UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ------ EXCHANGE ACT OF 1934
For the fiscal year ended January 31, 1998
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ------ EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 1-9505
HILLS STORES COMPANY
--------------------
(Exact name of registrant as specified in its charter)
DELAWARE 31-1153510
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
15 DAN ROAD, CANTON, MASSACHUSETTS 02021
---------------------------------- -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (781) 821-1000
--------------
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
<S> <C>
Common Stock, Par Value $0.01 per share New York Stock Exchange
Boston Stock Exchange
12 1/2% Senior Notes due 2003, Series B New York Stock Exchange
Series A Convertible Preferred Stock, New York Stock Exchange
Par Value $0.10 per share
</TABLE>
Securities registered pursuant to Section 12(g) of the Act:
<TABLE>
<CAPTION>
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
<S> <C>
Series 1993 Warrants to Boston Stock Exchange
Purchase Common Stock
</TABLE>
<PAGE>
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 require-
ments for the past 90 days.
Yes X No
---------- ----------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
or 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 state-
ments incorporated by reference in Part III of this Form 10-K or any amendment
to this Form 10-K. [ X ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant as of March 31, 1998 was $44,793,094 with respect to the Common
Stock and $4,250,045 with respect to the Series A Convertible Preferred Stock,
which has coextensive voting rights with the Common Stock.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes X No
---------- ----------
The number of shares of Common Stock outstanding as of March 31, 1998 was
10,388,224.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of Part III of this report on Form 10-K are incorporated by
reference from the proxy statement for the annual meeting of stockholders to
be held on June 17, 1998.
2
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<TABLE>
TABLE OF CONTENTS
PART I
<S> <C> <C>
ITEM 1. Business.................................................. 4
ITEM 2. Properties................................................ 7
ITEM 3. Legal Proceedings......................................... 7
ITEM 4. Submission of Matters to a Vote of Security Holders....... 9
Executive Officers of the Registrant...................... 9
PART II
ITEM 5. Market for the Registrant's Common Equity and Related
Stockholder Matters....................................... 12
ITEM 6. Selected Financial Data................................... 13
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation........................ 14
ITEM 8. Financial Statements and Supplementary Data............... 20
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 20
PART III
ITEM 10. Directors and Executive Officers of the Registrant........ 20
ITEM 11. Executive Compensation.................................... 20
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 20
ITEM 13. Certain Relationships and Related Transactions............ 20
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K............................................... 21
</TABLE>
3
<PAGE>
PART I
ITEM 1. BUSINESS
--------
Hills Stores Company (the "Company") operates, through its wholly-owned
subsidiary Hills Department Store Company ("HDSC"), a chain of discount
department stores under the trade name of Hills Department Stores. The Company,
HDSC and the wholly-owned subsidiaries of HDSC are hereinafter collectively
described as "Hills". Hills' stores are located primarily in the Great Lakes
and Ohio Valley regions of the United States. At fiscal year-end, Hills
operated 155 stores in twelve states. Hills closed 10 stores during the first
quarter of fiscal year 1997.
Hills is a leading regional discount retailer offering a broad range of brand
name and other first quality general merchandise. Management's business
strategy stresses a combination of every day low prices and promotional
offerings, depth and breadth of products in selected merchandise categories,
remodeled facilities and strict operating controls.
Hills stores are located in cities and towns of varying sizes, with some of the
larger cities being Pittsburgh, Buffalo and Cleveland. During fiscal year 1997,
nearly forty (40%) percent of Hills' sales were from stores located in the
metropolitan markets of Pittsburgh, Cleveland-Akron and Buffalo; slightly over
forty (40%) percent of Hills' sales were from stores located in smaller
communities with one or two stores; and approximately twenty (20%) percent of
Hills' sales were from intermediate sized markets such as Toledo and Youngstown,
Ohio, Syracuse, New York and Norfolk, Virginia.
Primarily during fiscal years 1992 through 1995, Hills remodeled substantially
all of its stores. In fiscal year 1997, enhancements and selected remodels
continued on an ongoing but substantially reduced basis. The remodeling
program is designed to make and keep Hills' stores more visually appealing to
customers and to take full advantage of the most profitable merchandise
categories.
Store managers report to district managers, who report to regional vice
presidents. The district managers and regional vice presidents visit their
stores on a regular basis to oversee operations. Store managers and associates
are empowered to respond directly to the needs of the customers. Hills
maintains a stores headquarters office strategically located near Pittsburgh.
The Company believes that its customer base consists primarily of female
customers shopping for family needs. Accordingly, Hills emphasizes merchandise
in its softlines departments and selected hardlines departments, such as toys
and seasonal merchandise, which appeal to Hills' targeted female customer. The
Company considers the breadth and depth of its merchandise in these departments
to be an important factor in attracting and retaining customers, and accordingly
emphasizes the availability of a wide selection of sizes, styles and colors of
items in these departments.
Hills pricing strategy stresses "low prices everyday" while concurrently
enhancing customer traffic by offering customers promotional prices on selected
merchandise, or special value pricing, for limited sale periods. Both
promotional and everyday priced merchandise are featured in advertising
circulars. These are generally circulated as Sunday newspaper inserts. Insert
circulation is focused on key selling periods including (1) stock-up periods at
the first and middle of the month, (2) holidays such as Christmas, Easter,
4
<PAGE>
Mother's and Father's days, Halloween, President's Day, Labor Day and Veteran's
Day, (3) the back-to-school period of July and August, and (4) other special
promotions designed to increase customer traffic. Beginning in the later part
of fiscal year 1997, the Company began a program to somewhat increase its
circulation frequency, which will continue into fiscal year 1998. The
Company also sometimes uses a "catalog" format to communicate its strong
assortment in key categories of merchandise, such as its toy catalog prior to
Christmas. Newspaper advertising is supplemented by television and radio
advertising. The Company's marketing efforts also include community service
programs and in-store signing.
Hills carries a diverse line of first quality products including a broad line of
clothing for women, men and children, fashion accessories, jewelry, toys, home
textiles and other ready to assemble home furnishings, health and beauty aids,
candy and other packaged convenience food products, small household appliances
and housewares, home entertainment equipment, stationery and greeting cards,
hardware, automotive supplies, household chemicals, pet products, luggage, lawn
and garden products, Christmas and other seasonal merchandise. Hills licenses
its footwear departments to a nationally known footwear retailer. Hills offers
a range of brand name apparel and other products for the family and supplements
brand name goods with manufacturers' private brands (brands made by major
manufacturers but not nationally advertised) and Hills' private label program.
Hills anticipates increasing the penetration of Hills private label merchandise
in fiscal year 1998, particularly in apparel. Hills accepts all major consumer
credit cards and offers a year-round layaway program.
During fiscal year 1997, imported goods were purchased directly by Hills or
indirectly through other sources. In fiscal year 1997, Hills directly imported
products that accounted for approximately 10% of total purchases of the Hills
Department Stores chain.
Hills uses a centralized buying organization staffed by merchandise managers,
buyers and a support staff organized along Hill's product lines. Most of Hills'
buying organization is located at its Canton, Massachusetts offices. Hills also
maintains a fashion buying office in the garment district of New York City to
purchase and merchandise women's fashion and basic apparel.
Hills' central distribution facilities are located in Columbus, Ohio. These
facilities provide central stocking of merchandise and flow-through allocation
of merchandise for delivery to the stores. During fiscal year 1997, Hills
shipped approximately 77% of the dollar value of its merchandise receipts
through these distribution facilities, which consisted primarily of items
handled in casepack quantities and imports. During the second half of fiscal
year 1997, approximately 82% of the dollar value of its merchandise receipts
was handled through these distribution facilities. The balance of Hills'
merchandise receipts, consisting primarily of apparel and less-than casepack
quantity items, were delivered to stores direct from vendors or through a
variety of distributor, jobber or in-store service vendors. In fiscal year
1997, Hills opened a processing center, primarily focused on apparel, to pre-
process merchandise, thereby reducing in-store handling costs and consolidating
and reducing freight costs. Hills is currently evaluating its options for cost-
effectively enhancing its existing distribution facilities and supply chain
practices in order to reduce its logistics costs and to improve its store in-
stock levels. Examples of targeted improvements include (but are not limited
to) integrating the processing activities described above into its primary
distribution facility, integrated management between facilities of outbound
traffic integration, adding breakpack capability, and enhancing replenishment
processes.
5
<PAGE>
Hills relies extensively on computerized information systems. Hills operates
its principal information technology center at its corporate offices in Canton,
Massachusetts. All Hills stores, distribution centers and administrative
locations are tied to the information center's computer by means of an on-line
data communications network.
Hills' merchandising systems are designed to integrate the key retailing
functions of seasonal merchandise planning and allocation, purchase order
management, merchandise distribution, receiving, sales capture, inventory
control, open-to-buy and replenishment. Hills maintains electronic data inter-
change (EDI) connections through third party services to a large number of its
vendors. Unit sales data are recorded via the point-of-sale register systems in
each store. The point-of-sale registers and bar code scanners in all stores
significantly reduce labor intensive price marking and price changes. Each
Hills buyer has on-line access to information via a workstation located in the
buyer's office. Sales performance reports are received both daily and weekly
and assist management in making related merchandising decisions. The
merchandising systems allow Hills to distribute specific categories and styles
of merchandise to each store based upon the sales patterns of the stores. Store
operations are supported by a number of additional on-line systems including
electronic correspondence among all locations, payroll and labor scheduling
systems, price change management and layaway control.
Hills has embarked on a project designed to replace most of its existing
systems and enhance processes to meet the demands of retailing in the year 2000
and beyond. This program will replace the existing mainframe based systems with
new technologies. The Company will install new hardware and applications and,
in some cases, reengineer its business processes in order to take advantage of
the new technologies. See Management's Discussion and Analysis of Financial
Condition and Results of Operation below. The Company expects to continue to
introduce major new systems-based functionality in subsequent years to enhance
its merchandise processing productivity, as well as to enhance its
merchandising, marketing and customer service activities.
The discount general merchandise retail business is highly competitive. The
Company considers merchandise price, presentation, selection and quality, store
location, and the expertise of its buying, selling and support management and
associates to be the most significant competitive factors. Hills' principal
competitors are regional and national discount department store chains, some of
which, such as WalMart, Kmart, and Target, as well as specialty retailers, such
as Toys "R" Us, are larger and have more capital than Hills. Management
believes that Hills' recent store remodeling program and its continued improve-
ment in marketing and certain merchandising lines will allow it to defend its
competitive position, even with Wal-Mart's presence in most of the Company's
markets.
The "Hills" name is a registered service mark. The Company considers this mark
and the associated name recognition to be valuable to its business. The
Company has additional trademarks, trade names and service marks, many of which,
such as "American Spirit," are used in connection with the Company's private
label program. Although the Company considers these additional marks to be
valuable in the aggregate, individually, they have varying degrees of importance
to the Company's business.
As of March 31, 1998, Hills employed approximately 14,632 persons, including
approximately 8,553 full-time and 6,079 part-time employees. None of the
Company's employees are represented by a labor union. The number of employees
6
<PAGE>
varies during the year, reaching a peak during the Christmas selling season.
The Company considers its relations with its employees to be good.
During fiscal year 1997, the Company substantially completed the rebuilding of
its senior management team with the additions of a new executive vice president-
chief merchandising officer, senior vice president-marketing/sales promotion,
merchandise vice president-mens and childrens and senior vice president-human
resources. In the first quarter of fiscal year 1998, the Company hired a new
senior vice president-chief information officer. Additional changes in other
mid-level management occurred in fiscal year 1997 and will continue into fiscal
year 1998.
Certain disclosures contained in this document include forward-looking
statements within the meaning of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Although the Company believes its
plans are based upon reasonable assumptions as of the current date, it can give
no assurances that any expectations will be attained. Among the factors that
could cause actual results to differ materially are the following: general
economic conditions, consumer demand, consumer preferences and weather patterns
in the Midwest and Mid-Atlantic regions of the United States; competitive
factors, including continuing pressure from pricing and promotional activities
of major competitors; impact of excess retail capacity and the availability of
desirable store locations on suitable terms; the availability, selection and
purchasing of attractive merchandise on favorable terms; import risks, including
potential disruptions and duties, tariffs and quotas on imported merchandise;
acquisition and divestment activities; and other factors that may be described
in this document.
ITEM 2. PROPERTIES
----------
At the end of fiscal year 1997, Hills operated 155 stores (154 stores leased and
one owned) in the states of Pennsylvania, Ohio, New York, West Virginia,
Indiana, Virginia, Tennessee, Illinois, Kentucky, Maryland, Massachusetts and
North Carolina. The stores are located in regional and other enclosed shopping
malls, strip shopping centers and as free standing units. The Company plans to
relocate one store in fiscal year 1998. In early 1997, the Company closed 10
stores, located in Kentucky (2), North Carolina (4), Virginia (3) and Ohio (1).
The Company leases nearly all of its stores under long-term leases. In
addition, Hills leases buying and administrative offices, including the
Company's executive, buying and administrative office in Canton, Massachusetts,
the stores headquarters in Aliquippa, Pennsylvania, a buying office in New York,
New York, and its central distribution facilities in Columbus, Ohio.
The typical store lease has an initial term of between 20 and 30 years, with
four to seven renewal periods of five years each, exercisable at the Company's
option. Substantially all of the Company's leases provide for a minimum annual
rent that is constant or adjusts to fixed levels through the lease term,
including renewal periods. Most leases provide for additional rent based on a
percentage of sales to be paid when designated sales levels are achieved. See
Note 7 of the Notes to Consolidated Financial Statements for additional
information about the Company's long-term leases.
ITEM 3. LEGAL PROCEEDINGS
-----------------
In September 1995, the Company and HDSC filed a suit in the Court of Chancery
of the State of Delaware against the former members of the Board of Directors
(the "Former Directors") of the Company. That action seeks, among other things,
7
<PAGE>
ITEM 3. LEGAL PROCEEDINGS (CONTINUED)
-----------------------------
recovery of damages caused by the breach by the Former Directors of their
fiduciary duties to shareholders arising from the refusal of the Former
Directors to approve the change in control which took place on July 5, 1995 (the
"1995 Change of Control") following the election of seven replacement directors
by the shareholders of the Company. In October 1995, the defendants filed a
motion to dismiss the suit. In February 1996, the court granted a motion of the
Former Directors to stay discovery pending the outcome of their motion to
dismiss. In March 1997, the court denied the Former Directors' motion to
dismiss.
In April 1997, three of the Former Directors, Michael Bozic, Norman S. Matthews
and John G. Reen, filed a counterclaim against the Company and the seven
replacement directors seeking damages of not less than $2.5 Million for breach
of contract, unjust enrichment and intentional interference with contractual
relations arising out of allegations that the Company improperly failed to honor
their request to exercise stock options. The Company believes the counterclaim
is without merit and has denied the allegations and asserted various defenses.
Discovery is ongoing in the case.
In August 1995, in the Court of Chancery of the State of Delaware, three share-
holders of the Company, Gayle Dolowich, Ivan J. Dolowich and Joseph Weiss, filed
a class action lawsuit against the seven new directors of the Company elected at
the 1995 annual meeting, Dickstein Partners Inc. ("Dickstein Partners") and the
Company. In November 1995, the plaintiffs amended their complaint to include a
shareholder's derivative cause of action against the Former Directors for breach
of their fiduciary duties to the Company and its shareholders. In the amended
complaint, the plaintiffs claim (under Section 225 of the Delaware Corporation
Code) that in connection with Dickstein Partners' effort to solicit proxies in
support of the election of its nominees for directors of the Company, Dickstein
Partners issued a number of false and misleading statements regarding its offer
to acquire all of the Company's shares it did not already own. On the Section
225 claim, the plaintiffs seek an order nullifying the election of directors and
declaring there has been no "change of control" of the Company. The derivative
cause of action seeks damages against the Former Directors. In January 1996,
in the same Delaware Chancery Court, another shareholder, Peter M. Fusco, filed
a substantially similar class action and shareholder derivative suit against the
parties named in the Dolowich suit. The Former Directors filed a motion to
dismiss the Dolowich and Fusco suits, and in March 1997 the Court denied that
motion.
The Company is involved in various other suits and claims in the ordinary course
of business.
