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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 JULY 1, 2001.
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 37202-4600
(mailing address) (Zip Code)
7100 SERVICE MERCHANDISE DRIVE, BRENTWOOD, TN 37027
(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 July 1, 2001, there were 99,871,123 shares of the Registrant's
common stock, $.50 par value, outstanding.
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TABLE OF CONTENTS
Page
No.
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PART I FINANCIAL INFORMATION
Consolidated Statements of Operations (Unaudited) - Three and Six Periods Ended July 1,
2001 and July 2, 2000 ..........................................................................3
Consolidated Balance Sheets - July 1, 2001 (Unaudited), July 2, 2000 (Unaudited) and
December 31, 2000 ..............................................................................4
Consolidated Statements of Cash Flows (Unaudited) - Six Periods Ended July 1, 2001 and
July 2, 2000 ...................................................................................5
Notes to Consolidated Financial Statements (Unaudited) ............................................6
Management's Discussion and Analysis of Financial Condition and Results of Operations.............14
Quantitative and Qualitative Disclosure about Market Risk.........................................24
PART II OTHER INFORMATION
Legal Proceedings ................................................................................25
Defaults Upon Senior Securities ..................................................................26
Exhibits and Reports on Form 8-K .................................................................26
SIGNATURES ................................................................................................27
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PART 1-FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<Table>
<Caption>
THREE PERIODS ENDED SIX PERIODS ENDED
----------------------- -------------------------
JULY 1, JULY 2, JULY 1, JULY 2,
2001 2001 2001 2001
---------- --------- ---------- ----------
Net Sales:
Operations excluding exiting categories and closed facilities $ 258,570 $ 315,784 $ 457,634 $ 617,525
Exiting categories and closed facilities -- 101,764 65 143,052
---------- ---------- ---------- ----------
258,570 417,548 457,699 760,577
---------- ---------- ---------- ----------
Costs of merchandise sold and buying and occupancy expenses:
Operations excluding exiting categories and closed facilities 183,058 222,858 327,166 441,556
Exiting categories and closed facilities -- 113,347 382 150,544
---------- ---------- ---------- ----------
183,058 336,205 327,548 592,100
---------- ---------- ---------- ----------
Gross margin (loss) after cost of merchandise sold and buying and
occupancy expenses:
Operations excluding exiting categories and closed facilities 75,512 92,926 130,468 175,969
Exiting categories and closed facilities -- (11,583) (317) (7,492)
---------- ---------- ---------- ----------
75,512 81,343 130,151 168,477
---------- ---------- ---------- ----------
Selling, general and administrative expenses:
Operations excluding exiting categories and closed facilities 75,264 86,298 145,531 170,491
Exiting categories and closed facilities 851 43,063 5,539 58,265
---------- ---------- ---------- ----------
76,115 129,361 151,070 228,756
---------- ---------- ---------- ----------
Other (income) expense, net 669 (971) 1,380 (13,267)
Restructuring charge (income) -- (838) -- (1,747)
Depreciation and amortization:
Operations excluding exiting categories and closed facilities 10,509 9,678 20,904 19,243
Exiting categories and closed facilities 24 334 48 513
---------- ---------- ---------- ----------
10,533 10,012 20,952 19,756
---------- ---------- ---------- ----------
Reorganization items 10,101 12,217 17,128 30,911
---------- ---------- ---------- ----------
Loss before interest and income tax (21,906) (68,438) (60,379) (95,932)
Interest expense (contractual interest $17,759, $34,951, $16,673
and $34,604 for the three and six periods ended July 1, 2001
and July 2, 2000, respectively) 10,720 9,634 20,873 20,526
---------- ---------- ---------- ----------
Loss before income tax (32,626) (78,072) (81,252) (116,458)
Income tax -- -- -- --
---------- ---------- ---------- ----------
Net loss $ (32,626) $ (78,072) $ (81,252) $ (116,458)
========== ========== ========== ==========
Weighted average common shares - basic and diluted 99,723 99,723 99,723 99,723
========== ========== ========== ==========
Net loss per common share - basic and diluted $ (0.33) $ (0.78) $ (0.81) $ (1.17)
========== ========== ========== ==========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<Table>
<Caption>
(UNAUDITED)
--------------------------
JULY 1, JULY 2, DECEMBER 31,
2000 2000 2000
---------- ---------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 19,535 $ 29,719 $ 31,838
Accounts receivable, net of allowance of $18,107, $17,496 and $18,542, respectively 6,834 8,268 7,061
Inventories 431,746 513,592 440,324
Prepaid expenses and other assets 12,889 16,968 11,025
---------- ---------- ------------
TOTAL CURRENT ASSETS 471,004 568,547 490,248
PROPERTY AND EQUIPMENT:
Net property and equipment - owned 353,893 348,189 364,898
Net property and equipment - leased 11,193 13,410 12,330
Other assets and deferred charges 49,066 61,138 58,376
---------- ---------- ------------
TOTAL ASSETS $ 885,156 $ 991,284 $ 925,852
========== ========== ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
LIABILITIES NOT SUBJECT TO COMPROMISE:
CURRENT LIABILITIES
Notes payable $ 194,844 $ 76,192 $ 89,143
Accounts payable 31,001 54,753 48,570
Accrued expenses 123,127 162,643 158,843
State and local sales taxes 8,290 14,985 16,300
Current maturities of capitalized lease obligations 97 305 93
---------- ---------- ------------
TOTAL CURRENT LIABILITIES 357,359 308,878 312,949
LONG-TERM LIABILITIES:
Long-term debt 60,000 60,000 60,000
Capitalized lease obligations 2,346 1,639 2,396
---------- ---------- ------------
TOTAL LONG-TERM LIABILITIES 62,346 61,639 62,396
LIABILITIES SUBJECT TO COMPROMISE 745,928 754,285 747,251
---------- ---------- ------------
TOTAL LIABILITIES 1,165,633 1,124,802 1,122,596
---------- ---------- ------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' DEFICIT:
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 99,871, 99,956 and 99,871 shares, respectively 49,935 49,979 49,935
Additional paid-in capital 5,881 6,211 5,881
Deferred compensation (157) (467) (221)
Accumulated other comprehensive loss (2,545) -- --
Retained deficit (333,591) (189,241) (252,339)
---------- ---------- ------------
TOTAL SHAREHOLDERS' DEFICIT (280,477) (133,518) (196,744)
---------- ---------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 885,156 $ 991,284 $ 925,852
========== ========== ============
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<Table>
<Caption>
SIX PERIODS ENDED
---------------------
JULY 1, JULY 2,
2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (81,252) $(116,458)
Adjustments to reconcile net loss to net cash provided
(used by operating activities:
Depreciation and amortization 22,973 23,694
Net loss (gain) on sale of property and equipment 1,380 (3,809)
Reorganization items 17,128 30,911
Changes in assets and liabilities:
Accounts receivable, net 227 4,903
Inventories 8,578 129,405
Prepaid expenses and other assets (1,864) 3,440
Accounts payable (16,687) (6,904)
Accrued expenses and state and local sales taxes (58,098) (60,719)
Accrued restructuring costs (110) (7,406)
