UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
- ----- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 1, 1998
- ----- 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
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
15 DAN ROAD, CANTON, MASSACHUSETTS 02021
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(Address of principal executive offices) (Zip Code)
781-821-1000
------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
YES X NO
-------- --------
Indicate by check mark 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 August 31, 1998
was 10,420,870 shares.
<PAGE>
<TABLE>
HILLS STORES COMPANY AND SUBSIDIARIES
TABLE OF CONTENTS
-----------------
PART I - FINANCIAL INFORMATION
FINANCIAL STATEMENTS
<S> <C> <C>
Condensed Consolidated Balance Sheets as of August 1, 1998,
January 31, 1998, and August 2, 1997 3
Condensed Consolidated Statements of Operations for the
Thirteen and Twenty-six Weeks Ended August 1, 1998
and August 2, 1997 4
Condensed Consolidated Statements of Cash Flows for the
Twenty-six Weeks Ended August 1, 1998 and August 2, 1997 5
Notes to Condensed Consolidated Financial Statements 6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS 15
ITEM 2: CHANGES IN SECURITIES 15
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 15
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K 15
</TABLE>
2
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HILLS STORES COMPANY AND SUBSIDIARIES
- -------------------------------------------------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS
<CAPTION>
August 1, January 31, August 2,
(in thousands) 1998 1998 1997
- -------------------------------------------------------------------------------
(unaudited) (unaudited)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 14,875 $ 37,523 $ 17,183
Accounts receivable, net 40,301 21,869 31,986
Inventories 443,706 340,719 426,658
Deferred and interim tax assets 46,833 26,933 46,776
Other current assets 5,604 5,542 5,140
---------- -------- --------
Total current assets 551,319 432,586 527,743
Property and equipment, net 177,385 183,112 174,639
Property under capital leases, net 102,953 102,350 107,231
Beneficial lease rights, net 5,698 6,081 6,465
Other assets, net 51,254 40,748 27,173
Deferred tax asset 28,592 28,592 21,585
Reorganization value in excess of amounts
allocable to identifiable assets, net 86,268 89,112 94,573
---------- -------- --------
$1,003,469 $882,581 $959,409
========== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of capital leases $ 10,943 $ 10,541 $ 7,430
Current portion of long-term debt 1,500 500 -
Borrowings under secured credit
facility 122,000 - 55,000
Accounts payable, trade 141,137 110,329 152,253
Other accounts payable and accrued
expenses 77,682 77,803 80,140
---------- -------- --------
Total current liabilities 353,262 199,173 294,823
Long term debt 203,500 204,500 195,000
Capital lease and
other financing obligations 144,090 144,254 151,340
Other liabilities 97,055 98,467 99,282
Preferred stock, at mandatory redemption
value (Note 2) 18,086 18,209 18,429
Common shareholders' equity 187,476 217,978 200,535
---------- -------- --------
$1,003,469 $882,581 $959,409
========== ======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
3
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HILLS STORES COMPANY AND SUBSIDIARIES
- -----------------------------------------------------------------------------------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
<CAPTION>
Thirteen Weeks Ended Twenty-six Weeks Ended
-------------------- ----------------------
(unaudited) August 1, August 2, August 1, August 2,
(in thousands, except per 1998 1997 1998 1997
share amounts)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $357,213 $349,269 $720,160 $702,773
Cost of sales 271,430 263,121 535,026 519,841
Selling and administrative
expenses 105,231 98,344 208,553 197,524
Amortization of reorganization
value in excess of amounts
allocable to identifiable assets 1,422 1,463 2,844 2,925
-------- -------- -------- --------
Operating loss ( 20,870) ( 13,659) ( 26,263) ( 17,517)
Interest expense, net ( 12,723) ( 12,060) ( 24,463) ( 23,322)
-------- -------- -------- --------
Loss before income taxes ( 33,593) ( 25,719) ( 50,726) ( 40,839)
Income tax benefit (Note 4) 13,400 9,600 19,900 14,900
-------- -------- -------- --------
Net loss ($ 20,193) ($ 16,119) ($ 30,826) ($ 25,939)
======== ======== ======== ========
Basic and diluted loss per
share (Note 5): ($ 1.93) ($ 1.56) ($ 2.95) ($ 2.51)
======== ======== ======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
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HILLS STORES COMPANY AND SUBSIDIARIES
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<CAPTION>
Twenty-Six Weeks Ended
-------------------------
(unaudited) August 1, August 2,
(in thousands) 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 30,826) ($ 25,939)
Adjustments to reconcile net loss to net cash used
