<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
CHECK ONE
____ Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended
-------------.
or
x Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
- --- Act of 1934 for the transition period from February 2, 1997 to September 27,
1997.
COMMISSION FILE NUMBER 0-7214
HECHINGER COMPANY
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 52-1001530
(State or other jurisdiction of incorporation) (I.R.S. Employer Identification No.)
</TABLE>
1801 MCCORMICK DRIVE, LARGO, MARYLAND 20774
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (301)341-1000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
5-1/2% CONVERTIBLE SUBORDINATED DEBENTURES DUE 2012
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 the 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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
YES x NO
---- ----
State the aggregate market value of the voting stock held by non-affiliates of
the registrant. (No voting stock is held by non-affiliates subsequent to
September 25, 1997.)
--- $ 0 ---
Indicate the number of shares outstanding of each of the registrant's classes of
Common Stock, as of January 13, 1998.
10 shares of Common Stock, $.01 par value
DOCUMENTS INCORPORATED BY REFERENCE
None.
<PAGE> 2
PART I
ITEM 1. BUSINESS.
Hechinger Company, a Delaware corporation (together with its direct and indirect
subsidiaries, the "Company" or the "Registrant") is a leading retailer of
products and services for the care, repair, remodeling and maintenance of the
home and garden. At September 27, 1997, the Company operated 271 stores under
the Hechinger ("Hechinger"), Home Quarters Warehouse ("Home Quarters"), Builders
Square ("Builders Square"), Wye River Hardware and Home ("Wye River"), and
Better Spaces ("Better Spaces") names. The 62 Hechinger stores are primarily
located in the Mid-Atlantic region; the 45 Home Quarters stores are primarily
located in the Southeastern, Northeastern and Midwestern parts of the United
States. There are two Wye River stores located in the metropolitan Washington,
D.C. market, and one Better Spaces store located in Albany, New York. The 161
Builders Square stores are located primarily in the South, Southeastern, North
and Midwestern parts of the United States.
The following table sets forth the number of stores operated by the Company at
year-end and the aggregate amount of square feet of store space under roof for
the specified periods:
<TABLE>
<CAPTION>
STORE
NUMBER SQUARE FOOTAGE
OF STORES (IN THOUSANDS)
- ------------------------------------------------------------------------------
<S> <C> <C>
As of January 29, 1994 125 9,640
1994 openings 12 1,497
1994 closings (4) (295)
--- ----
As of January 28, 1995 133 10,842
1995 openings 10 1,134
1995 closings (25) (2,081)
--- ------
As of February 3, 1996 118 9,895
1996 openings 2 185
1996 closings (3) (190)
-- ----
As of February 2, 1997 117 9,890
1997 purchase of Builders Square stores 161 16,048
1997 openings 0 0
1997 closings (7) (796)
--- ----
As of September 27, 1997 271 25,142
=== ======
</TABLE>
In 1997, the Company changed its fiscal year end to the Saturday closest to
September 30. Prior to this change, the Company's fiscal year ended on the
Saturday closest to January 31. The fiscal period ended September 27, 1997 was
34 weeks ("1997" or "the year") compared to the fiscal years ended February 1,
1997 ("1996") and January 28, 1995 ("1994") which were 52 weeks, and the fiscal
year ended February 3, 1996 ("1995") which was 53 weeks.
On September 25, 1997, Centers Holdings, Inc., a Delaware corporation, through a
wholly-owned subsidiary (collectively "Centers Holdings"), acquired the Company
through a merger transaction (the "Merger"). As a result of the Merger, the
Company became a wholly-owned subsidiary of Centers Holdings. On September 25,
1997, Centers Holdings also purchased BSQ Transferee Corporation ("BSQ"), a
Delaware corporation (which represented substantially all of the assets and
liabilities of Builders Square, Inc.) (the "Initial Purchase"). BSQ was a
wholly-owned subsidiary of Builders Square, Inc., which is in turn a
wholly-owned subsidiary of Kmart Corporation, a Michigan corporation ("Kmart").
BSQ and the Company are affiliates as a result of these transactions.
<PAGE> 3
On September 26, 1997, the Company purchased certain assets of BSQ (the
"Purchase"), primarily inventory, for cash of approximately $243 million and the
assumption of certain liabilities approximating $380 million, subject to
adjustment based on certain changes in working capital and final determination
of the fair value of assets and liabilities acquired in the Initial Purchase. On
September 26, 1997 as part of the Purchase, the Company also entered into
subleases and a lease with BSQ for its operating facilities. Also on September
26, 1997, Centers Holdings, BSQ and the Company entered into a new senior
revolving credit facility, which permits borrowings of up to $600 million (the
"Credit Agreement").
As a result of these transactions, the Company has substantially more assets and
liabilities than it has historically had or been subject to. Accordingly, the
Company's historical operating results may not be indicative of or comparable to
its future operating results.
Pursuant to the terms of the Purchase, 10 stores are subleased under a master
month-to-month rental agreement. In addition, the Company can put 15 of the
acquired stores and any remaining related lease obligations back to BSQ
(collectively with the month-to-month stores, the "put stores"), at any time
prior to July 17, 1998. Pursuant to the terms of the Initial Purchase, BSQ can
put 25 of the acquired leased stores and the remaining related lease obligations
back to Kmart, in the same time frame. BSQ is responsible for closing these
stores and liquidating the related inventory, and delivering a "broom clean"
store back to Kmart. The assets acquired and liabilities assumed from BSQ
pursuant to the Purchase include amounts related to the put stores.
Shortly after the year-end, the Company announced the closing and began the
liquidation of 12 Builders Square stores, as well as initiating the put process
to BSQ on ten of these stores, as applicable. In November 1997, the Company also
closed and sold seven Home Quarters stores in Michigan pursuant to a July 1997
agreement.
During the year, the Company remodeled and reopened its Home Quarters store
located in Albany, New York under the name "Better Spaces" and remodeled and
reopened two of its Hechinger stores in the metropolitan Washington, D.C. market
under the name, "Wye River Hardware and Home" (See Marketing section below for
further discussion. See Notes to Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations for further discussion of stores closed in 1997).
PRODUCTS
The Company's stores offer for sale a large selection of lumber and building
materials (except Better Spaces and Wye River, which offer less lumber and
building materials), hardware and tools, paint, garden supplies, electrical and
plumbing supplies and other items related to the home improvement market.
The following table sets forth the percentage of reported sales accounted for by
merchandise category:
<TABLE>
<CAPTION>
FISCAL PERIOD ENDED SEPT. 27, 1997 FEB. 1, 1997 FEB. 3, 1996 JAN. 28, 1995
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Lumber and building materials 28% 29% 28% 27%
Garden supplies and furniture 23 20 19 18
Plumbing supplies 17 18 16 16
Hardware and tools 11 12 13 12
Paint 8 8 8 9
Electrical supplies and small
appliances 7 7 10 11
Home decor, housewares, and other 6 6 6 7
- - - -
Total 100% 100% 100% 100%
=== === === ===
</TABLE>
Many of the items sold in the Company's stores are nationally advertised, brand
name products. The Company also offers some private label items such as garden
equipment and supplies, and paint. The Company may add private label items to
its merchandise in other areas where there are no major national brands or where
management deems it an effective way to meet price competition in a particular
product line.
<PAGE> 4
By merging the merchandise acquisition function of Hechinger and Home Quarters
with Builders Square, the Company believes it has increased its purchasing power
with its suppliers. The Company also believes it has good relationships with its
suppliers and does not consider itself dependent upon any single source for its
merchandise (See Notes to Consolidated Financial Statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations for
further discussion).
MARKETING
The majority of the Company's sales are to individual consumers, with the
remainder being made to contractors and other businesses. Employees are trained
to help the do-it-yourself customer make his or her purchases and solve
technical problems related to home repair, maintenance and improvement work. The
Company offers its customers a liberal return policy.
The Company employs a multi-media marketing strategy featuring a weekly circular
that promotes key products and special prices. Additional support as determined
to be effective is driven via direct mail, newspaper, radio, television, and
in-store signage programs. The focus of the advertising is on the stores' wide
selection and values, featuring recognizable brand name products. The promotion
of these brand name products enables the Company to share advertising costs
cooperatively with its suppliers.
In February 1997, the Company reopened its Home Quarters store located in
Albany, New York under the name "Better Spaces". This home decor superstore
carries products that a customer needs to refurbish, enhance and organize his or
her home, inside and out. Further expansion of "Better Spaces" to other markets
is pending the results of this pilot store.
In September 1997, the Company reopened two of its Hechinger stores located in
the Washington, D.C. market under the name "Wye River Hardware and Home". These
stores carry products needed for home repair, maintenance and organization, and
are specifically designed to be convenient, fast and easy to shop. Further
expansion of "Wye River Hardware and Home" to other markets is pending the
results of these pilot stores.
The Company offers a private label credit card program pursuant to which credit
is extended to its customers by third party financial institutions. The Company
also accepts VISA, MasterCard, Discover and American Express in all of its
stores. For the fiscal period ended September 27, 1997 credit card sales
accounted for 53% of the Company's total sales.
COMPETITION
The business of the Company is highly competitive. The Company competes in each
of its market areas with other national and regional home center chains
(including The Home Depot and Lowe's), national chains of general merchandise
stores and local hardware stores, some of which have greater financial,
management and other resources than the Company or have been operating longer in
particular geographic areas than the Company.
The extent of the Company's competition varies by geographic area. Competitors
have entered many of the Company's existing markets and established competitors
are expanding in certain of these markets, which may, in each case, adversely
affect the Company's sales. In addition, the Company's strategy to maintain
competitive pricing in each of its markets may result in lower gross margins as
competition intensifies. There can be no assurance that the Company's financial
results and condition will not be impacted negatively by existing competition,
by the further expansion of competitors into the Company's markets or by the
Company's expansion into competitors' markets (See Management's Discussion and
Analysis of Financial Condition and Results of Operations for discussion of
store closings in certain markets).
<PAGE> 5
SEASONALITY
The Company's business is seasonal and its annual results of operations depends
to a significant extent on the results of operations for the third quarter of
its new fiscal year. The Company's revenues and operating income have
traditionally been higher during March through September than during the period
from October through February.
EMPLOYEES
The Company currently has approximately 28,000 employees, approximately half of
whom are employed on a part-time basis. The Company believes its employee
relations are satisfactory.
ITEM 2. PROPERTIES.
The Home Quarters stores currently average approximately 99,000 square feet
under roof and an additional 33,000 square feet of outdoor selling and storage
space. The Hechinger stores currently average approximately 71,000 square feet
under roof and an additional 23,000 square feet of outdoor selling and storage
space. The Builders Square stores currently average approximately 100,000 square
feet under roof and an additional 24,000 square feet of outdoor selling and
storage space.
The Company currently owns 14 operating stores and leases the remaining units.
The Company believes that all of its facilities, both owned and leased, are in
good condition. Expiration dates of the leases range from 1999 to 2023. Almost
all leases contain renewal clauses. However, with respect to the properties
covered by BSQ's subleases with Kmart (which represents the majority of all
Builders Square stores), BSQ's ability to exercise renewal options available in
Kmart's leases with third parties is subject to various conditions. As a result,
the Company's ability to exercise renewal options under its sublease with BSQ
with respect to such properties is similarly conditioned (See Note 12 to the
Consolidated Financial Statements).
The Company's stores, in part, are currently serviced from the 640,000 square
foot central warehouse and distribution facility in Landover, Maryland. In
connection with the Merger, the geographic spread of the Company's stores will
require a new distribution strategy. As a result, the Company has begun to
utilize pool points throughout the country rather than the Landover, Maryland
central distribution center. The Company anticipates that it will either sell or
lease its Landover, Maryland facility when the transition to pool points is
complete.
The Company currently leases approximately 100,000 square feet of office space
in Largo, Maryland and owns a 58,000 square foot office building in Virginia
Beach, Virginia.
ITEM 3. LEGAL PROCEEDINGS.
On July 23, 1997, a purported class action complaint was filed in the Delaware
Chancery Court on behalf of all holders of the Company's common stock against
the Company and the former Company directors. The plaintiff has alleged that the
former officers and directors of the Company breached their fiduciary duties to
the holders of the common stock by, among other things, failing to take all
reasonable steps to assure the maximization of stockholder value including the
implementation of a bidding mechanism to foster a fair auction of the Company
and by entering into an agreement with Centers Holdings under which the
consideration offered by Centers Holdings to holders of the common stock was
"unfair and grossly inadequate." The Company believes that the plaintiff's
claims are without merit and intends to defend such action vigorously.
The Company and its subsidiaries are also parties to legal proceedings and
claims arising in the ordinary course of business. Although the outcome of such
proceedings and claims cannot be determined with certainty, based upon
evaluation by legal counsel, management believes that the outcome of such
proceedings and claims will not have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.
<PAGE> 6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On September 25, 1997, the Company held a special meeting of its stockholders,
at which time the Company's stockholders voted for approval and adoption of the
Merger and the merger agreement which provided for the Merger (the "Merger
Agreement"). The results of the vote were as follows:
<TABLE>
<CAPTION>
BROKER
CLASS OF COMMON STOCK FOR AGAINST ABSTENTIONS NON-VOTES
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Class A 12,614,032 1,825,372 234,114 18,080,856
Class B 88,416,070 628,150 76,510 5,463,010
----------- --------- ------- ----------
Total Votes 101,030,102 2,453,522 310,624 23,543,866
=========== ========= ======= ==========
</TABLE>
Pursuant to the terms of the Company's proxy statement dated September 5, 1997,
abstentions and broker non-votes had the same effect as a vote against the
Merger and Merger Agreement.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.
There is no established trading market for the Registrant's common stock. All of
the Registrant's common stock is owned by Centers Holdings.
ITEM 6. SELECTED FINANCIAL DATA.
The information called for by this item is hereby incorporated by reference from
Exhibit 99(a) of this report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OPERATIONS. On September 25, 1997, Centers Holdings, Inc., a Delaware
corporation, through a wholly-owned subsidiary (collectively "Centers
Holdings"), acquired the Company through a merger transaction (the "Merger").
Pursuant to the Merger, each share of the issued and outstanding common stock of
the Company immediately prior to the effective time of the Merger was converted
into the right to receive $2.375 in cash, without interest. On September 25,
1997, all of the outstanding shares of the Company were canceled in exchange for
the payment by Centers Holdings of approximately $100 million. Ten shares of
common stock with a par value of $.01 per share were issued to Centers Holdings.
As a result of the Merger, the Company became a wholly-owned subsidiary of
Centers Holdings.
On September 25, 1997, Centers Holdings also purchased BSQ, (which represented
substantially all of the assets and liabilities of Builders Square, Inc.) (the
"Initial Purchase"). BSQ was a wholly-owned subsidiary of Builders Square, Inc.,
which is in turn a wholly-owned subsidiary of Kmart Corporation, a Michigan
corporation ("Kmart"). BSQ and the Company are affiliates as a result of these
transactions. (See Note 2 to the Consolidated Financial Statements.)
On September 26, 1997, the Company purchased certain assets of BSQ (the
"Purchase"), primarily inventory, for cash of approximately $243 million and the
assumption of certain liabilities approximating $380 million, subject to
adjustment based on certain changes in working capital and final determination
of the fair value of assets and liabilities acquired in the Initial Purchase.
Operating results related to the assets acquired from BSQ were not significant
for the two days ended September 27, 1997. Also on September 26, 1997, Centers
Holdings, BSQ and the Company entered into a new senior revolving credit
facility, which permits borrowings of up to $600 million (the "Credit
Agreement").
On September 26, 1997, the Company also entered into subleases and a lease with
BSQ for its operating facilities. (See Notes 3 and 12 to the Consolidated
Financial Statements.)
<PAGE> 7
As a result of these transactions, the Company has substantially more assets and
liabilities than it has historically had or been subject to. Accordingly, the
Company's historical operating results may not be indicative of or comparable to
its future operating results.
In 1997, the Company changed its fiscal year end to the Saturday closest to
September 30. Prior to this change, the Company's fiscal year ended on the
Saturday closest to January 31. The fiscal period ended September 27, 1997 was
34 weeks ("1997" or "the year") compared to the fiscal years ended February 1,
1997 ("1996") and January 28, 1995 ("1994") which were 52 weeks, and the fiscal
year ended February 3, 1996 ("1995") which was 53 weeks.
