1
Exhibit 13.1
3
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 years indicated, certain information
derived from the Company's Statement of Income expressed in dollars (000's) and
as a percentage of net sales.
1997 1996 1995
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Net sales $210,200 100.0% $212,068 100.0% $178,008 100.0%
Cost of sales 152,625 72.6 156,612 73.8 128,672 72.3
Gross profit 57,575 27.4 55,456 26.2 49,336 27.7
Store operating, general and administrative expenses 49,586 23.6 46,954 22.2 40,935 23.0
Store preopening costs -- -- -- -- 1,778 1.0
Store development costs 1,436 0.7 -- -- -- --
Operating income 6,553 3.1 8,502 4.0 6,623 3.7
Other expenses, net 1,701 0.8 2,147 1.0 1,431 0.8
Income before income taxes 4,852 2.3 6,355 3.0 5,192 2.9
Income taxes 1,980 0.9 2,570 1.2 2,082 1.2
Net income $ 2,872 1.4% $ 3,785 1.8% $3,110 1.7%
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References to the years 1997, 1996 and 1995 relate to the fiscal years ended
January 3, 1998, December 28, 1996, and December 30, 1995, respectively. Fiscal
year 1997 consisted of 53 weeks; all other years reported consisted of 52 weeks.
FISCAL 1997 COMPARED TO FISCAL 1996
Fiscal 1997 consisted of 53 weeks compared to 52 weeks in fiscal 1996. Net
sales decreased by $1.9 million, or 1%, from $212.1 million in fiscal 1996 to
$210.2 million in fiscal 1997. Comparable store sales decreased by 2% in fiscal
1997. Sales throughout fiscal 1997 were impacted by additional competition and
sales during the first half of 1997 were negatively impacted by adverse weather
conditions.
Gross profit increased by $2.1 million, or 3.8%, to $57.6 million in fiscal
1997 from $55.5 million in fiscal 1996. As a percentage of net sales, gross
profit was 27.4% and 26.2% in fiscal 1997 and 1996, respectively. The increase
in gross margin percentage of 1.2% is a result of the Company's year-long
commitment to implementing programs to improve margin through re-negotiated
vendor programs, vendor changes, conversion to direct purchase versus
distributor purchase for certain product lines, freight and logistic programs,
increasing retail prices and enhanced information systems which provide tools to
better manage this aspect of the business.
Store operating, general and administrative expenses for fiscal 1997 were
$49.6 million compared to $47.0 million in fiscal 1996. As a percentage of net
sales, these expenses increased to 23.6% in fiscal 1997, from 22.2% in fiscal
1996. Operating expenses for fiscal 1997 increased over fiscal 1996 as a result
of general increases in certain expenses including rent, real estate tax and
personal property tax assessments and insurance, among others. Operating
expenses in fiscal 1997 also include expenses for a full year from the new
information system implemented in the second half of fiscal 1996.
The Company incurred store developments costs of $1.4 million in fiscal year
1997. During 1997, management assessed the business strategies and opportunities
of the Company to differentiate itself in the warehouse-format home improvement
retail market. This comprehensive process resulted in the development of new
merchandising, marketing and other strategic initiatives to strengthen the
Company's market position. These programs were implemented on a Company-wide
basis during the second through fourth quarters of fiscal 1997. In addition,
comprehensive renovations of certain store locations were undertaken in 1997. As
part of the program, the Company added a merchandise close-out bargain annex and
merchandise within some of the stores. The Company will incur limited additional
costs in 1998 to complete the implementation of these concepts in selected
remaining store locations.
Other expense, net decreased by approximately $400,000 from $2.1 million in
fiscal 1996 to $1.7 million in fiscal 1997 due primarily to benefits of reduced
debt levels as average amounts outstanding under the Revolving Credit Agreement
were approximately $7.2 million during fiscal 1997 compared to $11.7 million
during fiscal 1996.
The effective income tax rate was 40.8% in fiscal 1997 compared to 40.4% in
fiscal 1996.
