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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-K
<TABLE>
<C> <S>
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED FEBRUARY 28, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
</TABLE>
COMMISSION FILE NUMBER 0-15247
REEDS JEWELERS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
NORTH CAROLINA 56-1441702
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
2525 SOUTH SEVENTEENTH STREET
WILMINGTON, NORTH CAROLINA 28401
(Address of principal executive offices) (Zip Code)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(910) 350-3100
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK $.10 PAR VALUE
Title of Class
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of April 9, 1999 (computed by reference to the last reported
sales price of the registrant's common stock on the American Stock Exchange on
such date) was $4,222,669.
The number of shares outstanding as of April 9, 1999 of the registrant's
common stock, par value $.10 per share, was 8,476,372.
DOCUMENTS INCORPORATED BY REFERENCE
The following document is incorporated by reference into the indicated Part
of the Annual Report of Form 10-K to the extent indicated in such Part:
Part III of the registrant's definitive Proxy Statement for the 1999 Annual
Meeting of Shareholders.
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PART I
ITEM 1. BUSINESS
Reeds Jewelers, Inc. (the "Company" or the "Registrant") operates 106
specialty retail jewelry stores primarily in enclosed regional malls located
principally in the Sunbelt section of the United States. During the last five
years, the Company has increased its number of stores an average of 7.9% each
year and has increased transactions and net sales at compound annual rates of
5.9% and 10.2%, respectively. Of the 35 net new stores opened during the last
five years, 12 resulted from acquisitions that provided the Company with its
first stores in Maryland and Iowa.
The Company was incorporated in 1984 under the laws of North Carolina as
part of a reorganization whereby a number of affiliated corporations under
common ownership became subsidiaries of the Company. The oldest of these
affiliated corporations was incorporated as a North Carolina corporation in
1946. Its principal executive offices are located at 2525 South Seventeenth
Street, Wilmington NC 28401, and its telephone number is (910) 350-3100.
PRINCIPAL PRODUCTS, MARKETS, AND METHODS OF DISTRIBUTION
The Company operates stores under the names of Reeds Jewelers, Melart
Jewelers, and Mills Jewelers. The Melart name is used in one mall and the Mills
name in two malls; these names are used where the Company already has a store
displaying the Reeds logo. As of February 28, 1999, the Company operated 104
stores, located as follows:
<TABLE>
<S> <C> <C>
4 in Alabama 9 in Florida 9 in Georgia
4 in Iowa 3 in Kansas 1 in Kentucky
8 in Maryland 8 in Mississippi 22 in North Carolina
1 in Ohio 2 in Oklahoma 11 in South Carolina
6 in Tennessee 13 in Virginia 3 in West Virginia
</TABLE>
The Company plans to open a total of six to ten stores in the current
fiscal year. Two have already been opened in March, one in Kentucky and another
in Virginia. The Company has signed leases for three additional locations for
the current year, one each in North Carolina, Tennessee, and Virginia. The
Company also has signed leases for two locations to open in fiscal 2001, one in
Alabama and one in Tennessee. Management chooses locations for its stores based
upon various demographic factors, the aggregate amount of jewelry business being
done in the mall being considered, and the amount of rent that will be charged
for the location.
The Company's stores range in size from approximately 500 to 2,100 square
feet of selling space, and average 1,140 square feet of selling space. The
stores are designed to invite customers into a well-lighted and attractive
setting where typically more than 2,000 items will be offered for sale.
Promotional displays are changed periodically to provide variety and to reflect
special and seasonal events.
Each of the Company's stores is operated by a store manager who is
responsible for store-level operations. In addition, each store is assigned an
assistant manager who is being trained for future assignment as a store manager.
Depending upon the sales volume of each store, 4-16 additional sales associates
make up the balance of the staffing. In addition to a competitive salary or
hourly wage, each store associate has the opportunity to earn incentive
compensation based on achieving certain performance objectives, and is eligible
for various benefits.
The Company has strong inventory control systems, extensive security
systems, and loss prevention procedures to maintain low inventory losses. The
Company screens employment applicants and provides training in loss prevention
to its store associates. Despite these precautions, the Company experiences
losses from theft from time to time and maintains insurance to cover such
losses. The Company's losses from inventory shrinkage have averaged 0.5% of net
sales during each of the last three years.
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The Company believes it is important to provide knowledgeable and
responsive customer service. It maintains this capability through its various
training programs. New employees receive intensive training in sales techniques
at Reeds University I, a 3-day off-site training experience. Store management
associates and more experienced sales associates receive sales management
training at Reeds University II, another 3-day off-site session of classes and
role playing. Store managers annually attend a national training meeting where,
for three days, they attend various classes of their choice in management,
sales, product knowledge, and personnel issues, and also listen to motivational
speakers and are provided an overview of the Company's performance and plans. In
addition, associates receive individual and group training within their
respective stores on an on-going basis.
The Company's marketing efforts include the use of newspaper inserts,
direct mail, radio, and television offering selected items at a variety of price
points. The Company advertises throughout the year, but intensifies its efforts
for the major gift-giving holidays of Christmas, Mother's Day, and Valentine's
Day. The Company spent 4.4%, 4.7%, and 5.0% of its net sales for advertising and
marketing during the fiscal years ended February 28, 1999, 1998, and 1997,
respectively.
The Company believes that customer satisfaction is a valuable form of
advertising and therefore stands behind its sales with repair services and
return and trade-in policies. The Company's policy is to accept, in exchange for
a full refund, any item of merchandise returned in like new condition within
thirty days of its purchase. The Company backs its diamond jewelry with a
lifetime warranty and also offers a trade-in policy, pursuant to which a
customer may exchange a diamond in partial payment for one of higher value.
Approximately 75% of the merchandise sold in each store is available in all
the Company's stores, and the remainder is chosen to meet the demand for
particular merchandise at the individual locations. The Company offers a wide
selection of merchandise, including diamond rings and jewelry, gold jewelry and
chains, gemstone rings, watches, and other fine jewelry. Most of the diamonds
sold by the Company are up to one carat, with a limited selection of larger
diamonds. Gold jewelry items sold in the Company's stores are primarily 14 or 18
carat, and its gemstone rings contain either precious stones (such as rubies,
sapphires, and emeralds) or semi-precious gems (such as opals, blue topaz,
amethyst, and garnets). Watches offered by the Company represent many popular
brand names in a broad range of price points. Sales by major classes of similar
products offered by the Company during each of the last three fiscal years were
as follows:
<TABLE>
<CAPTION>
CLASS 1999 1998 1997
- ----- ---- ---- ----
<S> <C> <C> <C>
Diamonds & precious gems.................................... 57.0% 54.9% 54.2%
Watches..................................................... 15.3% 14.1% 13.3%
Karat gold jewelry.......................................... 11.2% 12.9% 14.0%
Semi-precious gems.......................................... 6.1% 7.4% 7.5%
</TABLE>
Approximately 80% of the products sold by the Company are purchased through
a centralized merchandising department at the Company's headquarters. The
centralization of buying allows the Company to establish long-term relationships
with vendors that provide a continuing source of product supply, consistent
quality control, and competitive pricing. The average price of a piece of
merchandise sold from the Company's basic merchandise mix in fiscal 1999 was
$233, compared to $209 in fiscal 1998.
The Company employs experienced buyers who concentrate on purchasing
specific product lines from many suppliers in the United States and abroad. Most
of the Company's purchases are finished merchandise, which it obtains at
attractive prices and terms. The Company also arranges about 10% of its own
finished goods production by purchasing gold castings for rings, pendants, and
other items from several domestic sources and engaging independent goldsmiths to
polish the castings and set the stones supplied by the Company.
