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 years indicated, certain information
derived from the Company's Statement of Income expressed in dollars (000's) and
as a percentage of net sales.
1998 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------
Net sales $ 172,600 100.0% $ 210,200 100.0 $ 212,068 100.0%
Cost of sales 127,215 73.7 152,625 72.6 156,612 73.8
- ----------------------------------------------------------------------------------------------------------------------------
Gross profit 45,385 26.3 57,575 27.4 55,456 26.2
Store operating, general and administrative expenses 45,336 26.3 49,586 23.6 46,954 22.2
Store closing and development costs 2,143 1.2 1,436 0.7 -- --
- ----------------------------------------------------------------------------------------------------------------------------
Operating income (loss) (2,094) (1.2) 6,553 3.1 8,502 4.0
Other expenses, net 1,761 1.0 1,701 0.8 2,147 1.0
- ----------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) .. (3,855) (2.2) 4,852 2.3 6,355 3.0
Income taxes (benefit) (1,556) (0.9) 1,980 0.9 2,570 1.2
- ----------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 2,299) (1.3) $ 2,872 1.4 $ 3,785 1.8%
============================================================================================================================
References to the years 1998, 1997 and 1996 relate to the fiscal years ended
January 2, 1999, January 3, 1998 and December 28, 1996, respectively. Fiscal
year 1997 consisted of 53 weeks; Fiscal years 1998 and 1996 consisted of 52
weeks.
Fiscal 1998 Compared to Fiscal 1997
Fiscal 1998 consisted of 52 weeks compared to 53 weeks in fiscal 1997. Net
sales decreased by $37.6 million, or 17.9%, from $210.2 million in fiscal 1997
to $172.6 million in fiscal 1998. Comparable store sales were impacted by
additional national warehouse competition in a majority of the Company's
markets.
Gross profit decreased by $12.2 million, or 21.2%, from $57.6 million in
fiscal 1997 to $45.4 million in fiscal 1998. Gross profit percentage, as a
percentage of net sales, was 26.3% in fiscal 1998 compared to 27.4% in fiscal
1997. The decrease in gross margin percentage was impacted by the liquidation
sales related to closing two stores during the fourth quarter of fiscal 1998.
(See discussion below on store closings.) Also, a decrease in vendor rebates and
discounts resulting from decreased inventory purchases in fiscal 1998 compared
to fiscal 1997 impacted the 1998 gross margin. During fiscal 1998, the Company
continued to focus on enhancing the balance sheet by reducing inventory levels.
As a result, inventory purchases in fiscal 1998 were approximately $37.0 million
lower than purchases during fiscal 1997.
Store operating, general and administrative expenses decreased $4.3 million,
or 8.6%, to $45.3 million in fiscal 1998 from $49.6 million in fiscal 1997. The
decrease is due to the Company's ongoing efforts to reduce operating costs. As a
percentage of net sales, store operating, general and administrative expenses
increased to 26.3% in fiscal 1998 compared to 23.6% in fiscal 1997 due to lower
sales on which to leverage these expenses.
During the first quarter of 1998, the Company incurred approximately $306,000
in store development costs as part of completing new merchandising, marketing
and other strategic initiatives implemented in fiscal year 1997.
During the fourth quarter of fiscal 1998, the Company closed two of its
stores. The Company incurred $1.8 million to close the two stores in the fourth
quarter of fiscal 1998. Included in the costs are approximately $700,000 related
to the write down of long lived assets of these two stores to their net
realizable value. The remainder represents the operating costs incurred to close
these stores.
Other expenses, net of $1.7 million, remained relatively the same in fiscal
1998 compared to fiscal 1997. However, interest expense decreased by
approximately $291,000 from $2.2 million in fiscal 1997 to $1.9 million in
fiscal 1998 due primarily to the benefit of reduced debt levels on average
amounts outstanding under the Revolving Credit Agreement and Mortgage Loans
which were approximately $18.2 million during fiscal 1998 compared to $22.5
million during fiscal 1997. (See discussion on New Credit Facility under Cash
Flows from Financing Activities.) The interest expense decrease was offset by
the gain of $214,000 on the sale of property in fiscal 1997.