FISCAL 1996 COMPARED TO FISCAL 1995
Net sales increased by $34.1 million, or 19%, to $212.1 million in fiscal
1996 from $178.0 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
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4
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 continued to focus on its core strategy of improving customer
service and loyalty which translated into increased sales. Programs completed in
1996 included 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 reflected 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.
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 development
activities, and historically to finance expansion.
CASH FLOWS FROM OPERATING ACTIVITIES
During the year ended January 3, 1998, operating activities net cash of
$4.4 million. The primary source of cash from operating activities was $6.2 from
net income plus depreciation and amortization. The primary use of cash was $1.7
million to fund the increase in merchandise inventories and $1.7 million to
reduce accounts payable. A major portion of the increase in merchandise
inventories is attributable to the initial development of the FrugalBees program
which is a close-out and bargain annex and merchandise within our existing
stores.
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.
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used in investing activities was $2.7 million and $1.7 million in
fiscal 1997 and 1996, respectively. Capital expenditures incurred in fiscal 1997
relate primarily to store development costs of $3.6 million associated with the
comprehensive renovations of certain store locations which were offset by
$851,000 from the sale of several parcels of property. Net cash used in
investing activities in fiscal 1996 were primarily due to remodeling initiatives
in the Company's older stores.
The Company did not open any new stores in fiscal 1997 and 1996. Further
expansion is not anticipated in 1998, however expansion is being explored for
1999 and beyond.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash used in financing activities of $1.6 million during fiscal 1997
was primarily a result of principal payments on the Company's mortgage loans,
note payable, affiliate and capital lease obligation.
Net cash used in financing activities during 1996 totaled $8.0 million, a
result of net repayments of the Company's revolving credit facility of $7.3
million and principal payments of debt and 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.
The Company has agreements with two banks at January 3, 1998 which provide
for borrowings under a revolving credit facility of up to $23.0 million. The
agreements extend through January 1, 2001 with annual renewal options thereafter
on the first $20.0 million. The commitment for the remaining $3.0 million
extends through December 1, 1998, with annual renewal options thereafter. The
Company had $6.4 million and $6.0 million outstanding under these agreements at
January 3, 1998 and December 28, 1996, respectively. The Company also had $15.2
million and $16.8 million outstanding at January 3, 1998 and December 28, 1996,
respectively, under mortgage loans and 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.
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FORWARD-LOOKING STATEMENTS
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.
DEPENDENCE ON KEY PERSONNEL
The Company's operations depend on the continuing efforts of its executive
officers and its senior management. Should the Company be unable to retain any
of its executive officers or senior management, the Company's prospects could be
adversely affected.
COMPETITION
The home improvement, hardware and garden businesses are all highly
competitive. The Company competes against traditional hardware, plumbing,
electrical and home supply retailers, as well as warehouse-format and discount
retail stores and many of the Company's competitors have substantially greater
resources than the Company. Builders Square and Lowe's Company have had stores
in the Company's markets since 1985 and 1994, respectively. Lowe's continued to
expand with additional locations in 1996 and 1997. In the fourth quarter of
1997, Home Depot began operations in several of the Company's markets and Home
Depot and Lowe's have announced further expansion plans. In addition, there has
been increasing consolidation within the home improvement industry, which may
provide certain entities increased competitive advantages. Specifically,
increased competition including, but not limited to, additional competitors'
store locations, price reductions, and advertising and marketing campaigns could
have a material adverse effect on the Company's business, recoverability of
asset values, financial condition and operating results.
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 store development activities
and related preopening and store development 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.
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.
YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four digits to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions or
engage in similar normal business activities. The Company has assessed the Year
2000 Issue with regard to its internal financial and operational systems as well
as its external financial vendors and determined that the costs to complete the
related compliance will not materially affect future financial results. The
Company anticipates its Year 2000 Issues to be completed and tested by the end
of fiscal year 1998.
