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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 3, 1999.
Commission File No. 1-9223
SERVICE MERCHANDISE COMPANY, INC.
(Debtor-in-Possession as of March 27, 1999)
(Exact Name of Registrant as Specified In Its Charter)
TENNESSEE 62-0816060
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
P.O. BOX 24600, NASHVILLE, TN (MAILING ADDRESS)
7100 SERVICE MERCHANDISE DRIVE, BRENTWOOD, TN 37202-4600
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number including area code: (615) 660-6000
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of Exchange on
-------------- Which Registered
----------------
COMMON STOCK ($.50 PAR VALUE) NEW YORK STOCK EXCHANGE
SERIES A JUNIOR PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE
9% SENIOR SUBORDINATED DEBENTURES NEW YORK STOCK EXCHANGE
8 3/8% SENIOR NOTES NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of February 28, 1999, there were outstanding 100,267,293 shares of
the Registrant's common stock, $.50 par value (the "Common Stock"). The
aggregate market value of the Common Stock held by non-affiliates on February
28, 1999 (based upon the average of the high and low sales prices of such stock
as of such date) was $55,010,205. This calculation assumes that all shares of
Common Stock beneficially held by officers and members of the Board of Directors
of the Registrant are owned by "affiliates," a status which each of the officers
and directors may individually disclaim.
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TABLE OF CONTENTS
Page
No.
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PART I ....................................................................................................................1
Item 1. Business............................................................................................1
Item 2. Properties .........................................................................................4
Item 3. Legal Proceedings...................................................................................7
Item 4. Submission of Matters to a Vote of Security Holders.................................................7
PART II ...................................................................................................................7
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters............................7
Item 6. Selected Financial Data.............................................................................8
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...............9
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.........................................20
Item 8. Financial Statements and Supplementary Data........................................................21
Item 9. Changes in and Disagreements With Independent Auditors on Accounting and Financial Disclosure......46
PART III..................................................................................................................46
Item 10. Directors and Executive Officers of the Registrant.................................................46
Item 11. Executive Compensation.............................................................................48
Item 12. Security Ownership of Certain Beneficial Owners and Management.....................................54
Item 13. Certain Relationships and Related Transactions.....................................................55
PART IV ..................................................................................................................56
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K ...................................56
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PART I
Except where the context indicates otherwise, the "Company" means
Service Merchandise Company, Inc. and its subsidiaries and the "Registrant"
means Service Merchandise Company, Inc. without reference to its subsidiaries.
Information included in this Annual Report on Form 10-K, unless indicated to be
given as of a specified date or for a specified period, is given as of January
3, 1999.
ITEM 1. BUSINESS
The Company, with 350 stores in 34 states at January 3, 1999, is one of
the nation's largest retailers of jewelry and offers a selection of brand-name
hard goods and other product lines. During the year ended January 3, 1999
("fiscal 1998"), the Company remerchandised its product offerings and attempted
to reposition itself in the mind of consumers as a specialty retailer focused on
jewelry and home products rather than a catalog showroom. The result was a
merchandise mix which provided more emphasis on higher margin home accents and
furnishings. Additionally, the Company ceased distribution of its traditional
fall catalog during fiscal 1998.
As a result of the Company's decreased net sales in the fourth quarter
of fiscal 1998 and the resulting negative cash flows from operations, in January
1999 the Company began an effort to effect an out-of-court restructuring plan.
As part of this out-of-court restructuring plan, on January 20, 1999, the
Company entered into a new credit facility with Citibank N.A. (the "Second
Amended and Restated Credit Facility"). The Company also developed a plan to
close up to 132 stores, up to four distribution centers and to reduce corporate
overhead (the "Rationalization Plan"). In March 1999, as part of the
Rationalization Plan, the Company announced the closing of the Dallas
distribution center and the reduction of its workforce at its Nashville
corporate offices by 150 employees.
PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
Before the Company was able to effect an out-of-court restructuring, on
March 15, 1999, five of the Company's vendors filed an involuntary petition for
reorganization under Chapter 11 ("Chapter 11") of title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
for the Middle District of Tennessee (the "Bankruptcy Court") seeking court
supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries (collectively, the "Debtors") filed voluntary
petitions with the Bankruptcy Court for reorganization under Chapter 11 under
case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and orders for
relief were entered by the Bankruptcy Court. The Chapter 11 Cases have been
consolidated for the purpose of joint administration under Case No. 399-02649.
The Debtors are currently operating their businesses as debtors-in-possession
pursuant to the Bankruptcy Code.
Actions to collect pre-petition indebtedness are stayed and other
contractual obligations against the Debtors may not be enforced. In addition,
under the Bankruptcy Code, the Debtors may assume or reject executory contracts,
including lease obligations. Parties affected by these rejections may file
claims with the Bankruptcy Court in accordance with the reorganization process.
Substantially all pre-petition liabilities are subject to settlement under a
plan of reorganization to be voted upon by creditors and equity holders and
approved by the Bankruptcy Court. Although the Debtors expect to file a
reorganization plan or plans that provide for emergence from bankruptcy in 2000
or 2001, there can be no assurance that a reorganization plan or plans will be
proposed by the Debtors or confirmed by the Bankruptcy Court, or that any such
plan(s) will be consummated. As provided by the Bankruptcy Code, the Debtors
initially have the exclusive right to submit a plan of reorganization for 120
days. Further extensions may be sought and may be granted or rejected by the
Bankruptcy Court. 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. A plan of reorganization could also result in holders of the
Common Stock receiving no value for their interests. Because of such
possibilities, the value of the Common Stock is highly speculative.
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At the first day hearing held on March 29, 1999 before Judge George C.
Paine, the Bankruptcy Court entered first day orders granting authority to the
Debtors, among other things, to pay pre-petition and post-petition employee
wages, salaries, benefits and other employee obligations, to pay vendors and
other providers in the ordinary course for goods and services received from
March 15, 1999, and to honor customer service programs, including warranties,
returns, layaways and gift certificates.
The Company has entered into an agreement dated March 29, 1999 with
Citicorp USA, Inc., as administrative agent, BankBoston, N.A. as documentation
agent and collateral monitoring agent, and Salomon Smith Barney Inc. as sole
arranger and book manager, for a debtor-in-possession credit facility (the "DIP
Facility") under which the Company may borrow up to $750 million, subject to
certain limitations, to fund ongoing working capital needs while it prepares a
reorganization plan. The DIP Facility includes $100 million in term loans and a
maximum of $650 million in revolving loans. Financial covenants are subject to
amendment pending the finalization of the Company's business plan. The DIP
Facility includes a $200 million sub-facility for standby and trade letters of
credit. Interest rates on the DIP Facility are based on either the Citibank N.A.
Alternative Base Rate plus 1.25% for ABR Loans or 2.25% over LIBOR for
Eurodollar Loans. The DIP Facility is secured by substantially all of the assets
of the Company and its subsidiaries, subject only to valid, enforceable,
subsisting and non-voidable liens of record as of the date of commencement of
the Chapter 11 Cases and other liens permitted under the DIP Facility.
Borrowings under the DIP Facility are limited based on a borrowing base
formula which considers eligible inventories, eligible accounts receivable,
trade letters of credit and mortgage values on eligible real properties. The DIP
Facility contains restrictive covenants which are substantially similar to those
contained in the Second Amended and Restated Credit Facility, and are subject to
amendment pending finalization of the Company's business plan. The Company's
ability to obtain new borrowings after the first anniversary of the DIP Facility
is subject to the Company and the lenders having agreed to a business plan and
revised financial and other covenants.
On March 29, 1999, the Bankruptcy Court approved the DIP Facility on an
interim basis. The final hearing with respect to the DIP Facility has been set
for April 27, 1999. The Company believes the DIP Facility (if finally approved
by the Bankruptcy Court) should provide it with adequate liquidity to conduct
its operations while it prepares a reorganization plan.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases or their effect on the Company's business. Reference is made to 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 herein which includes an explanatory
paragraph concerning a substantial doubt as to the Company's ability to continue
as a going concern. If it is determined that the liabilities subject to
compromise in the Chapter 11 Cases exceed the fair value of the assets,
unsecured claims may be satisfied at less than 100% of their face value and the
equity interests of the Company's shareholders may have no value.
GENERAL
The Company is one of the nation's largest retailers of jewelry and
offers a selection of brand-name hard goods and other product lines. Product
offerings are marketed to customers primarily through direct mail flyers,
newspaper inserts and television advertising. While customers may purchase
products through mail order, telephone order or via the Company's Internet web
site, the majority of purchases occur directly in a Company store.
The typical store consists of approximately 50,000 square feet of total
space (approximately 27,000 square feet selling space and 23,000 square feet
warehouse space) and is situated on a stand-alone lot or as an anchor in a
suburban mall or strip center. The Company also operates seven Service Select
stores, an 11,000 - 14,000 square foot format that carries a full line of
jewelry and an edited assortment of hardlines. The Company's stores are divided
into thematic product categories. In the Fine Jewelry department, merchandise is
displayed in showcases. In certain other departments, a sample of the
merchandise is displayed, and customers select their purchases via a "pull tag"
system. The pull tag is taken to a cashier, the product is paid for and the
merchandise is delivered to a pick-up station. In self-service departments,
customers select merchandise from a shelf or display and take it to a checkout
counter to finalize the purchase. In fiscal 1998, the Company transitioned from
a showroom retailer to a self-service retailer. Except for certain
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electronics, large fitness equipment and jewelry, almost all product categories
may now be shopped on a self-service basis.
The Company implemented a new private label credit card program in
January 1998 (the "Program Agreement"). Sales on the credit card generate
accounts receivable which are owned by World Financial Network National Bank
("WFNNB") who reimburses the Company for the value of such credit sales. The
agreement between the Company and WFNNB provides for daily advances to the
Company for the prior day's sales and a monthly settlement for contractual
amounts owed by each party related to the receivables portfolio. During fiscal
1998, the credit card program provided a pre-tax income contribution of $19.6
million. The occurrence of an Event of Bankruptcy (as defined in the Program
Agreement) constitutes an Early Termination Event if (a) WFNNB was unable to
arrange for alternative sources of funding, or (b) the Company does not obtain
an order from the Bankruptcy Court within 10 days of an Event of Bankruptcy
authorizing and approving the Program Agreement and continuation of the program.
Such an Early Termination Event provides WFNNB the right to terminate the
Program Agreement and the program. The Company believes that the program may be
terminated in fiscal 1999. If the program is terminated, it will result in
suspension of the use of private label credit cards. See Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Results of Operations -- Selling, General and Administrative Expenses" and Note
Q of Notes to Consolidated Financial Statements.
Virtually every transaction in the store that involves payment,
customer information or inventory is recorded and transmitted, on a daily basis,
via satellite to a central information system at the Company's corporate
offices. In addition, by using the computer, customers may be provided with
suggested alternative items, back-order information, online mail orders, gift
registry, special orders and layaway information.
The Company's computerized daily inventory system tracks the status (on
hand, on order, or in transit), location and history of inventory in the retail
network. The raw data is used in the Company's inventory replenishment system
which tracks inventory positions, sales data and sales forecasts and generates
either suggested transfers from distribution centers or suggested purchase order
quantities. The inventory system also records all sales information to produce
daily margin reports with historical comparisons.
The Company's information systems track customers' purchases and
facilitate tailoring the Company's mailing lists to meet specific objectives.
The Company maintains a household database of information on over 24 million
households that is updated with each purchase. This database allows the Company
to target customers based on specific criteria, including the categories
purchased, the frequency of purchases and the value of those purchases.
SEASONALITY AND COMPETITION
The Company's business is highly seasonal, with the Christmas season
being the largest volume-selling period of the year. In preparation for the
Christmas season, the Company significantly increases its merchandise
inventories, which traditionally have been financed by internally generated
funds, short-term borrowings, trade credit and terms from vendors. The Company's
profitability and cash flows are primarily dependent upon the large sales volume
generated during the fourth quarter of its fiscal year. Fourth quarter net sales
accounted for 40.6% of total net sales in fiscal 1998.
The Company is engaged in a highly competitive business and competes
with most nationally known jewelry and general retail merchandisers including
department, general merchandise, specialty and discount stores. Many of these
competitors are larger and have greater financial resources than the Company.
The Company considers quality, value, merchandise mix, service, quality of
shopping experience and location to be the most significant competitive factors
in its retailing business.
SUPPLIERS
The Company purchases merchandise from approximately 1,700 suppliers,
most of which are manufacturers. Generally, most merchandise is shipped to the
Company's regional distribution centers and transported to the stores by
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commercial contract carriers. In fiscal 1998, the largest vendor accounted for
approximately 7.8% of total cash disbursements for inventory items. On January
27, 1999, the Company announced that it had suspended payment on unpaid invoices
for goods shipped prior to January 8, 1999, totaling approximately $200 million
related to trade payables for merchandise from vendors. The Company also
announced its intent to pay on a current basis invoices for goods shipped after
January 8, 1999. Prior to the filing of the Chapter 11 Cases, the Company's
ability to purchase merchandise was adversely affected by its lack of cash
reserves and the Company's deteriorating financial performance. Certain vendors
refused to ship merchandise to the Company or would only ship on a cash in
advance basis. As a result of the Chapter 11 Cases and the DIP Facility, the
Company intends to pay suppliers for merchandise received post-petition. The
Company believes its ability to acquire merchandise from its suppliers is
adequate to supply its business needs.
The Company's direct import program is responsible for sourcing and
repackaging many promotional and seasonal items. Direct import purchases, which
totaled approximately $250.2 million in fiscal 1998, allow the Company to reduce
many traditional cost factors, thereby lowering the cost of merchandise sold in
several product lines. In addition to its direct import program, the Company
imports diamonds, gemstones and gold which are used by contract fabricators in
the manufacturing of jewelry items.
EMPLOYEES
The number of persons employed by the Company fluctuates seasonally.
During fiscal 1998, the number of active employees varied from approximately
23,600 to approximately 42,700 including both permanent and temporary employees.
As of January 3, 1999, the Company had 23,409 permanent employees, of whom 84%
were hourly-paid personnel engaged in non-supervisory activities; the balance
consisted of administrative, executive, distribution center and store management
personnel. In March 1999, the Company began a program to reduce its workforce as
part of its Rationalization Plan. See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Overview --
Out-of-Court Restructuring Plan." None of the Company's employees are covered by
a collective bargaining agreement. The Company has never experienced a work
stoppage due to a labor disagreement. The Company has experienced a material
loss of its workforce primarily due to the uncertainty surrounding the Company's
deteriorating financial condition and as a result of the filing of the Chapter
11 Cases. The Company anticipates implementing an employee retention plan,
subject to Bankruptcy Court approval, which the Company believes will enhance
its ability to retain employees.
ITEM 2. PROPERTIES
The Company leases and owns retail store facilities, warehouses and
office space. The Company has financed a number of its owned facilities out of
internally generated funds. Some owned facilities have ground leases on a
long-term basis, some are financed through industrial development financing
under which the Company either has ownership or a right to obtain ownership and
others are financed by real estate mortgages. The Company occupies office space
in two locations in greater Nashville, Tennessee, both of which are owned by the
Company. In March 1999, the Company announced a program to close up to 132 under
performing stores as part of its Rationalization Plan. During the pendency of
the Chapter 11 Cases, the Company expects to evaluate its properties and may
seek to reject a number of leases, including those related to stores scheduled
to be closed.
DISTRIBUTION CENTERS
The Company operated seven distribution centers and one return center
(Bowling Green, Kentucky) as of January 3, 1999. These distribution centers are
located in Florida, New York, Tennessee, and Texas, and contain an aggregate of
approximately 3,102,000 square feet as set forth below:
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Center Location Sq. Feet Owned/Leased Lease Term
--------------- -------- ------------ ----------
Orlando, FL 460,000 Leased Primary term extends through 6/30/00 with
renewal options through 6/30/22
Montgomery, NY 800,000 Sale/Leaseback Primary term extends through 12/31/24
Nashville, TN
(1) Owned 588,000 Owned Not applicable
(2) Owned satellite 268,000 Owned Not applicable
(3) Leased satellite 392,000 Leased Primary term extends through 1/31/01 with
renewal options through 1/31/05
Dallas, TX 594,000 Leased Primary term extends through 1/31/01 with
renewal options through 1/31/06
Bowling Green, KY (Return 180,000 Leased Primary term extends through 12/31/00 with
Center) renewal options through 12/31/25
In March 1999, the Company adopted a Rationalization Plan pursuant to
which it may close up to four distribution centers and it has announced the
closing of the Dallas distribution center.
RETAIL STORES
As of January 3, 1999, the Company operated 350 retail stores
(typically consisting of approximately 50,000 square feet) as follows:
Number of
Stores
------
Owned land and building 90
Long-term ground lease with an owned building 36
Owned land with industrial development financing under which the 2
Company has ownership or a right to obtain ownership of the building
Leased 237
Stores which have been subleased (15)
------
Total 350
======
Most of the leases contain renewal or purchase options. See Note I of
Notes to Consolidated Financial Statements for information concerning the
Company's lease commitments. In March 1999, the Company adopted a
Rationalization Plan pursuant to which it may close up to 132 stores.
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SERVICE MERCHANDISE COMPANY, INC.
STORE LOCATIONS
The numbers in parentheses show the number of stores per state and
where there is more than one store in any city, the number of stores in such
city as of fiscal year-end. An asterisk denotes locations with one or more
stores closed or scheduled to be closed as of April 2, 1999. As of January 3,
1999 the Company operated 350 stores in 34 states. As of April 2, 1999, the
Company operates 343 stores in 34 states.
ALABAMA (7) GEORGIA (14) MARYLAND (6) NEW YORK (20) SOUTH CAROLINA (5)
Birmingham (2) * Atlanta (8) Baltimore * Albany Charleston
Huntsville (2) Augusta Columbia * Binghamton Columbia
Mobile Buckhead * Forestville * Buffalo Greenville
Montgomery Columbus * Frederick * East Meadow * Greenwood
Tuscaloosa Douglasville * Salisbury Hartsdale * Sumter
ARIZONA (3) Macon * Waldorf * Huntington TENNESSEE (17)
Glendale Savannah MASSACHUSETTS(11) Lake Grove Cookeville
Mesa (2) ILLINOIS (22) Auburn * Lawrence * Chattanooga (2)
ARKANSAS (4) * Chicago (22) * Boston (7) * Massapequa Jackson
* Fayetteville INDIANA (14) * Holyoke Middletown Johnson City
* Fort Smith Bloomington * Lanesboro/Pittsfield * Nanuet * Kingsport
* Little Rock (2) Clarksville Swansea Patchoque * Knoxville (2)
CALIFORNIA (2) Evansville MICHIGAN (13) * Plattsburgh * Memphis (4)
San Francisco Fort Wayne * Ann Arbor Poughkeepsie * Nashville (5)
San Jose Griffith * Detroit (8) Queens TEXAS (40)
COLORADO (1) Indianapolis (4) * Flint * Rochester (2) * Abilene
* Pueblo * Kokomo * Lansing (2) * Syracuse * Amarillo
CONNECTICUT (6) * Lafayette * Waterford * Utica Arlington
Danbury Merrillville MISSISSIPPI (6) * Yorktown Heights Austin
Derby South Bend * Gautier NORTH CAROLINA (7) Beaumont
Hartford (2) * Terre Haute * Gulfport Charlotte (2) * College Station
Orange KANSAS (3) Hattiesburg Fayetteville * Corpus Christi
* Waterbury Overland Park * Jackson (2) Gastonia * Dallas (6)
DELAWARE (3) Wichita (2) Meridian Greensboro El Paso
Dover KENTUCKY (9) MISSOURI (7) Raleigh (2) Ft. Worth (2)
Wilmington (2) Bowling Green * Independence OHIO (12) Harlingen
FLORIDA (50) Elizabethtown Springfield * Akron Houston (9)
Boca Raton Florence * St. Louis (5) * Canton Lake Jackson
Boynton Beach Lexington NEVADA (3) Cincinnati (4) Laredo
* Coral Springs * Louisville (3) * Las Vegas (2) * Columbus (2) Longview
* Davie Owensboro * Reno * Lima * Lubbock
Daytona Beach Paducah NEW HAMPSHIRE (5) * Mansfield * McAllen (2)
Ft. Myers LOUISIANA (14) Dover * Toledo (2) * Midland
Gainesville * Alexandria Manchester OKLAHOMA (7) * San Angelo
Jacksonville (3) * Baton Rouge (2) Nashua * Norman San Antonio (3)
Lakeland Houma Plaistow * Oklahoma City (3) * Temple
Leesburg * Lafayette (2) Salem * Tulsa (3) Tyler
* Melbourne * Lake Charles NEW JERSEY (6) PENNSYLVANIA (14) * Waco
Miami/Ft. Lauderdale (11) Monroe Hazlet Allentown VERMONT (1)
Naples * New Orleans (3) Paramus Harrisburg Burlington
Ocala Shreveport (2) * Turnersville Lancaster VIRGINIA (11)
Orlando (7) Slidell * Voorhees * Philadelphia (2) * Alexandria
Pensacola MAINE (5) Wayne * Pittsburgh (6) * Bailey's Crossroad
Port Charlotte * Auburn * Woodbridge Reading Chantilly
Sarasota (2) Augusta NEW MEXICO (2) Scranton Chesapeake
* Stuart * Bangor * Albuquerque Wilkes-Barre Dale City
Tallahassee (2) * Brunswick * Las Cruces Fredericksburg
Tampa/Clearwater Portland * Hampton
St. Petersburg (7) * Manassas
* W. Palm Beach * Norfolk
Vero Beach * Richmond (2)
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ITEM 3. LEGAL PROCEEDINGS
On March 15, 1999, five of the Company's vendors filed an involuntary
petition for reorganization under Chapter 11 in the Bankruptcy Court seeking
court supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries filed voluntary petitions with the Bankruptcy
Court for reorganization under Chapter 11 of the Bankruptcy Code. The Debtors
are currently operating their businesses as debtors-in-possession. The Chapter
11 Cases have been consolidated for the purpose of joint administration under
case number 399-02649.