The income tax benefit of $1.6 million for fiscal year 1998 consisted of
approximately $622,000 of current federal income taxes, and $978,000 of deferred
tax benefits. The Company has available net operating loss carryforwards of
approximately $591,000 and $2,240,000 for federal and state income taxes,
respectively, which expire principally in year 2018 (federal) and in year 2013
(state). In addition, the Company has available Alternate Minimum Tax credit
carryforwards of approximately $202,000 which may be used indefinitely to reduce
federal income taxes.
The effective tax benefit was 40.4% in fiscal 1998 compared to an effective
tax expense rate of 40.8% in fiscal 1997.
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% was a result of the Company's
2
2
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, increased retail prices and enhanced information systems which
provided 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.
Other expenses, 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.
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.
Cash Flows from Operating Activities
During the year ended January 2, 1999, operating activities provided net cash
of approximately $7.6 million. The primary source of cash from operating
activities was $4.5 million from depreciation and amortization and $8.9 million
from reducing inventories, offset by $2.2 million to reduce accounts payable and
the Company's net loss of $2.3 million.
During the year ended January 3, 1998, operating activities provided 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.
Cash Flows from Investing Activities
Net cash used in investing activities was $1.4 million and $2.7 million in
fiscal 1998 and 1997, respectively. Capital expenditures incurred in fiscal 1998
and 1997 of $1.4 million and $3.6 million relate primarily to store development
costs associated with the comprehensive renovations of certain store locations.
Fiscal year 1997 capital expenditures were offset by $851,000 from the sale of
several parcels of property.
The Company did not open any new stores in fiscal 1998 and 1997. Further
expansion is not anticipated in 1999.
Cash Flows from Financing Activities
Net cash used in financing activities increased by $4.6 million from $1.6
million for the year ended January 3, 1998 to $6.2 million for the year ended
January 2, 1999. The increase in fiscal 1998 is primarily due to a reduction in
net borrowings under the revolving credit and mortgage loans of approximately
$4.3 million as a result of lower inventory purchases. Net cash used in
financing activities of $1.6 million in fiscal 1997 was primarily a result of
net principal payments on the Company's mortgage loans, note payable and capital
lease obligations.
On October 27, 1998, the Company terminated its existing Revolving Credit
Agreement with its two banks and entered into a new Credit and Security
Agreement (Credit Agreement) with a bank. The new Credit Agreement provides for
borrowings up to $20,000,000 pursuant to a formula based upon the Company's
inventories with interest at the Company's option of either LIBOR or the prime
rate for specified maturities adjusted by varying points in accordance with the
Security Agreement. The new Credit Agreement extends through October 27, 2001. A
commitment fee of .375 percent per annum is charged on the unused credit
facility. Borrowings under the new Credit Agreement are collateralized
substantially by all of the Company's assets, except for real estate which
secures the existing Mortgage Loans.
Concurrent with signing the new Credit Facility, the Company negotiated
amendments to its existing Mortgage Loans which allowed the Company to convert
its variable and half of its fixed Mortgage Loans aggregating $8,471,032 to
borrowings under the new Credit Agreement.
The Company had $10.1 million and $6.4 million outstanding on the Company's
credit facilities at January 2, 1999 and January 3, 1998, respectively. The
Company also had $5.7 million and $15.2 million outstanding at January 2, 1999
and January 3, 1998, respectively under mortgage loans and capital leases.
The terms of the new Credit Agreement and Amended Mortgage Loans require the
Company to meet certain financial covenants, and limit the level of additional
indebtedness. Management believes cash on hand, cash from operations and cash
available through the Company's financing agreements will be sufficient to meet
the short and long-term working capital requirements.
FORWARD-LOOKING STATEMENT
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.
3
3
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. However, Builders
Square announced in the first quarter of 1999 that they will be exiting the
marketplace in Northeastern Ohio. Lowe's continued to expand with additional
locations in 1996, 1997 and 1998. In the fourth quarter of 1997 and continuing
in 1998, Home Depot began operations in several of the Company's markets and
Home Depot and Lowe's have announced further expansion plans in 1999. 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.