for operating activities:
Depreciation and amortization 21,126 18,204
Amortization of deferred financing costs 1,454 1,252
Amortization of reorganization value in excess
of amounts allocable to identifiable assets 2,844 2,925
Deferred and interim income taxes ( 19,900) ( 14,900)
Loss on disposal of fixed assets - 28
Increase in accounts receivable and other
current assets ( 18,493) ( 7,665)
Increase in inventories ( 102,987) ( 85,181)
Increase in accounts payable, accrued expenses
and other liabilities 29,552 34,248
Other, net 127 187
-------- --------
Net cash used for operating activities ( 117,103) ( 76,841)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures ( 9,291) ( 13,337)
Deferred software expenditures ( 13,089) ( 10,183)
-------- --------
Net cash used for investing activities ( 22,380) ( 23,520)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under revolving credit facility, net 122,000 55,000
Principal payments under capital lease and other
financing obligations ( 5,165) ( 3,124)
Other financing activities - ( 495)
-------- --------
Net cash provided by financing activities 116,835 51,381
-------- --------
Net decrease in cash and cash equivalents ( 22,648) ( 48,980)
Cash and cash equivalents at beginning of period 37,523 66,163
-------- --------
Cash and cash equivalents at end of period $ 14,875 $ 17,183
======== ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital lease investments and obligations $ 5,403 $ -
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
5
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HILLS STORES COMPANY AND SUBSIDIARIES
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
---------------------
During the twenty-six weeks ended August 1, 1998, Hills Stores Company (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 condensed
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated. The information furnished reflects all normal
recurring adjustments which are, in the opinion of management, necessary to
present a fair statement of the results for the interim period.
The accompanying unaudited condensed consolidated financial statements are
presented in accordance with the requirements of Form 10-Q and consequently do
not include all the disclosures normally required by generally accepted
accounting principles nor those normally made in the Company's annual Form 10-K
filing. Reference should be made to the Company's Annual Report on Form 10-K
for additional disclosures, including a summary of the Company's accounting
policies. Certain prior year amounts have been reclassified to conform to the
current year presentation. The Company's business is seasonal in nature and
the results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the full fiscal year. The fourth
quarter of each fiscal year provides the most significant portion of the
Company's annual sales and most of its operating earnings, with operating
earnings particularly concentrated in the Christmas selling season.
2. HILLS STORES SERIES A CONVERTIBLE PREFERRED STOCK
-------------------------------------------------
During the twenty-six weeks ended August 1, 1998, 6,177 shares of the Company's
Series A Convertible Preferred Stock ($20 mandatory redemption value) were
converted to the Company's Common Stock on a share for share basis.
3. INTEREST EXPENSE
----------------
<TABLE>
Interest expense is stated net of the following (in thousands):
<catpion>
Thirteen Weeks Ended Twenty-Six Weeks Ended
-------------------- ----------------------
August 1, August 2, August 1, August 2,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Interest income $ 19 $ 58 $ 54 $ 475
Capitalized interest 660 236 1,270 346
------ ------ ------ ------
Total for each period $ 679 $ 294 $1,324 $ 821
====== ====== ====== ======
</TABLE>
Capitalized interest relates to the Company's program to replace its primary
information systems ocurring in fiscal years 1997 through 1999.
6
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HILLS STORES COMPANY AND SUBSIDIARIES
- ------------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4. INCOME TAX BENEFIT
------------------
The Company calculates its provision for interim income taxes in accordance
with Accounting Principles Board Opinion No. 28. This usually calls for the
application of the estimated full year tax rate to interim pretax accounting
income. In circumstances when the usual approach would cause an unrealistically
high interim tax benefit rate or other unreasonable tax results (which is the
case for the interim periods of fiscal years 1998 and 1997), the interim tax
provision is calculated by applying the appropriate Federal and State statutory
tax rates to taxable book income. The Company expects to employ this approach
until it is no longer reasonably possible that an unreasonably large interim tax
benefit rate would occur. The measurement of interim income taxes has no effect
on the amount of income tax expense for the full year.