Pursuant to the terms of the Purchase, 10 stores are leased on a master
month-to-month rental agreement. The Company can also put 15 of the acquired
leased stores and any remaining related lease obligations back to BSQ
(collectively with the month-to-month stores, the "put stores"), at any time
prior to July 17, 1998. Pursuant to the terms of the Initial Purchase, BSQ can
put 25 of the acquired leased stores and the remaining related lease obligations
back to Kmart, in the same time frame. BSQ is responsible for closing these
stores and liquidating the related inventory, and delivering a "broom clean"
store back to Kmart. The assets acquired and liabilities assumed from BSQ
pursuant to the Purchase include amounts related to the put stores.
The following table sets forth the sales reported by the Company (in billions):
<TABLE>
<CAPTION>
PERIOD 1997 1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $1.36 $2.20 $2.25 $2.45
Net sales (decrease)/increase (13%) (2%) (8%) 17%
Comparable store sales (decrease)/increase (12%) (3%) (8%) 2%
</TABLE>
Sales for the 34-week period ended September 26, 1996 were $1.56 billion. The
decrease in net sales and comparable store sales for 1997 compared with the
comparable period of 1996 was due primarily to increased competition during 1997
as well as unseasonable weather. The sales decrease for 1996 compared with 1995
was due primarily to the increased competition during 1996 and less stores open
during 1996 compared with 1995. Additionally, 1996 was a 52-week year compared
with the previous year which was a 53-week year. The sales decrease for 1995
compared with 1994 was due to 22 stores closed as a part of the store closing
plan announced in 1994 as well as increased competition, unseasonable weather
and weak sales of existing homes. Competition is expected to continue to expand
into the Company's markets and could have an adverse impact on the Company's
sales.
The following table sets forth the number of stores operated by the Company:
<TABLE>
<CAPTION>
PERIOD 1997 1996 1995 1994
- -------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At beginning of period 117 118 133 125
Openings 0 2 10 12
Closings (7) (3) (25) (4)
Purchase of Builders Square stores 161 0 0 0
--- --- --- ---
At end of period 271 117 118 133
=== === === ===
</TABLE>
Other income, which consists primarily of interest income, was $3.0 million,
$2.8 million, $2.9 million and $4.4 million in 1997, 1996, 1995 and 1994,
respectively. The decreases in 1997, 1996 and 1995 compared to 1994 were due
primarily to decreases in funds available for investment.
Cost of sales was 82.8% of sales for 1997 compared to 80.0% for the same 34-week
period in 1996, and 79.3%, 79.8% and 77.9% of sales for 1996, 1995 and 1994,
respectively. Distribution and buying and occupancy expenses, which are
primarily fixed costs, are included in cost of sales. As a percent of sales, the
increase in 1997 was due primarily to increases in inventory shrink and LIFO
charges, various inventory valuation adjustments, and the impact of competitive
pricing in certain markets. As a percent of sales, the decrease in 1996 was due
primarily to improvement in the merchandise margin resulting from
<PAGE> 8
the Company's vendor consolidation program and a LIFO credit in 1996 versus a
LIFO charge in 1995, offset by the impact of competitive pricing in certain
markets. In 1995, as a percent of sales, over one-half of the increase was due
primarily to less leverage of distribution, buying and occupancy expenses as a
result of lower sales in 1995 compared with 1994. The remaining amount of the
increase in 1995 is attributable to the impact of competitive pricing in certain
markets, among other factors. Cost of sales included a LIFO charge of $5.1
million, $2.6 million and $1.9 million in 1997, 1995 and 1994, respectively,
compared with a LIFO credit of $1.0 million in 1996. Inventory acquisition costs
and other inventory adjustments increased third quarter 1997 cost of sales by
$26 million and decreased fourth quarter cost of sales by $1.7 million, $2.0
million and $2.4 million in 1996, 1995 and 1994, respectively.
Selling, general and administrative expenses were 20.3% of sales for 1997
compared to 20.1% of sales for both 1996 and 1995 and 19.1% of sales for 1994.
Pre-opening expenses of $0.0 million, $1.9 million, $7.6 million and $8.9
million are included in selling, general and administrative expenses for 1997,
1996, 1995 and 1994, respectively. Excluding pre-opening expenses, as a percent
of sales, the increase in 1997 was due primarily to less leverage of selling,
general and administrative expenses as a result of lower sales levels in 1997
compared with 1996. The increase in selling, general and administrative expenses
in 1996 was due primarily to higher store payroll and other expenses to support
the Company's customer service programs and was partially offset by general and
administrative expense savings as a result of the combination of Hechinger and
Home Quarters operations under one management team. The increase in 1995 was due
primarily to less leverage of selling, general and administrative expenses as a
result of lower sales in 1995 compared with 1994. In addition, approximately $6
million was recorded in 1995 for costs related to the combination of the
Hechinger and Home Quarters operations, including relocation and professional
service fees.
Interest expense, net of capitalized interest, was $32.7 million, $40.2 million,
$31.3 million and $29.8 million for 1997, 1996, 1995 and 1994, respectively. The
increases in 1997 (over the comparable period in 1996) and in 1996 were
primarily due to the increased utilization of the Company's revolving credit
facility. The increase in 1995 was due primarily to less interest capitalized on
construction-in-progress compared with 1994. Capitalized interest amounted to
$0.0 million, $0.3 million, $2.4 million and $3.6 million for 1997, 1996, 1995
and 1994, respectively.
In 1997, as a result of the Merger and change in control, the Company incurred
merger-related expenses of approximately $29.1 million, consisting primarily of
approximately $4.5 million of professional and advisory services related to the
Merger transaction, and approximately $24.6 million of employee-related costs.
The majority of these costs were included in accrued liabilities as of September
27, 1997, and were subsequently paid by the Company. (See Note 2 to the
Consolidated Financial Statements.)
In 1997, the Company entered into an agreement to sell seven Home Quarters
stores in the Michigan market. Competition had continued to intensify in this
market, which adversely affected the performance of these stores. Based on the
recent performance and limited potential of these stores, management decided to
close them. For 1997, 1996 and 1995, these seven stores generated revenue of $84
million, $151 million and $171 million, respectively, while generating operating
losses of approximately $8 million, $13 million and $7 million, respectively.
(See Note 4 to the Consolidated Financial Statements.) The Company recorded a
store closing charge of $31.8 million related to the decision to close and sell
these stores. The main components of this charge were:
- - Estimated write-down to net realizable value of real estate (approximately
$13.6 million), and furniture, fixtures, equipment and other assets
(approximately $14.3 million) to be disposed of.
- - Estimated cash expenditures for operating costs for the stores during the
inventory liquidation period and for employee termination costs of
approximately $3.9 million.
The Company consummated the sale of these stores in November 1997.
In 1995, the Company recorded a restructuring charge of $25 million related
primarily to the Company's decision to combine its Hechinger and Home Quarters
operations under one management team. By merging the management, purchasing and
administrative functions of its two operating subsidiaries, the
<PAGE> 9
Company believed it would be in a better competitive position as it operated a
more efficient organization and increased purchasing power with its vendors. In
addition, in 1996 the Company reduced its annual general and administrative
costs by approximately $16 million primarily from the elimination of duplicate
information systems and management and administrative functions. (See Note 4 to
the Consolidated Financial Statements.)
In 1994, the Company recorded a store closing charge of $61.9 million primarily
related to the Company's decision to close 22 stores in certain markets (the
"Store Closing Charge"). The main components of this charge were costs related
to the write-down of inventories and furniture, fixtures, equipment and other
assets to be disposed of, carrying costs of the closed stores and employee
termination costs. Disposition of the closed stores is accomplished by
subleasing or assigning the property to a new occupant or reverting possession
back to the landlord. The Company previously expected that it would dispose of
or sublease the remaining stores by January 1999. As a result of certain
decisions made by management of the Company related to the future disposition of
these properties, in 1997 the Company revised its estimate and recorded an
additional store closing charge of $42.7 million for the estimated continuing
carrying costs for these stores, consisting primarily of rents and other related
costs (together with the Store Closing Charge, the "Store Closing Charges"). The
Company believes that the accrual of $47.6 million as of September 27, 1997 is
adequate to cover future liabilities related to the carrying costs of the closed
stores. (See Note 4 to the Consolidated Financial Statements.)
Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" was issued in 1995. The statement requires companies to review long-lived
assets and certain intangible assets in certain circumstances, and if the value
of the assets is impaired, to record an impairment loss. In 1997, management of
the Company made decisions to close and dispose of certain properties, including
a distribution facility. As a result, the Company recorded an impairment loss of
approximately $29.3 million which reflects the difference between the carrying
value of the properties and the estimated sales value, net of estimated costs to
sell. The Company is actively pursuing the disposal of these properties. This
amount also includes approximately $9.0 million related to the write-off of the
unamortized portion of leasehold acquisition costs of certain closed stores,
which management believes is not recoverable.
In 1995, the Company recorded aggregate impairment losses of approximately $30
million. As a result of the Company's decision to slow down its expansion plans
and not to pursue development of a number of real estate properties which had
been acquired for future store expansion, the Company decided to dispose of
these properties, and recorded an impairment loss related to these properties of
approximately $15 million. This non-cash charge reflected the difference between
the carrying value of the properties and the estimated sales value, net of
estimated costs to sell. The Company is actively pursuing the disposal of these
properties. Also in 1995, the Company reviewed its property, furniture, fixtures
and equipment and evaluated how these assets would continue to be used in its
operations. Based on this evaluation, the Company recorded an impairment loss
related to certain property, furniture, fixtures and equipment of approximately
$15 million.
The effective income tax expense (benefit) rates were 0.6%, 0.0%, (3.7%) and
(35.9%) of the losses before income taxes for 1997, 1996, 1995 and 1994,
respectively. The effective tax rates for 1997 and 1996 differ from the
statutory rates as a result of increases in the valuation reserve on the
deferred tax assets resulting from each year's loss. The effective tax rate for
1995 differed from the statutory rate as a result of the effect of a valuation
allowance established on the Company's deferred tax asset generated from
restructuring and asset impairment charges recorded in 1995. The effective tax
rate for 1994 differed from the statutory rate due primarily to tax-free
earnings on funds available for investment and various tax credits. As described
in Note 2 to the Consolidated Financial Statements, on September 25, 1997
Centers Holdings acquired the Company. This transaction constituted an ownership
change as defined under Section 382 of the Internal Revenue Code of 1986, as
amended (the "Code"). This ownership change subjects the Company to a $5.5
million annual limitation in future years in the use of certain items reflected
as deferred tax assets, including net operating loss carryforwards and certain
other tax attributes which were available on the date of the ownership change.
As a result, due to uncertainties regarding the realization in future periods of
the deferred tax assets, the Company has provided a
<PAGE> 10
valuation allowance on substantially all of its gross deferred tax assets. As of
September 27, 1997, the Company had net operating loss carryforwards for Federal
income tax purposes of approximately $81 million (net of approximately $44
million which will not be utilized by the Company pursuant to the Section 382
limitation), substantially all of which is subject to the $5.5 million annual
limitation resulting from the ownership change. The Company's net operating loss
carryforwards expire between 2009 and 2012. The Company's alternative minimum
tax credit carryforward of $3.6 million is available indefinitely as it does not
expire. (See Note 11 to the Consolidated Financial Statements.)
The Company has been proactive with respect to ensuring that its computer
systems will be year 2000 compliant. Much of the software utilized by the
Company has been updated in recent years for business reasons, is
"off-the-shelf" in nature, and was either purchased as being year 2000
compliant, or has been updated to be compliant under routine maintenance
agreements. Other Company systems that will need updating are more unique and
some are proprietary in nature. The Company estimates that approximately 60% of
its systems are currently compliant and expects that substantially all of its
remaining systems will be compliant by mid-1999. The Company estimates that it
will spend up to $3 million associated with these remaining system changes.
LIQUIDITY AND CAPITAL RESOURCES. Net cash flows from operations were $20.0
million, $47.1 million and $3.5 million in 1997, 1995 and 1994, respectively.
Net cash flows used in operations were $59.1 million in 1996. The change between
1997 and 1996 was the result of decreased inventory levels, due primarily to the
closing of the seven Michigan stores, and increases in accounts payable and
accrued expenses, partially offset by increased losses in 1997, net of non-cash
store closing and merger-related items. The decrease between 1996 and 1995 was
due primarily to a decrease in accounts payable and accrued expenses, increased
losses in 1996 and the use of cash relating to store closings and the Company's
restructuring. The increase between 1995 and 1994 was the result of decreased
inventory levels, due primarily to the store closings, and increases in accounts
payable and accrued expenses, partially offset by increased losses in 1995 and
the use of cash relating to store closings.
Net cash flows used in investing activities were $240.8 million in 1997 compared
to $19.9 million, $29.7 million and $89.0 million in 1996, 1995 and 1994,
respectively. The increase between 1997 and 1996 was primarily due to the
purchase of net assets from BSQ. The decreases between 1996 and 1995 as well as
1995 and 1994 were due to decreased levels of capital spending resulting from
reductions to the Company's store expansion, relocation and remodeling programs.
These programs were largely financed from the Company's marketable securities in
1995 and 1994.
Net cash flows from financing activities were $271.3 million in 1997 and were
largely funded by the Company's new senior secured revolving credit facility,
contributed capital from the Company's parent, and a non-interest-bearing
advance from the parent. Net cash flows were $79.9 million in 1996 and were
funded primarily from the Company's revolving credit facility. Net cash flows
used in financing activities were $7.9 million in 1995 and primarily resulted
from cash dividends paid to the Company's stockholders. Net cash flows from
financing activities were $92.1 million in 1994 and primarily resulted from the
net proceeds of sale and leaseback transaction.
Cash and cash equivalents were $87.2 million, $36.7 million and $35.8 million at
September 27, 1997, February 1, 1997 and February 3, 1996, respectively.
On September 26, 1997, Centers Holding, BSQ, and the Company entered into a new
senior secured revolving credit facility, which permits borrowings of up to $600
million (the "Credit Agreement"). The Credit Agreement replaced a $200 million
revolving credit facility and all letter of credit facilities outstanding. This
facility is guaranteed by the Company, collateralized by merchandise inventories
and expires in September 2002. The amount available under the facility
fluctuates based on the Company's "Eligible Inventory" balance (as defined in
the Credit Agreement). The initial borrowings under the facility were used to
buy the net assets of BSQ. The borrowings under the Credit Agreement bear
interest at a rate which fluctuates based on (i) the greatest of (a) Prime
Rate, (b) the Base CD Rate (as defined) plus 1.0%, or (c) the Federal Funds
rate plus 0.5%, plus an additional 0.0% to 0.5% based on the Interest Coverage
Ratio (as defined) or (ii) LIBOR plus an additional 1.5% to 2.0% based on the
Interest Coverage Ratio (as
<PAGE> 11
defined), in accordance with the Credit Agreement. The interest rate on the
borrowing was 9.0% at September 27, 1997. Amounts available under the borrowing
agreement as of September 27, 1997 approximated $285.4 million.
The Credit Agreement contains certain covenants which restrict the Company's
ability to, among other things, enter into additional indebtedness, make
acquisitions or sales of certain assets and declare and pay cash dividends. In
addition, the Credit Agreement limits the annual amount of capital expenditures
of the Company and, beginning with the period ending June 1998, requires the
Company to maintain minimum quarterly EBITDA (as defined) at increasing levels.
The Company is in the process of eliminating duplicate overhead functions
related to BSQ's operations. Accordingly, the Company will incur duplicative
overhead expenses during the integration period, including costs associated with
integrating information technology systems. The Company expects these costs to
approximate $22 million in fiscal 1998.
In August 1994, the Company sold 13 stores for $99.3 million, net of expenses,
and concurrently leased the properties back for an initial term of 25 years. The
lease is renewable at the Company's option for nine additional terms of five
years each.
Under the terms of a sale and leaseback transaction completed in 1990, the
Company is restricted from taking certain actions that would result in its net
worth, less goodwill, falling below $175 million. Under the terms of certain
sale and leaseback transactions completed in 1992, the Company is required to
maintain a minimum net worth of $200 million. Under the 1992 transaction, in the
event this minimum net worth is not maintained, the Company could be required to
repurchase properties aggregating approximately $42 million.
The Company anticipates that capital expenditures for fiscal 1998 will be
approximately $60 million. Management believes that cash and cash equivalents,
cash generated from operations and its available credit facility are adequate to
meet the Company's working capital needs and planned capital expenditures for
fiscal 1998.
IMPACT OF INFLATION AND CHANGING PRICES. The Company does not measure precisely
the effect of inflation on its operations; however, it does not believe
inflation has had a material effect on sales or results of operations.
