1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS D.I.Y. Home Warehouse, Inc.
Results of Operations
The following table sets forth, for the periods indicated, certain information
derived from the Company's Statement of Income expressed in dollars (000's) and
as a percentage of net sales.
1996 1995(1) 1994(1)
- -----------------------------------------------------------------------------------------------------------------------------
Net sales $212,068 100.0% $178,008 100.0% $136,369 100.0%
Cost of sales 156,612 73.8 128,672 72.3 98,202 72.0
- ---------------------------------------------------------- ------- ---- ------- ---- ------ ----
Gross profit 55,456 26.2 49,336 27.7 38,167 28.0
Store operating, general and administrative expenses 46,954 22.2 40,935 23.0 30,333 22.2
Store preopening costs -- -- 1,778 1.0 1,200 0.9
- ---------------------------------------------------------- ------- ---- ------- ---- ------ ----
Operating income 8,502 4.0 6,623 3.7 6,634 4.9
Other (expense) income, net (2,147) (1.0) (1,431) (0.8) 101 0.1
- ---------------------------------------------------------- ------- ---- ------- ---- ------ ----
Income before income taxes 6,355 3.0 5,192 2.9 6,735 5.0
Income taxes 2,570 1.2 2,082 1.2 2,654 2.0
- ---------------------------------------------------------- ------- ---- ------- ---- ------ ----
Net income $ 3,785 1.8% $ 3,110 1.7% $4,081 3.0%
========================================================== ======= ==== ======= ==== ====== ====
<FN>
References to the years 1996, 1995 and 1994 relate to the fiscal years ended
December 28, 1996, December 30, 1995 and December 31, 1994, respectively.
(1) Effective December 31, 1995, the Company changed its method of accounting
for merchandise inventories from the last-in, first-out (LIFO) method to the
first-in, first-out (FIFO) method. Merchandise inventories are now stated at the
lower of cost or market, cost being determined on a first-in, first-out ("FIFO")
method. As required by generally accepted accounting principles, the Company has
retroactively adjusted prior years' financial statements for this change.
Fiscal 1996 Compared to Fiscal 1995
Net sales increased by $34 million, or 19%, to $212 million in fiscal 1996
from $178 million in fiscal 1995. Comparable store sales for fiscal 1996
increased 7%. Sales during the first half of 1996 were negatively impacted by
adverse weather conditions and the liquidation of a competitor which had
competing stores in the Company's market. Sales during the second half of the
year were strong as the Company realized comparable store sales increases of 14%
and 13% during the third and fourth quarters of the year, respectively. The
Company continues to focus on its core strategy of improving customer service
and loyalty which translates into increased sales. Programs completed in 1996
include remodeling and re-merchandising of the Company's older stores and
expansion of the DIY Installation Program, development of the DIY Pro Club, and
extensive product knowledge and management training programs.
Gross profit increased by $6.1 million, or 12.4%, to $55.5 million in fiscal
1996 from $49.3 million in fiscal 1995. As a percentage of net sales, gross
profit was 26.2% and 27.7% in fiscal 1996 and 1995, respectively. The decrease
is due primarily to vendor discounts received in 1995 on the initial inventory
for five new stores opened during 1995. There were no new store openings in
fiscal 1996.
Store operating, general and administrative expenses for fiscal 1996 were
$47.0 million compared to $40.9 million in fiscal 1995. As a percentage of net
sales, these expenses decreased to 22.2% in fiscal 1996, from 23.0% in fiscal
1995. This decrease reflects the benefit of sales leveraging and continuing
progress in expense reduction efforts. There were no store preopening costs in
fiscal 1996 as there were no new stores opened in 1996. Store preopening costs
were $1.8 million in fiscal 1995 relative to five stores opened during the year.
Other expense, net increased to $2.1 million in fiscal 1996 compared to $1.4
million in fiscal 1995 due primarily to an increase in interest expense on
mortgage debt outstanding for the entire fiscal 1996 as compared to being
outstanding for a portion of fiscal 1995. In addition, approximately $190,000 of
construction period interest expense was capitalized in fiscal 1995 associated
with the five new stores opened in 1995. There was no capitalized interest in
fiscal 1996 as there were no new stores in the year. Interest expense on the
revolving credit facility remained relatively constant in fiscal 1996 compared
to fiscal 1995 although borrowings were at a higher level during the first half
of 1996. The Company's ability to manage cash and make repayments on the credit
facility in the second half of 1996 resulted in the average outstanding
borrowings for 1996 to be the same as fiscal 1995 and the average interest rate
was 7% during both years.
The effective income tax rate was 40.4% in fiscal 1996 compared to 40.1% in
fiscal 1995.
This Annual Report may contain statements that are forward-looking, as that
term is defined by the Private Securities Litigation Reform Act of 1995 or by
the Securities and Exchange Commission in its rules, regulations and releases.
The Company intends that such forward-looking statements be subject to the safe
harbors created thereby. All forward-looking statements are based on current
expectations regarding important risk factors. Accordingly, actual results may
differ materially from those expressed in the forward-looking statements and the
making of such statements should not be regarded as a representation by the
Company or any other person that the results expressed therein will be achieved.
Important risk factors include, but are not limited to, the following: general
economic conditions; consumer spending and debt levels; housing turnover;
weather; impact on sales and margins from both existing and new competition;
changes in operating expenses; changes in product mix; interest rates; changes
in and the application of accounting policies and practices; adverse results in
significant litigation matters; adverse state and federal regulations and
legislation; the occurrence of extraordinary events including events and acts of
nature or accidents; and the risks described from time to time in the Company's
Securities and Exchange Commission filings.