--------- ---------
NET CASH USED BY OPERATING ACTIVITIES (107,725) (2,943)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment -- owned (9,638) (17,790)
Proceeds from sale of property and equipment 134 8,613
Proceeds from sale of property and
equipment -- reorganization 142 4,059
Restricted cash and other assets, net 6,134 (1,267)
--------- ---------
NET CASH USED BY INVESTING ACTIVITIES (3,228) (6,385)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings, net 105,701 33,215
Repayment of long-term debt (5,301) (45,004)
Repayment of capitalized lease obligations (1,750) (2,194)
Debt issuance cost -- (8,500)
Forfeiture of restricted stock -- (61)
--------- ---------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 98,650 (22,544)
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (12,303) (31,872)
CASH AND CASH EQUIVALENTS -- BEGINNING OF PERIOD 31,838 61,591
--------- ---------
CASH AND CASH EQUIVALENTS -- END OF PERIOD $ 19,535 $ 29,719
========= =========
SUPPLEMENTAL DATA:
Cash paid (received) during the period for:
Interest $ 13,322 $ 11,525
Income taxes $ 462 $ (315)
Reorganization items $ 10,468 $ 7,658
Non-cash financing activities:
Other comprehensive loss $ 2,545 $ --
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
A. FINANCIAL STATEMENT PRESENTATION AND GOING CONCERN MATTERS
The consolidated financial statements except for the consolidated
balance sheet as of December 31, 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.
The accompanying 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 line item "Exiting categories and closed facilities" represents
activity specifically identifiable to closed facilities and inventory
liquidations conducted in conjunction with the Company's 2000 and 2001 Business
Plans. Prior year amounts reflect operating results for these same facilities
and merchandise classifications. Selling, general and administrative expenses
for closed facilities do not include any allocation of corporate overhead.
The Company's recent losses and the Chapter 11 Cases (defined herein)
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 the appropriateness of using the going concern
basis are dependent upon, among other things, (i) the Company's ability to
comply with the DIP to Exit Facility (defined herein), (ii) the Company's
ability to revise and implement its 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 January 31, 2002.
Management believes that the anticipated plan of reorganization, as it is being
developed and subject to approval of the Bankruptcy Court, along with cash
provided by the DIP 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.
On February 21, 2000, the Company's Board of Directors approved its
2000 Business Plan, which emphasized: (i) an expansion of jewelry and jewelry
related products; (ii) an exit of certain unprofitable home good categories;
(iii) the reducing of selling and warehouse spaces within the Company's stores
to adjust for the new merchandise mix, which allows for potential subleasing of
excess space; and (iv) cost saving initiatives. The 2001 Business Plan advances
the initiatives of the 2000 Business Plan and refines the business model to
include: focusing on the Company's core competency in jewelry; refining home
assortments and jewelry merchandising; developing a "key item" program;
advertising with an emphasis on quality, value and assortment; aligning sublease
and remodel programs; consolidating space at the corporate headquarters;
reconfiguring the jewelry repair organization; and implementing initiatives to
reduce the Company's corporate staffing levels and overall expense structure.
The execution and success of the Company's business plan is subject to numerous
known and unknown risks and uncertainties. See "Safe Harbor Statement Under the
Private Securities Litigation Reform Act of 1995."
The Company continues to review its business strategy, which may
include additional store closings, changes in merchandise assortments, changes
in distribution networks and overhead costs. The Company is also
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considering various options with respect to its Executive Security Plan and its
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 six periods ended July 1, 2001 and July 2, 2000 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 December
31, 2000.
B. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
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, the Company developed the
Rationalization Plan (defined herein) to close up to 132 stores, up to four
distribution centers and to reduce corporate overhead. In March 1999, as part of
the Rationalization Plan, the Company announced the closing of the Dallas, Texas
distribution center and the reduction of its workforce at its Nashville,
Tennessee corporate offices by 150 employees.
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.
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 of the Company and approved by the Bankruptcy
Court. Although the Debtors expect to file a reorganization plan or plans that
provide for emergence from bankruptcy in 2002, 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 plan 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 Bankruptcy
Court approval to extend the period in which the Company had the exclusive right
to file or advance a plan of reorganization in the Chapter 11 Cases. 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 Bankruptcy Court approval to extend the period in
which the Company had 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. On February 27, 2001,
the Bankruptcy Court again extended the period in which the Company has the
exclusive right to file or advance a plan until January 31, 2002, and extended
the Company's right to solicit acceptances of its plan until April 1, 2002. 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 required by the
Bankruptcy Code. The Bankruptcy Court may also confirm a plan notwithstanding
the non-acceptance of the plan by an impaired class of creditors or equity
security holders if
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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
pre-petition 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, will be worthless if the expected plan of reorganization is
consummated.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases, their effect on the Company's business or the ability of the Company
to exit Chapter 11 on a timely basis.
C. RESTRUCTURING PLANS
Restructuring Plan
On March 25, 1997, the Company adopted a restructuring plan (the
"Restructuring Plan"), a 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 recorded in the first quarter of fiscal 1997. The
remaining components of the restructuring charge accrual and an analysis of the
change in the accrual for the six periods ended July 1, 2001 are outlined in the
following table:
2001 ACTIVITY
--------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF RESTRUCTURING CHANGE IN COSTS AS OF
DECEMBER 31, 2000 COSTS PAID ESTIMATE JULY 1, 2001
----------------- ------------- --------- -------------
(in thousands)
Lease termination and other real estate costs $ 7,715 $ -- $ -- $7,715
======= ==== ==== ======
Note: The accrued restructuring costs 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 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 because it was unable to
negotiate acceptable exit terms with 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, to the greater of one year or 15
percent, not to exceed three years, of the remaining term of the lease. Any
unpaid rent is included in the claim.