The Company does not engage in hedging activities with respect to
merchandise held in inventory, since it has been able to adjust retail prices to
reflect price fluctuations in the commodities that are used in the merchandise
it sells. The Company is not subject to substantial currency fluctuations
because its purchases are dollar denominated.
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In the fiscal year ended February 28, 1999, the Company's three largest
suppliers accounted for 12.4%, 7.0%, and 6.1%, respectively, of the Company's
total merchandise purchases, with no other supplier accounting for more than
6.0%. Alternate sources exist for all merchandise provided by the Company's
suppliers, with the exception of any particular name brand.
Diamond products represent more than half of the sales made by the Company
and DeBeers Consolidated Mines Ltd. ("DeBeers") substantially controls the
supply and price of this major product. The availability of diamonds to DeBeers
and the Company's suppliers is to some extent dependent on the political
situation in diamond producing countries, such as the Democratic Republic of
Congo, South Africa, Botswana, Australia, and certain countries of the former
Soviet Union. Any sustained interruption in the supply of diamonds from the
producing countries could adversely affect the Company and the retail jewelry
industry as a whole. DeBeers maintains a large inventory of diamonds outside the
producing countries, however, mitigating the impact of volatility in supply from
the producing countries. Although changes in DeBeer's pricing cannot be
predicted and could have an adverse impact on the Company's business, the
Company believes DeBeers has had a stabilizing influence on the world diamond
markets.
SEASONALITY
The Company's business is seasonal in nature. The fourth quarter, which
includes the major part of the Christmas selling season, produces higher sales
and earnings than any of the first three quarters. Net sales and net earnings
for each quarter as a percentage of annual net sales and net earnings for the
three most recent fiscal years were:
<TABLE>
<CAPTION>
1999 1998 1997
---- ----- ----
<S> <C> <C> <C>
NET SALES
First Quarter............................................. 18.7% 19.7% 20.9%
Second Quarter............................................ 19.3 19.3 20.4
Third Quarter............................................. 22.3 22.4 22.1
Fourth Quarter............................................ 39.7 38.6 36.6
NET EARNINGS
First Quarter............................................. 1.1% (18.0)% 5.9%
Second Quarter............................................ 1.0 2.6 5.1
Third Quarter............................................. 2.2 3.0 5.9
Fourth Quarter............................................ 95.7 112.4 83.1
</TABLE>
PROPRIETARY CREDIT AND OTHER WORKING CAPITAL ITEMS
The Company considers its credit operations to be a separate segment of its
business because it is evaluated separately from the retail operations of the
Company, and also because the credit portfolio and other credit assets represent
more than 10% of the combined assets of all operating segments. Additional
details required under SFAS No. 131, "Disclosure about Segments of an Enterprise
and Related Information," are provided in Note 11 of the Notes to Consolidated
Financial Statements contained herein.
The Company's proprietary credit card programs help facilitate the sale of
merchandise to customers who wish to finance their purchases rather than use
cash or available credit limits on their bank cards. Proprietary credit sales
represented approximately 46% of net sales in 1999 and approximately 46% and 47%
of net sales during 1998 and 1997, respectively. The Company operates its
centralized credit functions under its wholly owned subsidiary, Reeds Financial
Services, Inc. ("RFSI"). All credit extension, collection, and related
activities are administered through RFSI.
The Company extends credit to its customers under a level-pay plan. Finance
charges, subject to rate ceilings imposed by the various state laws, are
assessed on customers' account balances. Credit is granted for varying lengths
of time, generally requiring payments of 4% of the individual customer's highest
balance, with minimum payments of $25 per month. During fiscal 1999, more
purchases were financed under the Company's 3-year plan than under the 2-year
plan, resulting in a reduction of the payment to 4% from 5% of
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the individual customer's highest balance. It also contributed to the higher
level of accounts receivable at February 28, 1999 compared to a year earlier.
The Company offers optional insurance coverage for all credit purchases.
Customers are also offered a layaway plan that allows them to set items aside
and pay for them over a period of up to six months with no finance charges.
The following table presents certain data concerning sales, credit sales,
and accounts receivable for the past three fiscal years:
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28,
-------------------------------------------
1999 1998 1997
------------ ------------ -----------
<S> <C> <C> <C>
Net sales................................. $109,284,000 $102,845,000 $98,952,000
Net credit sales.......................... $ 50,701,000 $ 47,647,000 $46,169,000
Credit sales as a percentage of net
sales................................... 46.4% 46.3% 46.7%
Average number of active customer
accounts................................ 60,000 59,000 61,000
Average balance per customer account...... $ 747 $ 704 $ 652
Customer receivables, before allowance for
doubtful accounts....................... $ 49,437,000 $ 43,629,000 $41,049,000
Average monthly collection percentage..... 9.4% 10.1% 10.2%
Bad debt expense as a percentage of total
sales................................... 3.9% 4.0% 3.6%
Accounts receivable greater than 90 days
past due................................ 8.1% 8.1% 8.9%
</TABLE>
Accounts are automatically charged off when no full scheduled payment is
received for a period of seven billing cycles. Additionally, accounts are
charged off if a total of 12 scheduled payments are missed.
Accounts receivable (prior to allowance for doubtful accounts) increased
13.3% to $49,437,000 at February 28, 1999 from $43,629,000 at February 28, 1998,
and had increased 6.3% from $41,049,000 at February 28, 1997. The allowance for
doubtful accounts was 7.65% of accounts receivable (prior to allowance for
doubtful accounts) at February 28, 1999 and was 7.65% and 7.5% at the end of
February 1998 and 1997, respectively.
Bad debt expense as a percentage of net sales was 3.9% in the fiscal year
ended February 28, 1999, compared to 4.0% and 3.6% in the years ended February
28, 1998 and 1997, respectively. The Company raised its allowance to 7.65% early
in the fiscal year ended February 28, 1998 in anticipation of higher losses
resulting from the Company's lack of ability to recover certain losses after
terminating its UCC non-filing option. Delinquency in the Company's accounts
receivable was flat at 8.1% for the fiscal years ended February 28, 1999 and
1998, down from 8.9% in the fiscal year ended February 28, 1997. The Company's
policies and procedures regarding credit authorization, collection, and
write-offs have not changed significantly during the three-year period.
Primarily as a result of the higher accounts receivable, finance charges
grew to $7,751,000 in the fiscal year ended February 28, 1999 from $7,078,000
and $6,893,000 in the fiscal years ended February 28, 1998 and 1997,
respectively. Credit insurance fees were $1,418,000 in fiscal 1999, up from
$1,249,000 in 1998 and $1,196,000 in 1997. Late fees in fiscal 1999 were
$1,165,000 and were $892,000 in 1998 and $614,000 in 1997. The increases in late
fees were caused primarily by increases in the amount charged and from charging
the fee after 10-30 days rather than after 60 days.
CUSTOMERS
As a retail organization, the Company is not dependent upon a single
customer, or a few customers, the loss of any one or more of which would have a
material adverse effect on the business of the Company.
COMPETITION
The retail jewelry industry is highly competitive and fragmented, with a
large number of independent jewelry retailers. According to National Jeweler,a
trade publication, the Company is the tenth largest retail jewelry chain in the
United States, based on the number of locations. However, other publicly held
jewelry
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chains are substantially larger than the Company and compete directly with the
Company in a number of markets. In 71% of its locations, the Company competes
with Zale Corporation (ZLC), with Freidman's, Inc. (FRDM) in 43%, with Sterling,
Inc. (a subsidiary of SIGYY) in 35%, and with Whitehall Jewellers, Inc. (WHJI)
in 26% of its locations. The malls in which the Company has stores have an
average of 4.9 specialty retail jewelers, with as few as two and as many as ten
in any single mall. Management estimates that its market share among specialty
jewelers in the malls in which it operates is 18 1/2%. Although the Company
considers its primary competition to be other specialty jewelers in the malls in
which it operates, it also competes for customers in various markets with
department stores, discount stores, catalog showrooms, direct mail suppliers,
television shopping networks, and merchants on the internet.
