. Most leases
require the payment of taxes, insurance and maintenance costs. Future minimum
rentals under noncancelable operating leases as of January 31, 2004 are as
follows:
Years ending January 31 (in thousands) Amount
- -----------------------------------------------------------------------------------
2005 $ 30,065
2006 29,614
2007 28,305
2008 27,356
2009 25,757
Thereafter 76,053
- -----------------------------------------------------------------------------------
Total future minimum rent obligations $ 217,150
- -----------------------------------------------------------------------------------
41
Total rental expense for all operating leases for the years ended January 31, is
as follows:
(in thousands) 2004 2003 2002
- -----------------------------------------------------------------------------
Rental expense:
Minimum $ 29,750 $ 28,437 $ 26,730
Rentals based on sales 761 923 1,137
Other 387 431 592
- -----------------------------------------------------------------------------
Total rental expense $ 30,898 $ 29,791 $ 28,459
- -----------------------------------------------------------------------------
(17) Related party transactions
In the past, the Company provided certain office services to Double P
Corporation, PDP Limited Liability Company and CBN Limited Liability Company or
other companies, from time to time, which own and operate primarily mall-based
snack food stores, and in which Messrs. Hugh Patinkin, John Desjardins and
Matthew Patinkin own a 52% equity interest. A substantial portion of the
remaining equity interest is owned by the adult children and other family
members of Norman Patinkin, a member of the Company's Board of Directors. For
these services, Double P Corporation paid the Company $700 per month. Effective
February 1, 2004, the Company no longer provides these services. Matthew
Patinkin previously served as a director of Double P Corporation and one of
Norman Patinkin's adult children is a director and chief executive officer of
Double P Corporation. Messrs. Hugh Patinkin, John Desjardins and Matthew
Patinkin spend a limited amount of time providing services to Double P
Corporation, PDP Limited Liability Company and CBN Limited Liability Company.
Such services are provided in accordance with the Company's Code of Ethics. In
the case of Hugh Patinkin and John Desjardins, these services are performed
solely in their capacities as shareholders of Double P Corporation. In the case
of Matthew Patinkin, these services are performed in his capacity as a
shareholder of Double P Corporation and were previously performed in his
capacities as a director and a shareholder of Double P Corporation. Messrs. Hugh
Patinkin and John Desjardins receive no remuneration for these services other
than reimbursement of expenses incurred. Matthew Patinkin receives no
remuneration for these services other than the fee he previously received for
his services as a director of Double P Corporation. In several cases, the
Company and Double P Corporation agreed to divide and separately lease
contiguous mall space. The Company and Double P Corporation concurrently
negotiated separately with each landlord ("Simultaneous Negotiations") to reach
agreements for their separate locations. Since the Company's initial public
offering, its policy had required that the terms of any such leases must be
approved by a majority of the Company's outside directors. The Company had
conducted such negotiations in less than ten situations, since the Company's
initial public offering in 1996. The Company's current policy is that it will no
longer enter into such Simultaneous Negotiations.
The Company offers health insurance coverage to the members of its
Board of Directors. The health insurance policy options and related policy cost
available to the Directors are the same as those available to the Company's
senior level employees.
The Company operates a program under which executive officers and
directors, and parties introduced to the Company by its executive officers and
directors, are permitted to purchase most Company merchandise at approximately
ten percent above the Company's cost. During fiscal 2003, such purchases totaled
approximately $174,000.
42
(18) Unaudited quarterly results
The Company's results of operations fluctuate on a quarterly basis. The
following table sets forth summary unaudited financial information of the
Company for each quarter in fiscal 2003 and 2002. In the opinion of management,
this quarterly information has been prepared on a basis consistent with the
Company's audited financial statements appearing elsewhere in this annual
report, and reflects adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of such unaudited quarterly results when read
in conjunction with the audited financial statements and notes thereto.
2003 Quarters Ended
(in thousands, except per share data) April 30, 2003 July 31, 2003 October 31, 2003 January 31, 2004
- -------------------------------------------------------------------------------------------------------------
Net sales $ 69,149 $ 72,732 $ 66,179 $136,595
Gross profit 23,111 24,192 20,880 58,850
Income (loss) from operations (3,659) (3,031) (9,661) 6,886
Net income (loss) (2,787) (2,803) (7,408) 4,284
Diluted earnings per share:
Net income (loss) $ (0.20) $ (0.20) $ (0.53) $ 0.30
In the fourth quarter of fiscal 2003, the Company accrued a litigation
reserve of $8.6 million for the consolidated Capital Factors actions and the
United States Attorney and SEC investigation, as further discussed in Note 16 to
the financial statements.
2002 Quarters Ended
(in thousands, except per share data) April 30, 2002 July 31, 2002 October 31, 2002 January 31, 2003
- -------------------------------------------------------------------------------------------------------------
Net sales $ 74,588 $ 76,243 $ 61,831 $128,375
Gross profit 27,094 26,445 18,762 55,494
Income (loss) from operations 1,467 1,194 (6,791) 24,135
Net income (loss) 293 54 (5,110) 14,457
Diluted earnings per share:
Net income (loss) $ 0.02 $ 0.00 $ (0.35) $ 1.00
(19) Reclassifications
Certain Balance Sheet amounts from prior periods were reclassified to conform to
the current year presentation. These reclassifications had no impact on earnings
or equity.