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 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 herein which includes an explanatory paragraph concerning a substantial
doubt as to the Company's ability to continue as a going concern. If it is
determined that the liabilities subject to compromise in the Chapter 11 Cases
exceed the fair value of the assets, unsecured claims may be satisfied at less
than 100% of their face value and the equity interests of the Company's
shareholders may have no value.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of fiscal 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
During fiscal 1998 and 1997, the Common Stock traded on the New York
Stock Exchange (the "NYSE") under the symbol "SME." The number of holders of
Common Stock at March 2, 1998 was 5,844. On March 17, 1999, the NYSE notified
the Company that it was reviewing the listing status of the Company's listed
securities, including the Common Stock. Accordingly, while an established public
trading market currently exists with respect to the Common Stock, there can be
no assurance that the Common Stock will remain listed on the NYSE or otherwise
be the subject of an established public trading market.
High and low closing sales prices as reported by the NYSE for fiscal
1998 and 1997 were as follows:
1998 HIGH LOW
- ---- ---- ---
First Quarter...................................................................2 7/16 1 5/8
Second Quarter..................................................................2 1/4 1 5/8
Third Quarter...................................................................1 15/16 1 1/2
Fourth Quarter..................................................................1 11/16 9/32
1997 HIGH LOW
- ---- ---- ---
First Quarter...................................................................4 3/4 3 3/8
Second Quarter..................................................................3 5/8 2 5/8
Third Quarter...................................................................4 1/2 2 7/8
Fourth Quarter..................................................................4 7/8 1 7/8
The Amended and Restated Credit Facility and its successor, the Second
Amended and Restated Credit Facility, contained certain restrictive covenants,
including a prohibition on the payment of cash dividends. The Company has not
declared any cash dividends to shareholders for fiscal 1998 or 1997.
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ITEM 6. SELECTED FINANCIAL DATA
FISCAL YEAR
(In thousands, except per share, store, ratio -----------------------------------------------------------------------
and rate data) 1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
RESULTS OF OPERATIONS
Net sales $ 3,169,525 $ 3,662,778 $ 3,955,016 $ 4,018,525 $ 4,050,381
Earnings (loss) before interest and income taxes (a) (27,145) (63,801) 138,564 162,078 179,643
Interest expense - debt and capitalized leases (a) 83,255 78,531 75,636 80,908 78,707
Earnings (loss) before extraordinary loss and
cumulative effect of change in accounting
principle (110,307) (88,957) 39,330 50,325 61,570
Net earnings (loss) (110,307) (91,600) 39,330 50,325 56,155
RATIOS & RATES
Gross margin to net sales 23.8% 23.2% 24.2% 24.3% 24.0%
Selling, general and administrative expenses to net
sales (a) 22.4% 19.8% 19.2% 18.7% 18.0%
Effective tax rate 0.1% 37.5% 37.5% 38.0% 39.0%
Earnings (loss) before extraordinary loss and
cumulative effect of change in accounting
principle to net sales (3.5%) (2.4%) 1.0% 1.3% 1.5%
Net earnings (loss) to net sales (3.5%) (2.5%) 1.0% 1.3% 1.4%
PER COMMON SHARE - BASIC AND DILUTED (b)
Earnings (loss) per share before extraordinary loss
and cumulative effect of change in accounting
principle - Basic $ (1.11) $ (0.89) $ 0.39 $ 0.50 $ 0.62
Earnings (loss) per share before extraordinary loss
and cumulative effect of change in accounting
principle - Assuming dilution (1.11) (0.89) 0.39 0.50 0.62
Net earnings (loss) per share - Basic (1.11) (0.92) 0.39 0.50 0.56
Net earnings (loss) per share - Assuming dilution (1.11) (0.92) 0.39 0.50 0.56
Weighted - average common shares:
Basic 99,703 99,930 99,209 99,059 99,432
Diluted 99,703 99,930 100,326 100,357 100,105
FINANCIAL POSITION
Inventories $ 896,303 $ 929,818 $ 1,052,969 $ 1,034,467 $ 1,004,282
Notes payable 156,000 -- -- -- --
Accounts payable (a) 228,373 482,235 639,887 679,107 685,297
Working capital 255,980 586,501 489,597 365,025 290,696
Total assets (a) 1,626,895 1,951,461 2,087,452 1,999,008 1,972,433
Long-term obligations (c) 508,385 761,522 682,156 623,286 618,423
Shareholders' equity 225,895 336,505 427,094 386,742 336,376
RATIOS
Inventory turnover 2.6x 2.8x 2.9x 3.0x 3.2x
Current ratio (a) 1.3x 1.7x 1.5x 1.4x 1.3x
Long-term debt to long-term debt + equity 68.8% 69.4% 61.5% 61.7% 64.8%
OTHER INFORMATION
Total net sales increase (decrease) (13.5%) (7.4%) (1.6%) (0.8%) 6.2%
Comparable store net sales increase (decrease) (d) (8.9%) (3.1%) (1.9%) (3.3%) 1.3%
Number of stores 350 361 401 410 407
ADJUSTED EBITDA DATA
Adjusted EBITDA (e) $ 73,637 $ (4,561) $ 199,189 $ 224,816 $ 242,495
Adjusted EBITDA to net sales 2.3% (0.1%) 5.0% 5.6% 6.0%
CASH FLOW DATA
Cash flow from operating activities $ (291,351) $ (21,443) $ 65,737 $ 72,829 $ 83,472
Cash flow from investing activities (36,189) (23,270) (29,926) (47,778) (75,166)
Cash flow from financing activities 97,120 78,879 58,431 (8,095) (160,134)
- ------------------------
(a) Certain prior period amounts have been reclassified for comparative
purposes.
(b) Restated to reflect the adoption of Statement of Financial Accounting
Standards ("SFAS") No. 128.
(c) Includes both long-term debt and long-term portion of capitalized lease
obligations.
(d) Adjusted to reflect a comparable number of selling days.
(e) Adjusted EBITDA consists of net earnings before interest, income taxes,
depreciation and amortization. Also included in Adjusted EBITDA is other
amortization classified as selling, general and administrative expenses in
the following amounts: 1998 - $630; 1997 - $992; 1996 - $966; 1995 - $964;
1994 - $317. Certain amounts have been reclassified from selling, general
and administrative expenses to interest expense for both current and prior
periods. Adjusted EBITDA does not reflect restructuring charges or SFAS No.
121 charges. Adjusted EBITDA is not intended to represent net earnings, cash
flow or any other measure of performance in accordance with generally
accepted accounting principles, but is included because management believes
certain investors find it to be a useful tool for measuring operating
performance. While Adjusted EBITDA and similar variations thereof are
frequently used as a measure of operations and the ability to meet debt
service requirements, these terms are not necessarily comparable to other
similarly titled captions of other companies due to the potential
inconsistencies in the method of calculation.
8
11
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-K includes certain forward-looking
statements 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 statements 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 obtain final Bankruptcy Court approval of the DIP
Facility and to operate pursuant to the terms of the DIP Facility; the ability
of the Company to operate successfully under a Chapter 11 proceeding; approval
of plans and activities by the Bankruptcy Court; risks associated with operating
a business in Chapter 11; the ability of the Company to create and have approved
a reorganization plan in the Chapter 11 Cases; adverse developments, with
respect to the Company's liquidity or results of operations; the ability of the
Company to obtain shipments and negotiate terms with vendors and service
providers for current orders; the ability to conduct inventory liquidation sales
to improve liquidity; the ability to develop, fund and execute an operating plan
for the Company; the ability of the Company to attract and retain key executives
and associates; competitive pressures from other retailers, including specialty
retailers and discount stores, which may affect the nature and viability of the
Company's business strategy; trends in the economy as a whole which may affect
consumer confidence and consumer demand for the types of goods sold by the
Company; the ability to maintain gross profit margins; the seasonal nature of
the Company's business and the ability of the Company to predict consumer demand
as a whole, as well as demand for specific goods; the ability of the Company to
attract and retain customers; costs associated with the shipping, handling and
control of inventory and the Company's ability to optimize its supply chain;
potential adverse publicity; availability and cost of management and labor
employed; real estate occupancy and development costs, including the substantial
fixed investment costs associated with opening, maintaining or closing a Company
store; the potential delisting of the Company's securities and the absence of an
active public trading market; the ability of the Company to provide a private
label credit card; and the ability to effect conversions to new technological
systems, including becoming Year 2000 compliant.
Actual results may differ materially from those anticipated in any such
forward-looking statements. The Company undertakes no obligation to update or
revise any forward-looking statements to reflect subsequent events or
circumstances.
OVERVIEW
The Notes to Consolidated Financial Statements are an integral part of
Management's Discussion and Analysis of Financial Condition and Results of
Operations and should be read in conjunction herewith.
The Company, with 350 stores in 34 states at January 3, 1999, is one
of the nation's largest retailers of jewelry and offers a selection of
brand-name hard goods and other product lines. During fiscal 1998, the Company
remerchandised its product offerings and attempted to reposition itself in the
mind of consumers as a specialty retailer focused on jewelry and home products
rather than a catalog showroom. The result was a merchandise mix which provided
more emphasis on higher margin home accents and furnishings. Additionally, the
Company ceased distribution of its traditional fall catalog during fiscal 1998.
Out-of-Court Restructuring Plan
As a result of the Company's decreased net sales in the fourth quarter
of fiscal 1998 and the resulting negative cash flows from operations, in January
1999 the Company began an effort to effect an out-of-court restructuring
plan. As part of this out-of-court restructuring plan, on January 20, 1999, the
Company entered into the Second Amended and Restated Credit Facility. The
Company also developed a Rationalization Plan 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 distribution center and the reduction of its workforce at its Nashville
corporate offices by 150 employees. As a result of the filing of the Chapter 11
Cases, aspects of the Rationalization Plan not implemented by March 27, 1999 or
not approved to date by the Bankruptcy Court may be subject to Bankruptcy Court
approval.
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Proceedings Under Chapter 11 of the Bankruptcy Code
Before the Company was able to effect an out-of-court restructuring, on
March 15, 1999, five of the Company's vendors filed an involuntary petition for
reorganization under Chapter 11 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 Company and 31 of
its subsidiaries 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 emergence from bankruptcy in 2000
or 2001, there can be no assurance that a reorganization plan or plans will be
proposed by the Debtors or confirmed by the Bankruptcy Court, or that any such
plan(s) will be consummated. As provided by the Bankruptcy Code, the Debtors
initially have the exclusive right to submit a plan of reorganization for 120
days. Further extensions may be sought and may be granted or rejected by the
Bankruptcy Court. 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. A plan of reorganization could also result in holders of the
Common Stock receiving no value for their interests. Because of such
possibilities, the value of the Common Stock is highly speculative.
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 from
March 15, 1999, and to honor customer service programs, including warranties,
returns, layaways and gift certificates.
The Company has entered into the DIP Facility dated March 29, 1999 with
Citicorp USA, Inc., as administrative agent, BankBoston, N.A. as documentation
agent and collateral monitoring agent, and Salomon Smith Barney Inc. as sole
arranger and book manager, for a debtor-in-possession credit facility under
which the Company may borrow up to $750 million, subject to certain limitations,
to fund ongoing working capital needs while it prepares a reorganization plan.
The DIP Facility includes $100 million in term loans and a maximum of $650
million in revolving loans. Financial covenants are subject to amendment pending
the finalization of the Company's business plan. The DIP Facility includes a
$200 million sub-facility for standby and trade letters of credit. Interest
rates on the DIP Facility are based on either the Citibank N.A. Alternative Base
Rate plus 2.25% for LIBOR Loans or 1.25% for ABR Loans. The DIP Facility is
secured by substantially all of the assets of the Company and its subsidiaries,
subject only to valid, enforceable, subsisting and non-voidable liens of record
as of the date of commencement of the Chapter 11 Cases and other liens permitted
under the DIP Facility.
Borrowings under the DIP Facility are limited based on a borrowing base
formula which considers eligible inventories, eligible accounts receivable,
trade letters of credit and mortgage values on eligible real properties. The DIP
Facility contains restrictive covenants which are substantially similar to those
contained in the Second Amended and Restated Credit Facility, and are subject to
amendment pending finalization of the Company's business plan. The Company's
ability to obtain new borrowings after the first anniversary of the DIP Facility
is subject to the Company and the lenders having agreed upon a business plan and
revised financial and other covenants.
On March 29, 1999, the Bankruptcy Court approved the DIP Facility on an
interim basis. The final hearing with respect to the DIP Facility has been set
for April 27, 1999. The Company believes the DIP Facility (if finally approved
by the Bankruptcy Court) should provide it with adequate liquidity to conduct
its operations while it prepares a reorganization plan.
10
13
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 filing of the involuntary and voluntary petitions referred to
above, the related circumstances and the losses from operations raise
substantial doubt with respect to the Company's ability to continue as a going
concern. The appropriateness of using the going concern basis is dependent upon,
among other things, confirmation of a plan or plans of reorganization, future
profitable operations and the ability to generate cash from operations and
financing sources sufficient to meet 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 Item 1. "Business -- Proceedings
Under Chapter 11 of the Bankruptcy Code," Note B of Notes to Consolidated
Financial Statements and the Report of Independent Auditors included herein
which includes an explanatory paragraph concerning a substantial doubt as to the
Company's ability to continue as a going concern. If it is determined that the
liabilities subject to compromise in the Chapter 11 Cases exceed the fair value
of the assets, unsecured claims may be satisfied at less than 100% of their face
value and the equity interests of the Company's shareholders may have no value.
The Company believes the DIP Facility, if finally approved by the Bankruptcy
Court, 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."
IMPAIRMENT
In the fourth quarter of fiscal 1998, the Company recorded a non-cash
impairment loss of $43.1 million related to a write-down of the Company's fixed
assets. See Note G of Notes to Consolidated Financial Statements.
RESULTS OF OPERATIONS
Fiscal Year Ended January 3, 1999 Compared to Fiscal Year Ended December 28,
1997
The Company's consolidated statement of operations presentation changed
beginning with the second quarter of fiscal 1997. This change was made to
disclose the financial statement impact of the inventory liquidations and other
operating results associated with the closed facilities as a result of
restructuring and remerchandising activities. "Closed facilities as a result of
restructuring and remerchandising activities" reflects inventory liquidations
and other operating results of 44 stores and one distribution center closed
during 1997 and nine stores closed in fiscal 1998 as part of: (1) the Company's
restructuring plan announced in the first quarter of fiscal 1997 (the
"Restructuring Plan") and (2) exiting certain product lines as part of a
remerchandising program. Selling, general and administrative expenses for closed
facilities as a result of restructuring and remerchandising activities does not
include any allocation of corporate overhead. Prior year amounts reflect
operating results for these same facilities and merchandise classifications.
Net loss for fiscal 1998 was $110.3 million, or $1.11 per share,
compared to a net loss of $91.6 million, or $0.92 per share, for the year ended
December 28, 1997 ("fiscal 1997"). The increase in net loss was primarily a
result of decreased net sales and a $43.1 million impairment loss with respect
to certain fixed assets. Net sales were $3.17 billion for fiscal 1998 compared
to $3.66 billion for fiscal 1997. The decrease of $493.3 million in net sales,
or 13.5%, was the result of a $283.4 million or 8.9%, decline in comparable
store sales and a decline in net sales from closed facilities and
remerchandising activities of $209.9 million, or 95.3 %, due to declining
overall performance, store closings and exiting certain business lines including
video games, camping, team sports and office equipment. The consolidated
statement of operations includes a pre-tax, non-cash charge of approximately
$43.1 million, in connection with the write-down of certain long-lived assets
resulting from decreased expectations regarding future store cash flows. See
Note G of Notes to Consolidated Financial Statements. Income tax expense
increased over the prior year by approximately $53 million primarily due to the
recording of a deferred tax asset valuation
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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. Debt Interest Expense increased approximately $6
million from the prior year as a result of increased borrowings.
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 40.6% and 39.4% of total net sales in fiscal 1998 and 1997, respectively.
Fourth quarter net sales for fiscal 1998 decreased $157.6 million, or 10.9%,
when compared to the fourth quarter of fiscal 1997, primarily due to comparable
store sales decreases and the closure of nine under performing stores in fiscal
1998. Comparable store sales decreased $171.3 million, or 12.4%, for the fourth
quarter of fiscal 1998 compared to the prior year.
Net Sales
Total net sales for the Company was $3.17 billion in fiscal 1998
compared to $3.66 billion in fiscal 1997. The decline in net sales was primarily
due to the closure of 53 stores as a result of the restructuring and
remerchandising activities and disappointing sales. The Company maintains its
books using a 52/53 week year ending on the Sunday closest to the end of the
calendar year. There were 53 weeks in fiscal 1998 and 52 weeks in each of the
previous fiscal years. During the first quarter of fiscal 1999, the Company
experienced inventory shortages due to its deteriorating financial performance
and the uncertainties related to the Company's out-of-court restructuring plan.
The Company believes these factors have adversely affected sales in the first
quarter of fiscal 1999.
Net sales from operations excluding closed facilities as a result of
restructuring and remerchandising activities were $3.16 billion for fiscal 1998
compared to $3.44 billion for fiscal 1997, a decrease of $283.4 million or 8.2%.
Jewelry comparable store sales increased 3.6%, while hardline comparable store
sales were down 13.6%. Contributing to the overall decline in comparable store
sales was the conversion of the traditional store format and merchandise
selections during the first three quarters of fiscal 1998, reduced advertising
and overall performance declines. Increases in gold sales, jewelry special sales
events and warranty sales were offset in part by sales decreases in watches,
diamonds and precious and semi-precious stones. Sales increases in decorative
home, seasonal, telephones, home furnishings and photo categories were offset in
part by sales decreases in sporting and fitness, toys, small appliances,
housewares, audio, video and home office equipment.
Net sales from closed facilities as a result of restructuring and
remerchandising activities were $10.3 million for fiscal 1998 compared to $220.2
million for fiscal 1997. Sales from closed facilities as a result of
restructuring and remerchandising activities decreased primarily due to closing
nine under performing stores in fiscal 1998 as compared to 44 under performing
stores in fiscal 1997.
The Company maintains its books using a 52/53 week year ending on the
Sunday closest to the end of the calendar year. There were 53 weeks in fiscal
1998 and 52 weeks in each of fiscal 1997 and 1996. In the fourth quarter of
fiscal 1998, there were 14 reporting weeks. All previous quarters in fiscal
year's 1998, 1997 and 1996 were reported on a 13 week basis.
Gross Margin (loss)
In fiscal 1998, gross margin was $754.3 million as compared to $851.0
million in fiscal 1997. The decrease in gross margin dollars was primarily due
to the overall decline in sales.
Gross margin after cost of merchandise sold and buying and occupancy
expenses and excluding closed facilities as a result of restructuring and
remerchandising was $763.0 million, or 24.2% of net sales from operations
excluding closed facilities as a result of restructuring and remerchandising for
fiscal 1998, compared to $843.0 million, or 24.5% of net sales from operations
excluding closed facilities as a result of restructuring and remerchandising
activities for fiscal 1997. The reduced gross margin rate reflects a $14.7
million write-down lowering discontinued inventory items to their net realizable
value and competition induced price mark-downs, partially offset by a shift to a
higher margin merchandise assortment.
Gross margin loss for closed facilities as a result of restructuring
and remerchandising activities, after cost of merchandise sold and buying and
occupancy expenses, was $(8.7) million, or (85.2)% of sales of these facilities
in fiscal 1998 as compared to gross margin of $8.0 million or 3.6% in fiscal
1997. The increase in both gross loss and rate was due to greater merchandise
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discounts offered in liquidating inventories at the nine under performing stores
closed in fiscal 1998 as compared to the 44 under performing stores closed in
fiscal 1997 as part of the Company's restructuring and remerchandising programs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses declined $20.5 million in
fiscal 1998 to $709.1 million from $729.6 million in fiscal 1997. The $20.5
million decline was primarily due to store closures and favorable results from
the private label credit card. If the credit card program is terminated, it will
result in suspension of the use of private label credit cards. See Note Q of
Notes to Consolidated Financial Statements.
Selling, general and administrative expenses were $706.7 million, or
22.4% of net sales from operations excluding closed facilities as a result of
restructuring and remerchandising for fiscal 1998 compared to $685.8 million, or
19.9% of net sales from operations excluding closed facilities as a result of
restructuring and remerchandising for fiscal 1997. The increase in selling,
general and administrative expenses was primarily attributable to an increase
in legal and consulting expenses of operations excluding closed facilities as a
result of restructuring and remerchandising activities incurred primarily in the
third and fourth quarters of fiscal 1998. This increase as a percent of sales
was partially offset by income of $19.6 million recognized from the private
label credit card program. If the program is terminated it will result in
suspension of the use of private label credit cards, which would adversely
affect selling, general and administrative expense for fiscal 1999.
The Company believes selling, general and administrative expenses in
the first quarter of fiscal 1999 will be adversely affected by severance and
other extraordinary expenses. See Item. 11 "Executive Compensation -- Severance
and Indemnification Agreements; Employment Agreements; Change in Control
Provisions."
Other Income
Other income increased $10.4 million in fiscal 1998 from $2.6 million
in fiscal 1997. The increase was primarily due to the gain on the sale/lease
back of the Company's aircraft.
Depreciation and Amortization
Depreciation and Amortization in fiscal 1998 was $57.1 million, a $1.2
million decline from $58.2 million in fiscal 1997.
Depreciation and amortization on owned and leased property and
equipment was $57.1 million for fiscal 1998 as compared to $58.2 million for
fiscal 1997, a decrease of 2.0%. Capital expenditures, excluding capitalized
leases, increased to $50.7 million in fiscal 1998 as compared to $40.8 million
in fiscal 1997. The Company closed a net 11 stores in fiscal 1998 as compared to
closing a net 40 stores (including the 44 under performing stores) in fiscal
1997.
Interest Expense
Interest expense on debt and capitalized leases increased to $83.3
million in fiscal 1998 from $78.5 million in fiscal 1997. Interest expense for
the year increased primarily due to the term loan being outstanding for the full
year partially offset by lower average borrowings against the revolver under the
Amended and Restated Credit Facility.
Income Tax
The Company recognized an income tax benefit of $0.1 million for fiscal
1998 compared to $53.4 million for fiscal 1997. The decrease in the benefit was
primarily due to the recording of a full valuation allowance against deferred
tax assets of $41.8 million. The effective income tax rate was reduced to 0.1%
for fiscal 1998 compared to 37.5% for fiscal 1997.