Management does not believe that the disposition of such suits and claims will
have a material adverse effect upon the continuing operations and financial
position of the Company.
8
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
NONE
EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------
(Furnished pursuant to General Instruction G of Form 10-K)
The executive officers of the Company currently are:
Gregory K. Raven, 48, was elected president and chief executive officer and a
director of Hills on February 7, 1996. He was executive vice president,
finance and chief financial officer of Revco D.S., Inc., from September 1988
until August 1995. From 1977 until he joined Revco in 1987, Mr. Raven served in
various financial management capacities with the Great Atlantic & Pacific Tea
Company, Inc.
Frederick L. Angst, 47, was elected executive vice president-chief merchandising
officer on July 22, 1997. He was vice president of ladies' apparel and
accessories from April of 1994 to July 1997. From 1991 to April 1994 he was
executive vice president-chief operating officer of Joseph Horne Co.
Michael R. Hamilton, 52, joined the Company as executive vice president-
operations on October 21, 1996. Prior to joining Hills, Mr. Hamilton had been
executive vice president of store operations for Venture Stores, Inc. He joined
Venture in 1973 and at the date of his departure from Venture he served as
executive vice president of stores, asset protection and leased businesses. In
January 1998 Venture Stores, Inc. filed a petition for reorganization under
Chapter 11 of the United States Bankruptcy Code.
C. Scott Litten, 48, was elected executive vice president and chief financial
officer on April 23, 1996. Previously, he served as senior vice president-
finance of Hechinger Stores Company from May 1994 to September 1995 and as chief
financial officer at The Butler Group, Inc. from January 1993 to May 1994. He
previously had served as senior vice president-finance of Family Dollar Stores,
Inc., as vice president-controller of Neiman Marcus Stores and was employed for
approximately eight years by Arthur Andersen & Co. He is a certified public
accountant.
James P. Fitzpatrick, 53, has been senior vice president-merchandise planning
and control since August 4, 1997. He was a consultant from March 1997 to July
1997. He was senior vice president of Lechmere, Inc. and Montgomery Ward & Co.
from November 1995 to February 1997. He was vice president-merchandise
planning and allocation of Hills from January 1994 to November 1995. He was
vice president-controller of Hills from 1991 to January 1994.
William K. Friend, 51, is senior vice president-secretary and corporate
counsel. From December 1985 to April 1, 1998, he was vice president-secretary
and corporate counsel for Hills. Prior to joining Hills, Mr. Friend held senior
management positions with SCOA Industries Inc. and Shoe Corporation of America,
Hills' predecessor companies.
Gregory B. Jones, 45, has been senior vice president-marketing/sales promotion
since September 2, 1997. He was vice president, marketing of Carpet One from
August 1995 to August 1997. He was vice president, marketing of Today's Man
from 1991 to August 1995.
9
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Jeffrey R. Sims, 47, is senior vice president-logistics. From March 1997 to
April 1, 1998, he was vice president-logistics. He was director of supply
chain operations of Sunbeam, Inc. from December 1996 through February 1997.
He was vice president-logistics of Thorn Americas, Inc. from March 1995 to
March 1996. He was vice president-logistics of Lesco, Inc. from September 1992
to November 1994.
Joseph J. Staffieri, 51, has been senior vice president-human resources since
January 14, 1998. He was director of staffing and associate relations from July
1997 to January 14, 1998. He was assistant vice president-field human resources
of TJX Companies from June 1995 to July 1997. He was vice president of human
resources of Lechmere, Inc. from prior to 1993 until June 1995.
Alan M. Weingarden, 50, has been senior vice president-chief information officer
since February 27, 1998. He was Senior vice president-chief information officer
of Bradlee's, Inc. from April 1995 to February 1998. He was vice president
management information services of Laura Ashley, Inc. from April 1993 until
April 1995. In June 1995 Bradlee's, Inc. filed a petition for reorganization
under Chapter 11 of the United States Bankruptcy Code.
Jeffrey S. Califano, 42, has been vice president-ladies apparel and accessories
since December 1, 1997. He was assistant vice president-merchandise manager-
sportswear of the Company from May 1994 to October 1997 and was merchandise
manager-sportswear from January 1990 to May 1994.
John M. Doyle, 38, joined the Company as vice president-treasurer on
September 23, 1996. He had been vice president and treasurer of Carson Pirie
Scott & Co. from 1995 to September 1996, and held various financial management
positions since joining that company in 1991 and at Marshall Field's from 1985
to 1990. Mr. Doyle is a certified public accountant.
Alfred G. Fortier, 43, has been vice president-fashion hardlines since May 1996.
He was assistant vice president-divisional merchandise manager of the Company
from June 1991 to May 1996.
Robert A. Greenwald, 50, has been vice president-boston softlines since
January 29, 1998. He was vice president general merchandise manager of Roses
Stores, Inc. from January 1997 to January 1998. He was executive vice president
merchandising and advertising of Rich's Department Stores from April 1995 to
January 1997. He was senior vice president general merchandise manager of
Jamesway Stores Inc. from May 1992 to April 1995. In October 1995, Jamesway
Stores Inc. filed a petition for reorganization under Chapter 11 of the United
States Bankruptcy Code. In December 1996, Rich's Department Stores filed a
petition for reorganization under Chapter 11 of the United States Bankruptcy
Code.
Ralph D. Nemeth, 43, has been vice president-regional manager since April 6,
1998. He was senior vice president of APS Holding Corporation, a distributor
of automotive replacement parts, from October 1996 to March 1998. He was
senior vice president/regional manager of Venture Stores, Inc. from 1992 to
September 1996. In February 1998, APS Holding Corporatio filed a petition for
reorganization under Chapter 11 of the United States Bankruptcy Code.
Daniel L. Ostrowski, 42, has been vice president-regional manager since January
6, 1997. He was divisional vice president, district manager of Venture Stores
Inc. from prior to 1993 to January 1997.
10
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Mark P. Ramsdell, 40, has been vice president-home division since May 1996. He
was vice president-general manager of the Toy Works Division of Melville Corp.
from February 1994 to May 1996. He was senior vice president general
merchandise manager of Wholesale Depot LLP from prior to 1993 to February 1994.
Brian J. Sheehan, 42, joined the Company as vice president-controller on
September 5, 1996. Prior to joining Hills, Mr. Sheehan was vice president and
chief financial officer of Healthcare Direct Inc., since November 1995. He
served as assistant corporate controller of Caldor Corporation from 1990 to
1995.
Officers are elected to serve until their successors are elected and qualified.
11
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PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
-----------------------------------------------------------------
(a) The principal market on which the Company's Common Stock is traded is the
New York Stock Exchange. The following table sets forth the range of high and
low prices of the Company's Common Stock as reported on the New York Stock
Exchange during each quarter of fiscal years 1996 and 1997.
<TABLE>
COMMON STOCK PRICES
- -------------------
<CAPTION>
Quarter Ended High Price Low Price
<S> <C> <C>
January 31, 1998 $ 4.000 $ 3.0000
November 1, 1997 $ 5.375 $ 3.1875
August 2, 1997 $ 4.875 $ 2.8125
May 3, 1997 $ 6.375 $ 2.8750
February 1, 1997 $ 7.750 $ 2.7500
November 2, 1996 $ 8.875 $ 6.7500
August 3, 1996 $12.875 $ 6.8750
May 4, 1996 $13.750 $ 7.8750
</TABLE>
(b) As of March 31, 1998, there were outstanding 10,388,224 shares of Common
Stock held by 2,161 holders of record, and 850,009 shares of Series A Conver-
tible Preferred Stock held by 1,932 holders of record.
(c) During the quarter ended January 31, 1998, the Company issued 5,381 shares
of Common Stock (the "Common Shares"), upon the conversion of 5,381 shares of
Series A Convertible Preferred Stock (the "Series A Preferred Shares"). The
Series A Preferred Shares were issued pursuant to the exemption from registra-
tion set forth in Section 1145(a) of the Federal Bankruptcy Code, and the Common
Shares were issued pursuant to the exemption from registration set forth in
Section 3(a)(9) of the Securities Act of 1933, as amended.
(d) The Company has not paid a cash dividend on its Common Stock in the last
two fiscal years. The Loan and Security Agreement dated as of September 30,
1996 and amended and restated as of January 30, 1998, between HDSC and C.R.H.
International, Inc. ("CRH"), the former importing subsidiary of HDSC which was
merged into HDSC effective January 31, 1998, as the Borrowers, BankAmerica
Business Credit, Inc. as the Agent, and the Company and its other subsidiaries
as the Guarantors, prohibits the payment of dividends on the Company's Common
Stock. HDSC is permitted to make all transfers of funds (in the form of loans,
advances or cash dividends) to the Company necessary for the Company to pay
interest on the Senior Notes and otherwise conduct its activities as a holding
company; however, such transfers can not be made for purposes other than in the
normal course of business. The Company's Senior Note Indenture also has
restrictions on the payment of cash dividends. See Notes 5 and 6 of the Notes
to Consolidated Financial Statements.
12
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<TABLE>
ITEM 6. SELECTED FINANCIAL DATA
-----------------------
The Company emerged from Chapter 11 proceedings on October 4, 1993. For financial reporting purposes, the Company adopted fresh-
start reporting as of October 2, 1993. Under fresh-start reporting, a new reporting entity is created and recorded amounts of
assets and liabilities are adjusted to reflect their estimated fair values. Financial data prior to October 2, 1993 has been
designated as those of the Predecessor Company. Black lines have been drawn to separate the Successor Company financial data
from the Predecessor Company financial data to signify that they are those of a new reporting entity and have been prepared on a
basis not comparable to prior periods.
<CAPTION>
Pro Forma || Predecessor
Successor Company Combined (8) || Company
----------------------------------------------------------------------------------------------------------
(in thousands, Fifty-Two Seventeen ||
except Fiscal Fiscal Fiscal Fiscal Weeks Ended Weeks Ended || Thirty-Five
per share amounts Year Year Year Year January 29, January 29, || Weeks Ended
and number of stores) 1997 1996 1995 1994 1994 1994 || October 2, 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> || <C>
Net sales $1,768,274 $1,878,477 $1,900,104 $1,872,021 $1,765,533 $ 772,685 || $ 992,848
Gross profit $ 461,939 $ 486,124 $ 515,683 $ 531,800 $ 505,583 $ 223,034 || $ 282,549
Net earnings (loss) ||
applicable to common ||
shareholders before ||
extraordinary items $ (9,015) $ (30,780)(1) $ (16,666)(2) $ 40,431(3) $ 30,041 $ 36,235 || $ (9,747)
Net earnings (loss) ||
applicable to common ||
shareholders $ (9,015) $ (35,058)(1) $ (16,666)(2) $ 40,431(3) $ 30,041 $ 36,235 || $ 248,492 (4)
||
Basic earnings (loss) ||
per common share (9) $ (0.87) $ (3.42)(1) $ (1.70)(2) $ 3.75 $ 3.34 $ 4.03 || $ 12.58 (5)
Diluted earnings (loss) ||
per common share (9) $ (0.87) $ (3.42)(1) $ (1.70)(2) $ 2.73 $ 2.03 $ 2.45 || $ 12.58 (5)
Basic average shares ||
outstanding 10,387 10,252 9,810 10,794 9,000 9,000 || 19,757
Diluted average shares ||
outstanding 10,387 10,252 9,810 14,832 14,794 14,794 || 19,757
FINANCIAL POSITION: ||
Total assets $ 882,581 $ 900,353 $ 863,563 $1,009,801 $ 928,129 || $ 987,268
Working capital (6) $ 233,413 $ 270,021 $ 250,965 $ 344,119 $ 232,742 || $ 301,980
Liabilities subject ||
to compromise (7) $ - $ - $ - $ - $ - || $ 775,169
Long-term obligations $ 447,221 $ 455,556 $ 416,084 $ 422,573 $ 365,599 || $ 122,230
Preferred stock $ 18,209 $ 19,942 $ 24,636 $ 64,144 $ 100,000 || $ 33,143
Common shareholders' ||
equity (deficit) $ 217,978 $ 224,784 $ 254,663 $ 306,741 $ 230,235 || $ (186,934)
Number of stores ||
operated at ||
period end 155 165 164 154 151 || 151
<FN>
(1) Includes a $33.7 million pretax charge ($20.7 million after tax, or $2.02 per diluted share) related to the estimated cost of
impairment of long-lived assets and the closing of ten stores in January 1997. In addition, the net loss applicable to common
shareholders includes an extraordinary after tax loss of $4.3 million, or $0.42 per diluted share, from early extinguishments
of debt.
(2) Includes a $45.5 million pretax charge ($32.5 million after tax, or $3.31 per diluted share) incurred in connection with the
1995 Change in Control (see Note 19 of Notes to Consolidated Financial Statements).
(3) Includes the following pretax items: $9.6 million of income related to a reversal of liabilities established in fresh-start
accounting, $2.2 million paid to holders of the Company's Senior Notes in connection with the Company's self-tender in March
1995, and a $4.5 million pension gain.
(4) Includes a $258.2 million after tax extraordinary gain on the discharge of prepetition debt.
(5) Diluted earnings per share for the thirty-five weeks ended October 2, 1993 includes an extraordinary gain per common share
of $13.07 on the discharge of prepetition debt.
(6) Working capital has been restated for all periods, except for the thirty-five weeks ended October 2, 1993, to reflect a
reclass between current and long term liabilities to conform to current year presentation.
(7) On February 4, 1991, the Company, its former parent, Hills Department Stores, Inc., and the five principal subsidiaries of
the Company, filed petitions for relief under Chapter 11 of the United States Bankruptcy Code. As a result, the Company
reclassified certain current liabilities to Liabilities subject to compromise at February 3, 1991.
(8) The unaudited Pro Forma Combining Statements of Operations present the pro forma combined results of the operations of the
Successor and Predecessor companies for the fifty-two weeks ended January 29, 1994 and have been adjusted to reflect: the
implementation of fresh-start reporting as of January 31, 1993; elimination of the effects of non-recurring transactions
resulting from the reorganization included in the results of the Predecessor Company; and payment to creditors pursuant to
the POR as of January 31, 1993. See the 1994 annual report previously filed which details the combination process.
(9) All earnings per share data for periods prior to 1997 have been restated to conform to FAS 128.
THE SELECTED FINANCIAL DATA SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS.
</TABLE>
13
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
FORWARD LOOKING STATEMENTS
Certain disclosures contained in this document include forward-looking
statements within the meaning of the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. Although the Company believes its
plans are based upon reasonable assumptions as of the current date, it can give
no assurances that any expectations will be attained. Among the factors that
could cause actual results to differ materially are the following: general
economic conditions, consumer demand, consumer preferences and weather patterns
in the Midwest and Mid-Atlantic regions of the United States; competitive
factors, including continuing pressure from pricing and promotional activities
of major competitors; impact of excess retail capacity and the availability of
desirable store locations on suitable terms; the availability, selection and
purchasing of attractive merchandise on favorable terms; import risks, including
potential disruptions and duties, tariffs and quotas on imported merchandise;
acquisition and divestment activities; and other factors that may be described
in this document.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JANUARY 31, 1998 (FISCAL YEAR 1997) VERSUS
FISCAL YEAR ENDED FEBRUARY 1, 1997 (FISCAL YEAR 1996)
Net sales for fiscal year 1997 decreased by 5.9 percent from the previous year
to $1,768.3 million, and comparable store sales decreased by 1.5 percent. The
decrease in total sales primarily resulted from the closing of 10 stores at the
beginning of the fiscal year. Comparable store sales decreased primarily due to
the elimination of a mid-year back to school layaway promotion, sales weakness
in men's and children's apparel, and unfavorable weather in both spring and
autumn for seasonal apparel sales. These factors were partially offset by
strong sales increases in home decor categories, especially in the second half
of the year.
Cost of sales as a percentage of sales was 73.9 percent in fiscal year 1997
compared with 74.1 percent in fiscal year 1996. Gross profit decreased by $24.2
million primarily due to the sales decrease, but increased as a percentage of
sales by 0.2 percent. The gross margin percentage increase was primarily the
result of decreased clearance markdowns between years and an increase in initial
markon associated with cost reductions in merchandise procurement programs.
These increases were partially offset by increased promotional markdowns during
the year.