The Company believes the retail jewelry industry competes primarily on the
basis of reputation, value, service, location, and fashion. Success is
substantially dependent on the experience, training, and enthusiasm of sales
personnel and the ability to respond quickly to the level of consumer demand for
particular items of merchandise. The Company seeks to maintain and increase its
market position by aggressively promoting competitive prices and value, by
offering quality products and services, and by employing superior inventory
replenishment and management information systems.
EMPLOYEES
As of February 28, 1999, the Company had a total of 802 full-time
equivalent (FTE) employees. Of these, 167 FTEs were employed in the corporate
headquarters and the remaining 635 FTEs were employed in the stores. Throughout
the year, the Company hires a number of part-time employees, primarily during
the holiday shopping seasons. Approximately 70% of all employees during the year
are full-time and 30% are part-time. The Company considers its relations with
its employees to be good.
MISCELLANEOUS
- The Company has made public no information about any new product that
would require the investment of a material amount of assets or that
otherwise is material.
- The Company holds no material patents, trademarks, licenses, franchises,
or concessions.
- As a retail organization, the Company maintains no significant amount of
backlog orders.
- No portion of the Company's business involves contracts or subcontracts
with the United States government.
- Federal, state, and local laws and regulations relating to the protection
of the environment are generally inapplicable to the operations of the
Company and, accordingly, are not expected to have a material effect on
the Company's business.
ITEM 2. PROPERTIES
With the exception of the downtown Wilmington location that it owns, the
Company occupies its various store premises generally under five to ten year
lease arrangements with monthly payments of four to six percent of net sales,
subject to minimum payments. Under the terms of the typical lease, the Company
is required to maintain and conform its usage to specified standards, often
including required advertising expenditures, and is responsible for its
proportionate share of expenses associated with common area maintenance,
utilities, insurance, and taxes. The table below sets forth information with
respect to the
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expiration of leases on 103 locations in operation and 7 locations committed to
by the Company as of February 28, 1999:
<TABLE>
<CAPTION>
NUMBER OF LEASES
YEAR OF EXPIRATION WHICH EXPIRE
- ------------------ ----------------
<S> <C>
1999.................................................. 5
2000.................................................. 7
2001.................................................. 14
2002.................................................. 7
2003.................................................. 5
2004.................................................. 8
2005.................................................. 9
2006.................................................. 15
2007.................................................. 15
2008.................................................. 15
2009.................................................. 5
2010.................................................. 5
</TABLE>
Leases for 17,831 square feet for the Corporate Headquarters in Wilmington,
North Carolina are with related parties and expire December 31, 2006. Additional
information regarding these leases is incorporated herein by reference to the
information contained under the heading Certain Relationships and Related
Transactions in Item 13 of Part III of this document.
ITEM 3. LEGAL PROCEEDINGS
The Company is from time to time involved in routine litigation incidental
to the conduct of its business. The Company believes that no currently pending
litigation to which it is a party will have a material adverse effect on its
consolidated financial condition or results of operations.
However, in the past, a subsidiary of the Company purchased non-file UCC
insurance from an unaffiliated insurance carrier for accounts originated in
certain states and charged its customers in those states a non-file UCC
insurance fee equal to the subsidiary's premium cost for that insurance.
Non-file insurance reimbursed the subsidiary for losses on accounts that
resulted from its decision not to file a UCC financing statement for the
collateral securing the account. Several plaintiffs challenged certain aspects
of the Company's non-file insurance practices. This civil action suit was
discussed in more detail in previous filings, including the Company's February
28, 1998 10-K and Annual Report. In July 1998, the final order for a settlement
provided for, among other things, the payment of $486,000 to a settlement fund
and the payment of administrative fees that were approximately $127,000. No
expense was incurred during the fiscal year ended February 28, 1999 due to the
fact that the Company recorded a charge of $700,000, or $ .08 per share, during
the fourth quarter of the prior fiscal year in anticipation of this settlement.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders
during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of February 28, 1999 there were 8,476,372 shares outstanding held by 228
shareholders of record plus approximately 300 non-objecting beneficial owners
whose shares are held in nominee or "street" name by brokers. The Company has
not paid any cash dividends on its stock since its inception, and has no
intention to pay cash dividends in the foreseeable future (See Footnote 2 to the
Consolidated Financial Statements). The Company's common stock trades on the
American Stock Exchange under the symbol RJI. The quarterly high
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and low sales prices of the Company's common stock (adjusted for the 100% stock
dividend issued on February 20, 1998) for the fiscal years ended February 28,
1999 and 1998 were as follows:
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
FISCAL YEAR ENDED FEBRUARY 28, 1999
Fourth Quarter.............................................. $4.6250 $3.2500
Third Quarter............................................... 5.6875 3.0000
Second Quarter.............................................. 4.1250 3.5625
First Quarter............................................... 4.3750 3.7500
FISCAL YEAR ENDED FEBRUARY 28, 1998
Fourth Quarter.............................................. $4.3750 $3.1875
Third Quarter............................................... 3.5625 3.2500
Second Quarter.............................................. 4.2500 3.0625
First Quarter............................................... 3.6875 2.8750
</TABLE>
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
-------- -------- ------- ------- -------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA AND
NUMBER OF STORES)
<S> <C> <C> <C> <C> <C>
FIVE-YEAR SUMMARY
Net Sales...................................... $109,284 $102,845 $98,952 $89,801 $77,496
Bad Debt Expense............................... 4,234 4,092 3,538 3,419 3,000
Interest Expense............................... 3,470 3,457 3,428 3,263 3,040
Net Earnings................................... 4,205 2,708 4,025 3,212 4,113
Earnings Per Share (basic & diluted)........... .50 .32 .48 .38 .49
Working Capital................................ 66,388 63,305 56,545 52,050 45,815
Total Assets................................... 110,965 100,986 97,519 88,886 77,401
Long-Term Debt, Less Current................... 44,193 43,793 39,651 38,019 29,278
Shareholders' Equity........................... 40,168 35,903 33,195 29,143 25,827
Number of Stores............................... 104 98 100 96 77
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
In order to make it easier for shareholders and potential investors to
compare the Company's performance to that of its publicly held competitors,
management has decided to format its financial presentation in a manner more
consistent with that of Zale Corporation, the largest specialty retail jeweler.
As a result, (1) occupancy costs are now included as selling, general, and
administrative expenses (SG&A) rather than as part of cost of goods, and (2)
other revenues and bad debt are now reflected in SG&A rather than as separate
line items. All presentations have been reclassified accordingly and
management's discussion will include various details of these items.
RESULTS OF OPERATIONS
Net Sales
At February 28, 1999 the Company operated 104 stores in fifteen states
compared to 98 stores in 13 states and 100 stores in 12 states at February 28,
1998 and 1997, respectively. Total net sales for fiscal 1999 were up 6.3% to
$109,284,000 from $102,845,000 in fiscal 1998, which were 3.9% higher than sales
of $98,952,000 in fiscal 1997. Same store sales, or stores open in comparable
periods, were up 5% in 1999, were up 1% in 1998, and were slightly positive in
1997. During the coming fiscal year ending February 29, 2000, the Company
already has commitments to open five new stores, two of which were opened in
March 1999. Management expects to open a total of eight to ten new stores during
the year and expects that it will not renew its leases for one or two
under-performing stores.