Restructuring Plan
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 related to the Restructuring
Plan were completed
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in May 1998. Impairment charges recognized on the nine stores closed in fiscal
1998 were $5.2 million. The components of the restructuring charges and an
analysis of the amounts charged against the accrual during fiscal 1998 are
outlined in the following table:
1998 ACTIVITY
---------------------------------------------------------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
DECEMBER 28, RESTRUCTURING ASSET CHANGE IN JANUARY 3,
(in thousands) 1997 COSTS PAID WRITE-DOWNS ESTIMATE 1999
-------- ---------- ----------- -------- --------
Lease termination and other real estate costs $ 73,511 $(13,737) $ -- $ (6,613) $ 53,161
Property and equipment write-downs -- -- 5,706 (5,706) --
Employee severance 531 (155) -- (376) --
Other exit costs 2,200 -- -- (2,200) --
-------- -------- -------- -------- --------
Total $ 76,242 $(13,892) $ 5,706 $(14,895) 53,161
======== ======== ======== ========
Less: Current portion (7,864)
--------
$ 45,297
========
The Restructuring Plan adopted by the Company in 1997 was for the
closure of up to 60 stores and one distribution center. The Company closed less
than 60 stores primarily due to the inability to negotiate acceptable exit terms
from the related lessors. Restructuring costs paid during fiscal 1998 relate
primarily to lease termination and other real estate costs. Lease termination
and other real estate costs consist principally of the remaining rental payments
required under the closing stores' lease agreements, net of any actual or
reasonably probable sublease income, as well as early termination costs. The
Company will pay lease termination fees as the Company is able to obtain such
terminations or as it rejects such leases under the Chapter 11 Cases. The leases
remaining on closed locations as of January 3, 1999 vary in length with
expiration dates ranging from February 1999 to December 2030. The ultimate
timing of lease termination payments will depend on the Company's ability to
negotiate acceptable lease exit terms. Reduced margins and changes in selling,
general and administrative expenses are reflected in the operating results as
inventory associated with the closing stores is liquidated.
Changes in estimates are representative of conditions existing as of
January 3, 1999. Due to favorable lease termination experience in the second
half of fiscal 1998 and favorable experience related to the sale of property and
equipment associated with the store closures, restructure reserves of $14.9
million were reversed in the fourth quarter of fiscal 1998.
The Restructuring Plan was based on an analysis of individual store
performance based on cash flow return on committed capital, suitability within
marketing demographic profiles and strategic geographic positioning. After the
effect of charges and costs related specifically to the closings, the immediate
ongoing impact of the closings on net income was insignificant as the stores
closed were near break-even contributors.
During the second quarter of fiscal 1997, the Company also began
implementing certain remerchandising strategies, including the exit of the low
margin computer business and certain components of the wireless communication
business. Additional remerchandising decisions were executed in the first
quarter of fiscal 1998 with the exit of infant and pet supply categories and
certain components of the sporting goods business.
In the third quarter of fiscal 1998, the Company completed the
remerchandising portion of its restructuring and repositioning plan announced in
March 1997.
Impaired Assets
In the fourth quarter of fiscal 1998, the Company recorded a non-cash
impairment loss of $43.1 million related to a write-down of the Company's fixed
assets. The Company performed a long-lived asset impairment analysis due to
projected cash flow losses combined with current operating and cash flow losses
at certain store locations.
Assets are evaluated for impairment on an individual store basis which
management believes is the lowest level for which there are identifiable cash
flows. Projected future cash flows (undiscounted and without interest) were
compared to the carrying amount of assets at each location. If the carrying
amount of the assets exceeded the projected future cash flows, an
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17
impairment loss was recognized. Impaired assets were written-down to their
estimated fair value. Fair value was based on sales of similar assets or other
estimates of fair value such as discounting estimated future cash flows.
Considerable management judgment is necessary to estimate fair value.
Accordingly, actual results could vary significantly from such estimates.
Fiscal Year Ended December 28, 1997 Compared to Fiscal Year Ended December 29,
1996
Net loss for fiscal 1997 was $(91.6) million, or $(0.92) per share,
compared to net earnings of $39.3 million, or $0.39 per share, for the year
ended December 29, 1996 ("fiscal 1996"). The decrease in earnings was primarily
the result of a $129.5 million pre-tax restructuring charge taken in the first
quarter of fiscal 1997, a $37.4 million pre-tax loss associated with inventory
liquidations from closed facilities and remerchandising activities, lower sales
from operations excluding closed facilities and remerchandising activities, a
$4.2 million pre-tax extraordinary loss on the early extinguishment of debt and
efforts to change the Company's business strategy to concentrate on core
merchandise strengths in jewelry and home furnishings. Several initiatives were
implemented during fiscal 1997 including launching a new marketing model aimed
at expanding the Company's customer base, aligning product offerings into
thematic merchandise categories, closing under performing stores and replacing
the traditional clipboard system with a new customer-friendly pull-tag system.
However, these initiatives did not result in an improvement in sales or earnings
for the Company in fiscal 1997.
Net Sales
Net sales were $3.66 billion for fiscal 1997 compared to $3.96 billion
for fiscal 1996. The decrease of $292.2 million or 7.4%, was the result of a
3.1% decline in comparable store sales and a decline in net sales from closed
facilities and remerchandising activities of $125.4 million due to the closure
of 53 under performing stores. Net sales from operations excluding closed
facilities and remerchandising activities were $3.44 billion for fiscal 1997
compared to $3.54 billion for fiscal 1996, a decrease of $102.1 million or 2.9%.
Comparable store sales declined 3.1%. Jewelry comparable store sales were down
0.4%. Improvements in gold sales, jewelry special sales events and warranty
sales were offset by sales declines in watches, diamonds and precious and
semi-precious stones.
Hardline comparable store sales were down 4.1%. Sales improvements in
decorative home, seasonal, telephone, home furnishing and photo categories were
offset by sales declines in sporting and fitness, toys, small appliances,
housewares, audio and home office equipment.
Net sales from closed facilities and remerchandising activities were
$220.2 million for fiscal 1997 compared to $410.3 million for fiscal 1996. Sales
from closed facilities and remerchandising activities for fiscal 1997 decreased
from fiscal 1996 due to the closing of 44 under performing stores in fiscal
1997.
Gross Margin
Gross margin, after cost of merchandise sold and buying and occupancy
expenses, decreased as a percentage of net sales to 23.2% in fiscal 1997 from
24.2% in fiscal 1996. The decrease in the margin rate is primarily attributable
to the closed facilities and remerchandising activities and declining overall
performance.
Gross margin, after cost of merchandise sold and buying and occupancy
expenses, for operations excluding closed facilities and remerchandising
activities decreased to $843.0 million, or 24.5% of sales from operations
excluding closed facilities and remerchandising activities for fiscal 1997 as
compared to $880.1 million, or 24.8% of sales from operations excluding closed
facilities and remerchandising activities for fiscal 1996. Lower sales from
operations excluding closed facilities and remerchandising activities affected
the gross margin dollar performance. Overall improvements in both jewelry and
hardline merchandise margins were offset by increases in freight and buying and
occupancy costs resulting in the reduction in gross margin rate from last year.
Gross margin after cost of merchandise sold and buying and occupancy
expenses, for closed facilities and remerchandising activities was $8.0 million,
or 3.6% of sales from closed facilities and remerchandising activities for
fiscal 1997 as compared to $77.0 million, or 18.8% of sales from closed
facilities and remerchandising activities for fiscal 1996. The decline in both
gross margin dollars and rate was due to the merchandise discounts offered in
liquidating inventories at the 44 under performing stores as part of the
Company's restructuring and remerchandising programs.
15
18
Selling, General and Administrative Expenses
While selling, general and administrative expenses decreased $33.9
million in fiscal 1997 compared to fiscal 1996, they increased as a percentage
of net sales to 19.9% from 19.3% in fiscal 1996. This increase relative to sales
reflects the higher selling, general and administrative expenses cost structure
for the inventory liquidations and lower-than-planned sales in the fourth
quarter of fiscal 1997.
Selling, general and administrative expenses of operations excluding
closed facilities and remerchandising activities were $685.8 million, or 19.9%
of sales from operations excluding closed facilities and remerchandising
activities for fiscal 1997 compared to $695.7 million, or 19.3% of sales from
operations excluding closed facilities and remerchandising activities for fiscal
1996. A decrease in selling, general and administrative expenses associated with
reduced employment and advertising costs was not enough to offset the sales
volume decline, the net result being an increase in selling, general and
administrative expenses as a percentage of sales.
Selling, general and administrative expenses for closed facilities and
remerchandising activities were $43.9 million for fiscal 1997 compared to $67.8
million in fiscal 1996. The closing of the 44 under performing stores completed
in July 1997 resulted in the decreased selling, general and administrative costs
for the fiscal 1997.
Depreciation and Amortization
Depreciation and amortization on owned and leased property and
equipment was $58.2 million for fiscal 1997 as compared to $59.7 million for
fiscal 1996, a decrease of 2.4%. Capital expenditures, excluding capitalized
leases, remained relatively flat at $40.8 million in fiscal 1997 as compared to
$40.7 million in fiscal 1996. The Company closed a net 40 stores (including the
44 under performing stores) in fiscal 1997 as compared to closing a net nine
stores in fiscal 1996.
Interest Expense
Interest expense on debt and capitalized leases increased to $78.5
million in fiscal 1997 from $75.6 million in fiscal 1996. The increase is
primarily attributable to the issuance of $74.8 million in mortgage financing
notes that occurred primarily in the fourth quarter of fiscal 1996.
Income Tax
The effective income tax rate was 37.5% in fiscal 1997 and 1996.
Restructuring Plan
On March 25, 1997, the Company adopted the Restructuring Plan to close
up to 60 under performing stores and one distribution center. During the first
quarter of fiscal 1997, a pre-tax charge of $129.5 million for restructuring
costs was taken by the Company. The components of the restructuring charge and
an analysis of the amounts charged against the accrual through December 28, 1997
are outlined in the following table:
16
19
1997 ACTIVITY
----------------------------------------------------------------------
ACCRUED
RESTRUCTURING
ORIGINAL COSTS AS OF
CHARGE RESTRUCTURING ASSET CHANGE IN DECEMBER 28,
(in thousands) RECORDED COSTS PAID WRITE-DOWNS ESTIMATE 1997
--------- ---------- ----------- --------- ---------
Lease termination and other real estate costs $ 83,225 $ (12,812) $ -- $ 3,098 $ 73,511
Property and equipment write-downs 32,915 -- (32,915) -- --
Employee severance 4,869 (3,469) -- (869) 531
Other exit costs 8,501 (4,072) -- (2,229) 2,200
--------- --------- --------- --------- ---------
Total $ 129,510 $ (20,353) $ (32,915) $ -- 76,242
========= ========= ========= =========
Less: Current portion (21,178)
---------
$ 55,064
=========
In the second quarter of fiscal 1997, management began the process of
closing 44 of the up to 60 stores and one distribution center. These closures
were completed by the end of July 1997. Liquidation of the inventory associated
with these 44 closed stores began in April 1997 and was completed in July 1997.
During the second quarter of fiscal 1997, the Company implemented
certain remerchandising strategies, including the exit of the low margin
computer business and certain components of the wireless communication business.
LIQUIDITY AND CAPITAL RESOURCES
On March 27, 1999, the Debtors filed the Chapter 11 Cases which will
affect the Company's liquidity and capital resources in fiscal 1999. See Item 1.
"Business--Proceedings Under Chapter 11 of the Bankruptcy Code."
Availability under the Amended and Restated Credit Facility, trade
credit and terms from vendors, and long-term financing provided the resources
required to support operations, seasonal working capital requirements and
capital expenditures during fiscal 1998. 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. Disappointing sales during the
holiday season, higher than projected inventories and lower than projected
payables resulted in negative cash flows, lower cash and cash equivalent
balances and higher short-term borrowings at January 3, 1999 compared to the
prior year.
Net cash provided (used) by operations was ($291.4) million for fiscal
1998 as compared to ($21.4) million for fiscal 1997 and $65.7 million for fiscal
1996. Cash flow from operations decreased for fiscal 1998 compared to fiscal
1997 primarily as a result of: (a) a significant reduction in accounts payable
balances related to, (i) disappointing sales during the holiday selling season,
which resulted in lower purchase levels, (ii) effects from changes in store
formats, merchandise mix and shortened terms, (iii) the prepayment of floor plan
vendors who terminated their financing arrangements, (iv) the prepayment of
certain outstanding factored payables, (v) the prepayment of various sales and
use taxes in anticipation of a potential Chapter 11 bankruptcy filing, and (b)
lower annual sales. Cash flow from operations decreased for fiscal 1997 compared
to fiscal 1996 as a result of: (a) decreased earnings attributable in part to
cash payments related to restructuring and remerchandising activities; (b)
reductions in accounts payable due to: (i) decreased purchase volumes as a
result of the store closings, (ii) a negotiated contraction in payment terms in
exchange for revised economics with certain vendors, (iii) aggressive use of
anticipation discounts or cash in advance payments at year-end and (iv) changes
in merchandise mix which changed the average terms. These factors were partially
offset by inventory liquidations associated with the closing stores.
Net cash provided by financing activities was $97.1 million, $78.9
million and $58.4 million for fiscal 1998, 1997, and 1996, respectively. Cash
provided in fiscal 1998 from financing activities reflected short-term
borrowings at year-end, partially offset by the repayment of long-term debt and
capitalized leases in accordance with scheduled maturities or related to
mortgage payoffs on stores closed and sold. Cash provided in fiscal 1997 from
financing activities reflected a $200 million term loan obtained in connection
with the completion of the Company's $900 million, five-year Amended and
Restated Credit Facility in the third quarter of fiscal 1997. This was partially
offset by the retirement of $86.2 million of Senior Notes due 2001
17
20
and $17.4 million of debt issuance costs incurred primarily for the Amended and
Restated Credit Facility. Additionally, the Company paid $15.8 million in
mortgage payments including both prepayments and regularly scheduled payments.
In fiscal 1996, cash provided from financing activities reflected $73.6 million
in mortgage financing, which primarily consisted of a single 15-year financing
at a weighted average rate of 9.2%.
Capital Expenditures
Capital expenditures in fiscal 1998 and 1997 related primarily to the
remodeling of certain stores, new store construction, capital maintenance and
information systems expenditures. In fiscal 1998, the Company opened six stores
and closed 17 stores as compared to the opening of five stores and closing of 45
stores, including 44 under performing stores as part of the Restructuring Plan,
in fiscal 1997. In fiscal 1996, the Company opened six stores and closed 15
stores.
Planned capital expenditures for fiscal 1999 are expected to be
approximately $25.0 million and are expected to be directed primarily to capital
maintenance and information systems improvements. The Company expects to fund
these planned expenditures primarily with borrowings under the DIP Facility,
subject to Bankruptcy Court approval.
Capital Structure
The Company's principal source of liquidity during fiscal 1998 were
borrowings under the Amended and Restated Credit Facility, which included a $200
million term loan and a revolving credit facility with a maximum commitment
level of $700 million. At January 3, 1999, the Company had $156 million in
revolving loans outstanding under the Amended and Restated Credit Facility. The
Company had no borrowings outstanding thereunder on December 28, 1997.
Average short-term borrowings for fiscal 1998 decreased to $55.0
million as compared to $101.2 million for fiscal 1997, due primarily to the
addition of the term loan. Short-term borrowings under the revolver portion of
the Amended and Restated Credit Facility reached a maximum of $298.8 million
during fiscal 1998 as compared to $283.7 million in fiscal 1997.
Total debt as a percentage of total capital for fiscal 1998 was 79.8%
as compared to 70.2% in fiscal 1997 and 62.0% in fiscal 1996. The increase in
fiscal 1998 was due to the increase in revolver borrowings of $156 million and a
decline in shareholders' equity, which were partially offset by a decrease in
long-term debt.
On December 15, 1998, the Company announced that it had not made the
approximately $13.5 million interest payment due December 15, 1998 on its 9%
Subordinated Debentures. The related indenture provides for a 30 day grace
period. The Company stated that it would evaluate available alternatives during
that period. The Company obtained a 30 day waiver with respect to any cross
default under the Amended and Restated Credit Facility with respect to the
failure to make the December 15, 1998 interest payment. The non-payment of the
interest on the 9% Subordinated Debentures was a technical default under the
Amended and Restated Credit Facility and the Company's operating performance,
absent a waiver, would have resulted in a breach of the fixed-charge coverage
ratio covenants in agreements with First American National Bank and the Canadian
Imperial Bank of Commerce. On January 14, 1999, the Company made the
approximately $13.5 million interest payment on the 9% Subordinated Debentures.
As a first step in an effort to effect an out-of-court restructuring
plan, on January 20, 1999, the Company completed the Second Amended and Restated
Credit Facility, a $750 million, 30 month, asset-based credit facility replacing
the Amended and Restated Credit Facility. The Second Amended and Restated Credit
Facility included $150 million in term loans and a maximum of $600 million in
revolving loans. Financial covenants were subject to amendment pending the
finalization of the Company's business plan. The Second Amended and Restated
Credit Facility included a $200 million sub-facility for standby and trade
letters of credit. Interest rates on the Second Amended and Restated Credit
Facility were based on either Prime Rate + 1.50% or Eurodollar + 2.75%. The
Second Amended and Restated Credit Facility was secured by all material
unencumbered assets of the Company, including inventory but excluding previously
mortgaged property and leasehold interests.
Borrowings under the Second Amended and Restated Credit Facility were
limited based on a borrowing base formula which considered eligible inventories,
eligible accounts receivable and mortgage values on eligible real properties,
and limitations contained in the Company's public senior subordinated debt
indenture. The Second Amended and Restated Credit Facility contained certain
restrictive covenants, the most restrictive of which included: (a) maintenance
of an EBITDA amount (to be determined at a later date), (b) restrictions on
dividends and the incurrence of additional indebtedness, (c) restrictions on
incurring and assuming liens on property or assets, and (d) restrictions on
mergers, consolidations, and sales of assets, and (e) a capital spending maximum
of $50 million annually. Additionally, the Second Amended and Restated Credit
Facility
18
21
required borrowings outstanding under the revolving loans to be less than an
amount to be specified at a later date for a period of 30 consecutive days each
year. From the date of its completion through the filing of the Chapter 11 Cases
and completion of the DIP Facility, availability under the Second Amended and
Restated Credit Facility was the Company's primary source of liquidity.
On March 29, 1999, the Company entered into the DIP Facility which
replaces the Second Amended and Restated Credit Facility and which the Company
believes will provide liquidity for the Company's operations while it prepares a
reorganization plan. However, there can be no assurance that the Company will be
able to access liquidity from the DIP Facility or from any other source, or that
such liquidity will be sufficient to meet the Company's needs. On March 29,
1999, the Bankruptcy Court approved the DIP Facility on an interim basis. The
DIP Facility remains subject to final Bankruptcy Court approval. A hearing for
this purpose has been set for April 27, 1999. See Item 1. "Business--Proceedings
under Chapter 11 of the Bankruptcy Code."
Inflation
The Company does not believe inflation has had a material impact on the
Company's net sales or net earnings (loss) during the last three fiscal years.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
This pronouncement will be effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company is still in the process of analyzing
the impact of the adoption of this Statement. The Company anticipates that the
adoption of this Statement will not have a material impact on its operating
results or financial position.
YEAR 2000 COMPLIANCE
The Company is currently conducting an organization wide program to
ensure that all the systems critical to the operation of the Company are year
2000 compliant. In all categories the awareness and assessment phases are
complete. The renovation, validation (including testing) and implementation
phases are currently in progress. As of January 3, 1999, information technology
supported systems are approximately 90% complete and non-information technology
systems (end user systems) are approximately 95% complete. It is expected that
information technology supported systems will be completed by the end of the
second quarter of 1999 and end user systems will be completed in the first
quarter of 1999. In the course of the Company's preparation for year 2000, the
Company has corresponded with all software vendors, financial institutions, and
its top 1,000 merchandise vendors and we are monitoring their progress.
Replacement, conversion and testing of hardware and systems
applications are expected to cost between $2.5 million and $3.0 million. To
date, approximately $2.2 million of costs have been incurred. These costs are
being expensed as incurred.
Given that there can be no assurance that the systems of other entities
on which the Company relies will be year 2000 compliant in a timely manner, the
major risk factor associated with year 2000 pertains to our third party
relationships. The Company is currently developing contingency plans to address
a potential worst case scenario involving difficulties experienced by the U.S.
Postal Service in the distribution of direct mailings and other publications. If
such an event occurs, the Company would have to insert a majority of its
publications into local newspapers and other publications in lieu of mailing
them. If local utility companies are unable to provide services to any of our
locations, there is no contingency plan in place and our business would be at
risk. The Company is unable to determine the impact, if any, of the Chapter 11
Cases on the Company's year 2000 program.
19
22
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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. As of January 3, 1999, the Company was a party to interest rate
swaps covering $125 million in principal amount of indebtedness and expiring in
December 2000. These swaps exchange the Company's floating interest rate
exposure on $125 million in debt for fixed interest rate exposure. The Company
will pay a weighted average fixed rate of 5.97% on the $125 million notional
amount rather than the three-month LIBOR rate, which was 5.23% as of January 3,
1999. The fair value of the interest rate swap agreements was ($2.3) million as
of January 3, 1999. The following table summarizes as of January 3, 1999, the
amount of fixed interest rate indebtedness and the amount of variable rate
indebtedness that will become due in the stated period.
EXPECTED MATURITY DATES OF TERM LOAN AND LONG-TERM DEBT AS OF 1/3/99 (INCLUDING CURRENT PORTION)
------------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 Thereafter Total Fair Value
-------- -------- -------- -------- -------- ---------- -------- ----------
(in thousands)
Fixed Rate Debt $ 3,903 $ 4,417 $ 18,623 $ 5,074 $155,884 $217,591 $405,492 $164,171
Average interest rate 8.96% 8.96% 8.97% 8.97% 9.07% 9.05
Variable Rate Debt 20,138 17,333 3,962 220,008 0 20,300 281,741 272,010
-------- --------
Average interest rate 7.09% 7.19% 7.53% 8.26% 3.72% 3.72%
Total Debt $ 24,041 $ 21,750 $ 22,585 $225,082 $155,884 $237,891 $687,233 $436,181
======== ========
On March 27, 1999, the Debtors filed the Chapter 11 Cases. As a result
of the filing of the Chapter 11 Cases, principal or interest payments may not be
made on any pre-petition debt until a plan of reorganization defining the
repayment terms has been approved by the Bankruptcy Court.