Selling and administrative expenses for fiscal year 1997, including depreciation
and other occupancy expenses, decreased by $19.1 million primarily due to the
Company operating nine fewer stores during most of the fiscal year. Selling and
administrative expenses rose as a percentage of sales to 23.7 percent from 23.3
percent last year, due to the comparable store sales decrease and an increase in
advertising expenses. Comparable direct store expenses before advertising
expense decreased slightly between years. The Company expects the expense rate
to increase marginally in fiscal year 1998 compared with fiscal year 1997, due
to continued increased investment in advertising exposure in the first half of
fiscal year 1998, and due to the overlap in expenses from the ramping-up of new
information systems while continuing to operate the old systems.
14
<PAGE>
RESULTS OF OPERATIONS (CONTINUED)
FISCAL YEAR ENDED JANUARY 31, 1998 (FISCAL YEAR 1997) VERSUS
FISCAL YEAR ENDED FEBRUARY 1, 1997 (FISCAL YEAR 1996) (CONTINUED)
Earnings before interest, taxes, depreciation, amortization, store closing
expenses, change in control costs, and other non-cash items (EBITDA) was
$80.3 million in fiscal year 1997 compared with $84.7 million in fiscal year
1996. The gross margin rate improvement between years, described above, was
not sufficient to offset the gross margin dollar loss stemming from the
comparable sales decrease and the advertising cost increase.
During fiscal year 1996, the Company recorded a $33.7 million charge for the
impairment of long-lived assets and store closings. See Note 15 of the Notes
to Consolidated Financial Statements.
Net interest expense for fiscal year 1997 decreased by $5.2 million from fiscal
year 1996, primarily due to reduced borrowings under the Company's working
capital facility, and due to reduced amortization costs associated with the
New Senior Notes that were refinanced in mid-1996. See Notes 5 and 6 of the
Notes to Consolidated Financial Statements.
In fiscal year 1997, the Company recorded a tax benefit of $1.8 million on a
loss before income taxes of $10.8 million, an effective tax benefit rate of 16.6
percent. The low tax benefit rate resulted from non-deductible expenses,
including goodwill amortization. The tax benefit is expected to be realized
through the application of net operating loss carryforwards and other deferred
tax items to offset future taxable income. See Note 16 of the Notes to the
Consolidated Financial Statements.
The after-tax extraordinary loss of $4.3 million in fiscal year 1996 represented
costs associated with the early extinguishment of debt related to the
refinancing and redemption of the 10.25 percent Senior Notes and the write-off
of the deferred financing costs related to the Company's previous credit
agreement which was replaced during fiscal year 1996. See Note 5 of the Notes
to Consolidated Financial Statements.
FISCAL YEAR ENDED FEBRUARY 1, 1997 (FISCAL YEAR 1996) VERSUS
FISCAL YEAR ENDED FEBRUARY 3, 1996 (FISCAL YEAR 1995)
Net sales for fiscal year 1996 decreased 1.1 percent compared with fiscal year
1995 principally due to fiscal year 1996 having 52 weeks compared with 53 weeks
in fiscal year 1995. Comparable store sales on an equivalent 52 week calendar
basis decreased 1.7 percent, reflecting weak sales in men's and children's
apparel and in the home decor categories of the business.
Cost of sales as a percentage of sales was 74.1 percent in fiscal year 1996
compared with 72.9 percent in fiscal year 1995. This margin decrease of 1.2
percent was due to a higher rate of markdowns, particularly in the men's and
girl's apparel, toys, and seasonal categories. The decrease was partially
offset by an improvement in inventory shrinkage results.
Selling and administrative expenses, including depreciation and other occupancy
costs, as a percentage of sales was 23.3 percent in fiscal year 1996 compared
with 22.5 percent in fiscal year 1995. The 0.8 percent increase was largely due
to the full year impact of expenses associated with the mid-year opening of ten
new stores in fiscal year 1995 compared with one store that opened in fiscal
15
<PAGE>
RESULTS OF OPERATIONS (CONTINUED)
FISCAL YEAR ENDED FEBRUARY 1, 1997 (FISCAL YEAR 1996) VERSUS
FISCAL YEAR ENDED FEBRUARY 3, 1996 (FISCAL YEAR 1995) (CONTINUED)
year 1996, combined with the decrease in comparable store sales. Direct store
expenses per average store decreased by approximately 3 percent.
Earnings before interest, taxes, depreciation, amortization, store closing
expenses, change in control costs, and other non-cash items (EBITDA) was $84.7
million in fiscal year 1996 compared with $119.3 million in fiscal year 1995.
See Note 15 of the Notes to Consolidated Financial Statements regarding fiscal
year 1996 charges for store closings and impairment of long-lived assets.
See Note 19 of the Notes to Consolidated Financial Statements regarding costs
related to the July 1995 change in control.
Interest expense was $53.6 million in fiscal year 1996 compared with $47.7
million in fiscal year 1995. The $5.9 million increase was primarily due to the
refinancing of $160 million, 10.25% Senior Notes with $195 million, 12 1/2%
Senior Notes. This increase was partially offset by decreased interest related
to bank borrowings under the Company's working capital facilities due to lower
average borrowings and lower interest rates.
In fiscal year 1996, the Company recorded a tax benefit of $14.0 million on a
loss before income taxes and extraordinary items of $44.8 million, an effective
tax rate of 31.3 percent. Of the total tax benefit, $13.0 million related to
impairment of long-lived assets and store closing costs. The remaining $1.0
million tax benefit related to the $11.1 million pretax loss before those
charges, a 9.0 percent effective tax rate, resulted from non-deductible
expenses, including goodwill amortization, and certain expenses only partially
deductible for state income tax purposes.
The after-tax extraordinary loss of $4.3 million in fiscal year 1996 represented
costs associated with the early extinguishment of debt related to the
refinancing and redemption of the 10.25 percent Senior Notes and the write-off
of the deferred financing costs related to the Company's previous credit
agreement. See Note 5 of the Notes to Consolidated Financial Statements.
16
<PAGE>
RESULTS OF OPERATIONS (CONTINUED)
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
A summary of cash flow information is presented below (in thousands):
<TABLE>
<CAPTION>
Fiscal Fiscal
1997 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Operating cash flow before net inventory
and store closing items $ 33,407 $ 31,808
Inventory, net of trade payables 23 13,813
Other store closing receipts (expenditures), net ( 4,767) 1,898
-------- --------
Net cash provided by operating activities 28,663 47,519
Capital expenditures ( 34,267) ( 32,858)
Deferred software expenditures ( 24,828) -
Refinancing of Senior Notes - 25,151
Capital lease and sale/leaseback financing - 16,559
Principal payments under capital lease
obligations ( 7,099) ( 6,467)
Cash distributions pursuant to the
Plan of Reorganization ( 84) ( 2,682)
Proceeds from term loan 10,000 -
Deferred finance costs and other
financing activities ( 1,025) ( 3,957)
-------- --------
Net change in cash ( 28,640) 43,265
Cash and cash equivalents
at beginning of period 66,163 22,898
-------- --------
Cash and cash equivalents
at end of period $ 37,523 $ 66,163
======== ========
</TABLE>
Net cash provided by operating activities for fiscal year 1997 decreased by
$18.9 million as compared with fiscal year 1996. This was due to
(a) operating cash flow for fiscal year 1996 included approximately $13.8
million of positive cash flow from an improved net inventory position (inventory
net of trade payables, most of which change was attributable to a $10.4 million
year-end cash infusion from the sale of inventories in stores to be closed),
and (b) operating cash flow for fiscal year 1997 included approximately $4.8
million of store closing payments, compared with approximately $1.9 million of
cash receipts in 1996 from the sale of leaseholds related to closed stores.
Capital expenditures were $34.3 million for fiscal year 1997 compared with $32.9
million for fiscal year 1996, a $1.4 million increase. This increase was
primarily the result of increased spending on the Company's information systems
which was partially offset by a decline in capital expenditures related to store
remodels performed in fiscal year 1996. In fiscal year 1997, the Company
invested $24.8 million in deferred software related to the Company's information
systems replacement program. During fiscal year 1998, capital expenditures and
deferred software expenditures are expected to approximate $20 million to $25
million and $15 million to $20 million, respectively. The Company expects to
relocate one store during fiscal year 1998. The Company does not expect to open
any new stores during fiscal year 1998.
17
<PAGE>
RESULTS OF OPERATIONS (CONTINUED)
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Net cash provided by financing activities was $1.8 million for fiscal year 1997
compared with $28.6 million for fiscal year 1996, a $26.8 million decrease. The
decrease was primarily due to $25.2 million in net proceeds received in fiscal
year 1996 from the sale of 12 1/2% Senior Notes (the "Senior Notes") in excess
of the debt refinanced, and $16.6 million received in fiscal year 1996 from
fixture and equipment financings. These were partially offset by the $10
million in net proceeds received from the term loan in fiscal year 1997 and
decreased cash out flows associated with 1996 payments for other financing costs
and cash disbursements pursuant to the plan of reorganization (see below).
During fiscal year 1996, the Company refinanced its $300 million secured
credit facility (the "Facility"). See description in Note 5 of Notes to
Consolidated Financial Statements. The Facility is secured by inventory and
most other tangible and intangible assets of the Company, excluding store
fixtures and real estate. While the terms of the Facility, including the
security arrangements, create restrictions on or limit the ability of the
Company to obtain certain types of financing, the Facility generally provides
reasonable flexibility for the Company to obtain additional asset acquisition
financing in connection with its capital spending programs. Since the inception
of the current Facility, the Company and the lending group have amended the
Facility (a) to extend its term, (b) to provide increased advance rates under
its borrowing base formula, (c) to clarify and modify financial covenants to
enhance operating and financing flexibility, and (d) as of January 30, 1998, to
create a $10 million term loan in order to better match the Company's cash flow
with economic lives of certain systems technology investments being made by the
Company in 1997-1998. During fiscal year 1997, average borrowings under the
revolving credit facility were $42.5 million at an average interest rate of 8.1
percent, with peak borrowings of $151.0 million. Average borrowings during
fiscal year 1996 were $58.0 million at an average interest rate of 8.4 percent,
with peak borrowings of $142.8 million. Peak borrowings in fiscal year 1995
were $188 million. Immediate credit availability under the Facility in excess
of the current uses at January 31, 1998 was approximately $154 million compared
with approximately $149 million at February 1, 1997.
The Company believes that its credit arrangements, together with cash from
operations, will enable the Company to maintain the liquidity necessary to
finance its continuing operations, including its planned capital and software
expenditures for fiscal year 1998.
The terms of the Company's secured credit facility and the Senior Notes limit
the ability of the subsidiaries to pay dividends. Any or all of the
restrictions, limitations or contingencies under the Facility and the Senior
Note Indenture, as well as the Company's leverage, could adversely affect the
Company's ability to obtain additional financing in the future, to make
capital expenditures, to effect store expansions, to make acquisitions, to
take advantage of business opportunities that may arise, and to withstand
adverse general economic and retail industry conditions and increased
competitive pressures. Retail suppliers and their factors monitor carefully
the financial performance of retail companies such as the Company, and may
reduce credit availability quickly upon learning of actual or perceived
deterioration in the financial condition or results of operations of a retail
company.
In addition to its funded debt, including capital lease obligations, the
Company has significant operating lease commitments which require cash outflows
18
<PAGE>
RESULTS OF OPERATIONS (CONTINUED)
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
that are included in the Company's operating expenses. The Company does not
expect significant changes in such cash outflows during fiscal year 1998. See
Note 7 to Notes to Consolidated Financial Statements.
In connection with the Company's information system replacement program, the
Company is implementing a program designed to assure that all new and continuing
systems are capable of year 2000 ("Y2K") compliance, including upgrades to
those systems not being replaced. The cost of most of such upgrades are
generally covered by on-going third-party software maintenance agreements, with
additional Y2K upgrade costs not anticipated to be material. Most of the new
systems are expected to be in place by the end of fiscal year 1998. However,
the Company has experienced difficulty in acquiring the contractors and staff
needed to install the new systems, and there have been some delays in the
installation of certain elements of the new systems. The Company is taking
corrective action and anticipates conversion of the final elements to the new
systems not later than early fiscal year 1999. Because the old systems being
replaced are not Y2K compliant, a substantial delay in conversion to the new
systems or improper functioning of the new systems could severely disrupt the
Company's ability to process merchandise orders, receive goods, pay its vendors
and/or employees, and/or service its customers. The Company currently believes
the probability of such circumstances is remote. In addition, if a significant
number of the Company's vendors or lenders are directly or indirectly negatively
impacted by Y2K noncompliance, the Company could suffer similar adverse effects.
The Company is undertaking steps to limit its exposure to merchandise and
service vendors who may be Y2K noncompliant.
The Internal Revenue Code limits the amount of net operating loss (NOL) and
credit carryforwards that may be used by the Company. The amount of the annual
limitation is subject to revision if, over a rolling three year period, there
is a collective change in excess of 50% among all 5 percent shareholders of the
Company (as defined by the Internal Revenue Code). The amount of the limitation
is determined as a percentage of the Company's fair market value on the date of
the change. This annual limitation was determined in 1993, at the date of the
Company's bankruptcy reorganization, and again in 1995, and is currently
approximately $15.8 million. Unused annual limitations accumulate; the Company
did not use any NOL or credit carryforwards in its federal income tax returns
in fiscal years 1995 through 1997.
OTHER MATTERS
SEASONALITY
The Company's business is highly seasonal due to increased consumer buying for
back-to-school needs and Christmas. The second half of each year provides the
major portion of the Company's annual sales and operating earnings with
operating earnings particularly concentrated in the Christmas selling season.
INFLATION
The moderate rate of inflation over the past three years has not had a
significant effect on the Company's sales, costs or profitability. Retail
prices and cost of merchandise in the categories sold by the Company have been
relatively stable. Inflation impact on operating costs has been partially
mitigated by the Company's productivity improvement efforts. The Company does
not expect these trends to change in the forseeable future.
19
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------
See accompanying pages F-1 through F-27.
Information called for by this item can be found at the pages listed in the
following index.
<TABLE>
INDEX TO FINANCIAL STATEMENTS
<CAPTION>
Hills Stores Company and Subsidiaries Page
<S> <C>
Independent Auditors' Report............................................ F-1
Consolidated Balance Sheets............................................. F-2
Consolidated Statements of Operations................................... F-3
Consolidated Statements of Cash Flows................................... F-4
Consolidated Statements of Common Shareholders' Equity.................. F-5
Notes to Consolidated Financial Statements.............................. F-6
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
-----------------------------------------------------------
AND FINANCIAL DISCLOSURE
------------------------
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------
Incorporated by reference from the item entitled "Information About Nominees"
in the proxy statement for the annual meeting of stockholders to be held
June 17, 1998, except for information regarding executive officers of the
Company, which information is furnished in a separate item captioned "Executive
Officers of the Registrant" in Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
----------------------
Incorporated by reference from the item entitled "Executive Compensation" in
the proxy statement for the annual meeting of stockholders to be held June 17,
1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------
Incorporated by reference from the item entitled "Beneficial Ownership" in the
proxy statement for the annual meeting of stockholders to be held June 17, 1998.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------
Incorporated by reference from the items entitled "Information About Nominees,"
"Executive Compensation," "Employment Contracts," and "Compensation of
Directors" in the proxy statement for the annual meeting of stockholders to be
held June 17, 1998.
20
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
----------------------------------------------------------------
(a) Documents filed as part of this report:
<TABLE>
<S> <C> <C>
1. Financial statements
Independent Auditors' Report F-1
Consolidated Balance Sheets F-2
Consolidated Statements of Operations F-3
Consolidated Statements of Cash Flows F-4
Consolidated Statements of Common Shareholders' Equity F-5
Notes to Consolidated Financial Statements F-6
2. Financial statements schedules
I Report of Independent Auditor S-1
II Valuation and Qualifying Accounts S-2
</TABLE>
Schedules other than these listed above are omitted because they are not
required, not applicable, or the information is otherwise included in the
financial statements.
3. Certain of the exhibits listed hereunder have previously been filed with
the Commission as exhibits to certain registration statements and periodic
reports set forth in the footnotes following this exhibit list and are hereby
incorporated by reference pursuant to Rule 411 promulgated under the Securities
Act and Rule 24 of the Commission's Rules of Practice. The location of each
document, so incorporated by reference, is indicated by footnote (the number in
parentheses).
