1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED APRIL 2, 2000.
Commission File No.1-9223
SERVICE MERCHANDISE COMPANY, INC.
(Debtor-in-Possession as of March 27, 1999)
(Exact Name of Registrant as Specified In Its Charter)
TENNESSEE 62-0816060
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
P.O. BOX 24600, NASHVILLE, TN (MAILING ADDRESS)
7100 SERVICE MERCHANDISE DRIVE, BRENTWOOD, TN 37202-4600
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 660-6000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
As of April 2, 2000, there were 99,976,123 shares of the Registrant's
common stock, $.50 par value, outstanding.
2
TABLE OF CONTENTS
Page
No.
---
PART I FINANCIAL INFORMATION
Consolidated Statements of Operations (Unaudited) First Quarter Ended April
2, 2000 and April 4, 1999...................................................................3
Consolidated Balance Sheets - April 2, 2000 (Unaudited), April 4, 1999
(Unaudited) and January 2, 2000.............................................................4
Consolidated Statements of Cash Flows (Unaudited) First Quarter Ended April
2, 2000 and April 4, 1999...................................................................5
Notes to Consolidated Financial Statements (Unaudited)........................................6
Management's Discussion And Analysis Of Financial Condition And Results Of Operations........16
Quantitative and Qualitative Disclosure about Market Risk....................................26
PART II OTHER INFORMATION
Legal Proceedings............................................................................27
Defaults Upon Senior Securities..............................................................28
Exhibits and Reports on Form 8-K.............................................................28
SIGNATURES............................................................................................30
3
PART I - FINANCIAL INFORMATION
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(DEBTOR-IN-POSSESSION)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FIRST QUARTER ENDED
----------------------
RESTATED
APRIL 2, APRIL 4,
2000 1999
--------- ---------
Net sales:
Operations excluding exiting categories and closed facilities $ 246,594 $ 236,168
Exiting categories and closed facilities 96,435 275,527
--------- ---------
343,029 511,695
--------- ---------
Costs and Expenses:
Cost of merchandise sold and buying and occupancy expenses:
Operations excluding exiting categories and closed facilities 184,435 187,204
Exiting categories and closed facilities 71,460 227,203
--------- ---------
255,895 414,407
--------- ---------
Gross margin after cost of merchandise sold and buying and occupancy expenses:
Operations excluding exiting categories and closed facilities 62,159 48,964
Exiting categories and closed facilities 24,975 48,324
--------- ---------
87,134 97,288
--------- ---------
Selling, general and administrative expenses:
Operations excluding exiting categories and closed facilities 85,481 106,278
Exiting categories and closed facilities 13,914 61,012
--------- ---------
99,395 167,290
--------- ---------
Other income, net (12,296) (3,049)
Restructuring charge (credit) (909) 99,454
Depreciation and amortization:
Operations excluding exiting categories and closed facilities 9,613 9,626
Exiting categories and closed facilities 131 2,608
--------- ---------
9,744 12,234
Reorganization items (income) 18,694 (43,743)
--------- ---------
Loss before interest, income tax, extraordinary item, and cumulative
effect of a change in accounting principle (27,494) (134,898)
Interest expense (contractual interest was $17,931 and $26,602 for
the quarters ended April 2, 2000 and April 4, 1999, respectively) 10,892 25,102
--------- ---------
Loss before income tax, extraordinary item, and cumulative effect of a
change in accounting principle (38,386) (160,000)
Income tax -- --
--------- ---------
Loss before extraordinary item and cumulative effect of a change in
accounting principle (38,386) (160,000)
Extraordinary loss from early extinguishment of debt -- (7,851)
Cumulative effect of a change in recording layaway sales -- (6,566)
--------- ---------
Net loss $ (38,386) $(174,417)
========= =========
Weighted average common shares - basic and diluted 99,723 99,717
========= =========
Loss per common share - basic and diluted:
Loss before extraordinary item and cumulative effect of a change in
accounting principle $ (0.38) $ (1.60)
Extraordinary loss from early extinguishment of debt -- (0.08)
Cumulative effect of a change in recording layaway sales -- (0.07)
--------- ---------
Net loss $ (0.38) $ (1.75)
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
3
4
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(DEBTOR-IN-POSSESSION)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
RESTATED AUDITED
APRIL 2, APRIL 4, JANUARY 2,
2000 1999 2000
----------- ----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 29,513 $ 80,956 $ 61,591
Accounts receivable, net of allowance of
$17,479, $870 and $19,474, respectively 6,135 19,586 13,171
Inventories 644,368 739,267 642,997
Prepaid expenses and other assets 24,174 78,625 29,135
----------- ----------- -----------
TOTAL CURRENT ASSETS 704,190 918,434 746,894
Property and equipment:
Net property and equipment - owned 346,340 406,471 353,078
Net property and equipment - leased 14,200 20,010 14,636
Other assets and deferred charges 45,337 47,453 47,336
----------- ----------- -----------
TOTAL ASSETS $ 1,110,067 $ 1,392,368 $ 1,161,944
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
Liabilities Not Subject to Compromise
Current Liabilities:
Notes payable $ 97,146 $ 155,490 $ 42,977
Accounts payable 60,382 9,083 67,318
Accrued expenses 130,289 131,246 181,860
State and local sales taxes 12,672 7,520 28,737
Accrued restructuring costs 7,954 -- 38
Borrowings classified as current 1,000 1,500 1,000
Current maturities of capitalized lease obligations 118 -- 86
----------- ----------- -----------
TOTAL CURRENT LIABILITIES 309,561 304,839 322,016
Long-term Liabilities:
Long-term debt 98,250 148,125 98,500
Capitalized lease obligations 2,467 -- 2,514
----------- ----------- -----------
TOTAL LONG-TERM LIABILITIES 100,717 148,125 101,014
Liabilities Subject to Compromise 755,244 888,073 755,975
----------- ----------- -----------
TOTAL LIABILITIES 1,165,522 1,341,037 1,179,005
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' (DEFICIT) EQUITY:
Preferred stock, $1 par value, authorized, 4,600 shares, undesignated as to
rate and other rights, none issued
Series A Junior Preferred Stock, $1 par value, authorized 1,100 shares, none
issued
Common stock, $.50 par value, authorized 500,000 shares,
issued and outstanding 99,976, 100,167 and 100,012
shares, respectively 49,989 50,084 50,006
Additional paid-in capital 6,288 7,027 6,424
Deferred compensation (565) (1,383) (708)
Accumulated other comprehensive loss -- (869) --
Retained (deficit) earnings (111,167) (3,528) (72,783)
----------- ----------- -----------
TOTAL SHAREHOLDERS' (DEFICIT) EQUITY (55,455) 51,331 (17,061)
----------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY $ 1,110,067 $ 1,392,368 $ 1,161,944
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
4
5
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DEBTOR-IN-POSSESSION)
(IN THOUSANDS)
QUARTER ENDED
---------------------
RESTATED
APRIL 2, APRIL 4,
2000 1999
-------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(38,386) $(174,417)
Adjustments to reconcile net loss to net
cash provided (used) by operating activities:
Extraordinary loss from early extinguishment of debt -- 7,851
Cumulative effect of a change in accounting principle - layaway sales -- 6,566
Depreciation and amortization 12,483 22,551
Net gain on sale of property and equipment (3,729) (3,049)
Write-down of property and equipment due to restructuring -- 24,452
Reorganization items 18,694 (43,743)
Changes in assets and liabilities:
Accounts receivable 7,036 6,711
Inventories (1,371) 164,730
Prepaid expenses and other assets (2,983) (54,246)
Accounts payable (3,984) (21,285)
Accrued expenses, state and local sales taxes (72,240) (27,630)
Accrued restructuring costs (3,933) 73,505
Income tax -- 18,470
-------- ---------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES: (88,413) 466
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (3,056) (3,066)
Proceeds from sale of property and equipment 4,043 3,955
Proceeds from sale of property and equipment - reorganization 7,927 --
Restricted cash and other assets, net (1,003) 23,525
-------- ---------
NET CASH PROVIDED BY INVESTING ACTIVITIES: 7,911 24,414
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings, net 54,169 (510)
Repayment of long-term loan and long-term debt (2,913) (56,485)
Repayment of capitalized lease obligations (2,760) (1,826)
Debt issuance costs -- (18,574)
Exercise of stock options (forfeiture of restricted stock), net (72) (278)
-------- ---------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 48,424 (77,673)
-------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (32,078) (52,793)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 61,591 133,749
-------- ---------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 29,513 $ 80,956
======== =========
SUPPLEMENTAL DATA:
Cash paid (received) during the quarter for:
Interest $ 6,214 $ 22,251
Income tax $ (299) $ (18,368)
Reorganization items $ 6,311 $ 2,238
The accompanying notes are an integral part of these consolidated financial
statements.
5
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE FIRST QUARTER ENDED APRIL 2, 2000
A. FINANCIAL STATEMENT PRESENTATION AND GOING CONCERN MATTERS
The consolidated financial statements, except for the consolidated
balance sheet as of January 2, 2000, have been prepared by the Company without
audit.
In management's opinion, the information and amounts furnished in this
report reflect all adjustments (consisting of normal recurring adjustments)
considered necessary for the fair presentation of the consolidated financial
position and consolidated results of operations for the interim periods
presented. Certain prior period amounts have been reclassified to conform to the
current period presentation.
As described in Note L, a change in accounting principle regarding
layaway sales was adopted during the quarter ended January 2, 2000. The
consolidated financial statements as of and for the quarter ended April 4, 1999
have been restated to reflect the effect of the retroactive application of the
change to January 4, 1999.