20
23
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF OPERATIONS
FISCAL YEAR ENDED
-------------------------------------------
JANUARY 3, DECEMBER 28, DECEMBER 29,
(in thousands, except per share data) 1999 1997 1996
----------- ----------- -----------
Net sales:
Operations excluding closed facilities as a result of restructuring and
remerchandising activities $ 3,159,260 $ 3,442,617 $ 3,544,670
Closed facilities as a result of restructuring and remerchandising activities 10,265 220,161 410,346
----------- ----------- -----------
3,169,525 3,662,778 3,955,016
----------- ----------- -----------
Costs and Expenses:
Cost of merchandise sold and buying and occupancy expenses:
Operations excluding closed facilities as a result of restructuring and
remerchandising activities 2,396,245 2,599,617 $ 2,664,585
Closed facilities as a result of restructuring and remerchandising activities 19,011 212,145 333,376
----------- ----------- -----------
2,415,256 2,811,762 2,997,961
----------- ----------- -----------
Gross margin after cost of merchandise sold and buying and occupancy
expenses:
Operations excluding closed facilities as a result of restructuring and
remerchandising activities 763,015 843,000 880,085
Closed facilities as a result of restructuring and remerchandising activities (8,746) 8,016 76,970
----------- ----------- -----------
754,269 851,016 957,055
----------- ----------- -----------
Selling, general and administrative expenses:
Operations excluding closed facilities as a result of restructuring and
remerchandising activities 706,701 685,779 695,717
Closed facilities as a result of restructuring and remerchandising activities: 2,384 43,851 67,771
----------- ----------- -----------
709,085 729,630 763,488
----------- ----------- -----------
Other income, net (12,927) (2,571) (4,656)
Restructuring charge (14,895) 129,510 --
Impairment of assets 43,079 -- --
Depreciation and amortization:
Operations excluding closed facilities as a result of restructuring and
remerchandising activities 56,979 55,063 53,857
Closed facilities as a result of restructuring and remerchandising activities 93 3,185 5,802
----------- ----------- -----------
57,072 58,248 59,659
----------- ----------- -----------
Earnings (loss) before interest, income tax and extraordinary item: (27,145) (63,801) 138,564
Interest expense - debt 76,563 70,663 66,993
Interest expense - capitalized leases 6,692 7,868 8,643
----------- ----------- -----------
Earnings (loss) before income tax and extraordinary item (110,400) (142,332) 62,928
Income tax provision (benefit) (93) (53,375) 23,598
----------- ----------- -----------
Earnings (loss) before extraordinary item (110,307) (88,957) 39,330
Extraordinary loss from early extinguishment of debt, net of
tax benefit of $1,585 -- (2,643) --
----------- ----------- -----------
Net earnings (loss) $ (110,307) $ (91,600) $ 39,330
=========== =========== ===========
Per Common Share - basic and diluted:
Earnings (loss) before extraordinary item $ (1.11) $ (0.89) $ 0.39
Extraordinary loss from early extinguishment of debt, net of tax benefit $ -- $ (0.03) $ --
----------- ----------- -----------
Net earnings (loss) $ (1.11) $ (0.92) $ 0.39
=========== =========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
21
24
CONSOLIDATED BALANCE SHEETS
JANUARY 3, DECEMBER 28,
(In thousands, except per share data) 1999 1997
----------- -----------
ASSETS
Current Assets:
Cash and cash equivalents $ 133,749 $ 364,169
Accounts receivable, net of allowance of $2,999 and $3,456, respectively 38,098 43,130
Refundable income taxes 10,769 --
Inventories 896,303 929,818
Prepaid expenses and other assets 24,379 25,276
Deferred income taxes -- 22,478
----------- -----------
TOTAL CURRENT ASSETS 1,103,298 1,384,871
Net property and equipment - owned 439,710 490,345
Net property and equipment - capitalized expenses 21,297 33,289
Other assets and deferred charges 62,590 42,956
----------- -----------
TOTAL ASSETS $ 1,626,895 $ 1,951,461
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable to banks $ 156,000 $ --
Accounts payable 228,373 482,235
Accrued expenses 224,813 214,451
State and local sales taxes 1,726 48,331
Accrued restructuring costs 7,864 21,178
Borrowings classified as current 220,041 23,723
Current maturities of capitalized lease obligations 8,501 8,452
----------- -----------
TOTAL CURRENT LIABILITIES 847,318 798,370
Accrued restructuring costs 45,297 55,064
Long-term debt 467,192 711,512
Capitalized lease obligations 41,193 50,010
----------- -----------
TOTAL LIABILITIES 1,401,000 1,614,956
----------- -----------
Commitments and contingencies (Note Q)
SHAREHOLDERS' EQUITY
Preferred stock, $1 par value, authorized, 4,600 shares, undesignated as to
rate and other rights, none issued
Series A Junior Preferred Stock, $1 par value, authorized 1,100 shares,
none issued
Common stock, $.50 par value, authorized 500,000 shares, issued and
outstanding 100,340 and 100,376 shares, respectively 50,170 50,188
Additional paid-in capital 7,680 7,908
Deferred compensation (1,975) (2,787)
Accumulated other comprehensive income (loss) (869) --
Retained earnings 170,889 281,196
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 225,895 336,505
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,626,895 $ 1,951,461
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
22
25
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
COMMON STOCK ACCUMULATED
--------------------- ADDITIONAL OTHER
COMMON PAR PAID-IN DEFERRED COMPREHENSIVE COMPREHENSIVE
(in thousands) SHARES VALUE CAPITAL COMPENSATION LOSS LOSS
-------- --------- --------- ------------ --------- ---------
BALANCE DECEMBER 31, 1995 99,686 $ 49,843 $ 5,483 $ (2,050) $ -- $ --
Net earnings -- -- -- -- -- --
Exercise of stock options 52 26 93 -- -- --
Shares issued under restricted
stock awards 26 13 115 (128) -- --
Amortization of deferred compensation -- -- -- 927 -- --
Cancellation/forfeiture of restricted stock (6) (3) (21) -- -- --
-------- --------- --------- --------- --------- ---------
BALANCE DECEMBER 29, 1996 99,758 49,879 5,670 (1,251) -- --
Net loss -- -- -- -- -- --
Exercise of stock options 57 29 75 -- -- --
Shares issued under restricted
stock awards 621 310 2,393 (2,703) -- --
Amortization of deferred compensation -- -- -- 948 -- --
Cancellation/forfeiture of restricted stock (60) (30) (230) 219 -- --
-------- --------- --------- --------- --------- ---------
BALANCE DECEMBER 28, 1997 100,376 50,188 7,908 (2,787) -- --
Comprehensive loss:
Net loss -- -- -- -- (110,307) --
Minimum pension liability adjustment -- -- -- -- (869) (869)
---------
Comprehensive net loss $(111,176)
=========
Shares issued under restricted
stock awards 50 25 83 (108) --
Amortization of deferred compensation -- -- -- 625 --
Cancellation/forfeiture of restricted stock (86) (43) (311) 295 --
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE JANUARY 3, 1999 100,340 $ 50,170 $ 7,680 $ (1,975) $ (869)
======== ========= ========= ========= =========
(in thousands) RETAINED
EARNINGS TOTAL
--------- ---------
BALANCE DECEMBER 31, 1995 $ 333,466 $ 386,742
Net earnings 39,330 39,330
Exercise of stock options -- 119
Shares issued under restricted
stock awards -- --
Amortization of deferred compensation -- 927
Cancellation/forfeiture of restricted stock -- (24)
--------- ---------
BALANCE DECEMBER 29, 1996 372,796 427,094
Net loss (91,600) (91,600)
Exercise of stock options -- 104
Shares issued under restricted
stock awards -- --
Amortization of deferred compensation -- 948
Cancellation/forfeiture of restricted stock -- (41)
--------- ---------
BALANCE DECEMBER 28, 1997 281,196 336,505
Comprehensive loss:
Net loss (110,307) (110,307)
Minimum pension liability adjustment -- (869)
Comprehensive net loss
Shares issued under restricted
stock awards -- --
Amortization of deferred compensation -- 625
Cancellation/forfeiture of restricted stock -- (59)
- ----------------------------------------------------------------------
BALANCE JANUARY 3, 1999 $ 170,889 $ 225,895
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
23
26
CONSOLIDATED STATEMENTS OF CASH FLOWS
FISCAL YEAR ENDED
-----------------------------------------
JANUARY 3, DECEMBER 28, DECEMBER 29,
(In thousands) 1999 1997 1996
---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $(110,307) $ (91,600) $ 39,330
Adjustments to reconcile net earnings (loss) to net
cash provided (used) by operating activities:
Depreciation and amortization (a) 63,820 62,345 62,683
Deferred income tax 24,303 (39,663) (1,244)
Gain on sale of property and equipment (12,927) (2,571) (4,656)
Write-down of property due to asset impairment 43,079 -- --
Write-down of property due to restructuring -- 32,915 --
Reversal of restructuring charges (14,895) -- --
Write-off of debt issue costs -- 2,208 --
Changes in assets and liabilities:
Accounts receivable 5,032 18,324 (7,833)
Inventories 33,515 123,151 (18,502)
Prepaid expenses and other assets (7,576) (1,368) 9,816
Accounts payable (253,862) (157,652) (39,219)
Accrued expenses (36,872) (9,866) 20,673
Accrued restructuring costs (13,892) 76,242 --
Income tax (10,769) (33,898) 4,689
--------- --------- ---------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES: (291,351) (21,433) 65,737
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (50,676) (40,838) (40,746)
Proceeds from sale of property and equipment 44,845 19,574 9,855
Restricted cash and other assets, net (30,358) (2,006) 965
--------- --------- ---------
NET CASH USED BY INVESTING ACTIVITIES: (36,189) (23,270) (29,926)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 156,000 483,700 421,700
Repayment of short-term borrowings -- (483,700) (421,700)
Proceeds from long-term debt -- 206,560 73,563
Repayment of term loan and long-term debt (48,002) (101,999) (2,486)
Repayment of capitalized lease obligations (8,649) (8,395) (8,693)
Debt issuance costs (2,170) (17,350) (4,048)
Exercise of stock options (forfeiture of restricted stock), net (59) 63 95
--------- --------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 97,120 78,879 58,431
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (230,420) 34,176 94,242
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 364,169 329,993 235,751
--------- --------- ---------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 133,749 $ 364,169 $ 329,993
========= ========= =========
SUPPLEMENTAL DATA:
Cash paid (received) during the year for:
Interest $ 63,632 $ 78,400 $ 71,300
Income tax $ (17,442) $ 21,100 $ 19,900
Non-cash financing activities --
Other comprehensive loss $ (869) $ -- $ --
(a) Includes other amortization classified as either selling, general and
administrative expense or interest expense of $6,748 for fiscal 1998,
$4,058 for fiscal 1997, $2,972 for fiscal 1996, and $0, $39 and $52 of
discount amortization classified as interest expense in fiscal 1998, 1997
and 1996, respectively.
The accompanying notes are an integral part of these consolidated financial
statements.
24
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED JANUARY 3, 1999
A. DESCRIPTION OF THE BUSINESS
The Company is one of the nation's largest retailers of jewelry and
offers a selection of brand-name hard goods and other product lines. The major
categories of goods offered by the Company are fine jewelry, kitchen and dining,
home accents and furniture, looking healthy/staying healthy, season to season,
travel and adventure, electronics and kid essentials. Customer purchases
typically take place in a Company store. The Company is engaged in a highly
competitive business and competes with most nationally known jewelry and general
retail merchandisers, including department, general merchandise, specialty and
discount stores. As of January 3, 1999, the Company operated 350 stores in 34
states.
B. SUBSEQUENT EVENTS AND GOING CONCERN MATTERS
Subsequent Events -- Out-of-Court Restructuring Plan
As a result of the Company's decreased net sales in the fourth quarter
of fiscal 1998 and the resulting negative cash flows from operations, in January
1999 the Company began an effort to effect an out-of-court restructuring plan.
As part of this out-of-court restructuring plan, on January 20, 1999, the
Company entered into a credit facility with Citibank, N.A. (the "Second Amended
and Restated Credit Agreement"). The Company also developed a plan to close up
to 132 stores, up to four distribution centers and to reduce corporate overhead
(the "Rationalization Plan"). In March 1999 as part of the Rationalization Plan,
the Company announced the closing of the Dallas distribution center and the
reduction of its workforce at its Nashville corporate offices by 150 employees.
As a result of the filing of the Chapter 11 Cases (as discussed below), aspects
of the Rationalization Plan not implemented by March 27, 1999 or not approved to
date by the Bankruptcy Court may be subject to Bankruptcy Court approval.
Subsequent Events -- Proceedings Under Chapter 11 of the Bankruptcy
Code
Before the Company was able to effect an out-of-court restructuring, on
March 15, 1999, five of the Company's vendors filed an involuntary petition for
reorganization under Chapter 11 ("Chapter 11") of title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
for the Middle District of Tennessee (the "Bankruptcy Court") seeking court
supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries (collectively, the "Debtors") filed voluntary
petitions with the Bankruptcy Court for reorganization under Chapter 11 under
case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and orders for
relief were entered by the Bankruptcy Court. The Chapter 11 Cases have been
consolidated for the purpose of joint administration under Case No. 399-02649.
The Debtors are currently operating their businesses as debtors-in-possession
pursuant to the Bankruptcy Code.
Actions to collect pre-petition indebtedness are stayed and other
contractual obligations against the Debtors may not be enforced. In addition,
under the Bankruptcy Code the Debtors may assume or reject executory contracts,
including lease obligations. Parties affected by these rejections may file
claims with the Bankruptcy Court in accordance with the reorganization process.
Substantially all pre-petition liabilities are subject to settlement under a
plan of reorganization to be voted upon by creditors and equity holders and
approved by the Bankruptcy Court. Although the Debtors expect to file a
reorganization plan or plans that provide for emergence from bankruptcy in 2000
or 2001, there can be no assurance that a reorganization plan or plans will be
proposed by the Debtors or confirmed by the Bankruptcy Court, or that any such
plan(s) will be consummated. As provided by the Bankruptcy Code, the Debtors
initially have the exclusive right to submit a plan of reorganization for 120
days. Further extensions may be sought and may be granted or rejected by the
Bankruptcy Court. 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. A plan of reorganization could also result in holders of the
Common Stock receiving no value for their interests. Because of such
possibilities, the value of the Common Stock is highly speculative.
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,
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benefits and other employee obligations, to pay vendors and other providers in
the ordinary course for goods and services received from March 15, 1999, and to
honor customer service programs, including warranties, returns, layaways and
gift certificates.
The Company has entered into an agreement dated March 29, 1999 with
Citicorp USA, Inc., as administrative agent, BankBoston, N.A. as documentation
agent and collateral monitoring agent, and Salomon Smith Barney Inc. as sole
arranger and book manager, for a debtor-in-possession credit facility (the "DIP
Facility") under which the Company may borrow up to $750 million, subject to
certain limitations, to fund ongoing working capital needs while it prepares a
reorganization plan. The DIP Facility includes $100 million in term loans and a
maximum of $650 million in revolving loans. Financial covenants are subject to
amendment pending the finalization of the Company's business plan. The DIP
Facility includes a $200 million sub-facility for standby and trade letters of
credit. Interest rates on the DIP Facility are based on either the Citibank N.A.
Alternative Base Rate plus 1.25% for ABR Loans or 2.25% over LIBOR or Eurodollar
Loans. The DIP Facility is secured by substantially all of the assets of the
Company and its subsidiaries, subject only to valid, enforceable, subsisting and
non-voidable liens of record as of the date of commencement of the Chapter 11
Cases, and other liens permitted by the DIP Facility.
Borrowings under the DIP Facility are limited based on a borrowing base
formula which considers eligible inventories, eligible accounts receivable,
trade letters of credit and mortgage values on eligible real properties. The DIP
Facility contains restrictive covenants which are substantially similar to those
contained in the Second Amended and Restated Credit Facility, and are subject to
amendment pending finalization of the Company's business plan. The Company's
ability to obtain new borrowings after the first anniversary of the DIP Facility
is subject to the Company and the lenders having agreed upon a business plan and
revised financial and other covenants.
On March 29, 1999, the Bankruptcy Court approved the DIP Facility on an
interim basis. The final hearing with respect to the DIP Facility has been set
for April 27, 1999. The Company believes the DIP Facility (if finally approved
by the Bankruptcy Court) should provide it with adequate liquidity to conduct
its operations while it prepares a reorganization plan.
Going Concern Matters
The accompanying consolidated financial statements have been prepared
on a going concern basis of accounting and do not reflect any adjustments that
might result if the Company is unable to continue as a going concern. The
Company's recent losses and negative cash flows from operations, and the Chapter
11 Cases raise substantial doubt about the Company's ability to continue as a
going concern. As discussed above, management intends to submit a plan for
reorganization to the Bankruptcy Court. The ability of the Company to continue
as a going concern and appropriateness of using the going concern basis is
dependent upon, among other things, (i) the Company's ability to obtain and
comply with debtor-in-possession financing agreements, (ii) confirmation of a
plan of reorganization under the Bankruptcy Code, (iii) the Company's ability to
achieve profitable operations after such confirmation, and (iv) the Company's
ability to generate sufficient cash from operations to meet its obligations.
Management believes that the plan of reorganization, as it is being
developed and subject to approval of the Bankruptcy Court, and the DIP Facility,
along with cash provided by 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. 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.
C. FINANCIAL STATEMENT PRESENTATION
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.
The Company's consolidated statements of operations presentation
changed in fiscal 1997 to disclose the financial statement impact of the
inventory liquidations associated with the closed facilities as a result of
restructuring and remerchandising activities. The line item "Closed facilities
as a result of restructuring and remerchandising activities" represents activity
specifically identifiable to inventory liquidations conducted in conjunction
with (1) the Company's restructuring plan
26
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adopted on March 25, 1997 ("Restructuring Plan") and (2) exiting the computer,
infant, pet supply and other merchandise categories and certain components of
the wireless communication and sporting goods categories as part of a
remerchandising program. As of January 3, 1999, 53 stores, one distribution
center and primarily all of the aforementioned merchandise categories have been
liquidated. All activity for these items is classified in "Closed facilities as
a result of restructuring and remerchandising activities." Prior year amounts
reflect operating results for these same facilities and merchandise
classifications. Selling, general and administrative expenses for closed
facilities as a result of restructuring and remerchandising activities does not
include any allocation of corporate overhead.
D. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation: The consolidated financial statements
include the accounts of the Company and its subsidiaries, all of which are
wholly-owned. All significant intercompany transactions and balances have been
eliminated.
Fiscal year: The Company maintains its books using a 52/53 week year
ending on the Sunday closest to the end of the calendar year. There were 53
weeks in the fiscal year ended January 3, 1999 and 52 weeks in each of the
previous two fiscal years.
Use of estimates: The preparation of the consolidated financial
statements, in conformity with generally accepted accounting principles,
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and related notes to the
consolidated financial statements. Changes in such estimates may affect amounts
reported in future periods.
Cash and cash equivalents: Cash and cash equivalents include cash on
hand and short-term, highly liquid investments which generally include
commercial paper, time deposits, securities under repurchase agreements, tax
exempt variable rate securities, master notes and institutional money market
funds, with an original maturity date less than 30 days. These investments are
valued at cost, which approximates market, and have a weighted-average interest
rate of 5.8% in the fiscal years ended January 3, 1999 and December 28, 1997.
Accounts receivable: Accounts receivable primarily includes trade
accounts, vendor allowances and customer layaway receivables and receivables for
income earned on the private label credit card.
Inventories: Inventories are valued at the lower of cost or market.
Cost is determined utilizing the first-in, first-out method and includes certain
buying and warehousing costs.
Advertising: The Company generally expenses the costs of producing and
communicating advertising the first time the advertising takes place. Net
advertising expense was $133.0 million, $135.0 million and $144.0 million for
fiscal 1998, 1997 and 1996, respectively. Advertising costs of $10.6 million and
$7.8 million were included in prepaid expenses at January 3, 1999 and December
28, 1997, respectively.
Property and equipment - owned: Owned property and equipment are stated
at cost. Depreciation and amortization are provided principally on the
straight-line method over a period of five to 10 years for furniture, fixtures
and equipment and 30 years for buildings. Leasehold improvements are depreciated
over the lesser of the life of the asset or the real estate lease term.
Accelerated depreciation methods are used for income tax purposes.
Property and equipment - capitalized leases: Capitalized leases are
recorded at the lower of fair value of the leased property or the present value
of the minimum lease payments at the inception of the lease. Amortization of
leased property is computed using the straight-line method over the lesser of
the life of the leased asset or the term of the lease.
Deferred charges and other assets: Deferred charges consist primarily
of debt issuance costs and deferred finance charges which are amortized over the
life of the related debt. This amortization is classified as interest expense.
Other assets primarily consist of restricted cash required by the private label
credit card agreement.
Derivative financial instruments: As part of a strategy to maintain an
acceptable level of exposure to the risk of interest rate fluctuation, the
Company has developed a targeted mix of fixed-rate versus variable rate debt.
The Company utilizes interest rate swaps to manage this mix. All outstanding
interest rate swaps have been designated as hedges of debt
27
30
instruments. The Company recognizes interest differentials as adjustments to
interest expense in the period they occur. Gains and losses on terminations of
interest rate swaps would be deferred and amortized to interest expense over the
shorter of the original term of the agreements or the remaining life of the
associated outstanding debt. The counterparties to these instruments are major
financial institutions. The fair value of the Company's interest rate swap
agreements is based on dealer quotes. These values represent the amounts the
Company would receive or pay to terminate the agreements taking into
consideration current interest rates. These counterparties expose the Company to
credit risk in the event of non-performance; however, the Company does not
anticipate non-performance by the other parties. The Company does not hold or
issue derivative financial instruments for trading purposes.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
This pronouncement will be effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. The Company is still in the process of analyzing
the impact of the adoption of this Statement. The Company anticipates that the
adoption of this Statement will not have a material impact on its operating
results or financial position.