3.1(1) Amended and Restated Certificate of Incorporation of the Company, as
amended.
3.2(2) Amended and Restated By-Laws of the Company.
4.1(3) Certificate of the Voting Powers, Preferences and other designated
attributes of the Series A Convertible Preferred Stock of the
Company.
4.2(4) Form of Series 1993 Stock Right.
4.3(5) Series 1993 Warrant Agreement dated October 4, 1993 between the
Company and Chemical Bank, as Warrant Agent.
4.4(6) Rights Agreement dated as of August 16, 1994 (the "Rights Agreement")
between the Company and Chemical Bank, as Rights Agent.
4.5(6) Form of Certificate of the Voting Powes, Preferences and other
designated attributes of Series B Participating Cumulative Preferred
Stock of the Company (which is attached as Exhibit A to the Rights
Agreement incorporated by reference as Exhibit 4.4 hereto).
4.6(6) Form of Right Certificate (which is attached at Exhibit B to the
Rights Agreement incorporated by reference as Exhibit 4.4 hereto).
21
<PAGE>
4.7(7) Amendment dated as of October 18, 1995 to the Rights Agreement.
4.8(8) Indenture dated as of April 19, 1996 relating to the 12 1/2% Senior
Notes due 2003, Series B, of the Company.
10.1(9) Loan and Security Agreement dated as of September 30, 1996 and
amended and restated as of January 30, 1998 among the Financial
Institutions named therein as the Lenders, BankAmerica Business
Credit, Inc. as the Agent, Hills Department Store Company and
C.R.H. International, Inc. as the Borrowers, and the other Loan
Parties named therein.
10.2(10) * Employment Agreement made as of February 7, 1996 with Gregory K.
Raven.
10.3 * Consulting Agreement made as of February 8, 1998 with Chaim Y.
Edelstein.
10.4(11) * Employment Agreement made as of November 19, 1996 with Michael R.
Hamilton.
10.5(12) * Employment Agreement made as of July 22, 1997 with Frederick L.
Angst.
10.6(13) * Employment Agreement made as of November 11, 1997 with C. Scott
Litten.
10.7(14) * Confidential Separation Agreement, Voluntary Release and Notice
dated March 6, 1997 between the Company and James E. Feldt.
10.8(4) * 1993 Incentive and Nonqualified Stock Option Plan, as amended.
10.9(10) * 1996 Directors Stock Option Plan.
10.10(15)* Hills Stores Company/Hills Department Store Company Associate Stock
Purchase Plan, as amended.
11.1 Computation of earnings per share.
21 Subsidiaries.
23 Consent of Independent Auditors'.
24 Powers of Attorney of directors and officers of the Company.
27 Financial Data Schedule.
[FN]
__________________________
* Executive Compensation Plans and Arrangements.
1. Incorporated by reference from the Annual Report on Form 10-K of the
Company for the fiscal year ended January 28, 1995.
2. Incorporated by reference from the Report on Form 8-K of the Company
dated January 18, 1996.
3. Incorporated by reference from the Form 8-A of the Company filed on
October 5, 1993.
22
<PAGE>
4. Incorporated by reference from the Annual Report on Form 10-K of the
Company for the fiscal year ended January 29, 1994.
5. Incorporated by reference from the Report on Form 8-K of the Company
dated October 4, 1993.
6. Incorporated by reference from the Report on Form 8-K of the Company
dated August 16, 1994.
7. Incorporated by reference from the Report on Form 10-Q of the Company
for the quarter ended October 28, 1995.
8. Incorporated by reference from the Report on Form 10-Q of the Company
for the quarter ended May 4, 1996.
9. Incorporated by reference from the Report on Form 8-K of the Company
dated January 30, 1998.
10. Incorporated by reference from the Annual Report on Form 10-K of the
Company for the fiscal year ended February 3, 1996.
11. Incorporated by reference from the Report on Form 10-Q of the Company
for the quarter ended November 2, 1996.
12. Incorporated by reference from the Report on Form 10-Q of the Company
for the quarter ended August 2, 1997.
13. Incorporated by reference from the Report on Form 10-Q of the Company
for the quarter ended November 1, 1997.
14. Incorporated by reference from the Annual Report on Form 10-K of the
Company for the fiscal year ended February 1, 1997.
15. Incorporated by reference from the Form S-8 of the Company filed on
May 28, 1997.
(b) Reports on Form 8-K:
1. A report on Form 8-K dated February 28, 1997 was filed by the Company
concerning the First Amendment to the Loan and Security Agreement.
2. A report on Form 8-K dated March 12, 1997 was filed by the Company con-
cerning the fourth quarter and year-end press release issued on that date.
3. A report on Form 8-K dated January 30, 1998 was filed by the Company
concerning the Loan and Security Agreement dated as of September 30, 1996
and amended and restated as of January 30, 1998.
23
<PAGE>
SIGNATURE
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, in the Town of Canton,
Commonwealth of Massachusetts, on April 20, 1998.
HILLS STORES COMPANY
By: /s/ William K. Friend
-------------------------
William K. Friend
Senior Vice President-Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
/s/ Gregory K. Raven Director, President and Chief April 20, 1998
- -------------------- Executive Officer of the Company
Gregory K. Raven and Hills Department Store Company
(Principal Executive Officer)
/s/ C. Scott Litten Executive Vice President-Chief April 20, 1998
- -------------------- Financial Officer of the Company
C. Scott Litten and Hills Department Store Company
(Principal Financial Officer)
/s/ Brian J. Sheehan Vice President-Controller of the April 20, 1998
- -------------------- Company and Hills Department Store
Brian J. Sheehan Company (Principal Accounting Officer)
By: /s/ William K. Friend April 20, 1998
---------------------
William K. Friend
Attorney-In-Fact for the following:
Chaim Y. Edelstein Chairman of the Board of the
Company and Hills Department
Store Company
Stanton J. Bluestone Director of the Company and
Hills Department Store Company
John W. Burden III Director of the Company and
Hills Department Store Company
Alan S. Cooper Director of the Company and
Hills Department Store Company
Mark B. Dickstein Director of the Company and
Hills Department Store Company
Samuel L. Katz Director of the Company and
Hills Department Store Company
Richard E. Montag Director of the Company and
Hills Department Store Company
</TABLE>
24
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Hills Stores Company and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Hills Stores
Company and Subsidiaries as of January 31, 1998 and February 1, 1997 and the
related consolidated statements of operations, common shareholders' equity, and
cash flows for the years ended January 31, 1998, February 1, 1997 and
February 3, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Companies as of January 31,
1998 and February 1, 1997 and the results of their operations and their cash
flows for the years ended January 31, 1998, February 1, 1997 and February 3,
1996 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
March 11, 1998
F-1
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
____________________________________________________________________________________________
CONSOLIDATED BALANCE SHEETS
<CAPTION>
January 31, February 1,
(dollars in thousands) 1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 37,523 $ 66,163
Accounts receivable, less allowance
for doubtful accounts of approximately
$5,500 and $4,500 21,869 24,346
Inventories 340,719 341,477
Deferred tax asset, net (Note 16) 26,933 32,991
Other current assets 5,542 5,115
-------- --------
Total current assets 432,586 470,092
Property and equipment, net (Note 2) 183,112 173,701
Property under capital leases, net (Note 7) 102,350 112,201
Beneficial lease rights, net (Note 1) 6,081 6,848
Deferred tax asset, net (Note 16) 28,592 21,585
Reorganization value in excess of amounts allocable
to identifiable assets, net (Notes 1 and 3) 89,112 97,508
Other assets, net (Note 1) 40,748 18,418
-------- --------
$882,581 $900,353
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of capital leases and
financial obligations (Note 7) $ 10,541 $ 7,255
Current portion of long term debt (Note 6) 500 -
Accounts payable, trade 110,329 111,064
Other accounts payable and accrued expenses (Note 4) 77,803 81,752
-------- --------
Total current liabilities 199,173 200,071
Long term debt (Note 6) 204,500 195,000
Obligations under capital leases (Note 7) 113,919 120,539
Financing obligations - sale/leaseback (Note 7) 30,335 34,100
Other liabilities 98,467 105,917
Commitments and contingencies (Note 18) - -
Preferred stock, at mandatory redemption value (Note 9) 18,209 19,942
Common shareholders' equity (Notes 10 and 11):
Common stock, 50,000,000 shares of $0.01 par value
authorized, 10,446,287 and 10,337,761 shares issued and
outstanding 105 103
Additional paid-in capital 217,388 215,537
Retained earnings 927 9,942
Unearned compensation (Note 11) ( 442) ( 798)
-------- --------
Total common shareholders' equity 217,978 224,784
-------- --------
$882,581 $900,353
======== ========
</TABLE>
See Notes to Consolidated Financial Statements
F-2
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
________________________________________________________________________________________
CONSOLIDATED STATEMENTS OF OPERATIONS
<CAPTION>
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
January 31, February 1, February 3,
(in thousands, except per 1998 1997 1996
share amounts) (52 Weeks) (52 Weeks) (53 Weeks)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $1,768,274 $1,878,477 $1,900,104
Cost of sales 1,306,335 1,392,353 1,384,421
Selling and administrative expenses
(Notes 7 and 8) 418,512 437,593 428,212
Amortization of reorganization
value in excess of amounts
allocable to identifiable assets 5,850 6,050 7,755
Impairment of long-lived assets and
store closings (Note 15) - 33,706 -
Costs related to change
in control (Note 19) - - 45,529
---------- ---------- ----------
Operating earnings 37,577 8,775 34,187
Interest expense, net (Note 1) 48,392 53,555 47,666
---------- ---------- ----------
Loss before income taxes ( 10,815) ( 44,780) ( 13,479)
Income tax benefit
(provision) (Note 16) 1,800 14,000 ( 3,187)
---------- ---------- ----------
( 9,015) ( 30,780) ( 16,666)
Extraordinary loss on early
extinguishment of debt, net - 4,278 -
---------- ---------- ----------
Net loss ($ 9,015) ($ 35,058) ($ 16,666)
========== ========== ==========
Basic and diluted loss
per common share (Note 17):
Loss before extraordinary loss ( 0.87) ($ 3.00) ($ 1.70)
Extraordinary loss - ( 0.42) -
---------- ---------- ----------
Net loss ($ 0.87) ($ 3.42) ($ 1.70)
========== ========== ==========
</TABLE>
See Notes to Consolidated Financial Statements
F-3
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
________________________________________________________________________________________
CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
January 31, February 1, February 3,
1998 1997 1996
(in thousands) (52 Weeks) (52 Weeks) (53 Weeks)
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 9,015) ($ 35,058) ($ 16,666)
Adjustments to reconcile net loss
to net cash provided by (used for)
operating activities:
Depreciation and amortization 36,845 35,130 31,784
Amortization of deferred financing costs 2,538 5,942 4,847
Deferred income taxes ( 949) ( 12,332) ( 11,260)
Decrease in deferred tax assets
recognized through a reduction in
reorganization value in excess of
amounts allocable to identifiable assets 2,546 2,592 9,496
Impairment of long-lived assets
and store closings - 28,958 -
Extraordinary loss on extinguishment of debt - 4,278 -
Amortization of reorganization value in
excess of amounts allocable to
identifiable assets 5,850 6,050 7,755
Loss on disposal of fixed assets 78 998 54
Decrease (increase) in accounts receivable
and other current assets 2,050 1,078 ( 2,325)
Decrease (increase) in inventories 758 ( 15,080) ( 17,846)
Increase (decrease) in accounts payable
and other accrued expenses ( 12,134) 25,293 ( 24,464)
Other, net 96 ( 330) ( 1,962)
-------- -------- --------
Net cash provided by (used for)
operating activities 28,663 47,519 ( 20,587)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ( 34,267) ( 32,858) ( 56,714)
Deferred software expenditures ( 24,828) - -
-------- -------- --------
Net cash used for investing activities ( 59,095) ( 32,858) ( 56,714)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from secured term loan 10,000 - -
Proceeds from issuance of
12 1/2% Senior Notes - 195,000 -
Fees incurred with the issuance of
12 1/2% Senior Notes - ( 8,100) -
Redemption of 10.25% Senior Notes - ( 160,000) -
Payment of premium on debt redemption - ( 1,749) -
Proceeds from sale/leaseback financing - 16,559 -
Principal payments under capital
lease obligations ( 7,099) ( 6,467) ( 6,121)
Cash distributions pursuant to the Plan
of Reorganization ( 84) ( 2,682) ( 5,297)
Shares repurchased per self-tender offer - - ( 75,000)
Deferred finance costs and
other financing activities ( 1,025) ( 3,957) ( 10,857)
-------- -------- --------
Net cash provided by (used for)
financing activities 1,792 28,604 ( 97,275)
-------- -------- --------
Net increase (decrease) in cash and
cash equivalents ( 28,640) 43,265 ( 174,576)
Cash and cash equivalents:
Beginning of period 66,163 22,898 197,474
-------- -------- --------
End of period $ 37,523 $ 66,163 $ 22,898
======== ======== ========
</TABLE>
See Notes to Consolidated Financial Statements
F-4
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
__________________________________________________________________________________________________________________
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' EQUITY
<CAPTION>
Common Stock Additional Common
------------------ Paid-in Retained Unearned Shareholders'
(dollars in thousands) Shares Amount Capital Earnings Compensation Equity
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at January 28, 1995 10,804,784 $108 $229,967 $76,666 $ - $306,741
Retirement of Common Stock (Note 20) ( 3,000,000) ( 30) ( 59,970) ( 15,000) - ( 75,000)
Conversion of Preferred Stock 1,975,400 20 39,488 - - 39,508
Exercise of stock options
and warrants 4,387 - 80 - - 80
Exchange for Stock Rights (Note 12) 198,271 2 ( 2) - - -
Net loss - - - ( 16,666) - ( 16,666)
--------------------------------------------------------------------------
Balance at February 3, 1996 9,982,842 100 209,563 45,000 - 254,663
Conversion of Preferred Stock 234,674 2 4,692 - - 4,694
Restricted stock grants 120,000 1 1,202 - (1,203) -
Amortization of restricted
stock grants - - - - 405 405
Other 245 - 7 - - 7
Stock options issued
under compensatory plan (Note 11) - - 73 - - 73
Net loss - - - ( 35,058) - ( 35,058)
--------------------------------------------------------------------------
Balance at February 1, 1997 10,337,761 103 215,537 9,942 ( 798) 224,784
Conversion of Preferred Stock 86,625 1 1,732 - - 1,733
Amortization of restricted
stock grants - - - - 356 356
Issuance due to Associated Stock
Purchase Plan (Note 11) 21,901 1 58 - - 59
Stock options issued
under compensatory plan (Note 11) - - 61 - - 61
Net loss - - - ( 9,015) - ( 9,015)
--------------------------------------------------------------------------
Balance at January 31, 1998 10,446,287 $105 $217,388 $ 927 ($ 442) $217,978
==========================================================================
</TABLE>
See Notes to Consolidated Financial Statements
F-5
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
BASIS OF REPORTING
During fiscal year 1997, Hills Stores Company (HSC or "the Company") operated,
through its wholly-owned subsidiary Hills Department Store Company ("HDSC"), a
chain of 155 discount department stores located primarily in the Great Lakes and
Ohio Valley regions of the United States. The consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries. All
significant intercompany transactions and balances have been eliminated.
Certain prior year amounts were reclassified to conform to the current year
presentation. The Company's fiscal year ends on the Saturday closest to
January 31. Fiscal year 1995 was a fifty-three week year; fiscal years 1997
and 1996 were fifty-two week years.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments with
maturities of three months or less from the date of purchase and whose cost
approximates market value due to the short maturity of the investments.
Interest income of $0.7 million, $1.3 million and $1.8 million was included
in interest expense, net for fiscal years 1997, 1996 and 1995, respectively.
INVENTORIES
Inventories are valued using the retail method on the lower of last-in,
first-out (LIFO) cost or market basis. LIFO cost at January 31, 1998,
February 1, 1997 and February 3, 1996 exceeded the cost of inventory on a
first-in, first-out basis; accordingly, there has been no LIFO charge.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization are provided on a straight-line basis over the
estimated useful lives of the related assets, which is 27 1/2 years for
buildings and range from five to eight years for fixtures and equipment.