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The Company averaged 94.4% in-stock on its key and core items during fiscal
1999, up from 92.6% last year; it averaged 83.7% in-stock on its entire basic
merchandise mix in fiscal 1999, compared to 87.2% during the previous year.
During the fiscal year ended February 28, 1999, key and core merchandise
accounted for 52.4% of net sales, 48.7% of the items in the Company's basic
merchandise mix, and 35.3% of its inventory investment. During the prior year,
key and core merchandise accounted for 57.8% of net sales, 64.7% of the items in
the Company's basic merchandise mix, and 43.5% of its inventory investment. The
average price of each piece of merchandise sold in fiscal 1999 was $233, up from
$209 a year earlier, and management plans to increase this average by
approximately 7% in the current year as it continues to increase its offerings
of higher price points.
Sales on the Company's proprietary credit card were up 6.4% and cash sales
rose 6.1%. Credit sales accounted for 46.4% of total net sales, up from 46.3% a
year earlier. The average credit transaction during the year was 7.2% higher
than that of last year. The average credit transaction was also 4.2 times the
size of the average cash transaction, compared to 4.3 times a year ago. The
primary reason for the difference in the average credit and cash transaction is
the large number of cash repair sales that yield a lower price per transaction.
The Company's credit-marketing efforts resulted in 13.3% more applications being
obtained and 19.4% more new accounts being opened throughout the year compared
to last year. Management believes that its proprietary financing program is a
strategic competitive strength and seeks to optimize its risk-reward ratio by
financing up to 55% of net sales.
Gross Profit
Gross margins were 50.1% of net sales in 1999, 50.3% in 1998, and 51.9% in
1997. The lower gross margins in each of the last two years resulted primarily
from fewer sales in the higher margin gold and colored stone categories and more
sales in the lower margin watch category. Repairs and special events accounted
for about 8% of net sales during each of the last two years, and these items
yield gross margins that are lower than average. Management has developed plans
to reverse the recent decline and increase gross margins during the current
fiscal year by as much as 100 basis points. These plans include changes in
sources for certain items and less discounting as the result of training
emphasis and revisions in incentive compensation for sales associates that
reward achieving goals for both sales and gross margins.
Selling, General, and Administrative Expenses (SG&A)
Selling, general, and administrative expenses as a percentage of net sales
were 37.9%, 39.8%, and 39.5% in 1999, 1998, and 1997, respectively. Significant
expense categories are reflected on a normalized basis for the three years in
the following table:
<TABLE>
<CAPTION>
1999 1998 1997
----- ----- -----
<S> <C> <C> <C>
Compensation - salaries & hourly wages.............. 16.5% 16.4% 16.7%
Compensation - bonuses & commissions................ 4.7 3.7 3.4
Compensation - benefits & other personnel costs..... 3.6 3.2 3.3
Rents for space..................................... 8.9 9.0 8.9
Advertising......................................... 4.4 4.7 5.0
Bad debt............................................ 3.9 4.0 3.6
Finance charges..................................... (7.1) (6.9) (7.0)
</TABLE>
The increase in compensation from bonuses and commissions in fiscal 1999
resulted from costs associated with changes in the Company's incentive plans
designed to reward associates for increases in personal sales and gross margins,
and for improved profitability. Outlays for advertising were essentially flat
throughout the three years as the Company leveraged its marketing investment
while making minor changes in its approach.
Extended service agreements equaled 2.9%, 1.9%, and 1.8% of net sales in
1999, 1998, and 1997, respectively. During the first quarter of fiscal 1999, the
Company stopped selling its own extended service contracts and began selling
such contracts on behalf of unrelated third parties only. As a result of this
change, the Company will continue to recognize existing deferred revenues from
previously sold contracts through
8
<PAGE> 10
January 31, 2001 and now recognizes commission revenue from the unrelated
third-party extended warranty plans at the time of sale. The effect of this
change for the year was an additional $1,427,000 pre-tax benefit from extended
service agreements, which has been reflected as a reduction of selling, general,
and administrative expenses. The effect in the coming year is expected to be a
benefit of approximately $850,000, or about $575,000 less than fiscal 1999.
Bad debt expense increased 3.5% to $4,234,000 in the year ended February
28, 1999 from $4,092,000 in 1998; bad debt expense in 1997 was $3,538,000.
Actual write-offs as a percentage of net sales during each of the years were
3.4% in 1999, 3.7% in 1998, and 3.4% in 1997. At the end of 1999, 1998, and 1997
the allowance for doubtful accounts was 7.65%, 7.65%, and 7.5%, respectively, of
customer receivables (prior to the allowance for doubtful accounts). The
Company's policies and procedures regarding credit authorization, collection,
and write-offs have not changed significantly during the three-year period.
Delinquent accounts (accounts more than 90 days past due) represented 8.1%,
8.1%, and 8.9% of the Company's accounts receivable portfolio on the last day of
February 1999, 1998, and 1997, respectively.
Interest Expense
Interest expense decreased to 3.2% of net sales in 1999 from 3.4% in 1998
and 3.5% in 1997. In 1999, the average borrowings were 5.7% higher than a year
earlier but the Company's effective interest rate for the year was 7.34%
compared to 7.70% the previous year.
Income Taxes
The provision for income taxes was $2,071,000 in 1999, $1,374,000 in 1998,
and $1,982,000 in 1997. The net effective tax rate in each of the three years
was approximately 33.0%. The Company earned a record $4,205,000 in the year
ended February 28, 1999, 55.3% higher than the previous year and 4.5% higher
than two years earlier. On a basic and diluted basis, the Company earned $ .50
per share compared to $ .32 per share and $ .48 per share during the two prior
years.
Non-File UCC Insurance Litigation
In the past, a subsidiary of the Company purchased non-file UCC insurance
from an unaffiliated insurance carrier for accounts originated in certain states
and charged its customers in those states a non-file UCC insurance fee equal to
the subsidiary's premium cost for that insurance. Non-file insurance reimbursed
the subsidiary for losses on accounts that resulted from its decision not to
file a UCC financing statement for the collateral securing the account. Several
plaintiffs challenged certain aspects of the Company's non-file insurance
practices. This civil action suit was discussed in more detail in previous
filings, including the Company's February 28, 1998 10-K and Annual Report. In
July 1998, the final order for a settlement provided for, among other things,
the payment of $486,000 to a settlement fund and the payment of administrative
fees that were approximately $127,000. No expense was incurred during the fiscal
year ended February 28, 1999 due to the fact that the Company recorded a charge
of $700,000, or $ .08 per share, during the fourth quarter of the prior fiscal
year in anticipation of this settlement.
Year 2000 ("Y2K")
The Year 2000 issue is the result of computer programs being written using
two digits rather than four digits to define a specific year. Any programs that
have date-sensitive software may recognize a date using "00" as the year 1900
rather than 2000. This could result in systems failures or miscalculations
causing disruptions to various activities and operations. Now that Year 2000 is
upon us, this problem is posing a threat to many companies and may be expensive
for many companies to correct. Reeds Jewelers had Year 2000 in mind in 1985 when
it began the first stages of developing its inventory and credit systems that
would allow the Company to grow and move into the next century.
The Company is using external and internal resources to test, reprogram, or
replace its operating software and hardware, application systems, EDI systems,
user written systems, network components, PC hardware and software, and embedded
chips. The Company has completed nearly all of its review of these areas and is
9
<PAGE> 11
compliant with Year 2000. Less than 1% of our user written programs remain to be
examined, a few desktop computers still need to be checked, and some small
programs need replacing. The remaining tasks are to be completed by mid-1999.