Impairment of assets: The Company reviews long-lived assets for
impairment whenever events or changes in circumstances indicate that net book
value of the asset may not be recoverable in accordance with the SFAS No. 121,
"Accounting for Impairment of Long-Lived Assets to Be Disposed Of." The impact
of SFAS No. 121 for fiscal 1998 is disclosed in Note G in these consolidated
financial statements.
Insurance: In July 1998, Service Plus Assurance Company, Ltd., a
wholly-owned insurance company incorporated under the laws of Bermuda, was
established to provide coverage for the retained loss portion of the Company's
workers' compensation and general liability coverage. Accordingly, provisions
are made for the Company's discounted actuarially determined estimates of future
claim costs for such risks. To the extent that subsequent claim costs vary from
those estimated, current earnings are charged or credited.
Stock-based compensation: The Company accounts for stock-based employee
compensation in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. The pro
forma impact of the fair value method of accounting for stock-based employee
compensation is disclosed in Note K to these consolidated financial statements
in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation."
Store opening costs: Costs of opening new stores are charged to
operations as incurred.
Income tax: The Company reports income taxes in accordance with SFAS
No. 109, "Accounting for Income Taxes." Under SFAS No. 109, the asset and
liability method is used for computing future income tax consequences of events
which have been recognized in the Company's consolidated financial statements or
income tax returns. Deferred income tax expense or benefit is the change during
the year in the Company's deferred income tax assets and liabilities.
Net earnings (loss) per common share: Net earnings (loss) per common
share for all periods have been computed in accordance with SFAS No. 128,
"Earnings Per Share." Basic net earnings (loss) per common share is computed by
dividing net earnings (loss) by the weighted average number of common shares
outstanding during the year. 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 year plus incremental shares that would
have been outstanding upon the assumed vesting of dilutive restricted stock and
the assumed exercise of dilutive stock options. See Note L for a reconciliation
of basic and diluted earnings (loss) per share.
Comprehensive Loss: Comprehensive loss is reported in accordance with
SFAS No. 130, "Reporting Comprehensive Income." Other comprehensive loss
includes minimum pension liability adjustments. For fiscal 1997 and 1996 net
income (loss) equaled comprehensive income (loss). See Note N for reporting of
minimum pension liabilities.
Retirement Plans and Other Postretirement Benefits: The Company reports
all information on its retirement plans and other postretirement benefits in
accordance with SFAS No. 132, "Employers' Disclosure about Pensions and Other
Postretirement Benefits". All periods reported have been stated in accordance
with SFAS 132. See Note N, "Retirement Plans".
Segment Reporting: The Company has adopted SFAS No. 131, "Disclosure
about Segments of an Enterprise and Related Information" during the year ended
January 3, 1999. See Note R, "Segment Reporting".
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Reclassification: Certain reclassifications have been made to fiscal
1997 and 1996 to conform to the fiscal 1998 presentation.
E. RESTRUCTURING PLAN
On March 25, 1997, the Company adopted a business restructuring plan to
close up to 60 under performing stores and one distribution center. As a result,
a pre-tax charge of $129.5 million for restructuring costs was taken in the
first quarter of fiscal 1997. The components of the restructuring charge and an
analysis of the amounts charged against the accrual during fiscal 1998 are
outlined in the following table:
1998 ACTIVITY
---------------------------------------------------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
DECEMBER 28, RESTRUCTURING ASSET CHANGE IN JANUARY 3,
(in thousands) 1997 COSTS PAID WRITE-DOWNS ESTIMATE 1999
-------- ---------- ----------- -------- --------
Lease termination and other real estate costs $ 73,511 $(13,737) $ -- $ (6,613) $ 53,161
Property and equipment write-downs -- -- 5,706 (5,706) --
Employee severance 531 (155) -- (376) --
Other exit costs 2,200 -- -- (2,200) --
-------- -------- -------- -------- --------
Total $ 76,242 $(13,892) $ 5,706 $(14,895) 53,161
======== ======== ======== ========
Less: Current portion (7,864)
--------
$ 45,297
========
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 due to the inability to
negotiate acceptable exit terms from the related lessors.
Restructuring costs paid during fiscal 1998 relate primarily to lease
termination and other real estate costs. The Company incurred $7.7 million in
contractual rent payments and lease termination fees and $6.0 million in other
real estate costs primarily related to utilities, common area maintenance fees,
real estate taxes and brokerage costs. The Company will pay lease termination
fees as the Company is able to obtain such terminations or as it rejects such
leases under the Chapter 11 Cases. In fiscal 1998, the Company paid $1.8 million
in lease termination fees compared with $4.1 million in fiscal 1997. The leases
remaining on closed locations as of January 3, 1999 vary in length with
expiration dates ranging from February 1999 to December 2030. The ultimate
timing of lease termination payments will depend on the Company's ability to
negotiate acceptable lease exit terms. The Company believes changes in estimates
are representative of deteriorating conditions existing as of January 3, 1999.
Restructure reserves of $14.9 million were reversed in the fourth quarter of
fiscal 1998 primarily due to favorable lease termination experience in the
second half of fiscal 1998 and favorable experience related to the sale of
property and equipment associated with the store closures.
As of January 3, 1999, property and equipment associated with the
Restructuring Plan have been written-down to reflect their estimated fair value.
Management anticipates selling or abandoning substantially all remaining owned
property and equipment associated with the Restructuring Plan. Approximately
3,000 employees were terminated pursuant to the Restructuring Plan. All such
terminations were completed as of May 1998.
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F. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
(In thousands) 1/3/99 12/28/97
----------- -----------
Owned assets:
Land $ 97,161 $ 106,551
Buildings 386,071 412,135
Furniture, fixtures and equipment 399,221 371,762
Leasehold improvements 108,375 110,672
Construction in progress 66 236
Other 2,484 6,618
----------- -----------
993,378 1,007,974
Less: Accumulated depreciation and amortization (553,668) (517,629)
----------- -----------
Owned assets, net $ 439,710 $ 490,345
=========== ===========
Capitalized leases:
Real estate $ 93,251 $ 99,750
Furniture, fixtures and equipment 7,046 10,274
----------- -----------
100,297 110,024
Less: Accumulated amortization (79,000) (76,735)
----------- -----------
Capitalized leases, net $ 21,297 $ 33,289
=========== ===========
G. IMPAIRED ASSETS
In the fourth quarter of fiscal 1998, the Company recorded a non-cash
impairment loss of $43.1 million related to a write-down of the Company's fixed
assets. The Company performed a long-lived impairment analysis due to projected
cash flow losses combined with current operating and cash flow losses at certain
store locations.
Assets are evaluated for impairment on an individual store basis which
management believes is the lowest level for which there are identifiable cash
flows. Projected future cash flows (undiscounted and without interest) were
compared to the carrying amount of assets at each location. If the carrying
amount of the assets exceeded the projected future cash flows, an impairment
loss was recognized. Impaired assets were written-down to their estimated fair
value. Fair value was based on sales of similar assets or other estimates of
fair value such as discounting estimated future cash flows. Considerable
management judgment is necessary to estimate fair value. Accordingly, actual
results could vary significantly from such estimates. The following table is a
summary of the impairment charges recognized:
IMPAIRMENT
ASSET TYPE AMOUNT
---------------------- -------
Land $ 3,196
Buildings 6,501
Furniture and Fixtures 16,470
Leasehold Improvements 12,011
Capital Lease Assets 4,901
-------
TOTAL $43,079
=======
H. BORROWINGS
This note contains information regarding the Company's short-term
borrowings and long-term debt as of January 3, 1999. On March 27, 1999, the
Company filed the Chapter 11 Cases. See Note B. As a result of the filing of the
Chapter 11 Cases, no principal or interest payments will be made on any
pre-petition debt until a plan of reorganization defining the repayment terms
has been approved by the Bankruptcy Court.
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The Company had a $900 million, fully-committed, asset-based credit
facility ("Amended and Restated Credit Facility") in place as of January 3, 1999
and December 28, 1997. The Amended and Restated Credit Facility included $200
million in term loans and up to a maximum of $700 million in revolving loans
including a $175 million subfacility for letters of credit. The Amended and
Restated Credit Facility was scheduled to mature on September 10, 2002. Interest
rates on the Amended and Restated Credit Facility were subject to change based
on a financial performance-based grid and could not exceed a rate of LIBOR
+2.25% on revolving loans and LIBOR +2.50% on the term loan. As of January 3,
1999 the revolving loans carried a rate of Prime +1.25% on both the term loan
and the revolver of LIBOR + 2.25%. The weighted-average interest rate on
borrowings under the Company's credit facilities in fiscal 1998 and 1997 was
8.0% and 7.8% respectively. There was a commitment fee of 3/8% on the undrawn
portion of the revolving loans. Revolving loans outstanding under the Amended
and Restated Credit Facility were $156 million and $0 as of January 3, 1999 and
December 28, 1997. The Amended and Restated Credit Facility was secured by all
material unencumbered assets of the Company and its subsidiaries, including
inventory but excluding previously mortgaged property and leasehold interests.
These security interests would have automatically terminated when the Company's
senior debt (or implied senior debt) achieves investment grade credit rating or
the Company met certain performance targets.
Borrowings under the Amended and Restated Credit Facility were limited
based on (a) a borrowing base formula which considers eligible inventories,
eligible accounts receivable and mortgage values on eligible real properties and
(b) limitations contained in the Company's public senior subordinated debt
indenture. Approximately $381.6 million of borrowings were unused and available
under the Amended and Restated Credit Facility as of January 3, 1999. The
Amended and Restated Credit Facility contained certain restrictive covenants,
the most restrictive of which included: (a) maintenance of a leverage ratio and
fixed charge coverage ratio, (b) restrictions on dividends, capital spending,
and the incurrence of additional indebtedness, (c) restrictions on incurring and
assuming liens on property or assets, and (d) restrictions on mergers,
consolidations, and sales of assets. The Amended and Restated Credit Facility
excluded from financial covenant calculations the impact of up to $175 million
of pre-tax charges and costs related to restructuring charges. Additionally, the
Amended and Restated Credit Facility required borrowings outstanding under the
revolving loans to be less than $150 million for a period of 30 consecutive days
each year. On October 28, 1998, the Company amended the Amended and Restated
Credit Facility to reduce the fixed charge coverage ratio from 1.25:1.0 to 1.05:
1.0 for the fourth quarter of fiscal 1998, for which the Company was not in
compliance.
As part of an out-of-court restructuring plan, on January 20, 1999, the
Company completed the Second Amended and Restated Credit Facility, a $750
million, 30 month, asset-based credit facility replacing the Amended and
Restated Credit Facility. The Second Restated and Amended Credit Facility
included $150 million in term loans, a maximum of $600 million in revolving
loans and a commitment fee of $23 million. Financial covenants were subject to
amendment pending the finalization of the Company's business plan. The Second
Amended and Restated Credit Facility included a $200 million sub- facility for
standby and trade letters of credit. Prior to the filing of the Chapter 11
Cases, interest rates on the Second Amended and Restated Credit Facility were
based on either Prime Rate + 1.50% or Eurodollar + 2.75%. The Second Amended and
Restated Credit Facility was secured by all material unencumbered assets of the
Company and its subsidiaries, including inventory but excluding previously
mortgaged property and leasehold interests.
Borrowings under the Second Amended and Restated Credit Facility were
limited based on a borrowing base formula which considered eligible inventories,
eligible accounts receivable and mortgage values on eligible real properties and
limitations contained in the Company's public senior subordinated debt
indenture. The Second Amended and Restated Credit Facility contained certain
restrictive covenants, the most restrictive of which included: (a) maintenance
of an EBITDA amount (to be determined at a later date), (b) restrictions on
dividends and the incurrence of additional indebtedness, (c) restrictions on
incurring and assuming liens on property or assets, (d) restrictions on mergers,
consolidations, and sales of assets, and (e) a capital spending maximum of $50
million annually. Additionally, the Second Amended and Restated Credit Facility
required borrowings outstanding under the revolving loans to be less than an
amount to be specified at a later date for a period of 30 consecutive days each
year. All borrowings under the Second Amended and Restated Credit Facility as of
January 3, 1999 are classified as current.
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Borrowings consists of the following:
(in thousands) 1/3/99 12/28/97
--------- ---------
9% Senior Subordinated Debentures, payable in equal
installments in 2003 and 2004 $ 300,000 $ 300,000
Term loan, variable interest rate at January 3, 1999 of 7.76%,
payable in quarterly installments to 2002 196,000 200,000
8 3/8% Senior Notes due 2001 13,799 13,799
First Mortgage Secured Notes, variable interest rate at January
3, 1999 of 6.64%, payable in varying amounts from 1998
to 2002 62,707 90,000
Real Estate Mortgage Financing Notes, weighted-average
fixed interest rate at January 3, 1999 of 9.12%, payable in
mortgage installments to 2011 69,264 71,987
Industrial Revenue Bonds, fixed and variable interest rates,
weighted-average interest rate at January 3, 1999 of 3.5%,
payable in varying amounts to 2024 24,300 37,185
Mortgage notes payable, weighted-average fixed interest rate
at January 3, 1999 of 8.08%, payable in varying amounts
to 2022 21,163 22,264
--------- ---------
687,233 735,235
Less: Borrowings classified as current (220,041) (23,723)
--------- ---------
Long-term debt $ 467,192 $ 711,512
========= =========
The Term Loan above has been classified as current, however the future scheduled
principal payments for the Company's borrowings (which are subject to being
restructured in connection with the Chapter 11 Cases) were as follows as of
January 3, 1999:
(In thousands)
Fiscal Year
-------------------
1999 $ 24,041
2000 21,750
2001 22,585
2002 225,082
2003 155,884
Thereafter 237,891
--------
Total $687,233
========
During fiscal 1997, the Company retired $86.2 million of the Company's
$100 million 8 3/8% Senior Notes due 2001. As a result of this early retirement,
the Company recorded an extraordinary loss of $2.0 million after tax, or $0.02
per share. Additionally, a non-cash extraordinary loss of $0.6 million, or $0.01
per share, was recorded to write-off deferred financing charges associated with
the replacement of the Company's $525 million Reducing Revolving Credit Facility
with the Amended and Restated Credit Facility.
The Company has entered into an agreement with the Long Term Credit
Bank of Japan ("LTCB") in which LTCB will lend to the Company a total of $50
million in three equal installments of $16.7 million in June of 1998, 1999 and
2000 as its portion of the First Mortgage Secured Notes matures. The new notes
will carry a floating interest rate of LIBOR + 2.25%, mature on March 1, 2002
and will be secured with a second lien on the properties securing the $90
million permanent mortgage financing until those notes are paid, at which time,
the Company will provide first liens on certain properties to secure this note.
In fiscal 1997 the Company issued $6.6 million of Real Estate Financing
Notes to a bank.
32
35
The 9% Senior Subordinated Debentures are subordinated to all senior
indebtedness of the Company, as defined, and are callable, at the Company's
option, at a premium of 104.5%, which decreases annually until reaching par in
December 2000. Interest on the debentures is payable semi-annually in June and
December. The Company delayed its interest payment due December 15, 1998. The
payment was made January 14, 1999. The non-payment of the interest was a
technical default under the Amended and Restated Credit Facility and the
Company's operating performance, absent a waiver, would have resulted in a
breach of the fixed-charge coverage ratio covenants in agreements with First
American National Bank and the Canadian Imperial Bank of Commerce. A waiver was
granted to the Company by those parties to waive the default until January 15,
1999. The technical default was cured upon payment.
Mortgages and Industrial Revenue Bonds are collateralized by property
and equipment having a net book value of approximately $26.3 million and $16.1
million, respectively, at January 3, 1999. The Industrial Revenue Bonds are
primarily floating rate demand obligations.
The Company has commercial and standby letters of credit used to secure
corporate obligations. The commercial letters of credit have contractual amounts
totaling $57.4 million and $44.5 million at January 3, 1999 and December 28,
1997, respectively. The standby letters of credit have contractual amounts
totaling $49.0 million and $59.0 million at January 3, 1999 and December 28,
1997, respectively.
General terms of the Company's debtor-in-possession financing facility
are discussed in Note B.
I. LEASE COMMITMENTS
The Company has both capital and operating lease agreements for stores
and other facilities as well as for certain furniture, fixtures and equipment.
Under most of these lease agreements, the Company pays taxes, insurance and
maintenance costs. Initial lease terms for stores generally range from 10 to 25
years with renewal periods for an additional five to ten years. Certain store
leases provide for additional contingent rental payments based on a percentage
of sales in excess of specified minimum amounts.
Future minimum lease payments as of January 3, 1999 (inclusive of
leases at closed stores that have not yet been terminated) are as follows:
CAPITALIZED LEASE
OBLIGATIONS
--------------------------------
FURNITURE,
FIXTURES
AND OPERATING
(In thousands) REAL ESTATE EQUIPMENT LEASES
------------ ---------- --------
Fiscal Year
1999 $ 11,860 $ 1,851 $ 66,801
2000 11,444 443 62,833
2001 10,423 62 57,528
2002 9,462 -- 55,103
2003 7,961 -- 50,389
Thereafter 23,686 -- 299,897
-------- ------- --------
Total minimum payments 74,836 2,356 $592,551
========
Less: Imputed interest and executory costs (27,478) (20)
-------- -------
Present value of net minimum lease payments 47,358 2,336
Less: Current maturities (6,334) (2,167)
-------- -------
Capitalized lease obligations $ 41,024 $ 169
======== =======
33
36
Minimum sublease rent income, not deducted from above, to be received
in the future under noncancellable operating subleases aggregated $28.3 million
at January 3, 1999. Minimum lease income to be received in the future on
noncancellable leases of owned properties aggregated $20.4 million at January 3,
1999.
Capitalized real estate and equipment leases are at effective interest
rates of approximately 12.5% and 8.2%, respectively, as of January 3, 1999.
There were no capital leases added in fiscal 1998 as compared to $5.4 million in
fiscal 1997.
Rental expense, net of lease income on owned properties and sublease
income on leased properties, consists of the following:
FISCAL YEAR
--------------------------------------
(in thousands) 1998 1997 1996
----------- ---------- ----------
Minimum rentals $ 71,537 $ 74,163 $ 85,038
Contingent rentals 962 1,237 1,376
Sublease rental income (3,353) (3,792) (4,296)
Owned properties rental income (3,768) (3,962) (4,819)
---------- ---------- ----------
Net rental expense $ 65,378 $ 67,646 $ 77,299
========== ========== ==========
The lease obligations described above are subject to the impact of the
Chapter 11 Cases described in Note B.
J. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments has been estimated by the
Company using available market information as of January 3, 1999 and December
28, 1997, and valuation methodologies considered appropriate to the
circumstances. The estimates presented are not necessarily indicative of amounts
the Company could realize in a current market exchange. The fair values set
forth below do not reflect the impact, if any, of the subsequent filing of the
Chapter 11 Cases described in Note B.
1/3/99 12/28/97
------------------------------ ---------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
(in thousands) AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------ ------------ ---------- ------------
Assets:
Cash and cash equivalents $ 133,749 $ 133,749 $ 364,169 $ 364,169
Liabilities:
9% Senior Subordinated Debentures 300,000 64,125 300,000 213,000
Term Loan 196,000 196,000 200,000 196,593
Mortgages 153,134 145,529 184,251 176,846
Industrial Revenue Bonds 24,300 24,300 37,185 37,185
Notes payable to banks 156,000 156,000 -- --
8 3/8% Senior Notes 13,799 6,227 13,799 12,833
Cash and cash equivalents: The carrying amount approximates fair value
due to the short maturity of these instruments (less than three months).
9% Senior Subordinated Debentures and 8 3/8% Senior Notes: Fair value
is based on quoted market prices from the New York Stock Exchange at January 3,
1999 and December 28, 1997.
Notes payable to banks, Term Loan and Mortgages: Fair value is based on
management's estimate of the present value of estimated future cash flows
discounted at the current market rate for financial instruments with similar
characteristics and maturities.
Industrial Revenue Bonds: The carrying value approximates the fair
value. Due to the variable rate nature of the instruments, the interest rate
paid by the Company is equivalent to the current market rate demanded by
investors; therefore, the instruments trade at par.
34
37
Derivatives: As of January 3, 1999, the Company was party to interest
rate swaps covering $125 million in principal amount of indebtedness and
expiring in December 2000. These swaps exchange the floating interest rate
exposure on the $125 million of debt for fixed interest rate exposure. The
Company will pay a weighted average fixed rate of 5.97% on the $125 million
notional amount rather than the three-month LIBOR rate, which was 5.23% as of
January 3, 1999. As of January 3, 1999, these instruments had no carrying value.
The fair value of interest rate swap agreements are estimated based on quotes
from dealers of these instruments and represent the estimated amounts the
Company would expect to pay or receive to terminate the agreements. The fair
value of the Company's interest rate swap agreements was ($2.3) million and
($0.1) million as of January 3, 1999 and December 28, 1997, respectively.
K. STOCK OPTIONS AND AWARDS
Under the Company's employee stock incentive plans, the Compensation
Committee of the Board of Directors ("Compensation Committee") has authority to
grant the following types of awards: (a) stock options; (b) stock appreciation
rights; (c) restricted stock; (d) deferred stock; (e) stock purchase rights
and/or (f) other stock-based awards. Awards are exercisable subject to terms and
conditions as determined by the Compensation Committee with no awards
exercisable ten years after the date of grant.
In fiscal 1991, the Board of Directors adopted the 1991 Directors'
Equity Plan for nonemployee directors. Under the Second Amended and Restated
Directors' Plan eligible directors annually receive stock options exercisable
for 3,000 shares of the Company's common stock. The plan was amended in fiscal
1998 and 1997 to increase the number of shares covered by option grants to
directors and to permit participating nonemployee directors to receive all or
any portion of their quarterly retainer in the form of an option to purchase
shares of the Company's common stock, respectively. The stock options are
granted with an exercise price equal to the fair market value of the Company's
common stock as of the date of grant, are exercisable in 20% installments
beginning one year from the date of grant and expire ten years from the grant
date. An aggregate of 296,875 shares of the Company's common stock is authorized
to be issued under this plan.
During fiscal 1995, the Company amended and restated the 1989 Employee
Stock Incentive Plan ("Stock Incentive Plan") to increase the number of shares
issuable, to extend the term during which awards may be made under the Stock
Incentive Plan and to limit the amount of stock-based awards that may be granted
to any single officer or key employee under that plan. Options are generally
granted with a three to five-year vesting requirement. At January 3, 1999, there
were approximately 1.1 million shares of unissued common stock reserved for
issuance under the Company's Stock Incentive Plan.