Amortization of leasehold improvements is provided on a straight-line basis over
the shorter of the lease term, considering renewal options that are likely to be
exercised, or the estimated useful life of the related asset. Leasehold
improvements are amortized principally over 15 years. Capital lease assets are
depreciated over the lease term or the estimated useful life of the related
asset.
DEFERRED FINANCING COSTS
Net deferred financing costs of $9.9 million at January 31, 1998 and $11.4
million at February 1, 1997 were included in other assets and are being
amortized on a straight-line basis over the estimated term of the related
debt. Accumulated amortization of deferred financing costs was $4.2 million
at January 31, 1998 and $1.7 million at February 1, 1997.
DEFERRED SOFTWARE EXPENDITURES
In fiscal year 1997, the Company had $24.8 million of deferred software
expenditures relating to its information systems replacement program. These
F-6
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------------------------------------------------------
DEFERRED SOFTWARE EXPENDITURES (CONTINUED)
expenditures primarily represent direct costs of obtaining and modifying
commercially available computer software and costs associated with developing
internally used computer software. Expenditures such as Company payroll,
contracted services, capitalized interest during the period that the
software is not in service and other costs relating to the installation and
testing of such software, are included in deferred software. When placed in
service, these assets are generally amortized on a straight-line basis over
seven years.
INTANGIBLE ASSETS
Beneficial lease rights are amortized using the straight-line method over the
terms of the related leases. Accumulated amortization of beneficial lease
rights was $3.3 million at January 31, 1998 and $2.5 million at February 1,
1997.
Reorganization value in excess of amounts allocable to identifiable assets
is being amortized over twenty years on a straight-line basis. (See Notes 3
and 16).
PREOPENING COSTS
Preopening costs consist of direct costs of opening a store and are charged to
operations within the fiscal year that a new store opens. The Company did not
open any new stores in fiscal year 1997, opened 1 store in fiscal year 1996 and
opened 10 stores during fiscal year 1995.
INTEREST CAPITALIZATION
The Company capitalizes interest incurred in connection with the construction
and development of new stores, computer systems, and other major assets for the
Company's own use. The Company capitalized interest of $1.4 million in fiscal
year 1997 and $0.5 million in fiscal year 1995. No interest was capitalized
during fiscal year 1996.
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 revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Significant estimates used in preparation of the consolidated financial
statements include, but are not limited to, income tax liabilities, self-
insurance liabilities for worker's compensation and general liability, store
closing liabilities, physical inventory shortage allowances, and the estimated
useful life of fixed and intangible assets.
F-7
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
------------------------------------------------------
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" which are effective for the Company's financial statements for the
year end January 31, 1999. The Company believes that neither pronouncement
will have a material impact on it's financial statements.
2. PROPERTY AND EQUIPMENT
----------------------
The components of property and equipment are listed below (in thousands):
<TABLE>
<CAPTION>
January 31, February 1,
1998 1997
------------ -----------
<S> <C> <C>
Fixtures and equipment $164,816 $152,731
Leasehold improvements 66,247 56,802
Buildings 16,192 16,192
Land 3,430 3,430
Improvements in progress 16,629 3,633
-------- --------
267,314 232,788
Accumulated depreciation and amortization ( 84,202) ( 59,087)
-------- --------
$183,112 $173,701
======== ========
</TABLE>
3. REORGANIZATION VALUE IN EXCESS OF AMOUNTS ALLOCABLE TO IDENTIFIABLE ASSETS
--------------------------------------------------------------------------
The activity for reorganization value is presented below (in thousands):
<TABLE>
<CAPTION>
January 31, February 1,
1998 1997
------------ -----------
<S> <C> <C>
Balance at beginning of period $ 97,508 $107,514
Amortization ( 5,850) ( 6,050)
Tax benefit applied to reduce
reorganization value ( 2,546) ( 2,592)
Impairment of long-lived assets and
store closings - ( 1,364)
-------- --------
Balance at end of period $ 89,112 $ 97,508
======== ========
</TABLE>
Accumulated amortization was $32.0 million at January 31, 1998 and $26.2 million
at February 1, 1997.
F-8
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES
-------------------------------------------
Significant components of other accounts payable and accrued expenses are
presented below (in thousands):
<TABLE>
<CAPTION>
January 31, February 1,
1998 1997
----------- -----------
<S> <C> <C>
Other accounts payable and accrued expenses:
Accrued payroll and related costs $ 20,880 $ 22,074
Taxes, other than income tax 13,988 13,418
Other 42,935 46,260
-------- --------
$ 77,803 $ 81,752
======== ========
</TABLE>
5. SECURED CREDIT FACILITY
-----------------------
The Company, through its wholly-owned operating subsidiaries Hills Department
Store Company (HDSC), maintains a $300 million secured credit facility (the
"Facility"), which matures in February, 2001. Borrowings under the Facility
include revolving working capital borrowings on a seasonal need basis and a
$10 million term note. Maximum borrowings under the Facility are limited by
an inventory-based borrowing base, as defined, and outstanding letters of
credit; up to $200 million of the Facility is available to secure letters of
credit. Borrowings under the Facility bear interest, at the option of the
Borrowers, at either of (1) the Bank of America's "reference rate" plus a
margin ranging up to 0.75% or (2) LIBOR plus a margin ranging from 1.5%
to 2.5% (2.25% at January 31, 1998). The Company pays fees on the average
undrawn letter of credit amount at an annual rate ranging from 1.5% to 2.25%,
and pays commitment fees at an annual rate of 3/8% on the average daily unused
portion of the commitment. Interest rates and fees on undrawn letter of credit
amounts are determined quarterly by the Company's "excess cash flow", as
defined. The Facility is secured by a security interest in tangible and
intangible assets of HDSC, other than certain fixtures, equipment and real
estate. The Facility is also guaranteed by the parent Company (HSC).
The financial covenants under the secured credit agreement require that the
Company maintain levels of consolidated net worth and consolidated cash flow
in excess of certain defined or computed amounts. In addition, the Facility
requires the outstanding principal balance of revolving loans to be zero for
at least thirty consecutive days during the period from December 1 of each year
to March 31 of the next year. The Agreement prohibits the payment of dividends
on the Company's common stock and also contains, among other restrictions,
provisions limiting to varying degrees: business combinations, the issuance of
certain kinds of additional debt and the repurchase and prepayment of debt.
Under the Agreement, HDSC is only permitted to make payments or transfers to the
parent Company in the normal course of business as necessary for the parent
Company to service its Senior Note interest obligations and to otherwise conduct
F-9
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. SECURED CREDIT FACILITY (CONTINUED)
-----------------------------------
its activities as a holding company. (Net assets of HDSC and its subsidiaries
at January 31, 1998 totaled $451 million.)
The term loan component of the secured credit Facility requires quarterly
payments of $500,000 beginning November 1998, and continuing until the earlier
of (1) full payoff or (2) agreement termination (whereupon a balloon payment
for the balance plus accrued and unpaid interest is payable.)
At January 31, 1998, the Company had $10 million of term loan borrowings under
the Facility, had no revolving borrowings, had outstanding letters of credit
totaling $40.3 million, had maintained its annual clean-up period for more than
the required thirty consecutive days, and was in compliance with all covenants
and restrictions.
In connection with replacing the prior Facility with the above Facility in
fiscal year 1996 with a new group of lenders, the Company recognized an
extraordinary after-tax loss for early extinguishment of debt of $2.3 million
($3.8 million pretax) from the write-off of deferred financing costs related to
the prior credit facility. Front-end fees in connection with the Facility were
$2.9 million. Additionally, $0.9 million of fees were paid in connection with
the two amendments during fiscal year 1997 which, among other things, extended
the maturity of the Facility. These fees are being amortized over the life of
the Facility.
6. LONG TERM DEBT
--------------
Long term debt at each year-end consisted of (in thousands):
<TABLE>
<CAPTION>
January 31, February 1,
1998 1997
----------- -----------
<S> <C> <C>
12 1/2% Senior Notes, due 2003 $195,000 $195,000
Secured term note (see Note 5) 10,000 -
-------- --------
205,000 195,000
Less current portion of secured term note ( 500) -
-------- --------
Net long term debt $204,500 $195,000
======== ========
</TABLE>
The 12 1/2% unsecured Senior Notes (the "Senior Notes") pay interest
semiannually, are noncallable, and are unconditionally guaranteed by all the
subsidiaries of the Company. The subsidiary guarantees are subordinate to
borrowings under the secured credit facility (see Note 5). The Senior Notes
contain covenants regarding limitations on debt incurrence and the issuance of
preferred stock. Additionally, the Senior Notes place limitations on the
Company and its subsidiaries relative to the payment of dividends or
distributions.
F-10
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG TERM DEBT (CONTINUED)
--------------------------
The estimated fair value of the Senior Notes was approximately $164 million at
January 31, 1998 and $144 million at February 1, 1997. These values were based
on quoted market prices in effect at those dates.
In fiscal year 1996, in connection with the sale of the Senior Notes, the
Company offered to redeem all of its outstanding 10.25% Senior Notes due 2003
(the "Old Senior Notes") at a redemption price equal to 101% of principal, plus
accrued interest. Pursuant to this offer, the Company subsequently redeemed
approximately $155 million of its approximately $157.5 million of outstanding
Old Senior Notes. The Company later called for redemption of the
approximately $2.5 million of remaining outstanding Old Senior Notes at the
indenture specified price of 104% of principal plus accrued interest. In
addition, the Company deposited, in trust, funds sufficient to redeem, upon
issuance, approximately $2.5 million of Old Senior Notes yet to be issued under
the terms of the Company's 1993 Plan of Reorganization (the "POR"). As a result
of these transactions, the Company recognized an extraordinary after-tax loss
for early extinguishment of debt of $2.0 million ($3.5 million pre-tax). The
extraordinary loss included the redemption premiums and the write-off of the
related deferred financing costs.
Separate financial statements of the Company's subsidiary guarantors have not
been provided because (1) the subsidiary guarantors constitute all of the
Company's direct and indirect subsidiaries, (2) they have fully and
unconditionally guaranteed the New Senior Notes on a joint and several basis,
(3) their aggregate assets, liabilities, earnings and equity are substantially
equivalent to those of the Company on a consolidated basis, and (4) separate
financial statements are not deemed to be material to investors.
7. LEASE COMMITMENTS
-----------------
The Company's operations are conducted predominantly in leased properties which
consist principally of retail outlets. Leases are generally for periods between
twenty to thirty years plus renewal options and generally include fixed rentals
and rentals based on sales in excess of predetermined levels.
The composition of property under capital leases, net of accumulated
amortization, is shown below (in thousands):
<TABLE>
<CAPTION>
January 31, February 1,
1998 1997
----------- -----------
<S> <C> <C>
Retail outlets $138,094 $138,094
Other 982 982
-------- --------
139,076 139,076
Accumulated amortization ( 36,726) ( 26,875)
-------- --------
Property under capital leases, net $102,350 $112,201
======== ========
</TABLE>
F-11
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LEASE COMMITMENTS (CONTINUED)
----------------------------
Consolidated rental expense under operating leases and rental expense based on
sales in excess of predetermined levels under capital leases are presented
below (in thousands):
<TABLE>
<CAPTION>
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
January 31, February 1, February 3,
1998 1997 1996
---------------------------------------------
<S> <C> <C> <C>
Capital leases:
Rental based on sales $ 803 $ 801 $ 1,251
Operating leases:
Minimum facility rentals 28,415 29,125 26,133
Equipment and other rentals 12,905 14,647 17,706
Rental based on sales 1,533 1,511 1,244
------- ------- -------
Consolidated rental expense $43,656 $46,084 $46,334
======= ======= =======
</TABLE>
At January 31, 1998, the financing obligations represent sale/leaseback
arrangements. The related property associated with these transactions, which
has a net book value of $62.4 million at January 31, 1998, remains in property
and equipment on the Company's books and continues to be depreciated. The
leases, which have terms from 42 months to ten years, include options to
purchase some or all of the assets either at the end of the initial lease term
or renewal periods at an amount not greater than the then current fair market
value of the properties. During fiscal year 1996, the Company obtained $16.6
million of financing through such arrangements.
Minimum future lease commitments under noncancelable leases in effect at
January 31, 1998 are listed below (in thousands):
<TABLE>
<CAPTION>
Capital Financing Operating
Fiscal years: Leases Obligations Leases Total
---------------------------------------------
<S> <C> <C> <C> <C>
1998 $ 19,488 $ 8,369 $ 35,290 $ 63,147
1999 19,159 7,699 30,817 57,675
2000 17,396 7,789 27,742 52,927
2001 16,931 6,257 24,906 48,094
2002 16,546 8,393 21,926 46,865
Thereafter 151,754 17,389 122,674 291,817
---------------------------------------------
Minimum rental commitments 241,274 $55,896 $263,355 $560,525
===================
Less amount representing
interest 120,579 21,796
-------- -------
Present value of net minimum
lease payments 120,695 34,100
Current portion ( 6,776) ( 3,765)
-------- -------
$113,919 $30,335
======== =======
</TABLE>
F-12
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE PLAN BENEFITS
----------------------
POST RETIREMENT BENEFITS
The Company accounts for postretirement benefits (such as health care) in
accordance with Statement of Financial Accounting Standards No. 106: "Employers'
Accounting for Postretirement Benefits Other Than Pensions" ("FAS 106"). This
statement requires accrual of postretirement benefits during the years an
employee provides services. Under FAS 106, the Company recognized expenses of
$0.2 million in fiscal years 1997, 1996 and 1995, respectively. The Company
funds benefit costs principally on a pay-as-you-go basis. The status of the
plan is as follows (in thousands):
<TABLE>
<CAPTION>
January 31, February 1,
1998 1997
----------- -----------
<S> <C> <C>
Accumulated postretirement
benefit obligation ("APBO") for:
Active employees $ 2,399 $ 2,212
Retirees 83 303
------- -------
2,482 2,515
Plan assets at fair value - -
------- -------
Unfunded APBO 2,482 2,515
Unrecognized actuarial gain 1,352 1,329
------- -------
Accrued postretirement benefit cost $ 3,834 $ 3,844
======= =======
</TABLE>
The assumed health care cost trend rate used in measuring the APBO was 10% in
fiscal year 1997 (8% for Medicare eligible retirees); grading down to 5% (5% for
Medicare eligible retirees) by fiscal year 2002 and remaining at that level
thereafter. A one percentage point increase in the assumed health care cost
trend rate would increase the APBO at the end of fiscal year 1997 by $367,400
(or by 15%) and the service and interest cost by $36,800 (or by 11%). The
assumed discount rate used in determining the APBO was 7% for both years.
401(k) PLAN
The Company offers a defined contribution 401(k) savings plan (the "401(k)") for
employees meeting certain employment conditions. In addition to permitting
employee contributions, the 401(k) plan provides for Company matching
contributions. Company matching contributions were $3.0 million in fiscal year
1997, $3.6 million in fiscal year 1996 and $3.9 million in fiscal year 1995.
9. HILLS STORES SERIES A CONVERTIBLE PREFERRED STOCK
-------------------------------------------------
The Company is authorized to issue 15,000,000 shares of preferred stock, par
value of $0.10 per share. Pursuant to the POR 5,000,000 of shares were
authorized to be issued as Hills Stores Series A Convertible Preferred Stock
F-13
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. HILLS STORES SERIES A CONVERTIBLE PREFERRED STOCK (CONTINUED)
------------------------------------------------------------
(the "Preferred Stock"). As of January 31, 1998, a total of 50,060 shares of
the 5,000,000 shares of the Preferred Stock remain to be issued pending
resolution of prepetition claims and interests pursuant to the POR.
The Preferred Stock is convertible by the holders, at any time, into Hills
Stores common stock at a rate of one share of Common Stock for each share of
the Preferred Stock, subject to antidilution adjustments. During fiscal year
1997, 86,625 shares of the Preferred Stock were converted to common stock on a
share for share basis. As of January 31, 1998 and February 1, 1997, 855,109 and
941,344 shares, respectively, were outstanding.
Each share of Preferred Stock has one vote per share in the same class as the
shares of common stock. The holders of the Preferred Stock are entitled to
dividends when and if declared by the Board of Directors; however, dividend
payments are restricted under the terms of the Facility and the New Senior
Notes. The Company does not expect to pay dividends in the foreseeable future.