Rationalization Plan
In February 1999, the Company announced a rationalization plan (the
"Rationalization Plan") to close up to 132 stores and 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, to close the Dallas, Texas distribution
center and to reduce the Company's workforce at its Nashville, Tennessee
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 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 six periods ended July 1, 2001 are outlined in the following
table:
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2001 ACTIVITY
----------------------
ACCRUED ACCRUED
COSTS AS OF CHANGE IN COSTS AS OF
DECEMBER 31, 2000 COSTS PAID ESTIMATE JULY 1, 2001
----------------- ---------- --------- ------------
(in thousands)
Lease termination and other real estate costs $ 34,127 $(110) $ -- $ 34,017
======== ===== ==== ========
Note: The accrued restructuring costs 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, to the greater of one year or 15 percent, not to exceed
three years, of the remaining term of the lease. Any unpaid rent is included in
the claim.
As of July 1, 2001, leases remaining on locations closed in connection
with the restructuring plans vary in length with expiration dates ranging from
September 2001 to February 2020.
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 was May 15, 2000. Differences between
amounts recorded by the Company and claims filed by creditors are continuing to
be investigated and resolved. 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 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 after March 15, 1999, and to honor customer
service programs, including warranties, returns, layaways and gift certificates.
In mid-March 2001, the Company filed approximately 1,250 complaints
seeking recovery of debit balances owed by third parties to the Company and
preference payments made by the Company to third parties during the 90-day
period prior to the Company's filing for reorganization relief under Chapter 11
of the Bankruptcy Code. At July 1, 2001, the Company has settled approximately
51 of these debit balance and preference actions and received approximately $0.6
million in settlement payments.
The principal categories of claims classified as Liabilities Subject to
Compromise under reorganization proceedings are identified below.
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JULY 1, 2001 JULY 2, 2000
------------ ------------
(in thousands)
Accounts payable $198,712 $195,538
Accrued expenses 73,492 66,954
Accrued restructuring costs:
1997 Restructuring Plan 7,715 7,720
1999 Rationalization Plan 34,017 35,272
Long-term debt 411,408 424,003
Capitalized lease obligations 20,584 24,798
-------- --------
Total $745,928 $754,285
======== ========
Contractual interest expense not accrued or recorded on certain
pre-petition debt totaled $7.0 million for each of the three periods ended July
1, 2001 and July 2, 2000, and $14.1 million for each of the six periods ended
July 1, 2001 and July 2, 2000.
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:
THREE PERIODS THREE PERIODS
ENDED ENDED
JULY 1, 2001 JULY 2, 2000
------------- -------------
(in thousands)
Professional fees and administrative items $ 8,427 $ 8,776
Loss on disposal of assets 642 3,474
Store closing costs -- (33)
Severance 1,032 --
-------- --------
Total reorganization items expense (income) $ 10,101 $ 12,217
======== ========
SIX PERIODS ENDED SIX PERIODS ENDED
(in thousands) JULY 1, 2001 JULY 2, 2000
----------------- -----------------
(in thousands)
Professional fees and administrative items $ 15,027 $ 15,764
Loss on disposal of assets 1,048 1,960
Store closing costs 21 3,764
Severance 1,032 9,423
-------- --------
Total reorganization items expense (income) $ 17,128 $ 30,911
======== ========
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.
LOSS ON DISPOSAL OF ASSETS:
Loss on disposal of assets primarily consists of gains and losses
associated with the sale of real property, the rejection of real estate leases
and disposition of fixtures and equipment.
STORE CLOSING COSTS:
Store closing costs include rent, common area maintenance, utilities,
asset write-downs and real estate
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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.
SEVERANCE:
Severance costs arise from workforce reductions at the corporate
offices, distribution centers and stores.
F. BORROWINGS
This note contains information regarding the Company's short-term
borrowings and long-term debt as of July 1, 2001. As a result of the filing of
the Chapter 11 Cases, no principal or interest payments were made on any
pre-petition unsecured debt after March 15, 1999. Repayment terms for
pre-petition unsecured debt must be set forth in a plan of reorganization and
approved by the Bankruptcy Court.
From March 29, 1999 through April 14, 2000, the Company had a 27-month,
$750.0 million fully committed asset-based debtor-in-possession credit facility
(the "DIP 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 plus
2.25% on Eurodollar loans and Prime Rate plus 1.25% on Alternate Base Rate
loans.
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 considered eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, eligible leasehold
interests, available cash equivalents and in-transit cash.
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 were initially LIBOR plus 2.50% on Eurodollar loans and Prime Rate plus
0.75% on Alternate Base Rate loans. Beginning with the second 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. Short-term
borrowings outstanding under the revolver of the DIP to Exit Facility were
$194.8 million as of July 1, 2001. Outstanding borrowings under the term loan of
the DIP to Exit Facility were $60.0 million as of July 1, 2001. Short-term
borrowings related to the DIP to Exit Facility were $76.2 million as of July 2,
2000. Outstanding borrowings under the term loan of the DIP to Exit Facility
were $60.0 million as of July 2, 2000. There is a commitment fee of 0.375% on
the undrawn portion of the revolving loans under the DIP to Exit Facility.
Borrowings under the DIP to Exit Facility are 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. Availability under the facility continues unless the Company
breaches the financial covenants for the DIP to Exit Facility. As of July 1,
2001, the Company was in compliance with the financial covenants under the DIP
to Exit Facility.
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G. EARNINGS (LOSS) 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 and
the assumed exercise of dilutive stock options. For the three and six periods
ended July 1, 2001 and July 2, 2000 all outstanding restricted stock and stock
options are considered anti-dilutive.
H. BENEFIT PLANS
On January 23, 2001, the U. S. Bankruptcy Court issued an order
authorizing the Company to take all steps necessary and appropriate to
effectuate the termination of the Company's Restated Retirement Plan and to
implement procedures for distributions thereunder.