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, closings and store development
activities.
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
BACKGROUND. Some computers, software, and other equipment include programming
code in which calendar year data is abbreviated to only two digits. As a result
of this design decision, some of these systems could fail to operate or fail to
produce correct results if "00" is interpreted to mean 1900, rather than 2000.
These problems are widely expected to increase in frequency and severity as the
year 2000 approaches, and are commonly referred to as the "Millennium Bug" or
"Year 2000 Problem."
ASSESSMENT. The Company has reviewed its internal computer programs and
systems to ensure that the programs and systems will be Year 2000 compliant. The
Company presently believes that its computer systems will be Year 2000 compliant
in a timely manner. The Company has incurred approximately $150,000 and will
expect to incur approximately an additional $150,000 to complete these efforts.
INTERNAL INFRASTRUCTURE. The Company believes that it has identified
substantially all of the major computers, software applications, and related
equipment used in connection with its internal operations that must be modified,
upgraded, or replaced to minimize the possibility of a material disruption to
its business. The Company has commenced the process of modifying, upgrading, and
replacing those systems that have been identified as affected, and expects to
complete this process by the second quarter of fiscal 1999.
SYSTEMS OTHER THAN INFORMATION TECHNOLOGY SYSTEMS. In addition to computers
and related systems, the operation of office and facilities equipment, such as
fax machines, photocopiers, telephone switches, security systems, and other
common devices may be affected by the Year 2000 Problem. The Company is
currently assessing the potential effect of, and costs of remediating, the Year
2000 Problem on its office and facilities equipment.
The Company does not expect to incur any material costs to complete these
efforts. Such costs are included in the estimate discussed above under
"Assessments."
SUPPLIERS. The Company has initiated communications with third party
suppliers of the major computers, software, and other equipment used, operated,
or maintained by the Company to identify and, to the extent possible, to resolve
issues involving the Year 2000 Problem. However, the Company has limited or no
control over the actions of these third party suppliers. Thus, while the Company
expects that it will be able to resolve any significant Year 2000 Problems with
these systems, there can be no assurance that these suppliers will resolve any
or all Year 2000 Problems with these systems before the occurrence of a material
disruption to the business of the Company or any of its customers. Any failure
of these third parties to resolve Year 2000 problems with their systems in a
timely manner could have a material adverse effect on the Company's business,
financial condition, and results of operation.
Based on the progress the Company has made in addressing its Year 2000
issues and the Company's plan and timeline to complete its compliance program,
the Company does not foresee significant risks associated with its Year 2000
compliance at this time. As the Company's plan is to address its significant
Year 2000 issues prior to being affected by them, it has not developed a
comprehensive contingency plan. The Company expects to complete its Year 2000
compliance testing by the end of the Company's 1999 second quarter. At that
time, the Company will assess the need for a contingency plan as deemed
necessary.
4
4
STATEMENT OF INCOME D.I.Y. Home Warehouse, Inc.
- -------------------
for the years ended January 2, 1999,
January 3, 1998 and December 28, 1996 1998 1997 1996
- --------------------------------------------------------------------------------------------------------------------------
Net sales $ 172,600,414 $ 210,199,898 $ 212,068,262
Cost of sales 127,215,341 152,624,851 156,611,900
- --------------------------------------------------------------------------------------------------------------------------
GROSS PROFIT 45,385,073 57,575,047 55,456,362
- --------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Store operating, general and administrative 45,336,514 49,585,529 46,954,847
Store closing and development costs 2,143,394 1,436,416 --
- --------------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 47,479,908 51,021,945 46,954,847
- --------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) (2,094,835) 6,553,102 8,501,515
Other income (expense):
Interest expense, net (1,860,892) (2,151,662) (2,452,575)
Other income, net 100,146 450,186 305,816
- --------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) (3,855,581) 4,851,626 6,354,756
Income taxes (benefit) (1,556,130) 1,979,556 2,569,570
- --------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (2,299,451) $ 2,872,070 $ 3,785,186
==========================================================================================================================
EARNINGS (LOSS) PER COMMON SHARE, BASIC AND DILUTED $ (0.30) $ 0.38 $ 0.50
==========================================================================================================================
Weighted average common shares outstanding 7,594,540 7,633,825 7,626,702
==========================================================================================================================
STATEMENT OF SHAREHOLDERS' EQUITY
- ---------------------------------
for the years ended January 2, 1999, January 3, 1998 and December 28, 1996
Total
Common Stock Retained Treasury Shareholders'
Shares Amount Earnings Stock Equity
- ------------------------------------------------------------------------------------------------------------------------------------
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
Net loss (2,299,451) (2,299,451)
Purchase of common stock for treasury (357,800) $ (201,441) (201,441)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCES, JANUARY 2, 1999 7,276,059 $ 22,955,462 $ 14,884,644 $ (201,441) $ 37,638,665
====================================================================================================================================
See Notes to Financial Statements.