The Company may redeem, at its option prior to October 4, 2008, all or part of
the outstanding Preferred Stock at $20 per share; and in any case shall redeem
all of the outstanding shares of Preferred Stock on October 4, 2008 at $20 per
share. Upon dissolution or liquidation of the Company, the holders of the
Preferred Stock will be entitled to receive $20 per share out of the assets of
the Company available for distribution to shareholders, in preference to the
holders of common stock and any other class or series of capital stock of the
Company that is junior to the Preferred Stock.
10. HILLS STORES COMMON STOCK
-------------------------
Each holder of common stock has one vote per share and is entitled to dividends
when and if declared by the Board of Directors. However, dividend payments are
restricted under the terms of the Facility and the Senior Notes. The Company
does not expect to pay dividends in the foreseeable future. As of January 31,
1998, a total of 58,151 shares of common stock remain to be issued pending
resolution of prepetition claims and interests, pursuant to the POR.
11. STOCK COMPENSATION PLANS
------------------------
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"). FAS 123 encourages, but does not require, the
recognition of compensation expense for the fair value of stock options and
other equity instruments issued to employees. This statement gives entities a
choice of recognizing related compensation expense by adopting the new fair
value method or to continue to measure compensation using the intrinsic value
approach under Accounting Principles Board Opinion No. 25 ("APB 25"), the
former standard. If the fair value provisions of FAS 123 are not adopted,
companies are required to disclose the proforma amounts of net earnings and
earnings per share that would have been reported had these provisions been
F-14
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK COMPENSATION PLANS (CONTINUED)
------------------------------------
adopted. The Company has chosen to continue to recognize compensation expense
under APB 25. Accordingly, no compensation cost has been recognized for its
fixed stock option plans, other than for options granted in connection with
consulting services. Such compensation expense was $61,000 and $73,000 for
fiscal years 1997 and 1996, respectively.
The Company has stock-based compensation plans, which are described below.
1993 STOCK OPTION PLAN
In October 1993, the Company established an incentive and nonqualified stock
option plan (the "Option Plan") providing for the grant of nonqualified stock
options or incentive stock options. The options are granted at prices greater
than or equivalent to the market price of the common stock on the date of each
grant. The options are generally subject to a five year vesting schedule, with
initial vesting beginning one year from the date of the grant, and expire ten
years from the date of the grant. A total of 1,303,763 shares of common stock
are reserved for grants of options under the Option Plan. During fiscal years
1997, 1996 and 1995 eligible participants were allowed, for a limited time, to
exchange existing options for new options with an exercise price of $5.00,
$10.125 and $12.00, respectively. The 1997 repricing was for a reduced number
of new options. The options exchanged in 1997 were subject to additional
vesting restrictions which prohibited exercise of any vested option for one year
and 50% of the vested options for two years from the date of the repricing.
1996 DIRECTORS STOCK OPTION PLAN
During fiscal year 1996, the Company received shareholder approval of a stock
option plan for non-employee members of the Board of Directors. The plan
provided for an initial grant of 4,000 options to each non-employee member of
the Board of Directors with subsequent annual automatic grants of 2,000 options.
All options are granted at prices greater than or equivalent to the market price
of the common stock on the date of each grant. The options are subject to a
three year vesting schedule with vesting beginning from the date of the grant.
A total of 100,000 shares of common stock are reserved for grants under the
plan. In March 1997, participants were allowed to exchange existing options
for a reduced number of new options with an exercise price of the greater of
$5.00 or the closing share price on the date of acceptance. The repriced
options were subject to additional vesting restrictions which prohibited
exercise of any vested option for one year and 50% of the vested options for
two years from the date of the repricing.
RESTRICTED STOCK AGREEMENTS
In fiscal year 1996, the Company entered into restricted stock agreements with
the Chairman of the Board and the President and Chief Executive Officer.
Pursuant to the agreements, the Company issued 120,000 shares of common stock
subject to certain restrictions. Unearned compensation was charged for the
market value of the restricted shares, shown as a reduction of common
shareholders' equity in the accompanying consolidated balance sheet, and is
F-15
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK COMPENSATION PLANS (CONTINUED)
------------------------------------
RESTRICTED STOCK AGREEMENTS (CONTINUED)
being amortized ratably over the restricted period. The weighted-average fair
value of shares granted during fiscal year 1996 was approximately $10.00 per
share. During fiscal years 1997 and 1996, approximately $356,000 and $405,000
respectively, was charged to expense.
PROFORMA INFORMATION
Had compensation cost for the Company's two fixed stock option plans and the
associate stock purchase plan been determined based on the fair value at the
grant dates for awards under those plans consistent with the method of FAS 123,
the Company's net loss and loss per share would have increased to the proforma
amounts indicated below:
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C> <C>
Net loss As reported ($ 9,015) ($35,058) ($16,666)
Proforma ($10,264) ($36,349) ($18,244)
Basic and diluted loss
per share As reported ($ 0.87) ($ 3.42) ($ 1.70)
Proforma ($ 0.99) ($ 3.55) ($ 1.86)
</TABLE>
The effects of applying FAS 123 in this proforma disclosure are not indicative
of future amounts. The proforma disclosure does not include awards prior to
1995 or additional awards which are anticipated to be made in future years.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in fiscal years 1997, 1996 and 1995: dividend yield
of zero; expected volatility of 50%, risk-free interest rate of 6.22%, 5.83% and
5.77% respectively; and expected lives of five years.
F-16
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK COMPENSATION PLANS (CONTINUED)
------------------------------------
<TABLE>
A summary of the status of the Company's fixed stock option plans as of January 31, 1998, February 1, 1997
and February 3, 1996, and changes during the years ending on those dates, is presented below:
<CAPTION>
1997 1996 1995
------------------------ ------------------------- -----------------------
Weighted- Weighted- Weighted-
Average Average Average
Fixed Options Shares Exercise Price Shares Exercise Price Shares Exercise Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 871,580 $ 10.64 416,797 $ 12.36 1,014,021 $ 18.48
Granted 317,950 4.22 678,751 11.08 203,000 12.75
Exchanged November 4, 1995 - - - - ( 337,200) 18.26
Issued in exchange on November 4, 1995 - - - - 224,797 12.00
Exchanged on March 8, 1996 - - ( 330,000) 12.00 - -
Issued in exchange on March 8, 1996 - - 330,000 10.12 - -
Exchanged on March 11, 1997 (687,482) 10.58 - - - -
Issued in exchange on March 11, 1997 453,305 5.00 - - - -
Exercised - - - - ( 4,300) 18.25
Forfeited (106,739) 7.26 ( 223,968) 12.42 ( 683,521) 18.49
------- -------- ---------
Outstanding at end of year 848,614 5.69 871,580 10.64 416,797 12.36
======= ======== =========
Options exercisable at year-end 200,715 141,961 231,894
Weighted-average fair value of
options granted during the year $ 2.18 $ 5.60 $ 6.40
</TABLE>
<TABLE>
<CAPTION>
The following table summarizes information about fixed stock options outstanding at January 31, 1998:
Options Outstanding Options Exercisable
------------------------------------------------------ --------------------------------
Number Weighted-Average Number
Range of Outstanding Remaining Weighted-Average Exercisable Weighted-Average
Exercise Prices at 1/31/98 Contractual Life Exercise Price at 1/31/98 Exercise Price
<C> <C> <C> <C> <C> <C>
$2.75 - $ 3.75 74,500 9.5 years $ 3.08 2,000 $ 3.00
$3.88 - $ 4.63 206,450 9.0 years $ 4.43 0 $ 0.00
$5.00 - $ 5.13 438,214 7.9 years $ 5.01 136,844 $ 5.00
$7.63 - $18.25 129,450 7.3 years $11.52 61,871 $12.21
------- -------
848,614 200,715
======= =======
</TABLE>
F-17
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK COMPENSATION PLANS (CONTINUED)
------------------------------------
ASSOCIATE STOCK PURCHASE PLAN
Under the Associate Stock Purchase Plan, the Company is authorized to issue up
to 500,000 shares of common stock to its full-time employees. Under the terms
of the Plan, during each semiannual subscription period associates can choose
to have up to 10 percent of their annual base earnings, up to $25,000, withheld
to purchase the Company's common stock. The purchase price of the stock is 85
percent of the lower of its market price at the commencement date or at the
termination date of each offering period. During fiscal year 1997, the Company
issued 21,901 shares pursuant to this plan. The Company anticipates issuing
approximately 25,000 shares for the subscription period ending on June 30,
1998.
12. SERIES 1993 STOCK RIGHTS
------------------------
Each Series 1993 Stock Right (the "Stock Right") entitles the holder to acquire,
at $0.01 per share, shares of common stock, subject to antidilution adjustments,
as determined pursuant to a formula which is based on the Company's proforma
utilization of certain tax benefits as defined in the Stock Right Agreements.
Shares under the Stock Right Agreements are not available for issuance until
vested. During 1995, the Company repurchased 693,949 of its 700,000 outstanding
stock rights in exchange for 198,271 shares of newly issued common stock. The
aggregate par value of the newly issued common stock was reclassified from
additional paid-in capital to common stock. As of January 31, 1998 and
February 1, 1997, 6,051 rights were outstanding.
13. SERIES 1993 WARRANTS
--------------------
Each Series 1993 Warrant entitles the holder to purchase, subject to
antidilution adjustments, one share of common stock at $30 per share. The
Warrants are callable by the Company at $.01 per Warrant at any time after
October 4, 1998 if the average closing price of common stock, subject to
antidilution adjustments, for a period of thirty consecutive trading days is
equal to or greater than $35 per share. The Warrants expire on October 4, 2000.
During fiscal year 1995, 87 warrants were exercised. None were exercised during
fiscal years 1997 and 1996. As of January 31, 1998 and February 1, 1997,
432,903 warrants were outstanding and 432,903 shares of common stock were
reserved for issuance upon exercise of the warrants.
14. RIGHTS AGREEMENT
----------------
Pursuant to a Rights Agreement adopted on August 16, 1994, the Company declared
a distribution of one purchase right (the "Right") for each share of Common
Stock and Preferred Stock then outstanding. Each Right would initially entitle
the holder to purchase, subject to adjustment, one one-thousandth share of the
Company's Series B Participating Cumulative Preferred Stock, consisting of
55,000 shares authorized, $.10 par value per share, at an exercise price of $75
F-18
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. RIGHTS AGREEMENT (CONTINUED)
----------------------------
per one one-thousandth share. Each share of Common Stock and Preferred Stock
issued after August 16, 1994 will also have one Right attached. The Rights
expire August 16, 2004 and, under certain conditions, may be redeemed by the
Company at a price of $.01 per Right. The Rights have no voting or dividend
privileges and are not currently separable from the capital stock. The Rights
would become exercisable if certain events occurred relating to a person or
group (the "Acquiring Person") acquiring or attempting to acquire 20% or more
of the outstanding shares of capital stock other than through a qualifying
tender offer. Upon the occurrence of such an event, each Right (except the
Rights beneficially owned by the Acquiring Person, which become null and void)
entitles its holder to purchase for $75 the economic equivalent of Common
Stock, or in certain circumstances, securities of the Acquiring Person, or its
affiliate, worth twice as much. After there is an Acquiring Person, the Rights
may be exchanged, at the election of the Company, for consideration per Right
consisting of one-half of the securities that would otherwise be issuable at
that time.
15. IMPAIRMENT OF LONG-LIVED ASSETS AND STORE CLOSINGS
--------------------------------------------------
Effective February 4, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121: "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" ("FAS 121"). FAS 121
requires that the carrying value of long-lived tangible and certain intangible
assets be evaluated periodically in relation to the operating performance and
estimated future cash flows of the underlying assets. In accordance with
FAS 121, the Company recognized a pre-tax charge of $23.6 ($11.7 million in the
first quarter of fiscal 1996 and $11.9 million in fourth quarter of fiscal
1996, in connection with the store closings and impairments) to reduce the
carrying value of certain of its long-lived tangible and intangible assets to
their estimated fair market value. The impaired assets include property and
equipment, beneficial lease rights and reorganization value related to
underperforming stores. The fair value was based on estimated future cash
flows to be generated by these stores, discounted at a rate commensurate with
the risks involved.
In January 1997, the Company announced plans to close ten stores during the
first quarter of fiscal year 1997 as part of its initiatives to improve
profitability. In connection with these closures, the Company recorded in
fiscal year 1996 a pretax charge of $10.1 million to cover costs for disposal
of inventories ($5.3 million), lease terminations, net ($3.2 million), and other
related costs ($1.6 million).
During fiscal year 1997, approximately $4.8 million was incurred and charged
against the accrual for store closings, consisting primarily of cash payments
relating to lease terminations. The majority of the January 31, 1998 liability
totalling $6.9 million is expected to be paid during fiscal years 1998 and 1999.
These 10 stores generated 4.6% and 3.9% of the total net sales of the Company
during fiscal years 1996 and 1995, respectively. In addition, these stores had
F-19
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. IMPAIRMENT OF LONG-LIVED ASSETS AND STORE CLOSINGS (CONTINUED)
--------------------------------------------------------------
operating losses, excluding corporate overhead allocations, of $4.3 million and
$1.7 million for fiscal years 1996 and 1995.
16. INCOME TAXES
------------
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109: "Accounting for Income Taxes" ("FAS 109"). Under
FAS 109, deferred taxes are computed on the difference between the bases of
assets and liabilities for tax reporting purposes and their corresponding bases
for financial reporting purposes. Deferred tax assets, net of appropriate
valuation reserves, may be recorded.
Temporary differences and carryforwards which give rise to significant deferred
tax assets and liabilities are as follows (in thousands):
<TABLE>
<CAPTION>
January 31, 1998 February 1, 1997
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Asset Liability Asset Liability
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Net operating loss and
tax credit carryforwards $ 74,369 $ - $ 58,307 $ -
Capital lease obligations 46,943 - 49,959 -
Assets under capital leases - 39,303 - 45,544
Accrued expenses 33,144 - 37,102 -
Beneficial lease rights 14,800 - 17,161 -
Property and equipment - 21,155 - 15,359
Inventories 5,356 - 11,922 -
Financing obligation-sale/
leaseback 8,984 - 11,717 -
Other 10,421 - 10,629 -
-------- -------- -------- -------
Total deferred taxes 194,017 60,458 196,797 60,903
Valuation allowance ( 78,034) - ( 81,318) -
-------- -------- -------- -------
Net deferred taxes $115,983 $ 60,458 $115,479 $60,903
======== ======== ======== =======
</TABLE>
The consummation of the POR resulted in a change in ownership for federal income
tax purposes. Subsequent to the POR, a second change in ownership occurred for
federal income tax purposes. As a result, the Company's ability to utilize its
net operating loss and tax credit carryforwards is subject to an annual
limitation of $15.8 million. This limitation may be changed if additional
changes in ownership (generally determined by the creation of new 5% equity
ownership blocks, accumulating to 50%, over a rolling three year period) are
deemed to occur subsequent to the second ownership change. For fiscal years
1996 and 1997, the Company generated estimated net operating tax loss
carryforwards of $19.7 million. Total deferred tax assets as of January 31,
1998, include $78.0 million of deferred tax assets which arose before the
F-20
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. INCOME TAXES (CONTINUED)
------------------------
Company's emergence from bankruptcy and which have been fully reserved. For
financial reporting purposes, any benefit derived from the reduction of the
valuation allowance related to deferred tax assets in existence at October 4,
1993 will not be credited to the tax provision, but instead will ultimately
reduce Reorganization Value.