I. 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 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 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.
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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 an amended complaint. On April 24, 2000, WFNNB filed a
motion to dismiss this amended complaint. The Company responded to the motion to
dismiss and filed a cross-motion seeking to treat its amended complaint as an
objection to WFNNB's proof of claim. On November 9, 2000, the Court granted in
part and denied in part WFNNB's motion to dismiss the Company's amended
complaint. The Court denied WFNNB's motion to dismiss the Company's claims for
breach of contract, anticipatory repudiation and violation of the automatic
stay. The Court granted WFNNB's motion to dismiss the Company's claims for
breach of the duty of good faith and fair dealing and indemnification. On
January 5, 2001, WFNNB answered the remaining parts of the Company's amended
complaint. On the same day, WFNNB filed a motion to lift the automatic stay so
they could file counter claims against the Company. On April 6, 2001, the
Bankruptcy Court, with the consent of the Company, lifted the automatic stay and
permitted the claims to proceed.
The Company was involved in litigation, investigations and various
legal matters during the six periods ended July 1, 2001, 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.
J. SEGMENT REPORTING
The Company manages its business on the basis of one reportable
segment. As of July 1, 2001, all of the Company's operations were located within
the United States. The following data is presented in accordance with SFAS No.
131 for all periods presented.
CLASSES OF SIMILAR PRODUCTS: THREE PERIODS ENDED SIX PERIODS ENDED
---------------------------- ------------------------ ------------------------
JULY 1, JULY 2, JULY 1, JULY 2,
2001 2000 2001 2000
-------- -------- -------- --------
Net Sales (in thousands):
Home products $137,677 $271,364 $229,667 $486,855
Jewelry 120,893 146,184 228,032 273,722
-------- -------- -------- --------
Total Net Sales $258,570 $417,548 $457,699 $760,577
======== ======== ======== ========
The decline in home products sales was primarily due to the inclusion
in July 2, 2000 sales of certain categories including electronics, toys and
sporting goods that were discontinued in fiscal 2000.
The decline in jewelry products is primarily due to a weak economic
environment and cross shop loss from exiting of certain home good categories.
K. OTHER COMPREHENSIVE LOSS
As part of the Company's risk management program, the Company uses
interest rate swap agreements. The Company does not hold or issue derivative
financial instruments for trading purposes.
Effective January 1, 2001, the Company adopted Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 requires the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the derivative
is a hedge, depending on the nature of the hedge, changes in the fair value of
derivatives are either offset against the change in fair value of assets,
liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value is immediately
recognized in earnings.
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The adoption of SFAS No. 133 on January 1, 2001, did not have a material impact
on results of operations but resulted in the cumulative effect of an accounting
change of $1.6 million being recognized as expense in other comprehensive
income.
The Company entered into interest rate swap agreements to reduce the
impact of potential increases on floating rate debt. The interest rate swaps
vary in notional amount from $110 million to $155 million and expire January 2,
2002. The Company accounts for the interest rate swaps as cash flow hedges
whereby the fair values of the interest rate swaps are reflected as liabilities
in the accompanying consolidated balance sheet with the offset, net of any hedge
ineffectiveness (which is not material) recorded as interest expense, to other
comprehensive loss. The fair values of the interest rate swaps was $(2.5)
million as of July 1, 2001. As interest expense on the underlying hedged debt is
recognized, corresponding amounts are removed from other comprehensive income
and charged to interest expense. Such amounts were not material during the
quarter ended July 1, 2001. The balance in other comprehensive income related to
derivative instruments as of July 1, 2001 is expected to be recognized in
earnings over the next six months.
The following table summarizes activity in other comprehensive
income related to derivatives classified as cash flow hedges held by the Company
during the period January 1 (the date of the Company's adoption of SFAS No. 133)
through July 1, 2001 (in thousands):
Three Periods Six Periods
Ended Ended
------------ ------------
July 1, 2001 July 1, 2001
------------ ------------
Accumulated derivative loss included in other
comprehensive income at the beginning
of the period, net $(2,697) $ 0
Cumulative effect of adopting SFAS 133, net 0 (1,606)
(Gains)/losses reclassified into earnings from
other comprehensive income, net 736 1,067
Change in fair value of derivatives, net (584) (2,006)
------- -------
Accumulated derivative loss included in other
Comprehensive income at the end of the
period, net $(2,545) $(2,545)
======= =======
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 (any statement
other than those made solely with respect to historical fact) 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 and access liquidity from the DIP to Exit Facility and
the vendor credit facility; the ability of the Company to develop, prosecute,
confirm and consummate on a timely basis one or more plans of reorganization
with respect to the Chapter 11 Cases and to exit Chapter 11; 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 ability of the Company to
successfully implement the 2001 Business Plan initiatives; risks associated with
third parties seeking and obtaining court approval to terminate or shorten the
exclusivity period for the Company to propose and confirm
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one or more plans of reorganization, for the appointment of a Chapter 11 trustee
or to convert the Company's cases to Chapter 7 cases; the ability of the Company
to reduce its workforce and related expenses and to achieve anticipated cost
savings; the ability of the Company to obtain trade credit and shipments and
terms with vendors and service providers for current orders; the ability of the
Company to sublease successfully additional portions of its real estate and to
consummate the sale/leaseback of its headquarters; the successful consolidation
of its distribution centers; the ability of the Company to access liquidity from
the DIP to Exit Facility upon its anticipated emergence from Chapter 11;
potential adverse developments with respect to the Company's liquidity or
results of operations; competitive pressures from other retailers, including
specialty retailers and discount stores, which may affect the nature and
viability of the Company's business strategy; 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 to fund and execute
its business plan; the ability of the Company to attract, retain and compensate
key executives and associates; the ability of the Company to attract and retain
customers; potential adverse publicity; and uncertainties regarding real estate
occupancy and development costs, including the substantial fixed investment
costs associated with opening, maintaining or closing a Company store.