FORWARD-LOOKING STATEMENTS. Forward-looking statements in this Form 10-K are
made pursuant to the safe harbor provision of the Private Securities Litigation
Reform Act of 1995. There are various factors that could cause results to differ
materially from those anticipated by some statements made herein. Investors are
cautioned that all forward looking statements involve risks and uncertainty.
Factors that could cause actual results to differ materially include, but are
not limited to the following: the strength and extent of new and existing
competition; the Company's ability to maintain competitive pricing in its
markets; the Company's ability to maintain adequate levels of vendor support;
the success of the Company's customer services programs; the Company's ability
to attract, train and retain experienced, quality management and employees; the
Company's ability to assimilate BSQ's operations into its own; the general
economic conditions; housing turnover; interest rates; weather; disposal of
excess real estate; and other factors described from time to time in the
Company's Securities and Exchange Commission filings.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information called for by this item is hereby incorporated by reference from
Exhibits 99(a) through 99(h) of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
On October 14, 1997, the Company filed a Current Report on Form 8-K which
reported that the Company had changed its independent accountants. Ernst &
Young, LLP was previously the Registrant's independent accounting firm. On
October 7, 1997, Ernst & Young's engagement by the Registrant as its independent
accounting firm was terminated and KPMG Peat Marwick LLP, the independent
accounting firm of Centers Holdings, was engaged by the Registrant as
independent accounting firm. The decision to change accountants was approved and
ratified by the Board of Directors of the Registrant at a meeting of said Board
on October 8, 1997.
In connection with the audits of the two fiscal years ended February 1, 1997 and
the subsequent interim period through October 7, 1997, there were no
disagreements with Ernst & Young LLP on any matter of accounting principles or
practices, financial statement disclosure, or auditing scope and procedures,
which disagreement if not resolved to their satisfaction would have caused them
to make reference in connection with their opinion to the subject matter of the
disagreement.
The audit reports of Ernst & Young LLP on the consolidated financial statements
of the Registrant as of and for the years ended February 1, 1997 and February 3,
1996 did not contain any adverse opinion or disclaimer of opinion, nor were they
qualified. The audit reports were modified for the Registrant's adoption of SFAS
121 in the fiscal year ended February 3, 1996 and change in method of
calculating LIFO inventories in the fiscal year ended January 28, 1995.
<PAGE> 12
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth certain information regarding the Company's
directors and executive officers as of January 1998:
<TABLE>
<CAPTION>
YEAR FIRST
JOINED
NAME AND AGE POSITION WITH THE COMPANY THE COMPANY
- ------------ ------------------------- -----------
<S> <C> <C>
Anthony R. Petrillo (58) President, Chief Executive Officer and Director since September 1997. 1997
Prior thereto, Consultant to Thrifty Payless, Inc. since May 1995
and prior thereto, Chairman, Chief Executive Officer and President
of Kash n' Karry Food Stores, Inc. since August 1994 and prior thereto,
Consultant.
Mark R. Adams (36) Executive Vice President, General Counsel, Treasurer 1988
and Secretary since September 1997. Prior thereto, Senior Vice President,
Treasurer and Secretary since March 1995 and prior thereto, served in various
capacities as an Officer of the Company.
Martin R. Bocola (49) Executive Vice President - Store Operations since 1997
September 1997. Prior thereto, Executive Vice President - Store Operations for
Builders Square Stores since September 1995 and prior thereto, Divisional Vice
President - Store Operations for Builders Square since September 1993 and
prior thereto, Vice President - Store Operations for Pergament Home Centers.
Harold R. Hall (48) Executive Vice President and Chief Financial Officer 1989
since September 1997. Prior thereto, Senior Vice President - Finance since
September 1995 and prior thereto, Senior Vice President and Chief Financial
Officer of Home Quarters Warehouse, which was then a wholly-owned subsidiary of
Hechinger Company.
Thomas P. Vertetis (53) Executive Vice President - Merchandising and Marketing 1997
since October 1997. Prior thereto, various officer level positions of
increasing responsibility in General Merchandise Management with The Home Depot,
Rickle Home Centers and the Handy Man Corporation.
Leonard I. Green (64) Director since September 1997. Executive officer and an
equity owner of Leonard Green & Partners, L.P. ("LGP"), a merchant banking
firm that manages GEI, since the formation of LGP and GEI in 1994 by the
principals of Leonard Green & Associates, L.P. ("LGA"). Mr. Green has also been,
individually or through a corporation, a partner in LGA, a merchant banking firm,
since its inception in 1989. Prior to forming LGA, Mr. Green had been a partner
of Gibbons, Green, van Amerongen for more than five years. Also a Director of
Rite Aid Corporation, Carr-Gottstein Foods Co., and Communications & Power
Industries, Inc.
</TABLE>
<PAGE> 13
<TABLE>
<S> <C>
Gregory J. Annick (33) Director since September 1997. Executive officer and an equity owner,
through a trust, of LGP, a merchant banking firm that manages GEI, since
the formation of GEI in 1994 by the principals of LGA. Joined LGA as an
associate in 1989, became a principal in 1993, and through a corporation
became a partner of LGA in 1994. From 1988 to 1989, an associate with the
merchant banking firm of Gibbons, Green, van Amerongen. Also a director of
Carr-Gottstein Foods Co., Communications & Power Industries, Inc., and
Leslie's Poolmart, Inc.
John G. Danhakl (41) Director since September 1997. Executive officer and an equity owner of
LGP, a merchant banking firm that manages GEI, since 1995. Previously a
Managing Director at Donaldson, Lufkin & Jenrette Securities Corporation
("DLJ") and had been with DLJ since 1990. Prior thereto a Vice President at
Drexel Burnham Lambert Incorporated. Also a director of Big 5 Corp.,
Communications & Power Industries, Inc., Leslie's Poolmart, Inc.,
Twinlab Corporation, and The Arden Group, Inc.
Jonathan D. Sokoloff (40) Director since September 1997. Executive officer and equity owner of LGP,
a merchant banking firm that manages GEI, since the formation of LGP and
GEI in 1994 by the principals of LGA. Joined LGA as a partner in 1990. Prior
thereto a Managing Director at Drexel Burnham Lambert Incorporated. Also a
director of Twinlab Corporation and Carr-Gottstein Foods Co.
Martin L. Grass (43) Director since September 1997. Chairman of the Board and Chief Executive
Officer of Rite Aid Corporation since 1995. Prior thereto President and
Chief Operating Officer since April 1989. Also a director of Tessco
Technologies, Inc. and Mercantile Safe Deposit & Trust Company.
Marvin P. Rich (52) Director since September 1997. Executive Vice President, Strategic Planning,
Finance and Administration of Kmart since 1994. Prior thereto Executive
Vice President, Specialty Companies, Wellpoint Health Networks/Blue Cross of
California from 1992 to 1994.
</TABLE>
There is no family relationship between any of the foregoing persons.
In September 1997, following the Merger, executive officers were elected by the
Board of Directors of the Company to serve until their successors are chosen and
qualified, or as otherwise provided in the Company's By-laws.
<PAGE> 14
ITEM 11. EXECUTIVE COMPENSATION.
The Summary Compensation Table sets forth individual compensation information
paid by the Company and its subsidiaries to the Chief Executive Officer and the
most highly paid executive officers (the "Named Executive Officers"), for
services rendered in all capacities during the fiscal period ended September 27,
1997 ("1997") and fiscal years ended February 1, 1997 ("1996") and February 3,
1996, ("1995"). Subsequent to the Merger (as defined under Item 1. Business.),
none of the Named Executive Officers continued to be employed by the Company.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
- -------------------------------------------------------------------------------------------------------------------------
LONG-TERM COMPENSATION
AWARDS
ANNUAL COMPENSATION --------------------- PAYOUTS
----------------------------------- SECURITIES -----------
OTHER ANNUAL RESTRICTED UNDERLYING PERFORMANCE ALL OTHER
NAME AND SALARY BONUS COMPENSATION STOCK OPTIONS SHARES COMPENSATION
PRINCIPAL AWARDS
POSITION YEAR ($) ($) ($) (1) ($) (#) ($) ($) (2)
- -------- ------- -------- --------- ---------- ---------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John W. Hechinger,
Jr. 1997(3) $400,000 $ 0 $2,565,080 $0 49,000 $0 $3,948,249
Chairman & Chief 1996 600,000 318,000 269,200 0 49,000 0 382,415
Executive Officer 1995 541,667 0 0 0 74,500 0 98,087
Kenneth J. Cort 1997(3) 356,667 0 2,458,233 0 38,500 0 3,646,049
President &
Chief 1996 535,000 283,550 129,200 0 38,500 0 134,665
Operating Officer 1995 478,334 0 0 0 519,250 0 4,012
W. Clark McClelland 1997(3) 223,333 0 1,887,092 0 26,666 0 2,530,050
Executive Vice 1996 335,000 177,550 247,200 0 26,666 0 264,665
President & Chief 1995 332,500 0 0 0 113,333 0 3,012
Financial Officer
</TABLE>
The employment of the Named Executive Officers identified above was terminated
two days prior to the end of the Company's fiscal year. With the exception of
the appointment of Anthony R. Petrillo as President and Chief Executive Officer
effective September 25, 1997, the executive authority of any officer of the
Company for the period September 25, 1997 through September 27, 1997 was not
confirmed. Mr. Petrillo's compensation for this period was not significant. His
compensation arrangements have not yet been definitively determined.
- ----------------------------------
(1) For 1997 and 1996, each amount represents an auto allowance of $8,800 and
$13,200, respectively, and the Federal and state taxes paid on each executive's
behalf in connection with the purchase of annuities under the Supplemental
Executive Retirement Plan ("SERP"). See Supplemental Executive Retirement Plan
to follow. For Messrs. Hechinger, Jr., Cort and McClelland, the 1997 amount also
includes $1,150,280, $1,093,433 and $750,292, respectively, paid on each
executive's behalf in connection with certain Federal excise taxes due as a
result of the Merger. See Severance Agreements to follow.
(2) For Messrs. Hechinger, Jr., Cort and McClelland, the 1997 amount includes
$1,555,000, $1,533,000 and $1,237,000, respectively, representing the value of
annuities purchased on behalf of each executive pursuant to the SERP. For
Messrs. Hechinger, Jr., Cort and McClelland, the 1996 amount include $283,000,
$129,000 and $259,000, respectively, representing the value of annuities
purchased on behalf of each executive pursuant to the SERP. See Supplemental
Executive Retirement Plan to follow.
For Messrs. Hechinger, Jr., Cort and McClelland, the 1997 amount also includes
severance payments made to each executive in connection with the Merger of
$2,289,999, $2,103,549 and $1,283,550, respectively. See Severance Agreements
to follow.
For Mr. Hechinger, Jr., the amounts in each year also includes an advance of
$93,750 made by the Company pursuant to a Split Dollar Life Insurance
arrangement entered into in 1994. Under this arrangement, a trust established
by Mr. Hechinger, Jr. has acquired an interest in a life insurance policy on
the life of Mr. Hechinger, Jr. and his spouse in the amount of $3,460,000. The
<PAGE> 15
trust is responsible for the payment of premiums on the policy. Each year, for
up to twelve years, the Company has agreed to advance the premium on the policy
up to $93,750 annually. The life insurance policy has been assigned to the
Company as security for the amounts advanced and upon the earliest of
termination of employment other than by death or disability, age 65, or the
death of Mr. Hechinger, Jr. and his spouse, the Company is entitled to be
reimbursed directly from the carrier for the amounts advanced. The amounts also
include contributions by the Company to the Company Profit Sharing and 401(k)
Plans. Company contributions to the Profit Sharing Plan are in such amounts as
may be determined by the Board up to the maximum amount allowable under the
Internal Revenue Code of 1986, as amended (the "Code"). Company contributions
to the 401(k) Plan represent a match of 50% of a participant's first 6% of pay
contributed subject to the maximum amount allowable under the Code. Company
contributions become 100% vested in both plans after a participant completes
prescribed Plan Service and in certain other circumstances.
(3) Represents compensation information related to the 34-week period ended
September 27, 1997.
- --------------------------------------------------
All stock options granted to the Named Executive Officers for the three previous
fiscal periods are disclosed in the Summary Compensation Table. The table below
restates the options granted to the Named Executive Officers in the last fiscal
period, and provides other information regarding such grants, including an
estimate of the Grant Date Present Value. Stock Options are granted pursuant to
the 1991 Stock Incentive Plan. The Company has not granted any stock
appreciation rights.
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL PERIOD
- ------------------------------------------------------------------------------------------------------------------------------
INDIVIDUAL GRANTS
NUMBER OF ----------------- ----------- GRANT DATE VALUE
SECURITIES PERCENT OF TOTAL EXERCISE OR -----------------
UNDERLYING OPTIONS GRANTED BASE PRICE GRANT DATE
OPTIONS GRANTED TO EMPLOYEES IN PER SHARE EXPIRATION PRESENT VALUE
NAME (#) FISCAL PERIOD ($/SH.) DATE ($)
- ------------------------ --------------- ---------------- ----------- ---------- -----------------
<S> <C> <C> <C> <C> <C>
John W. Hechinger, Jr. 49,000(1) 6.44% $1.8125 03/11/07 $27,563
Kenneth J. Cort 38,500(1) 5.06% 1.8125 03/11/07 21,656
W. Clark McClelland 26,666(1) 3.50% 1.8125 03/11/07 15,000
</TABLE>
- -------------------------------------
(1) The options to purchase these shares were granted on March 11, 1997 at an
exercise price equal to the fair market value of the then Class A common stock
on that date. While the options were originally scheduled to vest on March 11,
1999, pursuant to the merger agreement pursuant to which the Merger was
consummated, vesting was accelerated and the Named Executive Officers received
the amounts disclosed under Grant Date Value.
- ----------------------------------------------------------------
The following table sets forth certain information on options exercised during
the last fiscal period and unrealized value for both exercisable and
unexercisable options at fiscal year end.
<TABLE>
<CAPTION>
AGGREGATED OPTION EXERCISES IN LAST FISCAL PERIOD AND FISCAL PERIOD-END OPTION VALUES
- ------------------------------------------------------------------------------------------------------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
ACQUIRED OPTIONS AT FISCAL PERIOD END AT FISCAL PERIOD END(1)
ON VALUE --------------------------- -----------------------------
EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
NAME (#) (2) ($) (2) (#) (#) ($) ($)
- ---------------------- --------- --------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
John W. Hechinger, Jr. 49,000 $27,563 0 0 $0 $0
Kenneth J. Cort 38,500 21,656 0 0 0 0
W. Clark McClelland 26,666 15,000 0 0 0 0
</TABLE>
- ----------------------------------
(1) Market value of stock at fiscal year end less exercise price, before payment
of applicable income taxes.
(2) In connection with the Merger, holders of In-the-Money Options received
cash payments in lieu of shares. (See Note 17 to the Consolidated Financial
Statements.)
- --------------------------------------------------
<PAGE> 16
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
The Company had entered into agreements with the Named Executive Officers
pursuant to the Supplemental Executive Retirement Plan (the "SERP"). These
agreements provided for retirement benefits equal to 65% of the participant's
average annual compensation as defined by the agreements (and excluding certain
non-cash compensation such as income from the exercise of stock options and
other extraordinary items) for the five highest-paid years of the last ten years
of his or her employment, multiplied by a fraction, the numerator of which is
the executive's months of employment by the Company not in excess of 360 and the
denominator of which is 360. Such benefits are reduced by the amount of an
executive's Social Security benefits and payments under the Pension, Profit
Sharing and 401(k) Plans of the Company. Benefits generally vest and are payable
at age 65, except to the extent funded with annuity purchases as described
below, or in certain other cases including disability, on Board approved early
retirement. If the participant dies prior to retirement, the participant's named
beneficiary will receive an amount equal to 50% of his or her prior year's
compensation, payable in equal monthly installments, until the later of the
month following the month when the participant would have become 65 or the 120th
monthly payment. The agreements also provide for limited cost of living
adjustments to an executive's retirement benefits.