5
5
BALANCE SHEET D.I.Y. Home Warehouse, Inc.
- -------------
as of January 2, 1999 and January 3, 1998 1998 1997
- ---------------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 128,149 $ 141,401
Refundable federal income taxes 706,545 365,963
Merchandise inventories 31,261,721 40,156,756
Deferred income taxes 1,542,590 278,565
Prepaid expenses and other assets 780,086 846,350
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 34,419,091 41,789,035
- ---------------------------------------------------------------------------------------------------------------------------
PROPERTY AND EQUIPMENT, AT COST:
Land 4,275,402 4,275,402
Buildings 19,563,279 19,551,311
Furniture, fixtures and equipment 18,665,163 18,333,731
Leasehold improvements 11,246,915 10,166,236
- ---------------------------------------------------------------------------------------------------------------------------
53,750,759 52,326,680
Less accumulated depreciation and amortization 17,878,455 13,381,396
- ---------------------------------------------------------------------------------------------------------------------------
Property and equipment, net 35,872,304 38,945,284
Other assets 385,910 474,888
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 70,677,305 $ 81,209,207
===========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Note payable, affiliate $ 300,000 $ 600,000
Current maturities of long-term debt 1,288,330 946,183
Accounts payable 8,462,635 10,615,039
Accrued expenses 4,078,679 3,917,720
Accrued sales and income taxes 1,151,434 1,530,710
Customer deposits 297,273 328,485
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 15,578,351 17,938,137
Revolving credit 10,134,153 6,375,000
Long-term debt 4,438,867 14,208,586
Deferred income taxes 2,887,269 2,547,927
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 33,038,640 41,069,650
- ---------------------------------------------------------------------------------------------------------------------------
Commitments -- --
SHAREHOLDERS' EQUITY:
Preferred stock, authorized 1,000,000 shares, none issued -- --
Common stock, no par value, authorized 10,000,000 shares, issued 7,633,859 shares at
January 2, 1999 and January 3, 1998 outstanding 7,276,059 and 7,633,859 shares
at January 2, 1999 and January 3, 1998 respectively 22,955,462 22,955,462
Retained earnings 14,884,644 17,184,095
- ---------------------------------------------------------------------------------------------------------------------------
37,840,106 40,139,557
Less common stock in treasury, at cost:
357,800 shares (201,441) --
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 37,638,665 40,139,557
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 70,677,305 $ 81,209,207
===========================================================================================================================
See Notes to Financial Statements.
6
6
STATEMENT OF CASH FLOWS D.I.Y. Home Warehouse, Inc.