On October 16, 1998, the Company repriced options granted between
August 1, 1989 and September 30, 1998 with grant prices ranging from $1.59 per
share to $10.13 per share. For each option exchanged, one new option was issued
with an exercise price of $1.25 per share. A total of 6.4 million options were
repriced and are exercisable in equal one-third installments beginning one year
from the date of grant. The repriced options expire five years from the grant
date.
Stock options: A summary of the status of the Company's two fixed stock
option plans for fiscal 1998, 1997 and 1996, and changes during those years is
presented below:
1998 1997 1996
----------------------- -------------------- -------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
(shares in thousands) AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
FIXED OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE
--------- --------- -------- --------- --------- -------------
Outstanding, beginning of year 9,126 $4.65 5,759 $5.35 5,521 $ 6.00
Granted 7,282 1.31 5,034 3.92 1,924 4.95
Exercised -- -- (57) 1.91 (52) 2.43
Forfeited or canceled (8,499) 4.30 (1,610) 5.54 (1,634) 7.20
------- ------- ------
Outstanding, end of year 7,909 1.96 9,126 4.65 5,759 5.35
======= ======= ======
Options exercisable at year-end 1,176 5.41 2,970 5.22 2,361 5.39
Weighted-average fair value of options
granted during the year $ 0.52 $ 2.19 $ 2.69
35
38
The following table summarizes information about fixed stock options
outstanding at January 3, 1999:
(SHARES IN
THOUSANDS) OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- -------------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGED
RANGE OF OUTSTANDING AT CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES 1/3/99 LIFE PRICE AT 1/3/99 PRICE
- ---------------- ---------------- ---------------- -------------- -------------- --------------
$ 0.07-2.19 6,557 4.93 $ 1.24 73 $ 0.36
2.20-4.75 798 7.33 4.11 605 4.17
4.76-6.50 176 7.48 4.98 128 4.98
6.51-10.38 378 3.00 8.53 370 8.56
------ -----
$ 0.07-10.38 7,909 5.13 1.96 1,176 5.41
====== =====
Had the fair value of options granted under these plans beginning in
1995 been recognized as compensation expense on a straight-line basis over the
vesting period of the grant in accordance with SFAS No. 123, the Company's net
earnings (loss) and net earnings (loss) per share would have been adjusted to
the pro forma amounts indicated below:
(In thousands, except per share data)
FISCAL YEAR 1998 1997 1996
------------ ---------- ----------
Net earnings (loss) As reported $ (110,307) $ (91,600) $ 39,330
Pro forma $ (115,121) $ (94,285) $ 37,896
Net earnings (loss) per share - basic and diluted As reported $ (1.11) $ (0.92) 0.39
Pro forma $ (1.15) $ (0.94) 0.38
The pro forma effect on net earnings (loss) for fiscal 1998, 1997 and
1996 is not representative of the pro forma effect on net earnings (loss) in
future years because it does not take into consideration pro forma compensation
expense related to grants made prior to 1995. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option- pricing
model with the following weighted-average assumptions applied to options
granted:
Fiscal Year 1998 1997 1996
----------- ------------ -------------
Dividend yield N/A N/A N/A
Expected volatility 48% 47% 50%
Risk-free interest rate range 4.2 to 5.8% 5.9 to 6.8% 5.4 to 6.8%
Expected life 3 to 6 Years 6 Years 6 Years
Restricted stock awards: Periodically, the Company issues shares of
restricted stock under provisions of the Stock Incentive Plan. A total of
625,941 restricted shares remained outstanding at January 3, 1999. These
remaining shares will vest at various dates through the year 2002. During the
vesting periods, none of such shares may be sold, transferred, pledged or
assigned. During the restriction period, holders of the shares may exercise full
voting rights and receive all dividends with respect to those shares.
36
39
Restricted stock activity for the last three fiscal years was as
follows:
(Shares in thousands) 1998 1997 1996
SHARES SHARES SHARES
------ ------ ------
Outstanding, beginning of year 675 512 515
Granted 51 621 26
Vested (26) (398) (23)
Forfeited or canceled (74) (60) (6)
----- ----- -----
Outstanding, end of year 626 675 512
===== ===== =====
Weighted-average fair value of restricted stock granted during the year $1.15 $4.35 $4.95
Deferred compensation of $0.1 million was recorded during fiscal 1998
in connection with restricted stock awards. Deferred compensation amortization
relating to restricted stock awards of $0.6 million in fiscal 1998 and $0.9
million in fiscal 1997 and 1996 was charged to operations.
Service Merchandise Foundation option: The Service Merchandise
Foundation ("Foundation"), a private charitable foundation, was formed in 1990.
As a charitable contribution, the Company granted the Foundation an option to
purchase approximately 1.9 million shares of common stock at $2.20 per share,
the then current market price. The option is exercisable in whole or in part
from the date of grant until October 15, 2000. Under applicable Internal Revenue
Service rulings, the stock option may not be exercised directly by the
Foundation. The Foundation may sell all or a part of the option to unrelated
not-for-profit entities, which may then exercise the option directly. The option
is not treated as granted and outstanding until such time as the Foundation
sells all or part of it.
L. EARNINGS PER SHARE
The following table reconciles weighted-average shares used in the
earnings per share calculation for fiscal 1998, 1997 and 1996, respectively:
INCOME SHARES PER SHARE
(In thousands, except per share data) (NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
FOR THE YEAR ENDED JANUARY 3, 1999:
Basic EPS $(110,307) 99,703 $ (1.11)
========
Effect of dilutive securities:
None -- --
--------- --------
Diluted EPS $(110,307) 99,703 $ (1.11)
========= ======== ========
FOR THE YEAR ENDED DECEMBER 28, 1997:
Basic EPS-before extraordinary item $ (88,957) 99,930 $ (0.89)
========
Effect of dilutive securities:
None -- --
--------- --------
Diluted EPS-before extraordinary item $ (88,957) 99,930 $ (0.89)
========= ======== ========
FOR THE YEAR ENDED DECEMBER 29, 1996:
Basic EPS $ 39,330 99,209 $ 0.39
========
Effect of dilutive securities:
Restricted stock -- 521
Options outstanding -- 596
--------- --------
Diluted EPS $ 39,330 100,326 $ 0.39
========= ======== ========
The following table includes options to purchase shares of common stock
which were outstanding at the end of the respective fiscal year but were not
included in the computation of diluted earnings per share because the options'
exercise prices were greater than the average market price of the common shares.
Fiscal 1998 and 1997 include all options to purchase shares of common stock and
restricted stock, as they were anti-dilutive in the computation of diluted
earnings per share.
37
40
NUMBER SHARES
RANGE OF GRANT OUTSTANDING AT RANGE OF
YEAR DATES YEAR-END RANGE OF PRICES EXPIRATION DATES
- -------------- ----------------------- ------------------------ ------------------------ -------------------------
1998 08/01/89-12/29/98 8.5 million $1.10-$10.13 08/01/99-12/29/08
1997 04/23/88-11/03/97 9.8 million $2.20-$10.38 04/23/98-11/03/07
1996 10/27/88-11/08/95 1.6 million $5.77-$10.38 10/27/98-11/08/05
M. SHAREHOLDERS' RIGHTS PLAN
Under the 1998 Shareholder Rights Plan, Series A Junior Preferred Stock
Purchase Rights (the "Rights") were issued for each outstanding share of Common
Stock to shareholders of record at the close of business on February 9, 1998.
Each Right entitles the registered holders to purchase from the Company one
one-hundredth of a share (a "Unit") of Series A Junior Preferred Stock, par
value $1 per share (the "Preferred Stock"), at a purchase price of $10 per Unit,
subject to adjustment. Initially, the Rights will attach to all certificates
representing shares of outstanding Common Stock, and no separate Rights
Certificates will be distributed. The Rights will separate from the Common
Stock, and the Distribution Date will occur, upon the earlier of (i) 10 days
following public announcement ("Stock Acquisition Date") that a person or group
of affiliated persons (other than the Company, or certain of its affiliates) (an
"Acquiring Person") has acquired, obtained the right to acquire, or otherwise
obtained beneficial ownership of 15% or more of the then outstanding shares of
Common Stock, or (ii) 10 days (or such date as may be determined by the Board of
Directors prior to any person becoming an "Acquiring Person") following the date
that a tender offer or exchange offer that would result in a person or group
beneficially owning 15% or more of the then outstanding shares of Common Stock
is first published or sent or given to shareholders. The Rights are not
exercisable until the Distribution Date and will expire at the close of business
on the tenth anniversary of the Rights Agreement unless earlier redeemed by the
Company as described below. If any person becomes the beneficial owner of 15% of
the Common Stock or if a 15% or more shareholder engages in certain self-dealing
transactions or a merger with the Company where the Company is not the surviving
corporation, each Right will entitle the shareholder, under alternative
circumstances, to buy either securities of the Company or securities of an
acquiring company (depending on the form of the transaction) at an exercise
price that will be half of the market value of such securities at the time. At
any time until ten days following the Stock Acquisition Date, a majority of the
Board of Directors may redeem the Rights in whole, but not in part, at a price
of $.01 per Right, payable, at the election of such majority of Board of
Directors, in cash or shares of Common Stock.
N. RETIREMENT PLANS
The Company has a defined benefit pension plan (the "Restated
Retirement Plan") in which all employees of the Company are eligible to
participate upon reaching age 21 and completing one year of qualified service,
as defined in the Restated Retirement Plan. Benefits are based on years of
service and employee compensation. Contributions to the Restated Retirement Plan
are intended to provide not only for benefits attributed to service to date, but
also for benefits expected to be earned in the future. The Company's funding
policy has been to contribute at least the amount required by the Employee
Retirement Income Security Act of 1974, but no more than the maximum tax
deductible amount. In fiscal 1998, 1997 and 1996, the Company made contributions
of approximately $3.4 million, $4.8 million and $8.9 million, respectively, to
the Restated Retirement Plan.
The Company chose to remeasure the liabilities in June 1997 to reflect
the impact of closing 53 stores and one distribution center as part of the
Restructuring Plan (See Note E). This remeasurement resulted in a gain of $0.3
million due to curtailment of benefits.
The assets held by the Restated Retirement Plan primarily include
common stock, long-term corporate bonds and long-term government bonds.
The Company maintains a non-qualified supplemental retirement plan (the
"ESP") which covers certain management employees hired or promoted to their job
level prior to February 18, 1989. The ESP provides salary continuation and or
death benefits equal to two times the participant's annual salary at retirement
or at age 65. Employees who complete 20 years of service and terminate
employment prior to attaining retirement age are entitled to a death benefit up
to age 65, at which time they can elect salary continuation and/or a death
benefit. Salary continuation benefits are paid from the general assets of the
Company.
38
41
The following valuation results are based on actuarial assumptions and
methods mandated by SFAS No. 132 and SFAS No. 87 "Employers Accounting for
Pensions."
(IN THOUSANDS) RESTATED EXECUTIVE
CHANGE IN BENEFIT OBLIGATION RETIREMENT PLAN SECURITY PLAN
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
Benefit obligation at beginning of year $ 65,394 $ 63,732 $ 10,099 $ 9,095
Service cost 5,568 6,049 176 198
Interest cost 4,333 4,850 722 703
Actuarial loss 7,308 515 543 482
Benefits paid (9,884) (9,503) (596) (379)
Curtailment -- (249) -- --
-------- -------- -------- --------
Benefit obligation at end of year $ 72,719 $ 65,394 $ 10,944 $ 10,099
======== ======== ======== ========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 73,445 $ 69,945 $ -- $ --
Actual return on plan assets 7,646 8,245 -- --
Employer contribution 3,392 4,758 596 379
Benefits paid (9,884) (9,503) (596) (379)
-------- -------- -------- --------
Fair value of plan assets at end of year $ 74,599 $ 73,445 $ -- $ --
======== ======== ======== ========
RECONCILIATION OF FUNDED STATUS
Funded status $ 1,880 $ 8,051 $(10,944) $(10,099)
Amounts not recognized (4,642) (4,483) -- --
Unrecognized net actuarial loss 12,786 6,683 1,721 1,144
Unrecognized prior service cost (663) (825) -- --
Unrecognized transition obligation (1,897) (2.276) 2,910 3,274
-------- -------- -------- --------
Net amount recognized $ 7,464 $ 7,150 $ (6,313) $ (5,681)
======== ======== ======== ========
AMOUNTS RECOGNIZED ON THE BALANCE SHEET
Prepaid benefit cost $ 7,464 $ 7,150 $ -- $ --
Accrued benefit liability -- -- (10,092) (9,149)
Intangible asset -- -- 2,910 3,468
Accumulated and other comprehensive loss * -- -- 869 --
-------- -------- -------- --------
Net amount recognized $ 7,464 $ 7,150 $ (6,313) $ (5,681)
======== ======== ======== ========
* Change in other comprehensive loss
Intangible asset $ -- $ -- $ 240 $ --
Accrued pension benefit cost -- -- 629 --
-------- -------- -------- --------
$ -- $ -- $ 869 $ --
======== ======== ======== ========
RESTATED RETIREMENT PLAN 1998 1997 1996
------- ------- -------
NET PERIODIC PENSION COST
Service Cost $ 5,568 $ 6,049 $ 5,946
Interest Cost 4,332 4,850 4,463
Expected return on assets (6,282) (6,099) (5,773)
Amortization of net transition amount (379) (379) (379)
Amortization of prior service cost (162) (165) (167)
Recognized net loss -- 239 610
------- ------- -------
Net periodic pension cost 3,077 4,495 4,700
Gain due to curtailment -- (273) --
------- ------- -------
Total amount reflected in earnings $ 3,077 $ 4,222 $ 4,700
======= ======= =======
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42
(IN THOUSANDS)
ESP 1998 1997 1996
------ ------ ------
NET PERIODIC PENSION COST
Service Cost $ 176 $ 198 $ 222
Interest Cost 722 702 640
Amortization of net transition amount 364 364 364
Recognized net loss 31 -- 19
------ ------ ------
Net periodic pension cost $1,293 $1,264 $1,245
====== ====== ======
Total amount reflected in earnings $1,293 $1,264 $1,245
====== ====== ======
RESTATED RETIREMENT PLAN AND ESP
WEIGHTED AVERAGE ACTUARIAL ASSUMPTIONS
Discount rate 6.75% 7.25% 7.75%
Expected long-term rate of return on assets 9.50% 9.50% 9.50%
Future salary increases 3.50% 4.00% 4.50%
O. EMPLOYEE SAVINGS PLAN
The Service Merchandise Company, Inc. Savings and Investment Plan (the
"Plan") is a voluntary salary deferral plan under Section 401(k) of the Internal
Revenue Code. All employees of the Company (other than seasonal and temporary
employees) are eligible to participate upon reaching age 21 and completing one
qualifying year of service, as defined in the Plan. Eligible employees may elect
to defer from 1% to 15% of their compensation, subject to certain limitations.
The Company will match, based on earnings performance, up to 50% of the first 6%
of employees' salary deferrals. Deferrals and matching contributions are
invested in securities and investments as permitted by the Plan and directed by
each employee.
Company contributions to the Plan were $0.6 million, $1.3 million and
$2.1 million for fiscal 1998, 1997 and 1996, respectively. The Company match
percentage equaled 10% in fiscal 1998, 20% in fiscal 1997 and 30% in fiscal
1996.
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43
P. INCOME TAXES
Deferred income tax assets and liabilities at January 3, 1999 and
December 28, 1997 are comprised of the following:
(In thousands) 1/3/99 12/28/97
-------- --------
Deferred income tax assets:
Financial accruals $ 42,220 $ 42,106
Capitalized leases 8,511 9,277
Tax credit and loss carryover 12,304 0
Other 1,683 5,197
-------- --------
Deferred income tax asset 64,718 56,580
-------- --------
Deferred income tax liabilities:
Depreciation (13,473) (22,185)
Layaway sales (1,884) (2,489)
Pension liability (2,315) (3,358)
Other (5,293) (4,245)
-------- --------
Deferred income tax liability (22,965) (32,277)
-------- --------
Net deferred income tax asset $ 41,753 $ 24,303
======== ========
Net current deferred income tax asset $ 20,182 $ 22,478
Net long-term deferred income tax asset 21,571 1,825
-------- --------
41,753 24,303
Valuation Allowance (41,753) 0
-------- --------
Net Deferred income tax asset $ 0 $ 24,303
======== ========
The Company has recorded a full valuation allowance on net deferred tax
assets as realization of such assets in future years is uncertain.
The provision for income taxes, net of tax benefit of $1.6 million in
fiscal 1997 on the extraordinary loss from early extinguishment of debt,
consists of the following:
FISCAL YEAR
(In thousands) 1998 1997 1996
-------- -------- -------
Current income taxes:
Federal $(19,134) $(11,896) $21,695
State and local (423) (759) 1,271
-------- -------- -------
(19,557) (12,655) 22,966
Deferred benefit - tax attributes (12,304) (40,720) 632
Deferred benefit - other (9,985) 0 0
Valuation allowance 41,753 0 0
-------- -------- -------
Total income taxes $ (93) $(53,375) $23,598
======== ======== =======
At January 3, 1999, the Company had net operating loss carry forwards of
$41.1 million which expire beginning in 2019.
41
44
A reconciliation of the provision for income taxes to the federal
statutory rate is as follows:
FISCAL YEAR
1998 1997 1996
-------- ------ -----
Statutory federal tax rate 35.0% 35.0% 35.0%
State and local income taxes, net of federal benefit 1.3% 1.3% 1.6%
Valuation allowance (37.8)% --% --%
Other 1.6% 1.2% 0.9%
-------- ------ ------
Effective tax rate 0.1% 37.5% 37.5%
======== ====== ======
Cash payments (refunds) for income taxes were $(17.4) million, $21.1
million and $19.9 million in fiscal 1998, 1997 and 1996, respectively.
Q. 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
proprietary credit card to its customers. The contract requires the Subsidiary
to maintain a 3% credit risk reserve for the outstanding balances, which are
owned by WFNNB. The purpose of this reserve is to offset future potential
negative spreads or portfolio losses. The negative spreads or losses may result
from potential increased reimbursable contractual program costs. The 3% credit
risk reserve is held by the bankruptcy remote Subsidiary in the form of cash and
cash-equivalents. As of January 3, 1999, the contractual 3% credit risk reserve
was $10.8 million.
The Company believes the program may be terminated in fiscal 1999. If
the program is terminated, it will result in the suspension of the use of the
credit cards and all usual and customary contractual amounts due to each
respective party. Under the normal course of business, the amounts payable to
the respective parties result in positive cash flows to the Subsidiary. Under
Chapter 11, the amount payable to the respective parties may result in negative
cash flows (amounts due) from the Subsidiary. In the event that the program
costs exceed program revenues, the Subsidiary is obligated to pay WFNNB from the
credit risk reserve, the net difference between the program costs and the
program revenues.
Currently, the Subsidiary is analyzing its position and anticipates the
establishment of a provision to reflect the contractual credit risk reserve to
the maximum contractual obligation in the first quarter of fiscal year 1999. In
accordance with generally accepted accounting principles, certain income
deferrals and other accruals may be potentially impacted by the discontinuance
of the credit card program, which may have a significant negative impact on the
Company's future earnings.
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
Company and 31 of its subsidiaries filed voluntary petitions with the Bankruptcy
Court for reorganization under Chapter 11 of the Bankruptcy Code.
The Company was involved in litigation, investigations and various
legal matters during fiscal 1998 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
described in Note B.
42
45
R. SEGMENT REPORTING
The Company manages its business on the basis of one reportable
segment. See Note A for a brief description of the Company's business. As of
January 3, 1999, all of the Company's operations are located within the United
States. The following data is presented in accordance with SFAS No. 131 for all
periods presented.
YEARS ENDED
--------------------------------------------------
CLASSES OF SIMILAR PRODUCTS 1/3/99 12/28/97 12/29/96
---------- ---------- ----------
Net Sales (in thousands):
Hardlines $2,249,628 $2,725,837 $2,977,325
Jewelry 919,897 936,941 977,691
---------- ---------- ----------
Total Net Sales $3,169,525 $3,662,778 $3,955,016
========== ========== ==========
S. QUARTERLY FINANCIAL INFORMATION - UNAUDITED
The Company has historically incurred a net loss throughout the first
three quarters of the year due to the seasonality of its business. The results
of operations for the first three quarters are not necessarily indicative of the
operating results for the entire fiscal year.
(IN THOUSANDS, EXCEPT PER SHARE DATA)
14 WEEKS
13 WEEKS ENDED ENDED
--------------------------------------------- -----------
3/29/98 6/28/98 9/27/98 1/3/99
---------- --------- --------- ------------
Net sales $ 594,182 $ 685,112 $ 604,987 $ 1,285,244
========= ========= ========= ============
Gross margin(a) $ 143,101 $ 163,564 $ 138,254 $ 309,350
========= ========= ========= ============
Net Loss $ (24,101) $ (6,337) $ (38,098) $ (41,771)
========= ========= ========= ============
Per common share - basic and diluted-
Net loss $ (0.24) $ (0.06) $ (0.38) $ (0.42)
========= ========= ========= ============
13 WEEKS ENDED
-----------------------------------------------------------------------
3/30/97 6/29/97 9/28/97 12/28/97
--------- --------- --------- -----------
Net sales $ 686,400 $ 877,361 $ 656,144 $ 1,442,873
========= ========= ========= ===========
Gross margin(a) $ 154,760 $ 83,068 $ 151,190 $ 361,998
========= ========= ========= ===========
Earnings (loss) before extraordinary item $(107,217) $ (17,547) $ (22,360) $ 58,167
Extraordinary loss from early
extinguishment of debt, net of tax
benefit -- -- $ (2,643) --
--------- --------- --------- -----------
Net earnings (loss) $(107,217) $ (17,547) $ (25,003) $ 58,167
========= ======== ========== ===========
Per common share - basic and diluted-
Earnings (loss) before extraordinary item $ (1.07) $ (0.18) $ (0.22) $ 0.58
Extraordinary loss from early
extinguishment of debt, net of tax
benefit -- -- (0.03) --
--------- --------- --------- -----------
Net earnings (loss) $ (1.07) $ (0.18) $ (0.25) $ 0.58
========= ========= ========= ===========
(a) Gross margin after cost of merchandise sold and buying and occupancy
expenses.