Under the SERP, in the event of a change in control of the Company, the Company
would fund a Trust for the Named Executive Officers in an amount sufficient to
purchase annuities and make related tax payments for a ten-year period. The
Trust would then purchase annuities and make related tax payments annually
during the ten-year period unless, within two years of the change in control,
such Named Executive Officer's employment was terminated by the executive for
good reason or by the Company other than for cause; in which case, the Trust
would purchase an annuity (and make the related tax payment) on behalf of the
Named Executive Officers equal (together with any annuities already purchased
for the executive by the Trust) to the expected benefit over such ten-year
period. The Company would be required to make additional payments to compensate
for excise taxes incurred in connection with the provision of such benefits. As
a result of the Merger and subsequent employment termination of each Named
Executive Officer, the aggregate amount that the Company was required to fund on
behalf of the Named Executives (excluding excise taxes - see discussion under
Severance Agreements, below) was $7,730,000. In March 1997, pursuant to the
SERP, the Named Executive Officers also received total payments of $485,000.
STOCK INCENTIVE AGREEMENTS
The Company's 1992 Restricted Stock Award Agreement and the Performance
Restricted Stock Award Agreements each contain change in control arrangements
that were triggered by the Merger. These include: (i) 25,500 shares of
restricted stock which had been issued to Mr. Cort pursuant to a 1992 Restricted
Stock Award Agreement and (ii) 100,000 shares, 100,000 shares and 60,000 shares
of the Company's then Class A Common Stock which were awarded in 1995 to Messrs.
Hechinger, Jr., Cort and McClelland, respectively, under Performance Restricted
Stock Award Agreements.
The Stock Incentive Agreements generally provide that in the event the Named
Executive Officer's employment is terminated following a change in control due
to death, disability, by the executive for good reason or by the Company other
than for cause, the restriction on such shares granted shall lapse and the
executive shall receive such shares free of restrictions. The Stock Incentive
Agreements also provide for additional payments to compensate for any excise
taxes (see discussion under Severance Agreements, below) incurred in connection
with the exercise of any option or receipt of any benefits. The aggregate amount
received by Messrs. Hechinger, Jr., Cort and McClelland under these agreements
was $678,063.
SEVERANCE AGREEMENTS
Under the terms of the Named Executive Officers Severance Agreements dated April
10, 1997 entered into by the Company and each of the Named Executive Officers,
each Named Executive Officer would receive a benefit equal to three times the
sum of his annual salary and the average of his last three annual bonuses if the
executive was terminated for reasons other than cause, death, disability or
retirement or by
<PAGE> 17
the Named Executive Officer for "good reason" within two years following a
change in control of the Company. Each Named Executive Officer would also be
eligible for additional benefits for thirty-six months in the event of such
termination. These additional benefits included existing medical, dental and
life insurance (provided the executive paid the premiums due under such plans);
merchandise discounts; outplacement services; monthly auto allowances up to an
annual cost of $13,200; and payment of excise taxes incurred in connection with
the payments received. The Named Executive Officers Severance Agreements
contained confidentiality requirements applicable to the Named Executive
Officers during and after their employment with the Company. Pursuant to the
terms of the Named Executive Officers Severance Agreements, the Named Executive
Officers received approximately $5.7 million in the aggregate (excluding excise
taxes).
Total payments with respect to excise taxes made on behalf of the Named
Executive Officers for all benefits in the aggregate approximated $3 million.
CERTAIN NON-COMPETE ARRANGEMENTS
Simultaneously with the execution of the Merger Agreement, Messrs. Hechinger,
Jr., Cort and McClelland entered into certain arrangements pursuant to which
they have agreed to limit their ability to compete with the Company and not to
hire certain employees of the Company during for a period ranging from twelve to
twenty-four months.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The Company's outstanding capital stock is indirectly wholly-owned by Centers
Holdings. The following table sets forth the ownership of the common stock of
Centers Holdings ("Centers Holdings Common Stock") as of January 13,1998 by any
person known by the Company to be the beneficial owner of more than 5% of the
Centers Holdings Common Stock (for whom an address is also provided), the
Company's directors and executive officers named in the Summary Compensation
Table above, and all executive officers and directors of the Company as a group.
<TABLE>
<CAPTION>
NAME AND ADDRESS(1)
OF BENEFICIAL OWNER NUMBER OF SHARES PERCENT OF CLASS
- ----------------------------------- ---------------- ----------------
<S> <C> <C>
Green Equity Investors II, L.P. (2) 490,000 92.6%
Builders Square, Inc. (2) (3) 210,000 28.4
Anthony R. Petrillo 0 0
John W. Hechinger, Jr. 0 0
Kenneth J. Cort 0 0
W. Clark McClelland 0 0
Leonard I. Green (4) (4)
Jonathan D. Sokoloff (4) (4)
John G. Danhakl (4) (4)
Gregory J. Annick (4) (4)
Marvin P. Rich 0 0
Martin L. Grass (5) 39,200 7.4
All Executive Officers and Directors
as a Group (6) 529,200 100.0
</TABLE>
- ----------------------------------
(1) The address for Green Equity Investors II, L.P. ("GEI II") and
Messrs. Green, Sokoloff, Danhakl and Annick is 11111 Santa Monica Boulevard,
Suite 2000, Los Angeles, California 90025. The address for Builders Square,
Inc. (solely in the context of this Item 12. "Builders Square") is c/o Kmart
Corporation, 3100 West Big Beaver Road, Troy, Michigan, 48084. Builders Square
is a subsidiary of Kmart.
(2) Pursuant to the Securityholders Agreement (as defined below), each of GEI II
and Builders Square has agreed to vote for the directors designated by the
other. See Securityholders Agreement, below.
(3) Represents 210,000 shares of Centers Holdings that Builders Square has the
right to acquire pursuant to a currently-exercisable warrant received in
conjunction with the Initial Purchase. As of January 13, 1998, Builders Square
had not exercised
<PAGE> 18
the warrant. For purposes of calculating Builders Square's ownership
percentages, the shares for which the warrant is exercisable are deemed to be
outstanding, but are not so deemed in calculating the ownership percentages of
any of the other stockholders.
(4) GEI II is a Delaware limited partnership managed by Leonard Green &
Partners, L.P. ("LGP"), which is an affiliate of the general partner of GEI II.
Each of Messrs. Green, Sokoloff, Danhakl and Annick, either directly (whether
through ownership interest or position) or through one or more intermediaries,
may be deemed to control LGP and such general partner and thus may be deemed to
be beneficial owners of the shares of Centers Holdings Common Stock owned by GEI
II.
(5) All of these shares are owned by Square Builders, LLC, a Maryland limited
liability company, the managing member of which is Mr. Grass and the other
member of which is Mr. Grass's father.
(6) Includes the shares identified in note (4) above.
- --------------------------------------------------
SECURITYHOLDERS AGREEMENT
In connection with the Initial Purchase, GEI II, Builders Square and Centers
Holdings entered into a Securityholders Agreement (the "Securityholders
Agreement") which, among other things, provides that (i) the Board of Directors
of Centers Holdings (the "Centers Holdings Board") will consist of six members,
(ii) GEI II and Builders Square will each vote any shares of Centers Holdings
Common Stock they own (a) in the case of GEI II, in favor of one nominee
selected by Builders Square and (b) in the case of Builders Square five nominees
selected by GEI II (six if GEI II elects to expand the Centers Holdings Board to
seven members). The Securityholders Agreement also provides that, so
long as certain minimum ownership requirements by Builders Square or its
transferee are met, the affirmative vote of Builders Square's nominees on the
Centers Holdings Board will generally be required to approve transactions not in
the ordinary course of business. In addition, the Securityholders Agreement
provides for certain share transfer restrictions and grants Builders Square
"tag-along" rights in connection with certain sales of Centers Holdings Common
Stock by GEI II. In addition, the Securityholders Agreement grants GEI II and
Builders Square certain demand and "piggyback" registration rights. The voting,
transfer and tag-along provisions of the Securityholders Agreement will
terminate generally if the Centers Holdings Common Stock is listed or admitted
to trading on a national securities exchange or quoted on The Nasdaq Stock
Market's National Market or traded in the over-the-counter market.
COMPLIANCE WITH SECTION 16 OF THE SECURITIES EXCHANGE ACT OF 1934
Prior to September 25, 1997, Section 16(a) of the Securities Exchange Act of
1934, as amended (the "Exchange Act") required the Company's directors,
executive officers and persons who beneficially own more than 10% of a
registered class of the Company's equity securities to file with the Securities
and Exchange Commission (the "Commission") initial reports of ownership and
reports in changes in ownership of shares of the Company's common stock and
other equity securities of the Company. Executive officers, directors and 10%
beneficial owners were required by Commission regulation to furnish the Company
with copies of all Section 16 (a) reports they file.
To the Company's knowledge, based on review of the copies of such reports
furnished to the Company and representations from certain persons that no other
reports were required for such persons, all Section 16(a) filing requirements
applicable to its officers, directors and 10% beneficial owners were complied
with during the last fiscal year.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The majority of the Builders Square stores are leased or subleased by the
Company from BSQ pursuant to a lease and sublease. Ten stores are subleased
under a master month-to-month rental agreement. The lease and sublease each
provide for an initial lease term of six years, with two five-year options. In
addition, the Company may decline to renew the lease and/or sublease on up to 40
stores. At September 27, 1997, minimum fixed rental commitments under the lease,
sublease and rental agreement to BSQ for the next year were approximately $119
million. The approximate amount of rental expense under these agreements for the
period of September 26, 1997 through September 27, 1997 was $660,000.
<PAGE> 19
The majority of the facilities subleased by the Company from BSQ are in turn
subleased by BSQ from Kmart pursuant to subleases as modified by the Consent and
Undertaking Agreement (the "Consent Agreement"). The Consent Agreement provides
in general for certain standardized terms for the subleased properties, to the
extent permitted by and not violative of the underlying leases between Kmart and
its lessors. All of the subsidiaries of Centers Holdings, including the Company
and each of its subsidiaries, have unconditionally guaranteed the payment and
performance of the subleases.
During 1997, ten of the Company's stores were leased from Hechinger Enterprises,
a partnership consisting of members of the Hechinger and England families known
by the Company to have been the beneficial owners of more than 5% of the Company
stock prior to the Merger. The rentals paid by the Company to Hechinger
Enterprises under these leases were $2.3 million. In the opinion of management,
the terms of these leases were at least as favorable to the Company as those
leases which the Company has with unaffiliated lessors for comparable premises.
<PAGE> 20
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Report:
1. Financial Statements. The following Consolidated Financial Statements of
Hechinger Company and subsidiaries are hereby incorporated by reference from
Exhibits 99(a) - 99(h) of this report.
<TABLE>
<CAPTION>
EXHIBIT
-------
<S> <C>
Financial Highlights 99(a)
Quarterly Results 99(b)
Consolidated Statements of Operations - Thirty-four week period ended September
27, 1997, and years ended February 1, 1997, February 3, 1996 and January 28,
1995 99(c)
Consolidated Balance Sheets - As of September 27, 1997, February 1, 1997 and
February 3, 1996 99(d)
Consolidated Statements of Cash Flows - Thirty-four week period ended September
27, 1997, and years ended February 1, 1997, February 3, 1996 and January 28,
1995 99(e)
Consolidated Statements of Stockholders' Equity - Thirty-four week period ended
September 27, 1997, and years ended February 1, 1997, February 3, 1996 and
January 28, 1995 99(f)
Notes to Consolidated Financial Statements 99(g)
Independent Auditors' Reports 99(h)
</TABLE>
2. Financial Statement Schedules. Schedules have been omitted because the
information required to be set forth therein is included in the Consolidated
Financial Statements or Notes thereto.
3. Exhibits.
EXHIBIT NUMBER DOCUMENT
- -------------- --------
3(a) Certificate of Incorporation, as amended (incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-8, File No. 33-27134), as
amended by the merger agreement filed as Exhibit 10(f) herewith.
3(b) By-Laws, as amended (incorporated by reference to Exhibit 3(b) to Annual
Report on Form 10-K for the fiscal year ended February 3, 1990, File No.
0-7214).
4(a) Indenture, dated as of March 15, 1987, between the Company and First Union
National Bank of North Carolina, relating to 5-1/2% Convertible Subordinated
Debentures Due 2011 (incorporated by reference to Exhibit 4(d) to Registration
Statement on Form S-3, File No. 33-12649); as amended by Supplemental Indenture
dated January 31, 1997 between the Company and First Union National Bank of
North Carolina (incorporated by reference to Exhibit 4(a) to the Company's
Annual Report on Form 10-K for the fiscal year ended February 1, 1997).
4(b) Indenture, dated as of October 1, 1992, between the Company and First Union
National Bank of North Carolina, and the Prospectus Supplement dated November
12, 1992 relating to 9.45% Senior Debentures due 2012 (incorporated by reference
to Exhibit 4 to Registration Statement on Form S-3, File No. 33-52960); as
amended by Supplemental Indenture dated January 31, 1997 between the Company
<PAGE> 21
and First Union National Bank of North Carolina (incorporated by reference to
Exhibit 4(b) to the Company's Annual Report on Form 10-K for the fiscal year
ended February 1, 1997).
4(c) Indenture, dated as of October 1, 1992, between the Company and First Union
National Bank of North Carolina, and the Prospectus Supplement dated October 21,
1993 relating to 6.95% Senior Notes due 2003 (incorporated by reference to
Exhibit 4 to Registration Statement on Form S-3, File No. 33-52960); as amended
by Supplemental Indenture dated January 31, 1997 between the Company and First
Union National Bank of North Carolina (incorporated by reference to Exhibit 4(b)
to the Company's Annual Report on Form 10-K for the fiscal year ended February
1, 1997).
10(a) Form of Deferred Compensation Agreement between the Company and John W.
Hechinger and Richard England, respectively (incorporated by reference to
Exhibit 10 to Registration Statement on Form S-3, File No. 2-98155).
10(b) Revolving Credit Agreement dated as of February 20, 1996 among Hechinger
Stores Company and Hechinger Stores East Coast Company, as borrowers, the
financial institutions from time to time party thereto, as Lenders, and The CIT
Group/Business Credit, Inc., as Agent (incorporated by reference to Exhibit 99
to Registration Statement on Form 8-K, File No. 0-7214).
10(c) Form of Severance Agreement (incorporated by reference to Exhibit 10(g) to
the Company's Annual Report on Form 10-K for the fiscal year ended February 1,
1997).
10(d) Form of Supplemental Executive Retirement Agreement; form of amendments
between the Company and the Named Executive Officers (incorporated by reference
to Exhibit 10(h) to the Company's Annual Report on Form 10-K for the fiscal year
ended February 1, 1997).
10(e) Bill of Sale, Assignment and Assumption Agreement dated as of September
26, 1997 by and between BSQ Transferee Corp. and Hechinger Investment Company of
Delaware, Inc. (incorporated by reference to Exhibit 2 to the Company's Current
Report on Form 8-K dated October 14, 1997).
10(f) Agreement and Plan of Merger, dated as of July 17, 1997, by and among
Hechinger Acquisition, Inc., BSQ Acquisition, Inc. and Hechinger Company
(incorporated by reference to Exhibit 2A to the Company's Current Report on Form
8-K dated October 8, 1997), as amended by First Amendment, dated as of August
27, 1997, to the Agreement and Plan of Merger, dated as of July 17, 1997, by and
among Hechinger Acquisition, Inc., BSQ Acquisition, Inc. and Hechinger Company
(incorporated by reference to Exhibit 2B to the Company's Current Report on Form
8-K dated October 8, 1997).
10(g) Credit Agreement, dated as of September 26, 1997, among Hechinger
Investment Company of Delaware, Inc., as Borrower, Centers Holdings, Inc., BSQ
Acquisition, Inc., BSQ Transferee Corp., Hechinger Company, Hechinger Stores
Company and Hechinger Stores East Coast Company, The Lenders Party Thereto, The
Chase Manhattan Bank, as Administrative Agent, Collateral Agent, Issuing Bank
and Swingline Lender, BankAmerica Business Credit, Inc., as Documentation Agent
and Borrowing Base Audit Agent, and Citicorp USA, Inc., as Syndication Agent
with Chase Securities Inc., as Arranger (incorporated by reference to Exhibit 99
to the Company's Current Report on Form 8-K dated September 26, 1997).
21 Subsidiaries of the Registrant
27 Financial Data Schedule
99(a) Financial Highlights
99(b) Quarterly Results
99(c) Consolidated Statements of Operations
<PAGE> 22
99(d) Consolidated Balance Sheets
99(e) Consolidated Statements of Cash Flows
99(f) Consolidated Statements of Stockholders' Equity
99(g) Notes to Consolidated Financial Statements
99(h) Independent Auditors' Reports
(b) Reports on Form 8-K.
On July 21, 1997, the Company filed a Current Report on Form 8-K which reported
that the Company had entered into the Merger Agreement.