All vendors and suppliers have been contacted and have assured the Company that
they are or will be compliant by mid-1999. No material costs have been incurred,
nor are any expected to be incurred, by the Company related to the Y2K issue.
There can be no guarantee that actual results will not differ materially
from those planned. Specific factors that might cause such material differences
include, but are not limited to, the ability to locate and correct all relevant
computer codes, the ability of third parties to identify and resolve all Year
2000 issues, and similar uncertainties. However, since we expect no significant
problems, our contingency plan is limited to the handling of shipments and
invoices from any vendor or vendors that may have erroneously assessed their
readiness regarding Y2K.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires cash for purchasing inventory, opening new stores,
making leasehold improvements, and acquiring equipment. Working capital needs
normally peak in the fall as the Company increases inventories to meet
anticipated demand during the all-important Christmas selling season. The
Company's long-term growth strategy will require increasing working capital to
fund capital expenditures, receivables, and inventories for new stores. Working
capital requirements will be financed by funds generated from operations and
bank lines described below. Cash provided by operations in 1999, 1998, and 1997
was $3,875,000, $1,630,000, and $1,735,000, respectively.
Working Capital
Working capital increased 4.9% to $66,388,000 from $63,305,000 in 1998. The
resulting ratio of current assets to current liabilities as of February 28, 1999
was 3.7 to 1, compared to 4.5 to 1 at February 28, 1998.
Capital expenditures totaled $4,189,000 in 1999, $3,141,000 in 1998, and
$3,222,000 in 1997. The Company opened new stores in 1999 in Athens GA, Augusta
GA, Kennesaw GA, Lexington KY, Johnson City TN, and Richmond VA. The Company
also purchased four stores in Iowa. It closed stores in Raleigh NC, Hilton Head
SC, McLean VA, and Prince William VA during the fiscal year.
Since year-end, the Company has opened two new stores, one in Norfolk VA
and the other in Louisville KY, and plans to open four to eight more new stores
in the current fiscal year. The Company has a budget of approximately $4,000,000
for capital expenditures in the fiscal year ending February 29, 2000 for new
store openings, major and minor remodels, and other equipment. These capital
expenditures will be financed by funds generated from operations and bank lines
described below.
Debt
Borrowings under the Company's revolving credit facility averaged $46.0
million in 1999 and $43.0 million in 1998. The maximum borrowings outstanding
under the facility at any time during each year were $50.0 million in 1999 and
$49.4 million in 1998. At February 28, 1999, $43.3 million was outstanding under
the facility compared to $42.9 million at February 28, 1998.
On December 21, 1995, the Company entered into a revolving credit agreement
with two commercial banks whereby the Company could borrow up to $40,000,000
based on specified percentages of eligible inventory and accounts receivable. In
June 1997, the Company increased its revolving credit facility to $45,000,000
and extended its expiration to July 31, 2000; covenants and other terms remained
unchanged. In May 1998, the Company and the banks agreed to an additional
seasonal increase to $50,000,000 from May 10 through December 31, 1998. The
Company pays interest under the revolving credit facility at 30-day LIBOR plus
160-200 basis points or at the banks' prime rate plus 37 1/2 to 62 1/2 basis
points, depending upon the Company's debt-to-worth ratio. As of April 1, 1999,
the Company's rate was 30-day LIBOR plus 160 basis points.
10
<PAGE> 12
In April 1999, the Company, its existing banks, and two additional banks
entered into an amended revolving credit agreement whereby the Company may
borrow up to $65,000,000 through June 30, 2002 on terms similar to those of the
previous agreement. Under the amended agreement, the Company pays interest at an
interest rate ranging from the 30-day LIBOR plus 125 basis points to 185 basis
points or at the banks' prime rate plus 25 basis points, depending upon the
Company's debt-to-worth ratio. If this agreement had been in effect on April 1,
1999, the Company's rate would have been 30-day LIBOR plus 145 basis points.
The Company also has subordinated notes totaling $845,000 with three
related parties, with interest payable monthly at the prime rate quoted in The
Wall Street Journal. The notes are unsecured and are subordinate to the
revolving bank note, which is collateralized by substantially all of the
Company's assets.
Disclosure Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements to encourage companies to provide
prospective information about their companies without fear of litigation so long
as those statements are identified as forward-looking and are accompanied by
meaningful cautionary statements identifying important factors that could cause
actual results to differ materially from those projected in the statement.
Various forward-looking statements have been made throughout this discussion,
including comments about:
(i) planned store openings;
(ii) expected increases in gross margins;
(iii) expected increases in the average price of merchandise sales; and
(iv) goals for the mix of credit and cash sales.
Accordingly, the Company hereby identifies the following important factors that
could cause the Company's actual financial results to differ materially from
those projected by the Company in forward-looking statements:
(i) lack of available locations on terms acceptable to the Company;
(ii) unexpected changes in the marketing and pricing strategies of
competitors;
(iii) adverse changes in the political environments of countries
providing raw materials for the jewelry industry;
(iv) adverse changes in consumer spending or consumer credit-worthiness;
(v) significant changes in interest rates; or
(vi) the loss of key executives.
Impact of Inflation
In management's opinion, changes in net sales and net earnings that have
resulted from inflation and changing prices have not been material during the
periods presented. There is no assurance, however, that inflation will not
materially affect the Company in the future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates that
may adversely affect its financial position, results of operations, and cash
flows. In seeking to minimize the risks from interest rate fluctuations, the
Company manages exposures through its regular operating and financing
activities. From time to time, the Company will purchase interest rate caps or
swaps for the purpose of managing its interest rate exposure. However, the
Company does not use financial instruments for trading or other speculative
purposes and is not party to any leveraged financial instruments.
11
<PAGE> 13
The Company is exposed to interest rate risk primarily through its
borrowing activities that are described in Note 2 to the Consolidated Financial
Statements. All of the Company's borrowings are under floating rate
arrangements. See Note 2 to the Consolidated Financial Statements regarding
Long-Term Debt and Notes Payable, which is included herein.
Based on the Company's market risk sensitive instruments (its variable rate
debt) outstanding at February 28, 1999, the Company has determined that there
was no material market risk exposure to the Company's financial position,
results of operations, or cash flows as of such date.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For information required by this item, see "Index to Financial Statements
and Financial Statement Schedules" beginning at page F-1 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is incorporated herein by reference
to the information contained under the heading "Election of Directors" in the
Company's Proxy Statement for the 1999 Annual Meeting of Shareholders (except
for the information contained under the subheadings "Committees of the Board of
Directors; Meetings and Compensation of Directors" and "Certain Transactions,"
which is not incorporated herein by reference).
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference
to the information contained under the heading "Compensation of Executive
Officers" in the Company's Proxy Statement for the 1999 Annual Meeting of
Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated herein by reference
to the information contained under the heading "Election of Directors" in the
Company's Proxy Statement for the 1999 Annual Meeting of Shareholders (except
for the information contained under the subheadings "Committees of the Board of
Directors; Meetings and Compensation of Directors" and "Certain Transactions,"
which is not incorporated herein by reference).
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company leases its corporate headquarters, consisting of 17,831 square
feet of office space and 155 parking spaces, from a partnership comprised of
Alan M. Zimmer, Herbert J. Zimmer, Jeffrey L. Zimmer, and Arlene Z. Schreiber.
Alan M. Zimmer is President and Chief Executive Officer of the Company and
Herbert J. Zimmer, Jeffrey L. Zimmer, and Arlene Z. Schreiber are all Directors.