5. EARNINGS PER SHARE
------------------
Statement of Financial Accounting Standards Number 128, "Earnings per Share"
("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 thirteen and twenty-six week periods ended August 1, 1998 and
August 2, 1997, as all common stock equivalents are antidilutive, due to the
net loss incurred during these periods.
Basic loss per share for the thirteen week periods ended August 1, 1998 and
August 2, 1997 was computed based on the weighted average number of common
shares assumed to be outstanding during the period of 10,460,584 and 10,358,807
shares, respectively.
Basic loss per share for the twenty-six week periods ended August 1, 1998 and
August 2, 1997 was computed based on the weighted average number of common
shares assumed to be outstanding during the period of 10,454,500 and 10,353,394
shares, 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.
6. 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
7
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HILLS STORES COMPANY AND SUBSIDIARIES
- ------------------------------------------------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 (the "Dolowich suit") 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 (the "Fusco 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.
8
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HILLS STORES COMPANY AND SUBSIDIARIES
- -------------------------------------------------------------------------------
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 Great Lakes and Ohio River Valley regions of the Unites States where the
Company has the majority of its stores; 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; potential year 2000 disruption, whether directly
resulting from the state and costs of internal preparation or indirectly
resulting from the impact of year 2000 on customers and/or suppliers; and other
factors that may be described in this document.
RESULTS OF OPERATIONS
QUARTER ENDED AUGUST 1, 1998 COMPARED WITH
QUARTER ENDED AUGUST 2, 1997
Net sales and comparable store sales increased by 2.3% compared with the same
period in 1997. The Company generated above-average sales increases in home
categories, which were partially offset by weaker sales in toys, apparel and
other seasonal merchandise. During the quarter, the Company added two
advertising circulars compared with the prior year, and reinstated a "free"
back-to-school layaway promotion not run in 1997.
Cost of sales as percentage of sales was 76.0% in the second quarter of fiscal
year 1998 compared with 75.3% in the second quarter of fiscal year 1997. Gross
profit decreased by $0.4 million, and decreased as a percentage of sales by
0.7%. These decreases were primarily due to higher interim inventory shortages
in the second quarter this year.
Selling and administrative expenses, including depreciation and amortization,
increased as a percentage of sales to 29.5% in the current quarter compared with
28.2% in the second quarter of 1997. Selling and administrative expenses
excluding depreciation increased to 26.6% of sales in the second quarter of
fiscal year 1998 from 25.6% in the same period in 1997, as a result of increased
advertising costs, duplicative system migration costs and increased payroll
costs. Noncash depreciation and amortization for the second quarter increased
by approximately $1.2 million resulting from the Company's investment programs.
Net interest expense increased by $0.7 million primarily due to increased
borrowings under the Company's secured credit facility.
9
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HILLS STORES COMPANY AND SUBSIDIARIES
- -------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS (CONTINUED)
The effective tax benefit rate was 39.9% in the second quarter of fiscal year
1998 compared with a rate of 37.3% in the second quarter of fiscal year 1997.
See Note 4 of Notes to Condensed Consolidated Financial Statements.
TWENTY-SIX WEEKS ENDED AUGUST 1, 1998 COMPARED WITH
TWENTY-SIX WEEKS ENDED AUGUST 2, 1997
Net sales and comparable store sales increased by 2.5% compared with the same
period in 1997. Sales increases in home categories were partially offset
by weaker sales in toys and apparel. During the first six months, the Company
added four advertising circulars compared with the prior year and reinstated a
"free" back-to-school layaway promotion not run in 1997.
Cost of sales as a percentage of sales increased to 74.3% compared with 74.0%
for the same period in 1997. Gross profit decreased by $2.2 million or 0.3%.
These decreases were primarily due to higher interim inventory shortages this
year.