Overview
The Company, with 218 stores in 31 states at July 1, 2001, is one of
the nation's largest retailers of jewelry and offers a selection of brand-name
home products and other product lines. During the year ended December 31, 2000
("fiscal 2000"), the Company repositioned its product offerings to focus on
value pricing and a broad selection of jewelry and home products. These
remerchandising efforts were based on perceived customer expectations of entry
level price points and a large selection within each product assortment. The
Company also revised its media strategy during fiscal 2000 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, which emphasized: (i) an expansion of jewelry and jewelry
related products; (ii) an exit of certain unprofitable home good categories;
(iii) the reducing of selling and warehouse spaces within the Company's stores
to adjust for the new merchandise mix, which allows for potential subleasing of
excess space; and (iv) cost saving initiatives. The 2001 Business Plan advances
the initiatives of the 2000 Business Plan and refines the business model to
include: focusing on the Company's core competency in jewelry; refining home
assortments and jewelry merchandising; developing a "key item" program;
advertising with an emphasis on quality, value and assortment; aligning sublease
and remodel programs; consolidating space at the corporate headquarters;
reconfiguring the jewelry repair organization; and implementing initiatives to
reduce the Company's corporate staffing levels and overall expense structure.
The execution and success of the Company's business plan is subject to numerous
known and unknown risks and uncertainties. See "-Safe Harbor Statement Under the
Private Securities Litigation Reform Act of 1995."
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 of the Bankruptcy Code in the
United States Bankruptcy Court for the Middle District of Tennessee seeking
court supervision of the Company's restructuring efforts. On March 27, 1999, the
Debtors filed voluntary petitions with the Bankruptcy Court for reorganization
under Chapter 11 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. Although the Debtors expect to file a
reorganization plan or plans that provide for
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emergence from bankruptcy in 2002, 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 Company 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 Company had 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. On February 27,
2001, the Bankruptcy Court again extended the period in which the Company has
the exclusive right to file or advance a plan of reorganization until January
31, 2002, and extended the Company's right to solicit acceptances of its plan
until April 1, 2002. 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 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 pre-petition 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, will be 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, and to pay vendors and
other providers in the ordinary course for goods and services received after
March 15, 1999, and to honor customer service programs, including warranties,
returns, layaways and gift certificates.
On March 29, 1999, the Company entered into the DIP Facility, a
27-month, $750.0 million fully committed asset-based debtor-in-possession credit
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 plus 2.25% on Eurodollar loans and Prime
Rate plus 1.25% on Alternate Base Rate loans.
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 considered eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, eligible leasehold
interests, available cash equivalents and in-transit cash.
On April 14, 2000, the Company entered into the DIP to Exit Facility, a
four year, $600.0 million fully committed asset-based debtor-in-possession and
emergence credit 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 were initially LIBOR plus 2.50% on Eurodollar loans and Prime Rate plus
0.75% on Alternate Base Rate loans. Beginning with the second 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. Short-term
borrowings outstanding under the revolver of the DIP to Exit Facility were
$194.8 million as of July 1, 2001. Outstanding borrowings under the term loan of
the DIP to Exit Facility were $60.0 million as of July 1, 2001. Short-term
borrowings related to the DIP to Exit Facility were $76.2
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million as of July 2, 2000. Outstanding borrowings under the term loan of the
DIP to Exit Facility were $60.0 million as of July 2, 2000. There is a
commitment fee of 0.375% on the undrawn portion of the revolving loans under the
DIP to Exit Facility.
Borrowings under the DIP to Exit Facility are 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. Availability under the facility continues unless the Company
breaches the financial covenants for the DIP to Exit Facility. As of July 1,
2001, the Company was in compliance with the financial covenants under the DIP
to Exit Facility.
Conversion of the DIP to Exit Facility to an exit financing upon the
Company's anticipated emergence from Chapter 11 is subject to closing
conditions, including the collateral and administrative agent's reasonable
satisfaction with the Company's capital structure, plan of reorganization and
any materially revised projections, as well as the achievement by the Company of
a specified trailing 12-month earnings level (which varies depending on time of
exit) and certain minimum availability (which varies from $50.0 to $100.0
million depending on the time of exit.)
There can be no assurance that the Company will be able to access
liquidity from the DIP to Exit Facility, or from any other source, or that such
liquidity will be sufficient to meet the Company's needs. Moreover, there can be
no assurance that the Company will exit Chapter 11 or convert the DIP to Exit
Facility to an exit financing facility. See "-Safe Harbor Statement Under the
Private Securities Litigation Reform Act of 1995."
The Company's Consolidated Financial Statements have been prepared on a
going concern basis, which contemplates continuity of operations, realization of
assets and liquidation of liabilities and commitments in the normal course of
business. The Company's recent losses and the Chapter 11 Cases (defined herein)
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 the appropriateness of using the going concern
basis are dependent upon, among other things, (i) the Company's ability to
comply with the DIP to Exit Facility, (ii) the Company's ability to revise and
implement its 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 a result of the
filing of the Chapter 11 Cases and related circumstances, realization of assets
and liquidation of liabilities is subject to significant uncertainty. While
under the protection of Chapter 11, the Debtors may sell or otherwise dispose of
assets, and liquidate or settle liabilities, for amounts other than those
reflected in the Consolidated Financial Statements. Further, a plan or plans of
reorganization could materially change the amounts reported in the accompanying
Consolidated Financial Statements. The Consolidated Financial Statements do not
include any adjustments relating to recoverability of the value of recorded
asset amounts or the amounts and classification of liabilities that might be
necessary as a consequence of a plan of reorganization.
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 in Note B of Notes to Consolidated
Financial Statements. If it is determined that the liabilities subject to
compromise in the Chapter 11 Cases exceed the fair value of the assets available
therefor, unsecured claims may be satisfied at less than 100% of their face
value and the equity interests of the Company's current shareholders may have no
value. The Company believes 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."
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2001 Business Plan
In February 2001, the Company's Board of Directors approved its 2001
Business Plan. The 2001 Business Plan initiatives include: focusing on the
Company's core competency in jewelry; refining home assortments and jewelry
merchandising; developing a "key item" program; advertising with an emphasis on
quality, value and assortment; aligning sublease and remodel programs;
consolidating space at the corporate headquarters; reconfiguring the jewelry
repair organization; and implementing initiatives to reduce the Company's
corporate staffing levels and overall expense structure. Approximately 1,750
full time positions, including 1,630 positions in the store and field
organizations and approximately 120 positions at the corporate office, were
eliminated in January 2001.
