<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the fiscal year ended August 1, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-5967
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THREE D DEPARTMENTS, INC.(DEBTOR IN POSSESSION)
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(Exact name of registrant as specified in its charter)
DELAWARE 06-0733200
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3535 HYLAND AVENUE, SUITE 200, COSTA MESA, CALIFORNIA 92626-1439
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(Address of principal executive offices)
TELEPHONE NUMBER (714) 662-0818
(Registrant's telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Class A Common Stock
Class B Common Stock
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or an amendment to this
Form 10-K. [ X ]
The aggregate market value of the outstanding voting stock of the registrant
held by non-affiliates as of November 30, 1998 was $222,751 for Class A common
stock and $108,395 for Class B common stock, based upon the last closing price
of $.50 per share for Class A common stock and $.25 per share for Class B common
stock on that date.
As of November 30, 1998, 1,171,494 shares of Class A common stock and 1,264,455
shares of Class B common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Part III of this report (Items 10,11,12 and 13) is
incorporated by reference from the registrant?s definitive Proxy Statement for
its 1998 Annual Meeting of Stockholders which is expected to be filed with the
Commission on or about January 15, 1999.
The total number of pages is 40. The exhibit index is located on page 17.
<PAGE>
PART I
ITEM 1. BUSINESS
INTRODUCTORY NOTE This Annual Report on Form 10-K contains certain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (the "Securities Act"), and Section 21E of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the
Company intends that such forward-looking statements be subject to the safe
harbors created thereby.
THE COMPANY Three D Departments, Inc. (the "Company,") is a chain of specialty
retail home textiles and decorative housewares products stores generally located
in regional shopping centers. As of August 1, 1998, the Company operated 21
stores, principally in California, Arizona, and Connecticut. The Company's
corporate office is located at 3535 Hyland Avenue, Costa Mesa, California 92626,
and its telephone number is (714) 662-0818.
EVENTS LEADING UP TO CHAPTER 11 Beginning in February 1998, the Company
experienced a tightening of bank credit. The lack of available funds
precipitated extensions in trade payables, and as a result merchandise shipments
to the Company constricted to levels which could not adequately support the
Company's historical volume of business. Subsequently, the Company incurred
operating losses stemming from a lack of merchandise inventory.
On April 15, 1998 the Company met with its trade creditors to discuss a forecast
of a downturn in business the Company was projecting for the months of May,
June, and July, 1998. The Company asked its trade creditors to temporarily place
all demands for collection of trade credit on hold dated April 15, 1998 and
prior, while the Company sought alternative financing and strategic proposals.
On April 15, 1998 the trade creditors formed an Unofficial Creditors Committee
to consult with the Company. The Company asked the trade creditors to continue
the moratorium until July 15, 1998.
In July 1998 the Company sought a cash infusion and had made tentative
arrangements for additional financing, which was contingent upon a successful
compromise of the trade debt that was put on hold as of April 15, 1998. A
compromise plan was presented to the unofficial committee of unsecured
creditors, but was not accepted by one large unsecured creditor.
Most vendors were not extending terms, and the Company was unable to replenish
its shelves with new merchandise. Because of these restrictions on cash flow and
an inability to renegotiate existing bank debt or raise additional capital
through other sources, the Company decided to seek protection offered under
Chapter 11 of the US Bankruptcy Code.
PROCEEDINGS UNDER CHAPTER 11. On July 30, 1998 (the "Petition Date"), the
Company commenced a reorganization case by filing a voluntary petition (the
"Chapter 11 Petition") for relief under chapter 11 ("Chapter 11") of title 11 of
the United States Code (as amended from time to time, the "Bankruptcy Code") in
the United States Bankruptcy Court for the Central District of California, Los
Angeles Division (the "Bankruptcy Court"), case number SA 98 20792 LR.
Management determined that filing of the Chapter 11 Petition would allow the
needed time and flexibility to restructure the Company's operations, reestablish
the flow of merchandise to its stores, and provide the time and protection
necessary to restructure the Company's funding sources.
Since the Petition Date, the Company has continued in possession of its
properties and, as debtor-in-possession, is authorized to operate and manage its
businesses and enter into all transactions (including obtaining services,
inventories, and supplies) in the ordinary course of business, or out of the
ordinary course of business subject to approval of the Bankruptcy Court, after
notice and hearing. A statutory Creditors' Committee has been appointed in the
Chapter 11 case.
2
<PAGE>
Subsequent to the filing of the Chapter 11 Petition, the Company sought and
obtained several orders from the Bankruptcy Court, which were intended to
stabilize its business. The most significant of these orders: (1) established
debtor-in-possession Financing with the Company's pre-petition lender Foothill
Capital Corporation; and (2) authorized the Company to conduct "going out of
business" sales in six locations which the management of the Company had decided
to close due to the poor operating performance of those stores.
The Company's consolidated financial statements have been prepared on a going
concern basis, which contemplates realization of assets and satisfaction of
liabilities in the normal course of business. As a result of the Chapter 11
Petition filing and circumstances relating to this event, such realization of
assets and satisfaction of liabilities is subject to uncertainty. A plan of
reorganization could materially change the amounts reported in the accompanying
consolidated financial statements, which do not give effect to adjustments to
the carrying values of assets and liabilities, which may be necessary as a
consequence of a plan of reorganization. The Company's ability to continue as a
going concern is contingent upon, among other things, its ability to formulate a
plan of reorganization that will be confirmed by the Bankruptcy Court, to
achieve satisfactory levels of profitability and cash flow from operations, to
maintain compliance with the debtor-in-possession Financing Agreement, and the
ability to obtain sufficient financing sources to meet future obligations.
BUSINESS STRATEGY The Company's goal is to become a unique and preferred
specialty retailer of high quality bed, bath, decorative housewares and home
decorative accessories. The primary components of the strategy to achieve its
goal are as follows:
COORDINATED HIGH QUALITY MERCHANDISE The commitment to high quality is apparent
from the many recognizable brand names carried by the Company such as CROSCILL,
MARTEX, WAMSUTTA, and many more. The Company works closely with its supplier
base to select and in many cases create product that presents a decorator image
to the consumer. This process and store display technique fosters both a
pleasant shopping experience for browsing, and also facilitates a rapid decision
making process for the customer who has little time.
A COMPLETE DECORATIVE HOMe STORE: Currently, the various classifications
contribute to total sales in the following manner: bedding - 41% bath - 28%, and
decorative housewares and accessories - 31%. The Company is reputed as a high
quality and high fashion linen retailer. The long product life of bedding
product, coupled with its high-ticket price does not create enough demand for
frequent visits by the customer. With a wider array of products, (decorative
accessories and bath items) the Company seeks to attract increased visits and
sales from its customer base. The typical superstore carries 50,000 stock
keeping units (SKUs) featuring a broad assortment of brands, styles, colors, and
prices.
SHOPPING ENVIRONMENT: Home fashion merchandise requires enough space to
adequately separate different looks and help the customer feel the mood created
by the product. The Company has developed a racetrack formula store with alcoves
along the outer perimeter in order to create many display opportunities in a
compact space. As a result, the store has an at home ambience and the sales
associates are close to the customer when they are ready for assistance.
CUSTOMER SERVICE: The Company places a special emphasis on customer recognition
and service. Acknowledging customers and being aware of their needs are the
first steps in the customer service program. This is followed with extensive
product knowledge brochures made available to all staff. Sales associates are
encouraged to suggest coordinating product, search the entire Company for hard
to obtain merchandise, and assist the customer on merchandise returns. Sales
associates are compensated on an hourly basis with medical, vacation and 401K
profit sharing benefits.
3
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TRADE NAMES: The Company operates under four trade names: Three D Bed & Bath,
Three D Bed, Bath & More, Linens Plus, and Linens Plus + More.
INFORMATION TECHNOLOGY: The Company's electronic information systems are
continually reviewed to enable the Company to provide the best service to its
customers. The Company operates its systems on two information platforms using
IBM AS/400 based products and Microsoft Windows NT inter-office communication
products. The software utilized by the Company is purchased from outside vendors
and the programs themselves have not been heavily modified.
IMPACT OF YEAR 2000 As the year 2000 approaches, computer programs, computers
and embedded microprocessors controlling equipment with date sensitive systems
may recognize year 2000 as year 1900, or not at all. This inability to recognize
or properly handle the year 2000 date may result in computer system failures or
miscalculations of critical information as well as failures of equipment using
date sensitive microprocessors. The Company's various financial and operational
information systems and, in some cases, embedded microprocessors in certain
machinery and equipment that have computer systems and applications could be
affected by the Year 2000 issue. The Company has conducted a year 2000 readiness
review with its information technology vendors and have identified three major
areas requiring tasks to become year 2000 compliant. Both the merchandising and
financial systems of the Company will become year 2000 compliant upon
installation of the most current release from software vendors. The task of
upgrading to new releases is within the normal course of activity for the
Company's information technology professionals and will be completed by the
spring of 1999. The point-of-sale system utilized by the Company will require
upgrades in hardware in addition to installing the most current release of
software. The estimated cost of the new hardware and software is $200,000 and
has been included in the Company's projections for capital expenditures in
fiscal 1999. The Company is currently testing the new point-of sale hardware and
software, and will install the upgraded system after the Christmas season of
1998. The Company trades electronic information with financial institutions and
with major merchandise suppliers. The Company has received what it believes to
be reasonable assurance from both its financial institution vendors and its
major merchandise suppliers that systems related to standardized exchange of
electronic information is year 2000 compliant. The Company is in the early stage
of evaluating non-information technology systems, which includes
telecommunication equipment.
Although management believes the Company has an adequate plan to be year 2000
compliant there can be no assurance that this program ultimately will be
successful. The Company believes that it has sufficient resources to implement
new and modified computer systems and programming to address the year 2000
issue, and, accordingly, has not to date identified the need for any contingency
planning. However, the Company's assessment of its financial and operations
systems, non-information technology systems and those of third parties may
reveal the need for contingency planning in the future.
ITEM 2. PROPERTIES
HOME FASHION SUPERSTORES Beginning in 1990, the Company changed its strategy
from that of a linens only specialty store and decided to offer housewares and
decorative accessories to its customers. The superstore prototype is a 25,000
square foot rectangular store designed in a racetrack format, which showcases
the broad and complete assortment in its various product categories. Decorative
accessories are prominently featured as the customer enters the store. The
Company specializes in high quality silk flowers, hard to find decorative vases,
candle holders, and picture frames. The linen area makes extensive use of fully
dressed beds, coordinated four-foot fashion vignettes and coordinating bath
products in high quality glass displays. The decorative housewares are presented
on promotional stepped displays, which help the customer pull together a
stylized look.