43
46
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
COL. A COL. B COL. C COL. D COL. E
ADDITIONS
(1) (2)
CHARGED CHARGED
BALANCE AT TO COSTS TO OTHER DEDUCTIONS BALANCE AT
BEGINNING AND ACCOUNTS (DESCRIBE) END OF
DESCRIPTION OF PERIOD EXPENSES (DESCRIBE) (A) PERIOD
- ------------------------------------------ ------------- ------------- ------------ ----------- -----------
INVENTORY VALUATION ALLOWANCE
INCLUDED UNDER THE BALANCE SHEET
CAPTION "INVENTORY"
Year ended January 3, 1999 $ 16,945 $ 50,144 $ (42,072) $ 25,017
Year ended December 28, 1997 $ 10,048 $ 44,226 $ (37,329) $ 16,945
Year ended December 29, 1996 $ 11,694 $ 37,391 $ (39,037) $ 10,048
DEFERRED TAX ASSET VALUATION
ALLOWANCE INCLUDED UNDER THE BALANCE
SHEET CAPTION "DEFERRED INCOME TAXES"
Year ended January 3, 1999 (A) $ 0 $ 41,753 $ 0 $ 41,753
Year ended December 28, 1997 (A) $ 0 $ 0 $ 0 $ 0
Year ended December 29, 1996 (A) $ 0 $ 0 $ 0 $ 0
ALLOWANCE FOR DOUBTFUL ACCOUNTS
INCLUDED UNDER THE BALANCE SHEET
CAPTION "ACCOUNTS RECEIVABLE"
Year ended January 3, 1999 (A) $ 3,456 $ 4,541 $ (4,998) $ 2,999
Year ended December 28, 1997 (A) $ 4,593 $ 4,388 $ (5,525) $ 3,456
Year ended December 29, 1996 (A) $ 2,763 $ 2,183 $ (353) $ 4,593
ALLOWANCE FOR UNCOLLECTIBLE VENDOR
DEBITS INCLUDED UNDER THE BALANCE SHEET
CAPTION "ACCOUNTS PAYABLE"
Year ended January 3, 1999 (A) $ 0 $ 4,300 $ 0 $ 4,300
Year ended December 28, 1997 (A) $ 0 $ 0 $ 0 $ 0
Year ended December 29, 1996 (A) $ 0 $ 0 $ 0 $ 0
- ------------
(A) Amounts written-off against the reserve.
44
47
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders
Service Merchandise Company, Inc.
We have audited the accompanying consolidated balance sheets of Service
Merchandise Company, Inc. and subsidiaries as of January 3, 1999 and December
28, 1997, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended January 3, 1999. Our audits also included the financial statement schedule
listed in the Index at Item 14. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of Service Merchandise
Company, Inc. and subsidiaries as of January 3, 1999 and December 28, 1997, and
the consolidated results of their operations and cash flows for each of the
three years in the period ended January 3, 1999, in conformity with generally
accepted accounting principles. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, present fairly in all material respects the
information set forth therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company has experienced
recurring losses and negative cash flows from operations and as discussed in
Note B to the consolidated financial statements, on March 15, 1999 certain of
the Company's creditors filed an involuntary Chapter 11 reorganization petition
in the United States Bankruptcy Court seeking court supervision of the Company's
restructuring efforts. As also disclosed in Note B on March 27, 1999, the
Company and 31 of its subsidiaries filed voluntary petitions for relief under
Chapter 11 of the United States Bankruptcy Code. These matters raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans concerning these matters are also described in Note B. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
DELOITTE & TOUCHE LLP
Nashville, Tennessee
March 5, 1999
(March 31, 1999 as to Note B)
45
48
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT AUDITORS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
No reportable items.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS OF THE REGISTRANT
The following is a list of directors, their ages, positions and
business experience as of the date hereof:
Name and Position Age Experience
- ----------------- --- ----------
Raymond Zimmerman 66 Chairman of the Board since January 1999; Chairman of the Board
Chairman of the Board from October 1981 through January 1998; Chief Executive Officer
from October 1981 to April 1997; President from July 1984 to
November 1994 and from 1981 to October 1983. Board member of
The Limited Stores, Columbus, Ohio.
S. Cusano 45 Chief Executive Officer since March 1999; Executive Vice President
Chief Executive Officer and Chief Financial Officer from April 1997 to March 1999; Vice
President and Chief Financial Officer from July 1993 to April 1997;
Group Vice President - Finance from December 1991 to July 1993.
Charles Septer 47 President and Chief Operating Officer since March 1999; Senior Vice
President and Chief Operating President, Jewelry Merchandising since 1988.
Officer
Richard P. Crane, Jr. 59 Practicing Attorney, Partner, Musick, Peeler & Garrett, Los Angeles,
California; Board member of North American Gaming, Inc.
R. Maynard Holt, J.D. 59 R. Maynard Holt, Business Consulting & Insurance, Nashville,
Tennessee.
Charles V. Moore 59 President and Board member of Trainer, Wortham & Company, Inc.,
Investment Counselors, New York, New York.
Harold Roitenberg 72 President of Roitenberg Investments, Inc., Minneapolis, Minnesota;
Board member of Damark International, Inc.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following is a list of executive officers, their ages, positions
and business experience during the past five years as of the date hereof:
46
49
Name and Position (1) Age Experience
- --------------------- --- ----------
S. Cusano 45 Chief Executive Officer since March 1999; Executive Vice President
Chief Executive Officer and Chief Financial Officer from April 1997 to March 1999; Vice
President and Chief Financial Officer from July 1993 to April 1997;
Group Vice President - Finance from December 1991 to July 1993.
Charles Septer 47 President and Chief Operating Officer since March 1999; Senior Vice
President and Chief Operating President, Jewelry Merchandising since 1988.
Officer
Thomas L. Garrett, Jr. 45 Senior Vice President and Chief Financial Officer since March 1999;
Senior Vice President, Chief Vice President and Treasurer since July 1996; Treasurer, Magma
Financial Officer and Treasurer Copper Company from July 1992 to May 1996.
C. Steven Moore 36 Chief Administrative Officer since March 1999, Senior Vice President
Chief Administrative Officer, since February 9, 1999; Corporate Secretary since August 1996; Vice
Senior Vice President, President and General Counsel since August 1996; Senior Corporate
General Counsel and Attorney from November 1994 to August 1996; Corporate Attorney
Corporate Secretary from May 1992 to November 1994.
Gary Sease 55 Senior Vice President, Logistics since September 1996; Senior Vice
Senior Vice President, President, Operations Services of American National Can Company
Logistics from September 1992 to September 1996.
Kenneth Brame 51 Senior Vice President, Information Services and Chief Information
Senior Vice President, Officer since February 1996; Vice President, Systems Development,
Information Services and American Stores Company from May 1994 to February 1996; Director
Chief Information Officer of Systems Development, Belk Stores Services from April, 1989 to
April 1994.
Steven F. McCann 46 Senior Vice President of Finance and Chief Accounting Officer since
Senior Vice President of Finance August 1998; Vice President, Corporate Controller since June 1994;
and Chief Accounting Officer Vice President, Controller of Robinsons-May division of the May
Department Store Company from February 1993 to June 1994.
- ---------------------
(1) All Executive Officers serve at the pleasure of the Board of Directors.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's directors, the Company's executive officers and persons
who beneficially own more that ten percent of the Common Stock to file reports
of ownership and changes in ownership with the SEC. Such directors, officers and
greater than ten percent shareholders are required by SEC regulations to furnish
the Company with copies of all Section 16(a) forms they file.
Based solely on the Company's review of the copies of such forms
furnished to the Company, or written representations from certain reporting
persons, the Company believes that during fiscal 1998 its directors, officers
and greater than ten percent beneficial owners were in compliance with all
applicable filing requirements.
47
50
ITEM 11. EXECUTIVE COMPENSATION
This item contains information with respect to compensation paid to the
Company's Six Named Officers and its Directors.
SUMMARY COMPENSATION TABLE
Long-Term Compensation
Annual Compensation Awards
---------------------------------------------- -------------------------
Securities
Other Restricted Underlying
Annual Stock Options/ All Other
Name and Principal Position Salary Bonus Compensation Awards SARs Compensation
During Fiscal 1998 Year ($) ($) ($)(5) ($)(7) (#) ($) (10)
- -------------------------- -------- --------- --------- ------------- --------- ----------- -------------
Gary M. Witkin(1) 1998 $ 756,911 $ -- $ 30,000 $ -- 999,999 $ 8,794
President and CEO 1997 773,614 108,150 30,000 -- 1,000,000 5,474
1996 752,605 108,150 107,300 -- 200,000 179,996(6)
S. Cusano 1998 406,906 -- -- -- 579,500 4,050
Executive Vice President 1997 369,616 25,000 -- 31,250 (8) 425,000 2,300
and CFO 1996 326,105 -- -- 123,438 (9) 50,000 2,315
Harold Mulet(2) 1998 357,692 -- -- -- 365,000 3,428
Senior Vice President, 1997 319,492 50,000 -- -- 240,000 2,848
Store Operations 1996 309,226 50,000 -- -- 50,000 3,068
Charles Septer 1998 366,296 -- -- -- 402,153 2,818
Senior Vice President 1997 349,860 -- -- -- 240,000 2,757
Jewelry Merchandising 1996 340,607 -- -- -- 50,000 2,769
Gary Sease(3) 1998 324,861 -- -- -- 290,000 5,765
Senior Vice President 1997 309,000 50,000 -- -- -- 12,173
Logistics 1996 80,503 -- -- -- -- 5,212(11)
Raymond Zimmerman(4) 1998 322,730 -- 30,000 -- -- 3,362,629(12)
Chairman of the Board 1997 803,468 -- 30,000 -- 275,000 41,004
1996 781,604 -- 30,000 -- -- 39,538
(1) Mr. Witkin resigned as President and CEO on January 4, 1999.
(2) Mr. Mulet's employment with the Company ceased on March 26, 1999.
(3) Mr. Sease's employment with the Company began on September 15, 1996.
(4) Mr. Zimmerman resigned as Chairman on January 29, 1998 and was
re-elected as Chairman on January 4, 1999.
(5) Mr. Zimmerman and Mr. Witkin received a non-accountable expense
allowance of $30,000 in fiscal 1998, 1997 and 1996.
(6) Includes $174,068 in relocation expense.
(7) The value of outstanding restricted stock awards as of January 3, 1999
are as follows:
Name Number of Shares Value
---- ---------------- -----
Gary M. Witkin 70,000 $135,625
S. Cusano 15,001 29,054
Dividends are payable on restricted stock when and if it is paid on
unrestricted stock. No dividends were paid in the reported fiscal years.
(8) Represents the value of 10,000 shares of restricted stock granted on
April 16, 1997, which had a market price of $3.125 on the grant date.
On April 16, 1998, 3,333 of the shares vested. The remainder will vest
on April 16, 1999 and 2000 respectively.
(9) Represents the value of 25,000 shares of restricted stock granted on
February 7, 1996, which had a market price of $4.937 on the grant date.
As of February 7, 1998, 16,666 of the shares had vested. The remainder
will vest on February 7, 1999.
(10) Represents estimated Company contributions in the defined contribution
plan, benefits derived from payments by the Company for group life
insurance, and benefits derived from split dollar life insurance. The
amount of such benefits for 1998 is set forth in the following table:
Defined Contribution Plan Group Term Life Insurance Split Dollar Life Insurance
------------------------- ------------------------- ---------------------------
Raymond Zimmerman $500 $ 12,500 $ 21,580
Gary M. Witkin $600 $ 8,294 --
S. Cusano $500 $ 2,318 $ 957
Harold Mulet $500 $ 2,205 $ 723
Charles Septer $500 $ 2,593 --
Gary Sease $500 $ 5,265 --
48
51
The Company is the owner of the split dollar life insurance policies on
Messrs. Zimmerman, Cusano and Mulet. In 1998, the Company paid premiums
of approximately $114,116, $114,116 and $24,000, respectively. For each
policy, upon the payment of the policy proceeds, the Company will
receive, net of any tax liability, an amount equal to the aggregate
premiums paid. The remaining policy proceeds will be paid to the duly
named beneficiaries. None of these individuals have an interest in the
cash surrender value of the respective policies. Either party may
terminate the split dollar agreements at any time with thirty days
written notice.
(11) These amounts represent relocation expense.
(12) Includes $2,748 with respect to office equipment; $25,000 as a
relocation expense; $17,800 pertaining to the purchase of an
automobile; $160,000 as an office allowance; $3,111,837 in retirement
and benefit payments; $9,522 for reimbursed cobra costs; and $1,042 for
supplementary medical expense.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL
REALIZED VALUE AT
ASSUMED ANNUAL RATES
OF STOCK PRICE APPRECIATION
INDIVIDUAL GRANTS FOR OPTION TERM
- ----------------------------------------------------------------------------------- -------------------------
NUMBER OF
SECURITIES PERCENT OF TOTAL
UNDERLYING OPTIONS/SARS
OPTION/SAR GRANTED TO EXERCISE OR
GRANTED EMPLOYEES IN BASE PRICE EXPIRATION
NAME (#) (1) FISCAL YEAR ($/SH) DATE 5% ($) 10%($)
- ------------------------- ---------- ---------------- ----------- --------- ------------ ----------
Raymond Zimmerman -- -- -- -- -- --
Gary M. Witkin 999,999 13.73% $1.2500 10/16/02 $ 1,503,722 $1,794,113
S. Cusano 579,500 7.96 1.2500 10/16/02 871,408 1,039,690
Harold Mulet 365,000 5.01 1.2500 10/16/02 559,686 667,770
Charles Septer 402,153 5.52 1.2500 10/16/02 604,727 721,509
Gary Sease 290,000 3.98 1.2500 10/16/02 436,080 520,293
- -------------------
(1) Options granted effective as of October 16, 1998 at the fair market
value on the date of grant which vest 33.33% per year with the first
33.33% vesting on October 16, 1999 in exchange for outstanding options.
There are no criteria for vesting other than continued employment
through the vesting dates and no other material terms of the options
except as disclosed under "Change in Control Provisions Under the
Company's Stock Incentive Plans."
OPTIONS/SAR EXERCISE AND YEAR-END VALUE TABLE
The following table provides information as to opinions exercised or
held by the six Named Officers during fiscal 1998. None of the Named Officers
has been granted SARs.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/SARS AT OPTION/SARS AT
SHARES ACQUIRED VALUE FISCAL YEAR-END (#) FISCAL YEAR-END (#)
NAME ON EXERCISE REALIZED EXERCISABLE/UNEXERCISABLE(1) EXERCISABLE/UNEXERCISABLE(1)
- -------------------------- ------------------- ----------- ---------------------------- -----------------------------
Raymond Zimmerman -- -- 279,166 / 0 $0/$0
Gary M. Witkin -- -- 191,667 / 1,133,333 $0/$0
S. Cusano -- -- 0 / 579,500 $0/$0
Harold Mulet -- -- 0 / 365,000 $0/$0
Charles Septer -- -- 0 / 402,153 $0/$0
Gary Sease -- -- 0 / 290,000 $0/$0
(1) The number of unexercised options and/or SARs available at fiscal
year-end, whether exercisable or Unexercisable, includes out-of-the
money options, and the value of unexercised options and/or SARs
available at fiscal year-end does not include out-of-the money options.
49
52
DIRECTOR COMPENSATION
In fiscal 1998, directors not otherwise employed as officers of the
Company initially received fees of $5,750 per quarter. Mr. Holt, Chairman of the
Audit Committee, received an additional $3,000 for the year.
Under the Directors' Deferred Compensation Plan, implemented in 1991,
directors have the option of deferring receipt of their fees until a period
following their service as a director or until retirement age.
Under the Second Amended and Restated Directors' Equity Plan each
nonemployee director receives on the date of the Annual Meeting of Shareholders,
options to purchase 3,000 shares of Common Stock at an exercise price equal to
the fair market value of such shares on the date of grant. The options expire 10
years from the date of grant and are exercisable in installments of twenty
percent each year beginning one year from the date of grant. The options become
immediately exercisable on a director's death or disability or on the date a
"change in control" is deemed to occur under the Amended and Restated 1989
Employee Stock Incentive Plan. See "Change in Control Provisions Under the
Company's Stock Incentive Plans." The Second Amended and Restated Directors'
Equity Plan provides nonemployee directors the option to apply their cash
retainer payment to acquire options to purchase shares of Common Stock of the
Company.
From January 29, 1998 until his resignation on January 7, 1999, James
E. Poole served as Chairman of the Board. The Company and Mr. Poole entered into
an agreement providing that so long as Mr. Poole served as Chairman of the Board
he was to receive $ 10,000 per month as additional compensation. Such
compensation was in addition to the compensation paid to each nonemployee
director and Mr. Poole continued to participate in the Directors' Equity Plan
for nonemployee directors. The agreement also provided for certain compensation
upon death, disability or removal from office, secretarial assistance and
reimbursement of reasonable expenses. In connection with his resignation as
Chairman of the Board and his retirement from the Board of Directors, the
Company paid Mr. Poole $250,000.
SEVERANCE AND INDEMNIFICATION AGREEMENTS; EMPLOYMENT AGREEMENTS; CHANGE IN
CONTROL PROVISIONS
During fiscal 1998, the Company had severance agreements with each of
the Named Officers currently employed by the Company other than Mr. Zimmerman.
The severance agreements were entered into in December 1998 and replaced
severance agreements previously in place with the Named Officers. Mr. Cusano's
severance agreement was subsequently amended as described below, and Mr. Cusano
and Mr. Septer subsequently entered into employment agreements as described
below.
The severance agreements in place during fiscal 1998 with Messrs.
Cusano, Mulet, Sease and Septer provide for the payment of compensation in the
form of salary continuation to the Named Officer in the amount of two times the
officer's maximum annual base salary payable in a lump sum or in twenty-four
(24) equal monthly installments, if the employment of the Named Officer is
terminated for any reason other than the officer's death, disability, or for
cause. If the Named Officer is terminated or deemed to be terminated within two
years of a Change in Control, he will be entitled to salary continuation in the
amount of three times the officer's maximum annual base salary. A Change in
Control under these agreements is the same as that used in the Company's Stock
Incentive Plan described below. Under the terms of these agreements, the
employment of a Named Officer is deemed terminated for cause if he engages in
(i) willful misconduct materially injurious to the Company; (ii) acts of
dishonesty or fraud; (iii) willful violations of obligations not to compete with
the Company or disclose confidential information. If the employment of a Named
Officer is terminated for death or for cause, he will be entitled only to his
base salary through the date of termination. If the employment is terminated by
reason of disability, the officer will be entitled only to his base salary
through the date of termination and such amounts as he is entitled to receive
under the Company's disability insurance policies. The agreements provide that
these Named Officers will not engage in various activities competitive with the
business of the Company for a period of one year from the date of any
termination giving rise to salary continuation payments.
On June 25, 1998, the Company entered into an agreement with Raymond
Zimmerman, wherein in light of Mr. Zimmerman's more than 40 years of service
and other valuable contributions to the Company, the Company agreed to pay Mr.
Zimmerman a retirement payment of $750,000; to cause Mr. Zimmerman's
outstanding options to vest pursuant to the terms of the Amended and Restated
1989 Employee Stock Incentive Plan; to provide for the continuation of certain
healthcare and life insurance benefits; and to provide for an automobile and a
moving expenses allowance. The agreement also provided for the payment of
$2,361,837, which together with amounts payable under the Company's Executive
Security Plan approximated on a discounted basis the amount of retirement
benefits which would have been payable to Mr. Zimmerman under the Restated
Retirement Plan if such plan did not contain maximum payment limits.
On January 8, 1999, the Company entered into an agreement with James
Poole, then the Chairman of the Board of Directors. The agreement provides for
the payment on January 11, 1999 of $250,000 in connection with his resignation
as Chairman of the Board of Directors and his retirement from the Board. The
agreement requires Mr. Poole to cooperate with the Company in litigation and
related proceedings. Mr. Poole is obligated under the agreement to maintain
certain matters in confidence and not to engage in various activities
competitive with the business of the Company.
50
53
Gary M. Witkin entered into an agreement with the Company January 7,
1999 pursuant to which he resigned as President, Chief Executive Officer, and as
a director. The agreement provides for (i) the payment to Mr. Witkin of
$2,317,890, (ii) continuation of health care coverage for the shorter of two
years or his eligibility for coverage with another employer, (iii) the transfer
of title to his Company provided automobile. The agreement requires Mr. Witkin
to cooperate with the Company in litigation and related proceedings. Mr. Witkin
is obligated under the agreement to maintain certain matters in confidence and
not to compete with the Company.
Effective February 1, 1999, the Company entered into an agreement with
S. Cusano, then the Executive Vice President and Chief Financial Officer,
amending and restating his severance agreement with the Company. Under the terms
of this restated agreement, Mr. Cusano resigned effective May 20, 1999, but
agreed to continue as Executive Vice President and Chief Financial Officer
through the effective date of his resignation. The agreement provides for (i)
the payment to Mr. Cusano of $1,288,000 in installments payable through May 20,
1999, in addition to his regular pay while employed with the Company, (ii) the
vesting of all unvested stock options held by him on May 20, 1999, (iii) the
immediate transfer of title to his Company provided automobile, (iv) the
continuation of health care benefits for the shorter of two years or his
eligibility for coverage with another employer, and (v) the payment of Mr.
Cusano's attorney's fees. The Company has the right to terminate him at any
time. If he is terminated for Cause (defined as (a) the willful engaging in
misconduct materially injurious to the Company, (b) acts of dishonesty or fraud,
or (c) the willful violation of obligations not to compete with the Company or
disclose confidential information) the Company can stop further payments and
recoup prior incentive payments made. If his employment is terminated for death
or for cause, he will be entitled only to his base salary through the date of
termination. If the employment is terminated by reason of disability, the
officer will be entitled only to his base salary through the date of
termination, and such amounts as he is entitled to receive under the Company's
disability insurance policies. The agreement provides that Mr. Cusano will not
compete with the Company during the term of the Agreement.