Selling and administrative expenses, including depreciation and amortization,
increased as a percentage of sales to 29.0% in the first half of 1998 from 28.1%
in the same period of 1997. Selling and administrative expenses excluding
depreciation increased to 26.1% from 25.6% in the same period in 1997 due to
duplicative system migration costs, increased advertising, and higher payroll
costs. Noncash depreciation and amortization increased during the period by
approximately $2.9 million as a result of the Company's investment programs.
Net interest expense increased by $1.1 million, primarily due to increased
borrowings under the Company's secured credit facility.
The Company's effective tax benefit rate was 39.2% for the twenty-six weeks
ended August 1, 1998 compared with a rate of 36.5% for the twenty-six weeks
ended August 2, 1997. See Note 4 of the Notes to Condensed Consolidated
Financial Statements.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Net cash used for operating activities was $117.1 million for the twenty-six
weeks ended August 1, 1998 compared with a use of $76.8 million for the same
period last year, an increase of $40.3 million. This was primarily due to a
decrease of approximately $6 million in operating cash flow, or EBITDA
(earnings/loss before interest, taxes, depreciation and amortization), an
increase of approximately $11 million in layaway receivables in July 1998,
and a larger increase in inventory together with a smaller increase in trade
payables, in the first six months of 1998 compared with the same period of 1997.
The larger inventory increase in 1998 resulted from the run-off of excess
inventories in fiscal year 1997 that were on hand at the end of fiscal year
1996, together with a larger build-up of certain basic inventories in July 1998.
The smaller trade payables increase resulted primarily from a shift in the flow
of merchandise in 1998 to imported merchandise requiring letters of credit.
10
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HILLS STORES COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Net cash used for investing activities was $22.4 million compared with $23.5
million in the first half of 1997, a $1.1 million decrease. An increase in
expenditures related to the Company's information systems replacement program
was offset by a reduction in other capital expenditure programs. Fixed asset
capital spending decreased to $9.3 million in the first six months of fiscal
year 1998 compared with $13.3 million in the same period of 1997, while deferred
software expenditures increased to $13.1 million in the first half of 1998
compared with $10.2 million last year. During fiscal year 1998, capital
expenditures are expected to approximate $29 million including approximately
$9 million of non-cash acquisitions which the Company expects to finance by
capital leases, and deferred software expenditures are expected to approximate
$34 million including approximately $3 million of capitalized interest. The
Company relocated one store during the second quarter of fiscal year 1998 and
expects to open no new stores during the year.
Net cash provided by financing activities was $116.8 million in the first half
of fiscal 1998 compared with $51.4 million in the same period a year ago, a
$65.4 million increase. The increase was due to reduced beginning of the year
cash balances in fiscal year 1998 compared with fiscal year 1997 and the
increased use of funds for operating activities which required increased
borrowings under the secured credit facility in fiscal year 1998. During the
first half of fiscal year 1998, average revolving borrowings under the secured
credit facility were $50.3 million at an average interest rate of 8.1% compared
to $12.1 million at an interest rate of 8.3% for the same period in 1997.
Excess credit availability under the revolving credit facility at August 1, 1998
was approximately $83 million compared with approximately $111 million at
August 2, 1997. Subsequent to August 1, 1998, the Company sold and leased-back
certain equipment at original cost of approximately $0.8 million.
The Company's systems replacement program is designed to replace the Company's
outdated mainframe systems, including certain host-connected store systems and
certain other office systems. The program is intended to provide benefits
in improved operating efficiencies, improved data integrity and improved
information access, through new and improved process functionality included in
new application programs, and through upgraded data management and systems
infrastructure. While the systems replacement program was not initiated
specifically for correcting year 2000 (Y2K) "bugs," the systems replacement
program eliminates the need for specific Y2K corrections for the impacted
systems being replaced, which represents the majority of the Company's
information and data processing systems.