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6
STATEMENT OF INCOME D.I.Y. Home Warehouse, Inc.
for the years ended January 3, 1998, December 28, 1996 and December 30, 1995 1997 1996 1995
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Net sales $210,199,898 $212,068,262 $178,008,474
Cost of sales 152,624,851 156,611,900 128,672,389
GROSS PROFIT 57,575,047 55,456,362 49,336,085
Operating expenses:
Store operating, general and administrative 49,585,529 46,954,847 40,934,818
Store preopening costs -- -- 1,778,418
Store development costs 1,436,416 -- --
TOTAL OPERATING EXPENSES 51,021,945 46,954,847 42,713,236
OPERATING INCOME 6,553,102 8,501,515 6,622,849
Other income (expense):
Interest expense, net (2,151,662) (2,452,575) (1,911,003)
Other income, net 450,186 305,816 479,730
Income before income taxes 4,851,626 6,354,756 5,191,576
Income taxes 1,979,556 2,569,570 2,081,733
NET INCOME $ 2,872,070 $ 3,785,186 $ 3,109,843
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EARNINGS PER COMMON SHARE, BASIC AND DILUTED $ 0.38 $ 0.50 $ 0.41
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Weighted average common shares outstanding 7,633,825 7,626,702 7,625,000
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STATEMENT OF SHAREHOLDERS' EQUITY
for the years ended January 3, 1998, December 28, 1996 and December 30, 1995
Total
Common Stock Retained Shareholders'
Shares Amount Earnings Equity
BALANCES, DECEMBER 31, 1994 7,625,000 $22,912,521 $7,416,996 $ 30,329,517
Net income 3,109,843 3,109,843
BALANCES, DECEMBER 30, 1995 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
Shares issued under the Retainer Stock Plan for
Non-Employee Directors 3,174 13,457 13,457
Net income 2,872,070 2,872,070
BALANCES, JANUARY 3, 1998 7,633,859 $22,955,462 $ 17,184,095 $ 40,139,557
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See Notes to Financial Statements.
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BALANCE SHEET D.I.Y. Home Warehouse, Inc.
as of January 3, 1998 and December 28, 1996 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 141,401 $ 161,360
Accounts receivable, trade 100,389 51,812
Refundable federal income taxes 365,963 248,688
Merchandise inventories 40,156,756 38,462,125
Deferred income taxes 278,565 280,791
Prepaid expenses and other assets 745,961 850,113
TOTAL CURRENT ASSETS 41,789,035 40,054,889
PROPERTY AND EQUIPMENT, AT COST:
Land 4,275,402 4,476,301
Buildings 19,551,311 19,823,392
Furniture, fixtures and equipment 18,333,731 17,284,376
Leasehold improvements 10,166,236 7,934,600
52,326,680 49,518,669
Less accumulated depreciation and amortization 13,381,396 10,186,763
PROPERTY AND EQUIPMENT, NET 38,945,284 39,331,906
Other assets 474,888 577,442
TOTAL ASSETS $81,209,207 $79,964,237
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Note payable, affiliate $ 600,000 $ 900,000
Current maturities of long-term debt 946,183 798,377
Accounts payable 10,615,039 12,278,455
Accrued expenses 3,917,720 3,140,735
Accrued sales and property taxes 1,270,776 1,056,267
Accrued income taxes 259,934 437,914
Customer deposits 328,485 554,583
TOTAL CURRENT LIABILITIES 17,938,137 19,166,331
Revolving credit 6,375,000 6,000,000
Long-term debt 14,208,586 16,030,953
Deferred income taxes 2,547,927 1,512,923
Commitments -- --
SHAREHOLDERS' EQUITY:
Preferred stock, authorized 1,000,000 shares, none issued -- --
Common stock, no par value, authorized 10,000,000 shares,
7,633,859 and 7,630,685 shares outstanding at January 3, 1998
and December 28, 1996, respectively 22,955,462 22,942,005
Retained earnings 17,184,095 14,312,025
TOTAL SHAREHOLDERS' EQUITY 40,139,557 37,254,030
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $81,209,207 $ 79,964,237
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See Notes to Financial Statements.