The consolidated financial statements have been prepared on a going
concern basis of accounting and in accordance with AICPA Statement of Position
("SOP") 90-7 "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code."
The consolidated statements of operations line item "Exiting categories
and closed facilities" represents activity specifically identifiable to
inventory liquidations conducted in conjunction with (1) the Company's
restructuring plan adopted on March 25, 1997 (the "1997 Restructuring Plan");
(2) the Company's rationalization plan adopted on March 8, 1999 (the
"Rationalization Plan") and (3) the exiting of toys, juvenile, sporting goods,
most consumer electronics and other merchandise categories as part of the 2000
Business Plan. All activity for these items is classified in "Exiting categories
and closed facilities." Prior year amounts reflect operating results for these
same facilities and merchandise classifications. Selling, general and
administrative expenses for exiting categories and closed facilities do not
include any allocation of corporate overhead.
The Company's recent losses and the Chapter 11 Cases raise substantial
doubt about the Company's ability to continue as a going concern. The
consolidated financial statements do not include any adjustments relating to
recoverability and classification of recorded asset amounts or the amount and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The ability of the Company to continue as
a going concern and appropriateness of using the going concern basis is
dependent upon, among other things, (i) the Company's ability to comply with its
debtor-in-possession to exit financing agreements, (ii) the Company's ability to
implement its 2000 business plan; (iii) confirmation of a plan of reorganization
under the Bankruptcy Code, (iv) the Company's ability to achieve profitable
operations after such confirmation, and (v) the Company's ability to generate
sufficient cash from operations to meet its obligations.
As described in Note B, the Company has an exclusive right to submit a
plan of reorganization to the Bankruptcy Court through April 30, 2001.
Management believes that the plan of reorganization, as it is being developed
and subject to approval of the Bankruptcy Court, along with cash provided by the
debtor-in-possession to exit facility and operations, will provide sufficient
liquidity to allow the Company to continue as a going concern; however, there
can be no assurance that the sources of liquidity will be available or
sufficient to meet the Company's needs. A plan of reorganization could
materially change the amounts currently recorded in the consolidated financial
statements. The consolidated financial statements do not give effect to any
adjustment to the carrying value of assets or amounts and classifications of
liabilities that might be necessary as a result of the Chapter 11 Cases.
6
7
On February 21, 2000, the Company's Board of Directors approved its
2000 Business Plan, which includes the following components: (i) an expansion of
jewelry and jewelry related products; (ii) a more targeted selection of those
categories that have historically performed well and have an affinity to jewelry
and an exit from certain unprofitable hardline categories; (iii) the convergence
of the Company's in-store and Internet environment; (iv) the reduction of
selling and warehouse spaces within the Company's stores to adjust for the new
merchandise mix, which allows for the subleasing of excess space; and (v) the
rationalization of the Company's overhead structure, logistics network and
stores/field organization to generate anticipated cost savings. The execution
and success of the 2000 Business Plan is subject to numerous risks and
uncertainties.
Pursuant to the 2000 Business Plan, the Company will feature an
expanded offering of jewelry and jewelry-related products, with the bulk of the
expansion in diamonds. In addition to jewelry, the Company will focus on
hardline categories that have performed well and which generate cross-selling
opportunities with jewelry. The Company will exit certain unprofitable
categories, including toys, juvenile, sporting goods and most electronics. As a
multi-channel specialty retailer, the Company has included as part of the 2000
Business Plan the planned convergence of the Internet and store selling
environments. Each store will feature Internet kiosks that will provide
immediate access to the Company's web site, www.servicemerchandise.com, its
bridal and gift registry and its store directory.
The Company's stores will be reconfigured to feature less overall
selling square footage (approximately 18,000 square feet as compared to 27,000
square feet), but increased square footage for jewelry. The excess store space
will be available for sub-leasing or other real estate transactions. Pursuant to
the 2000 Business Plan (See 8-K filed April 7, 2000), seventy stores are
scheduled for total refurbishment and upgrade to an expanded jewelry selling
area in 2000 while the balance will undergo a more limited capital improvement
remodel during 2000. Another 83 stores are scheduled for total refurbishment in
2001. Although the Company plans to continue operating substantially all of its
221 stores, in 2000 it will close its distribution centers in Montgomery, New
York and Orlando, Florida. As part of the 2000 Business Plan, the Company will
reduce its workforce at its corporate offices, its distribution centers and its
stores resulting in the elimination of 5,000 to 6,000 positions.
The Company continues to develop its business plans, which may include
additional store closings, changes in merchandise assortments, changes in
distribution networks and overhead costs and is considering various options with
respect to the Restated Retirement Plan, the Executive Security Plan and the
Savings and Investment Plan, which may include reinstatement, amendments,
termination or substitution of such plans, among other things.
The Company has historically incurred a net loss for the first three
quarters of the year because of the seasonality of its business. The results of
operations for the quarters ended April 2, 2000 and April 4, 1999 are not
necessarily indicative of the operating results for an entire fiscal year.
These consolidated financial statements should be read in conjunction
with the Company's Annual Report on Form 10-K for the fiscal year ended January
2, 2000.
B. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On March 15, 1999, five of the Company's vendors filed an involuntary
petition for reorganization under Chapter 11 ("Chapter 11") of title 11 of the
United States Bankruptcy Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the Middle District of Tennessee (the "Bankruptcy Court")
seeking court supervision of the Company's restructuring efforts. On March 27,
1999, the Company and 31 of its subsidiaries (collectively, the "Debtors") filed
voluntary petitions with the Bankruptcy Court for reorganization under Chapter
11 under case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and
orders for relief were entered by the Bankruptcy Court. The Chapter 11 Cases
have been consolidated for the purpose of joint administration under Case No.
399-02649. The Debtors are currently operating their businesses as
debtors-in-possession pursuant to the Bankruptcy Code.
7
8
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
are stayed and other contractual obligations against the Debtors may not be
enforced. In addition, under the Bankruptcy Code the Debtors may assume or
reject executory contracts, including lease obligations. Parties affected by
these rejections may file claims with the Bankruptcy Court in accordance with
the reorganization process. Substantially all pre-petition liabilities are
subject to settlement under a plan of reorganization to be voted upon by
creditors and equity holders and approved by the Bankruptcy Court. Although the
Debtors expect to file a reorganization plan or plans that provide for emergence
from bankruptcy in 2001, there can be no assurance that a reorganization plan or
plans will be proposed by the Debtors or confirmed by the Bankruptcy Court, or
that any such plan(s) will be consummated. As provided by the Bankruptcy Code,
the Debtors initially had the exclusive right to submit a plan of reorganization
for 120 days. On May 25, 1999, the Company received Court approval to extend the
period in which the Company has the exclusive right to file or advance a plan of
reorganization in its Chapter 11 case. The order extended the Company's
exclusive right to file a plan from July 23, 1999 to February 29, 2000, and
extended the Company's exclusive right to solicit acceptances of its plan from
September 21, 1999 to May 1, 2000. On February 2, 2000, the Company received
Court approval to extend the period in which the Company has the exclusive right
to file or advance a plan from February 29, 2000 to April 30, 2001 and extend
the Company's right to solicit acceptances of its plan from May 1, 2000 to June
30, 2001. If the Debtors fail to file a plan of reorganization during such
period or extension thereof or if such plan is not accepted by the required
number of creditors and equity holders, any party in interest may subsequently
file its own plan of reorganization for the Debtors. A plan of reorganization
must be confirmed by the Bankruptcy Court, upon certain findings being made by
the Bankruptcy Court which are required by the Bankruptcy Code. The Bankruptcy
Court may confirm a plan notwithstanding the non-acceptance of the plan by an
impaired class of creditors or equity security holders if certain requirements
of the Bankruptcy Code are met. The plan or plans currently being considered by
the Company involve a debt conversion of the Company's prepetition unsecured
claims into new common equity of the reorganized Company. Under such
circumstances, the existing common stock of the Company would be cancelled and
would result in existing holders of the common stock receiving no value for
their interests. The Company believes the value of the Common Stock is highly
speculative since it is probable that it will be cancelled, and therefore,
worthless if the expected plan of reorganization is consummated.
C. RESTRUCTURING PLANS
1997 RESTRUCTURING PLAN
On March 25, 1997, the Company adopted a business restructuring plan to
close up to 60 under performing stores and one distribution center. As a result,
a pre-tax charge of $129.5 million for restructuring costs was taken in the
first quarter of fiscal 1997. The remaining component of the restructuring
charge accrual and an analysis of the change in the accrual for the quarter
ended April 2, 2000 are outlined in the following table:
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN APRIL 2,
2000 COSTS ESTIMATE 2000
---- ----- -------- ----
(in thousands)
Lease termination and other real estate costs $7,894 $20 $(207) $7,707
====== === ===== ======
Note: The accrued restructuring costs as of April 2, 2000 are included in
Liabilities Subject to Compromise.
8
9
The closing of nine stores during the first half of fiscal 1998 brought
the total number of closures, in accordance with the 1997 Restructuring Plan, to
53 stores and one distribution center. Store closures were completed as of May
1998. The Company closed less than 60 stores primarily due to the inability to
negotiate acceptable exit terms from the related lessors.
Lease terminations and other real estate costs primarily consist of
contractual rent payments and other real estate costs. These amounts have been
accrued according to the remaining leasehold obligations under Section 502(b)(6)
of the Bankruptcy Code. Section 502(b)(6) limits a lessor's claim to the rent
reserved by such lease, without acceleration for the greater of one year, or 15
percent, not to exceed three years. Any unpaid rent is included in the claim.
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the quarter ended April 2,
2000. As a result the Company reduced its estimate for these costs by $0.2
million.