The Company's systems replacement program was initiated at the end of fiscal
year 1996, following a planning engagement by a major systems consulting
organization. The consultants initially informed the Company that there was a
high probability that substantial completion could be achieved in 1998 as a
result of the plan to install a specific collection of unmodified, slightly or
moderately modified third-party package systems. However, during late 1997 and
early 1998, the Company experienced difficulty in acquiring the contractors and
staff needed to install portions of the new systems, and there were delays in
the integration, testing and installation of certain elements of the new
systems. The Company has taken corrective action, including obtaining an
11
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HILLS STORES COMPANY AND SUBSIDIARIES
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
independent assessment of steps that can be implemented to further assure the
program's timely success. As of early September 1998, the Company has:
* installed and is increasing its use of most of its new systems
infrastructure, including most office processors, office and store
servers, networks, client workstations, data storage and backup
devices, and operating systems and systems management software,
* previously deployed or during the fall of 1998 will deploy most
of its new support systems, primarily its finance-related and
payroll/human resource systems,
* begun deployment of the first merchandise system component, and
* finalized or is nearing completion of modifications and interfaces
for the remaining systems components (primarily merchandise-related).
For these remaining systems, data conversion has begun, a portion of initial
testing remains to be completed in the fall of 1998, which is to be followed in
the fall/winter of 1998 by systems integration testing, completion of data
conversion, and pilot testing. The Company currently anticipates deployment of
these remaining new system components and the completion of the training of
impacted Company personnel in their use not later than mid-1999.
The systems replacement program investment to date through August 1, 1998, and
projected remaining spending for the systems replacement program, is as follows
(in millions):
<TABLE>
<CAPTION>
Additional
To Date Projected Total
------- ---------- -------
<S> <C> <C> <C>
Hardware capital expenditures $ 11.7 $ 1.0 $ 12.7
Deferred software expenditures 36.6 29.6 66.2
------- ------- -------
Subtotal 48.3 30.6 78.9
Less - expenditures financed by 3.1 1.0 4.1
capital leases ------- ------- -------
Net cash program expenditures $ 45.2 $ 29.6 $ 74.8
======= ======= =======
</TABLE>
Expenditures to complete the information systems replacement program are
estimated at approximately $20 million for the balance of fiscal year 1998, and
approximately $10 million in fiscal year 1999.
In addition, the Company has acquired certain additional computer equipment for
this program (with an initial value if purchased of approximately $6.2 million)
through operating lease transactions for periods less than the economic lives of
of the equipment. Following the period of systems duplication that continues
into mid-1999, rents for this equipment will supplant rents for the replaced
equipment.
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 and its capital and systems expenditure
requirements.
12
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HILLS STORES COMPANY AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
In connection with the Company's information systems 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 the
continuing systems, as needed. The cost of most of such upgrades are generally
covered by on-going third party software maintenance agreements. Additional Y2K
systems remediation cost, primarily for the Company's store point-of-sale (POS)
system, is not currently anticipated to exceed $2 million. To address the Y2K
needs of the store POS control equipment as well as to improve its function-
ality, the Company has decided to accelerate the replacement of the existing
control equipment (which is currently leased or owned for negligible cost) with
new leased equipment. The vendors for the POS remediation and control equipment
upgrade have been selected, detailed design work is under way, and completion is
targeted for late summer 1999. The POS remediation and control equipment
upgrade is not a component of the general mainframe systems replacement program.
The Company is also taking steps to test, and assess its exposure and related
alternatives and costs, if any, to resolve potential non-systems Y2K problems.
The Company is initiating steps in a program to communicate with its merchandise
and service vendors, for the purpose of limiting its exposure to vendors who may
be Y2K noncompliant. In connection with this program, the Company expects to
undertake contingency plans, if necessary, for the shifting of merchandise
orders to vendors who can demonstrate Y2K readiness most clearly, as well as to
find alternative methods of interacting with any key vendors who may need
assistance should they have Y2K difficulties. Testing is under way to validate
incoming and outgoing electronic data interchange (EDI) commerce with EDI
partners. The Company does not currently have other contingency plans for
direct (internal) or indirect (external) Y2K disruption, but intends to address
such contingency plans as its evaluation progresses regarding its internal Y2K
plans and as it obtains additional information regarding the readiness of its
merchandise and service vendors and lenders.
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,
remediated or upgraded systems could severely disrupt the Company's ability to
process merchandise orders, receive goods, pay its vendors, and/or service and
sell to its customers. In addition, if a significant number of the Company's
merchandise and service vendors or lenders are directly or indirectly negatively
impacted by Y2K noncompliance, the Company could suffer similar adverse effects.