Fiscal 1995 Compared to Fiscal 1994
Net sales increased by $41.6 million, or 30%, to $178.0 million in fiscal
1995 from $136.4 million in fiscal 1994. This increase in net sales was
attributable to five new stores opened in 1995 and the effect of full period
sales for the four stores opened in 1994. Comparable store sales were down 5%
compared to fiscal 1994. Net sales and comparable store sales were below
expectations due to conservative consumer spending patterns, a softness in
housing turnover which is a key indicator of sales in home improvement products,
and poor weather during the spring selling season and an early and severe winter
in November and December. The Company opened five stores in Ohio in 1995, in
Medina, Mentor, northwest Akron, south Akron, and Ashtabula in March, April,
May, June and November, respectively.
Gross profit increased by $11.2 million, or 29%, to $49.3 million in fiscal
1995 from $38.2 million in fiscal 1994. As a percentage of net sales,
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gross profit was 27.7% and 28% in fiscal 1995 and 1994, respectively. This
decrease was primarily due to competitive pricing pressures.
Store operating, general and administrative expenses for fiscal 1995 were
$40.9 million compared to $30.3 million in fiscal 1994. As a percentage of net
sales, these expenses were 23.0% in fiscal 1995 compared to 22.2% in fiscal
1994. This increase was attributable primarily to the comparable store sales
decrease and lower-than-expected sales at non-comparable stores which impacted
the leveraging of expenses. In view of the lower-than-forecasted sales, the
Company responded by controlling and reducing expenses. Store operating, general
and administrative expenses were reduced to a per store average of approximately
$2.9 million in fiscal 1995 compared to approximately $3.1 million in fiscal
1994, a 5% decrease, based on full year store equivalents.
Store preopening costs increased $578,000 to approximately $1.8 million (1.0%
of net sales) in fiscal 1995 from $1.2 million (0.9% of net sales) in fiscal
1994 as a result of the timing and number of new store openings in the
respective periods. Other income (expense), net, was $101,000 in fiscal 1994
compared to ($1,431,000) in fiscal 1995. The Company had amounts outstanding
under its revolving credit facility and mortgage debt throughout the entire 1995
fiscal year. This debt was incurred to fund the Company's expansion and for
working capital needs. Lower levels of debt were outstanding for a portion of
fiscal 1994.
The effective income tax rate was 40.1% in fiscal 1995, up from 39.4% in
fiscal 1994. This increase was primarily due to the legislative termination of
the targeted jobs tax credit effective December 31, 1994. This tax credit
provided tax benefits to the Company in fiscal 1994.
Seasonality
The Company's business is seasonal in nature. On a per store basis, the
Company generally experiences its lowest sales during the first and fourth
quarters of each fiscal year. The Company believes the seasonality is caused by
the effect of winter weather on consumers' willingness to undertake outdoor home
improvement projects and the lack of significant sales of lawn and garden
products during the first and fourth fiscal quarters. In addition, a longer or
harsher period of winter weather than is usual in the Company's markets, or an
excessively rainy or unseasonably cold spring season, could have a material
adverse effect on the Company's sales. On a per store basis, the Company
generally experiences its highest sales during the second and third quarters.
However, gross profit margins are lower during the second quarter than in the
third quarter due to higher sales of lawn and garden and lumber and building
materials which generally carry lower gross profit margins than the Company's
average gross profit margin. The Company's gross profit margins on kitchen,
plumbing, bath, electrical and hardware are generally higher than the Company's
average gross profit margin, and sales of such products are not as seasonal as
sales of lawn and garden and building material products.
The Company's quarterly results of operations may also fluctuate materially
depending on the timing of new store openings and related preopening expenses.
The Company believes new stores opened later in a fiscal year may have an
adverse impact on the Company's profitability in that year, because it is the
Company's experience that stores opened early in the year achieve higher levels
of profitability sooner than stores opened later in the year.
Liquidity and Capital Resources
The Statement of Cash Flows reflects cash inflows and outflows from the
Company's operating, investing, and financing activities. The Company's primary
capital needs are to finance merchandise inventories and store expansion.
Cash Flows from Operating Activities
During the year ended December 28, 1996, operating activities provided net
cash of $8.4 million. The primary source of cash from operating activities was
$7.0 million from net income plus depreciation and amortization, and $1.5
million from a decrease in merchandise inventories. Average merchandise
inventories per store were $2.4 million in fiscal 1996 compared to $2.5 million
in fiscal 1995 reflecting a successful program by management to continue to
control inventory levels while maintaining good in-stock positions and
increasing sales and inventory turnover.
During the year ended December 30, 1995, operating activities provided net
cash of $4.5 million. The primary source of cash from operating activities was
$5.4 from net income plus depreciation and amortization. The primary use of cash
was $8.3 million to fund the increase in merchandise inventories offset by an
increase of $5.3 million in accounts payable. The increase in merchandise
inventories attributable to new stores in fiscal 1995 was $12.3 million offset
by a decrease in merchandise inventories at pre-existing stores of $4.0 million.
Average merchandise inventories per store were $2.5 million in fiscal 1995
compared to $2.8 million in fiscal 1994, reflecting a successful program to
control inventory levels while maintaining good in-stock positions.
Cash Flows from Investing Activities
Net cash used in investing activities was $1.7 million and $18.2 million in
fiscal 1996 and 1995, respectively, due to the remodeling initiatives in the
Company's older stores in 1996 and the acquisition of property and equipment
related primarily to the Company's five new stores in fiscal 1995.
The Company did not open any new stores in fiscal 1996. Further expansion is
not anticipated in 1997, however expasion is being explored for 1998 and beyond.