RESULTS OF OPERATIONS
THREE PERIODS ENDED JULY 1, 2001 COMPARED TO THREE PERIODS ENDED JULY 2, 2000
The line item "Exiting categories and closed facilities" represents
activity specifically identifiable to closed facilities and inventory
liquidations conducted in conjunction with the Company's 2000 and 2001 Business
Plans. Prior year amounts reflect operating results for these same facilities
and merchandise classifications. Selling, general and administrative expenses
for closed facilities do not include any allocation of corporate overhead.
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 33.2% and 37.5% of total net sales in fiscal 2000 and 1999, respectively.
Net Sales
Net sales for the Company were $258.6 million for the three periods
ended July 1, 2001 compared to $417.5 million for the three periods ended July
2, 2000. The decline in net sales was primarily due to the increased
restructuring and remerchandising activities in fiscal 2000, cross shop loss
from exiting of certain home good categories and a weak economic environment.
Net sales from operations excluding exiting categories and closed
facilities were $258.6 million for the three periods ended July 1, 2001 compared
to $315.8 million for the three periods ended July 2, 2000. Comparable store
sales for jewelry were down 16.6% and home products comparable store sales were
down 21.7% compared to the three periods ended July 2, 2000. The jewelry
comparable stores sales decrease was led by declines in watches/accessories and
diamonds/stones. The home products comparable store sales performance was driven
by declines in seasonal, personal care, photo, and housewares. The Company
believes that the decline in net sales was primarily due to cross shop loss from
exiting of certain home good categories and a weak economic environment.
There were no net sales from exiting categories and closed facilities
for the three periods ended July 1, 2001 compared to $101.8 million for the
three periods ended July 2, 2000. Sales from exiting categories and closed
facilities decreased primarily due to the fact that the three periods ended July
2, 2000 reflects the sales of discontinued product lines that were primarily
completed by December 31, 2000.
Gross Margin
Gross margin was $75.5 million for the three periods ended July 1, 2001
as compared to $81.3 million for the three periods ended July 2, 2000. The
decrease in gross margin was primarily due to a decrease in sales.
Gross margin after costs and expenses and excluding exiting categories
and closed facilities was $75.5 million or 29.2% of net sales for the three
periods ended July 1, 2001, compared to $92.9 million or 29.4% of net
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sales for the three periods ended July 2, 2000. The margin decrease was
primarily due to a decrease in sales with approximately the same occupancy costs
as the prior year.
There was no gross loss after costs and expenses for exiting categories
and closed facilities for the three periods ended July 1, 2001 compared to
$(11.6) million for the three periods ended July 2, 2000. The margin increase
was primarily due to the fact that the three periods ended July 2, 2000 reflects
the sales of discontinued product lines that were primarily completed by
December 31, 2000.
Selling, General and Administrative Expenses
Selling, general and administrative expenses declined $53.3 million in
the three periods ended July 1, 2001 to $76.1 million from $129.4 million in the
three periods ended July 2, 2000. The decline was primarily due to store
closures, corporate downsizing and overhead reduction efforts.
Selling, general and administrative expenses were $75.3 million or
29.1% of net sales from operations excluding exiting categories and closed
facilities for the three periods ended July 1, 2001 compared to $86.3 million or
27.3% of net sales from operations excluding exiting categories and closed
facilities for the three periods ended July 2, 2000. The decrease in expenses
was attributable to a decrease in employment costs and other selling, general
and administrative expenses primarily due to the corporate downsizing and
overhead reduction efforts.
Selling, general and administrative expenses for exiting categories and
closed facilities were $0.9 million for the three periods ended July 1, 2001
compared to $43.1 million for the three periods ended July 2, 2000. The decrease
in selling, general and administrative expenses was attributable to lower sales
efforts for discontinuing merchandise and closed facilities.
Other Expense (Income), net
The net (gain) loss on dispositions of property and leases recorded for
the three periods ended July 1, 2001 was $0.7 million, as compared to $(1.0)
million for the three periods ended July 2, 2000. The loss for the three periods
ended July 1, 2001 included the disposition of fixtures at the corporate office
compared to a gain realized from the completion of the auction property sale of
20 properties for the three periods ended July 2, 2000.
Depreciation and Amortization
Depreciation and amortization on owned and leased property and
equipment was $10.5 million for the three periods ended July 1, 2001 as compared
to $10.0 million for the three periods ended July 2, 2000. The increase was
primarily attributable to fixture additions for the remodeled stores.
Interest Expense
Interest expense for the three periods ended July 1, 2001 was $10.7
million as compared to $9.6 million for the three periods ended July 2, 2000.
The increase in interest expense primarily relates to higher average borrowings
and higher interest rates.
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.
Management does not believe it is more likely than not that the Company will
realize the deferred tax asset.
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SIX PERIODS ENDED JULY 1, 2001 COMPARED TO SIX PERIODS ENDED JULY 2, 2000
NET SALES
Net sales for the Company were $457.7 million for the first half of
2001 compared to $760.6 million for the first half of 2000. The decline in net
sales was primarily due to the increased restructuring and remerchandising
activities in fiscal 2000, cross shop loss from exiting of certain home good
categories and a weak economic environment.
Net sales from operations excluding exiting categories and closed
facilities were $457.6 million for the first half of 2001 compared to $617.5
million for the first half of 2000. Comparable store sales for jewelry were down
15.7% and comparable store sales for home products was down 22.4% as compared to
the first half of 2000. The jewelry comparable store sales decrease was driven
by declines in watches/accessories and diamond/stones. Home products comparable
sales performance was driven by declines in personal care, photo and housewares.
The Company believes that the decline in net sales was primarily due to cross
shop loss from exiting of certain home good categories and a weak economic
environment.
Net sales from exiting categories and closed facilities were $0.1
million for the first half of 2001 compared to $143.1 million for the first half
of 2000. Sales from exiting categories and closed facilities decreased primarily
due to the fact that the first half of 2000 reflects the sales of discontinued
product lines that were primarily completed by December 31, 2000 and were not
reflected in the first half of 2001.
GROSS MARGIN
Gross margin was $130.2 million for the first half of 2001 compared to
$168.5 million in the first half of 2000. The decrease was primarily due to a
$302.9 million decline in sales, partially offset by a $264.6 million decrease
in cost of goods sold.