The leases remaining on closed locations as of April 2, 2000 vary in
length with expiration dates ranging from April 2000 to February 2015.
RATIONALIZATION PLAN
In February 1999, the Company announced a rationalization plan to close
up to 132 stores, up to four distribution centers and to reduce corporate
overhead. On March 8, 1999, as part of the Rationalization Plan and prior to the
filing of the involuntary bankruptcy petition, the Board of Directors approved
the adoption of a business restructuring plan to close 106 stores and the Dallas
distribution center and to reduce the Company's workforce at its Nashville
corporate offices by 150 employees. As a result, a pre-tax charge of $99.5
million for restructuring costs was recorded in the first quarter of 1999. On
March 29, 1999 and in connection with the Chapter 11 Cases, store leases under
this plan were approved for rejection by the Bankruptcy Court. The remaining
components of the restructuring charge accrual and an analysis of the change in
the accrual for the quarter ended April 2, 2000 are outlined in the following
table:
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN APRIL 2,
2000 COSTS PAID ESTIMATE 2000
---------- ---------- ------- ----------
(in thousands)
Lease termination and other real estate costs $ 38,315 $ (1,127) $ (877) $ 36,311
Employee severance 478 (410) 175 243
---------- ---------- ------- ----------
Total $ 38,793 $ (1,537) $ (702) $ 36,554
========== ========== ======= ==========
Note: The accrued restructuring costs as of April 2, 2000 are included in
Liabilities Subject to Compromise.
Lease terminations and other real estate costs primarily consists of
contractual rent payments. These amounts have been accrued according to the
remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code.
Section 502(b)(6) limits a lessor's claim to the rent reserved by such lease,
without acceleration for the greater of one year, or 15 percent, not to exceed
three years. Any unpaid rent is included in the claim.
9
10
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the quarter ended April 2,
2000. As a result the Company reduced its estimate for these costs by $0.9
million.
The employee severance provision was recorded for the planned
termination of approximately 4,400 employees associated with the closures, as
well as the reduction of corporate overhead. Substantially all such terminations
were completed as of December 1999.
D. LIABILITIES SUBJECT TO COMPROMISE
"Liabilities subject to compromise" refers to liabilities incurred
prior to the commencement of the Chapter 11 Cases. These liabilities consist
primarily of amounts outstanding under long-term debt and also include accounts
payable, accrued interest, accrued restructuring costs, and other accrued
expenses. These amounts represent the Company's estimate of known or potential
claims to be resolved in connection with the Chapter 11 Cases. Such claims
remain subject to future adjustments. Adjustments may result from (1)
negotiations; (2) actions of the Bankruptcy Court; (3) further development with
respect to disputed claims; (4) future rejection of additional executory
contracts or unexpired leases; (5) the determination as to the value of any
collateral securing claims; (6) proofs of claim; or (7) other events. Payment
terms for these amounts, which are considered long-term liabilities at this
time, will be established in connection with the Chapter 11 Cases.
Pursuant to order of the Bankruptcy Court, on or about March 15, 2000,
the Company mailed notices to all known creditors that the deadline for filing
proofs of claim with the Bankruptcy Court is May 15, 2000. Differences between
amounts scheduled by the Company and claims by creditors will be investigated
and resolved in connection with the Company's claims resolution process. That
process will not commence until after the May 15, 2000, bar date and, in light
of the number of creditors of the Company, may take considerable time to
complete.
The Company has received approval from the Bankruptcy Court to pay
pre-petition and post-petition employee wages, salaries, benefits and other
employee obligations, to pay vendors and other providers in the ordinary course
for goods and services received from March 15, 1999, and to honor customer
service programs, including warranties, returns, layaways and gift certificates.
The principal categories of claims classified as liabilities subject to
compromise under reorganization proceedings are identified below.
APRIL 2, APRIL 4,
2000 1999
-------- --------
(in thousands)
Accounts payable $192,829 $198,005
Accrued expenses 64,905 72,541
Accrued restructuring costs:
1997 Restructuring Plan 7,707 5,683
1999 Rationalization Plan 36,554 75,002
Long-term debt 426,844 488,974
Capitalized lease obligations 26,405 47,868
-------- --------
Total $755,244 $888,073
======== ========
Contractual interest expense not accrued or recorded on certain
pre-petition debt totaled $7.0 million and $1.5 million for the quarters ended
April 2, 2000 and April 4, 1999, respectively.
10
11
E. REORGANIZATION ITEMS
Expenses and income directly incurred or realized as a result of the
Chapter 11 Cases have been segregated from the normal operations and are
disclosed separately. The major components are as follows:
QUARTER ENDED
--------------------
APRIL 2, APRIL 4,
2000 1999
------- --------
(in thousands)
Reduction of accrued rent for rejected leases $ -- $(45,981)
Professional fees and other administrative items 6,988 2,238
Store closing costs 2,283 --
Severance 9,423 --
------- --------
Total reorganization items (income) expense $18,694 $(43,743)
======= ========
REDUCTION OF ACCRUED RENT FOR REJECTED LEASES:
In connection with the Chapter 11 Cases, the 1997 Restructuring Plan
was adjusted to reflect the reduction allowed under Section 502(b)(6) of the
Bankruptcy Code. An amount had been accrued according to the remaining leasehold
obligation. Section 502(b)(6) limits the lessor's claim to the rent reserved by
such leases, without acceleration, for the greater of one year, or 15 percent,
not to exceed three years, of such leases, plus any unpaid rent.
PROFESSIONAL FEES AND OTHER ADMINISTRATIVE ITEMS:
Professional fees and administrative items relate to legal, accounting
and other professional costs directly attributable to the Chapter 11 Cases.
SEVERANCE:
Severance costs relate to workforce reductions at the corporate
offices, distribution centers and stores as a part of the reorganization
process.
STORE CLOSING COSTS:
Store closing costs include rent, common area maintenance, utilities,
asset write-downs and real estate taxes offset by other income resulting from
store dispositions. Rent amounts have been adjusted to reflect the reduction
allowed under Section 502(b)(6) of the Bankruptcy Code
F. BORROWINGS
This note contains information regarding the Company's short-term
borrowings and long-term debt as of April 2, 2000. Any plan of reorganization
defining the repayment terms must be approved by the Bankruptcy Court.
From September 1997 through January 20, 1999, the Company had a
five-year, $900.0 million, fully committed asset-based credit facility (the
"Amended and Restated Credit Facility"). The Amended and Restated Credit
Facility included $200.0 million in term loans and up to a maximum of $700.0
million in revolving loans including a $175.0 million sub-facility for letters
of credit. The Amended and Restated Credit Facility was set to mature on
September 10, 2002. Interest rates on the Amended and Restated Credit Facility
were subject to change based on a financial performance-based grid and could not
exceed a rate of LIBOR + 2.25% on revolving loans and
11
12
LIBOR + 2.50% on the term loan. There were no short-term borrowings under the
Amended and Restated Credit Facility at April 4, 1999.
On January 20, 1999, the Company completed a $750.0 million, 30-month
asset-based credit facility (the "Second Amended and Restated Credit Facility")
which replaced the Amended and Restated Credit Facility. The Second Amended and
Restated Credit Facility included $150.0 million in term loans and a maximum of
$600.0 million in revolving loans. The Second Amended and Restated Credit
Facility included a $200.0 million sub-facility for standby and trade letters of
credit. Interest rates on the Second Amended and Restated Facility were based on
either Prime Rate + 1.5% or LIBOR + 2.75%. There were no short term borrowings
under the Second Amended and Restated Credit Facility at April 2, 2000. Short
term borrowings under this facility at April 4, 1999 were $128.8 million.
Outstanding borrowings under the term loan of the Second Amended and
Restated Credit Facility were $149.6 million as of April 4, 1999.
On March 29, 1999, the Company entered into a 27-month, $750.0 million
fully committed asset-based debtor-in-possession credit facility (the "DIP
Facility") which replaced the Second Amended and Restated Credit Facility. The
Bankruptcy Court approved the DIP Facility on an interim basis on March 29, 1999
and granted final approval on April 27, 1999. The DIP Facility included $100.0
million in term loans and up to a maximum of $650.0 million in revolving loans
including a $200.0 million sub-facility for letters of credit. Interest rate
spreads on the DIP Facility were LIBOR + 2.25% on Eurodollar loans and Prime
Rate + 1.25% on Alternate Base Rate loans. Short term borrowings related to the
DIP Facility were $97.1 million and $26.7 million as of April 2, 2000 and April
4, 1999, respectively. Outstanding borrowings under the term loan of the DIP
Facility were $99.3 million as of April 2, 2000. There was a commitment fee of
0.375% on the undrawn portion of the revolving loans under the DIP Facility.
The DIP Facility was secured by all material unencumbered assets of the
Company and its subsidiaries, including inventory, but excluding previously
mortgaged property. Borrowings under the DIP Facility were limited based on a
borrowing base formula which considers eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, eligible leasehold
interests, available cash equivalents and in-transit cash. Availability under
the facility continues unless the Company breaches the financial covenants for
the DIP facility. As of April 2, 2000, the Company was in compliance with its
financial covenants.
On April 14, 2000, the Company entered into a four year, $600.0 million
fully committed asset-based debtor-in-possession and emergence credit facility
(the "DIP to Exit Facility") which replaced the DIP Facility. The Bankruptcy
Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit
Facility matures on April 14, 2004, and includes $60.0 million in term loans and
up to a maximum of $540.0 million in revolving loans including a $150.0 million
sub-facility for letters of credit. Interest rate spreads on the DIP to Exit
Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75%
on Alternate Base Rate loans. After the first quarter of 2001, these spreads are
subject to quarterly adjustment pursuant to a pricing grid based on availability
and financial performance, with ranges of 200 to 275 basis points over LIBOR and
25 to 100 basis points over prime rate. There were no outstanding borrowings
under the DIP to Exit Facility as of April 2, 2000.