for the years ended January 2, 1999,
January 3, 1998 and December 28, 1996 1998 1997 1996
- -----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,299,451) $ 2,872,070 $ 3,785,186
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,504,100 3,372,876 3,201,110
Deferred income tax expense (924,683) 1,037,230 818,428
Common shares issued under Retainer Stock Plan -- 13,457 29,484
Net (gain) loss on disposal of property 3,649 (214,675) --
Changes in operating assets and liabilities:
Refundable federal income taxes (340,582) (117,275) (248,688)
Merchandise inventories 8,895,035 (1,694,631) 1,466,668
Prepaid expenses and other assets 66,264 55,575 (141,350)
Other assets 88,978 102,554 107,738
Accounts payable (2,152,404) (1,663,416) (789,444)
Accrued income taxes (235,644) (177,980) (148,105)
Accrued expenses and other liabilities (13,885) 765,396 311,892
- -----------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 7,591,377 4,351,181 8,392,919
- -----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (1,434,769) (3,599,180) (1,745,975)
Proceeds from sale of property -- 850,911 --
- -----------------------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING ACTIVITIES (1,434,769) (2,748,269) (1,745,975)
- -----------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments, notes payable (300,000) (300,000) --
Principal payments under capital lease obligations (160,739) (157,624) (56,970)
Principal payments of long-term debt (9,266,833) (1,540,247) (597,511)
Proceeds from revolving credit 12,384,153 9,000,000 4,000,000
Principal payments, revolving credit (8,625,000) (8,625,000) (11,300,000)
Purchase of treasury stock (201,441) -- --
- -----------------------------------------------------------------------------------------------------------------------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (6,169,860) (1,622,871) (7,954,481)
- -----------------------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (13,252) (19,959) (1,307,537)
Cash and cash equivalents, beginning of year 141,401 161,360 1,468,897
- -----------------------------------------------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 128,149 $ 141,401 $ 161,360
=======================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 1,907,064 $ 2,146,071 $ 2,571,345
=======================================================================================================================
Cash paid for income taxes $ 456,288 $ 1,446,974 $ 2,146,248
=======================================================================================================================
SUPPLEMENTAL INVESTING AND FINANCING INFORMATION:
Capital lease obligations incurred $ -- $ 23,310 $ 815,988
=======================================================================================================================
See Notes to Financial Statements.
7
7
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 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
1998, 1997 and 1996 relate to the fiscal years ended January 2, 1999, January 3,
1998 and December 28, 1996, respectively. Fiscal year 1997 consisted of 53
weeks. Fiscal years 1998 and 1996 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.
Advertising Costs
Advertising and promotion costs are charged to operations in the year
incurred. Advertising expense was $2,624,787, $2,181,935 and $2,064,058 in 1998,
1997 and 1996, respectively.
Store Closing and Development Costs
Store Closing Costs
- -------------------
In the fourth quarter of 1998, the Company announced the closing of two of
its stores. The Company incurred $1,837,703 in the fourth quarter to close these
stores. Also included in these costs are the write down of long-lived assets of
these two stores to their net realizable value.
Store Development Costs
- -----------------------
The Company incurred $305,691 and $1,436,416 related to store development
costs for the fiscal years ended January 2, 1999 and 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 related 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 1997 and the first quarter of 1998.
Certain of the costs incurred in 1997 and 1998 relate to the development and
creative design of these strategic concepts while other costs pertain to
implementation including marketing, advertising, promotions and payroll costs.
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.
As discussed under store development and closing costs, the Company announced
the closing of two of its stores during the fourth quarter of 1998. The Company
closed the retail operations of these stores at the end of January 1999. The
Company is actively marketing the one location owned by the Company. Included in
property and equipment, net on the balance sheet are net assets of approximately
$3.8 million held for resale. The Company estimates the net proceeds of the sale
will approximate the property's net book value.
Earnings Per Share
Earnings per share have been computed according to Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings Per Share." The denominators for
calculating the Company's basic and diluted earnings per share are identical as
all common stock equivalents are anti-dilutive as of January 2, 1999, January 3,
1998 and December 28, 1996.
Income Taxes
Income taxes are provided based upon income for financial reporting purposes.
Deferred income taxes reflect the net tax effects of temporary differences
8
8
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.
Reclassifications
Certain prior year balances have been reclassified to conform to current year
presentation.
2. DEBT
The Note payable, affiliate of $300,000 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 1998 and 1997,
the Company made principal payments of $300,000 each 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 $31,526,
$64,295 and $82,544 in 1998, 1997 and 1996, respectively.