Cash Flows from Financing Activities
Net cash used in financing activities during fiscal 1996 totaled $8.0
million, as a result of net repayments of the Company's revolving credit
facility of $7.3 million and principal payments of debt and a capital lease
obligation of approximately $700,000. During 1996, the Company entered into a
capital lease obligation of approximately $800,000 for computer hardware and
software.
Net cash provided by financing activities during fiscal 1995 totaled $14.3
million primarily from financing under a revolving credit facility of $7.3
million and long-term mortgage loans of approximately $8 million.
The Company has an agreement with two banks at December 28, 1996 which
provide for borrowings under a revolving credit facility of up to $23.0 million.
The agreement extends through January 1, 2000 with annual renewal options
thereafter on the first $20.0 million. The commitment for the remaining $3.0
million extends through December 1, 1997, with annual renewal options
thereafter. The Company had $6 million and $13.3 million outstanding under these
agreements at December 28, 1996 and December 30, 1995, respectively. The Company
also had $16.8 million and $16.7 million outstanding at December 28, 1996 and
December 30, 1995, respectively, under mortgage loans with the banks and under a
capital lease obligation.
The terms of the revolving credit facility and mortgage loans require the
Company to maintain certain levels of net worth, liquidity, and cash flow, and
limit the level of additional indebtedness and capital expenditures. Management
believes cash on hand, cash from operations and cash available through the
Company's financing agreements will be sufficient to meet short-term and
long-term working capital requirements.
Inflation
General inflation has not had a significant impact on the Company during the
past three years. The Company's commodity products, primarily lumber and certain
building materials, experience unusual deflation or inflation due to a
combination of price volatility, increased demand and supply levels. Resulting
price increases or decreases are generally passed on to customers through retail
price changes and, accordingly, do not significantly impact the Company.
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STATEMENT OF INCOME D.I.Y. Home Warehouse, Inc.
- -------------------------------------------------
for the years ended December 28, 1996, As adjusted (Note 1) As adjusted (Note 1)
December 30, 1995 and December 31, 1994 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------
Net sales $212,068,262 $178,008,474 $136,368,915
Cost of sales 156,611,900 128,672,389 98,201,511
- ------------------------------------------------- ------------ ------------ ------------
GROSS PROFIT 55,456,362 49,336,085 38,167,404
Operating expenses:
Store operating, general and administrative 46,954,847 40,934,818 30,332,875
Store preopening costs -- 1,778,418 1,200,716
- ------------------------------------------------- ------------ ------------ ------------
TOTAL OPERATING EXPENSES 46,954,847 42,713,236 31,533,591
- ------------------------------------------------- ------------ ------------ ------------
OPERATING INCOME 8,501,515 6,622,849 6,633,813
Other income (expense):
Interest expense, net (2,452,575) (1,911,003) (33,115)
Other income, net 305,816 479,730 134,089
- ------------------------------------------------- ------------ ------------ ------------
Income before income taxes 6,354,756 5,191,576 6,734,787
Income taxes 2,569,570 2,081,733 2,653,850
- ------------------------------------------------- ------------ ------------ ------------
NET INCOME $ 3,785,186 $ 3,109,843 $ 4,080,937
================================================= ============ ============ ============
EARNINGS PER SHARE $ 0.50 $ 0.41 $ 0.54
================================================= ============ ============ ============
Weighted average common shares outstanding 7,626,702 7,625,000 7,625,000
================================================= ============ ============ ============
STATEMENT OF SHAREHOLDERS' EQUITY D.I.Y. Home Warehouse, Inc.
- -------------------------------------------------
for the years ended December 28, 1996, December 30, 1995 and December 31, 1994
-------------------------------------------------------------------------------
Common Stock Total
--------------------------- Retained Shareholders'
Shares Amount Earnings Equity
--------- ----------- ----------- -----------
BALANCES, JANUARY 1, 1994, AS
PREVIOUSLY REPORTED 7,625,000 $22,912,521 $ 2,888,944 $25,801,465
Adjustment for the cumulative effect of the change in
accounting for merchandise inventories (Note 1) 447,115 447,115
- -------------------------------------------------------- --------- ----------- ----------- -----------
BALANCES, JANUARY 1, 1994, AS ADJUSTED 7,625,000 22,912,521 3,336,059 26,248,580
Net income 4,080,937 4,080,937
- -------------------------------------------------------- --------- ----------- ----------- -----------
BALANCES, DECEMBER 31, 1994, AS ADJUSTED 7,625,000 22,912,521 7,416,996 30,329,517
Net income 3,109,843 3,109,843
- -------------------------------------------------------- --------- ----------- ----------- -----------
BALANCES, DECEMBER 30, 1995, AS ADJUSTED 7,625,000 22,912,521 10,526,839 33,439,360
Shares issued under the Retainer Stock Plan for
Non-Employee Directors 5,685 29,484 29,484
Net income 3,785,186 3,785,186
- -------------------------------------------------------- --------- ----------- ----------- -----------
BALANCES, DECEMBER 28, 1996 7,630,685 $22,942,005 $14,312,025 $37,254,030
======================================================== ========= =========== =========== ===========
See Notes to Financial Statements.
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BALANCE SHEET D.I.Y. Home Warehouse, Inc.