4
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Since 1994, the Company has built 8 racetrack superstores. The average
investment for a racetrack superstore is approximately $863,000 for fixtures,
equipment, building and leasehold, and $496,000 for inventory. For the year
ended August 1, 1998, these stores generated store level operating cash flow of
approximately 13.2% annual return on sales. Operating cash flow excludes
depreciation and write-downs of asset values associated with the Company's
Chapter 11 filing.
In addition to its racetrack superstores, the Company has added contiguous space
to expand or has renovated existing bed and bath stores in order to add
decorative housewares and decorative accessory product. As a part of the Chapter
11 reorganization strategy, the Company has decided to close or reduce square
footage in this group of stores due to the poor operating performance. For the
year ended August 1, 1998, these stores lost store level operating cash flow of
approximately 3.3% annual return on sales. Operating cash flow excludes
depreciation and write-downs of asset values associated with the Company's
Chapter 11 filing.
BED AND BATH STORES The Company continues to operate six stores in its
previously existing markets where the store was originally opened as a bed and
bath store. The Company intends, subject to the availability of funds, to either
convert these stores to superstores or replace them with new space on an
opportunistic basis. For the year ended August 1, 1998, these stores generated
store level operating cash flow of approximately 4.4% annual return on sales.
Operating cash flow excludes depreciation and write-downs of asset values
associated with the Company's Chapter 11 filing. The Company will close two of
these stores as a part of its Chapter 11 reorganization in fiscal 1999 due to
poor operating performance in these stores.
REAL ESTATE STRATEGY The Company leases all of its existing space except for a
22,000 square foot commercial building it purchased in December 1994 in Phoenix,
Arizona, which is used as a home fashion super store. The corporate offices are
located at 3535 Hyland Avenue, Costa Mesa, California. During fiscal 1998 the
Company incurred approximately $6,243,000 in aggregate annual rent payments in
connection with leases that expire between fiscal 1999 and fiscal 2012. The
leases typically require the payment of minimum annual rentals or a percentage
of net sales, whichever is greater, payable in monthly installments. In some
cases, the Company has options to renew its leases. Due to the Chapter 11
filing, certain leases can be terminated by the lessee. Management believes that
existing property is adequate to carry out its new plans.
ITEM 3. LEGAL PROCEEDINGS
Pursuant to section 362 of the Bankruptcy Code, during the Chapter 11case,
creditors and other parties in interest may not, without court approval, (i)
commence or continue a judicial, administrative or other proceeding against the
Company which was or could have been commenced prior to the commencement of the
Chapter 11 case, or recover a claim that arose prior to the commencement of the
Chapter 11 case; (ii) enforce any pre-petition judgment against the Company;
(iii) take any action to obtain possession of property of the Company or to
exercise control over property of the Company or its estate; (iv) create,
perfect or enforce any lien against property of the Company; (v) collect,
assess, or recover claims against the Company that arose before the commencement
of the Chapter 11 case; or (vi) offset any debt owing to the Company that arose
prior to the commencement of the Chapter 11 case against a claim of such
creditor or party in interest against the Company that arose before the
commencement of the Chapter 11 case.
As a result of the foregoing, all pre-petition claims asserted or assertable
against the Company have been automatically stayed. The nature of a Chapter 11
case is to have all claims against and interest in the Company resolved. The
Bankruptcy Court has ordered that any entity desiring to participate in any
distribution in the Chapter 11 case must either have been previously properly
scheduled by the Company or file a proof of claim with the Bankruptcy Court no
later than sixty days from the date of service of Notice to Creditors of Last
Date to File Proofs of Claim. The Company will evaluate proofs of claims filed
during the Chapter 11 case.
The Company is, from time to time, involved in routine litigation incidental to
the conduct of its business. The Company believes that no litigation currently
pending against it will have a material adverse effect on its financial position
or results of operations.
5
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NOT APPLICABLE.
6
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Beginning March 1, 1997 both classes of the Company's common stock began trading
on the OTC Bulletin Board. Prior to March 1, 1997 both classes of the Company's
common stock were listed on the American Stock Exchange. The high and low sales
prices for each quarter within the past two fiscal years as reported by the OTC
Bulletin Board and the American Stock Exchange are as follows:
1998 HIGH LOW DIVIDEND
---- ---- --- --------
First Quarter
Class A $2.0000 $.2500
Class B $.7500 $.2500
Second Quarter
Class A $.3750 $.1250
Class B $.3750 $.1250
Third Quarter
Class A $.8750 $.4000
Class B $.3950 $.3750
Fourth Quarter
Class A $.4800 $.4375
Class B $.4300 $.3950
1997 HIGH LOW DIVIDEND
---- ---- --- --------
First Quarter
Class A $1.1875 $1.0000 $0.0125
Class B $1.0625 $.9375 0.0075
Second Quarter
Class A $1.1875 $.6250 0.0125
Class B $.8750 $.5000 0.0075
Third Quarter
Class A $.8750 $.3750 0.0125
Class B $.7500 $.3750 0.0075
Fourth Quarter
Class A $.8750 $.6250
Class B $.6250 $.1719
In the fourth quarter of fiscal 1997, the Company suspended the payment of
dividends on both classes of its common stock. The Company had approximately 324
holders of record of its Class A common stock and approximately 321 holders of
record of its Class B common stock as of August 1, 1998.
7
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<TABLE>
ITEM 6. SELECTED FINANCIAL DATA
<CAPTION>
FISCAL YEAR ENDED (a)
AUGUST 1, 1998 AUGUST 2, 1997 AUGUST 3, 1996 JULY 29, 1995 JULY 30, 1994
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
Sales $ 37,559,411 $ 44,181,878 $ 47,851,248 $ 49,981,704 $ 41,752,567
Operating expenses 41,138,040 44,648,400 47,819,764 49,910,773 42,614,231
Impairment loss 648,913 - - - -
Restructuring expense 1,167,172 - - - -
Reorganization expenses 257,315 - - - -
Interest expense 1,152,387 1,210,227 1,317,052 1,054,330 539,797
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Loss before income taxes and
cumulative effect of accounting
changes (6,804,416) (1,676,749) (1,285,568) (983,399) (1,401,461)
Income taxes expense (benefit) 632,340 - - (455,771) (629,677)
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Loss before cumulative effect of
accounting change (7,436,756) (1,676,749) (1,285,568) (527,628) (771,784)
Cumulative effect of accounting
change (b)(c) - - 310,427 - 96,223
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Net loss $ (7,436,756) $ (1,676,749) $ (975,141) $ (527,628) $ (675,561)
==============================================================================
Weighted average number of common
shares outstanding 2,435,949 2,435,955 2,433,417 2,528,011 2,850,804
==============================================================================
Loss per share before cumulative
effect of accounting change $ (3.05) $ (0.69) $ (0.53) $ (0.21) $ (0.27)
Net loss per share $ (3.05) $ (0.69) $ (0.40) $ (0.21) $ (0.24)
Book value per share $ 0.62 $ 3.67 $ 4.39 $ 4.65 $ 4.53
Dividends declared per share
Class A $ - $ 0.0375 $ 0.05 $ 0.05 $ 0.05
Class B $ - $ 0.0225 $ 0.03 $ 0.03 $ 0.03
Working capital $ 8,398,859 $ 9,652,600 $ 11,225,777 $ 12,191,536 $ 12,867,856
Long-term debt $ 5,094,223 $ 8,497,177 $ 9,143,410 $ 9,784,325 $ 6,015,911
Stockholders equity $ 1,499,044 $ 8,935,800 $ 10,684,928 $ 11,745,345 $ 12,922,169
Total assets $ 15,336,229 $ 25,340,324 $ 27,507,134 $ 28,077,285 $ 25,446,968
</TABLE>
(a) The Company operates on a 52-53 week basis. Years end on the Saturday
nearest to July 31. The fiscal years 1994, 1995, 1997 and 1998 each,
included 52 weeks, fiscal year 1996 included 53 weeks.
(b) In fiscal 1996 the Company changed its method of accounting for inventories
to include the costs of certain buying, warehousing and transportation
costs.
(c) In fiscal 1994 the Company adopted the provisions of Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes".
8
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Reorganization under Chapter 11 of the US Bankruptcy Code
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On July 30, 1998 (the "Petition Date"), the Company commenced a reorganization
case by filing a voluntary petition (the "Chapter 11 Petition") for relief under
chapter 11 ("Chapter 11") of title 11 of the United States Code (as amended from
time to time, the "Bankruptcy Code") in the United States Bankruptcy Court for
the Central District of California, Los Angeles Division (the "Bankruptcy
Court"), case number SA 98 20792 LR. Management determined that filing of the
Chapter 11 Petition would allow the needed time and flexibility to restructure
the Company's operations, help reestablish the flow of merchandise to its
stores, and provide the time and protection necessary to restructure the
Company's funding sources.
Since the Petition Date, the Company has continued in possession of its
properties and, as debtor-in-possession, is authorized to operate and manage its
businesses and enter into all transactions (including obtaining services,
inventories, and supplies) in the ordinary course of business, or out of the
ordinary course of business subject to approval of the Bankruptcy Court, after
notice and hearing. A statutory Creditors' Committee has been appointed in the
Chapter 11 case.
Subsequent to the filing of the Chapter 11 Petition, the Company sought and
obtained several orders from the Bankruptcy Court, which were intended to
stabilize its business. The most significant of these orders: (1) established
debtor in possession Financing with the Company's pre-petition lender Foothill
Capital Corporation; and (2) authorized the Company to conduct "going out of
business" sales in six locations which the management of the Company had decided
to close due to the poor operating performance of those stores.
In a Chapter 11 filing, substantially all liabilities as of the Petition Date
are subject to compromise or other treatment under a plan of reorganization. For
financial reporting purposes, those liabilities and obligations whose
disposition is dependent on the outcome of the Chapter 11 filing have been
segregated and classified as liabilities subject to compromise under
reorganization proceedings in the accompanying consolidated balance sheet (Note
5). Generally, actions to enforce or otherwise effect payment of all
pre-petition Chapter 11 liabilities as well as all pending litigation against
the Company are stayed while the Company continues its business operations as
debtor-in-possession. The Company has filed schedules with the Bankruptcy Court
setting forth its assets and liabilities as of the Petition Date as reflected in
the Company's accounting records. Differences between amounts reflected in such
schedules and claims filed by creditors will be investigated and either amicably
resolved or adjudicated before the Bankruptcy Court. The ultimate amount of and
settlement terms for such liabilities are subject to a plan of reorganization
and accordingly are not presently determinable.