While the Company can not quantify the probability or possible degree of impact
on the Company's business operations should signficant direct or indirect Y2K
disruptions occur, a significant disruption could result in the Company's
available liquidity falling short of its cash requirements to support its
operations and service its debt.
As a contingency should the successful, timely completion of the Company's
systems replacement program become unacceptably uncertain, the Company is
employing an independent consultant to provide assistance in assessing the
feasibility of alternative strategies for meeting the Y2K deadline. The
consultant has advised the Company that, based on the consultant's initial
13
<PAGE>
HILLS STORES COMPANY AND SUBSIDIARIES
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
review of the alternatives (the initial conclusions of which are subject to more
detailed investigation), the successful transition to an alternative solution
during the Fall of 1998 would probably be feasible. Accordingly, an updated
assessment by the consultant and management is scheduled for that time
regarding the status of the systems replacement program, the separate Y2K
preparations, and the alternative strategies.
The terms of the Company's secured credit facility and senior notes limit the
ability of the subsidiaries to pay dividends. Any or all of the restrictions,
limitations or contingencies under the secured credit 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.
14
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
- ------- -----------------
See Note 6 of the Notes to Condensed Consolidated Financial Statements.
ITEM 2. CHANGES IN SECURITIES
- ------- ---------------------
During the quarter ended August 1, 1998, the Company issued 1,077 shares of
Common Stock, par value $.01 per share (the "Common Shares"), upon the
conversion of 1,077 shares of Series A Convertible Preferred Stock, par value
$.10 per share (the "Series A Preferred Shares"). The Series A Preferred Shares
were issued pursuant to the exemption from registration set forth in Section
1145(a) of the Federal Bankruptcy Code, and the Common Shares were issued
pursuant to the exemption contained in Section 3(a)(9) of the Securities Act of
1933, as amended. In addition, during the quarter ended August 1, 1998, the
Company issued 26,295 shares of Common Stock in connection with the Hills Stores
Company/Hills Department Store Company Associate Stock Purchase Plan.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------- ---------------------------------------------------
<TABLE>
The Company held its Annual Meeting of Shareholders on June 17, 1998. At the
Annual Meeting, the following directors, comprising the entire Board, were
elected for one year terms:
<CAPTION>
NOMINEE VOTES FOR VOTES WITHHELD
------- --------- --------------
<S> <C> <C> <C>
Chaim Y. Edelstein 9,320,812 344,121
Gregory K. Raven 9,322,812 342,121
Stanton J. Bluestone 9,315,887 349,046
John W. Burden III 9,317,750 347,183
Alan S. Cooper 8,872,950 791,983
Mark B. Dickstein 8,818,885 846,048
Samuel L. Katz 8,833,807 831,126
Richard E. Montag 9,315,275 349,658
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ------ --------------------------------
a. The following documents are filed as part of this report:
1
3.1 Amended and Restated Certificate of Incorporation of the Company,
as amended.
2
3.2 Amended and Restated By-Laws of the Company.
3
4.1 Certificate of the Voting Powers, Preferences and other
designated attributes of the Series A Convertible Preferred
Stock of the Company.
4
4.2 Form of Series 1993 Stock Right.
15
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (continued)
- ------- --------------------------------------------
5
4.3 Series 1993 Warrant Agreement dated October 4, 1993 between the
Company and Chemical Bank, as Warrant Agent.
6
4.4 Rights Agreement dated as of August 16, 1994 (the "Rights
Agreement") between the Company and Chemical Bank, as Rights
Agent.
6
4.5 Form of Certificate of the Voting Powers, 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).
6
4.6 Form of Right Certificate (which is attached as Exhibit B to the
Rights Agreement incorporated by reference as Exhibit 4.4 hereto).
7
4.7 Amendment dated as of October 18, 1995 to the Rights Agreement.
8
4.8 Indenture dated as of April 19, 1996 relating to the 12 1/2%
Senior Notes due 2003, Series B, of the Company.
9
10.1 Loan and Security Agreement (the "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
10.2 * Employment Agreement made as of February 7, 1996 with Gregory K.
Raven.
11
10.3 * Consulting Agreement made as of February 7, 1998 with Chaim Y.