- -------------------------------------------------
As adjusted (Note 1)
as of December 28, 1996 and December 30, 1995 1996 1995
- -----------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 161,360 $ 1,468,897
Accounts receivable, trade 51,812 97,584
Refundable federal income taxes 248,688 --
Merchandise inventories 38,462,125 39,928,793
Deferred income taxes 280,791 685,312
Prepaid expenses and other assets 850,113 662,991
- --------------------------------------------------------------------------------------- ----------- -----------
TOTAL CURRENT ASSETS 40,054,889 42,843,577
- --------------------------------------------------------------------------------------- ----------- -----------
PROPERTY AND EQUIPMENT, AT COST:
Land 4,476,301 4,516,301
Buildings 19,823,392 19,707,438
Furniture, fixtures and equipment 17,284,376 15,246,103
Leasehold improvements 7,934,600 7,486,864
- --------------------------------------------------------------------------------------- ----------- -----------
49,518,669 46,956,706
Less accumulated depreciation and amortization 10,186,763 6,985,653
- --------------------------------------------------------------------------------------- ----------- -----------
Property and equipment, net 39,331,906 39,971,053
Other assets 577,442 685,180
- --------------------------------------------------------------------------------------- ----------- -----------
TOTAL ASSETS $79,964,237 $83,499,810
======================================================================================= =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Note payable, affiliate $ 900,000 $ 900,000
Current maturities of long-term debt 798,377 552,670
Accounts payable 12,278,455 13,067,899
Accrued expenses 3,140,735 2,797,215
Accrued sales and property taxes 1,056,267 969,862
Accrued income taxes 437,914 586,019
Customer deposits 554,583 672,616
- --------------------------------------------------------------------------------------- ----------- -----------
TOTAL CURRENT LIABILITIES 19,166,331 19,546,281
- --------------------------------------------------------------------------------------- ----------- -----------
Revolving credit 6,000,000 13,300,000
Long-term debt 16,030,953 16,115,153
Deferred income taxes 1,512,923 1,099,016
Commitments -- --
SHAREHOLDERS' EQUITY:
Preferred stock, authorized 1,000,000 shares, none issued -- --
Common stock, no par value, authorized 10,000,000 shares, 7,630,685 and 7,625,000 shares
outstanding at December 28, 1996 and December 30, 1995, respectively 22,942,005 22,912,521
Retained earnings 14,312,025 10,526,839
- --------------------------------------------------------------------------------------- ----------- -----------
TOTAL SHAREHOLDERS' EQUITY 37,254,030 33,439,360
- --------------------------------------------------------------------------------------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $79,964,237 $83,499,810
======================================================================================= =========== ===========
See Notes to Financial Statements.
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STATEMENT OF CASH FLOWS D.I.Y. Home Warehouse, Inc.
- -------------------------------------------------
for the years ended December 28, 1996, As adjusted (Note 1) As adjusted (Note 1)
December 30, 1995 and December 31, 1994 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $3,785,186 $ 3,109,843 $ 4,080,937
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,201,110 2,353,851 1,413,753
Amortization of deferred gain on sale of property -- (36,905) (36,905)
Deferred income taxes 847,912 346,412 51,231
Changes in operating assets and liabilities:
Accounts receivable, trade 45,772 78,176 (99,440)
Refundable federal income taxes (248,688) -- --
Merchandise inventories 1,466,668 (8,289,333) (14,218,370)
Prepaid expenses and other assets (187,122) (78,102) (191,657)
Other assets 107,738 12,027 (647,903)
Accounts payable (789,444) 5,316,280 625,208
Accrued income taxes (148,105) 82,103 (207,390)
Accrued expenses and other liabilities 311,892 1,590,117 1,177,284
- ---------------------------------------------------------------------- ---------- ----------- -----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 8,392,919 4,484,469 (8,053,252)
- ---------------------------------------------------------------------- ---------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (1,745,975) (18,233,696) (15,428,174)
- ---------------------------------------------------------------------- ---------- ----------- -----------
NET CASH USED IN INVESTING ACTIVITIES (1,745,975) (18,233,696) (15,428,174)
- ---------------------------------------------------------------------- ---------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Accounts receivable, affiliate -- -- 2,495,829
Proceeds from notes payable -- -- 2,087,176
Principal payments, notes payable -- (687,176) (1,400,000)
Proceeds from long-term debt -- 7,975,000 9,000,000
Principal payments under capital lease obligation (56,970) -- --
Principal payments of long-term debt (597,511) (307,177) --
Proceeds from revolving credit 4,000,000 10,800,000 12,000,000
Principal payments, revolving credit (11,300,000) (3,500,000) (6,000,000)
- ---------------------------------------------------------------------- ---------- ----------- -----------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (7,954,481) 14,280,647 18,183,005
- ---------------------------------------------------------------------- ---------- ----------- -----------
Net (decrease) increase in cash and cash equivalents (1,307,537) 531,420 (5,298,421)
Cash and cash equivalents, beginning of year 1,468,897 937,477 6,235,898
- ---------------------------------------------------------------------- ---------- ----------- -----------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 161,360 $ 1,468,897 $ 937,477
====================================================================== ========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest, net of capitalized interest $2,571,345 $ 1,680,658 $ 122,742
====================================================================== ========== =========== ===========
Cash paid for income taxes $2,146,248 $ 1,653,259 $ 2,810,404
====================================================================== ========== =========== ===========
SUPPLEMENTAL INVESTING AND FINANCING INFORMATION:
Capital lease obligations incurred $ 815,988 $ -- $ --
====================================================================== ========== =========== ===========
See Notes to Financial Statements.
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NOTES TO FINANCIAL STATEMENTS D.I.Y. Home Warehouse, Inc.
- -------------------------------------------------
- ---------------------------
1. Organization and Summary of Significant
Accounting Policies
D.I.Y. Home Warehouse, Inc. (DIY or the Company) operates sixteen retail
warehouse-format home improvement centers that sell products primarily to
do-it-yourself home repair and remodeling customers. The Company's "DIY Home
Warehouse" stores are located in Northeast Ohio and range in size from 66,000 to
96,800 square feet of enclosed selling space and 12,000 to 20,000 square feet of
outside selling space.