Federal income tax carryforwards at January 31, 1998 consisted of $3.0 million
of Alternative Minimum Tax credits which do not expire, and net operating losses
and general business credits which expire as follows (in thousands):
<TABLE>
<CAPTION>
Net Operating Tax
Losses Credits
----------------------------------
<S> <C> <C>
Fiscal years:
2000 $ - $ 413
2001 - 797
2002 - 664
2003 - 1,369
2004 329 2,196
2005 - 1,547
2006 60,901 949
2007 56,848 797
2008 10,954 944
2009 - 174
2010 - 492
2011 21,519 -
2012 19,661 -
----------------------------------
$170,212 $10,342
==================================
</TABLE>
The provision (benefit) for income taxes consists of the following components
(in thousands):
<TABLE>
<CAPTION>
Fiscal Year Ended
January 31, February 1, February 3,
1998 1997 1996
----------------------------------------------
<S> <C> <C> <C>
Current provision:
Federal ($ 3,096) ($ 3,673) $ 227
State and local ( 301) ( 587) 23
------- ------- -------
( 3,397) ( 4,260) 250
Deferred provision:
Federal ( 865) ( 9,159) ( 9,986)
State and local ( 84) ( 3,173) ( 1,274)
------- ------- -------
( 949) ( 12,332) ( 11,260)
Amount to be applied to
reorganization value 2,546 2,592 14,197
------- ------- -------
Total tax provision (benefit) ($ 1,800) ($14,000) $ 3,187
======= ======= =======
</TABLE>
F-21
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
16. INCOME TAXES (CONTINUED)
------------------------
The income tax provision in each of the periods presented reflects an effective
tax rate that differs from the statutory federal income tax rate for those
periods. For net earnings (loss) from operations before extraordinary items,
the table below reconciles the federal statutory rate to the effective tax rate.
<TABLE>
<CAPTION>
Fiscal Year Ended
January 31, February 1, February 3,
1998 1997 1996
-------------------------------------------
<S> <C> <C> <C>
Statutory tax rate (35.0%) (35.0%) (35.0%)
State and local income taxes,
net of federal tax benefit ( 0.6 ) ( 2.7 ) 3.7
Goodwill 18.9 5.8 20.1
Targeted jobs credit
and other, net 0.1 0.6 0.7
Change in control costs - - 34.2
----- ----- -----
Effective tax rate (16.6%) (31.3%) 23.7%
===== ===== =====
</TABLE>
The IRS is nearing completion of its audit of fiscal years 1991, 1992 and 1993.
The Company has filed a Protest to certain adjustments proposed by the IRS. The
Company does not believe the final adjustments resulting from this examination
would have a material adverse effect on the Company's financial condition.
17. EARNINGS PER SHARE
------------------
In fiscal year 1997, the Company adopted Statement of Financial Accounting
Standards Number 128, "Earnings per Share" ("FAS 128"). FAS 128 requires the
presentation of "basic" earnings per share (income applicable to common
shareholders divided by the weighted-average number of common shares outstanding
during the period) and "diluted" earnings per share (which gives effect to all
dilutive potential common shares that were outstanding during the period). All
prior-period earnings per share data have been restated to conform to FAS 128.
Basic and diluted earnings per share are the same for the periods ended
January 31, 1998, February 1, 1997 and February 3, 1996, as all common stock
equivalents are antidilutive, due to the net loss incurred during these periods.
Basic earnings per share was computed based on the weighted average number of
common shares assumed to be outstanding during each period. Such shares
amounted to 10,387,080, 10,252,022 and 9,809,675 for fiscal years 1997, 1996
and 1995, respectively.
If the impact would be dilutive, the following securities would be included in
the calculation of diluted earnings per share: preferred stock, stock options,
series 1993 Warrants and stock rights (contingently issuable as described in
Note 14).
F-22
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. COMMITMENTS AND CONTINGENCIES
-----------------------------
In September 1995, the Company and HDSC filed a suit in the Court of Chancery
of the State of Delaware against the former members of the Board of Directors
(the "Former Directors") of the Company. That action seeks, among other things,
recovery of damages caused by the breach by the Former Directors of their
fiduciary duties to shareholders arising from the refusal of the Former
Directors to approve the change in control which took place on July 5, 1995 (the
"1995 Change of Control") following the election of seven replacement directors
by the shareholders of the Company. In October 1995 the defendants filed a
motion to dismiss the suit. In February 1996, the court granted a motion of the
Former Directors to stay discovery pending the outcome of their motion to
dismiss. In March 1997, the court denied the Former Directors' motion to
dismiss.
In April 1997, three of the Former Directors, Michael Bozic, Norman S. Matthews
and John G. Reen, filed a counterclaim against the Company and the seven
replacement directors seeking damages of not less than $2.5 million for breach
of contract, unjust enrichment and intentional interference with contractual
relations arising out of allegations that the Company improperly failed to honor
their request to exercise stock options. The Company believes the counterclaim
is without merit and has denied the allegations and asserted various defenses.
Discovery is ongoing in the case.
In August 1995, in the Court of Chancery of the State of Delaware, three
shareholders of the Company, Gayle Dolowich, Ivan J. Dolowich and Joseph Weiss,
filed a class action lawsuit against the seven new directors of the Company
elected at the 1995 annual meeting, Dickstein Partners Inc. ("Dickstein
Partners") and the Company. In November 1995, the plaintiffs amended their
complaint to include a shareholder's derivative cause of action against the
Former Directors for breach of their fiduciary duties to the Company and its
shareholders. In the amended complaint, the plaintiffs claim (under Section
225 of the Delaware Corporation Code) that in connection with Dickstein Partners
effort to solicit proxies in support of the election of its nominees for
directors of the Company, Dickstein Partners issued a number of false and
misleading statements regarding its offer to acquire all of the Company's shares
it did not already own. On the Section 225 claim, the plaintiffs seek an order
nullifying the election of directors and declaring there has been "no change of
control" of the Company. The derivative cause of action seeks damages against
the Former Directors. In January 1996 in the same Delaware Chancery Court,
another shareholder, Peter M. Fusco, filed a substantially similar class action
and shareholder derivative suit against the parties named in the Dolowich suit.
The Former Directors filed a motion to dismiss the Dolowich and Fusco suits, and
in March 1997 the court denied that motion.
The Company is also involved in various suits and claims in the ordinary course
of business.
Management does not believe that the disposition of such suits and claims will
have a material adverse effect upon the continuing operations and financial
position of the Company.
F-23
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. CHANGE IN CONTROL
-----------------
On July 5, 1995, following a proxy contest in connection with the annual
meeting of shareholders held on June 23, 1995, nominees of Dickstein Partners
were certified as being elected to the Board of Directors. The Company
reimbursed Dickstein Partners for, or directly paid, approximately $1.9 million
in third-party fees and expenses incurred or committed to by Dickstein Partners
in connection with the proxy contest and the related acquisition proposal of
Dickstein Partners. This amount included $1.0 million paid by the Company to
the financial advisor of Dickstein Partners, in respect of the advisor's
proposal to refinance the indebtedness of the Company accelerated as a result of
the election of the Dickstein Partners nominees. These costs are included in
the Consolidated Statements of Operations in costs related to change in control.
In connection with the change in control, the Company recognized $45.5 million
in expense, including $31.0 million related to severance and retirement
payments, including certain taxes attributable thereto, to six senior
executives, a consultant to the Company and approximately twenty associates of
the Company, $6.0 million paid to holders of the Senior Notes, and legal and
other miscellaneous change in control costs.
20. SELF-TENDER FOR COMMON STOCK
----------------------------
In August 1994, Dickstein Partners, L.P., et al. ("Dickstein") commenced a
consent solicitation to replace four members of the then current Board of
Directors with Dickstein nominees. In response to the Dickstein consent
solicitation, the Company's Board of Directors announced a program to enhance
shareholder value, including the approval of a self-tender to purchase up to
3,000,000 common shares at $25 per share in cash. Effective February 21, 1995,
the Company accepted for payment 3,000,000 shares of Common Stock which were
validly tendered pursuant to the Company's offer, and for which payment of
$75,000,000 was made in March 1995. The excess of the purchase price over the
original issue price of the Common Stock, or $15,000,000, was charged to
retained earnings. In connection with this offer, 561,863 shares of Preferred
Stock were converted to Common Stock.
F-24
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<CAPTION>
21. STATEMENTS OF CASH FLOWS
------------------------
Supplemental disclosures of cash flow information are presented in the table
below:
Fiscal Year Fiscal Year Fiscal Year
Ended Ended Ended
January 31, February 1, February 3,
(in thousands) 1998 1997 1996
------------------------------------------
<S> <C> <C> <C>
NONCASH INVESTING AND
FINANCING ACTIVITIES:
Preferred stock conversions
to common stock $ 1,733 $ 4,694 $39,508
Capital lease obligations, net - 3,735 -
CASH PAID:
Interest 50,059 50,122 38,655
Income taxes ( 834) ( 8,956) 17,877
</TABLE>
F-25
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
<CAPTION>
22. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
-------------------------------------------
(in thousands, First Second Third Fourth
except per share amounts) Quarter Quarter Quarter Quarter
-----------------------------------------------------
<S> <C> <C> <C> <C>
FISCAL YEAR 1997
- ----------------
Net sales $353,504 $349,269 $434,555 $630,946
======== ======== ======== ========
Gross profit $ 96,784 $ 86,148 $115,101 $163,906
======== ======== ======== ========
Net earnings (loss) (2) ($ 9,820) ($ 16,119) ($ 3,946) $ 20,870 (1)
======== ======== ======== ========
Basic earnings (loss) per
common share ($ 0.95) ($ 1.56) ($ 0.38) $ 2.00
======== ======== ======== ========
Diluted earnings (loss) per
common share (3) ($ 0.95) ($ 1.56) ($ 0.38) $ 1.84
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
FISCAL YEAR 1996
- ----------------
<S> <C> <C> <C> <C>
Net sales $370,248 $388,600 $460,983 $658,646
======== ======== ======== ========
Gross profit $ 99,263 $ 97,691 $120,831 $168,339
======== ======== ======== ========
Loss before extraordinary loss ($ 14,738) ($ 10,321) ($ 2,804) ($ 2,917)
======== ======== ======== ========
Net loss (2) ($ 14,738) ($ 12,367) ($ 5,036) ($ 2,917)
======== ======== ======== ========
Basic loss per common share:
Loss before extraordinary loss ($ 1.45) ($ 1.01) ($ 0.27) ($ 0.28)
Extraordinary loss - ( 0.20) ( 0.22) -
-------- -------- -------- --------
Net loss ($ 1.45) ($ 1.21) ($ 0.49) ($ 0.28)
======== ======== ======== ========
Diluted loss per common share:
Loss before extraordinary loss ($ 1.45) ($ 1.01) ($ 0.27) ($ 0.28)
Extraordinary loss - ( 0.20) ( 0.22) -
-------- -------- -------- --------
Net loss ($ 1.45) ($ 1.21) ($ 0.49) ($ 0.28)
======== ======== ======== ========
</TABLE>
F-26
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
_______________________________________________________________________________
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
22. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
-------------------------------------------
(1) Operating expenses for the fourth quarter and fiscal year ended January 31,
1998 included approximately $0.5 million of business process reengineering
costs, incurred primarily during fiscal year 1997 in connection with the
Company's systems replacement initiatives, and charged to earnings as required
by Emerging Issues Task Force Issue 97-13 "Accounting for Costs Incurred in
Connection with a Consulting Contract or an Internal Project That Combines
Business Process Reengineering and Information Technology Transformation".
(2) In fiscal year 1997, the Company modified its approach to calculate the
interim income tax benefit compared with the approach used in fiscal year 1996.
The Company believes the approach used more appropriately reflects income taxes
on a quarterly basis for 1997. Had the 1997 approach been used in 1996, the
income tax provision for the fourth quarter would have been reduced, and the
net loss decreased, by approximately $9.9 million or $0.96 per share,
respectively.
In the fourth quarter of fiscal year 1996, income tax expense included a charge
of $22.8 million as the result of a lower full year effective rate than the
estimated used in the first three-quarters of the fiscal year.
(3) Diluted average shares outstanding used in the quarterly earnings per share
calculations, excluding the fourth quarter in fiscal year 1997, do not include
Preferred Shares, as the effect of the inclusion of such additional shares would
be anti-dilutive.
F-27
<PAGE>
INDEPENDENT AUDITORS' REPORT ON SCHEDULES
To the Board of Directors and Stockholders of
Hills Stores Company and Subsidiaries:
We have audited the accompanying consolidated financial statements of Hills
Stores Company and Subsidiaries as of January 31, 1998 and February 1, 1997
and and for the years ended January 31, 1998, February 1, 1997 and February 3,
1996, and have issued our report thereon dated March 11, 1998; such consolidated
financial statements and report are included elsewhere in this Form 10-K.
Our audits also included the consolidated financial statement schedule of
Hills Stores Company and Subsidiaries for the years ended January 31, 1998,
February 1, 1997 and February 3, 1996, listed in Item 14(a)(2). This
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits. In our
opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Boston, Massachusetts
March 11, 1998
S-1
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
- -------------------------------------------------------------------------------
<CAPTION>
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Fiscal Years Ended January 31, 1998, February 1, 1997 and February 3, 1996.
Additions
Balance at Charged to Deductions Balance at
Beginning Cost and from End of
(in thousands) of Period Expense Reserves Period
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
FISCAL YEAR ENDED JANUARY 31, 1998:
Allowance for doubtful accounts $4,500 $2,944 $1,944 $5,500
====== ====== ====== ======
FISCAL YEAR ENDED FEBRUARY 1, 1997:
Allowance for doubtful accounts $3,459 $1,696 ($ 655) $4,500
====== ====== ====== ======
FISCAL YEAR ENDED FEBRUARY 3, 1996:
Allowance for doubtful accounts $4,228 $1,010 ($1,779) $3,459
====== ====== ====== ======
</TABLE>
S-2
EXHIBIT 10.3
CONSULTING AGREEMENT made as of February 8, 1998, by and between Hills
Department Store Company, a Delaware corporation having its principal office at
15 Dan Road, Canton, Massachusetts ("Principal Office"), and Hills Stores
Company (the "Company"), a Delaware corporation having its principal office at
the Principal Office, and Chaim Y. Edelstein the ("Consultant"), with an office
address of 1040 Park Avenue-12E, New York, New York 10028.
WHEREAS, Consultant is presently working for the Company as a consultant;
and
WHEREAS, the Company desires to secure the continued services of Consultant
and Consultant is willing to continue to provide such services.
NOW, THEREFORE, in consideration of the premises and the mutual covenants
hereinafter contained, the Company and Consultant agree as follows:
SECTION 1. ENGAGEMENT. The Company hereby agrees to continue to engage
Consultant and Consultant hereby accepts such engagement. The Consultant agrees
to provide professional service from time to time and when requested to do so,
to assist the Company with its merchandise, marketing and strategic planning
efforts.
SECTION 2. TERM. The engagement of Consultant by the Company as provided
in Section 1 shall continue to February 7, 1999.
SECTION 3. FEES AND EXPENSES.
(a) FEES. Consultant shall receive the consulting fee, specified in
Schedule A. Consultant will be paid in equal monthly installments on the 1st
day following each calendar month in which consultant's services are provided to
the Company.
(b) BONUS. Consultant shall receive, as a supplemental fee, the bonus
specified in Schedule A, upon the terms and conditions specified in Schedule A.
Such bonus shall be paid to Consultant within sixty (60) days after the end of
the Company's 1998 fiscal year.
(c) EXPENSES. The Company shall reimburse Consultant for all
reasonable and documented out-of-pocket expenses incurred by Consultant in
connection with the business of the Company and in performance of Consultant's
duties under this Agreement.
SECTION 4. TERMINATION BY THE COMPANY. The Company shall have the right
to terminate Consultant's engagement at any time for "Cause." For purposes of
this Agreement, "Cause" shall mean termination by action of a majority of the
members of the Hills Stores Company's Board of Directors, because of:
1
<PAGE>
(i) The Consultant's willful or intentional failure or refusal to
perform or observe any of the Consultant's material duties,
responsibilities or obligations set forth in, or as contemplated
under, this Agreement, if such breach is not cured within 30 days
after notice thereof to the Consultant by the Company;
(ii) Any willful or intentional act or failure to act involving fraud,
theft, embezzlement, dishonesty or moral turpitude (collectively,
"Fraud") affecting the Company or any supplier or employee of the
Company; or
(iii) Conviction of (or a plea of nolo contendere to) an offense which
is a felony in the jurisdiction involved or which is a misdemeanor
in the jurisdiction involved but which involves Fraud.
The Company shall have the right to terminate Consultant's engagement
hereunder at anytime without "cause." If a termination without "cause" occurs:
(i) The Consultant shall be entitled to continuation of his consulting
fee payments through the end of the term, as set forth in Section 7(b).