On August 29, 1997, the Company filed a Current Report on Form 8-K which
reported that the Company had entered into the First Amendment to the Merger
Agreement.
On October 8, 1997, the Company filed a Current Report on Form 8-K which
reported that (i) a change in control of the Company had occurred on September
25, 1997, (ii) the Company had requested that the Company's Common Stock be
delisted from the Nasdaq National Market and (iii) the Company intended to file
a statement on Form 15 with the Commission to terminate the Company's periodic
reporting requirements under the Exchange Act, with respect to the Company
Common Stock.
On October 14, 1997, the Company filed a Current Report on Form 8-K which
reported that (i) the Company, pursuant to a Bill of Sale, Assignment and
Assumption Agreement dated as of September 26, 1997, purchased from BSQ certain
of the assets of BSQ, (ii) the Company had entered into leases and subleases for
stores and support facilities previously operated by BSQ, (iii) the Company,
Centers Holdings and BSQ had entered into the Credit Agreement, (iv) the Company
had changed its independent accountants, and (v) the Company had changed its
fiscal year end. (See "Item 1. Business.")
On December 19, 1997, the Company filed a Current Report on Form 8-K which filed
the financial statements and pro forma financial information required by the
Current Report on Form 8-K filed by the Company on October 14, 1997.
<PAGE> 23
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.
HECHINGER COMPANY
-----------------
(Registrant)
Date: January 13, 1998 By /S/ Anthony R. Petrillo
-------------------------------------
Anthony R. Petrillo
President, Chief Executive Officer and
Director
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- -------------------------- -------------------------------------------- -------------------
<S> <C> <C>
/S/ Anthony R. Petrillo President, Chief Executive Officer and January 13, 1998
- -------------------------- Director
Anthony R. Petrillo
/S/ Harold R. Hall Executive Vice President and Chief January 13, 1998
- -------------------------- Financial Officer (Principal Financial
Harold R. Hall and Accounting Officer)
/S/ Leonard I. Green Director January 13, 1998
- --------------------------
Leonard I. Green
/S/ Gregory J. Annick Director January 13, 1998
- --------------------------
Gregory J. Annick
/S/ John G. Danhakl Director January 13, 1998
- --------------------------
John G. Danhakl
/S/ Jonathan D. Sokoloff Director January 13, 1998
- --------------------------
Jonathan D. Sokoloff
Director January 13, 1998
- --------------------------
Martin L. Grass
Director January 13, 1998
- --------------------------
Marvin P. Rich
</TABLE>
<PAGE> 24
HECHINGER COMPANY AND SUBSIDIARIES
ANNUAL REPORT ON FORM 10-K
PERIOD ENDED SEPTEMBER 27, 1997
INDEX TO SCHEDULES AND EXHIBITS
<TABLE>
<CAPTION>
SEQUENTIALLY
DESCRIPTION NUMBERED PAGE
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Exhibit 21 Subsidiaries of the Registrant
Exhibit 27 Financial Data Schedule
Exhibit 99(a) Financial Highlights
Exhibit 99(b) Quarterly Results
Exhibit 99(c) Consolidated Statements of Operations
Exhibit 99(d) Consolidated Balance Sheets
Exhibit 99(e) Consolidated Statements of Cash Flows
Exhibit 99(f) Consolidated Statements of Stockholders' Equity
Exhibit 99(g) Notes to Consolidated Financial Statements
Exhibit 99(h) Independent Auditors' Reports
</TABLE>
<PAGE> 1
EXHIBIT 21
HECHINGER COMPANY
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
STATE OF
NAME INCORPORATION
- ---- -------------
<S> <C>
A) Hechinger Company (has 4 direct subsidiaries) Delaware
(1) Hechinger Stores Company (has 2 direct subsidiaries) Delaware
a. Hechinger Stores East Coast Company Delaware
b. Hechinger Investment Company of Delaware, Inc. (has 2 direct subsidiaries) Delaware
(1) Hechinger Royalty Company Delaware
(2) HIDS, Inc. Delaware
(2) Hechinger International, Inc. Delaware
(3) Hechinger Property Company Delaware
(4) Hechinger Financial Holdings Company (has 9 direct subsidiaries) Delaware
(a) Hechinger Finance Inc. Delaware
(b) Pennsy, Inc. Delaware
(c) HS Square, Inc. Delaware
(d) Hechinger Towers Company Delaware
(e) PhilProp Holding Company Pennsylvania
(f) ManProp Holding Company Virginia
(g) BucksProp Holding Company Pennsylvania
(h) HProp, Inc. Delaware
(i) RemProp, Inc. Delaware
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
CONSOLIDATED BALANCE SHEET OF HECHINGER COMPANY AND SUBSIDIARIES AS OF
SEPTEMBER 27, 1997 AND CONSOLIDATED STATEMENT OF OPERATIONS FOR 34 WEEKS THEN
ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH TRANSITION REPORT
ON FORM 10-K FOR THE TRANSITION PERIOD FROM FEBRUARY 2, 1997 TO SEPTEMBER 27,
1997.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> OTHER
<FISCAL-YEAR-END> SEP-27-1997
<PERIOD-START> FEB-02-1997
<PERIOD-END> SEP-27-1997
<CASH> 87,215
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 973,139
<CURRENT-ASSETS> 1,137,678
<PP&E> 554,727
<DEPRECIATION> 229,090
<TOTAL-ASSETS> 1,668,399
<CURRENT-LIABILITIES> 935,060
<BONDS> 352,960
0
0
<COMMON> 0
<OTHER-SE> 276,468
<TOTAL-LIABILITY-AND-EQUITY> 1,668,399
<SALES> 1,360,891
<TOTAL-REVENUES> 1,363,921
<CGS> 1,127,258
<TOTAL-COSTS> 1,403,038
<OTHER-EXPENSES> 132,878
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 32,749
<INCOME-PRETAX> (204,744)
<INCOME-TAX> 1,267
<INCOME-CONTINUING> (206,011)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (206,011)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
<PAGE> 1
EXHIBIT 99(a)
HECHINGER COMPANY
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
34 WEEKS YEAR ENDED
ENDED ---------------------------------------------------------------------
SEPT. 27, 1997 FEB. 1, 1997 FEB. 3, 1996 JAN. 28, 1995 JAN. 29, 1994 JAN. 30, 1993
- ------------------------------------------------------------------------------------------------------------------------------------
(in thousands except per share data)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Net sales $ 1,360,891 $ 2,199,067 $ 2,252,780 $ 2,449,554 $ 2,094,968 $ 1,869,349
Gross profit 233,633 455,208 455,932 540,680 462,266 437,009
Interest expense 32,749 40,194 31,341 29,793 23,063 14,121
Income tax expense (benefit) 1,267 - (3,000) (5,545) 10,611 (15,429)
Net (loss)/earnings (206,011) (25,076) (77,636) (9,911) 24,760 (26,272)
BALANCE SHEET DATA
Total assets $ 1,668,399 $ 1,105,103 $ 1,150,421 $ 1,261,229 $ 1,229,242 $ 1,075,749
Current portion of long-term debt and 32,382 3,657 3,806 3,453 3,068 1,544
capital lease obligations
Long-term debt and capital lease obligations 429,784 394,478 399,530 403,377 407,873 305,974
Total stockholders' equity 276,468 374,256 399,039 481,273 493,867 473,924
</TABLE>
Note: All periods presented were 52 weeks except for the transition period ended
September 27, 1997, which was 34 weeks and the year ended February 3, 1996,
which was 53 weeks. In 1997, the Company recorded a charge of $74.5 million
related to store closings, a non-cash charge of $29.3 million related to SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to Be Disposed of", and a charge of $29.1 million related to its
acquisition by Centers Holdings, Inc. In 1996, the Company suspended dividend
payments. In 1995, the Company recorded a charge of $25 million related to its
decision to combine its Hechinger and Home Quarters operations under one
management team and a non-cash charge of $30 million related to the adoption
of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to Be Disposed of." In 1994, the Company recorded a charge of
$61.9 million primarily related to its decision to close its stores in certain
markets. Also in 1994, the Company changed its method of calculating LIFO
inventories. In 1992, the Company recorded a charge of $83 million to cover
estimated costs associated with the repositioning of its Hechinger stores. (See
Notes to Consolidated Financial Statements and Management's Discussion and
Analysis of Financial Condition and Results of Operations)
<PAGE> 1
EXHIBIT 99(b)
HECHINGER COMPANY
QUARTERLY RESULTS (UNAUDITED)
(in thousands)
The following table sets forth summarized unaudited quarterly results for the
fiscal periods ended September 27, 1997, February 1, 1997 and February 3, 1996:
<TABLE>
QUARTER ENDED MAY 3, 1997 AUG. 2, 1997 SEPT. 27, 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 507,981 $ 591,626 $ 261,284
Gross profit 102,651 113,855 17,127
Income tax expense - - 1,267
Net earnings/(loss) (13,544) (40,567) (151,900)
QUARTER ENDED MAY 4, 1996 AUG. 3, 1996 NOV. 2, 1996 FEB. 1, 1997
- -------------------------------------------------------------------------------------------------------------------------
Net sales $ 561,317 $ 665,902 $ 533,276 $ 438,572
Gross profit 115,845 139,564 109,006 90,794
Income tax expense - - - -
Net earnings/(loss) (5,990) 12,215 (9,965) (21,337)
QUARTER ENDED APRIL 29, 1995 JULY 29, 1995 OCT. 28, 1995 FEB. 3, 1996
- -------------------------------------------------------------------------------------------------------------------------
Net sales $ 553,174 $ 648,649 $ 549,189 $ 501,768
Gross profit 119,548 138,531 103,949 93,904
Income tax expense/(benefit) 686 5,368 (3,762) (5,292)
Net earnings/(loss) 1,167 9,139 (6,406) (81,536)
</TABLE>
Note: Final LIFO valuation and inventory acquisition cost adjustments impacted
the 8-week period ended September 27, 1997, and the fourth quarters of 1996 and
1995. In the second quarter of 1997, the Company recorded a charge of $31.8
million for the closing of seven stores in the Detroit market. In the 8-week
period ended September 27, 1997, the Company recorded a charge of $42.7 million
related to store closings, a non-cash charge of $29.3 million related to SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived
Assets to Be Disposed of", a charge of $29.1 million related to costs incurred
in connection with its acquisition by Centers Holdings, Inc., and inventory
adjustments aggregating approximately $26 million resulting from shrink, LIFO
reserve charges, discontinued inventory and other inventory valuation
adjustments. All quarters presented were 13 weeks except for the quarter ended
September 27, 1997, which was 8 weeks, and the quarter ended February 3, 1996,
which was 14 weeks. (See Notes to Consolidated Financial Statements and
Management's Discussion and Analysis of Financial Condition and Results of
Operations)
<PAGE> 1
EXHIBIT 99(c)
HECHINGER COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
SEPT. 27, 1997 FEB. 1, 1997 FEB. 3, 1996 JAN. 28, 1995
(34 WEEKS) (52 WEEKS) (53 WEEKS) (52 WEEKS)
-------------------------------------------------------------
<S> <C> <C> <C> <C>
REVENUES
Net sales $1,360,891 $2,199,067 $2,252,780 $2,449,554
Other (principally interest) 3,030 2,757 2,869 4,405
-------------------------------------------------------------
Total Revenues 1,363,921 2,201,824 2,255,649 2,453,959
COSTS AND EXPENSES
Cost of sales 1,127,258 1,743,859 1,796,848 1,908,874
Selling, general and administrative expenses 275,780 442,847 452,796 468,898
Interest expense 32,749 40,194 31,341 29,793
Store closing and restructuring charges 74,489 - 25,000 61,850
Impairment of long-lived assets 29,284 - 30,300 -
Merger related expenses 29,105 - - -
-------------------------------------------------------------
Total Costs and Expenses 1,568,665 2,226,900 2,336,285 2,469,415
-------------------------------------------------------------
LOSS BEFORE INCOME TAXES (204,744) (25,076) (80,636) (15,456)
INCOME TAX EXPENSE/(BENEFIT) 1,267 - (3,000) (5,545)
-------------------------------------------------------------
NET LOSS ($206,011) ($25,076) ($77,636) ($9,911)
=============================================================
</TABLE>
See notes to consolidated financial statements.
<PAGE> 1
EXHIBIT 99(d)
HECHINGER COMPANY
CONSOLIDATED BALANCE SHEETS
(in thousands except share data)
<TABLE>
<CAPTION>
SEPT. 27, 1997 FEB. 1, 1997 FEB. 3, 1996
--------------------------------------------------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 87,215 $ 36,727 $ 35,785
Merchandise inventories 973,139 414,980 414,974
Other current assets 77,324 66,637 79,533
--------------------------------------------------
Total Current Assets 1,137,678 518,344 530,292
ASSETS HELD FOR SALE 76,671 9,400 9,400
PROPERTY, FURNITURE AND EQUIPMENT, NET 325,637 461,752 497,577
COST IN EXCESS OF NET ASSETS ACQUIRED, NET 50,967 52,066 53,743
LEASEHOLD ACQUISITION COSTS, NET 36,438 46,876 49,128
OTHER ASSETS 41,008 16,665 10,281
--------------------------------------------------
TOTAL ASSETS $ 1,668,399 $ 1,105,103 $ 1,150,421
==================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Revolving credit facility $ 243,970 $ 84,814 $ -
Current portion of long-term debt and capital lease obligations 32,382 3,657 3,806
Due to parent 34,324 - -
Accounts payable and accrued expenses 562,987 207,468 278,021
Accrued costs for store closings 61,397 12,828 43,246
--------------------------------------------------
Total Current Liabilities 935,060 308,767 325,073
LONG-TERM DEBT, LESS CURRENT PORTION 352,960 380,868 383,709
CAPITAL LEASE OBLIGATIONS, LESS CURRENT PORTION 76,824 13,610 15,821
DEFERRED RENT 27,087 27,602 26,779
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; authorized 1,000; 0; and 0 shares
respectively; issued 10; 0 and 0 shares, respectively - - -
Class A common stock, $.10 par value; authorized 0; 50,000,000 and
50,000,000 shares, respectively; issued 0; 32,608,139 and 30,892,581
shares, respectively - 3,261 3,089
Class B common stock, $.10 par value, authorized 0; 30,000,000 and
30,000,000 shares, respectively; issued 0; 9,716,371 and 11,431,929
shares, respectively - 971 1,143
Additional paid-in capital 241,507 238,248 238,248
Contributed capital 108,058 - -
Retained earnings (accumulated deficit) (73,097) 132,914 157,990
Unearned compensation - (253) (759)
Less treasury stock at cost, 0; 97,265 and 39,325 Class A common shares,
respectively, and 0; 14,497 and 14,497 Class B common
shares, respectively - (885) (672)
---------------------------------------------------
Total Stockholders' Equity 276,468 374,256 399,039
---------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,668,399 $ 1,105,103 $ 1,150,421
===================================================
</TABLE>
See notes to consolidated financial statements.
<PAGE> 1
EXHIBIT 99(e)
HECHINGER COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
SEPT. 27, 1997 FEB. 1, 1997 FEB. 3, 1996 JAN. 28, 1995
(34 WEEKS) (52 WEEKS) (53 WEEKS) (52 WEEKS)
----------------------------------------------------------------
<S> <C> <C> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net loss $ (206,011) $ (25,076) $ (77,636) $ (9,911)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Store closing and restructuring charges 66,391 (28,507) (5,600) 55,871
Impairment of long-lived assets charges 29,284 - 30,300 -
Depreciation and amortization 41,038 56,898 58,535 53,268
Deferred income taxes - 5,444 10,249 (24,085)
Deferred rent (515) 823 (559) (1,122)
CHANGES IN OPERATING ASSETS AND LIABILITIES
Merchandise inventories 24,517 (943) 38,170 (53,817)
Other current assets 9,489 (5,314) 2,363 (17,006)
Accounts payable and accrued expenses 51,093 (71,526) 7,875 (10,678)
Income taxes payable 4,717 9,132 (16,570) 10,957
----------------------------------------------------------------
NET CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES 20,003 (59,069) 47,127 3,477
----------------------------------------------------------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Purchase of net assets from BSQ, net (232,224) - - -
Property, furniture, equipment and other assets:
Additions (17,532) (41,002) (107,185) (175,577)
Proceeds from disposals 8,926 21,107 8,577 4,549
Marketable securities:
Purchases - - (192,101) (206,870)
Proceeds from sales - - 261,012 288,948
----------------------------------------------------------------
NET CASH FLOWS USED IN INVESTING ACTIVITIES (240,830) (19,895) (29,697) (88,950)
----------------------------------------------------------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Proceeds from revolving credit facility 562,876 467,441 - -
Payments on revolving credit facility (403,720) (382,627) - -
Increase in amounts due to parent 23,800 - - -
Debt financing costs (2,026) - - -
Contributed capital 89,102 - - -
Net proceeds from sale and leaseback transaction - - - 99,295
Dividends paid to stockholders - - (5,664) (5,635)
Other 1,283 (4,908) (2,233) (1,610)
----------------------------------------------------------------
NET CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES 271,315 79,906 (7,897) 92,050
----------------------------------------------------------------
INCREASE IN CASH AND CASH EQUIVALENTS 50,488 942 9,533 6,577
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 36,727 35,785 26,252 19,675
----------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 87,215 $ 36,727 $ 35,785 $ 26,252
================================================================
SUPPLEMENTAL INFORMATION
Cash payments for income taxes $ - $ 1,629 $ 3,428 $ 8,814
Cash payments for interest, net of amount capitalized $ 23,679 $ 37,566 $ 30,949 $ 29,005
</TABLE>
See notes to consolidated financial statements.