The significant accounting policies followed in the preparation of the
accompanying financial statements are summarized below.
Fiscal Year
The Company's fiscal year is comprised of 52 or 53 weeks, ending on the
Saturday nearest December 31. Unless otherwise stated, references to the years
1996, 1995 and 1994 relate to the fiscal years ended December 28, 1996, December
30, 1995 and December 31, 1994, respectively. Fiscal years 1996, 1995 and 1994
consisted of 52 weeks.
Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Financial Instruments
The Company has provided fair value estimates and information about valuation
methodologies of financial instruments in this note and Note 2 to the financial
statements. The Company's financial instruments consist of investments in cash
and cash equivalents and obligations under notes payable and long-term debt.
Cash and Cash Equivalents
Cash equivalents consist of short-term, highly liquid investments, with a
maturity of three months or less, carried at cost plus accrued interest, which
are readily convertible into cash. The carrying value for cash and cash
equivalents approximates fair value.
Merchandise Inventories
Effective December 31, 1995, the Company changed its method of accounting for
merchandise inventories from the last-in, first-out (LIFO) method to the
first-in, first-out (FIFO) method. Merchandise inventories are now stated at the
lower of cost or market, cost being determined on a first-in, first-out ("FIFO")
method.
As required by generally accepted accounting principles, the Company has
retroactively adjusted prior years' financial statements for this change. The
new method of accounting for inventory was adopted in recognition of industry
practice and to provide for a better matching of costs and revenues. The
Internal Revenue Service granted permission to the Company to change to the FIFO
method of inventory valuation for income tax purposes. The effect of the change
increased net income as previously reported by $13,300 for the year ended
December 30, 1995 and did not impact earnings per share. Net income and earnings
per share as previously reported for the year ended December 31, 1994 decreased
by $186,000 and $0.02, respectively. Had the Company maintained the LIFO method,
net income for the year ended December 28, 1996 would have been lower by
$390,000 or $0.05 per share. The balances of retained earnings for 1995 and 1994
have been adjusted for the effect (net of income taxes) of applying
retroactively the new method of accounting.
Property, Equipment and Depreciation
Property and equipment are stated at cost and are depreciated for financial
reporting purposes using the straight-line method over estimated useful lives of
thirty-nine years for buildings and five to ten years for furniture, fixtures
and equipment. Leasehold improvements are amortized by the straight-line method
over the initial term of the lease. At retirement or sale, the cost of the
assets and related accumulated depreciation are removed from the appropriate
accounts, and any resulting gain or loss is included in current income. Routine
maintenance, repairs and renewals are expensed as incurred. Renewals and
betterments which substantially increase the life of property and equipment are
capitalized.
During 1994, the Company revised the estimated useful lives of certain
property and equipment to reflect the Company's actual experience. The Company
changed the estimated useful lives of furniture, fixtures and equipment from
five to ten years and MIS equipment from three to five years. The effect of this
change in estimate increased income before income taxes, net income, and
earnings per share $309,000, $190,000, and $0.02, respectively, for the year
ended December 31, 1994.
Advertising Costs
Advertising and promotion costs are charged to operations in the year
incurred. Advertising expense was $2,064,058, $2,753,145 and $2,314,948 in 1996,
1995 and 1994, respectively.
Store Preopening Costs
Non-capital expenditures associated with new store preopening costs are
expensed as incurred.
Earnings Per Share
Earnings per share are computed using the weighted average number of shares
of common stock outstanding for the period. Earnings per share have not been
adjusted for the effect of stock options as the dilutive effect would be less
than 3 percent for each period.
Income Taxes
Income taxes are provided based upon income for financial reporting purposes.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Tax credits are applied
to reduce the provision for income taxes in the year in which the credits arise.
- ----------------
2. Debt
The Note payable, affiliate of $900,000 represents a note payable to Edgemere
Enterprise, Inc., an entity owned by the Company's majority shareholder, which
is due on demand. The note bears interest at three-quarters of one percent above
the base lending rate of Comerica Bank and is subordinated to the Company's
revolving credit facility and other debt with its banks. Interest expense on the
Note payable, affiliate was $82,544, $87,203 and $77,263 in 1996, 1995 and 1994,
respectively.
The Company has an agreement with two banks at December 28, 1996, which
provide for borrowings under a revolving credit facility of up to $23,000,000
with interest at the Company's option of either the prime rate, LIBOR for
specified maturities, or the banks' certificate of deposit rate for specified
maturities each adjusted by varying basis points in accordance with the debt
agreement. The agreement extends through January 1, 2000, with annual renewal
options thereafter on the first $20,000,000. The commitment for the remaining
$3,000,000 extends through December 1, 1997, with annual renewal options
thereafter. A commitment fee of .25 percent per annum is charged on the unused
credit facility. Borrowings under this agreement are collateralized by the
Company's merchandise inventories and receivables. The Company had $6,000,000
and $13,300,000 outstanding under this agreement at December 28, 1996 and
December 30, 1995, respectively, at a weighted average interest rate of 7
percent at December 28, 1996 and December 30, 1995.