(ii) Notwithstanding the termination of the Consulting Agreement, all
stock options and restricted stock grants issued to Consultant pursuant to the
February 8, 1996 Consulting Agreement, which have not been otherwise terminated,
shall remain in effect and all vesting and exercise rights of Consultant shall
continue as scheduled, without accelerated vesting.
SECTION 5. TERMINATION BY DEATH. In the event Consultant dies during the
Term, Consultant's engagement shall terminate and the payment of consulting fees
shall cease.
SECTION 6. TERMINATION BY DISABILITY. In the event that Consultant
suffers a disability which prevents Consultant from substantially performing
Consultant's duties under this Agreement for a period of at least ninety (90)
consecutive or nonconsecutive calendar days within any three hundred sixty-five
(365) calendar day period, the Company shall have the right, after such ninety
(90) calendar day period has elapsed, to terminate Consultant's engagement
hereunder and the payment of consulting fees shall cease as of that date.
SECTION 7. TERMINATION BY CONSULTANT. Notwithstanding any other provision
of this Agreement, Consultant may terminate Consultant's engagement following a
Change in Control, by written notice served upon the Company within thirty (30)
calendar days after Consultant has knowledge of an event constituting "Good
Reason."
(a) For purposes of this Agreement, the term "Change in Control" shall
mean any one of the following events:
(i) any "person" as such term is used in Sections 3(a)(9) and
13(d) of the Securities Exchange Act of 1934, other than
Dickstein Partners Inc. and its Affiliates becomes a
"beneficial owner", as such term is used in Rule 13-d-3
promulgated under such Act, of 30% or more of the voting
stock of Hills Stores Company or the majority of the Board
2
<PAGE>
of Directors of Hills Stores Company consist of individuals
other than Incumbent Directors, which term means the members
of the Board on the date of this Agreement; provided that any
person becoming a director subsequent to such date whose
election or nomination for election was supported by a
majority of the directors who then comprised the Incumbent
Directors shall be considered to be an Incumbent Director;
(ii) the Company adopts any plan of liquidation providing for the
distribution of all or substantially all of the assets of the
Company on a consolidated basis;
(iii) Hills Stores Company merges or combines with another company
and, immediately after the merger or combination, the stock-
holders of the Company immediately prior to the combination
hold, directly or indirectly, (1) in the event Hills Stores
Company is the surviving corporation 50% or less of the
voting stock of the combined company or (2) in the event
Hills Stores Company is not the surviving corporation 50% or
less of the voting stock or other ownership interests of the
entity or entities, if any, that succeed to the business of
Hills Stores Company; or
(iv) the Company sells all or substantially all of its assets
determined on a consolidated basis.
For purposes of this Agreement, the term "Good Reason" shall mean:
any failure by the Company to timely pay the amounts or provide
the benefits prescribed by this Agreement, other than an isolated
failure not occurring in bad faith and which is remedied promptly
after receipt of written notice thereof given by Consultant.
(b) In the event of (i) termination of this Agreement by the Company
other than for Cause or (ii) termination of this Agreement by
Consultant for Good Reason after a Change in Control, the Company
shall continue to pay Consultant, the amounts described in Section
3 and in the manner set forth in Section 3 of this Agreement
throughout the term of the Agreement. In the event the Company's
performance bonus goals are met or exceeded for the year in which
such a termination occurs, Consultant shall be entitled to receive
a performance bonus which is prorated to reflect that portion of
the year prior to the termination date, consulting services were
provided to the Company.
SECTION 8. ACCELERATION AND EXPIRATION OF OPTIONS.
(a) Any options to purchase the Common Stock of the Company
("Options") granted by the Company to Consultant that have not yet
become exercisable shall become exercisable upon the earliest to
occur of(i) the termination of Consultant's engagement as a result
of Consultant's death or disability; (ii) the termination by
Consultant with Good Reason; after a Change in Control. Notwith-
standing the foregoing, all Options, whether currently exercisable
or not, shall expire and cease to be exercisable as follows:
3
<PAGE>
(i) if the Company terminates Consultant's engagement for Cause,
immediately upon the effective date of such termination;
(ii) if Consultant dies while engaged by the Company, six (6)
calendar months after Consultant's death; and
(iii) if Consultant's engagement is terminated as a result of
disability, six (6) calendar months after the effective date
of such termination.
(b) Notwithstanding the termination of this Consulting Agreement
(provided Consultant's stock options, as shown on Schedule A
hereto, have not been otherwise terminated pursuant to the terms
of this Consulting Agreement or the terms of the 1993 Incentive
and Nonqualified Stock Option Plan) as long as Consultant is
available, willing and able to provide the Consulting services
contemplated by this Agreement, the stock options shown on
Schedule A shall remain in effect and all vesting and exercise
rights of Consultant with respect to these options shall
continue.
SECTION 9. ACCELERATED VESTING OF RESTRICTED STOCK. Consultant has
received restricted stock grants from the Company which are subject to periodic
vesting. In the event Consultant's engagement with the Company is terminated
(a) as a result of Consultant's death or disability or (b) by Consultant with
good reason after a Change in Control, then all restricted stock held by
Consultant, not otherwise vested, shall become fully vested, subject to the
terms of the restricted stock agreement between the Company and Consultant.
SECTION 10. NO MITIGATION; NO OFFSET. Consultant shall be under no
obligation to mitigate damages or the amount of any payment provided for under
this Agreement by seeking another engagement or otherwise and there shall be no
offset against amounts due Consultant under this Agreement on account of any
remuneration attributable to any subsequent engagement that Consultant may
obtain.
SECTION 11. COVENANTS OF CONSULTANT.
(a) Consultant recognizes that the knowledge of, information
concerning and relationship with customers, suppliers and agents,
and the knowledge of the Company's business methods, systems,
plans and policies which Consultant will establish, receive or
obtain as a consultant to the Company, are valuable and unique
assets of the business of the Company. Consultant will not,
during or within two (2) years after the Term, disclose any such
knowledge or information pertaining to the Company, its customers,
suppliers, agents, policies or other aspects of the business, for
any reason or purpose, whatsoever except pursuant to Consultant's
duties hereunder or as otherwise authorized by the Company in
writing. The foregoing restriction shall not apply, following
termination of Consultant's engagement hereunder, to knowledge or
information which (i) is in or enters the public domain without
4
<PAGE>
violation of this Agreement or other obligations of
confidentiality by Consultant or his agents or representatives,
(ii) Consultant can demonstrate was in his possession on a
non-confidential basis prior to the commencement of his engagement
with the Company, or (iii) Consultant can demonstrate was received
or obtained by him on a non-confidential basis from a third party
who did not acquire it wrongfully or under an obligation of
confidentiality, subsequent to the termination of his engagement
hereunder.
(b) All memoranda, notes, records or other documents made or compiled
by Consultant or made available to Consultant while engaged
concerning customers, suppliers, agents or personnel of the
Company, or the Company's business methods, systems, plans and
policies, shall be the Company's property and shall be delivered
to the Company on termination of Consultant's engagement or at any
other time on request.
(c) During the term of the Consultant's engagement and for two (2)
years thereafter, Consultant shall not, except pursuant to and in
furtherance of his duties hereunder, directly or indirectly
solicit or initiate contact with any employee of the Company with
a view to inducing or encouraging such employee to leave the
employ of the Company for the purpose of being hired by
Consultant, an employer affiliated with him or any competitor of
the Company.
(d) Consultant acknowledges that the provisions of this section are
reasonable and necessary for the protection of the Company and
that the Company will be irrevocably damaged if such covenants are
not specifically enforced. Accordingly, Consultant agrees that,
in addition to any other relief to which the Company may be
entitled in the form of actual or punitive damages, the Company
shall be entitled to seek and obtain injunctive relief from a
court of competent jurisdiction for the purposes of restraining
Consultant from any actual or threatened breach of such covenants.
(e) In the event that, following the termination of this Agreement,
Consultant is entitled to receive any further payments other than
for compensation or other amounts accrued prior to termination or
expiration of this Agreement, such payments shall nonetheless
cease and the Company shall no longer be obligated to make such
payments if there is a material breach of any of the covenants in
this section and Consultant shall forthwith upon demand of the
Company repay any such amounts paid to Consultant subsequent to
the date such breach occurred.
SECTION 12. ENTIRE AGREEMENT. This Agreement contains the entire under-
standing of the parties with respect to the subject matter thereof, and, super-
sedes and replaces in its entirety any and all prior agreements and arrangements
of the parties with respect to the subject matter hereof.
SECTION 13. GOVERNING LAW. This Agreement and all matters and issues
collateral thereto shall be governed by the laws of The Commonwealth of
Massachusetts applicable to contracts performed entirely therein.
5
<PAGE>
SECTION 14. SEVERABILITY. If any of this Agreement, as applied to either
party or to any circumstance, shall be adjudged by a court to be void and
unenforceable, the same shall in no way affect any other provision of this
Agreement or the validity or enforceability thereof.
SECTION 15. NOTICES. All notices or other communications hereunder shall
be given in writing and shall be deemed given if served personally or mailed by
registered or certified mail, return receipt requested, to the parties at their
respective addresses indicated below, or at such other address or addresses as
they may hereafter designate in writing
To the Company c/o: Hills Stores Company
15 Dan Road
Canton, MA 02021-9128
ATTN: Vice President-Secretary
& Corporate Counsel
To the Consultant: At the address noted on Exhibit A.
IN WITNESS WHEREOF, the parties have executed this Agreement on
January 29, 1998.
/s/ Chaim Edelstein
------------------------------
Chaim Edelstein
HILLS DEPARTMENT STORE COMPANY
HILLS STORES COMPANY
BY: /s/ Gregory K. Raven
------------------------------
President
6
<PAGE>
February 8, 1998
SCHEDULE A
TO
CONSULTING AGREEMENT
BETWEEN
HILLS DEPARTMENT STORE COMPANY
AND
CONSULTANT
NAME: Chaim Y. Edelstein
ADDRESS: 1040 Park Avenue - 12E
New York, NY 10028
TITLE OF POSITION: Consultant
TERM OF ENGAGEMENT: February 8, 1998 through
February 7, 1999
ANNUAL CONSULTING FEE: $250,000 - payable in equal monthly
installments of $20,833
BONUS
If the Consultant provides or is available to
provide consulting services to the Company
throughout the term of this Agreement, then
Consultant shall be entitled to a performance
bonus in accordance with the schedule set forth
herein below, provided the Company's
performance goals for the year are achieved.
The Company's performance goals and the
bonus to be paid to Consultant upon attaining
these goals will be determined by the
HR/Compensation Committee at the same time
as the bonus goals are determined for
Company executives.
OPTIONS: An option to purchase 30,000 shares of Hills
Stores Company Common Stock was granted
on February 7, 1996. The purchase price was
$10.125. After elected repricing in 1997 and
an additional option grant in 1997 Consultant
has 19,370 shares at $5.00 per share purchase
price and 5,000 shares at $4.625 per share
purchase price.
RESTRICTED STOCK: 20,000 shares of restricted stock were granted
to Consultant pursuant to a Restricted Stock
Agreement between Hills Stores Company and
Consultant dated February 8, 1996.
7
<TABLE>
EXHIBIT 11.1
HILLS STORES COMPANY AND SUBSIDIARIES
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
<CAPTION>
Thirteen Fiscal Year Thirteen Fiscal Year Fiscal Year
Weeks Ended Ended Weeks Ended Ended Ended
January 31, January 31, February 1, February 1, February 3,
1998 1998 1997 1997 1996
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BASIC
Weighted average number of
common shares assumed to be
outstanding during the period 10,427,983 10,387,120 10,306,070 10,252,022 9,809,675
Assumed conversion of preferred
stock - - - - -
Assumed exercise of stock options - - - - -
Assumed exercise of stock rights - - - - -
---------- ---------- ---------- ---------- ---------
10,427,983 10,387,120 10,306,070 10,252,022 9,809,675
========== ========== ========== ========== =========
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
DILUTED
Weighted average number of
common shares assumed to be
outstanding during the period 10,432,249 10,387,120 10,306,070 10,252,022 9,809,675
Assumed conversion of preferred
stock 910,495 - - - -
Assumed exercise of stock options - - - - -
Assumed exercise of stock rights - - - - -
---------- ---------- ---------- ---------- ---------
11,342,744 10,387,120 10,306,070 10,252,022 9,809,675
========== ========== ========== ========== =========
</TABLE>
<TABLE>
EXHIBIT 21
SUBSIDIARIES OF HILLS STORES COMPANY
<CAPTION>
NAME OF SUBSIDIARY STATE OF INCORPORATION
- ------------------ ----------------------
<S> <C>
Hills Department Store Company Delaware
HDS Transport, Inc. * Ohio
Canton Advertising, Inc. * Massachusetts
Corporate Vision Inc. * Massachusetts
Hills Distributing Company * Delaware
* Wholly-owned subsidiary of Hills Department Store Company
</TABLE>
EXHIBIT 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-56321, 333-35599, 333-27875 on Form S-8 and Registration No. 333-4627 on
Form S-3, of Hills Stores Company of our report dated March 11, 1998 appearing
in this Annual Report on Form 10-K of Hills Stores Company for the year ended
January 31, 1998.
DELLOITTE & TOUCHE LLP
Boston, Massachusetts
April 20, 1998
<TABLE>
EXHIBIT 24
HILLS STORES COMPANY
FORM 10-K
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that each of the directors and officers of Hills
Stores Company whose signature appears below constitutes and appoints Gregory
K. Raven, C. Scott Litten and William K. Friend, and each of them, his true and
lawful attorneys-in-fact and agents with full power of substitution, for him and
in his name, place and stead, in any and all capacities, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection with the preparation, delivery and filing of an Annual Report on Form
10-K of Hills Stores Company for the fiscal year ended January 31, 1998 with the
Securities and Exchange Commission and any appropriate state or governmental
agencies, as fully to all intents and purposes as such person might or could do
in person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or their or his substitutes, may lawfully do or cause to
be done by virtue hereof.
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
/s/ Chaim Y. Edelstein Chairman of the Board of
- ------------------------ the Company and Hills
Chaim Y. Edelstein Department Store Company March 10, 1998
/s/ Gregory K. Raven Director, President and Chief
- ------------------------ Executive Officer of the Company
Gregory K. Raven and Hills Department Store Company
(Principal Executive Officer) March 10, 1998
/s/ Mark B. Dickstein Director of the Company and Hills
- ------------------------ Department Store Company March 10, 1998
Mark B. Dickstein
/s/ Stanton J. Bluestone Director of the Company and Hills
- ------------------------ Department Store Company March 10, 1998
Stanton J. Bluestone
/s/ Samuel L. Katz Director of the Company and Hills
- ------------------------ Department Store Company March 10, 1998
Samuel L. Katz
/s/ John W. Burden III Director of the Company and Hills
- ------------------------ Department Store Company March 10, 1998
John W. Burden III
/s/ Alan S. Cooper Director of the Company and Hills
- ------------------------ Department Store Company March 10, 1998
Alan S. Cooper
/s/ Richard E. Montag Director of the Company and Hills
- ------------------------ Department Store Company March 10, 1998
Richard E. Montag
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-END> JAN-31-1998
<CASH> 37,523
<SECURITIES> 0
<RECEIVABLES> 27,369
<ALLOWANCES> (5,500)
<INVENTORY> 340,719
<CURRENT-ASSETS> 432,586
<PP&E> 267,314
<DEPRECIATION> (84,202)
<TOTAL-ASSETS> 882,581
<CURRENT-LIABILITIES> 199,173
<BONDS> 348,754
18,209
0
<COMMON> 105
<OTHER-SE> 217,873
<TOTAL-LIABILITY-AND-EQUITY> 882,581
<SALES> 1,768,274
<TOTAL-REVENUES> 1,768,274
<CGS> 1,306,335
<TOTAL-COSTS> 1,306,335
<OTHER-EXPENSES> 424,362
<LOSS-PROVISION> 2,526
<INTEREST-EXPENSE> 48,392
<INCOME-PRETAX> (10,815)
<INCOME-TAX> (1,800)
<INCOME-CONTINUING> (9,015)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,015)
<EPS-PRIMARY> (0.87)
<EPS-DILUTED> (0.87)
</TABLE>