Borrowings under the DIP to Exit Facility will be secured by all
material unencumbered assets of the Company and its subsidiaries, including
inventory, but excluding previously mortgaged property. Borrowings under the DIP
to Exit Facility are limited based on a borrowing base formula which considers
eligible inventories, eligible accounts receivable, mortgage values on eligible
real properties, eligible leasehold interests, available cash equivalents and
in-transit cash.
G. EARNINGS PER SHARE
Basic earnings (loss) per common share is computed by dividing net
earnings (loss) by the weighted-average number of common shares outstanding
during the reported period. Diluted net earnings (loss) per common share is
computed by dividing net earnings (loss) by the weighted-average number of
common shares outstanding during the period plus incremental shares that would
have been outstanding upon the assumed vesting of dilutive restricted stock
12
13
and the assumed exercise of dilutive stock options. As of April 2, 2000 and
April 4, 1999, all outstanding restricted stock and stock options are considered
anti-dilutive.
H. PREPAID EXPENSES AND OTHER ASSETS
Prepaid expenses and other assets for the Company were $24.2 million as
of April 2, 2000 compared to $78.6 million as of April 4, 1999. The decrease was
primarily due to the reduction of cash in advance payments to purchase
inventory.
I. BENEFIT PLANS
On August 31, 1999, the Bankruptcy Court approved a motion by the
Company to amend the Restated Retirement Plan and the Executive Security Plan.
The amendment to the Restated Retirement Plan ceased the accrual of benefits,
disallowed new enrollments to the Plan and vested benefits already accrued under
the Plan effective September 30, 1999. The amendment to the Executive Security
Plan, covering approximately 165 former and current management associates,
ceased the accrual of benefits and suspended payments effective September 30,
1999.
J. OTHER COMMITMENTS AND CONTINGENCIES
On January 28, 1997, the Company and Service Credit Corp. (the
"Subsidiary"), a wholly-owned subsidiary, entered into an agreement with World
Financial Network National Bank ("WFNNB") for the purpose of providing a private
label credit card to the Company's customers. The contract requires the
Subsidiary to maintain a 3.0% credit risk reserve for the outstanding balances,
which are owned by WFNNB. The purpose of this reserve is to offset future
potential negative spreads and portfolio losses. The negative spreads or losses
may result from potential increased reimbursable contractual program costs. The
3.0% credit risk reserve is held by the Subsidiary, which is not in Chapter 11,
in the form of cash and cash-equivalents. On April 28, 1999, WFNNB advised the
Company that WFNNB had projected that such portfolio losses and negative spreads
would be at least approximately $9.0 million. The Company does not have in its
possession sufficient information to determine the accuracy or validity of
WFNNB's projection. Pending confirmation of the accuracy of WFNNB's projection
and a resolution of the Company's rights and remedies, the Company has made
provision for such potential liability during fiscal 1999 by maintaining an
allowance on the 3.0% credit risk reserve of $9.0 million.
On July 16, 1999, the Company filed a complaint against WFNNB in the
Bankruptcy Court alleging, among other things, breach of contract and violation
of the automatic stay provisions of the Bankruptcy Code by WFNNB with respect to
and in connection with the January 1997 private label credit card program
agreement between the Company, the Subsidiary and WFNNB (the "World Financial
Agreement"). Under the World Financial Agreement, a program was established
pursuant to which, among other things, WFNNB agreed to issue credit cards to
qualifying Company customers for the purchase of goods and services from the
Company. While the ultimate result of this litigation cannot be determined or
predicted with any accuracy at this time, the Company intends to pursue
available remedies against WFNNB.
On August 20, 1999, over the objection of WFNNB, the Bankruptcy Court
authorized the Company to enter into an agreement with Household Bank (SB), N.A.
("Household") for the purpose of offering new private label credit cards to
those customers of the Company who meet Household's credit standards. The
Company's prior private label credit card program with WFNNB was suspended in
March of 1999, and the rights and liabilities of WFNNB, the Company and the
Subsidiary are the subject of the litigation referred to in the preceding
paragraph.
On September 23, 1999, WFNNB filed a motion to dismiss the Company's
complaint and a separate motion seeking to have the complaint litigated in the
United States District Court for the Middle District of Tennessee (the
13
14
"District Court"), rather than the Bankruptcy Court. The Company filed timely
oppositions to both motions, and, on October 27, 1999, the District Court denied
WFNNB's motion to have the complaint litigated in the District Court. The
Bankruptcy Court scheduled a hearing on December 6, 1999, to consider WFNNB's
motion to dismiss and the Company's opposition thereto.
On December 6, 1999, the Bankruptcy Court entered an order dismissing
the Company's complaint. On December 16, 1999, the Company filed a motion asking
the Court to clarify the order issued on December 6, 1999, and to grant the
Company leave to file an amended complaint (the "Company's Motion"). On January
11, 2000, WFNNB responded with an objection to the Company's Motion. On February
22, 2000 the Bankruptcy Court entered an order granting the Company's Motion and
the Company filed the amended complaint. On April 24, 2000 WFNNB filed a motion
to dismiss this amended complaint.
The Company was involved in litigation, investigations and various
legal matters during the quarter ended April 2, 2000, which are being defended
and handled in the ordinary course of business. While the ultimate results of
these matters cannot be determined or predicted, management believes that they
will not have a material adverse effect on the Company's results of operations
or financial position. Any potential liability may be affected by the Chapter 11
Cases.
K. SEGMENT REPORTING
The Company manages its business on the basis of one reportable
segment. As of April 2, 2000, all of the Company's operations are located within
the United States. The following data is presented in accordance with SFAS No.
131 for all periods presented.
CLASSES OF SIMILAR PRODUCTS
QUARTER ENDED
---------------------
APRIL 2, APRIL 4,
2000 1999
-------- --------
(in thousands)
Net Sales:
Hardlines $216,267 $349,805
Jewelry 126,762 161,890
-------- --------
Total Net Sales $343,029 $511,695
======== ========
L. LAYAWAY SALES
A change in accounting principle regarding layaway sales was adopted
during the quarter ended January 2, 2000 to recognize layaway sales upon
delivery of merchandise to the customer. Layaway sales in prior periods were
recognized when the initial deposit was received. The Company changed its method
of accounting for layaway sales in response to the Securities and Exchange
Commission's Staff Accounting Bulletin: No. 101 - Revenue Recognition In
Financial Statements. The amount of cash received upon initiation of the layaway
is recorded as a deposit liability within accrued expenses. The cumulative
effect of the change for periods prior to fiscal 1999 is an increase in net loss
of $6.6 or ($0.07) per share. The restated amounts below reflect the effect of
the retroactive application of the
14
15
accounting change on the Consolidated Financial Statements as of and for the
quarter ended April 4, 1999.
QUARTER ENDED
APRIL 4,
(in thousands, except per share data) 1999
---------
Net sales as originally reported $ 510,509
Effect of change in accounting for layaway sales 1,186
---------
Net sales as restated $ 511,695
=========
Gross margin as originally reported(a) $ 96,801
Effect of change in accounting for layaway sales 487
---------
Gross margin as restated $ 97,288
=========
Net loss as originally reported $(168,338)
Effect of change in accounting for layaway sales 487
Extraordinary loss 7,851
---------
Loss before cumulative effect of change in
accounting principle and extraordinary loss as
restated (160,000)
Extraordinary loss (7,851)
Cumulative effect of change in accounting for
layaway sales (6,566)
---------
Net loss as restated $(174,417)
=========
Per common share - basic and diluted
Net loss as originally reported $ (1.69)
Effect of change in accounting for layaway sales 0.01
Extraordinary loss 0.08
---------
Loss before cumulative effect and extraordinary
loss as restated (1.60)
Extraordinary loss (0.08)
Cumulative effect of change in accounting for
layaway sales (0.07)
---------
Net loss as restated $ (1.75)
=========
(a) Gross margin after cost of merchandise sold and buying and occupancy
expenses.
Accounts receivable as originally reported $ 30,483
Effect of change in accounting for layaway sales (10,897)
---------
Accounts receivable as restated $ 19,586
=========
Inventories as originally reported $ 732,166
Effect of change in accounting for layaway sales 7,101
---------
Inventories as restated $ 739,267
=========
Accrued expenses as originally reported $ 128,963
Effect of change in accounting for layaway sales 2,283
---------
Accrued expenses as restated $ 131,246
=========
15
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
For comparative purposes, interim balance sheets are more meaningful
when compared to the balance sheets at the same point in time of the prior year.
Comparisons to balance sheets of the most recent fiscal year end may not be
meaningful due to the seasonal nature of the Company's business.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report includes certain forward-looking statements (statements
other than with respect to historical fact, including statements relating to the
Company's 2000 Business Plan, its expected plan of reorganization and
anticipated availability under the DIP to Exit Facility) based upon
management's beliefs, as well as assumptions made by and data currently
available to management. This information has been, or in the future may be,
included in reliance on the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. These forward-looking statements are based on a
variety of assumptions that may not be realized and are subject to significant
business, economic, judicial and competitive uncertainties and potential
contingencies, including those set forth below, many of which are beyond the
Company's control. Actual results may differ materially from those anticipated
in any such forward-looking statements. The Company undertakes no obligation to
update or revise any such forward-looking statements.