9
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Results of Operations
- ---------------------
The following table sets forth selected data from the Statement of Operations
expressed in percentage form and other statistical information, which the
Company believes, is pertinent to its operating results:
<TABLE>
<CAPTION>
Fiscal Year Ended
-----------------------------------------------
August 1, 1998 August 2, 1997 August 3, 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Sales 100% 100% 100%
Cost of sales, including warehousing,
transportation and buying expenses 60.8% 57.2% 57.3%
Store operating, administrative and general expenses 48.7% 43.9% 42.6%
Impairment loss 1.7% 0.0% 0.0%
Restructuring expenses 3.1% 0.0% 0.0%
Reorganization expenses 0.7% 0.0% 0.0%
Interest expense 3.1% 2.7% 2.8%
------------------------------------------------
Loss before income taxes and cumulative effect of
accounting change -18.1% -3.8% -2.7%
Income taxes 1.7% 0.0% 0.0%
Cumulative effect of accounting change 0.0% 0.0% 0.6%
------------------------------------------------
Net loss -19.8% -3.8% -2.1%
================================================
- ------------------------------------------------------------------------------------------------------
Number of store open beginning of year 22 23 28
New store openings 1 - -
Store closures (2) (1) (5)
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Number of stores, end of year 21 22 23
------------------------------------------------
</TABLE>
Fiscal 1998 Compared to Fiscal 1997
- -----------------------------------
Sales in fiscal 1998 were $37,559,411, a 15.0% decrease from fiscal 1997 sales
of $44,181,878. Sales of stores open in both fiscal 1998 and 1997 decreased by
16.5%. One new store was added during fiscal 1998, which accounted for sales of
$1,645,994. Additionally, sales of the stores closed during fiscal 1998
accounted for a decrease $1,155,196. Beginning in February 1998, the Company
experienced a tightening of bank credit. The lack of available funds
precipitated extensions in trade payables, and as a result merchandise shipments
to the Company constricted to levels which could not adequately support the
Company's historical volume of business. Subsequently, revenues decreased and
the Company incurred operating losses stemming from a lack of merchandise
inventory.
Cost of sales, including warehouse, transportation, and buying expenses, was
60.8% of sales in fiscal 1998, compared to 57.2% in fiscal 1997. Fixed expenses,
such as merchandise buying costs and distribution expenses accounted for a
larger percentage of cost of sales during fiscal 1998 due to the sharply reduced
merchandise purchases. In connection with the announced closure of six stores as
a part of the Company's reorganization effort an inventory valuation reserve of
$430,230 was established as of August 1, 1998 to adjust the carrying value of
ending inventory in the stores to be closed to its estimated net realizable
value.
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<PAGE>
Store operating, administrative and general expenses were 48.7% of sales in
fiscal 1998 compared to 43.9% in fiscal 1997. The decrease in comparable store
sales of 16.5% negatively impacted the Company's ability to leverage its fixed
expenses such as rent and depreciation.
The Company incurred substantial costs and expenses in connection with the
Chapter 11 petition and the restructuring plan adopted by management. A
provision for the impairment of long-lived assets was recorded in the amount of
$648,913. The charge related to a decrease in the carrying value of fixed
assets, leaseholds and inventory related to certain stores, which the Company
plans to close. Additionally the Company established a restructuring reserve in
the amount of $1,167,172 related to expenses in stores slated for closure during
the Chapter 11 reorganization period and lease rejection claims. Finally the
Company incurred $257,315 of legal and professional fees in connection with its
efforts to reorganize. The Company anticipates it will incur additional
reorganization costs throughout its Chapter 11 reorganization, it is not
possible to estimate those costs at this time.
Property, fixtures and improvements, except as discussed above, have been
reflected in the accompanying financial statements at their historical cost
bases. Such assets have been reflected at historical cost as management believes
that the Company's plan of reorganization will be approved and accordingly, the
Company will emerge from bankruptcy. Should the Company's plan of reorganization
not be approved by the Bankruptcy Court and the Company is forced to liquidate
its assets, or should an approved plan require the closure of additional stores,
the amounts realized by the Company from such liquidation and/or store closures
may be substantially less than the carrying values of such assets as reflected
in the accompanying balance sheet.
Interest expense decreased $57,840 to $1,152,387 in fiscal 1998 due principally
to a decrease in average outstanding borrowings. Average outstanding borrowings,
including loans against the cash surrender value of life insurance were
$10,875,962 for fiscal 1998 compared to $12105,736 in fiscal 1997. The weighted
average cost of interest was 10.6% in fiscal 1998 compared to 10.0% in fiscal
1997.
Income tax expense of $632,340 in fiscal 1998 was incurred as the Company
recorded a valuation allowance against all of the deferred tax assets. In fiscal
1998 the effective income tax rate was 9.3% compared to a statutory benefit of
34.0%. The primary difference between the statutory and effective rate was the
decision of the Company to record no tax benefit from the current year operating
loss. Additionally, because management can not determine that it is more likely
than not that deferred tax assets will be realized a full reserve was recorded
against all previously recorded deferred tax assets.
For the year ended August 1, 1998, net loss was $7,436,756 compared to a net
loss of $1,676,749 in the prior year.
Fiscal 1997 Compared to Fiscal 1996
- -----------------------------------
Sales in fiscal 1997 were $44,181,878, a 7.7% decrease from fiscal 1996 sales of
$47,851,248. Sales of stores open in both fiscal 1997 and 1996 decreased by
3.5%. The Company experienced competitive openings against several of its key
stores during fiscal 1997. Additionally, sales of the stores closed during
fiscal 1996 accounted for a decrease $1,986,234.
11
<PAGE>
Cost of sales, including warehouse, transportation, and buying expenses, was
57.2% of sales in fiscal 1997, compared to 57.3% in fiscal 1996.
Store operating, administrative and general expenses were 43.9% of sales in
fiscal 1997 compared to 42.6% in fiscal 1996. The decrease in comparable store
sales of 3.5% negatively impacted the Company's ability to leverage its fixed
expenses such as rent and depreciation.
Interest expense decreased $106,825 to $1,210,227 in fiscal 1997 due principally
to a decrease in average outstanding borrowings. The average outstanding
borrowings for fiscal 1997 were $9,005,13 compared to $9,689,023 in fiscal 1996.
The Company retired $757,573 in debt during the year as its working capital
needs decreased in conjunction with the decrease in merchandise inventory.
The Company did not record a tax benefit arising from the operating loss of
$1,676,749 in fiscal 1997. The Company increased the valuation allowance against
deferred tax assets from $478,929 at the end of fiscal year 1996 to $1,289,313
at the end of fiscal 1997. The valuation allowance relates primarily to
operating loss carry forwards generated in fiscal years 1994 through 1997.
Taxable income is required to offset these loss carry forwards before their
expiration dates, which occur between fiscal 1998 and 2012. The ultimate
realization of deferred tax assets, net of the valuation allowance, of
$1,083,083 depends on the Company's ability to generate sufficient taxable
income in the future. The amount of the deferred tax asset could be reduced in
the near term if estimates of future taxable income are reduced.
For the year ended August 2, 1997, net loss was $1,676,749 compared to a net
loss of $975,141 in the prior year. In fiscal 1996 the Company recorded income
representing the cumulative effect of a change in accounting principle of
$310,427 relating to the capitalization into inventory of certain buying,
warehousing and transportation costs.
Liquidity and Capital Resources
- -------------------------------
As discussed previously, the Company filed a voluntary petition for relief under
Chapter 11 of the United States Code on July 30, 1998. Under Chapter 11, actions
taken to enforce certain claims against the Company are stayed if the claims
arose, or are based on, events that occurred on or before the Petition Date. The
ultimate terms of settlement of these claims will be determined in accordance
with a plan of reorganization, which requires the approval of the impaired
pre-petition creditors and confirmation by the Bankruptcy Court.
Until a plan of reorganization is confirmed by the Bankruptcy Court, only such
payments on pre-petition obligations that are approved or required by the
Bankruptcy Court will be made. Except as approved by the Bankruptcy Court,
principal and interest payments on pre-petition debt have not been made since
the Petition Date and will not be made without the Bankruptcy Court's approval
or until a plan of reorganization, defining the repayment terms, has been
confirmed by the Bankruptcy Court. As a result, $6,859,467 has been reclassified
as liabilities subject to compromise as of August 1, 1998. See Note 5 to the
Financial Statements. Other liabilities may arise or be subject to compromise as
a result of rejection of executory contracts or unexpired leases.
The restriction on payments of pre-petition liabilities as a result of the
Chapter 11 filing enabled the Company to report $1,403,349 in cash and cash
equivalents at August 1, 1998.
12
<PAGE>
Inherent in a successful plan of reorganization is a capital structure, which
permits the Company to generate sufficient cash flow after reorganization to
meet its restructured obligations and fund the current obligations of the
reorganized Company. Under the Bankruptcy Code, the rights of and ultimate
payment to pre-petition creditors may be substantially altered and, as to some
classes, eliminated.
Subsequent to the Balance Sheet Date of this Report, on August 21, 1998, the
Bankruptcy Court approved, a post-petition credit agreement between the Company
and Foothill Capital Corporation (Foothill), pursuant to which, among other
things, Foothill agreed to provide the Company with debtor-in-possession
financing (the "DIP Credit Agreement""). The DIP Credit Agreement extinguished
the pre-petition Credit Agreement dated July 27, 1994 between the Company and
Foothill. The DIP Credit Agreement matures on August 21, 1999, and provides for
borrowings of 60% of eligible inventory, and 50% of appraised real estate value,
not to exceed a maximum loan value of $10,000,000. The loan carries interest at
prime rate plus two percent (2%). The DIP Credit Agreement incurred a Facility
Fee of $25,000 on August 21, 1998. Additional Facility Fees of $25,000 each will
be incurred on September 15, 1998, November 15, 1998, January 15, 1999 and March
15, 1999 if any amount on the loan is then outstanding. The DIP Credit Agreement
is secured by all the assets of the Company and was granted super-priority
status by the Bankruptcy Court. The agreement requires the Company to maintain
certain financial covenants, beginning October 31, 1998 related to sales, gross
margin and the sale of certain real estate.
The Company's principal needs for liquidity are to finance the purchase of
merchandise inventories, fund its operations and pay professional and
administrative fees in connection with its reorganization.