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STATEMENT OF CASH FLOWS D.I.Y. Home Warehouse, Inc.
for the years ended January 3, 1998, December 28, 1996 and December 30, 1995 1997 1996 1995
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,872,070 $3,785,186 $ 3,109,843
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 3,372,876 3,201,110 2,353,851
Amortization of deferred gain on sale of property -- -- (36,905)
Deferred income tax expense 1,037,230 818,428 346,412
Common shares issued under Retainer Stock Plan 13,457 29,484 --
Net gain on disposal of property (214,675) -- --
Changes in operating assets and liabilities:
Accounts receivable, trade (48,577) 45,772 78,176
Refundable federal income taxes (117,275) (248,688) --
Merchandise inventories (1,694,631) 1,466,668 (8,289,333)
Prepaid expenses and other assets 104,152 (187,122) (78,102)
Other assets 102,554 107,738 12,027
Accounts payable (1,663,416) (789,444) 5,316,280
Accrued income taxes (177,980) (148,105) 82,103
Accrued expenses and other liabilities 765,396 311,892 1,590,117
NET CASH PROVIDED BY OPERATING ACTIVITIES 4,351,181 8,392,919 4,484,469
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (3,599,180) (1,745,975) (18,233,696)
Proceeds from sale of property 850,911 -- --
NET CASH USED IN INVESTING ACTIVITIES (2,748,269) (1,745,975) (18,233,696)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments, notes payable (300,000) -- (687,176)
Proceeds from long-term debt -- -- 7,975,000
Principal payments under capital lease obligations (157,624) (56,970) --
Principal payments of long-term debt (1,540,247) (597,511) (307,177)
Proceeds from revolving credit 9,000,000 4,000,000 10,800,000
Principal payments, revolving credit (8,625,000) (11,300,000) (3,500,000)
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,622,871) (7,954,481) 14,280,647
Net (decrease) increase in cash and cash equivalents (19,959) (1,307,537) 531,420
Cash and cash equivalents, beginning of year 161,360 1,468,897 937,477
CASH AND CASH EQUIVALENTS, END OF YEAR $ 141,401 $ 161,360 $ 1,468,897
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest, net of capitalized interest $2,146,071 $2,571,345 $ 1,680,658
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Cash paid for income taxes $1,446,974 $2,146,248 $ 1,653,259
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SUPPLEMENTAL INVESTING AND FINANCING INFORMATION:
Capital lease obligations incurred $ 23,310 $ 815,988 $ --
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See Notes to Financial Statements.
7
NOTES TO FINANCIAL STATEMENTS D.I.Y. Home Warehouse, Inc.
9
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
109,000 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
1997, 1996 and 1995 relate to the fiscal years ended January 3, 1998, December
28, 1996 and December 30, 1995, respectively. Fiscal year 1997 consisted of 53
weeks. Fiscal years 1996 and 1995 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.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to concentrations
of credit risk consist principally of cash equivalents. The Company places its
cash equivalents with high quality financial institutions.
MERCHANDISE INVENTORIES
Merchandise inventories are stated at the lower of cost or market, cost being
determined on a first-in, first-out ("FIFO") method.
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.
ADVERTISING COSTS
Advertising and promotion costs are charged to operations in the year
incurred. Advertising expense was $2,181,935, $2,064,058 and $2,753,145 in 1997,
1996 and 1995, respectively.
STORE PREOPENING COSTS
Non-capital expenditures associated with new store preopening costs are
expensed as incurred.
STORE DEVELOPMENT COSTS
The Company incurred $1,436,416 related to store development costs for the
fiscal year ended January 3, 1998. During 1997, management assessed the business
strategies and opportunities of the Company to differentiate itself in the
warehouse-format home improvement retail market. This comprehensive process
resulted in the development of new merchandising, marketing and other strategic
initiatives to strengthen the Company's market position. Select marketing and
merchandising programs were implemented on a Company-wide basis during the
second, third and fourth quarters of 1997. Certain of the costs incurred in 1997
relate to the development and creative design of these strategic concepts while
other costs pertain to implementation including marketing, advertising,
promotions and payroll costs.