On October 27, 1998, the Company terminated its existing Revolving Credit
Agreement with its two banks and entered into a new Credit and Security
Agreement (Credit Agreement) with a bank. The new Credit Agreement provides for
borrowings up to $20,000,000 pursuant to a formula based upon the Company's
inventories with interest at the Company's option of either LIBOR or the prime
rate for specified maturities adjusted by varying points in accordance with the
Security Agreement. The new Credit Agreement extends through October 27, 2001. A
commitment fee of .375 percent per annum is charged on the unused credit
facility. Borrowings under the new Credit Agreement are collateralized
substantially by all of the Company's assets, except for real estate.
Concurrent with signing the new Credit Facility, the Company negotiated
amendments to its existing Mortgage Loans which allowed the Company to convert
its variable and half of its fixed Mortgage Loans aggregating $8,471,032 to
borrowings under the new Credit Agreement.
The Company had $10,134,153 and $6,375,000 outstanding on the Company's
credit facilities at January 2, 1999 and January 3, 1998, respectively at
weighted average annual interest rates of 7.2 percent at January 3, 1999 and 7.3
percent at January 3, 1998.
Long-term debt consists of the following:
1998 1997
-----------------------------
Mortgage loans due in monthly installments of $98,206 including principal and
interest at 10.3 percent per annum, 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 $ 3,821,737 $ 8,182,770
Mortgage loans due in monthly installments of $34,796 including principal and
interest at 9.28 percent per annum, 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 1,441,494 3,086,303
Mortgage loans, converted to new credit facility on October 27, 1998 -- 3,260,992
Capital lease obligations (Note 4) 463,966 624,704
- -----------------------------------------------------------------------------------------------------------------
Long-term debt 5,727,197 15,154,769
Less current maturities of long-term debt 1,288,330 946,183
- -----------------------------------------------------------------------------------------------------------------
Long-term debt, net of current maturities $ 4,438,867 $14,208,586
=================================================================================================================
Principal amounts of long-term debt payable, including capital lease
obligations in fiscal years 1999 through 2003 are $1,288,330, $1,423,782,
$1,461,492, $1,474,663, and $78,930, respectively.
During fiscal years 1998, 1997 and 1996, interest expense was $1,865,949,
$2,170,060 and $2,491,845, respectively.
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, $5,727,197, was
estimated to have a fair value of $6,100,000 at January 2, 1999.
The terms of the new credit facility and amended mortgage loans require the
Company to meet certain financial covenants and limit the level of additional
indebtedness.
3. INCOME TAXES
Income taxes include the following:
1998 1997 1996
----------------------------------------------
Federal $ 622,968) $ 935,053 $ 1,307,458
Deferred (933,162) 761,469 859,083
State and local -- 283,034 403,029
- -------------------------------------------------------------------
$(1,556,130) $ 1,979,556 $ 2,569,570
===================================================================
A reconciliation of the statutory federal income tax rate to the Company's
effective income tax rate follows:
1998 1997 1996
----------------------------
Statutory federal income tax rate (34.0)% 34.0% 34.0%
State and local income taxes, net of federal benefit (6.3) 6.2 6.2
Tax credits and other (0.1) 0.6 0.2
- ---------------------------------------------------------------------------------------
Effective income tax rate (40.4)% 40.8% 40.4%
=======================================================================================
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:
1998 1997
-----------------------------
Depreciation $(2,837,837) $(2,537,061)
LIFO (169,113) (225,485)
Accrued liabilities 876,045 297,896
State income tax 129,546 195,288
Net operating loss carry forwards 656,680 --
- --------------------------------------------------------------------
Net deferred tax (liability) $(1,344,679) $(2,269,362)
====================================================================
The Company has available net operating loss carryforwards of approximately
$591,000 and $2,240,000 for federal and state income taxes, respectively, which
expire principally in year 2018 (federal) and in year 2013 (state). In addition,
the Company has available Alternate Minimum Tax credit carryforwards of
approximately $202,000 which may be used indefinitely to reduce federal income
taxes.