The forward-looking statements and the Company's liquidity, capital
resources and results of operations are subject to a number of risks and
uncertainties including, but not limited to, the following: the ability of the
Company to continue as a going concern; the ability of the Company to operate
pursuant to the terms of the DIP to Exit Facility; the ability of the Company to
conduct successful clearance sales in connection with the 2000 Business Plan;
the ability of the Company to sublease successfully portions of its real estate
in connection with the 2000 Business Plan; the ability of the Company to
complete its store refurbishment program within cost and time expectations; the
successful implementation of the consolidation of its distribution centers;
risks associated with third parties seeking and obtaining Court action to
terminate or shorten the exclusivity period, the time for the Company to accept
or reject executory contracts including its store leases, and for appointment of
a Chapter 11 operation trustee or to convert the Company's reorganization cases
to liquidations cases; the ability of the Company to operate successfully under
a Chapter 11 proceeding, achieve planned sales and margin, and create and have
approved a reorganization plan in the Chapter 11 Cases; potential adverse
developments with respect to the Company's liquidity or results of operations;
the ability of the Company to obtain shipments, negotiate and maintain terms
with vendors and service providers for current orders; the ability to fund and
execute the 2000 Business Plan; the ability of the Company to achieve
cost-savings; the ability of the Company to enter into satisfactory arrangements
with third parties with respect to real estate and internet related strategies;
the ability of the Company to attract, retain and compensate key executives and
associates; competitive pressures from other retailers, including specialty
retailers and discount stores, which may affect the nature and viability of the
Company's business strategy; trends in the economy as a whole which may affect
consumer confidence and consumer demand for the types of goods sold by the
Company; the seasonal nature of the Company's business and the ability of the
Company to predict consumer demand as a whole, as well as demand for specific
goods; the ability of the Company to attract and retain customers; potential
adverse publicity; real estate occupancy and development costs, including the
substantial fixed investment costs associated with opening, maintaining or
closing a Company store; uncertainties with respect to continued public trading
in the Company's securities; the ability to effect conversions to new
technological systems; and the ability to develop, prosecute, confirm and
consummate one or more plans of reorganization with respect to the Chapter 11
Cases.
OVERVIEW
The Company, with 221 stores in 32 states at April 2, 2000, is one of
the nation's largest retailers of jewelry and offers a selection of brand-name
hard goods and other product lines. During the year ended January 2, 2000
("fiscal 1999"), the Company repositioned its product offerings to focus on
value pricing and a broad selection of jewelry and hard good products. These
remerchandising efforts were based on perceived customer expectations of
16
17
entry level price points and a large selection within each product assortment.
The Company also revised its media strategy during fiscal 1999 to employ TV,
radio and print (including a seasonal sourcebook) campaigns in a coordinated
effort to build awareness, prospect for new customers and drive customer
traffic.
On February 21, 2000, the Company's Board of Directors approved its
2000 Business Plan. Key components of the 2000 Business Plan include exiting
certain hardlines categories, including toys, juvenile, sporting goods, most
consumer electronics and most indoor furniture. As part of the 2000 Business
Plan, the Company plans to eliminate between 5,000 and 6,000 positions in stages
during 2000 and 2001, including approximately 350 distribution center and 200
corporate positions. The Company announced an initiative to reformat its
existing stores as part of the 2000 Business Plan, which would result in excess
store space becoming available for subleasing or other real estate transactions.
Another important element to the Company's strategy is the convergence of the
Internet and store selling environments. Each store will feature Internet kiosks
that will provide immediate access to the Company's web site,
www.servicemerchandise.com, its bridal and gift registry, and its store
directory.
As a result of the Company's decreased net sales in the fourth quarter
of fiscal 1998 and the resulting negative cash flows from operations, in January
1999 the Company began an effort to effect an out-of-court restructuring plan.
As part of this out-of-court restructuring plan, on January 20, 1999, the
Company entered into a new credit facility with Citibank N.A. (the "Second
Amended and Restated Credit Facility"). The Company also developed a plan to
close up to 132 stores, up to four distribution centers and to reduce corporate
overhead (the "Rationalization Plan"). In March 1999, as part of the
Rationalization Plan, the Company announced the closing of the Dallas
distribution center and the reduction of its workforce at its Nashville
corporate offices by 150 employees.
Proceedings Under Chapter 11 of the Bankruptcy Code
Before the Company was able to effect an out-of-court restructuring, on
March 15, 1999, five of the Company's vendors filed an involuntary petition for
reorganization under Chapter 11 ("Chapter 11") of title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
for the Middle District of Tennessee (the "Bankruptcy Court") seeking court
supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries (collectively, the "Debtors") filed voluntary
petitions with the Bankruptcy Court for reorganization under Chapter 11 under
case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and orders for
relief were entered by the Bankruptcy Court. The Chapter 11 Cases have been
consolidated for the purpose of joint administration under Case No. 399-02649.
The Debtors are currently operating their businesses as debtors-in-possession
pursuant to the Bankruptcy Code.
Actions to collect pre-petition indebtedness are stayed and other
contractual obligations against the Debtors may not be enforced. In addition,
under the Bankruptcy Code, the Debtors may assume or reject executory contracts,
including lease obligations. Parties affected by these rejections may file
claims with the Bankruptcy Court in accordance with the reorganization process.
Substantially all pre-petition liabilities are subject to settlement under a
plan of reorganization to be voted upon by creditors and equity holders and
approved by the Bankruptcy Court in accordance with the Bankruptcy Code.
Although the Debtors expect to file a reorganization plan or plans that provide
for emergence from bankruptcy in 2001, there can be no assurance that a
reorganization plan or plans will be proposed by the Debtors or confirmed by the
Bankruptcy Court, or that any such plan(s) will be consummated. As provided by
the Bankruptcy Code, the Debtors initially had the exclusive right to submit a
plan of reorganization for 120 days. On May 25, 1999, the Bankruptcy Court
extended the period in which the Debtors had the exclusive right to file or
advance a plan of reorganization to February 29, 2000. On February 2, 2000, the
Bankruptcy Court extended the period in which the Debtors has the exclusive
right to file or advance a plan of reorganization to April 30, 2001 and extended
the right to solicit acceptance of its plan to June 30, 2001. If the Debtors
fail to file a plan of reorganization during such period or if such plan is not
accepted by the required number of creditors and equity holders, any party in
interest may subsequently file its own plan of reorganization for the Debtors. A
plan of reorganization must be confirmed by the Bankruptcy Court, upon certain
findings being made by the Bankruptcy Court which are required by the Bankruptcy
Code. The Bankruptcy Court may confirm a plan notwithstanding the non-acceptance
of the plan
17
18
by an impaired class of creditors or equity security holders if certain
requirements of the Bankruptcy Code are met. The plan or plans currently being
considered by the Company involve a debt conversion of the Company's prepetition
unsecured claims into new common equity of the reorganized Company. Under such
circumstances the existing common stock of the Company would be cancelled and
would result in existing holders of the common stock receiving no value for
their interests. The Company believes the value of the common stock is highly
speculative since it is highly probable that it will be cancelled, and
therefore, worthless if the expected plan of reorganization is consummated.
At the first day hearing held on March 29, 1999 before Judge George C.
Paine, the Bankruptcy Court entered first day orders granting authority to the
Debtors, among other things, to pay pre-petition and post-petition employee
wages, salaries, benefits and other employee obligations, to pay vendors and
other providers in the ordinary course for goods and services received from and
after March 15, 1999, and to honor customer service programs, including
warranties, returns, layaways and gift certificates.
The Company entered into an agreement dated March 29, 1999, for a
debtor-in-possession credit facility (the "DIP Facility") under which the
Company could borrow up to $750.0 million, subject to certain limitations, to
fund ongoing working capital needs while it prepares a reorganization plan. On
April 27, 1999, the Bankruptcy Court approved the DIP Facility. The DIP Facility
included $100.0 million in term loans and a maximum of $650.0 million in
revolving loans. The DIP Facility included a $200.0 million sub-facility for
standby and trade letters of credit. Interest rates on the DIP Facility were
based on either the Citibank N.A. Alternative Base Rate plus 1.25% for ABR Loans
or 2.25% over LIBOR for Eurodollar Loans. The DIP Facility was secured by
substantially all of the assets of the Company and its subsidiaries, subject
only to valid, enforceable, subsisting and non-voidable liens of record as of
the date of commencement of the Chapter 11 Cases and other liens permitted under
the DIP Facility.
On June 10, 1999, the Company filed with the Bankruptcy Court schedules
and statements of financial affairs setting forth, among other things, the
assets and liabilities of the Company as shown by the Company's books and
records, subject to the assumptions contained in certain global notes filed in
connection therewith. Certain of the schedules were amended on March 6, 2000 and
all of the schedules and statements of financial affairs are subject to further
amendment or modification. Pursuant to order of the Bankruptcy Court, on or
about March 15, 2000, the Company mailed notices to all known creditors that the
deadline for filing proofs of claim with the Bankruptcy Court is May 15, 2000.
Differences between amounts scheduled by the Company and claims by creditors
will be investigated and resolved in connection with the Company's claims
resolution process. That process will not commence until after the May 15, 2000,
bar date and, in light of the number of creditors of the Company, may take
considerable time to complete. Accordingly, the ultimate number and amount of
allowed claims is not presently known and, because the settlement terms of such
allowed claims is subject to a confirmed plan of reorganization, the ultimate
distribution with respect to allowed claims is not presently ascertainable.
The Company has filed over 200 motions in the Chapter 11 Cases whereby
it was granted authority or approval with respect to various items required by
the Bankruptcy Code and/or necessary for the Company's reorganizational efforts.