EARNINGS PER SHARE
Earnings per share have been computed according to Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings Per Share." SFAS 128 replaced the
previously reported "primary earnings per share" with "basic earnings per share"
and replaced "fully diluted earnings per share" with "diluted earnings per
share." This statement had no effect on the resulting earnings per share for the
Company, as the Company's basic and diluted earnings per share are identical.
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 $600,000 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. In April 1997, the
Company made a principal payment of $300,000 on the Note payable, affiliate in
accordance with the terms of the subordination agreement with the Company's
banks. Interest expense on the Note payable, affiliate was $64,295, $82,544 and
$87,203 in 1997, 1996 and 1995, respectively.
The Company has agreements with two banks at January 3, 1998, 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 agreements.
The agreements extend through January 1, 2001, with annual renewal options
thereafter on the first $20,000,000. The commitment for the remaining $3,000,000
extends through December 1, 1998, with annual renewal options thereafter. A
commitment fee of .25 percent per annum is charged on the unused credit
facility. Borrowings under these agreements are collateralized by the Company's
merchandise inventories and receivables. The Company had $6,375,000 and
$6,000,000 outstanding under these agreements at January 3, 1998 and December
28, 1996, respectively, at a weighted average annual inter est rate of 7.3
percent at January 3, 1998 and 7.1 percent at December 28, 1996.
8
10
Long-term debt consists of the following:
1997 1996
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. $8,182,770 $8,491,497
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. 3,086,303 3,207,204
Mortgage loans due in monthly installments of $44,480
including principal and interest through October 1, 2005 and
$113,209 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 (7.6 percent as of January 3, 1998).
Collateralized by certain real property. 3,260,992 4,371,611
Capital lease obligations (Note 4) 624,704 759,018
Long-term debt 15,154,769 16,829,330
Less current maturities of long-term debt 946,183 798,377
Long-term debt, net of current maturities $14,208,586 $ 16,030,953
- --------------------------------------------------------------------------------------------------------------------
Principal amounts of long-term debt payable, including capital lease
obligations in fiscal years 1998 through 2002 are $946,183, $1,034,930,
$1,134,798, $1,129,442 and $1,127,779, respectively.
During fiscal years 1997, 1996 and 1995, interest expense incurred and
capitalized was as follows:
1997 1996 1995
Interest expense incurred $2,170,060 $ 2,491,845 $ 2,153,005
Interest capitalized -- -- 190,800
Interest expense, net $2,170,060 $ 2,491,845 $ 1,962,205
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, $15,154,769, was
estimated to have a fair value of $16,404,131 at January 3, 1998.
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:
1997 1996 1995
Federal $ 935,053 $ 1,307,458 $ 1,328,683
Deferred 761,469 859,083 346,412
State and local 283,034 403,029 406,638
$1,979,556 $2,569,570 $2,081,733
- -----------------------------------------------------------------------
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate follows:
1997 1996 1995
Statutory federal income tax rate 34.0% 34.0% 34.0%
State and local income taxes, net of
federal benefit 6.2 6.2 6.3
Tax credits and other 0.6 0.2 (0.2)
Effective income tax rate 40.8% 40.4% 40.1%
- -------------------------------------------------------------------
Deferred income taxes are provided for the temporary differences between the
financial reporting basis and the tax basis of assets and liabilities. The
deferred tax assets (liabilities) shown on the balance sheet are as follows:
1997 1996
Depreciation $(2,537,061) $(1,411,338)
LIFO (225,485) (281,729)
Accrued liabilities 297,896 305,624
State income tax 195,288 155,311
Net deferred tax (liability) $(2,269,362) $(1,232,132)
- -------------------------------------------------------------------------------
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 11
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 $24,090 and $42,463 in 1997 and 1996,
respectively. There were no percentage lease payment requirements for fiscal
year 1995.