<PAGE> 1
EXHIBIT 99(f)
HECHINGER COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands except share data)
<TABLE>
<CAPTION>
CLASS A CLASS B
COMMON STOCK, COMMON COMMON ADDITIONAL CONTRIBUTED
PAR $. 01 STOCK STOCK PAID-IN CAPITAL CAPITAL
-------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE, JAN. 29, 1994 $ - $ 2,881 $ 1,331 $ 236,543 $ -
Restricted stock awards earned - - - - -
Performance stock awards earned and issued - 5 - 577 -
Exercise of stock options, including income tax benefit - 15 - 1,037 -
Conversions from Class B to Class A common stock - 179 (179) - -
Conversion of 5-1/2% Convertible Subordinated Debentures
into shares of Class A common stock - - - 25 -
Purchase of treasury stock - - - - -
Adjustment to fair value of marketable securities - - - - -
Cash dividends on common stock:
Class A - $0.16 per share - - - - -
Class B - $0.06 per share - - - - -
Net loss - - - - -
-------------------------------------------------------------------
BALANCE, JAN. 28, 1995 - 3,080 1,152 238,182 -
Restricted stock awards earned - - - - -
Exercise of stock options, including income tax benefit - - - 66 -
Conversions from Class B to Class A common stock - 9 (9) - -
Purchase of treasury stock - - - - -
Adjustment to fair value of marketable securities - - - - -
Cash dividends on common stock:
Class A - $0.16 per share - - - - -
Class B - $0.06 per share - - - - -
Net loss - - - - -
-------------------------------------------------------------------
BALANCE, FEB. 3, 1996 - 3,089 1,143 238,248 -
Restricted stock awards earned - - - - -
Conversions from Class B to Class A common stock - 172 (172) - -
Purchase of treasury stock - - - - -
Net loss - - - - -
-------------------------------------------------------------------
BALANCE, FEB. 1, 1997 - 3,261 971 238,248 -
Restricted stock awards earned - - - - -
Conversions from Class B to Class A common stock - 24 (24) - -
Capital contribution - - - - 108,058
Cancellation of Class A and Class B common stock and
issuance of common stock, par $.01, pursuant to Merger - (3,285) (947) 3,259 -
Net loss - - - - -
-------------------------------------------------------------------
BALANCE, SEPT. 27, 1997 $ - $ - $ - $ 241,507 $ 108,058
===================================================================
</TABLE>
<TABLE>
<CAPTION>
RETAINED
EARNINGS UNEARNED TREASURY
(DEFICIT) COMPENSATION STOCK TOTAL
------------------------------------------- ---------
<S> <C> <C> <C> <C>
BALANCE, JAN. 29, 1994 $ 256,836 $ (2,201) $ (1,523) $ 493,867
Restricted stock awards earned - 648 - 648
Performance stock awards earned and issued - - - 582
Exercise of stock options, including income tax benefit - - 1,260 2,312
Conversions from Class B to Class A common stock - - - -
Conversion of 5-1/2% Convertible Subordinated Debentures
into shares of Class A common stock - - - 25
Purchase of treasury stock - - (244) (244)
Adjustment to fair value of marketable securities (371) - - (371)
Cash dividends on common stock:
Class A - $0.16 per share (4,883) - - (4,883)
Class B - $0.06 per share (752) - - (752)
Net loss (9,911) - - (9,911)
------------------------------------------- ---------
BALANCE, JAN. 28, 1995 240,919 (1,553) (507) 481,273
Restricted stock awards earned - 794 - 794
Exercise of stock options, including income tax benefit - - 66 132
Conversions from Class B to Class A common stock - - - -
Purchase of treasury stock - - (231) (231)
Adjustment to fair value of marketable securities 371 - - 371
Cash dividends on common stock:
Class A - $0.16 per share (4,931) - - (4,931)
Class B - $0.06 per share (733) - - (733)
Net loss (77,636) - - (77,636)
------------------------------------------- ---------
BALANCE, FEB. 3, 1996 157,990 (759) (672) 399,039
Restricted stock awards earned - 506 - 506
Conversions from Class B to Class A common stock - - - -
Purchase of treasury stock - - (213) (213)
Net loss (25,076) - - (25,076)
------------------------------------------- ---------
BALANCE, FEB. 1, 1997 132,914 (253) (885) 374,256
Restricted stock awards earned - 165 - 165
Conversions from Class B to Class A common stock - - - -
Capital contribution - - - 108,058
Cancellation of Class A and Class B common stock and
issuance of common stock, par $.01, pursuant to Merger - 88 885 -
Net loss (206,011) - - (206,011)
------------------------------------------- ---------
BALANCE, SEPT. 27, 1997 $ (73,097) $ - $ - $ 276,468
=========================================== =========
</TABLE>
See notes to consolidated financial statements.
<PAGE> 1
EXHIBIT 99(g)
HECHINGER COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(34 week period ended September 27, 1997 and
years ended February 1, 1997, February 3, 1996 and January 28, 1995)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. Hechinger Company, a Delaware corporation (together
with its direct and indirect subsidiaries, the "Company") is a leading
specialty retailer providing products and services for the care, repair,
remodeling and maintenance of the home and garden. At September 27, 1997, the
Company operated 271 stores under the Hechinger ("Hechinger"), Home Quarters
Warehouse ("Home Quarters"), Builders Square ("Builders Square"), Wye River
Hardware and Home ("Wye River"), and Better Spaces ("Better Spaces") names.
The 62 Hechinger stores are primarily located in the Mid-Atlantic region; the
45 Home Quarters stores are primarily located in the Southeastern, Northeastern
and Midwestern parts of the United States. There are two Wye River stores
located in the metropolitan Washington, D.C. market, and one Better Spaces
store located in Albany, New York. The 161 recently acquired Builders Square
stores are located primarily in the South, Southeastern, North and Midwestern
parts of the United States (see note 3). The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiaries. All
material intercompany transactions and balances have been eliminated. Certain
amounts in the financial statements for the fiscal years ended February 1,
1997, February 3, 1996 and January 28, 1995 have been reclassified to conform
to the presentation for the period ended September 27, 1997. The Company's
business is seasonal and its annual results of operations depends to a
significant extent on the results of operations during the spring and summer
months.
FISCAL YEAR. In 1997, the Company changed its fiscal year end to the Saturday
closest to September 30. Prior to this change, the Company's fiscal year ended
on the Saturday closest to January 31. The fiscal period ended September 27,
1997 was 34 weeks ("1997") compared to the fiscal years ended February 1, 1997
("1996") and January 28, 1995 ("1994") which were 52 weeks, and the fiscal year
ended February 3, 1996 ("1995") which was 53 weeks.
MERCHANDISE INVENTORIES. Inventories of Hechinger, Home Quarters, Wye River
and Better Spaces stores are stated at the lower of cost, last-in, first-out
method ("LIFO"), or market. If inventories were valued under the first-in,
first-out method ("FIFO") method, which approximates replacement cost,
inventories would have been $25.6 million, $20.5 million, and $21.5 million
higher than reported at September 27, 1997, February 1, 1997 and February 3,
1996, respectively. Distribution, buying and occupancy expenses are included
in cost of sales.
Inventories of Builders Square stores are stated at lower of cost or market,
with cost determined on the LIFO method using the retail inventory method and
internal price indices to measure inflation. At September 27, 1997,
inventories approximated the value that would have been reported under the FIFO
method.
CHANGES IN ACCOUNTING PRINCIPLES. As further described under the caption,
"Impairment of Long-Lived Assets," in 1995 the Company adopted Statement of
Financial Accounting Standards No. 121.
In 1994, the Company changed its method of calculating LIFO inventories to
provide for a better matching of costs and revenues, more closely conform the
LIFO methods used to the method used for the majority of its inventories,
provide for a LIFO adjustment more representative of the Company's actual
inflation on its inventories and reduce the likelihood of LIFO layer
liquidations during periods of overall growth in inventories. The change in
method consisted of adopting consolidated cost-based inflation indices applied
to inventories grouped into two pools on a consolidated basis. Prior to 1994,
the Company calculated its LIFO inventories using a combination of retail and
cost-based indices applied to inventories grouped into six pools. The
underlying methods of computing FIFO inventory values have not changed, only
the method of adjusting inventories for the impact of inflation. The
cumulative effect of the change in method and the pro forma effects of the
change on prior years' results of operations was not determinable. The effect
of the change on results of operations for 1994 was to reduce the net loss by
$6.2 million.
PROPERTY, FURNITURE AND EQUIPMENT. Property, furniture and equipment are
stated at cost plus capitalized interest. Capitalized interest amounted to
$0.0 million, $0.3 million, $2.4 million, and $3.6 million for 1997,
<PAGE> 2
1996, 1995 and 1994, respectively. Depreciation is computed using the
straight-line method over the estimated useful lives of various classes of
assets. Capital leases are amortized on a straight-line basis over the terms
of the respective leases.
CASH EQUIVALENTS. For purposes of the statement of cash flows, the Company
considers all highly liquid investments with a maturity of three months or less
when purchased to be cash equivalents.
DEFERRED RENT. Deferred rent represents the difference between amounts paid
and amounts expensed for operating leases.
PRE-OPENING EXPENSES. Costs related to new store openings are expensed as
incurred and are included in selling, general and administrative expenses.
Pre-opening expenses amounted to $0.0 million, $1.9 million, $7.6 million, and
$8.9 million for 1997, 1996, 1995 and 1994, respectively.
ADVERTISING EXPENSES. The Company expenses advertising costs as they are
incurred. Advertising expenses net of cooperative advertising credits received
from suppliers amounted to $22.1 million, $38.0 million, $39.7 million, and
$40.2 million for 1997, 1996, 1995 and 1994, respectively.
INCOME TAXES. Following its acquisition on September 25, 1997 (see note 2),
the results of the Company's operations are included in the consolidated
federal income tax return of its ultimate parent, Centers Holdings, Inc.
Income tax expense for the period subsequent to September 25, 1997 has been
computed as if the Company filed its own tax return.
The Company computes income taxes in accordance with Financial Accounting
Standards Board Statement of Financial Accounting Standards No. 109, Accounting
for Income Taxes, ("SFAS 109"). Under the asset and liability method of SFAS
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
NET LOSS PER COMMON SHARE. Net loss per common share information is not
presented in the consolidated financial statements because the Company is
currently closely held (see note 2) and because historical net loss per common
share would not be indicative of the Company's continuing capital structure.
ASSETS HELD FOR SALE. Assets held for sale are recorded at the lower of cost
or estimated net realizable value. Net realizable value is based on the
estimated fair value (measured primarily based on letters of intent or the
approximate appraised value) less estimated selling costs.
IMPAIRMENT OF LONG-LIVED ASSETS. The Company reviews its long-lived assets for
impairment whenever circumstances indicate that the carrying amount of an asset
may not be recoverable. To the extent that the future undiscounted net cash
flows expected to be generated from an asset are less than the carrying amount
of the asset, an impairment loss will be recognized based on the difference
between the asset's carrying amount and its estimated fair market value.
INTANGIBLES. Cost in excess of net assets acquired relates principally to the
purchase of Home Quarters. This cost is being amortized using the
straight-line method over a period of 40 years. Accumulated amortization
related to cost in excess of net assets acquired was $16.2 million, $15.1
million and $13.4 million as of September 27, 1997, February 1, 1997 and
February 3, 1996, respectively.
Leasehold acquisition costs relate to the purchase of lease rights to certain
stores. The costs for these leases are being amortized using the straight-line
method over the terms of the related leases, ranging up to 30 years.
Accumulated amortization related to leasehold acquisition costs was $13.7
million, $16.3 million and $14.0 million as of September 27, 1997, February 1,
1997 and February 3, 1997, respectively (see note 5).
The Company considers recoverability of intangible assets in connection with
its review of impairment of long-lived assets.
<PAGE> 3
USE OF ESTIMATES. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and 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 amounts of revenue and expenses during the
reporting period. Actual results could differ from those estimates.
2. CHANGE IN OWNERSHIP OF THE COMPANY.
On September 25, 1997, Centers Holdings, Inc., a Delaware corporation, through
a wholly-owned subsidiary (collectively "Centers Holdings"), acquired the
Company through a merger transaction (the "Merger"). Pursuant to the Merger,
each share of the issued and outstanding Class A and Class B shares of common
stock of the Company immediately prior to the effective time of the Merger was
converted into the right to receive $2.375 in cash, without interest. On
September 25, 1997, all of the outstanding shares of the Company were canceled
in exchange for the payment by Centers Holdings of approximately $100 million.
Ten shares of common stock with a par value of $.01 per share were issued to
Centers Holdings. As a result of the Merger, the Company became a wholly-owned
subsidiary of Centers Holdings.
As a result of the Merger and change in control, the Company incurred expenses
of approximately $29.1 million, consisting primarily of approximately $4.5
million of professional and advisory services related to the Merger
transaction, and approximately $24.6 million of employee-related costs, as
follows:
- - Pursuant to certain retirement agreements, including a nonqualified
supplemental retirement plan, the Company was required to fund trusts for
certain key executives, resulting in expense of approximately $11.0
million.
- - Under the terms of individual severance agreements, costs of approximately
$13.6 million were incurred related to employees terminated pursuant to the
Merger.
The majority of these costs were included in accrued liabilities as of
September 27, 1997, and were subsequently paid by the Company.
On September 25, 1997, Centers Holdings also purchased BSQ Transferee
Corporation ("BSQ"), a Delaware corporation, (which represented substantially
all of the assets and liabilities of Builders Square, Inc.) (the "Initial
Purchase"). BSQ was a wholly-owned subsidiary of Builders Square, Inc., which
is in turn a wholly-owned subsidiary of Kmart Corporation, a Michigan
corporation ("Kmart"). BSQ and the Company are affiliates as a result of these
transactions.
3. PURCHASE OF CERTAIN ASSETS OF BSQ.
On September 26, 1997, the Company purchased certain assets of BSQ (the
"Purchase") for cash and the assumption of certain liabilities. The assets
purchased, which consisted primarily of inventory, and the liabilities assumed
were recorded at BSQ's carrying values, which are subject to certain
adjustments. BSQ's preliminary carrying values are subject to adjustment
based on certain changes in working capital and final determination of the fair
value of the assets and liabilities acquired in the Initial Purchase. The
principal assets of BSQ which were not acquired by the Company included assets
held for resale, real property, buildings and fixtures.
Also on September 26, 1997, as part of the Purchase, BSQ and the Company
entered into subleases which cover substantially all of BSQ's leased operating
facilities, and a lease which covers certain operating facilities which are
owned by BSQ (see note 12).
<PAGE> 4
The preliminary purchase price of the net assets acquired from BSQ of
approximately $242.9 million, which is subject to certain adjustments as
described above, has been allocated as follows (in millions):
<TABLE>
<S> <C>
Inventory $ 587.6
Other assets, including cash of approximately $10.7 35.8
Liabilities assumed (380.5)
-------
$ 242.9
=======
</TABLE>
Shown below is the Company's unaudited pro forma consolidated results of
operations for the periods ended September 27, 1997 and February 1, 1997, as
though the Purchase had occurred as of February 4, 1996 (in millions):
<TABLE>
<CAPTION>
34 Weeks Ended Year Ended
(in millions) Sept. 27, 1997 Feb. 1, 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C>
Total Revenues $2,912.4 $4,607.9
Net Loss ($207.2) ($60.7)
</TABLE>
This method of combining historical financial statements for the preparation of
unaudited pro forma condensed consolidated financial information is for
presentation only. Actual statements of operations of the Company will reflect
the operating results from the purchase date with no retroactive adjustments.