In addition to motions pertaining to real estate disposition matters, the
Company has obtained orders providing for, among other things, (i)
implementation of employee retention and incentive programs, (ii) termination or
suspension of certain employee benefit programs, (iii) adequate protection to
certain secured creditors, (iv) implementation of a return to vendor program and
other vendor related programs, (v) the conduct of a joint review by the Company
and the creditors committee with respect to certain prepetition Board conduct,
(vi) the sale of the assets of B.A. Pargh., and (vii) the extension of time to
assume or reject leases.
2000 Business Plan
On February 21, 2000, the Company's Board of Directors approved its
2000 Business Plan, which includes the following components: (i) an expansion of
jewelry and jewelry related products; (ii) a more targeted selection of
18
19
those categories that have historically performed well and have an affinity to
jewelry and an exit from certain unprofitable hardlines categories; (iii) the
convergence of the Company's in-store and Internet environment; (iv) the
reduction of selling and warehouse spaces within the Company's stores to adjust
for the new merchandise mix, which allows for the subleasing of excess space;
and (v) the rationalization of the Company's overhead structure, logistics
network and stores/field organization to generate anticipated cost savings. The
execution and success of the 2000 Business Plan is subject to numerous risks and
uncertainties.
Pursuant to the 2000 Business Plan, the Company will feature an
expanded offering of jewelry and jewelry-related products, with the bulk of the
expansion in diamonds. In addition to jewelry, the Company will focus on
hardlines categories that have performed well and which generate cross-selling
opportunities with jewelry. The Company will exit certain unprofitable
categories, including toys, most electronics and sporting goods. As a
multi-channel specialty retailer, the Company has included as part of the 2000
Business Plan the planned convergence of the Internet and store selling
environments. Each store will feature Internet kiosks that will provide
immediate access to the Company's web site, www.servicemerchandise.com, its
bridal and gift registry and its store directory.
The Company's stores will be reconfigured to feature less overall
selling square footage (approximately 18,000 square feet as compared to 27,000
square feet), but increased square footage for jewelry. The excess store space
will be available for sub-leasing or other real estate transactions. Pursuant to
the 2000 Business Plan (see 8-K filed April 7, 2000,) seventy stores are
scheduled for total refurbishment and upgrade to an expanded jewelry selling
area in 2000 while the balance will undergo a more limited capital improvement
remodel during 2000. Another 83 stores are scheduled for total refurbishment in
2001. Although the Company plans to continue operating substantially all of its
221 stores, in 2000 it will close its distribution centers in Montgomery, New
York and Orlando, Florida. As part of the 2000 Business Plan, the Company will
reduce its workforce at its corporate offices, its distribution centers and its
stores resulting in the elimination of 5,000 to 6,000 positions.
To fund the 2000 Business Plan, on April 14, 2000, the Company entered
into a four year, $600.0 million fully committed asset-based
debtor-in-possession and emergence credit facility (the "DIP to Exit Facility")
which replaced the DIP Facility.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases or their effect on the Company's business. If it is determined that the
liabilities subject to compromise in the Chapter 11 Cases exceed the fair value
of the assets, unsecured claims may be satisfied at less than 100% of their face
value and the equity interests of the Company's shareholders may have no value.
The Company believes and the DIP to Exit Facility should provide the Company
with adequate liquidity to conduct its business while it prepares a
reorganization plan. However, the Company's liquidity, capital resources,
results of operations and ability to continue as a going concern are subject to
known and unknown risks and uncertainties, including those set forth above under
"Safe Harbor Statement Under The Private Securities Litigation Reform Act of
1995."
RESULTS OF OPERATIONS
First Quarter Ended April 2, 2000 Compared to First Quarter Ended April 4, 1999
The consolidated statements of operations line item "Exiting categories
and closed facilities" represents activity specifically identifiable to
inventory liquidations conducted in conjunction with (1) the Company's
restructuring plan adopted on March 25, 1997 ("Restructuring Plan"); (2) the
Company's rationalization plan adopted on March 8, 1999 ("Rationalization Plan")
and (3) the exiting of toys, juvenile, sporting goods, most consumer
electronics, most indoor furniture and other merchandise categories as part of
the 2000 Business Plan. All activity for these items is classified in "Exiting
categories and closed facilities." Prior year amounts reflect operating results
for these same facilities and merchandise classifications. Selling, general and
administrative expenses for exiting categories and closed facilities do not
include any allocation of corporate overhead.
19
20
The Company's business is highly seasonal with a significant portion of
its sales occurring in the fourth quarter. Fourth quarter net sales accounted
for 37.5% and 40.6% of total net sales in fiscal 1999 and 1998, respectively.
Net Sales
Net sales for the Company were $343.0 million for the first quarter of
2000 compared to $511.7 million for the first quarter of 1999. The decline in
net sales was primarily due to the closure of 127 stores as a result of the
restructuring and remerchandising activities in fiscal 1999.
Net sales from operations excluding exiting categories and closed
facilities were $246.6 million for the first quarter of 2000 compared to $236.2
million for the first quarter of 1999. Comp store sales for hardlines were up
4.5% compared to the first quarter of 1999, and jewelry comp store sales were up
7.8%. The Jewelry comp sales increase was driven by Jewelry Special Events and
Diamonds. The hardlines comp sales increase was led by a strong performance in
seasonal/outdoor, houseware and personal care.
Net sales from exiting categories and closed facilities were $96.4
million for the first quarter of 2000 compared to $275.5 million for the first
quarter of 1999. Sales from exiting categories and closed facilities decreased
primarily due to the fact that first quarter 1999 reflects the sales of 127
stores that were closed by July 31, 1999 and were not reflected in first quarter
2000. First quarter 2000 sales reflect primarily the discontinued merchandise
categories of toys, juvenile, sporting goods, most consumer electronics and
other merchandising categories.
Gross Margin
Gross margin was $87.1 million for the first quarter of 2000 as
compared to $97.3 million in the first quarter of 1999. The decrease in gross
margin was primarily due to a decrease in sales.
Gross margin after cost of merchandise sold and buying and occupancy
expenses and excluding exiting categories and closed facilities was $62.2
million or 25.2% of net sales for the first quarter of 2000, compared to $49.0
million or 20.7% of net sales for the first quarter of 1999. The margin increase
was primarily due to increased sales and a shift to higher margin merchandise
assortments.
Gross margin after cost of merchandise sold and buying and occupancy
expenses for exiting categories and closed facilities as a result of
restructuring and remerchandising activities was $25.0 million, or 25.9% of net
sales for the first quarter of 2000 compared to $48.3 million, or 17.5% of net
sales for the first quarter of 1999. The margin decrease was primarily a result
of decreased sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses declined $67.9 million in
the first quarter 2000 to $99.4 million from $167.3 million in the first quarter
1999. The decline was primarily due to store closures, corporate downsizing and
overhead reduction efforts.
Selling, general and administrative expenses were $85.5 million or
34.7% of net sales from operations excluding exiting categories and closed
facilities for the first quarter of 2000 compared to $106.3 million or 45.0% of
net sales from operations excluding exiting categories and closed facilities for
the first quarter 1999. The decrease was attributable to a decrease in
employment costs and other selling, general and administrative expenses
primarily due to corporate downsizing and overhead reduction efforts.
20
21
Selling, general and administrative expenses for exiting categories and
closed facilities were $13.9 million or 14.4% of net sales from operations for
exiting categories and closed facilities for the first quarter 2000 compared to
$61.0 million or 22.1% of net sales from operations for exiting categories and
closed facilities for the first quarter 1999. The decrease was attributable to
decreases in employment costs and other selling, general and administrative
expenses primarily due to store closures.
Other Income, net
The net gain on dispositions of property and leases recorded for the
first quarter of 2000 was $12.3 million, as compared to $3.0 million in 1999.
The gain included amounts realized from the completion of the auction property
sale of 20 properties. These consisted of 10 owned and 10 leased properties with
proceeds of $20.5 million, resulting in a net gain of $12.5 million.
Depreciation and Amortization
Depreciation and amortization on owned and leased property and
equipment was $9.7 million for the quarter ended April 2, 2000 as compared to
$12.2 million for the quarter ended April 4, 1999. The decrease of 20.4% was
primarily attributable to store closures.
Interest Expense
Interest expense for the first quarter of 2000 was $10.9 million as
compared to $25.1 million for the first quarter of 1999. As a result of the
filing of the Chapter 11 Cases, the Company ceased accruing interest on the 8
3/8% Senior Notes and 9% Senior Subordinated Debentures on March 16, 1999.
Income Taxes
The Company did not recognize an income tax benefit due to the
recording of a deferred tax asset valuation allowance. Deferred taxes are
recognized to reflect the estimated future utilization of temporary book/tax
differences. The Company has recorded a full valuation allowance on net deferred
tax assets as realization of such assets in future years is uncertain.
Extraordinary Item
An extraordinary loss on the early extinguishment of debt was recorded
in the amount of $7.9 million during the first quarter ended April 4, 1999. This
charge related to the write-off of deferred financing charges paid in
conjunction with the Company's prior Amended and Restated Credit Facility and
Second Amended and Restated Credit Facility upon the consummation of the DIP
Facility.
Cumulative Effect of a Change in Accounting Principle
The Company changed its method of accounting for layaway sales during
fiscal 1999. The cumulative effect of the change for periods prior to fiscal
1999 is an increase in net loss of $6.6 million or ($0.07) per share. Layaway
sales for 1999 have been recognized upon delivery of merchandise to the
customer. Layaway sales in prior years were recognized when the initial layaway
deposit was received. The Company changed its method of accounting for layaway
sales in response to the Securities and Exchange Commission's Staff Accounting
Bulletin: No. 101 - Revenue Recognition In Financial Statements.