On September 1, 1999 the Company will be increasing its office space to a total
of 20,731 square feet. Monthly rental payments under the lease are $23,448,
increasing to $26,484 on September 1, 1999, and rising to $26,927 on January 1,
2003. The Company also pays the related insurance, property taxes, maintenance
fees, and utilities for this location. The leases for these facilities expire
December 31, 2006. Based on rentals charged for comparable properties in
Wilmington, the Company believes the terms of the lease are no less favorable to
the Company than those that could be obtained from unaffiliated parties.
12
<PAGE> 14
Herbert J. Zimmer and Jeffrey L. Zimmer are partners in the law firm of
Zimmer and Zimmer, which serves as general counsel to the Company. During the
fiscal year ended February 28, 1999, the Company paid Zimmer and Zimmer legal
fees and reimbursement of costs advanced in the amount of $184,000; the Company
paid $175,000 and $175,000 to Zimmer and Zimmer in 1998 and 1997, respectively.
Between June 30, 1989 and February 6, 1990, the Company borrowed a total of
$1,370,000 from three of its principal shareholders, of which $470,000 was
repaid as of May 18, 1990, $21,000 was repaid in June 1996, and $34,000 was
repaid in July 1998. Interest is paid monthly on the amounts borrowed at the
prime rate as quoted each month in The Wall Street Journal. The amounts
remaining outstanding under the notes are $560,000 to Alan M. Zimmer, $185,000
to Arlene Z. Schreiber, and $100,000 to Ronna T. Zimmer (the wife of Herbert J.
Zimmer). These amounts are evidenced by various subordinated notes and are due
upon full payment of all senior obligations or with approval of all senior
lenders.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A)(1) AND (2)
Financial Statement and Financial Statement Schedules: The financial
statements, financial statement schedules and reports of independent auditors
listed in the accompanying index are filed as part of this annual report.
(A)(3) EXHIBITS:
<TABLE>
<S> <C> <C> <C>
3(a) -- Charter and Charter Amendments of the Registrant, as amended
effective June 28, 1990 (incorporated by reference to the
Company's Form 10-K for the fiscal year ended February 28,
1991, file number 0-15247)
3(b) -- Bylaws of the Registrant, as amended effective August 10,
1990 (incorporated by reference to the Company's Form 10-K
for the fiscal year ended February 28, 1991, file number
0-15247)
4 -- Registrant undertakes to furnish the Commission, upon
request, a copy of any instrument defining the rights of
holders of long-term debt of the Registrant and all of its
subsidiaries for which consolidated or unconsolidated
financial statements are required to be filed.
10(a) -- Lease Agreement with Zimmer Brothers, a Partnership, dated
February 13, 1986 and First Amendment dated August 15, 1986
(incorporated by reference to the Company's Registration
Statement on Form S-1, file number 33-10091)
10(b) -- Second Amendment to Lease Agreement with Zimmer Brothers, a
Partnership (incorporated by reference to the Company's Form
10-K for the fiscal year ended February 28, 1991, file
number 0-15247)
10(c) -- 1986 Employee Incentive Stock Option Plan (incorporated by
reference to the Company's Registration Statement on Form
S-1, file number 33-10091)
10(d) -- Shareholder Agreement (incorporated by reference to the
Company's Registration Statement on Form S-1, file number
33-10091)
10(e) -- Lease Agreement with Zimmer Brothers, a Partnership, dated
January 22, 1991 (incorporated by reference to the Company's
Form 10-K for the fiscal year ended February 28, 1991, file
0-15247)
</TABLE>
13
<PAGE> 15
<TABLE>
<S> <C> <C> <C>
10(f) -- Reeds Jewelers 401(k) Profit Sharing Plan and Trust Summary
(incorporated by reference to the Company's Form 10-K for
the fiscal year ended February 28, 1993, file number
0-15247)
10(g) -- 1992 Director Stock Option Plan (incorporated by reference
to the Company's Form 10-K for the fiscal year ended
February 28, 1993, file number 0-15247)
10(h) -- Amendment dated March 23, 1987 to 1986 Employee Incentive
Stock Option Plan (incorporated by reference to the
Company's Form 10-K for the fiscal year ended February 28,
1987, file number 0-15247)
10(i) -- Form of non-qualified supplemental executive retirement plan
(incorporated by reference to the Company's Form 10-K for
the fiscal year ended February 28, 1994, file number
0-15247)
10(j) -- 1994 Stock Option Plan (incorporated by reference to the
Company's Form 10-K for the fiscal year ended February 28,
1995, file number 0-15247)
***** 10(k) -- Third Amendment dated February 16, 1999 to Lease Agreement
with Zimmer Brothers, a Partnership.
***** 21 -- List of Subsidiaries of the Registrant
***** 23 -- Consent of Ernst & Young LLP
***** 27 -- Financial data schedule
</TABLE>
(B) REPORTS ON FORM 8-K FILED DURING THE LAST QUARTER OF THE PERIOD COVERED BY
THIS REPORT.
None.
14
<PAGE> 16
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 12th day of
April 1999.
REEDS JEWELERS, INC.
(Registrant)
By /s/ JAMES R. ROUSE
------------------------------------
James R. Rouse
Treasurer and Chief Financial
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on the 12th day of April 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ ALAN M. ZIMMER President and Chief Executive Officer and
- ----------------------------------------------------- Director
(Alan M. Zimmer)
/s/ WILLIAM R. ZIMMER Chairman of the Board of Directors
- -----------------------------------------------------
(William R. Zimmer)
/s/ JAMES R. ROUSE Treasurer and Chief Financial Officer
- -----------------------------------------------------
(James R. Rouse)
/s/ ALLAN E. METZNER Vice President and Corporate Controller
- ----------------------------------------------------- (Principal Accounting Officer)
(Allan E. Metzner)
/s/ ROBERTA G. ZIMMER Secretary and Director
- -----------------------------------------------------
(Roberta G. Zimmer)
/s/ GARLAND WADDY GARRETT Director
- -----------------------------------------------------
(Garland Waddy Garrett)
/s/ FENTON N. HORD Director
- -----------------------------------------------------
(Fenton N. Hord)
/s/ ARLENE Z. SCHREIBER Director
- -----------------------------------------------------
(Arlene Z. Schreiber)
/s/ RICHARD F. SHERMAN Director
- -----------------------------------------------------
(Richard F. Sherman)
/s/ HERBERT J. ZIMMER Director
- -----------------------------------------------------
(Herbert J. Zimmer)
/s/ JEFFREY L. ZIMMER Director
- -----------------------------------------------------
(Jeffrey L. Zimmer)
</TABLE>
15
<PAGE> 17
REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED FEBRUARY 28, 1999, 1998, AND 1997
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<S> <C>
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Income........................... F-4
Consolidated Statements of Shareholders' Equity............. F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
Schedule II -- Valuation and Qualifying Accounts............ F-18
</TABLE>
F-1
<PAGE> 18
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Reeds Jewelers, Inc. and Subsidiaries
Wilmington, North Carolina
We have audited the accompanying consolidated balance sheets of Reeds
Jewelers, Inc. and subsidiaries as of February 28, 1999 and 1998 and the related
consolidated statements of income, shareholders' equity and cash flows for each
of the three years in the period ended February 28, 1999. Our audits also
included the financial statement schedule listed in the Index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Reeds Jewelers,
Inc. and subsidiaries at February 28, 1999 and 1998, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended February 28, 1999, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered in relation to the financial statements taken as a whole, presents
fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Raleigh, North Carolina
March 31, 1999
F-2
<PAGE> 19
REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
FEBRUARY 28,
---------------------------
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 1,080,000 $ 996,000
Accounts receivable:
Customers, less allowance of $3,782,000 in 1999 and
$3,338,000 in 1998..................................... 45,655,000 40,291,000
Other................................................... 853,000 627,000
Merchandise inventories................................... 40,798,000 36,466,000
Deferred income taxes..................................... 2,312,000 2,577,000
Other..................................................... 523,000 582,000
------------ ------------