Gross margin after costs and expenses and excluding exiting categories
and closed facilities was $130.5 million or 28.5% of net sales for the first
half of 2001, compared to $176.0 million or 28.5% of net sales for the first
half of 2000. The margin decrease was primarily due to decreased sales.
Gross (loss) after costs and expenses for exiting categories and closed
facilities was $(0.3) million, compared to $(7.5) million for the first half of
2000. The margin increase was primarily a result of decreased inventory
clearance sales for the first half of 2001.
SELLING GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses decreased $77.7 million in
the first half of 2001, to $151.1 million from $228.8 million in the first half
of 2000. The decline was primarily due to store closures, corporate downsizing
and overhead reduction efforts.
Selling, general and administrative expenses were $145.5 million or
31.8% of net sales from operations excluding exiting categories and closed
facilities for the first half of 2001, compared to $170.5 million or 27.6% of
net sales from operations excluding exiting categories and closed facilities for
the first half of 2000. The decrease in expenses was attributable to a decrease
in employment costs and other selling, general and administrative expenses
primarily due to corporate downsizing and overhead reduction efforts.
Selling, general and administrative expenses for exiting categories and
closed facilities were $5.5 million for the first half of 2001, compared to
$58.3 million for the first half of 2000. The decrease in expenses was
attributable to decreases in employment costs and other selling, general and
administrative expenses primarily due to store closures.
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OTHER (INCOME) EXPENSE, NET
The net (gain) loss on dispositions of property and leases recorded for
the first half of 2001 was $1.4 million, as compared to $(13.3) million in 2000.
The loss for the first half of 2001 is primarily related to the disposition of
corporate fixtures, compared to a gain in the first half of 2000 for amounts
realized from the completion of the auction property sale of 10 owned and 13
leased properties.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization on owned and leased property and
equipment was $21.0 million for the first half of 2001 as compared to $19.8
million for the first half of 2000. The increase was primarily attributable to
new fixtures for remodeled stores.
INTEREST EXPENSE
Interest expense for the first half of 2001 was $20.9 million as
compared to $20.5 million for the first half of 2000. Interest expense increased
due to higher average borrowings and higher interest rates.
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.
Management does not believe it is more likely than not that the Company will
realize the deferred tax asset.
RESTRUCTURING PLAN
On March 25, 1997, the Company adopted the 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 recorded in the
first quarter of fiscal 1997. The remaining components of the restructuring
charge accrual and an analysis of the change in the accrual for the six periods
ended July 1, 2001 are outlined in the following table:
2001 ACTIVITY
--------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF RESTRUCTURING CHANGE IN COSTS AS OF
DECEMBER 31, 2000 COSTS PAID ESTIMATE JULY 1, 2001
----------------- ------------- --------- -------------
(in thousands)
Lease termination and other real estate costs $ 7,715 $ -- $ -- $ 7,715
======= ==== ==== =======
Note: The accrued restructuring costs 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 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 because it was unable to
negotiate acceptable exit terms with 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, to the greater of one year or 15
percent, not to exceed three years, of the remaining term of the lease. Any
unpaid rent is included in the claim.
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RATIONALIZATION PLAN
In February 1999, the Company announced its 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, to close the
Dallas, Texas distribution center and to reduce the Company's workforce at its
Nashville, Tennessee 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 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 six periods ended July 1, 2001 are
outlined in the following table:
2001 ACTIVITY
-----------------------
ACCRUED ACCRUED
COSTS AS OF CHANGE IN COSTS AS OF
DECEMBER 31, 2000 COSTS PAID ESTIMATE JULY 1, 2001
-------------------- ---------- --------- ------------
(in thousands)
Lease termination and other real estate costs $34,127 $ (110) $ -- $ 34,017
======= ====== ==== ========
Note: The accrued restructuring costs 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, to the greater of one year or 15 percent, not to exceed
three years, of the remaining term of the lease. Any unpaid rent is included in
the claim.
As of July 1, 2001, leases remaining on locations closed in connection
with the restructuring plans vary in length with expiration dates ranging from
September 2001 to February 2020.
LIQUIDITY AND CAPITAL RESOURCES
On March 27, 1999, the Debtors filed the Chapter 11 Cases, which affect
the Company's liquidity and capital resources. See Note B "Proceedings Under
Chapter 11 of the Bankruptcy Code."
Availability under the DIP to Exit Facility, trade credit and terms
from vendors provided the resources required to support operations, seasonal
working capital requirements and capital expenditures during the six periods
ended July 1, 2001. The Company's business is highly seasonal with the Company's
inventory investment and related short-term borrowing requirements reaching a
peak prior to the Christmas season. Historically, positive cash flow from
operations has been generated principally in the latter part of the fourth
quarter of each fiscal year, in line with the seasonal nature of the Company's
business.
Net cash used by operations was $107.7 million for six periods ended
July 1, 2001 as compared to $2.9 million for six periods ended July 2, 2000. The
increase in net cash used by operations was primarily a result of higher
proceeds from liquidation of exiting merchandise categories in the six periods
ended July 2, 2000.
Net cash used by investing activities was $3.2 million for the six
periods ended July 1, 2001 and $6.4 million for the six periods ended July 2,
2000. Cash used by investing activities for the six periods ended July 1, 2001
resulted primarily from capital spending for store remodeling. Cash used by
investing activities for the six periods ended July 2, 2000 resulted primarily
from capital expenditures partially offset by proceeds from the sale of real
estate.
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Net cash provided (used) by financing activities was $98.7 million for
the six periods ended July 1, 2001 and $(22.5) million for the six periods ended
July 2, 2000. For the six periods ended July 1, 2001, cash provided by financing
activities reflected a $105.7 million net increase in short-term borrowings. For
the six periods ended July 2, 2000, cash provided by financing activities
reflected a $33.2 million net increase in short-term borrowings, offset by
repayments of long-term debt.
Capital Expenditures
Capital expenditures for the six periods ended July 1, 2001 and July 2,
2000, respectively, related primarily to store remodeling and preparing the
stores for subleasing.
Planned capital expenditures for fiscal 2001 are expected to be
approximately $27.0 million and are expected to be directed primarily to store
remodels, capital maintenance and information systems improvements. The Company
expects to fund these planned expenditures primarily with borrowings under the
DIP to Exit Facility.