In 1996, the Company entered into a capital lease for a new computer
information 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 Rental Payments
Year ending:
1998 $4,087,098 $187,500 $3,899,598 $207,900
1999 3,762,554 118,380 3,644,174 207,900
2000 3,650,118 105,195 3,544,923 207,900
2001 3,598,331 100,800 3,497,531 86,078
2002 2,543,407 84,000 2,459,407 --
Later years 6,954,719 -- 6,954,719 --
Total minimum
lease payments $24,596,227 $595,875 $24,000,352 $709,778
- ---------------------------------------------------------
Less amounts
representing interest 85,074
Present value of net
minimum lease
payments $624,704
- -------------------------------------------------------------------------
Total net rental expense for all operating leases for the years ended
January 3, 1998, December 28, 1996 and December 30, 1995 was approximately
$3,943,000, $3,738,000 and $3,397,000, respectively. Rental expense is net of
sublease rental income of $185,510, $252,000 and $223,000 for the years ended
January 3, 1998, December 28, 1996 and December 30, 1995, 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 $1,873,992, $1,837,403 and $1,794,940 for the years ended January 3, 1998,
December 28, 1996 and December 30, 1995, respectively.
5. STOCK OPTIONS
The Company has a Long Term Incentive Plan (the "Plan") which reserves
1,350,000 shares of the Company's authorized common stock for issuance. 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 three
to five years at the rate of 33% to 20% each year and expire no more than ten
years from the date of grant. On May 21, 1997, the Company's Board of Directors
authorized an amendment to outstanding stock option awards to reprice such stock
options at an exercise price equal to the fair market value of the stock as of
that date. As a result, 796,000 options were repriced at the fair market value
on May 21, 1997. The vesting period of such options was re-established to vest
over 3 years at a rate of one-third per year. A summary of the Company's stock
option activity and related information for fiscal years 1997, 1996 and 1995 is
as follows:
9
11
Average Option
Stock Option Price Per Share
Outstanding at January 1, 1995 503,000 $11.42
Granted 205,000 6.99
Canceled (35,000) 9.24
Outstanding at December 30, 1995 673,000 10.18
Granted 159,000 4.62
Canceled (31,000) 8.39
Outstanding at December 28, 1996 801,000 9.15
Granted 237,500 3.75
Canceled (40,500) 7.76
Canceled in connection with stock option repricing (796,000) 8.88
Granted in connection with stock option repricing 796,000 3.56
Outstanding at January 3, 1998 998,000 $3.68
- --------------------------------------------------------------
1997 1996 1995
Options exercisable at end of year 11,400 286,300 163,500
Weighted-average option price per share
of options exercisable $11.66 $ 10.65 $10.96
Exercisable price per share for options at end of year:
Exercisable $4.69 to $ 6.44 to $6.44 to
$16.13 $ 16.13 $16.13
Outstanding $3.56 to $ 3.63 to $6.44 to
$16.13 $ 16.13 $16.13
Weighted-average remaining contractual life (years):
Exercisable 3.25 2.50 1.50
Outstanding 4.25 3.00 3.75
Options available for future grant 352,000 549,000 177,000
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 1997, 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:
1997 1996 1995
Net income As Reported $ 2,872,070 $3,785,186 $ 3,109,843
Pro Forma $ 2,664,621 $3,683,661 $ 3,051,592
Earnings per common share As Reported $0.38 $0.50 $0.41
Pro Forma $0.35 $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 weighted average
assumptions:
1997 1996 1995
SHARES SUBJECT SHARES NOT SUBJECT
TO REPRICING TO REPRICING
Risk free interest rates 6.46% 6.2 - 6.5% 5.4 - 5.7% 5.9 - 7.8%
Expected life (years) 4 5 5 5
Volatility 37% 38% 36% 36%
Dividend yield 0% 0% 0% 0%
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. Effective February 1,
1997 the matching cash contribution was increased to 66 percent of a
participant's contribution from 33.3 percent 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 $476,051, $211,789
and $177,126 for fiscal years 1997, 1996 and 1995, respectively.