Edelstein.
10.4 * Amendment dated as of August 1, 1998 to the Consulting Agreement
with Chaim Y. Edelstein.
12
10.5 * Employment Agreement made as of November 19, 1996 with Michael
R. Hamilton.
13
10.6 * Employment Agreement made as of July 22, 1997 with Frederick L.
Angst.
14
10.7 * Employment Agreement made as of November 11, 1997 with C. Scott
Litten.
15
10.8 * 1993 Incentive and Nonqualified Stock Option Plan, as amended.
10
10.9 * 1996 Directors Stock Option Plan.
16
10.10 * Hills Stores Company/Hills Department Store Company Associate
Stock Purchase Plan, as amended.
11 Statements regarding computation of per share earnings.
16
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (continued)
- ------ --------------------------------------------
27 Financial Data Schedule.
- ---------------------
* 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 September 16, 1993.
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 8-K of the
Company dated October 18, 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 Annual Report on Form 10-K
of the Company for the fiscal year ended January 31, 1998.
12. Incorporated by reference from the Quarterly Report on Form 10-Q
for the quarter ended November 2, 1996.
13. Incorporated by reference from the Quarterly Report on Form 10-Q
of the Company for the quarter ended August 2, 1997.
14. Incorporated by reference from the Quarterly Report on Form 10-Q
of the Company for the quarter ended November 1, 1997.
15. Incorporated by reference from the Company's definitive proxy
materials dated May 5, 1997.
16. Incorporated by reference from the Quarterly Report on Form 10-Q
of the Company for the quarter ended May 2, 1998.
b. Reports on Form 8-K.
None.
17
<PAGE>
SIGNATURES
Pursuant to the requirements 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.
HILLS STORES COMPANY
Date: September 15, 1998 /s/C. Scott Litten
---------------------------
C. Scott Litten
Executive Vice President-
Chief Financial Officer
Date: September 15, 1998 /s/Brian J. Sheehan
---------------------------
Brian J. Sheehan
Vice President - Controller
and Principal Accounting Officer
18
<PAGE>
<TABLE>
EXHIBIT INDEX
Pursuant to Item 601 of Regulation S-K
Exhibit Title
- ------- -----
<S> <C>
10.4 Amendment dated as of August 1, 1998 to the Consulting
Agreement with Chaim Y. Edelstein.
11 Statements regarding computations of earnings per share.
27 Financial Data Schedule.
</TABLE>
19
EXHIBIT 10.4
CONSULTING AGREEMENT AMENDMENT
------------------------------
THIS CONSULTING AGREEMENT AMENDMENT made effective as of August 1,
1998 by and between Hills Department Store Company and Hills Stores Company,
Delaware corporations having their principal office at 15 Dan Road, Canton,
Massachusetts (the "Company") and Chaim Y. Edelstein, with an office address
of 1040 Park Avenue 12E, New York, NY 10028, (the "Consultant").
WHEREAS, the Company and the Consultant currently have an agreement
dated February 8, 1998, (the "Consulting Agreement") whereby the Company has
engaged the Consultant and the Consultant has agreed to provide professional
services and advice to the Company on its merchandise, marketing and strategic
planning efforts; and
WHEREAS, the Company and the Consultant desire to amend the Consulting
Agreement to expand the duties and responsibilities of the Consultant and to
compensate him accordingly.
NOW, THEREFORE, in consideration of the premises and the mutual
covenants hereinafter contained, the Company and the Consultant hereby agree,
effective August 1, 1998, to amend the Consulting Agreement as follows:
1. In exchange for the expanded duties and responsibilities to be
performed by Consultant, the Annual Consulting Fee provision of Schedule A to
the Consulting Agreement will now read:
Annual Consulting Fee: $400,000 - payable in equal
monthly installments of
$33,333.33 on the first day of
each month commencing August 1,
1998.
2. SECTION 7. TERMINATION BY CONSULTANT is hereby modified by
adding the following language:
7(c) In the event of the occurrence of an event covered by
Section 7(a)(iii) or (iv) on or before June 30, 1999,
Consultant shall be entitled to receive a lump sum
payment of a full year's consulting fee ($400,000)
payable on the date such event is consummated.