Operating results related to the assets acquired from BSQ were not significant
for the two days ended September 27, 1997. The unaudited pro forma condensed
consolidated financial information is provided for illustrative purposes only
and is not necessarily indicative of the consolidated results of operations
that would have been reported had the Purchase occurred on February 4, 1996,
nor does it represent a forecast of the consolidated results of operations for
any future period.
Pursuant to the terms of the Purchase, 10 stores are subleased under a master
month-to-month rental agreement. In addition, the Company can put 15 of the
acquired stores and any remaining related lease obligations back to BSQ
(collectively with the month-to-month stores, the "put stores"), at any time
prior to July 17, 1998. Pursuant to the terms of the Initial Purchase, BSQ can
put 25 of the acquired leased stores and the remaining related lease
obligations back to Kmart, in the same time frame. BSQ is responsible for
closing these stores and liquidating the related inventory, and delivering a
"broom clean" store back to Kmart. Shortly after the Initial Purchase, BSQ
began the process of putting 10 stores back to Kmart, and accordingly recorded
a liability for costs related to the closing of the stores. The assets
acquired and liabilities assumed from BSQ pursuant to the Purchase included
amounts related to the put stores. Accordingly, included in accrued costs for
store closings in the accompanying balance sheet as of September 27, 1997 is
approximately $10.2 million related to the initial 10 put stores.
At the date of the Purchase, the Company also began the process of identifying
the remaining 15 put stores, as well as certain other overlap stores which may
be closed. With respect to the additional 15 put stores, as part of the
Purchase, BSQ and the Company agreed that once a decision is reached regarding
which stores will be put, BSQ will purchase the inventory in those stores from
Hechinger at book value, and BSQ will be responsible for liquidating the
inventory and closing these stores. With respect to overlap stores which may
be closed, the Company expects to finalize its store closing plan within one
year from the Merger date. Any loss on liquidating inventory at these overlap
stores will be expensed as incurred.
The Company is in the process of eliminating duplicate overhead functions
related to BSQ's operations. Accordingly, the Company will incur duplicative
overhead expenses during the integration period, including costs associated
with integrating information technology systems. The Company expects these
costs to approximate $22 million in fiscal 1998.
4. STORE CLOSING AND RESTRUCTURING RESERVE.
In July 1997, the Company entered into an agreement to sell seven Home Quarters
Warehouse stores in the Michigan market. As a result, as of August 2, 1997,
the Company recorded a charge of $31.8 million related to the decision to close
and sell these stores (the "Detroit Store Closing Charge"). The main
components of this charge were:
- - Estimated write-down to net realizable value of real estate (approximately
$13.6 million), and furniture, fixtures, equipment and other assets
(approximately $14.3 million) to be disposed of.
<PAGE> 5
- - Estimated cash expenditures for operating costs for the stores during the
inventory liquidation period and for employee termination costs of
approximately $3.9 million.
As of September 27, 1997, assets held for sale included approximately $50.0
million related to these stores, and approximately $3.0 million of accrued
liabilities remained. The Company consummated the sale of these stores in
November 1997.
In 1995, the Company recorded a charge of $25 million (the "HQ Merger Charge")
related primarily to the Company's decision to combine its Hechinger and Home
Quarters operations under one management team (the "HQ Merger"). The main
components of this charge were:
- - Employee termination costs of approximately $13.6 million;
- - Approximately $7.7 million for costs primarily related to terminating the
Company's defined benefit pension plan as of December 31, 1995 to conform
the retirement plans of Hechinger and Home Quarters and costs related to
eliminating various computer systems; and
- - Estimated write-down to net realizable value of equipment and other assets
to be disposed of approximately $3.7 million.
As of February 1, 1997, all components of the HQ Merger Charge had been
completed except for employee termination costs which were estimated at $2.4
million. As of September 27, 1997, this liability had been substantially
discharged.
In 1994, the Company recorded a charge of $61.9 million primarily related to
the Company's decision to close 22 stores in certain markets (the "Store
Closing Charge"). The main components of this charge were costs related to the
write-down of inventories and furniture, fixtures, equipment and other assets
to be disposed of, carrying costs of the closed stores and employee termination
costs. Disposition of the closed stores is accomplished by subleasing or
assigning the property to a new occupant or reverting possession back to the
landlord. The Company previously expected that it would dispose of or sublease
the remaining stores by January 1999. As a result of certain decisions made by
management of the Company related to the future disposition of these
properties, in 1997 the Company revised its estimate and recorded an additional
charge of $42.7 million for the estimated continuing carrying costs for these
stores, consisting primarily of rents and other related costs (together with
the Store Closing Charge, the "Store Closing Charges"). The Company believes
that the accrual of $47.7 million as of September 27, 1997 is adequate to cover
future liabilities related to the carrying costs of the closed stores.
The Detroit Store Closing Charge, the HQ Merger Charge and Store Closing
Charges are based on certain estimates and as a result, the actual amounts
could vary from these estimates.
5. IMPAIRMENT OF LONG-LIVED ASSETS.
Management reviews long-lived assets and certain intangible assets for
impairment whenever events or changes in circumstances indicate the carrying
amount of such assets may not be recoverable. Recoverability of these assets
is determined by comparing the forecasted undiscounted net cash flows of the
operation to which the assets relate to the carrying amount, including
associated intangible assets, of such operation. If the operation is
determined to be unable to recover the carrying amount of its assets, then
intangible assets are written down first, followed by the other long-lived
assets of the operation, to fair value. Fair value is determined based on
discounted cash flows or appraised values, depending upon the nature of the
assets.
In 1997, management of the Company made decisions to close and dispose of
certain properties, including a distribution facility. As a result, the
Company recorded an impairment loss of approximately $29.3 million which
reflects the difference between the carrying value of the properties and the
estimated sales value, net of estimated costs to sell. The Company is actively
pursuing the disposal of these properties. This amount also includes
approximately $9.0 million related to the write-off of the unamortized portion
of leasehold acquisition costs of certain closed stores, which management
believes is not recoverable.
In 1995, the Company recorded aggregate impairment losses of approximately $30
million. As a result of the Company's decision to slow down its expansion
plans and not to pursue development of a number of real estate properties which
had been acquired for future store expansion, the Company decided to dispose of
these properties, and recorded an impairment loss related to these properties
of approximately $15
<PAGE> 6
million. This non-cash charge reflected the difference between the carrying
value of the properties and the estimated sales value, net of estimated costs
to sell. The Company is actively pursuing the disposal of these properties.
Also in 1995, the Company reviewed its property, furniture, fixtures and
equipment and evaluated how these assets would continue to be used in its
operations. Based on this evaluation, the Company recorded an impairment loss
related to certain property, furniture, fixtures and equipment of approximately
$15 million.
6. PROPERTY, FURNITURE AND EQUIPMENT.
The Company's investments in property, furniture and equipment consist of the
following:
<TABLE>
<CAPTION>
(in thousands) Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Land $ 49,030 $ 99,091 $ 99,982
Buildings 125,773 197,151 191,338
Leasehold improvements 121,471 120,944 115,937
Furniture, fixtures and equipment 233,691 245,061 232,776
Capital leases 24,762 24,762 24,875
Construction-in-progress -- -- 11,719
--------- --------- ---------
554,727 687,009 676,627
Less accumulated depreciation and
amortization (229,090) (225,257) (179,050)
--------- --------- ---------
$ 325,637 $ 461,752 $ 497,577
========= ========= =========
</TABLE>
Accumulated amortization on capital leases was $17.3 million, $16.1 million and
$14.2 million as of September 27, 1997, February 1, 1997 and February 3, 1996,
respectively.
7. ACCOUNTS PAYABLE AND ACCRUED EXPENSES.
Accounts payable and accrued expenses consist of the following:
<TABLE>
<CAPTION>
(in thousands) Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Accounts payable $376,206 $111,851 $176,643
Accrued expenses and other 111,161 64,285 74,774
Accrued compensation and benefits 75,620 31,332 26,604
-------- -------- --------
$562,987 $207,468 $278,021
======== ======== ========
</TABLE>
8. REVOLVING CREDIT AGREEMENT.
On September 26, 1997, Centers Holding, BSQ, and the Company entered into a new
senior secured revolving credit facility, which permits borrowings of up to
$600 million (the "Credit Agreement"). The Credit Agreement replaced a $200
million revolving credit facility and all letter of credit facilities
outstanding. This facility is guaranteed by the Company, collateralized by
merchandise inventories and expires in September 2002. The amount available
under the facility fluctuates based on the Company's "Eligible Inventory"
balance (as defined in the agreement). The borrowings under the Credit
Agreement bear interest at a rate which fluctuates based on (i) the greatest of
(a) Prime Rate, (b) the Base CD Rate (as defined) plus 1.0%, or (c) the Federal
Funds rate plus 0.5%, plus an additional 0.0% to 0.5% based on the Interest
Coverage Ratio (as defined) or (ii) LIBOR plus an additional 1.5% to 2.0% based
on the Interest Coverage Ratio (as defined), in accordance with the Credit
Agreement. The interest rate on the borrowing was 9.0% at September 27, 1997.
The Credit Agreement contains certain covenants which restrict the Company's
ability to, among other things, enter into additional indebtedness, make
acquisitions or sales of certain assets and declare and pay cash dividends. In
addition, the Credit Agreement limits the annual amount of capital expenditures
of the Company and, beginning with the period ending June 1998, requires the
Company to maintain minimum quarterly EBITDA (as defined) at increasing levels.
As of September 27, 1997, the Company had outstanding borrowings of $244.0
million under the Credit Agreement, and had issued and outstanding letters of
credit of $70.6 million under this facility. The available borrowing as of
September 27, 1997 was approximately $285.4 million.
<PAGE> 7
9. LONG-TERM DEBT.
Long-term debt consists of the following:
<TABLE>
<CAPTION>
(in thousands) Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
6.95% Senior Notes, due 2003 $100,000 $100,000 $100,000
9.45% Senior Debentures, due 2012 100,000 100,000 100,000
5 1/2% Convertible Subordinated Debentures 123,050 123,050 123,050
Mortgage loans 42,929 43,206 43,637
Other long-term debt 15,618 15,953 18,252
-------- -------- --------
381,597 382,209 384,939
Less current portion (28,637) (1,341) (1,230)
-------- -------- --------
$352,960 $380,868 $383,709
======== ======== ========
</TABLE>
Under the terms of the 6.95% Senior Notes and 9.45% Senior Debentures, the
Company is restricted, in certain circumstances, from pledging certain Company
assets and entering into sale and leaseback transactions. Prior to the Merger
(see note 2), the 5 1/2% Convertible Subordinated Debentures were convertible
into Class A common stock of the Company by the holders at any time at a
conversion price of $27.84 per share, subject to adjustments in certain events.
As a result of the Merger, these Debentures are thereafter entitled to convert
into cash of $2.375 per share, which represents the asset they would have
received had they converted just prior to the Merger. Accordingly, the portion
of the outstanding balance of the Debentures represented by this conversion
price, approximating $10.7 million, has been included in the current portion of
long-term debt as of September 27, 1997. The Convertible Subordinated
Debentures are redeemable by the Company at any time. Mandatory sinking fund
payments of $6.6 million or 5% of the $132 million aggregate principal amount
of Convertible Subordinated Debentures issued, are to be made annually
commencing April 1, 1998 to and including April 1, 2011. Convertible
Subordinated Debentures purchased by the Company in prior years are sufficient
to fulfill the mandatory sinking fund payment scheduled for April 1, 1998 and
partially fulfill the scheduled payment for April 1, 1999.
The mortgage loans bear interest rates, on average, of approximately 10% and
are due in varying monthly and semi-annual installments of principal and
interest through 2016. These mortgages are collateralized by properties with a
total net book value of $28.6 million.
Other long-term debt consists primarily of a sale and leaseback transaction
that has been recorded as a financing transaction rather than as a sale. Other
long-term debt bears interest rates ranging between 4.57% and 11.38%, is due in
varying principal and interest installments through 2018 and is collateralized
by properties with a total net book value of $11.3 million.
Aggregate principal maturities of all long-term debt are as follows:
<TABLE>
<CAPTION>
Fiscal year (in thousands)
- ---------------------------------------------------
<S> <C>
1998 $ 28,637
1999 5,812
2000 8,345
2001 8,638
2002 9,077
Thereafter 321,088
--------
$381,597
========
</TABLE>
10. ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS.
The following methods and assumptions were used by the Company in estimating
the fair values of the financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance sheet
for cash and cash equivalents approximated its fair value.
Long-term debt: The estimated fair values of the Company's long-term debt that
is traded publicly are based on quoted and third party estimates of market
prices. The estimated fair values of the privately held debt are
<PAGE> 8
calculated using a discounted cash flow analysis, based on the Company's
current incremental borrowing rates for similar types of borrowing
arrangements.
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows:
<TABLE>
<CAPTION>
September 27, 1997 February 1, 1997 February 3, 1996
---------------------- ------------------------- -------------------------
Carrying Estimated Carrying Estimated Carrying Estimated
(in thousands) Values Fair Values Values Fair Values Values Fair Values
-------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 87,215 $ 87,215 $ 36,727 $ 36,727 $ 35,785 $ 35,785
Long-term debt:
Publicly traded debt $312,386 $196,017 $323,050 $164,452 $323,050 $197,141
Privately held debt 40,574 34,359 57,818 35,984 60,659 42,863
-------- -------- -------- -------- -------- --------
Total long-term debt $352,960 $230,376 $380,868 $200,436 $383,709 $240,004
======== ======== ======== ======== ======== ========
</TABLE>
11. INCOME TAXES.
The income tax expense/(benefits) are summarized as follows:
<TABLE>
<CAPTION>
(in thousands)
Period ended Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996 Jan. 28, 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Current $1,267 $(5,444) $(13,249) $ 18,540
Deferred - 5,444 10,249 (24,085)
------ ------- -------- --------
$1,267 $ - $ (3,000) $ (5,545)
====== ======= ======== ========
</TABLE>
Significant components of the Company's deferred tax liabilities and assets are
as follows:
<TABLE>
<CAPTION>
(in thousands) Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Deferred tax liabilities:
Depreciation and amortization $ - $ - $ 4,103
Inventories 361 9,816 12,078
Capitalized leases 2,598 - -
Corporate-owned life insurance 3,150 - -
Other 368 3,342 2,575
-------- -------- -------
Total deferred tax liabilities 6,477 13,158 18,756
-------- -------- -------
Deferred tax assets:
Accrued costs for store closings 21,986 - -
Other accrued expenses 20,190 10,168 23,363
Depreciation and amortization 6,866 2,742 -
Alternative minimum tax and other
tax credit carryforwards 3,633 11,292 15,419
Accrued compensation and benefits 5,342 8,230 5,515
Capital lease obligations 26,888 - -
Net operating loss carryforward 28,612 18,303 7,086
Other 7,390 5,230 4,310
-------- -------- -------
Total gross deferred tax assets 120,907 55,965 55,693
Valuation allowance 110,797 39,174 27,860
-------- -------- -------
10,110 16,791 27,833
-------- -------- -------
Net deferred tax assets $ 3,633 $ 3,633 $ 9,077
======== ======== =======
</TABLE>
The valuation allowance for deferred taxes as of September 27, 1997 was $110.8
million. The net change in the total valuation allowance for the periods ended
September 27, 1997, February 1, 1997, and February 3, 1996 were increases of
$71.6 million, $11.3 million and $27.8 million, respectively.
As described in note 2 of the consolidated financial statements, on September
25, 1997, Centers Holdings acquired the Company. This transaction constituted
an ownership change as defined under Section 382 of the Internal Revenue Code
of 1986, as amended (the "Code"). This ownership change subjects the Company
to a $5.5 million annual limitation in future years in the use of certain items
reflected as deferred tax assets above, including net operating loss
carryforwards and certain other tax attributes which were available on the date
of the ownership change. As a result, due to uncertainties regarding the
realization in
<PAGE> 9
future periods of the deferred tax assets, the Company has provided a valuation
allowance on substantially all of its gross deferred tax assets.