4. LEASES AND COMMITMENTS
The Company leases eight retail stores, its corporate offices and warehouse
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 10 years and have renewal options varying from 10 to 45 years. Six leases
require
9
9
additional lease payments based upon a percentage of sales above certain sales
levels. There were no percentage lease payment requirements for fiscal year
1998. Percentage lease payments were $24,090 and $42,463 in 1997 and 1996,
respectively.
In 1996, the Company entered into a capital lease for a new computer
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 Rental Payments
---------------------------------
Year ending:
1999 $3,943,403 $166,380 $3,777,023 $207,900
2000 3,737,826 153,195 3,584,631 207,900
2001 3,593,138 159,800 3,433,338 87,172
2002 2,589,374 119,000 2,470,374
2003 1,828,729 -- 1,828,729
Later years 5,249,330 -- 5,249,330
- -----------------------------------------------------------------
Total minimum
lease payments $20,941,800 $598,375 $20,343,425 $502,972
=======================================================
Less amounts
representing interest 39,006
- -----------------------------------------------------------------
Present value of net
minimum lease
payments $463,966
=================================================================
Total net rental expense for all operating leases for the years ended January
2, 1999, January 3, 1998 and December 28, 1996 was approximately $3,990,000,
$3,943,000 and $3,738,000, respectively. Rental expense is net of sublease
rental income of $187,500, $185,510 and $252,000 for the years ended January 2,
1999, January 3, 1998 and December 28, 1996, respectively.
The Company leased four of its retail stores from the Company's majority
shareholder or entities affiliated with him during fiscal years 1998, 1997 and
1996. The majority shareholder sold one of the retail stores to a third party
during the fourth quarter of 1998. Rents associated with these leases were
$1,784,555, $1,873,992 and $1,837,403 for the years ended January 2, 1999,
January 3, 1998 and December 28, 1996, respectively.
5. STOCKHOLDERS' EQUITY
Treasury Stock
On November 11, 1998, the Company received an unsolicited offer from a
brokerage firm on behalf of an existing shareholder to sell 357,800 shares of
the Company's stock (the "Shares") at $9/16 ($0.563). At that time, due to the
timing of the proposed transaction, the Company did not participate in the
proposed sale and the shares were acquired by the Company's Chairman and
Controlling Stockholder. On November 23, 1998, the Company accepted the
Controlling Stockholder's offer to sell the Shares to the Company at the price
per share which the Controlling Stockholder paid. The Company's decision to
purchase the Shares was based on the Company's conclusion that the purchase
would enhance shareholder value. The Company's lender approved the purchase of
the Shares. The Company also announced that it has no present intention to
acquire additional shares of its stock.
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 1998, 1997 and 1996 is
as follows:
Average Option
Stock Option Price Per Share
-----------------------------
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
Granted -- --
Canceled (113,000) 4.10
- ------------------------------------------------------------------
Outstanding at January 2, 1999 885,000 3.63
==================================================================================
1998 1997 1996
--------------------------------------
Options exercisable at end of year 298,641 11,400 286,300
Weighted-average option price per share
of options exercisable $ 3.75 $ 11.66 $ 10.65
Exercisable price per share for options at end of year:
Exercisable $3.56 to $4.69 to $6.44 to
$ 16.13 $ 16.13 $ 16.13
Outstanding $3.56 to $3.56 to $3.63 to
$ 16.13 $ 16.13 $ 16.13
Weighted-average remaining contractual life (years):
Exercisable 3.25 1.50 2.50
Outstanding 3.25 4.25 3.00
Options available for future grant 465,000 352,000 549,000
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 1998, 1997 and 1996 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:
1998 1997 1996
-------------------------------------------
Net income (loss) As Reported $(2,299,451) $2,872,070 $3,785,186
Pro Forma $(2,565,906) $2,664,621 $3,683,661
Earnings (loss)
per common share As Reported $(0.30) $0.38 $0.50
Pro Forma $(0.34) $0.35 $0.48
The fair value of each option granted during fiscal years 1997 and 1996 was
estimated on the date of grant using the Black-Scholes option pricing model with
the following weighted average assumptions. There were no options granted in
fiscal year 1998.