7. Quarterly Financial Data (Unaudited)
1997 1st 2nd 3rd 4th Total
Net sales $ 39,652,011 $66,857,265 $56,461,962 $47,228,660 $210,199,898
Gross profit 11,661,430 17,383,294 15,088,857 13,441,466 57,575,047
Net income (loss) (89,616) 1,969,304 882,708 109,674 2,872,070
Earnings (loss) per
common share $ (0.01) $ 0.26 $ 0.12 $ 0.01 $ 0.38
Weighted average
common shares
outstanding 7,633,719 7,633,859 7,633,859 7633,859 7,633,825
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) 2,029 676,831561 3,785,186
Earnings (loss) per
common 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 common share does not equal fiscal
1996 earnings per common share due to the effects of rounding.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors Coopers & Lybrand L.L.P.
D.I.Y. Home Warehouse, Inc. a professional service firm
We have audited the accompanying balance sheet of D.I.Y. Home Warehouse, Inc.
as of January 3, 1998 and December 28, 1996, and the related statements of
income, shareholders' equity, and cash flows for each of the three years in the
period ended January 3, 1998. 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 January 3, 1998 and December 28, 1996, and the results of its operations and
its cash flows for each of the three years in the period ended January 3, 1998
in conformity with generally accepted accounting principles.
/s/ Coopers Lybrand L.L.P.
Cleveland, Ohio
February 19, 1998
10
12
SELECTED FINANCIAL DATA AND OPERATING HIGHLIGHTS D.I.Y. Home Warehouse, Inc.
Fiscal Year
(Amounts in thousands, except per share data) 1997(1) 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------
Operating Results
Net sales $210,200 $212,068 $178,008 $136,369 $88,022
Cost of sales 152,625 156,612 128,672 98,202 62,602
Gross profit 57,575 55,456 49,336 38,167 25,420
Store operating, general and administrative expenses 49,586 46,954 40,935 30,333 18,451
Store preopening costs -- -- 1,778 1,200 1,309
Store development costs 1,436 -- -- -- --
Other expense (income), net 1,701 2,147 1,431 (101) (315)
Income before income taxes 4,852 6,355 5,192 6,735 5,975
Income taxes (2) 1,980 2,570 2,082 2,654 1,844
Net income (2) $ 2,872 $ 3,785 $ 3,110 $ 4,081 $ 4,131
- ----------------------------------------------------------------------------------------------------------------------------
Earnings per common share (2) $ 0.38 $ 0.50 $ 0.41 $ 0.54 $ 0.62
- ----------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding 7,634 7,627 7,625 7,625 6,705
- ----------------------------------------------------------------------------------------------------------------------------
Pro forma results: (3)
Pro forma income before income taxes $ 5,975
Pro forma income taxes 2,450
Pro forma net income $ 3,525
- ------------------------------------------------- -------
Pro forma earnings per common share $ 0.53
- -------------------------------------------------- -------
1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------
Selected Operating Data
Number of stores open at end of period 16 16 16 11 7
Interior selling square footage at end of period 1,369,000 1,353,000 1,353,000 918,000 583,000
Comparable store sales increase (decrease) (2)% 7% (5)% 8% (3)%
Number of employees 1,254 1,334 1,325 939 669
(Amounts in thousands) 1997 1996 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------------
Balance Sheet Data (at period end)
Working capital $ 23,851 $20,889 $23,297 $20,769 $16,285
Total assets 81,209 79,764 83,500 58,519 36,963
Notes payable and current maturities of long-term debt 1,546 1,698 1,452 1,820 900
Long-term debt 20,584 22,031 29,415 14,767 --
Shareholders' equity 40,140 37,254 33,439 30,330 26,249
<FN>
- --------------------------
(1) Fiscal year 1997 consisted of 53 weeks; all other years reported consisted
of 52 weeks.
(2) For the period January 2, 1993 through May 18, 1993, the Company was
treated for federal income tax purposes as an S corporation and,
accordingly, income tax was taxed directly to the shareholders. See (3) for
Pro forma results.
(3) Pro forma results assume the Company had been taxed as a C Corporation for
the entire period. Pro forma results are not applicable in 1997, 1996, 1995
and 1994.