As of September 27, 1997, the Company had net operating loss carryforwards for
Federal income tax purposes of approximately $81 million (net of approximately
$44 million which will not be utilized by the Company pursuant to the Section
382 limitation), substantially all of which is subject to the $5.5 million
annual limitation resulting from the ownership change. The Company's net
operating loss carryforwards expire between 2009 and 2012. The Company's
alternative minimum tax credit carryforward of $3.6 million is available
indefinitely as it does not expire.
Reconciliations of the Federal statutory rate to the Company's effective tax
rate are summarized as follows:
<TABLE>
<CAPTION>
Period ended Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996 Jan. 28, 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Statutory rate (35.0)% (35.0)% (35.0)% (35.0)%
Change in valuation allowance 31.9 39.5 34.6 0.0
Federal tax credits 0.0 (7.2) 0.0 (5.3)
Federal tax-exempt
investment income 0.0 0.0 (1.0) (4.7)
Merger related costs 3.3 0.0 0.0 0.0
Amortization of goodwill 0.3 3.3 0.7 4.9
State taxes 0.4 0.0 0.0 0.0
Other (0.3) (0.6) (3.0) 4.2
------ ------ ------ ------
0.6% 0.0% (3.7)% (35.9)%
====== ====== ====== ======
</TABLE>
12. LEASE COMMITMENTS.
On September 26, 1997, the Company entered into a sublease with BSQ which
covers substantially all of BSQ's leased operating facilities, has a six-year
term with two five-year option periods, and has rental payments which are
consistent with the subleases between BSQ and Kmart, and BSQ and other
landlords. However, with respect to the properties covered by BSQ's subleases
with Kmart, BSQ's ability to exercise renewal options available in Kmart's
leases with third parties is subject to various conditions. As a result, the
Company's ability to exercise renewal options under its sublease with BSQ with
respect to such properties is similarly conditioned. On September 26, 1997,
the Company also entered into a lease with BSQ for certain operating facilities
owned by BSQ as well as a master month-to-month rental agreement for 10 stores.
The term of the lease is six years with two five-year option periods. Under
the terms of the lease, sublease and master rental agreement with BSQ, the
Company has the ability to terminate the lease as to 25 of the stores. In
addition, the Company may elect to exclude from renewal a total of 40
additional stores from the lease or sublease with BSQ. The Company has
guaranteed the payments and performance under BSQ's subleases with Kmart.
Pursuant to these transactions, the Company's lease classification is
consistent with that of BSQ, and accordingly, BSQ's capital lease obligations
of approximately $67 million were recorded by the Company.
Certain leases require excess rentals based on a percentage of sales, certain
increments in real estate taxes and rent increases as determined by formulas
set forth in the leases. In addition, the Company pays all other ownership and
operating costs related to the leased properties. Excluding the leases with
BSQ described above, most of the leases provide for renewals for various
periods up to 30 years.
In August 1994, the Company sold 13 stores for $99.3 million, net of expenses,
and concurrently leased the properties back for an initial term of 25 years.
The lease is renewable at the Company's option for nine additional terms of
five years each. The Company recorded the transaction as an operating lease.
Under the terms of a sale and leaseback transaction completed in 1990, the
Company is restricted from taking certain actions that would result in its net
worth, less goodwill, falling below $175 million. Under the terms of certain
sale and leaseback transactions completed in 1992, the Company is required to
maintain a minimum net worth of $200 million. Under the 1992 transactions, in
the event this minimum net worth is not maintained, the Company could be
required to repurchase properties aggregating approximately $42 million.
<PAGE> 10
At September 27, 1997, the minimum fixed rental commitments related to all
noncancelable leases together with the present value of the net minimum lease
payments for capital leases were as follows:
<TABLE>
<CAPTION>
Operating Leases Total Affiliate Non-Affiliate
(in thousands) (BSQ)
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fiscal year
1998 $ 184,512 $ 109,895 $ 74,617
1999 184,227 109,027 75,200
2000 183,838 108,774 75,064
2001 182,122 107,846 74,276
2002 173,792 100,147 73,645
Thereafter 2,302,540 1,476,289 826,251
---------- ---------- ----------
Total minimum lease payments 3,211,031 2,011,978 1,199,053
Minimum sublease rentals due to the Company (136,734) - (136,734)
---------- ---------- ----------
Total minimum lease payments, net $3,074,297 $2,011,978 $1,062,319
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Capital Leases Total Affiliate Non-Affiliate
(in thousands) (BSQ)
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fiscal year
1998 $ 12,349 $ 9,021 $ 3,328
1999 11,877 9,021 2,856
2000 11,690 9,020 2,670
2001 11,420 9,021 2,399
2002 11,427 9,020 2,407
Thereafter 133,670 123,550 10,120
--------- --------- --------
Total minimum lease payments 192,433 168,653 23,780
Less executory costs and imputed interest (111,450) (101,278) (10,172)
--------- --------- --------
Present value of net minimum
lease payments (including
current portion of $3,745) $ 80,983 $ 67,375 $ 13,608
========= ========= ========
</TABLE>
Capital lease obligations bear imputed interest at rates ranging from 6.0% to
14.0%. Amortization of assets recorded under capital lease obligations is
included in depreciation and amortization expense.
Net rent expense charged to operations was as follows:
<TABLE>
<CAPTION>
(in thousands)
Period ended Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996 Jan. 28, 1995
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Minimum operating lease rentals $ 46,485 $ 70,535 $ 66,174 $ 62,794
Excess rentals 621 1,534 1,914 1,943
-------- -------- -------- --------
47,106 72,069 68,088 64,737
Less sublease income (14,416) (20,552) (16,623) (13,192)
-------- -------- -------- --------
Net rent expense $ 32,690 $ 51,517 $ 51,465 $ 51,545
======== ======== ======== ========
</TABLE>
The net rent expense charged to operations does not include approximately $3.3
million, $6.1 million, $5.7 million and $0.6 million charged to the store
closing reserve for 1997, 1996, 1995 and 1994, respectively (see note 4).
13. CONTINGENCIES.
On July 23, 1997, a purported class action complaint was filed in the Delaware
Chancery Court on behalf of all holders of the Company's common stock against
the Company and the former Company directors. The plaintiff has alleged that
the former officers and directors of the Company breached their fiduciary
duties to the holders of the common stock by, among other things, failing to
take all reasonable steps to assure the maximization of stockholder value
including the implementation of a bidding mechanism to foster a fair auction of
the Company and by entering into an agreement with Centers Holdings under which
the consideration offered by Centers Holdings to holders of the common stock
was "unfair and grossly inadequate." The Company believes that the plaintiff's
claims are without merit and intends to defend such action vigorously.
<PAGE> 11
The Company and its subsidiaries are also parties to legal proceedings and
claims arising in the ordinary course of business. Although the outcome of
such proceedings and claims cannot be determined with certainty, based upon
evaluation by legal counsel, management believes that the outcome of such
proceedings and claims will not have a material adverse effect on the Company's
consolidated financial position, results of operations or liquidity.
14. STOCKHOLDERS' EQUITY.
Prior to the Merger, the Company had two classes of common stock, designated as
Class A and Class B. On September 25, 1997, in exchange for the payment by
Centers Holdings of approximately $100 million, all of the issued and
outstanding Class A and Class B shares of the Company were canceled. Ten
shares of common stock with a par value of $.01 per share were issued to the
Company's parent.
Class A and Class B common and treasury shares outstanding and related changes
were as follows:
<TABLE>
<CAPTION>
Issued Treasury
------------------------------------------------- --------------------------------
Common
Stock, $.01 par Class A Class B Class A Class B
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, Jan. 29, 1994 - 28,812,090 13,312,356 (92,769) (14,497)
Performance shares awarded - 45,157 - - -
Exercise of stock options - 145,741 - 92,670 -
Conversions from Class B to Class A - 1,793,627 (1,793,627) - -
Conversion of 5-1/2% Convertible
Subordinated Debentures - 897 - - -
Purchase of treasury - - - (17,114) -
-------- ----------- ---------- -------- -------
Balance, Jan. 28, 1995 - 30,797,512 11,518,729 (17,213) (14,497)
Exercise of stock options - 8,269 - 5,279 -
Conversions from Class B to Class A - 86,800 (86,800) - -
Purchase of treasury - - - (27,391) -
-------- ----------- ---------- ------- -------
Balance, Feb. 3, 1996 - 30,892,581 11,431,929 (39,325) (14,497)
Conversions from Class B to Class A - 1,715,558 (1,715,558) - -
Purchase of treasury - - - (57,940) -
-------- ----------- ---------- ------- -------
Balance, Feb. 1, 1997 - 32,608,139 9,716,371 (97,265) (14,497)
Conversions from Class B to Class A - 243,500 (243,500) - -
Purchase of treasury - - - - -
Cancellation of shares outstanding
and treasury stock - (32,851,639) (9,472,871) 97,265 14,497
Issuance of Common Stock, par $.01 10 - - - -
-------- ----------- ---------- ------- -------
Balance, Sept. 27, 1997 10 - - - -
======== =========== ========== ======= =======
</TABLE>
Following the Merger, the Company's parent made cash payments of $112.9 million
to the Company. This amount consists of an $89.1 million capital contribution
to the Company, and a $23.8 million non-interest-bearing advance which is
included in due to parent in the accompanying consolidated balance sheet as of
September 27, 1997. In addition, the Company's parent paid approximately $18.9
million of financing costs on behalf of the Company, which were recorded as
deferred financing costs and contributed capital as of September 27, 1997.
15. EMPLOYEE BENEFIT PLANS AND RETIREMENT AGREEMENTS.
Defined Benefit Plans.
As of December 31, 1995, the Company terminated its defined benefit pension
plan. In 1996, the Company completed distribution of the plan assets to all
qualified participants. The cost of the pension curtailment and benefit
settlement was accrued as a component of the 1995 HQ Merger Charge (see note
4).
Profit Sharing and 401(k) Plan.
As of September 27, 1997, the Company maintained a 401(k) plan and a profit
sharing plan for all Hechinger and Home Quarters (the "Hechinger Plan")
qualified employees. The 401(k) plan allowed for employee contributions of up
to 16% of the employee's salary and a matching contribution of 50% from the
Company on employee pretax contributions of up to 6%. The profit sharing plan
allowed for discretionary annual contributions as determined by the Board of
Directors. Subsequent to the year-end, the
<PAGE> 12
Hechinger Plan was replaced with a new 401(k) plan, in which eligible Builders
Square associates could participate. The new 401(k) plan is substantially
similar to the Hechinger Plan.
In addition to the above, the Company maintains certain other employee benefit
plans such as unfunded post retirement benefit plans, none of which have a
material impact on the Company's results of operations. Total expenses related
to all of the above plans amounted to $2.2 million, $4.0 million, $3.8 million
and $6.3 million, for 1997, 1996, 1995 and 1994, respectively. In addition, as
a result of the Merger and change in control, the Company was required to fund
trusts for certain key executives, including a nonqualified supplemental
retirement plan, resulting in expense of approximately $11 million in 1997 (see
note 2).
17. STOCK COMPENSATION PLANS.
1991 Incentive Plan.
In 1991, stockholders approved the Hechinger Company 1991 Stock Incentive Plan
(the "Incentive Plan"). The Incentive Plan authorized the issuance of Class A
common stock as incentive and nonqualified stock options, and as restricted
stock to eligible employees of the Company. In 1995, stockholders approved an
amendment to the Incentive Plan authorizing an increase in the number of shares
of the Company's stock authorized for issuance upon exercise of options.
Incentive stock options granted were at the fair market value on the date of
the grant. Nonqualified stock options were granted at a price not less than
40% of the fair market value at the date of the grant. Generally, options
granted under the plan were exercisable beginning two years after the date of
the grant and over the succeeding eight years, after which time they expired.
During the period ended September 27, 1997 and each of the last two fiscal
years ended February 1, 1997, nonqualified options were granted. As a result
of the Merger, each holder of options issued that had exercise prices of less
than $2.375 per share ("In the Money Options") received payment in an amount
equal to the difference between (i) the product of (A) $2.375 and (B) the
aggregate number of shares of common stock issuable upon exercise of all In the
Money Options held by such holder and (ii) the aggregate exercise price payable
upon such exercise. No payments were made with respect to any option having a
per share exercise price equal to or greater than $2.375 and such options were
terminated prior to the closing of the Merger. The aggregate cash payments
made by the Company approximated $0.5 million.
A summary of shares issuable under stock options outstanding is as follows:
<TABLE>
<CAPTION>
September 27, 1997 February 1, 1997 February 3, 1996
------------------- -------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
(shares in thousands) Shares Price Shares Price Shares Price
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Beginning balance 5,049 $8.83 4,618 $ 10.01 3,314 $12.30
Granted 771 1.81 779 3.88 1,948 7.00
Canceled (5,820) 7.90 (348) 13.41 (635) 12.75
Exercised 0 0.00 0 0.00 (9) 8.86
------ ----- ------- ------- ------ ------
Ending balance 0 $0.00 5,049 $ 8.83 4,618 $10.01
====== ===== ======= ====== ====== ======
Weighted average fair value of
options granted during the period $0.57 $ 1.97 $ 2.73
===== ====== ======
</TABLE>
In 1995, the Company awarded rights to earn 260,000 shares of Class A common
stock to certain key executives of the Company if certain performance goals
were met. Under the terms of the award, once the rights were earned, the stock
would vest over a two year period. As a result of the Merger, these options
became fully vested and the Company paid the executives approximately $0.6
million for the options.
Total charges to earnings for these plans amounted to $0.7 million, $0.5
million, $0.8 million and $1.0 million for 1997, 1996, 1995 and 1994,
respectively.
Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting
and Disclosure of Stock-Based Compensation" was issued in 1995. The statement
relates to the measurement of compensation of stock options issued to employees
and requires either the expense recognition based on the fair value method or
the continued application of APB 25, "Accounting for Stock Issued to Employees"
and disclosure of pro forma net income/loss as if the recognition and
measurement provisions of SFAS 123 had been adopted.
<PAGE> 13
The Company accounts for its stock compensation arrangements under the
provisions of APB 25. The pro forma information regarding net loss has been
determined as if the Company had accounted for its employee stock options under
the fair value method of SFAS 123. The fair value for these options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted average assumptions, and for 1997 considering the Merger
transaction:
<TABLE>
<CAPTION>
Period Ended Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Risk-free interest rates 6.1% 6.1% 6.4%
Dividend yields 0.0% 0.0% 2.7%
Volatility factors of the expected market
price of common stock .50 .50 .43
Expected life of the option in years 5 5 5
</TABLE>
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. In
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options because the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period of two years. The
Company's pro forma information is as follows:
<TABLE>
<CAPTION>
Period Ended Sept. 27, 1997 Feb. 1, 1997 Feb. 3, 1996
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Pro forma net loss (in millions) $(206.8) $(27.1) $(78.9)
</TABLE>
18. UNAUDITED COMPARATIVE TRANSITION PERIOD RESULTS.
The following table sets forth summarized unaudited comparative transition
period results:
<TABLE>
<CAPTION>
34 Weeks Ended
-------------------------------
Sept. 27, 1997 Sept. 26, 1996
(in millions) (unaudited)
- ---------------------------------------------------------
<S> <C> <C>
Net sales $1,360.9 $1,562.4
Gross margin 233.6 312.7
Income tax expense 1.3 0.0
Net earnings/(loss) (206.0) (2.8)
</TABLE>
<PAGE> 1
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS AND STOCKHOLDER
HECHINGER COMPANY
We have audited the accompanying consolidated balance sheet of Hechinger Company
and subsidiaries as of September 27, 1997 and the related consolidated
statements of operations, stockholders' equity and cash flows for the 34 weeks
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 audits.
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 consolidated financial position of Hechinger Company
and subsidiaries at September 27, 1997 and the results of their operations and
their cash flows for the 34 weeks then ended in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
Washington, D.C.
December 23, 1997
<PAGE> 2
REPORT OF INDEPENDENT AUDITORS
BOARD OF DIRECTORS AND STOCKHOLDERS
HECHINGER COMPANY
We have audited the accompanying consolidated balance sheets of Hechinger
Company and subsidiaries as of February 1, 1997 and February 3, 1996 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended February 1, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Hechinger Company
and subsidiaries at February 1, 1997 and February 3, 1996 and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended February 1, 1997, in conformity with generally accepted
accounting principles.
As discussed in the notes to the consolidated financial statements, in the
fiscal year ended February 3, 1996, the Company adopted SFAS 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of," and in the fiscal year ended January 28, 1995, the Company changed its
method of calculating LIFO inventories.
ERNST & YOUNG LLP
Washington, D.C.
February 27, 1997