(20) Subsequent events
The Company amended the Credit Agreement effective March 23, 2004 in order to,
among other things, (i) add a Layaway Reserve to the Borrowing Base (as defined
in the Agreement), (ii) add and amend certain financial covenants including,
amending the Fixed Charge Coverage Ratio (as defined in the Credit Agreement)
and adding a covenant to maintain a Net Worth (as defined in the Credit
Agreement) of at least $90.0 million at January 31, 2005, (iii) cap the
borrowings under the facility to a maximum of $85.0 million for at least thirty
consecutive calendar days during the period December 15, 2004 through and
including February 15, 2005, (iv) increase the interest rate at which LIBOR
based borrowings are available under the Credit Agreement to LIBOR plus 2.5%
through April 30, 2005, (v) set the Commitment Fee Rate (as defined in the
Credit Agreement) at 0.5% through April 30, 2005, and (vi) set the Standby
Letter of Credit Fee Rate (as defined in the Credit Agreement) at 2.0% through
April 30, 2005.
43
On October 29, 2003, the Company entered into a letter agreement with
its lenders which clarified and supplemented the 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 Credit Agreement reserved their rights to determine that
the consolidated Capital Factors actions, the SEC investigation or the United
States Attorney's investigation constituted a breach of the Credit Agreement. As
of March 22, 2004, the Company and its lenders entered into a new letter
agreement which rescinded the October 29, 2003 letter agreement. Pursuant to the
new letter agreement, the lenders under the Credit Agreement have agreed that,
as of March 23, 2004, the consolidated Capital Factors actions, the SEC
investigation and the United States Attorney's investigation have not resulted
in a breach of the Credit Agreement. In addition, the lenders have agreed that
none of these matters will give rise to a default or event of default under the
Credit Agreement so long as the resolution of such matters does not involve the
payment by the Company of Restitution (which is defined below) in an amount in
excess of $15.0 million, or does not result in the indictment of the Company or
any of its current officers, directors or employees with principal financial or
accounting responsibilities. The new letter agreement also states that any
settlement involving the payment of Restitution in excess of $15.0 million shall
constitute a default under the Credit Agreement or any indictment of the Company
or any of the persons described above may constitute a default under the Credit
Agreement.
"Restitution" is defined as any restitution paid by the Company
(whether cash or non-cash or current or deferred consideration) arising from a
civil settlement or award and/or criminal penalties paid or payable in
connection with the Capital Factors Lawsuit, the SEC Investigation and/or the
United States Attorney Investigation and any other actions or proceedings
directly related thereto; excluding, however, (i) amounts paid by the Company
for consignment inventory held on behalf of the parties involved in the Capital
Factors Lawsuit and (ii) amounts already accrued on the books of the Company for
the purchase of merchandise from the parties involved in the Capital Factors
Lawsuit and (iii) the value of any consigned inventory returned to parties
involved in the Capital Factors Lawsuit.
As previously disclosed in a press release furnished to the SEC under
cover of a Current Report on Form 8-K dated March 23, 2004, during the fourth
quarter of the fiscal year ended January 31, 2004, the Company accrued a
litigation reserve of $6.0 million for the consolidated Capital Factors actions
and the United States Attorney and SEC investigations. Since March 23, 2004, the
Company has engaged in additional settlement negotiations relating to these
matters. In light of developments in the ongoing settlement discussions, the
Company has accrued an additional reserve for the fourth quarter of the fiscal
year ended January 31, 2004, in the amount of $2.6 million, with respect to
these matters. There are no assurances that the Company will be able to reach a
settlement with any of the parties to the consolidated Capital Factors actions
or that such a settlement or settlements, as the case may be, will be for the
amount recorded as a reserve. However, the Company currently believes that it is
more likely than not that it will reach a settlement or settlements, as the case
may be, pertaining to the consolidated Capital Factors actions in the near term.
The Company is unable at this time to predict the ultimate outcome of the
consolidated Capital Factors actions or the United States Attorney and SEC
investigations.
44
Report of Independent Auditors
To the Board of Directors and Shareholders of Whitehall Jewellers, Inc.
In our opinion, the accompanying balance sheets and the related statements of
operations, shareholders' equity, and cash flow present fairly, in all material
respects, the financial position of Whitehall Jewellers, Inc. (the "Company") at
January 31, 2004 and 2003, and the results of its operations and its cash flows
for each of the three years in the period ended January 31, 2004, in conformity
with accounting principles generally accepted in the United States of America.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 7 to the financial statements, effective February 1, 2002,
the Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets."
PricewaterhouseCoopers LLP (signed)
Chicago, Illinois
March 22, 2004, except for the last paragraph of Note 20 as to which the date is
April 15, 2004
45
MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The
Company's stock began trading on the New York Stock Exchange under the symbol
"JWL" on January 27, 2000. Prior to that date the Company's stock traded on the
NASDAQ National Market System under the symbol "WHJI." At April 1, 2004, there
were 103 registered holders of Class B stock and 322 registered holders of
Common Stock for a total of 425 registered shareholders.
2004 2003
-----------------------------------------------------
Year ended January 31 High Low High Low
- ------------------------------------------------------------------------------------------------------------------
First Quarter $ 10.23 $ 7.90 $ 20.25 $ 13.54
Second Quarter 12.20 8.88 23.00 9.80
Third Quarter 12.60 10.23 12.97 8.00
Fourth Quarter 13.25 8.66 12.35 8.41
The Company has not declared any dividends in fiscal 2003 and 2002, and intends
to retain its earnings to finance future growth. Therefore, the Company does not
anticipate paying any cash dividends in the foreseeable future. The declaration
and payment of dividends, if any, is subject to the discretion of the Board of
Directors of the Company and to certain limitations under the General
Corporation Law of the State of Delaware. In addition, the Company's Credit
Agreement contains restrictions of the Company's ability to pay dividends. The
timing, amount and form of dividends, if any, will depend, among other things,
on the Company's results of operations, financial condition, cash requirements
and other factors deemed relevant by the Board of Directors.
46