Capital Structure
The Company's principal sources of liquidity during the six periods
ended July 1, 2001 and July 2, 2000 were borrowings under the DIP to Exit
Facility. At July 1, 2001, the Company had $194.8 million in revolving loans
outstanding under the DIP to Exit Facility. The Company had $97.1 million in
revolving loans outstanding under the DIP to Exit Facility on July 2, 2000.
Average short-term borrowings for the six periods ended July 1, 2001
increased to $182.2 million compared to $100.1 million for the six periods ended
July 2, 2000, due primarily to a decline in sales from liquidations of
merchandise in toys, electronics and sporting goods categories and a decline in
sales of property and equipment. Short-term borrowings under the revolver
portion of the DIP to Exit Facility reached a maximum of $240.3 million during
the six periods ended July 1, 2001 as compared to short-term borrowings under
the revolver portions of the DIP to Exit Facility of $176.3 million during the
six periods ended July 2, 2000.
On April 14, 2000, the Company entered into 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 were initially LIBOR
plus 2.50% on Eurodollar loans and Prime Rate plus 0.75% on Alternate Base Rate
loans. Beginning with the second 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 is a commitment fee of 0.375% on the
undrawn portion of the revolving loans under the DIP to Exit Facility.
Borrowings under the DIP to Exit Facility are 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. Availability under the facility continues unless the Company
breaches the financial covenants for the DIP to Exit Facility. As of July 1,
2001, the Company was in compliance with the financial covenants under the DIP
to Exit Facility.
To fund capital expenditures in 2001, the DIP to Exit Facility permits
capital expenditures up to $105.9 million. During 2002 and 2003, the Company may
invest up to $50.0 million each year with 100 percent carryover of unexpended
amounts from prior years.
Conversion of the DIP to Exit Facility to an exit financing upon the
Company's anticipated emergence from Chapter 11 is subject to customary closing
conditions, including the collateral and administrative agent's
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reasonable satisfaction with the Company's capital structure, plan of
reorganization and any materially revised projections, as well as the
achievement by the Company of a specified trailing 12-month earnings level
(which varies depending on time of exit) and certain minimum availability (which
varies from $50.0 to $100.0 million) depending on the time of exit.
There can be no assurance that the Company will be able to access
liquidity from the DIP to Exit Facility, or from any other source, or that such
liquidity will be sufficient to meet the Company's needs. Moreover, there can be
no assurance that the Company will exit Chapter 11 or convert the DIP to Exit
Facility to an exit financing facility. See "- Safe Harbor Statement Under the
Private Securities Litigation Reform Act of 1995."
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and No.
142 "Goodwill and Other Intangible Assets". SFAS No. 141 will require that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001 and that the use of the pooling-of-interest method is no
longer allowed. SFAS No. 142 requires that upon adoption, amortization of
goodwill will cease and instead, the carrying value of goodwill will be
evaluated for impairment on an annual basis. Identifiable intangible assets will
continue to be amortized over their useful lives and reviewed for impairment in
accordance with SFAS No. 121 "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of". SFAS No. 142 is effective for
fiscal years beginning after December 15, 2001. The Company is evaluating the
impact of the adoption of these standards and has not yet determined the effect
of adoption on its financial position and results of operations.
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. The Company manages its interest rate risk by entering into interest rate
swap agreements and balancing its debt portfolio with both fixed and floating
rate borrowings. As of July 1, 2001, the Company was party to interest rate
swaps covering a portion of its short-term borrowings and term loan, which vary
seasonally. These swaps, which vary in notional amount from $110 million to $155
million and expire January 2, 2002, exchange floating interest rate exposure for
fixed interest rate exposure. The Company will pay a weighted average fixed rate
of 6.97%, rather than the one-month LIBOR, which was 5.08% as of July 1, 2001.
The fair values of interest rate swap agreements is estimated based on quotes
from dealers of these instruments and represents the estimated amounts the
Company could expect to pay or receive to terminate the agreements. The fair
value of the Company's interest rate swap agreements was ($2.5) million as of
July 1, 2001.
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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 (the " Debtors") 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.
("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 made
provision for such potential liability during fiscal 1999 by maintaining an
allowance on the 3.0% credit risk reserve of approximately $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.
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 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 responded to the motion to
dismiss and filed a cross-motion seeking to treat its amended complaint as an
objection to WFNNB's proof of claim. On November 9, 2000, the Court granted in
part and denied in part WFNNB's motion to dismiss the Company's amended
complaint. The Court denied WFNNB's motion to dismiss the Company's claims for
breach
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of contract, anticipatory repudiation and violation of the automatic stay. The
Court granted WFNNB's motion to dismiss the Company's claims for breach of the
duty of good faith and fair dealing and indemnification. On January 5, 2001,
WFNNB answered the remaining parts of the Company's amended complaint. On the
same day, WFNNB filed a motion to lift the automatic stay so they could file
counter claims against the Company. On April 6, 2001, the Bankruptcy Court, with
the consent of the Company, lifted the automatic stay and permitted the claims
to proceed.
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, and the Report of Independent Auditors included in the Company's
Annual Report on Form 10-K filed on March 16, 2001, 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
available to satisfy them, 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
10.1 Employment Agreement between Registrant and Jane Gilmartin
dated May 14, 2001.
(b) Reports on Form 8-K.
During the three periods ended July 1, 2001, the Company filed the
following reports on Form 8-K: (i) dated April 20, 2001, announcing the
Company's 2001 business plan; (ii) dated April 30, 2001, announcing the filing
with the Bankruptcy Court of the Company's monthly operating report for the
period commencing February 26, 2001 and ending April 1, 2001; (iii) dated June
1, 2001, announcing the filing with the Bankruptcy Court of the Company's
monthly operating report for the period commencing April 2, 2001 and ending
April 29, 2001; and (iv) dated June 22, 2001, announcing the filing with the
Bankruptcy Court of the Company's monthly operating report for the period
commencing April 30, 2001 and ending May 27, 2001.
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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
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
August 13, 2001
/s/ Michael E. Hogrefe
- -------------------------------------------------------
Michael E. Hogrefe
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
August 13, 2001
/s/ Kenneth A. Conway
- -------------------------------------------------------
Kenneth A. Conway
Vice President Controller and Chief Accounting Officer
(Principal Accounting Officer)
August 13, 2001
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