The primary element in producing cash from operating activities in fiscal 1998
was due to the reduction in merchandise inventory as a result of a reduction in
bank and trade credit. Net cash provided by operating activities for fiscal 1998
was $4,359,207, compared to $1,213,496 and $1,931,583 in fiscal 1997 and fiscal
1996, respectively. The Company's cash provided by operating activities of
$4,359,207 resulted primarily from the reduction of merchandise inventories of
$7,565,595, which was offset by the operating loss for the fiscal year ended
August 1, 1998. At August 1, 1998 the Company maintained a working capital
position of $8,398,859 compared to $9,652,600 as of August 2, 1997. During
fiscal 1998 borrowings under credit facilities decreased by $3,565,877 due
primarily to a reduction in the amount of availability per the July 27, 1994
Credit Agreement with Foothill, from $8,497,177 at August 2, 1997 to $5,094,223
at August 1, 1998. The Company increased its borrowings from the cash value of
life insurance policies by $1,104,499. During the year ended August 1, 1998, the
Company used cash generated by operations to invest in store fixtures and
equipment of $534,833, and invest in life insurance policies of $248,619. Net
cash increased by $1,105,559 from $297,790 at August 2, 1997 to $1,403,349 at
August 1, 1998.
The Company opened a new superstore in the Connecticut market during the first
month of fiscal 1998. The point-of-sale system utilized by the Company will
require upgrades in hardware in addition to installing the most current release
of software. The estimated cost of the new hardware is $200,000 and has been
included in the Company's projections for capital expenditures in fiscal 1999.
The DIP Credit Agreement, cash on hand, revenues generated from operations and
credit terms extended by the vendor community are the Company's principal
sources of liquidity. Additionally, the Company's plans include the sale of
13
<PAGE>
several under market leases to yield approximately $1,000,000 in estimated
proceeds during fiscal 1999. The Company believes that these sources will be
sufficient to meet the Company's operating and capital requirements. However, to
the extent that results of operations continue to decline, short and long-term
liquidity will be adversely affected, particularly if the availability of funds
under the DIP Credit Agreement are significantly reduced or are no longer made
available.
As a result of the uncertainties related to the Chapter 11 filing, the Company's
independent certified public accountants have included an explanatory paragraph
in their audit reports with respect to the Company's financial statements with
respect to the Company's ability to continue as a going concern.
Inflation and Seasonality
- -------------------------
The Company's financial condition and results of operations are presented on a
historical cost basis. While it is difficult to accurately measure the impact of
inflation due to the imprecise nature of estimates required, the Company
believes its operating results have not been materially affected by inflation in
fiscal 1998, 1997 and 1996.
The Company's second quarter (November through January) which includes the
Christmas season, is the strongest sales quarter. Additionally, the third
quarter (February through April) has traditionally been the weakest.
Impact of Year 2000 on Computer Systems
- ---------------------------------------
The Company has conducted a Year 2000 readiness review with its information
technology vendors and have identified three major areas requiring tasks to
become Year 2000 compliant. Both the merchandising and financial systems of the
Company will become Year 2000 compliant upon installation of the most current
release from software vendors. The task of upgrading to new releases is within
the normal course of activity for the Company's information technology
professionals and will be completed by the spring of 1999. The point-of-sale
system utilized by the Company will require upgrades in hardware in addition to
installing the most current release of software. The estimated cost of the new
hardware and software is $200,000 and has been included in the Company's
projections for capital expenditures in fiscal 1999. The Company is currently
testing the new point-of sale hardware and software, and will install the
upgraded system after the Christmas season of 1998.
Forward Looking Statements
- --------------------------
The preceding Business and Management's Discussion and Analysis contain various
forward looking statements within the meaning of section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended, which represent the Company's expectations or beliefs concerning
future events, including the following: the ability of the Company to obtain
positive cash flow from its current portfolio of stores; the ability of the
Company to maintain its credit facilities; the timely availability of branded
and private label merchandise in sufficient quantities to satisfy customer
demand; the sale of several under market leases; and sufficiency of the
Company's working capital, DIP Credit Agreement and cash flow from operating
activities for the Company's future operating and capital requirements. The
Company cautions that these statements are further qualified by important
factors that could cause actual results to differ materially from those in the
forward looking statements, including, without limitations, the following:
decline in demand for merchandise offered by the Company; the ability of the
Company to gauge the fashion tastes of its customers and provide merchandise to
14
<PAGE>
satisfy customer demand; the ability of the Company to hire and train employees;
the possible unavailability of merchandise from the Company's vendors and
private label suppliers; the effect of economic conditions in the Company's
markets, the effect of severe weather or natural disaster; and the effect of
competitive pressures from other retailers. Results actually achieved thus may
differ materially from expected results in these statements.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
The Company's financial statements at August 1, 1998 and August 2, 1997, and for
each of the three years in the period ended August 1, 1998, and the Reports of
BDO Seidman, LLP and PricewaterhouseCoopers LLP are included in this Annual
Report on Form 10-K on pages 19 through 37 below.
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Changes in Registrant's Certifying Accountant
---------------------------------------------
(a) Previous independent accountants
(i) On January 16, 1998, Three D Departments, Inc. dismissed Price
Waterhouse LLP as its independent accountants.
(ii) The reports of Price Waterhouse LLP on the financial statements for the
past two fiscal years contained no adverse opinion or disclaimer of
opinion and were not qualified or modified as to uncertainty, audit
scope or accounting principle.
(iii) The Registrant's Board of Directors participated in and approved the
decision to change independent accountants.
(iv) In connection with its audits for the two most recent fiscal years and
through January 16, 1998, there have been no disagreements with Price
Waterhouse LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements if not resolved to the satisfaction of Price Waterhouse
LLP would have caused them to make reference thereto in their report on
the financial statements for such years.
(iv) During the two most recent fiscal years and through January 16, 1998,
there have been no reportable events (as defined in Regulation S-K Item
304(a)(l)(v).
(v) The Registrant has requested that Price Waterhouse LLP furnish it with
a letter addressed to the SEC stating whether or not it agrees with the
above statements. A copy of such letter, dated January 21, 1998, is
filed as Exhibit 16 to this Form 8-K.
(b) New independent accountants
The Registrant engaged BDO Seidman, LLP as its new independent
accountants as of January 16, 1998. During the two most recent fiscal
years and through January 16, 1998, the Registrant has not consulted
with BDO Seidman, LLP regarding either (i) the application of
15
<PAGE>
accounting principles to a specified transaction, either completed or
proposed; or the type of audit opinion that might be rendered on the
Registrant's financial statements, and either a written report was
provided to the Registrant or oral advice was provided that BDO
Seidman, LLP concluded was an important factor considered by the
Registrant in reaching a decision as to the accounting, auditing or
financial reporting issue; or (ii) any matter that was either the
subject of a disagreement, as that term is defined in Item
304(a)(l)(iv) of Regulation S-K and the related instructions to Item
304 of Regulation S-K, or a reportable event, as that term is defined
in Item 304(a)(l)(iv) of Regulation S-K.
PART III
The information required by items 10,11,12, and 13 of Form 10-K will be set
forth in the Company's Proxy Statement for its 1998 Annual Meeting of
Stockholders. The Proxy Statement is expected to be filed with the Securities
and Exchange Commission on or about January 15, 1999, and such information is
incorporated herein by this reference.
16
<PAGE>
PART IV
-------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
---------------------------------------------------------------
<TABLE>
(a) The following financial statements and financial schedules are filed as a
part of this Report:
<CAPTION>
<S> <C>
(1) Financial Statements Page No.
-------------------- --------
Report of Independent Certified Public Accountants 19
Report of Independent Accountants 20
Balance Sheets as of August 1, 1998 and August 2, 1997 21
Statements of Operations for the Fiscal Years Ended August 1, 1998,
August 2, 1997, and August 3, 1996 22
Statements of Changes in Stockholders' Equity for the Fiscal Years
Ended August 1, 1998, August 2, 1997, and August 3, 1996 23
Statements of Cash Flows for the Fiscal Years Ended August 1, 1998,
August 2, 1997, and August 3, 1996 24
Notes to Financial Statements 25
</TABLE>
(2) Financial Statement Schedules
-----------------------------
All schedules are omitted because they are not required, are
inapplicable, or the information is included in the Financial Statements or
Notes thereto.
(3) Exhibits
--------
Exhibit No. Title
----------- -----
3.1 Restated Certificate of Incorporation of the
Company, as filed with the Delaware Secretary of
State on November 30, 1984, together with the
Certificate of Amendment of the Restated
Certificate of Incorporation, as filed with the
Delaware Secretary of State on March 3, 1987. *
3.2 By-laws of the Company as amended through July 29,
1987. *
4.1 Class A Common Stock share certificate. *
4.2 Class B Common Stock share certificate. *
10.1 1993 Incentive Stock Option Plan and Option
Certificate. *
10.2 Promissory note with an officer. *
23.1 Consent of BDO Seidman, LLP for incorporation of
S-8 filing.
23.2 Consent of PricewaterhouseCoopers LLP for
incorporation of S-8 filing.
99.1 $10,000,000 Post-petition Credit Agreement
Commitment Letter between Three D Departments, Inc.
and Foothill Capital Corporation, dated as of July
30, 1998. *
99.2 Interim Order (I) Authorizing a Secured
Post-Petition Financing on a Super Priority Basis
Pursuant to 11 U.S.C.ss. 363 and 364, (II) Granting
of Adequate Protection Pursuant to 11 U.S.C.ss. 364
and (III) scheduling A Final Hearing pursuant to
Bankruptcy Rule 4001(C) approved on August 6, 1998.
*
* Previously filed
(b) Reports on Form 8-K
-------------------
The Company filed two Reports on Form 8-K during or related to the fourth
quarter of fiscal 1998. On June 6, 1998 the Company filed a report on Form 8-K
17
<PAGE>
reporting on the development of the Unofficial Creditors Committee and on the
appointment of a new Chief Executive Officer. On August 10, 1998 the Company
filed a report on Form 8-K under Item 3, Bankruptcy, reporting the voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code and also reporting on the
$10,000,000 Post-petition Credit Agreement with Foothill Capital Corporation.
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: January 15, 1999
THREE D DEPARTMENTS, INC.
(Registrant)
By: /s/ Steven Kerkstra
------------------------
Steven Kerkstra, Vice President
And Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated and on the date set forth above.