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Long-term debt consists of the following:
1996 1995
----------- -----------
Mortgage loans due in monthly
installments of $98,206 including
principal and interest at 10.3
percent per annum through January
1, 2005 and $4,833,044 due
January 1, 2005. Collateralized
by certain real property. On
December 23, 1999, the interest
rate adjusts to 2.5 percent plus
the then current 5
year Treasury Securities yield $ 8,491,497 $ 8,767,338
Mortgage loans due in monthly
installments of $34,796 including
principal and interest at 9.28
percent per annum through May 1,
2005 and $1,751,090 due May 1,
2005 collateralized by certain
real property. On April 28, 2000,
the interest rate adjusts to 2.5
percent plus the then current
5 year Treasury Securities yield 3,207,204 3,316,461
Mortgage loans due in monthly
installments of $44,480 including
principal and interest through
October 1, 2005 and $1,696,964
due October 1, 2005. Interest is
at the Company's option of either
the prime rate plus .125 percent,
LIBOR for specified maturities
plus 1.625 percent, the banks'
certificate of deposit rate for
specified maturities plus 1.75
percent, or the 5 year Treasury
Securities yield plus 2.5 percent
(7.19 percent as of
December 28, 1996). Collateralized
by certain real property 4,371,611 4,584,024
Capital lease obligations (Note 4) 759,018 --
- ------------------------------------------ ----------- -----------
Long-term debt 16,829,330 16,667,823
Less current maturities of long-term debt 798,377 552,670
- ------------------------------------------ ----------- -----------
Long-term debt, net of current maturities $16,030,953 $16,115,153
========================================== =========== ===========
Principal amounts of long-term debt payable, including capital lease
obligations in fiscal years 1997 through 2001 are $798,377, $854,874, $957,633,
$1,061,482 and $1,045,859, respectively.
During fiscal years 1996, 1995 and 1994, interest expense incurred and
capitalized was as follows:
1996 1995 1994
---------- ---------- --------
Interest expense incurred $2,491,845 $2,153,005 $308,060
Interest capitalized -- 190,800 167,588
- ------------------------- ---------- ---------- --------
Interest expense, net $2,491,845 $1,962,205 $140,472
========================= ========== ========== ========
The carrying amount of the Company's notes payable and borrowings under the
revolving credit facility approximate fair value. The fair value of the
Company's long-term debt was estimated using a discounted cash flow analysis
based on the Company's current incremental borrowing rate for similar types of
borrowing arrangements. The carrying value of this debt, $16,829,330, was
estimated to have a fair value of $17,697,069 at December 28, 1996.
The terms of the revolving credit facility and mortgage loans require the
Company to maintain certain levels of net worth, liquidity, cash flow and fixed
charge coverage, and limit the level of additional indebtedness and capital
expenditures.
- -----------------
3. Income Taxes
Income taxes include the following:
1996 1995 1994
---------- ---------- ----------
Federal $1,307,458 $1,328,683 $1,981,333
Deferred 859,083 346,412 51,231
State and local 403,029 406,638 621,286
- ---------------- ---------- ---------- ----------
$2,569,570 $2,081,733 $2,653,850
================ ========== ========== ==========
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate follows:
1996 1995 1994
---- ---- ----
Statutory federal income tax rate 34.0% 34.0% 34.0%
State and local income taxes, net of federal benefit 6.2 6.3 6.4
Tax credits and other 0.2 (0.2) (1.0)
- --------------------------------------------------------- ---- ---- ----
Effective income tax rate 40.4% 40.1% 39.4%
========================================================= ==== ==== ====
Deferred income taxes are provided for the temporary differences between the
financial reporting basis and the tax basis of assets and liabilities. The net
deferred taxes shown on the balance sheet are as follows:
1996 1995
----------- ---------
Depreciation $(1,411,338) $(761,127)
Vacation accrual 97,076 244,938
LIFO (281,729) (337,889)
Other accrued liabilities 66,266 351,042
Workers' compensation 142,282 89,332
State income tax 155,311 --
- ------------------------------ ----------- ---------
Net deferred tax (liability) $(1,232,132) $(413,704)
============================== =========== =========
- ----------------------
4. Leases and Commitments
The Company leases nine retail stores and its corporate offices under
operating leases. In addition, two of the Company's retail stores are subject to
land leases. The Company's operating leases have remaining terms from 1 to 12
years and have renewal options varying from 10 to 45 years. Six leases require
additional lease payments based upon a percentage of sales above certain sales
levels. Percentage lease payments were $42,463 in 1996. There were no percentage
lease payment requirements for fiscal years 1995 or 1994.
In 1996, the Company entered into a capital lease for a new management
information computer system. The lease is for 5 years and the lease can be
renewed or the assets purchased at the end of the initial lease term.
Future minimum rental payments required under operating and capital leases
that have non-cancelable lease terms in excess of one year and sublease rentals
due the Company under non-cancelable subleases are as follows:
Capital
Operating Leases Leases
----------------------------------- ---------
Lease Sublease Net
Payments Rentals Payments
----------- --------- -----------
Year ending:
1997 $ 4,070,706 $ 214,762 $ 3,855,944 $ 201,336
1998 3,622,107 206,760 3,415,347 201,336
1999 3,263,040 137,640 3,125,400 201,336
2000 3,100,888 104,810 2,996,078 201,336
2001 2,934,270 100,800 2,833,470 115,227
Later years 7,618,430 122,805 7,495,625 --
- -------------------------------- ----------- --------- ----------- ---------
Total minimum
lease payments $24,609,441 $ 887,577 $23,721,864 $ 920,571
================================ =========== ========= ===========
Less amounts
representing interest 161,553
---------
Present value of net
minimum lease
payments $ 759,018
=========
Total net rental expense for all operating leases for the years ended
December 28, 1996, December 30, 1995 and December 31, 1994 was approximately
$3,738,000, $3,397,000 and $2,816,000, respectively. Rental expense is net of
sublease rental income of $252,000, $223,000 and $169,000 for the years ended
December 28, 1996, December 30, 1995 and December 31, 1994, respectively.
The Company leases four of its retail stores from the Company's majority
shareholder or entities affiliated with him. Rents associated with these leases
were $1,837,403, $1,794,940 and $1,833,755 for the years ended December 28,
1996, December 30, 1995 and December 31, 1994, respectively.