In connection with his appointment as Chief Executive Officer, on March
23, 1999, the Company and Mr. Cusano entered into an employment agreement with
an initial term of three years which renews automatically for additional one
year terms unless either party gives appropriate notice to the other party. The
agreement provides for a base salary of $650,000 with the opportunity to receive
an annual incentive bonus. Any such annual incentive bonus would be subject to
offset by up to one-third of the amounts paid to Mr. Cusano pursuant to the
February 1, 1999 agreement between the Company and Mr. Cusano. In the event of
Mr. Cusano's termination other than for death, disability or cause within the
term of the agreement, Mr. Cusano would receive salary continuation in an amount
of two times his base salary and continuation of certain health care benefits.
This agreement is subject to Bankruptcy Court approval.
In connection with his appointment as President and Chief Operating
Officer, on March 23, 1999, the Company and Mr. Septer entered into an
employment agreement with an initial term of three years which renews
automatically for additional one year terms unless either party gives
appropriate notice to the other party. The agreement provides for a base salary
of $500,000. The agreement provides that Mr. Septer will be paid a bonus of
$250,000 on each of March 26, 1999 and April 23, 1999 (the "Special Bonus") and
that he will be entitled to receive an annual incentive bonus pursuant to the
Company's annual bonus plan offset by up to one-third of the amount of the
Special Bonus. In the event of Mr. Septer's termination other than for death,
disability or cause within the term of the agreement, Mr. Septer would receive
salary continuation in an amount of two times his base salary and continuation
of certain health care benefits. This agreement is subject to Bankruptcy Court
approval.
The Company also has indemnification agreements with each of its
directors and Named Officers providing for contractual rights of indemnification
to the fullest extent permitted by Tennessee law.
CHANGE IN CONTROL PROVISIONS UNDER THE COMPANY'S STOCK INCENTIVE PLANS
Under the Stock Incentive Plan, any stock options and SAR's which are
not then exercisable will become fully exercisable and vested upon a change in
control or a potential change in control. Similarly, a change in control or a
potential change in control will result in the lapsing of restrictions
applicable to restricted stock and other stock-based awards and such shares and
awards being deemed fully vested. Stock options, SARs, limited SARs, restricted
stock and other stock-based awards will, in such instances, unless otherwise
determined by the Compensation Committee in is sole discretion, be cashed out on
the basis of the change in control price as defined in the plan. A change in
control occurs if (i) any person becomes a beneficial owner directly or
indirectly of 20% or more of the total voting stock of the Company (subject to
certain exceptions); (ii) as a result of, or in connection with, any cash tender
or exchange offer, merger or other business combination or similar transaction,
less than a majority of the combined voting power of the then outstanding
securities of the Company is held in the aggregate
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by the holders of Company securities entitled to vote generally in the election
of directors immediately prior to such transaction; or (iii) during any period
of two consecutive years, individuals who at the beginning of such period
constitute the Board of Directors cease for any reason to constitute at least a
majority thereof. A potential change in control means (i) approval by the
shareholders of an aggregate which, if completed, would constitute a change in
control, or (ii) the acquisition by a person of 5% or more of the total voting
stock of the Company and the adoption by the Board of a resolution that a
potential change in control, as defined in the plan, has occurred.
Options and shares of restricted stock granted under the Second
Amendment and Restated Directors' Equity Plan become immediately vested on the
date a "change in control" is deemed to occur under the Stock Incentive Plan.
PENSION PLAN
The Company's pension plan (the "Pension Plan") which is qualified
under Section 401(a) of the Internal Revenue Code of 1986, as amended (the
"Code"), includes all full-time employees who are at least age twenty-one with
one year of qualified service as defined by the Pension Plan. Directors who are
not officers or employees of the Company do not participate. In 1996, the
Pension Plan was changed to a traditional final average compensation plan, with
monthly benefits on years of service. Participants in the Pension Plan as of
January 1, 1998 are provided certain minimum benefits reflecting the provisions
of the prior Pension Plan based on compensation received during 1998.
The following table shows the estimated annual pension benefits payable
to a covered participant at normal retirement age, based on selected
compensation and years of service compensations:
YEARS OF SERVICE
-------------------------------------------------------------------------------------------------------
REMUNERATION 15 20 25 30 35
---- ---- ---- --- ---
$125,000 $20,430 $27,240 $34,050 $40,860 $47,670
150,000 26,055 34,740 43,425 52,110 60,795
175,000 28,305 34,740 47,175 56,610 66,045
200,000 28,305 34,740 47,175 56,610 66,045
225,000 28,305 34,740 47,175 56,610 66,045
250,000 28,305 34,740 47,175 56,610 66,045
300,000 28,305 34,740 47,175 56,610 66,045
400,000 28,305 34,740 47,175 56,610 66,045
450,000 28,305 34,740 47,175 56,610 66,045
500,000 28,305 34,740 47,175 56,610 66,045
Compensation covered by the plan generally includes all compensation
earned by a participant, including elective deferrals to qualified plans but
excluding severance payments, expense reimbursements and allowances, and other
non-wage items. However, for purposes of determining benefits, compensation
covered by the plan is limited to $160,000. As a result, covered compensation
for each of the Named Officers is limited to $160,000 by Section 401 (a)(17) of
the Code. In addition, annual benefits payable from the plan are limited to
$130,000 by Section 415 of the Code. These limitations are indexed periodically
for inflation.
The estimated credited years of service covered by the plan for each of
the persons named in the compensation table are:
As of December 31, 1998 As of Age 65
----------------------- ------------
Raymond Zimmerman 42 42
Gary M. Witkin 4 19
S. Cusano 7 27
Harold Mulet 3 21
Charles Septer 17 35
Gary Sease 2 12
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Retirement benefits are computed on the basis of a straight life
annuity, unless the participant elects another method of payment. If the
participant is married, the benefit is converted into an actuarially equivalent
joint and 50% survivor benefit. The benefits shown in the table above are not
subject to deduction for Social Security or other offset amounts.
EXECUTIVE SECURITY PROGRAM
The Company maintains a non-qualified supplemental retirement plan (the
"ESP") which covers certain management employees hired or promoted to their job
level prior to February 28, 1989. The plan provides salary continuation and/or
death benefits equal to two times the participant's annual salary at retirement
age or at age 65. Employees who complete 20 years of service and terminate
employment prior to attaining retirement age are entitled to a death benefit up
to age 65, at which time they can elect salary continuation and/or death
benefits. Salary continuation benefits are paid from the general assets of the
Company. There are approximately 156 active employees covered. Twenty-nine
retirees currently received benefits and twenty-six terminated vested
participants are entitled to a future benefit. The Company maintains Corporate
Owned Life Insurance (COLI) policies purchased on participants covered by the
plan prior to the Tax Reform Act of 1986. The Company continues to maintain COLI
policies following termination or retirement of covered employees. Of the Named
Officers. only Raymond Zimmerman and Charles Septer are participants in the ESP.
Mr. Zimmerman's annual installment benefit is $154,600. Upon retirement and if
Mr. Septer chose to waive 100% of the death benefit, Mr. Septer's annual
installment benefit would be approximately $71,900. Continuation of the ESP is
subject to Bankruptcy Court approval.
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'
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of February 28, 1999, certain
information regarding the beneficial ownership of Common Stock by all directors
of the Company (unless otherwise noted), the Company's Chief Executive Officer
as of January 3, 1999, the four most highly compensated executive officers of
the Company other than such Chief Executive Officer, by all directors and
executive officers as a group, and all other persons beneficially owning greater
than five percent of the Common Stock. The Company believes each director or
officer, except as otherwise indicated, has sole voting and investment power
over the shares of Common Stock listed as beneficially owned by him.
SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
NUMBER OF SHARES PERCENT OF
NAME BENEFICIALLY OWNED CLASS (1)
- ---- ------------------ ---------
Raymond Zimmerman.................................... 4,396,624
24,341 (2)
392,070 (3)
566,280 (4)
---------
5,379,315 (5) 5.4 %
Richard P. Crane..................................... 13,363 (6)
Charles V. Moore..................................... 162,945 (7)(8)
R. Maynard Holt...................................... 10,439 (6)(9)
Harold Roitenberg.................................... 42,813 (10)
S. Cusano............................................ 32,206 (11)
Harold Mulet......................................... --
Charles Septer....................................... 46,175 (12)
Gary M. Witkin....................................... 415,350 (13)
Gary Sease........................................... 10,000
FPA Paramount Fund, Inc.............................. 9,500,000 (14) 9.5%
All directors and executive officers as a group
(15 persons)...................................... 6,228,606 6.2 %
- --------------------
(1) Percentages representing less than 1% of the outstanding shares of
Common Stock are not shown.
(2) Shares held by the Equitable Trust Company in an IRA account.
(3) Represents 239,748 shares owned of record by Mr. Zimmerman as trustee
for two nieces and 152,322 shares as to which Mr. Zimmerman is trustee
under the will of Mark K. Zimmerman.
(4) Represents 405,000 shares owned of record by the Raymond Zimmerman
Family Foundation and 161,280 shares owned of record by the Zimmerman
Foundation.
(5) The address for Mr. Zimmerman is 7100 Service Merchandise Drive,
Brentwood, Tennessee 37027.
(6) Includes 188 restricted shares of Common Stock granted under the Second
Amended and Restated Directors' Equity Plan, held by the Company until
restrictions lapse on April 15,1999, and currently exercisable options
to acquire 3,750 shares granted under the Second Amended and Restated
Directors' Equity Plan.
(7) Includes 188 restricted shares of Common Stock granted under the Second
Amended and Restated Directors' Equity Plan, held by the Company until
restrictions lapse on April 15,1999, and currently exercisable options
to acquire 67,547 shares granted under the Second Amended and Restated
Directors' Equity Plan.
(8) Includes 9,280 shares owned by Mr. Moore as custodian for two minor
children.
(9) Includes 1,937 shares owned of record by Mr. Holt as trustee for the R.
Maynard Holt Profit Sharing Plan, a qualified profit sharing plan under
the Internal Revenue Code, 2,100 shares owned by Mr. Holt's wife and
2,000 shares owned by Mr. Holt's mother.
(10) Includes 28,564 shares owned by Roitenberg Investments, Inc., which is
100% owned by Mr. Roitenberg, 188 restricted shares of Common Stock
granted under the Second Amended and Restated Directors' Equity Plan,
held by the Company until restrictions lapse on April 15, 1999, and
currently exercisable options to acquire 12,745 shares granted under
the Second Amended and Restated Directors' Equity Plan.
(11) Includes 32,206 restricted shares of Common Stock held by the Company
until restrictions lapse.
(12) Includes 1,148 shares held by Mr. Septer's wife (who is an employee of
the Company).
(13) Reflects Mr. Witkin's ownership as of January 3, 1999.
(14) Address: 11400 West Olympic Boulevard, Suite 1200, Los Angeles,
California 90064. According to its most recent Schedule 13G amendment,
FPA Paramount Fund, Inc. is a Maryland corporation registered as an
investment company under the Investment Company Act of 1940. First
Pacific Advisors, Inc., a Massachusetts corporation registered as an
investment adviser under the Investment Advisers Act of 1940, exercises
shared dispositive power over such shares of Common Stock.
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company leases one store property from Raymond Zimmerman. For the
fiscal year ended January 3, 1999, Mr. Zimmerman received $81,000 under this
lease. The rent that has been or may be paid under this lease is and will be
comparable to rent paid by lessees of similar properties in the same general
location, and the terms of such lease are at least as favorable to the Company
as the terms that could be obtained from unaffiliated persons. The Company also
entered into certain other contractual arrangements with directors and
executive officers during fiscal 1998. See Item 11. "Executive Compensation --
Severance and Indemnification Agreements; Employment Agreements; Change in
Control Provisions."
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this report:
EXHIBITS FILED WITH THIS FORM 10-K:
Exhibit No. Under Exhibit No. in
Item 601 of Document Where
Regulation S-K Brief Description Originally Filed
-------------- ----------------- ----------------
3.2 Registrant's By-Laws, as amended (restated in
electronic format only for the purpose of filing
with the Commission).
4.17 Post-Petition Credit Agreement dated as of
March 29, 1999 by and among the Registrant,
Citicorp USA, Inc., as administrative agent, Bank
Boston, N.A., as documentation agent and
collateral monitoring agent, and Salomon Smith
Barney, Inc., as sole arranger and book manager.
4.18 Master Security Agreement dated as of March 29,
1999 by and among Registrant and the Guarantors
as Grantors and Citicorp, USA, Inc. as
Administrative Agent.
10.8 Letter Agreement between the Registrant and
Jay Alix & Associates dated January 8,
1999.
10.9 Letter Agreement II between the Registrant and
Jay Alix & Associates dated March 23, 1999.
10.10 Form of Severance Agreement Amendment
between the Registrant and each of Messrs.
Cusano, Mulet, Sease and Septer.
10.11 Amended and Restated Employment Agreement
between the Registrant and Gary M. Witkin dated
December 16, 1998.
10.12 Letter Agreement between the Registrant and
Gary M. Witkin dated January 7, 1999.
10.13 Letter Agreement between the Registrant and
James E. Poole dated January 8, 1999, as
amended.
10.14 Letter Agreement among the Registrant and
S. Cusano dated February 1, 1999.
10.15 Second Amended and Restated Directors' Equity
Plan.
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Exhibit No. Under Exhibit No. in
Item 601 of Document Where
Regulation S-K Brief Description Originally Filed
-------------- ----------------- ----------------
10.16 Employment Agreement between Registrant and
S. Cusano dated March 23, 1999.
10.17 Employment Agreement between Registrant and
Charles Septer dated March 23, 1999.
10.18 Employment Agreement between Registrant and
C. Steven Moore dated March 23, 1999.
21 Subsidiaries of the Registrant.
23 Independent Auditors' consent.
27 Financial Data Schedule for the fiscal year ended
January 3, 1999.
EXHIBITS INCORPORATED HEREIN BY REFERENCE:
3.1 Registrant's Charter, as amended February 5, 1998 3.1
which is incorporated herein by reference to the
Registrant's Form 10-K for the fiscal year ended
December 28, 1997.
4.1 Rights Agreement dated February 2, 1998 which 99.2
is incorporated herein by reference from
Registrant's Form 8-K dated February 3, 1998.
4.2 Amended and Restated Rights Agreement dated 99.2
November 4, 1998 which is incorporated herein
by reference from Registrant's Form 8-K dated
November 4, 1998.
4.3 Note Purchase Agreement dated as of June 28, 4.2a
1990 concerning the refinancing of $90 million of
the Real Estate Bridge Loan under Credit
Agreement dated as of July 24, 1989 among the
Registrant, Various Banks and Chemical Bank as
Agent, which is incorporated herein by reference
from the Registrant's Form 10-Q for the second
quarter ended June 30, 1990.
4.4 Trust Indenture dated as of June 28, 1990 4.2b
concerning the refinancing of $90 million of the
Real Estate Bridge Loan under the Credit
Agreement dated as of July 24, 1989 among the
Registrant, Various Banks and Chemical Bank as
Agent, which is incorporated herein by reference
from the Registrant's Form 10-Q for the second
quarter ended June 30, 1990.
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Exhibit No. Under Exhibit No. in
Item 601 of Document Where
Regulation S-K Brief Description Originally Filed
-------------- ----------------- ----------------
4.5 Indenture, dated as of February 15, 1993, between 4.1
the Registrant and First American National
Bank, as Trustee, regarding the
Registrant's $300,000,000 of 9% Senior
Subordinated Debentures due 2004, which is
incorporated herein by reference from the
Registrant's Form 8-K dated February 17,
1993.
4.6 First Supplemental Indenture, dated as of 4.2
February 15, 1993, between the Registrant and
First American National Bank, as Trustee,
regarding the Registrant's $300,000,000 of 9%
Senior Subordinated Debentures due 2004, which
is incorporated herein by reference from the
Registrant's Form 8-K dated February 17 1993.
4.7 Form of Debenture, regarding the Registrant's 4.3
$300,000,000 of 9% Senior Subordinated
Debentures due 2004, which is incorporated
herein by reference from the Registrant's Form 8-
K dated February 17, 1993.
4.8 Form of Notes, regarding the Registrant's 4.3
$100,000,000 of 8 3/8% Senior Notes due 2001,
which is incorporated herein by reference from the
Registrant's Form 8-K dated October 26, 1993.
4.9 Conditional Loan Commitment dated as of 4.2
September 9, 1996, concerning the $75 million
Real Estate Mortgage Financing among Service
Merchandise Company, Inc., and First Union
National Bank of North Carolina which is
incorporated herein by reference from the
Registrant's Form 10-Q for the third quarter ended
September 29, 1996.
4.10 Loan Agreement dated as of October 4, 1996 4.2a
concerning the $75 million Real Estate Mortgage
Financing among SMC-SPE- 1, Inc., and First
Union National Bank of North Carolina which is
incorporated herein by reference from the
Registrant's Form 10-Q for the third quarter ended
September 29, 1996.
4.11 Loan Agreement dated as of October 4, 1996 4.2b
concerning the $75 million Real Estate Mortgage
Financing among SMC-SPE-2, Inc., and First
Union National Bank of North Carolina which is
incorporated herein by reference from the
Registrant's Form 10-Q for the third quarter ended
September 29, 1996.
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Exhibit No. Under Exhibit No. in
Item 601 of Document Where
Regulation S-K Brief Description Originally Filed
-------------- ----------------- ----------------
4.12 First Amendment to Loan Agreement dated as of 4.19
November 7, 1996 concerning the $75 million
Real Estate Mortgage Financing among SMC-
SPE-2, Inc., and First Union National Bank of
North Carolina which is incorporated herein by
reference to the Registrant's Form 10-K for the
fiscal year ended December 29, 1996.
4.13 Second Amendment to Loan Agreement dated as 4.20
of December 20, 1996 concerning the $75 million
Real Estate Mortgage Financing among SMC-
SPE-2, Inc., and First Union National Bank of
North Carolina which is incorporated herein by
reference to the Registrant's Form 10-K for the
fiscal year ended December 29, 1996.
4.14 Third Amendment to Loan Agreement dated as of 4.22
January 16, 1997 concerning the $75 million Real
Estate Mortgage Financing among SMC-SPE-2,
Inc., and First Union National Bank of North
Carolina which is incorporated herein by reference
to the Registrant's Form 10-K for the fiscal year
ended December 29, 1996.
4.15 Second Amended and Restated Credit Agreement 99.2
dated as of January 20, 1999 by and among
Service Merchandise Company, Inc., Citicorp
USA, Inc., as Administrative Agent, Bank Boston,
N.A. as Documentation Agent and Collateral
Monitoring Agent and other lenders which is
incorporated herein by reference from the
Registrant's Form 8-K dated January 28, 1999.
4.16 Note Issuance Agreement dated September 30, 4.15
1997 among Service Merchandise Company, Inc.,
H.J. Wilson Co., Inc. and The Long-Term Credit
Bank of Japan, Ltd. which is incorporated herein
by reference to the Registrant's Form 10-K for the
fiscal year ended December 28, 1997.
10.1 Stock Option Pledge Agreement between Service 10.2
Merchandise Company, Inc., and the Service
Merchandise Foundation dated October 15, 1990,
which is incorporated herein by reference from the
Registrant's Form 10-K for the fiscal year ended
December 29, 1990.
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Exhibit No. Under Exhibit No. in
Item 601 of Document Where
Regulation S-K Brief Description Originally Filed
-------------- ----------------- ----------------
10.2 Aircraft Lease Agreement dated as of June 26, 10.1
1998 between the Registrant and General
Electric Capital Corporation which is
incorporated herein by reference from the
Registrant's Form 10-Q for the second
quarter ended June 28, 1998.
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS:
10.3 Form of Indemnification Agreement between the Exhibit A
Registrant and each of Messrs. Zimmerman,
Crane, Holt, Moore, Roitenberg, Cusano,
Mulet and Septer which is incorporated
herein by reference from the Registrant's
Proxy Statement dated April 19, 1989.
10.4 Directors' Deferred Compensation Plan, which is 10.1
incorporated herein by reference from the
Registrant's Form 10-K for the fiscal year ended
December 29, 1990.
10.5 Key Executive Severance Plan Agreement for 10.2
execution by certain key executives in
replacement of employment contracts which is
incorporated herein by reference from the
Registrant's Form 10-Q for the third quarter ended
October 2, 1994.
10.6 Amended and Restated 1989 Employee Stock 10.2
Incentive Plan which is incorporated herein by
reference from the Registrant's Form 10-K for the
fiscal year ended January 1, 1995.
10.7 Retirement Benefits Agreement dated as June 25, 10.1
1998 which is incorporated herein by reference
from the Registrant's Form 10-Q for the third
quarter ended September 27, 1998.
(b) Reports on Form 8-K.
During the quarter ended January 3, 1999, the Company filed the
following three reports on Form 8-K: (i) dated October 30, 1998
announcing an amendment to the $900 million term loan and revolving
line of credit; (ii) dated November 4, 1998 announcing an amendment to
the shareholder rights plan; and (iii) dated December 15, 1998
announcing that the Company had not made the $13.5 million interest
payment due on its 9% Subordinated Debentures and planned to exercise
the thirty-day grace period to evaluate available alternatives.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
SERVICE MERCHANDISE COMPANY, INC.
April 5, 1999 By: /s/ S. Cusano
- ------- -----------------------------------
S. Cusano
Chief Executive Officer
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/ Raymond Zimmerman
- ------------------------------------------
Raymond Zimmerman
Chairman of the Board
April 5, 1999
- --------
/s/ S. Cusano
- ------------------------------------------
S. Cusano
Director and Chief Executive Officer
(Principal Executive Officer)
April 5, 1999
- ---------
/s/ Richard P. Crane, Jr.
- ------------------------------------------
Richard P. Crane, Jr.
Director
April 5, 1999
- --------
- ------------------------------------------
Charles V. Moore
Director
, 1999
- ------------------
/s/ R. Maynard Holt
- ------------------------------------------
R. Maynard Holt
Director
April 5, 1999
- --------
- ------------------------------------------
Harold Roitenberg
Director
, 1999
- ------------------
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/s/ Charles Septer
- ------------------------------------------
Charles Septer
Director, President and Chief Operating Officer
April 5, 1999
- -------
/s/ Thomas L. Garrett
- ------------------------------------------
Thomas L. Garrett
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
April 5, 1999
- --------
/s/ Steven F. McCann
- ------------------------------------------
Steven F. McCann
Senior Vice President of Finance and
Chief Accounting Officer
(Principal Accounting Officer)
April 5, 1999
- --------
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