Signature Title
- --------- -----
/s/ Donald Abrams Chairman of the Board, Chief Executive
- ---------------------- Officer, President and Director
Donald Abrams
/s/ Steven Kerkstra Vice President, Chief Operating Officer,
- ---------------------- Chief Financial Officer, and Assistant
Steven Kerkstra Secretary
/s/ John Dawson Vice President, General Merchandising
- ---------------------- Manager, and Director
John Dawson
/s/ Jennie Daniells Director
- ----------------------
Jennie Daniells
/s/ Richard Carr Director
- ----------------------
Richard Carr
/s/ Ronald C. Dow Controller and Treasurer
- ----------------------
Ronald C. Dow
18
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Three D Departments, Inc. (Debtor in Possession)
Costa Mesa, California
We have audited the accompanying balance sheet of Three D Departments, Inc. as
of August 1, 1998 and the related statements of operations, stockholders'
equity, and cash flows for the year then ended. 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 audit.
We conducted our audit 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 audit provides 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 Three D Departments, Inc. at
August 1, 1998 and the results of its operations and its cash flows for the year
then ended in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has commenced a reorganization case by filing
a voluntary petition for relief under Chapter 11 of the United States Bankruptcy
Code in the United States Bankruptcy Court for the Central District of
California, Los Angeles Division on July 30, 1998, has suffered recurring losses
from operations and has no guarantee of debt financing past September 1999. The
continuation of Three D Departments, Inc. as a going concern is contingent upon
the ability to formulate an acceptable plan of reorganization that will be
confirmed by the Bankruptcy Court, obtain ongoing financing and achieve
satisfactory levels of profitable operations. These matters and the
uncertainties inherent in the bankruptcy process raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The financial statements
do not include any adjustments that might result from the outcome of these
uncertainties.
BDO SEIDMAN, LLP
Costa Mesa, California
November 24, 1998
<PAGE>
19
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------
To the Board of Directors and Stockholders of Three D Departments, Inc.
In our opinion, the accompanying balance sheet and the related statements of
operations, changes in stockholders' equity and cash flows present fairly, in
all material respects, the financial position of Three D Departments, Inc. at
August 2, 1997, and the results of its operations and its cash flows for each of
the two years in the period ended August 2, 1997, 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 from 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.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has commenced a reorganization case by filing
a voluntary petition for relief under Chapter 11 of the United States Bankruptcy
Code in the United States Bankruptcy Court for the Central District of
California, Los Angeles Division on July 30, 1998. This matter and the
uncertainties inherent in the bankruptcy process raise substantial doubt about
the Company's ability to continue as a going concern. Management's plans in
regard to these matters are also described in Note 1. The financial statements
do not include any adjustments that might result from the outcome of these
uncertainties.
As described in Note 2 to the financial statements, the Company changed its
method of accounting for merchandise inventory in fiscal year 1996.
PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
October 16, 1997, except
as to Note 1, which is as
of July 30, 1998
20
<PAGE>
<TABLE>
THREE D DEPARTMENTS, INC. (Debtor in Possession)
------------------------------------------------
BALANCE SHEETS
--------------
<CAPTION>
August 1, 1998 August 2, 1997
-------------- --------------
ASSETS
------
CURRENT ASSETS
- --------------
<S> <C> <C>
Cash $ 1,403,349 $ 297,790
Receivables 135,505 397,460
Inventories 7,589,396 15,585,221
Prepaid expenses 276,203 251,900
Deferred income taxes - 35,635
-------------------------------
Total current assets 9,404,453 16,568,006
PROPERTY, FIXTURES AND IMPROVEMENTS, at cost
- ------------------------------------
Buildings 1,193,834 1,193,834
Fixtures and equipment 8,196,700 8,943,029
Leasehold improvements 2,838,987 3,014,051
-------------------------------
12,229,521 13,150,914
Less - accumulated depreciation 7,835,837 7,269,480
-------------------------------
4,393,684 5,881,434
OTHER ASSETS
- ------------
Deferred cost of leases, net 1,026,271 1,247,924
Deferred income taxes - 574,432
Other 511,821 1,068,528
-------------------------------
Total Assets $ 15,336,229 $ 25,340,324
===============================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES
- -------------------
Long-term debt - current portion $ - $ 263,580
Accounts payable 27,671 5,442,886
Accrued liabilities 460,943 1,208,940
Reserve for store closings 516,980 -
-------------------------------
Total current liabilities 1,005,594 6,915,406
LONG-TERM DEBT, LESS CURRENT PORTION 5,094,223 8,497,177
-------------------------------
DEFERRED COMPENSATION - 200,000
-------------------------------
OTHER LIABILITIES 877,901 791,941
-------------------------------
LIABILITIES SUBJECT TO COMPROMISE 6,859,467 -
-------------------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
- --------------------
Preferred stock; $1.00 par value; authorized 300,000 shares;
none issued - -
Common stock; $1.00 par value
Class A - authorized 6,000,000; issued 1,676,969, convertible
to Class B 419,242 419,242
Class B - authorized 6,000,000; issued 1,563,863 390,966 390,966
Additional paid-in capital 1,255,525 1,255,525
Retained earnings 1,238,055 8,674,811
-------------------------------
3,303,788 10,740,544
Less - 804,883 shares of common stock in treasury, at cost 1,804,744 1,804,744
-------------------------------
1,499,044 8,935,800
-------------------------------
Total Liabilities and Stockholders' Equity $ 15,336,229 $ 25,340,324
===============================
</TABLE>
The accompanying notes are an integral part of these Financial Statements.
21
<PAGE>
<TABLE>
THREE D DEPARTMENTS, INC. (Debtor in Possession)
------------------------------------------------
Statements of Operations
------------------------
<CAPTION>
Fiscal Year Ended
---------------------------------------------
August 1, 1998 August 2, 1997 August 3, 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Sales $ 37,559,411 $ 44,181,878 $ 47,851,248
Cost of sales, including warehousing, transportation and buying
expenses 22,846,124 25,254,183 27,443,694
Store operating, administrative and general expenses 18,291,916 19,394,217 20,376,070
Impairment loss (see note 2) 648,913 - -
Restructuring expenses (see note 2) 1,167,172 - -
---------------------------------------------
Operating income (loss) (5,394,714) (466,522) 31,484
Reorganization expenses (see note 2) 257,315 - -
Interest expense 1,152,387 1,210,227 1,317,052
---------------------------------------------
Loss before income taxes and cumulative effect of accounting
change (6,804,416) (1,676,749) (1,285,568)
Income taxes 632,340 - -
---------------------------------------------
Loss before cumulative effect of accounting change (7,436,756) (1,676,749) (1,285,568)
Cumulative effect of accounting change (see note 2) - - 310,427
---------------------------------------------
Net loss $ (7,436,756) $ (1,676,749) $ (975,141)
=============================================
Loss per share basic and dilutive (see note 2)
Loss per share before cumulative effect of accounting change $ (3.05) $ (0.69) $ (0.53)
Cumulative effect - - 0.13
---------------------------------------------
Net loss per share $ (3.05) $ (0.69) $ (0.40)
=============================================
Weighted average number of common shares outstanding 2,435,949 2,435,955 2,433,417
=============================================
</TABLE>
The accompanying notes are an integral part of these Financial Statements.
22
<PAGE>
<TABLE>
THREE D DEPARTMENTS, INC. (Debtor in Possession)
------------------------------------------------
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
---------------------------------------------
<CAPTION>
CLASS A CLASS B ADDITIONAL TOTAL
COMMON COMMON PAID IN RETAINED TREASURY STOCKHOLDERS'
STOCK STOCK CAPITAL EARNINGS STOCK EQUITY
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JULY 29, 1995 $414,242 $394,028 $1,246,557 $11,495,251 $(1,804,733) $11,745,345
Net (loss) - - - (975,141) - (975,141)
Cash dividends:
Class A common stock ($.05 per share) - - - (57,888) - (57,888)
Class B common stock ($.03 per share) - - - (38,294) - (38,294)
Shares issued under option agreement (3,500
Class A shares and 4,250 Class B Shares) 875 1,063 8,968 - - 10,906
Conversions from Class B to Class A common
stock 1,525 (1,525) - - - -
------------------------------------------------------------------------------------
BALANCE AT AUGUST 3, 1996 416,642 393,566 1,255,525 10,423,928 (1,804,733) 10,684,928
Net (loss) - - - (1,676,749) - (1,676,749)
Cash dividends: -
Class A common stock ($.0375 per share) - - - (43,891) - (43,891)
Class B common stock ($.0225 per share) - - - (28,477) - (28,477)
Purchase of 12 shares Class B common stock
for treasury - - - - (11) (11)
Conversions from Class B to Class A common
stock 2,600 (2,600) - - - -
------------------------------------------------------------------------------------
BALANCE AT AUGUST 2, 1997 419,242 390,966 1,255,525 8,674,811 (1,804,744) 8,935,800
Net (loss) - - - (7,436,756) - (7,436,756)
------------------------------------------------------------------------------------
BALANCE AT AUGUST 1, 1998 $419,242 $390,966 $1,255,525 $1,238,055 $(1,804,744) $1,499,044
====================================================================================
</TABLE>
The accompanying notes are an integral part of these Financial Statements.
23
<PAGE>
<TABLE>
THREE D DEPARTMENTS, INC., (Debtor in Possession)
-------------------------------------------------
STATEMENTS OF CASH FLOWS
------------------------
<CAPTION>
Fiscal Year Ended
August 1, 1998 August 2, 1997 August 3, 1996
-------------- -------------- --------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (7,436,756) $ (1,676,749) $ (975,141)
Adjustments to reconcile net loss to cash provided from
operating activities:
Depreciation and amortization 1,456,030 1,667,895 1,709,186
Deferred income taxes 610,067 - 331,284
Increase in cash value of life insurance (102,049) (155,847) (41,007)
Inventory valuation allowance 430,230 - -
Impairment of long-lived assets 627,362 - -
Reserve for store closings 1,167,172 - -
(Gain) loss on sales/write down of fixtures and
improvements 232,166 (60,303) 54,587
Changes in assets and liabilities: - - -
Accounts receivable 2,327 (20,610) (80,559)
Inventories 7,565,595 846,264 (170,998)
Prepaid expenses (24,303) 235,455 (63,322)
Prepaid income taxes - 51,402 98,363
Accounts payable and accrued liabilities (618,690) 362,763 1,017,971
Other liabilities 450,056 (36,774) 51,219
------------------------------------------------
Net cash provided by operating activities 4,359,207 1,213,496 1,931,583
Cash flows from investing activities:
Proceeds from the sales of fixtures - - 10,034
Purchase of fixtures, equipment and improvements (534,833) (860,390) (802,406)
Purchase of leases - (250,000) -
Investment in life insurance policies (248,619) (250,975) (280,583)
Purchase of software (8,818) (44,749) (6,440)
------------------------------------------------
Net cash used in investing activities (792,270) (1,406,114) (1,079,395)
Cash flows from financing activities:
Proceeds from the exercise of stock options - - 10,906
Dividends paid - (72,368) (96,182)
Purchase of treasury stock - (11) -
Repayment of debt (3,565,877) (577,573) (578,924)
Proceeds from loan against cash value of insurance 1,104,499 633,327 -
------------------------------------------------
Net cash (used in) financing activities (2,461,378) (16,625) (664,200)
Net increase (decrease) in cash and cash equivalents 1,105,559 (209,243) 187,988
Cash and cash equivalents:
Beginning of period 297,790 507,033 319,045
------------------------------------------------
End of period $ 1,403,349 $ 297,790 $ 507,033
================================================
</TABLE>
The accompanying notes are an integral part of these Financial Statements.