- --------------------
5. Stock Options
The Company has a Long Term Incentive Plan (the "Plan") which reserves shares
of the Company's authorized common stock for issuance. On May 22, 1996, the
Company's shareholders authorized an increase of the number of shares authorized
for issuance under the Plan from 850,000 shares to 1,350,000 shares. The Plan
provides for the granting of incentive stock options to purchase shares of
common stock at a price not less than 100% of the fair market value of the stock
on the dates options are granted. Options granted under the Plan vest over five
years at the rate of 20% each year and expire no more than ten years from the
date of grant.
D
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10
8
A summary of stock options is as follows:
1996 1995 1994
-------- -------- --------
Options outstanding beginning of year 673,000 503,000 286,000
Granted 159,000 205,000 221,000
Cancelled (31,000) (35,000) (4,000)
- --------------------------------------- -------- -------- --------
Options outstanding end of year 801,000 673,000 503,000
======================================= ======== ======== ========
Options exercisable at end of year 286,000 163,500 57,000
- --------------------------------------- -------- -------- --------
Exercise price per share for options $3.63 to $6.44 to $9.00 to
exercisable at end of year $ 4.69 $ 7.25 $ 16.13
Weighted-average fair value of options
granted during the year $ 4.62 $ 6.98 $ 12.59
All options issued were granted at 100 percent of the fair market value of
the Company's common stock on the date of grant. Options outstanding as of
December 28, 1996 had a weighted-average exercise price of $9.15 and will expire
at various dates between November 18, 1998 and September 6, 2001. At December
28, 1996, there were 549,000 shares of common stock reserved for future growth.
The Company applies APB Opinion Number 25 and related interpretations in
accounting for its stock option plan. Accordingly, since all options are granted
at a fixed price not less than the fair market value of the Company's common
stock on the date of grant, no compensation expense has been recognized relative
to its stock option plan. Had compensation expense for the Company's stock-based
plan been determined based on the fair value at the 1996 and 1995 grant dates
for awards under the plan consistent with the method of FASB Statement Number
123, the Company's net income and earnings per share would have been reduced to
the pro forma amounts indicated below:
1996 1995
---------- ----------
Net income As Reported $3,785,186 $3,109,843
Pro Forma $3,683,661 $3,051,592
Earnings per share As Reported $0.50 $0.41
Pro Forma $0.48 $0.40
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions for 1996
and 1995: risk free interest rates of 5.4 percent to 5.7 percent in 1996 and 5.9
percent to 7.8 percent in 1995; no dividend yield in either year; expected lives
of five years; and volatility of 36 percent for each year. Option valuation
models, like the Black-Scholes model, require the input of highly subjective
assumptions including the expected stock price volatility. Since changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options or the resultant
compensation expense for stock option awards.
- -----------------
6. Employee Benefit Plan
The Company has a contributory 401(k) savings and investment plan for all
employees who have obtained certain age and length of service requirements.
Eligible employees may contribute up to 15 percent of their compensation to the
plan, subject to any limitations imposed by federal income tax regulations. The
Company partially matches participants' contributions. The matching contribution
is made with cash at a rate of 33.3 percent of a participant's contribution up
to 6 percent of their compensation. Effective February 1, 1997 such matching
contribution was increased to 66 percent of a participant's contribution up to 6
percent of their compensation. Each employee controls the investment of funds
credited to their respective account. Company contributions to this plan were
$211,789, $177,126 and $124,731 for fiscal years 1996, 1995 and 1994,
respectively.
- -------------------------
7. Related Party Transactions
D.I.Y. Home Warehouse, Inc. is majority-owned by Mr. Fred A. Erb ("Mr. Erb").
In 1993, the Company paid on behalf of a partnership affiliated with Mr. Erb,
$2,426,829 during the building construction phase of its Boardman location. The
Company leases its Boardman location from this partnership. On March 24, 1994,
the amounts due to the Company were paid by the partnership. In addition, on
March 22, 1994, the Company purchased from the partnership affiliated with Mr.
Erb, the land and building for its Mansfield location in the amount of
$1,280,000. The cost to the Company for the land was equal to the amount paid
during 1993 by the partnership to a third party.
- -----------------------------
8. Quarterly Financial Data (Unaudited)
1996 1st 2nd 3rd 4th Total
------------ ----------- ----------- ----------- ------------
Net sales $ 39,143,905 $68,168,668 $56,806,258 $47,949,431 $212,068,262
Gross profit 10,765,103 16,886,574 14,903,928 12,900,757 55,456,362
Net income (loss) (108,791) 2,029,585 1,187,561 676,831 3,785,186
Earnings (loss)
per share $(0.01) $0.27 $0.16 $0.09 $0.50
Weighted average
common shares
outstanding 7,625,000 7,625,000 7,626,125 7,630,685 7,626,702
The sum of 1996 quarterly earnings (loss) per share does not equal fiscal 1996
earnings per share due to the effects of rounding.
1995 1st 2nd 3rd 4th Total
------------ ----------- ----------- ----------- ------------
Net sales $ 30,257,805 $58,411,111 $47,308,171 $42,031,387 $178,008,474
Gross profit 9,187,457 16,292,609 12,227,877 11,628,142 49,336,085
Net income 503,251 2,135,002 448,660 22,930 3,109,843
Earnings per share $0.07 $0.28 $0.06 $0.00 $0.41
Weighted average
common shares
outstanding 7,625,000 7,625,000 7,625,000 7,625,000 7,625,000
REPORT OF INDEPENDENT ACCOUNTANTS
- ------------------------------------------------
Coopers COOPERS & LYBRAND L.L.P
& Lybrand
a professional services firm
To the Shareholders and Board of Directors
D.I.Y. Home Warehouse, Inc.