1997 RESTRUCTURING PLAN
On March 25, 1997, the Company adopted a business restructuring plan to
close up to 60 under performing
21
22
stores and one distribution center. As a result, a pre-tax charge of $129.5
million for restructuring costs was taken in the first quarter of fiscal 1997.
The remaining component of the restructuring charge accrual and an analysis of
the change in the accrual for the quarter ended April 2, 2000 are outlined in
the following table:
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN APRIL 2,
2000 COSTS ESTIMATE 2000
---------- ---------- ------- ----------
(in thousands)
Lease termination and other real estate costs $ 7,894 $ 20 $ (207) $ 7,707
========= ======== ====== =========
Note: The accrued restructuring costs as of April 2, 2000 are included in
Liabilities Subject to Compromise.
The closing of nine stores during the first half of fiscal 1998 brought
the total number of closures, in accordance with the 1997 Restructuring Plan, to
53 stores and one distribution center. Store closures were completed as of May
1998. The Company closed less than 60 stores primarily due to the inability to
negotiate acceptable exit terms from the related lessors.
Lease terminations and other real estate costs primarily consist of
contractual rent payments and other real estate costs. These amounts have been
accrued according to the remaining leasehold obligations under Section 502(b)(6)
of the Bankruptcy Code. Section 502(b)(6) limits a lessor's claim to the rent
reserved by such lease, without acceleration for the greater of one year, or 15
percent, not to exceed three years. Any unpaid rent is included in the claim.
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the quarter ended April 2,
2000. As a result the Company reduced its estimate for these costs by $0.2
million.
The leases remaining on closed locations as of April 2, 2000 vary in
length with expiration dates ranging from April 2000 to February 2015.
RATIONALIZATION PLAN
In February 1999, the Company announced a rationalization plan to close
up to 132 stores, up to four distribution centers and to reduce corporate
overhead. On March 8, 1999, as part of the Rationalization Plan and prior to the
filing of the involuntary bankruptcy petition, the Board of Directors approved
the adoption of a business restructuring plan to close 106 stores and the Dallas
distribution center and to reduce the Company's workforce at its Nashville
corporate offices by 150 employees. As a result, a pre-tax charge of $99.5
million for restructuring costs was recorded in the first quarter of 1999. On
March 29, 1999 and in connection with the Chapter 11 Cases, store leases under
this plan were approved for rejection by the Bankruptcy Court. The remaining
component of the restructuring
22
23
charge accrual and an analysis of the change in the accrual for the quarter
ended April 2, 2000 are outlined in the following table:
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN APRIL 2,
2000 COSTS PAID ESTIMATE 2000
---------- ---------- ------- ----------
(in thousands)
Lease termination and other real estate costs $ 38,315 $ (1,127) $ (877) $ 36,311
Employee severance 478 (410) 175 243
---------- ---------- ------- ----------
Total $ 38,793 $ (1,537) $ (702) $ 36,554
========== ========== ======= ==========
Note: The accrued restructuring costs as of April 2, 2000 are included in
Liabilities Subject to Compromise.
Lease terminations and other real estate costs primarily consists of
contractual rent payments. These amounts have been accrued according to the
remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code.
Section 502(b)(6) limits a lessor's claim to the rent reserved by such lease,
without acceleration for the greater of one year, or 15 percent, not to exceed
three years. Any unpaid rent is included in the claim.
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the quarter ended April 2,
2000. As a result the Company reduced its estimate for these costs by $0.9
million.
The employee severance provision was recorded for the planned
termination of approximately 4,400 employees associated with the closures, as
well as the reduction of corporate overhead. Substantially all such terminations
were completed as of December 1999.
LIQUIDITY AND CAPITAL RESOURCES
On March 27, 1999, the Debtors filed the Chapter 11 Cases, which will
affect the Company's liquidity and capital resources in fiscal 2000. See Note B,
Notes to the Financial Statements - "Proceedings Under Chapter 11 of the
Bankruptcy Code."
From September 1997 through January 20, 1999, the Company had a
five-year, $900.0 million, fully committed asset-based credit facility (the
"Amended and Restated Credit Facility"). The Amended and Restated Credit
Facility included $200.0 million in term loans and up to a maximum of $700.0
million in revolving loans including a $175.0 million sub-facility for letters
of credit. The Amended and Restated Credit Facility was set to mature on
September 10, 2002. Interest rates on the Amended and Restated Credit Facility
were subject to change based on a financial performance-based grid and could not
exceed a rate of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on the term
loan. There were no short-term borrowings under the Amended and Restated Credit
Facility at April 4, 1999.
On January 20, 1999, the Company completed a $750.0 million, 30-month
asset-based credit facility (the "Second Amended and Restated Credit Facility")
which replaced the Amended and Restated Credit Facility. The Second Amended and
Restated Credit Facility included $150.0 million in term loans and a maximum of
$600.0 million in revolving loans. The Second Amended and Restated Credit
Facility included a $200.0 million sub-facility for standby and trade letters of
credit. Interest rates on the Second Amended and Restated Facility were based on
either
23
24
Prime Rate + 1.5% or LIBOR + 2.75%. There were no short term borrowings under
the Second Amended and Restated Credit Facility at April 2, 2000. Short term
borrowings under this facility at April 4, 1999 were $128.8 million.
Outstanding borrowings under the term loan of the Second Amended and
Restated Credit Facility were $149.6 million as of April 4, 1999.
On March 29, 1999, the Company entered into a 27-month, $750.0 million
fully committed asset-based debtor-in-possession credit facility (the "DIP
Facility") which replaced the Second Amended and Restated Credit Facility. The
Bankruptcy Court approved the DIP Facility on an interim basis on March 29, 1999
and granted final approval on April 27, 1999. The DIP Facility, which was
scheduled to mature on June 30, 2001, included $100.0 million in term loans and
up to a maximum of $650.0 million in revolving loans including a $200.0 million
sub-facility for letters of credit. Interest rate spreads on the DIP Facility
were LIBOR + 2.25% on Eurodollar loans and Prime Rate + 1.25% on Alternate Base
Rate loans. Short term borrowings related to the DIP Facility were $97.1 million
and $26.7 million as of April 2, 2000 and April 4, 1999, respectively.
Outstanding borrowings under the term loan of the DIP Facility were $99.3
million as of April 2, 2000. There was a commitment fee of 0.375% on the undrawn
portion of the revolving loans under the DIP Facility.
The DIP Facility was secured by all material unencumbered assets of the
Company and its subsidiaries, including inventory, but excluding previously
mortgaged property. Borrowings under the DIP Facility were limited based on a
borrowing base formula which considers eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, eligible leasehold
interests, available cash equivalents and in-transit cash. Availability under
the facility continued unless the Company breached the financial covenants for
the DIP facility. As of April 2, 2000, the Company was in compliance with its
financial covenants.
On April 14, 2000, the Company entered into a four year, $600.0 million
fully committed asset-based debtor-in-possession and emergence credit facility
(the "DIP to Exit Facility") which replaced the DIP Facility. The Bankruptcy
Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit
Facility matures on April 14, 2004, and includes $60.0 million in term loans and
up to a maximum of $540.0 million in revolving loans including a $150.0 million
sub-facility for letters of credit. Interest rate spreads on the DIP to Exit
Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75%
on Alternate Base Rate loans. After the first quarter of 2001, these spreads are
subject to quarterly adjustment pursuant to a pricing grid based on availability
and EBITDA performance, with ranges of 200 to 275 basis points over LIBOR and 25
to 100 basis points over prime. There were no outstandings under the DIP to Exit
Facility as of April 2, 2000.
The DIP to Exit Facility is secured by all material unencumbered assets
of the Company and its subsidiaries, including inventory, but excluding
previously mortgaged property. Borrowings under the DIP to Exit Facility are
limited based on a borrowing base formula which considers eligible inventories,
eligible accounts receivable, mortgage values on eligible real properties,
eligible leasehold interests, available cash equivalents and in-transit cash.
The following table sets forth the Company's three month borrowing base
and borrowing availability projections under the DIP to Exit Facility. The
forecast projects a borrowing base which ranges from $424 million to $522
million over the period from May 7, 2000 to July 30, 2000, and unused borrowing
availability which ranges from $174 million to $255 million. The borrowing base
and borrowing availability projections under the DIP to Exit Facility are
forward-looking statements subject to various assumptions regarding the
Company's business, operating performance and other factors including revenues,
expenses, asset dispositions, trade terms, capital expenditures and various
other known and unknown risks and uncertainties including those set forth in
"Safe Harbor Statement under the Private Securities Litigation Reform Act." The
Company undertakes no obligation to update such information
24
25
or to disclose similar information in future reports. These projections are
subject to future adjustments, if any, that could materially affect such
information.
Actual Forecast Forecast Forecast
4/30/00 5/28/00 7/2/00 7/30/00
------------------------------------------
(in millions)
Ending Total Revolver Balance $ 156.7 $ 144.6 $ 105.2 $ 117.9
Term Loan 60.0 60.0 60.0 60.0
Standby Letters of Credit 58.7 38.7 33.0 27.5
Trade Letters of Credit 0.0 10.0 28.2 44.8
-------- -------- -------- --------
Total Extensions of Credit $ 275.4 $ 253.3 $ 226.4 $ 250.2
-------- -------- -------- --------
Borrowing Base $ 522.6 $ 499.0 $ 445.8 $ 424.9
Availability $ 247.2 $ 245.7 $ 219.4 $ 174.7
CAPITAL STRUCTURE
During the first quarter of 2000, the Company's principal source of
liquidity was the DIP Facility, which includes a $100 million term loan and a
revolving credit facility with a maximum commitment level of $650 million.