IN WITNESS WHEREOF, the parties have executed this Agreement on August
25, 1998.
/s/ Chaim Y. Edelstein
------------------------------
Chaim Y. Edelstein
HILLS DEPARTMENT STORE COMPANY
HILLS STORES COMPANY
/s/ Gregory K. Raven
------------------------------
President & CEO
<TABLE>
EXHIBIT 11
HILLS STORES COMPANY AND SUBSIDIARIES
STATEMENTS RE COMPUTATION OF PER SHARE EARNINGS
<CAPTION>
Thirteen Thirteen
Weeks Ended Weeks Ended
August 1, August 2,
1998 1997
---------- -----------
<S> <C> <C>
Weighted average basic shares outstanding
- -----------------------------------------
Weighted average number of common shares
assumed to be outstanding during the period 10,460,584 10,358,807
Assumed conversion of preferred stock - -
Assumed exercise of stock options - -
Assumed exercise of stock rights - -
Assumed exercise of stock warrants - -
---------- ----------
10,460,584 10,358,807
========== ==========
</TABLE>
<TABLE>
<CAPTION>
Twenty-six Twenty-six
Weeks Ended Weeks Ended
August 1, August 2,
1998 1997
---------- -----------
<S> <C> <C>
Weighted average basic shares outstanding
- -----------------------------------------
Weighted average number of common shares
assumed to be outstanding during the period 10,454,500 10,353,394
Assumed conversion of preferred stock - -
Assumed exercise of stock options - -
Assumed exercise of stock rights - -
Assumed exercise of stock warrants - -
---------- ----------
10,454,500 10,353,394
========== ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT 11
HILLS STORES COMPANY AND SUBSIDIARIES
STATEMENTS RE COMPUTATION OF PER SHARE EARNINGS
Thirteen Thirteen
Weeks Ended Weeks Ended
August 1, August 2,
1998 1997
---------- -----------
<S> <C> <C>
Weighted average diluted shares outstanding
- -------------------------------------------
Weighted average number of common shares assumed
to be outstanding during the period 10,460,584 10,358,807
Assumed conversion of preferred stock - -
Assumed exercise of stock options - -
Assumed exercise of stock rights - -
Assumed exercise of stock warrants - -
---------- ----------
10,460,584 10,358,807
========== ==========
</TABLE>
<TABLE>
<CAPTION>
Twenty-six Twenty-six
Weeks Ended Weeks Ended
August 1, August 2,
1998 1997
---------- -----------
<S> <C> <C>
Weighted average diluted shares outstanding
- -------------------------------------------
Weighted average number of common shares assumed
to be outstanding during the period 10,454,500 10,353,394
Assumed conversion of preferred stock - -
Assumed exercise of stock options - -
Assumed exercise of stock rights - -
Assumed exercise of stock warrants - -
---------- ----------
10,454,500 10,353,394
========== ==========
</TABLE>
The conversion of Preferred Stock, and the exercise of stock options, stock
rights, and stock warrants was not assumed as the result would be anti-dilutive.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> AUG-01-1998
<PERIOD-END> JAN-30-1999
<CASH> 14,875
<SECURITIES> 0
<RECEIVABLES> 41,288
<ALLOWANCES> (987)
<INVENTORY> 443,706
<CURRENT-ASSETS> 551,319
<PP&E> 276,605
<DEPRECIATION> (99,220)
<TOTAL-ASSETS> 1,003,469
<CURRENT-LIABILITIES> 353,262
<BONDS> 347,590
18,086
0
<COMMON> 105
<OTHER-SE> 169,285
<TOTAL-LIABILITY-AND-EQUITY> 1,003,469
<SALES> 720,160
<TOTAL-REVENUES> 720,160
<CGS> 535,026
<TOTAL-COSTS> 535,026
<OTHER-EXPENSES> 211,397
<LOSS-PROVISION> 1,449
<INTEREST-EXPENSE> 24,463
<INCOME-PRETAX> (50,726)
<INCOME-TAX> (19,900)
<INCOME-CONTINUING> (30,826)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (30,826)
<EPS-PRIMARY> (2.95)
<EPS-DILUTED> (2.95)
</TABLE>