Total current assets............................... 91,221,000 81,539,000
Property, furniture and equipment:
Land and building......................................... 83,000 83,000
Furniture and equipment................................... 19,601,000 17,196,000
Leasehold improvements.................................... 10,972,000 10,776,000
------------ ------------
30,656,000 28,055,000
Less accumulated depreciation and amortization............ 17,895,000 16,351,000
------------ ------------
12,761,000 11,704,000
Other assets:
Goodwill, net of accumulated amortization of $2,101,000 in
1999 and $1,654,000 in 1998............................. 6,295,000 6,741,000
Deferred income taxes, net of valuation allowance of
$157,000 in 1999 and $178,000 in 1998................... 127,000 406,000
Miscellaneous............................................. 561,000 596,000
------------ ------------
6,983,000 7,743,000
------------ ------------
Total assets....................................... $110,965,000 $100,986,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 15,638,000 $ 9,369,000
Accrued compensation...................................... 3,780,000 2,586,000
Accrued expenses.......................................... 2,628,000 2,733,000
Deferred revenue.......................................... 908,000 1,548,000
Income taxes (Note 6)..................................... 1,879,000 1,998,000
------------ ------------
Total current liabilities.......................... 24,833,000 18,234,000
Revolving credit note (Note 2).............................. 43,348,000 42,914,000
Subordinated notes payable to shareholders (Note 2)......... 845,000 879,000
Deferred income taxes....................................... 1,440,000 1,768,000
Deferred revenue............................................ 314,000 1,222,000
Other long-term liabilities................................. 17,000 66,000
------------ ------------
70,797,000 65,083,000
Commitments and contingencies (Notes 3 and 10)
Shareholders' equity (Notes 7 and 8):
Common stock, par value $.10 per share, 25,000,000 shares
authorized, 8,476,372 shares issued and outstanding in
1999 8,449,752 shares issued and outstanding in 1998.... 847,000 844,000
Additional paid-in capital................................ 10,560,000 10,503,000
Retained earnings......................................... 28,761,000 24,556,000
------------ ------------
Total shareholders' equity......................... 40,168,000 35,903,000
------------ ------------
Total liabilities and shareholders' equity......... $110,965,000 $100,986,000
============ ============
</TABLE>
See accompanying notes.
F-3
<PAGE> 20
REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28,
-----------------------------------------
1999 1998 1997
------------ ------------ -----------
<S> <C> <C> <C>
Net sales............................................. $109,284,000 $102,845,000 $98,952,000
Cost of sales......................................... 54,559,000 51,136,000 47,644,000
------------ ------------ -----------
Gross profit................................ 54,725,000 51,709,000 51,308,000
Selling, general, and administrative expenses......... 41,410,000 40,924,000 39,064,000
Depreciation and amortization......................... 3,569,000 3,187,000 2,809,000
------------ ------------ -----------
Operating earnings.......................... 9,746,000 7,598,000 9,435,000
Interest expense...................................... 3,470,000 3,457,000 3,428,000
------------ ------------ -----------
Income before income taxes and
extraordinary items....................... 6,276,000 4,141,000 6,007,000
Income taxes (Note 6)................................. 2,071,000 1,374,000 1,982,000
------------ ------------ -----------
Net income before extraordinary item.................. 4,205,000 2,767,000 4,025,000
Extraordinary item -- loss on early extinguishment of
debt, net of income tax benefit of $40,000 in
1998................................................ -- (59,000) --
------------ ------------ -----------
Net income.................................. $ 4,205,000 $ 2,708,000 $ 4,025,000
============ ============ ===========
Net income per common share:
Income before extraordinary item.................... $ .50 $ .33 $ .48
Extraordinary item -- loss on early
extinguishment of debt........................... -- (.01) --
------------ ------------ -----------
Basic and diluted net income per common share......... $ .50 $ .32 $ .48
============ ============ ===========
Weighted average shares outstanding -- diluted........ 8,476,417 8,465,752 8,465,160
============ ============ ===========
</TABLE>
See accompanying notes.
F-4
<PAGE> 21
REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON ADDITIONAL RETAINED
STOCK PAID-IN CAPITAL EARNINGS TOTAL
-------- --------------- ----------- -----------
<S> <C> <C> <C> <C>
Balance at February 29, 1996.................. $422,000 $10,898,000 $17,823,000 $29,143,000
Exercise of stock options for common
stock.................................... -- 27,000 -- 27,000
Net income for 1997......................... -- -- 4,025,000 4,025,000
-------- ----------- ----------- -----------
Balance at February 28, 1997.................. 422,000 10,925,000 21,848,000 33,195,000
Two-for-one stock split effective in the
form of a 100% stock dividend (Note 7)... 422,000 (422,000) -- --
Net income for 1998......................... -- -- 2,708,000 2,708,000
-------- ----------- ----------- -----------
Balance at February 28, 1998.................. 844,000 10,503,000 24,556,000 35,903,000
Exercise of stock options for common
stock.................................... 3,000 57,000 -- 60,000
Net income for 1999......................... -- -- 4,205,000 4,205,000
-------- ----------- ----------- -----------
Balance at February 28, 1999.................. $847,000 $10,560,000 $28,761,000 $40,168,000
======== =========== =========== ===========
</TABLE>
See accompanying notes.
F-5
<PAGE> 22
REEDS JEWELERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28,
------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................................. $4,205,000 $2,708,000 $4,025,000
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation.......................................... 3,123,000 2,741,000 2,363,000
Amortization.......................................... 446,000 446,000 446,000
Provision for deferred income taxes................... 216,000 (745,000) (520,000)
Loss (gain) on sale of property, furniture and
equipment........................................... 44,000 -- (92,000)
Changes in operating assets and liabilities:
Accounts receivable................................. (5,590,000) (2,252,000) (1,264,000)
Merchandise inventories............................. (4,332,000) (377,000) (5,678,000)
Other current assets and other assets............... 59,000 (19,000) (283,000)
Accounts payable.................................... 6,269,000 (2,121,000) 1,918,000
Accrued compensation and expenses................... 1,089,000 919,000 (55,000)
Deferred revenue.................................... (1,548,000) 234,000 199,000
Income taxes........................................ (119,000) 252,000 747,000
Other long-term liabilities......................... (49,000) (43,000) (71,000)
---------- ---------- ----------
Net cash provided by operating activities.................. 3,813,000 1,743,000 1,735,000
INVESTING ACTIVITIES
Purchases of property, furniture and equipment............. (4,189,000) (3,141,000) (3,222,000)
---------- ---------- ----------
Net cash used in investing activities...................... (4,189,000) (3,141,000) (3,222,000)
FINANCING ACTIVITIES
Proceeds from exercise of stock options.................... 26,000 -- 6,000
Net proceeds from revolving credit note.................... 434,000 4,803,000 4,420,000
Principal payments on debt................................. -- (3,105,000) (2,429,000)
---------- ---------- ----------
Net cash provided by financing activities.................. 460,000 1,698,000 1,997,000
---------- ---------- ----------
Net increase in cash and cash equivalents.................. 84,000 300,000 510,000
Cash and cash equivalents at beginning of year............. 996,000 696,000 186,000
---------- ---------- ----------
Cash and cash equivalents at end of year................... $1,080,000 $ 996,000 $ 696,000
========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during year for:
Interest................................................. $3,487,000 $3,275,000 $3,479,000
========== ========== ==========
Income taxes............................................. $2,191,000 $1,082,000 $1,755,000
========== ========== ==========
</TABLE>
See accompanying notes.