We have audited the accompanying balance sheet of D.I.Y. Home Warehouse, Inc.
as of December 28, 1996 and December 30, 1995, and the related statements of
income, shareholders' equity, and cash flows for each of the three years in the
period ended December 28, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits 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, the financial statements referred to above present fairly, in
all material respects, the financial position of D.I.Y. Home Warehouse, Inc. as
of December 28, 1996 and December 30, 1995, and the results of its operations
and its cash flows for each of the three years in the period ended December 28,
1996 in conformity with generally accepted accounting principles.
As discussed in Note 1 to the financial statements, the Company changed its
method of accounting for inventories in 1996 and restated prior period financial
statements to reflect the change.
/s/ Coopers & Lybrand L.L.P.
Cleveland, Ohio
February 14, 1997
D
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Y
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11
9
SELECTED FINANCIAL DATA AND OPERATING HIGHLIGHTS D.I.Y. Home Warehouse, Inc.
- ---------------------------------------------------
Fiscal Year
------------------------------------------------------------
(Amounts in thousands, except per share data) 1996 1995(1) 1994(1) 1993(1) 1992(1)
- ------------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Net sales $212,068 $178,008 $136,369 $88,022 $68,003
Cost of sales 156,612 128,672 98,202 62,602 48,252
- ---------------------------------------------------------- -------- -------- -------- ------- -------
Gross profit 55,456 49,336 38,167 25,420 19,751
Store operating, general and administrative expenses 46,954 40,935 30,333 18,451 16,971
Store preopening costs -- 1,778 1,200 1,309 1,182
Other expense (income), net 2,147 1,431 (101) (315) (30)
- ---------------------------------------------------------- -------- -------- -------- ------- -------
Income before income taxes (2) 6,355 5,192 6,735 5,975 1,628
Income taxes (3) 2,570 2,082 2,654 1,844 --
========================================================== ======== ======== ======== ======= =======
Net income (3) $ 3,785 $ 3,110 $ 4,081 $ 4,131 $ 1,628
========================================================== ======== ======== ======== ======= =======
Earnings per share (3) $ 0.50 $ 0.41 $ 0.54 $ 0.62 $ 0.32
========================================================== ======== ======== ======== ======= =======
Weighted average common shares outstanding 7,627 7,625 7,625 6,705 5,136
Pro forma results: (4)
Pro forma income before income taxes $ 5,975 $ 3,208
Pro forma income taxes 2,450 1,315
========================================================== ======= =======
Pro forma net income $ 3,525 $ 1,893
========================================================== ======= =======
Pro forma earnings per share $ 0.53 $ 0.37
========================================================== ======= =======
1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------
SELECTED OPERATING DATA
Number of stores open at end of period 16 16 11 7 5
Selling square footage at end of period 1,353,000 1,353,000 918,000 583,000 408,000
Comparable store sales increase (decrease) 7% (5)% 8% (3)% 1%
Number of employees 1,334 1,325 939 669 462
(Amounts in thousands) 1996 1995(1) 1994(1) 1993(1) 1992(1)
- ------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA (at period end)
Working capital $ 20,889 $23,297 $20,769 $16,285 $ 2,287
Total assets 79,764 83,500 58,519 36,963 14,691
Notes payable and current maturities of long-term debt 1,698 1,452 1,820 900 2,900
Long-term debt 22,031 29,415 14,767 -- 725
Shareholders' equity 37,254 33,439 30,330 26,249 5,155
(1) Fiscal years 1995, 1994, 1993 and 1992 have been restated to reflect the
change in method of accounting for merchandise inventories. In 1996, the
Company changed its method of accounting for merchandise inventories from
the last-in, first-out (LIFO) method to the first-in, first-out (FIFO)
method. As required by generally accepted accounting principles, the
Company has retoactively adjusted prior years' financial statements for
this change. The effect of the accounting change on net income as
previously reported is as follows:
(Amounts in thousands, except per share data) 1995 1994 1993 1992
---------------------------------------------------------------------------------------------------------------------
Net income as previously reported $3,097 $4,267 $4,140 $1,424
Adjustment for effect of a change in accounting principle 13 (186) (9) 204
--------------------------------------------------------------------- ------ ------ ------ ------
Net income as adjusted $3,110 $4,081 $4,131 $1,628
===================================================================== ====== ====== ====== ======
Earnings per share as previously reported $ 0.41 $ 0.56 $ 0.62 $0.28
Adjustment for effect of a change in accounting principle -- (0.02) -- 0.04
--------------------------------------------------------------------- ------ ------ ------ ------
Earnings per share as adjusted $ 0.41 $ 0.54 $ 0.62 $0.32
===================================================================== ====== ====== ====== ======
(2) Income before income taxes reflects payment of shareholder bonuses for the
year ended January 2, 1993 in the amount of $1,580,000. Such shareholder
bonuses were paid by the Company to fund shareholders' federal, state and
certain local income tax liabilities attributable to the income of the
Company.
(3) For the period January 2, 1993 through May 18, 1993 and fiscal year 1992,
the Company was treated for federal income tax purposes as an S corporation
and, accordingly, income tax was taxed directly to the shareholders. See
(4) for Pro forma results.
(4) Pro forma results assume the Company had been taxed as a C Corporation for
the entire period and exclude $1,580,000 in shareholder bonuses paid in
1992 to fund shareholders' income tax liabilities attributable to the
income of the Company. Pro forma results are not applicable in 1996, 1995
and 1994.
D
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Y
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12