24
<PAGE>
THREE D DEPARTMENTS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1- REORGANIZATION AND BASIS OF PRESENTATION
- ------------------------------------------------
Three D Departments, Inc. (the "Company,") is a chain of specialty retail home
textiles and decorative housewares products stores generally located in regional
shopping centers. As of August 1, 1998, the Company operated 21 stores,
principally in California, Arizona, and Connecticut. The Company's fiscal year
is based on a 52-53 week calendar ending on the Saturday nearest to July 31.
Fiscal years 1998 and 1997 included 52 weeks, fiscal year 1996 included 53
weeks.
Beginning in February 1998, the Company experienced a tightening of bank credit.
The lack of available funds precipitated extensions in trade payables, and as a
result merchandise shipments to the Company constricted to levels which could
not adequately support the Company's historical volume of business.
Subsequently, the Company incurred operating losses stemming from a lack of
merchandise inventory.
On April 15, 1998 the Company met with its trade creditors to discuss a forecast
of a downturn in business the Company was projecting for the months of May,
June, and July, 1998. The Company asked its trade creditors to temporarily place
all demands for collection on trade credit on hold dated April 15, 1998 and
prior, while the Company sought alternative financing and strategic proposals.
On April 15, 1998 the trade creditors formed an Unofficial Creditors Committee
to consult with the Company. The Company asked the trade creditors to continue
the moratorium until July 15, 1998.
In July 1998 the Company sought a cash infusion and had made tentative
arrangements for additional financing, which was contingent upon a successful
compromise of the trade debt that was put on hold as of April 15, 1998. A
compromise plan was presented to the unofficial committee of unsecured
creditors, but was not accepted by one large unsecured creditor.
Most vendors were not extending terms, and the Company was unable to replenish
its shelves with new merchandise. Because of these restrictions on cash flow and
an inability to renegotiate existing bank debt or raise additional capital
through other sources, the Company decided to seek bankruptcy protection.
On July 30, 1998 (the "Petition Date"), the Company commenced a reorganization
case by filing a voluntary petition (the "Chapter 11 Petition") for relief under
Chapter 11 ("Chapter 11") of Title 11 of the United States Code (as amended from
time to time, the "Bankruptcy Code") in the United States Bankruptcy Court for
the Central District of California, Los Angeles Division (the "Bankruptcy
Court"), case number SA 98 20792 LR. Management determined that filing of the
Chapter 11 Petition would allow the needed time and flexibility to restructure
the Company's operations, reestablish the flow of merchandise to its stores, and
provide the time and protection necessary to restructure the Company's funding
sources.
Since the Petition Date, the Company has continued in possession of its
properties and, as debtor-in-possession, is authorized to operate and manage its
businesses and enter into all transactions (including obtaining services,
inventories, and supplies) in the ordinary course of business, or out of the
25
<PAGE>
ordinary course of business subject to approval of the Bankruptcy Court, after
notice and hearing. A statutory Creditors' Committee has been appointed in the
Chapter 11 case.
Subsequent to the filing of the Chapter 11 Petition, the Company sought and
obtained several orders from the Bankruptcy Court, which were intended to
stabilize its business. The most significant of these orders: (1) established
debtor in possession financing with the Company's pre-petition lender Foothill
Capital Corporation; and (2) authorized the Company to conduct "going out of
business" sales in six locations which the management of the Company had decided
to close due to the poor operating performance of those stores.
In a Chapter 11 filing, substantially all liabilities as of the Petition Date
are subject to compromise or other treatment under a plan of reorganization. For
financial reporting purposes, those liabilities and obligations whose
disposition is dependent on the outcome of the Chapter 11 filing have been
segregated and classified as liabilities subject to compromise under
reorganization proceedings in the accompanying consolidated balance sheet (Note
5). Generally, actions to enforce or otherwise effect payment of all
pre-petition Chapter 11 liabilities as well as all pending litigation against
the Company are stayed while the Company continues its business operations as
debtor-in-possession. The Company has filed schedules with the Bankruptcy Court
setting forth its assets and liabilities as of the Petition Date as reflected in
the Company's accounting records. Differences between amounts reflected in such
schedules and claims filed by creditors will be investigated and either amicably
resolved or adjudicated before the Bankruptcy Court. The ultimate amount of and
settlement terms for such liabilities are subject to a plan of reorganization
and accordingly are not presently determinable.
The accompanying financial statements have been prepared in conformity with
principles of accounting applicable to a going concern, which contemplate the
realization of assets and the satisfaction of liabilities in the normal course
of business. As a result of the Chapter 11 filing and circumstances relating to
this event, such realization of assets and satisfaction of liabilities is
subject to uncertainty. A plan of reorganization could materially change the
amounts reported in the accompanying financial statements, which do not give
effect to adjustments to the carrying values of assets and liabilities, which
may be necessary as a consequence of a plan of reorganization. The Company's
ability to continue as a going concern is contingent upon, among other things;
its ability to formulate a plan of reorganization that will be confirmed by the
Bankruptcy Court, to achieve satisfactory levels of profitability and cash flow
from operations, to maintain compliance with the debtor-in-possession financing
agreement, and the ability to obtain sufficient financing sources to meet future
obligations. Given these uncertainties there can be no assurance that the Plan
will be approved by the Creditors or confirmed by the Bankruptcy Court or when
or whether the Plan will become effective.
NOTE 2 - SUMMARY OF ACCOUNTING POLICIES:
- ----------------------------------------
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make certain estimates and
26
<PAGE>
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported revenues and expenses during the respective
reporting periods. Actual results could differ from those estimates.
Inventories
Inventories are valued at the lower of cost or market. In fiscal 1996 the
Company changed its method of accounting for inventories to include the costs of
certain buying, warehousing, and transportation costs. The Company believes this
refinement provides a better measurement of operations by more closely matching
revenues with expenses. At the beginning of fiscal 1996 the Company restated its
inventory to include $527,040 of such costs. This amount, less the tax effect of
$216,613, is reported as a change in accounting principle totaling $310,427.
Capitalized costs in inventory at August 1, 1998 and August 2, 1997 were
$323,844 and $417,636, respectively.
In connection with the announced closure of six stores as a part of the
Company's reorganization effort, an inventory valuation reserve of $430,230 was
established as of August 1, 1998 to adjust the carrying value of ending
inventory in the stores to be closed to its estimated net realizable value.
Pre-Opening Costs
Costs associated with the opening of new stores are expensed in the period
incurred.
Property, Fixtures and Improvements
Property, fixtures and improvements are stated at cost, less accumulated
depreciation. Depreciation and amortization are computed on the straight line
method based upon estimated useful lives as follows: buildings - 20 to 25 years;
fixtures, furniture and equipment - 3 to 8 years; and leasehold improvements - 4
to 15 years.
Property, fixtures and improvements, except as discussed below, have been
reflected in the accompanying financial statements at their historical cost
bases. Such assets have been reflected at historical cost as management believes
that the Company's plan of reorganization will be approved and accordingly, the
Company will emerge from bankruptcy. Should the Company's plan of reorganization
not be approved by the Bankruptcy Court and the Company is forced to liquidate
its assets, or should an approved plan require the closure of additional stores,
the amounts realized by the Company from such liquidation and/or store closures
may be substantially less than the carrying values of such assets as reflected
in the accompanying balance sheet.
Impairment of long-lived assets
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of long-lived Assets and for
long-lived Assets to be Disposed Of (SFAS 121), during fiscal 1997. This
statement requires that long-lived assets and certain intangibles be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
27
<PAGE>
be held and used is measured by a comparison of the future cash flows on an
undiscounted basis to the net book value of the assets. In the event the
projected undiscounted cash flows are less than the net book value of the
assets, the carrying value of the assets will be written down to their fair
value. In addition, SFAS 121 requires that assets to be disposed of be measured
at the lower of cost or fair value, less estimated costs to sell. In fiscal
1998, the Company reduced the carrying value of Property, Fixtures and Equipment
by $586,042 for certain assets which are likely to be disposed or abandoned in
conjunction with the reorganization. Additionally the Company reduced the
carrying value of certain leasehold interests by $62,871.
Advertising
Advertising costs are expensed in the period incurred. Advertising costs of
$536,665, $1,127,107, and $1,220,658 were incurred during the years ended August
1, 1998, August 2, 1997, and August 3, 1996, respectively.
Deferred Costs
Deferred costs of leases are amortized over the number of years remaining under
such lease agreements. Such costs are recorded net of amortization of $885,265
and $726,483 at August 1, 1998 and August 2, 1997, respectively, in the balance
sheet. Amortization charged to the statement of operations amounted to $158,782,
$136,509 and $129,079 for fiscal years 1998, 1997 and 1996, respectively.
Income Taxes
Income taxes are provided for using an asset and liability approach which
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the financial statement
and tax bases of assets and liabilities at the applicable enacted tax rates. A
valuation allowance is provided when it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
Reorganization Expenses
Professional fees and expenditures related to the Chapter 11 filing and the
Unofficial Unsecured Creditors' Committee are classified as reorganization costs
and are expensed as incurred. Reorganization costs for the year ended August 1,
1998 were $257,315.
Loss per Share
Net loss per share is computed based upon the weighted average number of shares
outstanding. In February 1997, The Financial Accounting Standards Board ("FASB")
issued SFAS No. 128, Earnings Per Share ("EPS"). SFAS No. 128 requires dual
presentation of basic EPS and diluted EPS on the face of all income statements
issued after December 15, 1997 for all entities with complex financial
structures. Adoption of SFAS No. 128 had no effect on the Company's financial
statements. Basic EPS is computed as net income divided by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur from common shares issuable through stock
options, warrants and other convertible securities. As the Company's stock
options and warrants, which cover 256,269 shares of the Company's common stock
at August 1, 1998, are antidilutive for all periods presented, only basic EPS is
presented. These securities could potentially dilute future EPS calculations.