At April 2, 2000, the Company had total extensions of credit of $248.3
million under the DIP Facility. At April 4, 1999, the Company had total
extensions of credit of $380.6 million under the DIP Facility.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This pronouncement will be
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133." This pronouncement postpones the effective date of SFAS No.
133 to all fiscal quarters of fiscal years beginning after June 15, 2000. The
Company is currently in the process of analyzing the impact of the adoption of
this Statement.
YEAR 2000 COMPLIANCE
The Year 2000 issue was primarily the result of computer programs using
a two-digit format, as opposed to four digits, to indicate the year. As a
result, such computer systems would be unable to interpret dates beyond the year
1999, which could have caused a system failure or other computer errors leading
to a disruption in the operation of such systems. In 1997, the Company developed
a strategic plan to update its information systems in order to meet business
needs. As a result of this plan, several major processing systems were replaced
or significantly upgraded during 1998 and 1999, and are, for the most part, Year
2000 compliant, including certain point of sale systems, human resources and
financial reporting systems. The Company's plan devoted the necessary resources
to identify and modify systems potentially impacted by Year 2000, or implement
new systems to become Year 2000 compliant in
25
26
a timely manner. In 1999, the Company executed its Year 2000 plan as systems
potentially impacted by Year 2000 were identified and, if necessary, were
modified. In addition, the Company developed contingency plans for key
operational areas that could have been impacted by the Year 2000 problem. The
Company did not incur any significant Year 2000 issues during, or after, the
move into the new calendar year.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's operations are subject to market risks primarily from
changes in interest rates. The Company has immaterial exposure to exchange rate
risk. As discussed in the Company's Annual Report on Form 10-K filed on March
16, 2000, the Company had interest rate swaps at fiscal year-end with a notional
amount of $125 million. As of April 2, 2000, the fair value of the interest rate
swap agreements was $0.1 million.
26
27
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On March 15, 1999, five of the Company's vendors filed an involuntary
petition for reorganization under Chapter 11 in the Bankruptcy Court seeking
court supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries filed voluntary petitions with the Bankruptcy
Court for reorganization under Chapter 11 of the Bankruptcy Code. The Debtors
are currently operating their businesses as debtors-in-possession. The Chapter
11 Cases have been consolidated for the purpose of joint administration under
Case No. 399-02649.
On January 28, 1997, the Company and Service Credit Corp. (the
"Subsidiary"), a wholly-owned subsidiary, entered into an agreement with World
Financial Network National Bank ("WFNNB") for the purpose of providing a private
label credit card to the Company's customers. The contract requires the
Subsidiary to maintain a 3.0% credit risk reserve for the outstanding balances,
which are owned by WFNNB. The purpose of this reserve is to offset future
potential negative spreads and portfolio losses. The negative spreads or losses
may result from potential increased reimbursable contractual program costs. The
3.0% credit risk reserve is held by the Subsidiary, which is not in Chapter 11,
in the form of cash and cash-equivalents. On April 28, 1999, WFNNB advised the
Company that WFNNB has projected that such portfolio losses and negative spreads
will be at least approximately $9.0 million. The Company does not have in its
possession sufficient information to determine the accuracy or validity of
WFNNB's projection. Pending confirmation of the accuracy of WFNNB's projection
and a resolution of the Company's rights and remedies, the Company has made
provision for such potential liability during fiscal 1999 by maintaining an
allowance on the 3.0% credit risk reserve of $9.0 million.
On July 16, 1999, the Company filed a complaint against WFNNB in the
Bankruptcy Court alleging, among other things, breach of contract and violation
of the automatic stay provisions of the Bankruptcy Code by WFNNB with respect to
and in connection with the January 1997 private label credit card program
agreement between the Company, the Subsidiary and WFNNB (the "World Financial
Agreement"). Under the World Financial Agreement, a program was established
pursuant to which, among other things, WFNNB agreed to issue credit cards to
qualifying Company customers for the purchase of goods and services from the
Company. While the ultimate result of this litigation cannot be determined or
predicted with any accuracy at this time, the Company intends to pursue
available remedies against WFNNB.
On August 20, 1999, over the objection of WFNNB, the Bankruptcy Court
authorized the Company to enter into an agreement with Household Bank (SB), N.A.
("Household") for the purpose of offering new private label credit cards to
those customers of the Company who meet Household's credit standards. The
Company's prior private label credit card program with WFNNB was suspended in
March of 1999, and the rights and liabilities of WFNNB, the Company and the
Subsidiary are the subject of the litigation referred to in the preceding
paragraph.
On September 23, 1999, WFNNB filed a motion to dismiss the Company's
complaint and a separate motion seeking to have the complaint litigated in the
United States District Court for the Middle District of Tennessee (the "District
Court"), rather than the Bankruptcy Court. The Company filed timely oppositions
to both motions, and, on October 27, 1999, the District Court denied WFNNB's
motion to have the complaint litigated in the District Court. The Bankruptcy
Court scheduled a hearing on December 6, 1999, to consider WFNNB's motion to
dismiss and the Company's opposition thereto.
On December 6, 1999, the Bankruptcy Court entered an order dismissing
the Company's complaint. On December 16, 1999, the Company filed a motion asking
the Court to clarify the order issued on December 6, 1999, and to grant the
Company leave to file an amended complaint (the "Company's Motion"). On January
11, 2000, WFNNB responded with an objection to the Company's Motion. On February
22, 2000 the Bankruptcy Court entered
27
28
an order granting the Company's motion and the Company filed the amended
complaint. On April 24, 2000 WFNNB filed a motion to dismiss this amended
complaint.
The Company was involved in litigation, investigations and various
legal matters during the fiscal year ended January 2, 2000, which are being
defended and handled in the ordinary course of business. While the ultimate
results of these matters cannot be determined or predicted, management believes
that they will not have a material adverse effect on the Company's results of
operations or financial position. Any potential liability may be affected by the
Chapter 11 Cases.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases or their effect on the Company's business. Additional information
regarding the Chapter 11 Cases is set forth elsewhere in this Quarterly report
on Form 10-Q and in Item 1. "Business -- Proceedings Under Chapter 11 of the
Bankruptcy Code," Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations," Note B of Notes to Consolidated Financial
Statements (Unaudited) and the Report of Independent Auditors included in the
Company's Annual Report on Form 10-K filed on March 16, 2000, which includes an
explanatory paragraph concerning a substantial doubt as to the Company's ability
to continue as a going concern. If it is determined that the liabilities subject
to compromise in the Chapter 11 Cases exceed the fair value of the assets,
unsecured claims may be satisfied at less than 100% of their face value and the
equity interests of the Company's shareholders may have no value.
ITEM 2. DEFAULTS UPON SENIOR SECURITIES.
The Company commenced the Chapter 11 Cases on March 27, 1999. As a
result of filing the Chapter 11 Cases, no principal or interest payments will be
made on certain indebtedness incurred by the Company prior to March 27, 1999,
including the 9% Senior Subordinated Debentures and 8 3/8% Senior Notes, until a
plan of reorganization defining the payment terms has been approved by the
Bankruptcy Court.
ITEM 3. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits filed with this Form 10-Q
4 Post-Petition Credit Agreement dated as of April 14, 2000 by
and among Registrant, Fleet Retail Finance Inc., as collateral
agent and administrative agent, Foothill Capital Corporation,
National City Commercial Finance Inc. and Jackson National
Life Insurance Company, as co-agents, Heller Financial, Inc.,
as documentation agent and Fleet Boston Robertson Stephens,
Inc., as arranger.*
27.1 Financial Data Schedule for the First Quarter ended April 2,
2000.
27.2 Restated Financial Data Schedule for the First Quarter ended
April 4, 1999.
(b) Reports on Form 8-K.
During the first quarter ended April 2, 2000, the Company filed the
following current reports on Form 8-K: (i) dated January 7, 2000 attaching a
press release announcing the Company's successful holiday selling season, the
preliminary results of the 1999 business plan and the seeking of further
extension of the exclusive plan period; (ii) dated January 27, 2000 announcing
the filing and introduction into evidence in the Bankruptcy Court of certain
selected preliminary and other financial information of the Company; (iii) dated
February 2, 2000 announcing the filing with the Bankruptcy Court of the
Company's monthly operating report for the period commencing November 29, 1999
and ending January 2, 2000; (iv) dated February 25, 2000 announcing the filing
with the Bankruptcy Court of portions of the Company's monthly operating report
for the period commencing January 3, 2000 and ending January 30, 2000; (v) dated
February 25, 2000 announcing the Company's 1999 results and that the Company had
entered into a commitment letter with Fleet Retail Financing, Inc. for the DIP
to Exit Facility and attaching the commitment letter for the DIP to Exit
Facility; and (vi) dated March 14, 2000 announcing the filing with the
* Certain exhibits/schedules have been omitted, but will be supplied to the
staff upon request.
28
29
Bankruptcy Court of portions of the Company's monthly operating report for the
period commencing January 3, 2000 and ending January 30, 2000.
29
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ S. Cusano
- --------------------------------------
S. Cusano
Director and Chief Executive Officer
(Principal Executive Officer)
May 17, 2000
/s/ Thomas L. Garrett, Jr.
- --------------------------------------
Thomas L. Garrett, Jr.
Senior Vice President and Chief
Financial Officer
(Principal Financial Officer)
May 17, 2000
/s/ Kenneth A. Conway
- --------------------------------------
Kenneth A. Conway
Vice President Controller and Chief
Accounting Officer
(Principal Accounting Officer)
May 17, 2000
30