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10
1997 1996
-------------------------------------------------
Shares Subject Shares Not Subject
to Repricing to Repricing
-------------------------------------------------
Risk free interest rates 6.46% 6.2 - 6.5% 5.4 - 5.7%
Expected life (years) 4 5 5
Volatility 37% 38% 36%
Dividend yield 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 $410,000, $476,051
and $211,789 for fiscal years 1998, 1997 and 1996, respectively.
7. QUARTERLY FINANCIAL DATA (UNAUDITED)
1998 1st 2nd 3rd 4th Total
------------------------------------------------------------------------------------------
Net sales $37,412,172 $56,334,029 $42,900,050 $35,954,163 $172,600,414
Gross profit 10,684,252 14,458,674 11,267,626 8,974,521 45,385,073
Net income (loss) (797,045) 885,394 (337,491) (2,050,309) (2,299,451)
Earnings (loss) per
common share $(0.10) $0.12 $(0.04) $(0.27) $(0.30)
Weighted average
common shares
outstanding 7,633,859 7,633,859 7,633,859 7,476,584 7,594,540
The sum of the 1998 quarterly earnings (loss) per common shares does not equal
fiscal 1998 earnings (loss) per common share due to the effects of rounding.
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 7,633,859 7,633,825
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
D.I.Y. Home Warehouse, Inc.
In our opinion, the accompanying balance sheets and the related statements of
income, shareholders' equity and of cash flows present fairly, in all material
respects, the financial position of D.I.Y. Home Warehouse, Inc. at January 2,
1999 and January 3, 1998, and the results of its operations and its cash flows
for each of the three years in the period ended January 2, 1999, in conformity
with generally accepted accounting principles. 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 of these statements in accordance with generally accepted auditing
standards which 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, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Cleveland, Ohio
February 12, 1999
11
11
SELECTED FINANCIAL DATA AND OPERATING HIGHLIGHTS D.I.Y. Home Warehouse, Inc.
Fiscal Year
------------------------------------------------------------
(Amounts in thousands, except per share data) 1998 1997(1) 1996 1995 1994
- -------------------------------------------------------------------------------------------------------------------------
OPERATING RESULTS
Net sales $172,600 $210,200 $212,068 $178,008 $136,369
Cost of sales 127,215 152,625 156,612 128,672 98,202
- -------------------------------------------------------------------------------------------------------------------------
Gross profit 45,385 57,575 55,456 49,336 38,167
Store operating, general and administrative expenses 45,336 49,586 46,954 40,935 30,333
Store preopening costs -- -- -- 1,778 1,200
Store closing and development costs 2,143 1,436 -- -- --
Other expense (income), net 1,761 1,701 2,147 1,431 (101)
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes (benefit) (3,855) 4,852 6,355 5,192 6,735
Income taxes (benefit) 1,556 1,980 2,570 2,082 2,654
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (2,299) $ 2,872 $ 3,785 $ 3,110 $ 4,081
=========================================================================================================================
Earnings (loss) per common share, basic and diluted $ (0.30) $ 0.38 $ 0.50 $ 0.41 $ 0.54
=========================================================================================================================
Weighted average common shares outstanding 7,595 7,634 7,627 7,625 7,625
=========================================================================================================================
(1) Fiscal year 1997 consisted of 53 weeks; all other years reported consisted
of 52 weeks.
1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------
SELECTED OPERATING DATA
Number of stores open at end of period 14 16 16 16 11
Interior selling square footage at end of period 1,189,000 1,369,000 1,353,000 1,353,000 918,000
Comparable store sales increase (decrease) (17.9)% (2)% 7% (5)% 8%
Number of employees 1,009 1,254 1,334 1,325 939
(Amounts in thousands) 1998 1997 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA (AT PERIOD END)
Working capital $ 18,841 $ 23,851 $ 20,889 $ 23,297 $ 20,769
Total assets 70,677 81,209 79,764 83,500 58,519
Notes payable and current maturities of long-term debt 1,588 1,546 1,698 1,452 1,820
Long-term debt 14,573 20,584 22,031 29,415 14,767
Shareholders' equity 37,639 40,140 37,254 33,439 30,330
12