Fair Value of Financial Instruments
The carrying amount of cash, accounts and other receivables, accounts payables,
and accrued liabilities approximate fair value because of the short maturity of
28
<PAGE>
these instruments. The carrying amount of the Company's debt approximates fair
value based upon the prevailing market rates. At August 2, 1997, the Company had
performance letters of credit outstanding totaling $95,997, which primarily
guarantee various trade activities. The fair value of these letters of credit
approximates contract values based on the nature of the fee arrangements with
the issuing bank.
Reclassification
Certain amounts have been reclassified to conform to the 1998 financial
statement presentation.
New Accounting Standards
SFAS No. 131 - In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, Disclosures about Segments of an Enterprise and Related
Information. This pronouncement establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. This pronouncement
is effective for fiscal years and interim periods beginning after December 15,
1997. The Company has not determined the effect, if any, of adoption on its
financial reporting.
SFAS No. 130 - In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income. SFAS 130 establishes
standards for reporting and display of comprehensive income, which includes
certain items which have historically been excluded from the income statement,
and instead charged directly to equity. The Company has not incurred any of the
specific items addressed in this pronouncement. As a result, management does not
believe that this pronouncement will have any impact on the Company's financial
reporting. This pronouncement is effective for fiscal years beginning after
December 15, 1997.
NOTE 3 - OTHER ASSETS:
- ----------------------
The Company has life insurance policies on key executives in which the Company
is the principal beneficiary. Cash surrender value (net of policy loans of
$3,248,864 at August 1, 1998 and $2,403,993 at August 2, 1997) was $412,746 at
August 1, 1998 and $906,948 at August 2, 1997. Net cash surrender values are
included in other assets.
NOTE 4 - ACCRUED LIABILITIES:
- -----------------------------
Accrued liabilities consist of the following:
August 1,1998 August 2,1997
------------- -------------
Accrued expenses $ 161,431 $ 805,279
Accrued salaries and wages 299,512 403,661
------------- -------------
$ 460,943 $ 1,208,940
============= =============
29
<PAGE>
NOTE 5 - LIABILITIES SUBJECT TO COMPROMISE UNDER REORGANIZATION PROCEEDINGS:
- ----------------------------------------------------------------------------
Liabilities subject to compromise include substantially all of the current and
non-current unsecured liabilities of the Company as of the Petition Date. These
liabilities were transferred from their respective pre-petition balance sheet
accounts to liabilities subject to compromise and have been treated as non-cash
items in the accompanying Fiscal 1998 statement of cash flows.
Unsecured liabilities:
Trade accounts payable $4,498,228
Accrued expenses 1,265,390
Deferred compensation 195,000
Long-term lease liability and lease rejection claims 800,192
Note payable to officer 100,657
-----------
$6,859,467
===========
Any plan of reorganization ultimately approved by the Company's impaired
pre-petition creditors and shareholders, and confirmed by the Bankruptcy Court,
may materially change the amounts and terms of these pre-petition liabilities.
Such amounts are estimated as of August 1, 1998, and the Company anticipates
that claims filed with the Bankruptcy Court by the Company's creditors will be
reconciled to the Company's financial records. The additional liability arising
from this reconciliation process, if any, is not subject to reasonable
estimation, and accordingly, no provision has been recorded for these possible
claims. The termination of other contractual obligations and the settlement of
disputed claims may create additional pre-petition liabilities. Such amounts, if
any, will be recognized in the balance sheet as they are identified and become
subject to reasonable estimation.
NOTE 6 - LONG TERM DEBT:
- ------------------------
<TABLE>
<CAPTION>
August 1, 1998 August 2, 1997
-------------- --------------
<S> <C> <C>
Long-term debt consists of the following:
Note payable - revolving credit loan, payable monthly
through July 28, 2001, interest at prime rate plus 2% (10.5%
at August 1, 1998). Subsequently cancelled and replaced
with DIP Credit Agreement on August 21, 1998, which
matures on August 21, 1999. $ 5,094,223 $ 8,370,227
Note payable - secured promissory note, payable monthly
through July 28, 1999, principal and interest at prime rate
plus 2% (10.5% at August 2, 1997). - 180,000
Note payable to officer - monthly interest payments of
$4,167 through July, 1996, monthly payments of principal
and interest of $16,923 through March 1999 at 10 % interest. 100,657 210,530
-------------- --------------
Total long-term debt 5,194,880 8,760,757
Less current portion - 263,580
Less liabilities subject to compromise 100,657 -
-------------- --------------
Long-term debt less current portion $ 5,094,223 $ 8,497,177
============== ==============
</TABLE>
The revolving credit line, as amended, previously matured on July 28, 2001, and
provided for borrowings of 60% of eligible inventory, not to exceed a maximum of
$12,000,000, of which $5,094,223 was outstanding at August 1, 1998. Payments of
principal were required if inventory fell below 167 percent of the amount then
30
<PAGE>
outstanding. A commitment fee of 0.5% per annum on the average unused amount is
required. Average outstanding borrowings, including loans against the cash
surrender value of life insurance (see note 3) were $10,875,962 for fiscal 1998
compared to $12,105,736 in fiscal 1997. The weighted average cost of interest
was 10.6% in fiscal 1998 compared to 10.0% in fiscal 1997.
The revolving credit line was secured by inventory, fixtures and receivables of
the Company. The agreement required the Company to maintain certain financial
covenants, some of which limit capital expenditures and dividend payments and
restrict disposal of assets without prior approval. At August 1, 1998 the
Company was not in compliance with these covenants.
On August 21, 1998, the Bankruptcy Court approved, a post-petition credit
agreement between the Company and Foothill Capital Corporation (Foothill),
pursuant to which, among other things, Foothill agreed to provide the Company
with debtor-in-possession financing (the "DIP Credit Agreement""). The DIP
Credit Agreement extinguished the revolving credit line. The DIP Credit
Agreement matures on August 21, 1999, and provides for borrowings of 60% of
eligible inventory, and 50% of appraised real estate value, not to exceed a
maximum loan value of $10,000,000. The loan carries interest at prime rate plus
two percent (2%). The DIP Credit Agreement incurred a Facility Fee of $25,000 on
August 21, 1998. Additional Facility Fees of $25,000 each will be incurred on
September 15, 1998, November 15, 1998, January 15, 1999 and March 15, 1999 if
any amount on the loan is then outstanding. The DIP Credit Agreement is secured
by all the assets of the Company and was granted super-priority status by the
Bankruptcy Court. The agreement requires the Company to maintain certain
financial covenants, beginning October 31, 1998 related to sales, gross margin
and the sale of certain real estate on which date the Company was in compliance
with its covenants.
NOTE 7 - INCOME TAXES:
- ----------------------
The provision for income taxes for each of the three fiscal years in the period
ended August 1, 1998 comprised the following:
1998 1997 1996
------------ ------------ ------------
Current tax expense
Federal $ - $ - $ -
State 22,273 - -
------------ ------------ ------------
22,273 - -
Deferred tax expense
Federal 414,117 - -
State 195,950 - -
------------ ------------ ------------
610,067 - -
------------ ------------ ------------
$ 632,340 $ - $ -
============ ============ ============
31
<PAGE>
The differences between the Company's income tax expense (benefit) and the
statutory U.S. federal income tax rate for each of the three fiscal years in the
period ended August 1, 1998 are as follows:
1998 1997 1996
---------- ---------- ----------
Statutory U.S. federal income tax rate (34.0)% (34.0)% (34.0)%
State taxes, net of federal benefit (6.5)% (5.7)% (6.5)%
Valuation allowance 52.0 % 42.8 % 37.3 %
Other (2.2)% (3.1)% 3.2 %
---------- ---------- ----------
9.3 % 0.0 % 0.0%
========== ========== ==========
Deferred tax assets and liabilities as of August 1, 1998 and August 2, 1997
relate to the following:
August 1, 1998 August 2, 1997
-------------- --------------
Deferred tax assets
Inventories $ 182,300 $ 13,058
Contribution carryforwards 1,400 13,445
Accrued vacation 28,300 25,431
Accrued compensation 79,000 87,612
Loss carry forwards 3,485,900 1,911,572
Reorganization reserves 726,600 -
Leasehold improvements 323,600 321,278
-------------- --------------
Total deferred tax assets 4,827,100 2,372,396
Valuation allowance for deferred tax assets (4,469,200) (1,289,313)
-------------- --------------
Net deferred tax assets 357,900 1,083,083
Deferred tax liabilities:
Fixtures and equipment 357,900 473,016
-------------- --------------
Total net deferred tax assets $ - $ 610,067
============== ==============
At August 1, 1998 the Company had federal net operating loss carry forwards of
$9,384,988 expiring from 2009 through 2013 and associated state net operating
loss carry forwards expiring from 1999 through 2003. A valuation allowance has
been provided as management cannot determine it is more likely than not that the
deferred tax assets will be realized.
NOTE 8 - STOCKHOLDERS' EQUITY:
- ------------------------------
The Company is authorized to issue 6,000,000 shares of Class A common stock,
$.25 par value per share, and 6,000,000 shares of Class B common stock, $.25 par
value per share. Class A shares differ in that quarterly cash dividends, if
declared, must be for a higher amount than Class B shares and Class A shares
have only one-tenth vote per share as compared to one vote per share for Class B
stock. The Class B shares are convertible into Class A shares at any time at no
cost to the stockholder.
NOTE 9 -EMPLOYEE BENEFITS:
- --------------------------
Effective June 1, 1996 the Company adopted the Three D Departments, Inc.
Employee Savings and Profit Sharing Plan (the Plan) under section 401(k) of the
Internal Revenue Code. All employees, who have completed 90 days of service,
have attained the age of 21 years and worked at least 1,000 hours are eligible
32
<PAGE>
to participate in the Plan. The Plan is funded by voluntary employee salary
deferrals of up to 15% of annual compensation and employer matching
contributions equal to five percent of the Company's net income. There was no
Company contribution for the fiscal years ended August 1, 1998, August 2, 1997,
and August 3, 1996.
The Company has a deferred compensation agreement with a former officer
providing for payments of $20,000 annually for ten years after retirement. In
the event of death, the unpaid balance is payable in two equal installments. The
liability under this agreement is included as a part of Liabilities Subject to
Compromise (see Note 5).
The Company has a non-qualified and two qualified stock option plans (the "1983
Plan" and the "1993 Plan") that provide for the granting of options to purchase
the Company's common stock to selected key employees, officers and directors.
Under the 1988 non-qualified Stock Option Plan, a maximum of 100,000 shares of
Class A common stock are authorized for grants at not less than 100% of fair
market value on date of grant and expire ten years after the date of grant.
Options vest in cumulative amounts at 25% per year, one year from the date of
grant. At August 1, 1998 100,000 shares were available for future grants.
Under the 1983 Plan, shares were authorized for grants at not less than 100% of
fair market value on date of grant. Options were vested in cumulative amounts at
25% per year commencing in the first year and expire ten years after date of
grant. In June 1992, the 1983 Plan expired and no additional shares will be
granted under the 1983 Plan. At August 1, 1998, 36,078 options issued pursuant
to the 1983 plan were exercisable.
The 1993 Plan, as amended, authorizes options for a maximum of 300,000 shares of
Class A common stock and 300,000 shares of Class B common stock to be granted at
not less than 100% of fair market value on the date of grant. Options are
exercisable in cumulative amounts at 25% per year one year from the date of
grant, and expire ten years after date of grant. Under the 1993 Plan, the number
of options granted to any single employee in a twelve month period is limited to
100,000 shares. As of August 1, 1998 remaining options open for grant to
employees, officers and directors were 218,500 Class A shares and 161,309 Class
B shares.
33
<PAGE>
Information with respect to the Company's stock option plans is summarized below
for each of the three fiscal years in the period ended August 1, 1998:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------- --------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year 322,889 $2.01 334,889 $2.02 375,389 $2.05
Granted - - - - 25,000 1.63
Exercised - - - - (7,750) 1.41
Canceled (66,620) 2.38 (12,000) 2.36 (57,750) 2.14
-------------------------------------------------------------------------------
Outstanding at end of year 256,269 $1.91 322,889 $2.01 334,889 $2.02
===============================================================================
Option price
range at end $1.125 $1.125 $1.125
of year to $5.250 to $5.250 to $5.250
Weighted average fair
value of options granted - - $1.53
</TABLE>
In fiscal 1997, the Company adopted Statement of Financial Accounting Standards
No. 123 (SFAS 123), "Accounting for Stock Based Compensation" which encourages,
but does not require companies to recognize compensation cost for stock-based
compensation plans over the vesting period based upon the fair value of awards
on the date of the grant. However, the Statement allows the alternative of the
continued use of the intrinsic value method as prescribed in Accounting
Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to
Employees". Therefore, as permitted, the Company will continue to apply APB 25,
and related interpretations, in accounting for its stock-based compensation
plans. Had compensation cost for these plans been determined in accordance with
SFAS 123 the Company's net loss and loss per common share would have been
increased to the following pro forma amounts as presented below:
1998 1997
---- ----
Net loss: As reported ($7,436,756) ($1,676,749)
Pro forma ($7,446,256) ($1,686,249)
Net loss per common share: As reported ($3.05) ($0.69)
Pro forma ($3.05) ($0.69)
At the end of fiscal 1998, the total options had an average remaining life of
5.4 years. At the end of fiscal 1998 there were 216,894 options exercisable at
an average price of $1.91. The fair value of each option granted was estimated
on the date of grant using the Black-Scholes option pricing model with the
following assumptions used for the grants during 1996: risk free interest rate
of 4.99%; expected volatility of 115%; expected dividend yield of .8%, and the
expected life of the options was ten years.
34
<PAGE>
NOTE 10 - RELATED PARTIES:
- --------------------------
On May 6, 1998, the Company entered into a one-year agreement with its former
Chairman and Director for consulting services. During fiscal 1998 the Company
paid $91,667 for services under this agreement.
In October 1996 the Company sold a residence it owned in West Hartford,
Connecticut to a shareholder, who is a former officer and director of the
Company, in exchange for a reduction of $180,000 in the note payable the Company
owes to the officer. The Company obtained an independent appraisal of the
property prior to the transaction, reviewed the appraisal with the Company's
executive committee and believes the price is competitive with those of similar
properties. In Fiscal 1997 the Company recorded a gain of $78,833 in connection
with this transaction.
In December 1994, the Company entered into a note agreement to borrow $500,000
from a shareholder, who is a former officer and director of the Company. The
agreement provides for interest payable monthly at 10% for the first eighteen
months and interest and principal thereafter. The Company paid interest expense
of $17,048, $29,223, and $54,083 in fiscal 1998, 1997 and 1996, respectively.
The agreement was amended on May 6, 1998 which fixed the amount of the monthly
payment including principal and interest to be $16,923 until the debt was fully
repaid. The outstanding balance at August 1, 1998 is $100,657 and is included in
liabilities subject to compromise (see note 5).
In May 1990, the Company entered into a lease agreement for space in a shopping
center in which several former officers and directors of the Company have 41%
ownership. During fiscal 1998, 1997, and 1996, the Company paid approximately
$161,000, $170,000, and $153,000 respectively, in rent for such space.
Management believes the terms of the lease are competitive with those available
for similar properties. The commitment remaining under this lease, which expires
on May 31, 2005, is $981,000.
In May 1992, an officer, director and stockholder of the Company entered into a
note agreement with the Company to borrow $37,107. The agreement provides for
interest to accrue at 8.5% annually for four years with principal and interest
due in May 1995. In May 1997, the Company agreed to extend the note maturity
until such time as the officer received any proceeds from the sale of Company
stock, at which time the note would be fully repaid. In May 1995, the Company
also increased the interest on the note to 10.75% per annum. The outstanding
balance at August 1, 1998 is $70,883 and is included in receivables.
A stockholder of the Company is the principal stockholder of an insurance agency
used by the Company. During fiscal 1998, 1997 and 1996, the Company paid
insurance premiums on insurance policies issued through this agency of $22,962,
$93,163, and $383,874, respectively. Management believes that such premiums are
competitive with those charged by unrelated insurance brokers.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
- ---------------------------------------
Lease agreements relating to the occupancy of retail stores, warehouses, office
facilities and to the rental of equipment are in effect and expire at varying
dates through 2012. The agreements provide for minimum annual rentals and/or
payments based on percentages of sales. A number of agreements are renewable at
the Company's option and/or are cancelable by either party if a specified level
of annual sales is not attained.
35
<PAGE>
Aggregate annual minimum rental commitments at August 1, 1998, excluding real
estate taxes and certain other expenses, under the aforementioned leases are as
follows:
Fiscal Year Rental
(000's)
1999 $ 4,383
2000 3,907
2001 3,452
2002 2,930
2003 2,762
Thereafter 10,436
----------
$ 27,870
==========
Total rents charged against income, including payments for real estate taxes and
certain other expenses amounted to approximately $6,243,000 in fiscal 1998,
$5,914,700 in fiscal 1997, and $5,917,000 in fiscal 1996.
The Company is, from time to time, involved in routine litigation incidental to
the conduct of its business. The Company believes that no litigation currently
pending against it will have a material adverse effect on its financial position
or results of operations.
NOTE 12 - STATEMENTS OF CASH FLOWS:
- -----------------------------------
For the three fiscal years in the period ended August1, 1998, supplemental cash
flow information is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Interest paid $1,152,387 $1,210,227 $1,317,052
Income taxes paid (refunded) - - (86,084)
Sale of residence in exchange for reduction
of notes payable to officer - 180,000 -
</TABLE>
NOTE 13 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
- --------------------------------------------------------
<TABLE>
<CAPTION>
First Second Third Fourth Full
Quarter Quarter Quarter Quarter Year
<S> <C> <C> <C> <C> <C>
Revenues
1998 $10,395,796 $12,129,386 $ 8,657,360 $ 6,376,869 $37,559,411
1997 $10,987,481 $13,213,052 $ 9,807,148 $10,174,197 $44,181,878
Income (loss) before taxes
1998 $ (460,584) $ 163,551 $(1,528,953) $(4,978,430) $(6,804,416)
1997 $ (529,973) $ 237,192 $ (581,635) $ (802,333) $(1,676,749)
Net income (loss)
1998 $ (460,584) $ 163,551 $(1,528,953) $(5,610,770) $(7,436,756)
1997 $ (529,973) $ 237,192 $ (581,635) $ (802,333) $(1,676,749)
Net income (loss) per share
1998 $ (0.19) $ 0.07 $ (0.63) $ (2.30) $ (3.05)
1997 $ (0.22) $ 0.10 $ (0.24) $ (0.33) $ (0.69)
</TABLE>
36
<PAGE>
NOTE 14 - FOURTH QUARTER ADJUSTMENTS:
- -------------------------------------
During the fourth quarter of 1998 the Company recorded the following reserves
and expenses as a result of the deterioration of operations, filing of Chapter
11 Bankruptcy protection and the anticipated restructuring of the Company:
Store closing reserve $ 516,980
Reserve for lease rejection claims 650,192
Inventory liquidation reserve 430,230
Asset impairment loss 648,913
Valuation reserve for deferred taxes 632,340
Reorganization expenses 257,315
-------------
$ 3,135,970
=============
37
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Three D Departments, Inc.
Costa Mesa, California
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-63897) of our report dated November 24, 1998
relating to the financial statements of Three D Departments, Inc. appearing in
the Company's Annual Report on Form 10-K for the year ended August 1, 1998. Our
report contains an explanatory paragraph regarding the Company's ability to
continue as a going concern.
/s/ BDO Seidman
BDO SEIDMAN, LLP
Costa Mesa, California
January 15, 1999
38
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-63897) of Three D Departments, Inc. of our report
dated October 16, 1997, except as to Note 1 which is as of July 30, 1998,
appearing on page 20 of this Form 10-K.
PRICEWATERHOUSECOOPERS LLP
Los Angeles, California
January 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form 10-K,
August 1, 1998, and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-01-1998
<PERIOD-START> AUG-03-1997
<PERIOD-END> AUG-01-1998
<CASH> 1,403,349
<SECURITIES> 0
<RECEIVABLES> 135,505
<ALLOWANCES> 0
<INVENTORY> 7,589,396
<CURRENT-ASSETS> 9,404,453
<PP&E> 12,794,011
<DEPRECIATION> 8,400,327
<TOTAL-ASSETS> 15,336,229
<CURRENT-LIABILITIES> 1,005,594
<BONDS> 5,094,223
0
0
<COMMON> 810,208
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 15,336,229
<SALES> 37,559,411
<TOTAL-REVENUES> 37,559,411
<CGS> 22,846,124
<TOTAL-COSTS> 18,291,916
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 2,073,400
<INTEREST-EXPENSE> 1,152,387
<INCOME-PRETAX> (6,804,416)
<INCOME-TAX> 632,340
<INCOME-CONTINUING> (7,436,756)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,436,756)
<EPS-PRIMARY> (3.05)
<EPS-DILUTED> (3.05)
</TABLE>