F-6
<PAGE> 23
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 28, 1999
1. ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Reeds Jewelers, Inc. and subsidiaries (the "Company") are specialty
retailers of fine jewelry, selling to the general public through retail outlets
in fifteen states in the United States. Substantially all of the Company's
accounts receivable are due from individual customers in these states.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries, all of which are wholly owned. Significant intercompany
accounts and transactions have been eliminated in consolidation.
USE OF ESTIMATES
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
RECLASSIFICATIONS
The classifications in use at February 28, 1999 have been applied to the
financial statements for February 28, 1998 and 1997. These reclassifications had
no effect on net income or shareholders' equity as previously reported.
STORE PRE-OPENING COSTS
Store pre-opening costs are charged to results of operations in the period
in which the store is opened. Store closing costs are estimated and recognized
in the period in which the Company makes the decision that the store will close.
Such costs include the present value of estimated future rentals, loss on
retirement of property and equipment, and other related occupancy costs.
ACCOUNTING CHANGES
As of March 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
requires all non-owner changes in equity that are excluded from net income under
existing FASB standards be included as comprehensive income. The Company
presently does not have any transactions that directly affect equity other than
those transactions with owners. Therefore, the Company's comprehensive income is
the same as the Company's net income.
Effective March 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS 131"). SFAS 131 establishes standards for the way
that public companies report information about operating segments in annual
financial statements and requires that those companies report selected
information about operating segments in interim financial reports. The adoption
of SFAS 131 did not affect the Company's net income or financial position.
Effective March 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 132, "Employers' Disclosures About Pensions and Other
Post-retirement Benefits" ("SFAS 132"). SFAS 132 does not change the recognition
or measurement of pension or post-retirement benefit obligations, but
standardizes disclosure requirements. Therefore, the provisions of SFAS 132 did
not affect the Company's net income or financial position.
F-7
<PAGE> 24
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities," which is
required to be adopted in years beginning after June 15, 1999. Management does
not anticipate that the adoption of the new Statement will have a significant
effect on earnings or the financial position of the Company.
IMPAIRMENT
Under the provisions of FASB Statement No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,"
impairment losses are recognized when expected future cash flows are less than
the assets' carrying value. Accordingly, when indicators of impairment are
present, the Company evaluates the carrying value of property, furniture and
equipment and intangibles, including goodwill, in relation to the operating
performance and expected future undiscounted cash flows of the underlying
business. The Company adjusts the net book value of the underlying assets if the
sum of expected future cash flows is less than book value. Since adoption, no
impairment losses have been recognized.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company has estimated the fair value amounts of financial instruments
as required by Statement of Financial Accounting Standards No. 107, "Disclosures
about Fair Value of Financial Instruments," using market information available
to management as of February 28, 1999 and appropriate valuation methodologies.
However, considerable judgment is required in interpreting market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts that the Company would realize in
a current market exchange. The carrying amount of assets and liabilities are
reasonable estimates of their fair values.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
ACCOUNTS RECEIVABLE
Accounts receivable include installment amounts maturing more than one year
from the balance sheet dates, in accordance with trade practice. Interest rates
on these balances vary by state. The allowance for doubtful accounts was
$3,782,000 and $3,338,000 at February 28, 1999 and 1998, respectively. Finance
charge income and net earnings from credit insurance subsidiaries of $8,861,000,
$8,023,000, and $7,843,000, as well as late fees and other minor revenues of
$1,512,000, $1,239,000, and $921,000, for the years ended February 28, 1999,
1998, and 1997, respectively, has been reflected as a reduction of selling,
general, and administrative expenses. The Company's exposure to credit loss in
the event that payment is not received for revenue recognized equals the
outstanding accounts receivable balance less the value received for any
merchandise repossessed due to uncollectible accounts. As of February 28, 1999,
the Company had no significant concentrations of credit risk with individual
customers.
MERCHANDISE INVENTORIES
Merchandise inventories are carried at the lower of cost or market using
the first-in, first-out (FIFO) method. Merchandise inventories were $40,798,000
and $36,466,000 at February 28, 1999 and 1998, respectively. The Company also
maintained consigned inventory at its retail locations of $12,670,000 and
$10,403,000 at February 28, 1999 and 1998, respectively. This consigned
inventory and related contingent obligation are not reflected in the Company's
financial statements. At the time consigned inventory is sold, the
F-8
<PAGE> 25
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company records the purchase liability in accounts payable and the related cost
of merchandise in cost of sales.
PROPERTY, FURNITURE AND EQUIPMENT
Property, furniture and equipment are stated at cost. Depreciation is
computed by the straight-line method over the estimated useful lives of the
related assets. Amortization of leasehold improvements is provided using the
straight-line method over the useful life of the improvement or the remaining
lease term, whichever is shorter. The estimated useful lives are as follows:
<TABLE>
<S> <C>
Building.................................................... 40 years
Furniture and equipment..................................... 5 - 10 years
Leasehold improvements...................................... 5 - 10 years
</TABLE>
GOODWILL
Goodwill represents the excess cost over the fair value of net assets
acquired and is being amortized on a straight-line basis over 15-40 years.
DEFERRED REVENUE
For the fiscal years ended February 28, 1998 and 1997, in accordance with
FASB Technical Bulletin 90-1, "Accounting for Separately Priced Extended
Warranty and Product Maintenance Contracts," revenue from these contracts was
deferred and recognized in income on a straight-line basis over the contract
period. This deferred revenue has been separated into its current and long-term
portions on the balance sheet. Commission costs that were directly related to
the acquisition of these contracts were deferred and are charged to expense in
proportion to the revenue recognized. All other costs, such as costs of services
performed under the contracts, general and administrative expenses, and
advertising expenses, were charged to expense as incurred. Previously deferred
extended service contract revenue recognized for the years ended February 28,
1999, 1998, and 1997 of $1,351,000, $2,177,000, and $1,924,000, respectively,
has been reflected as a reduction of selling, general, and administrative
expenses.
During the first quarter of the fiscal year ended February 28, 1999, the
Company stopped selling its own extended service contracts and began selling
such contracts on behalf of unrelated third parties only. As a result of this
change, the Company will continue to recognize existing deferred revenues from
previously sold contracts through January 31, 2001 and will now recognize
commission revenue for the unrelated third-party extended warranty plans at the
time of sale. The effect of this change for the fiscal year ended February 28,
1999 was a $1,427,000 benefit ($918,000 after-tax benefit), which has been
reflected as a reduction of selling, general, and administrative expenses.
LAYAWAYS
The Company offers its customers a layaway plan that allows them to set
items aside and pay for them over a period of up to six months with no finance
charges. Receipts of payments for layaway deposits are treated as a liability on
the Company's balance sheet and are included in accrued expenses. Layaway
transactions are not recognized as sales until fully paid for by customers.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Cooperative advertising
funds are received from certain vendors. Net advertising expense, net of amounts
contributed by vendors to the Company, was $4,861,000, $4,845,000, and
$4,903,000 for 1999, 1998, and 1997, respectively. The amounts of prepaid
advertising at February 28, 1999 and 1998 were $232,000 and $263,000,
respectively.
F-9
<PAGE> 26
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STOCK BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), requires companies to either (i)
recognize as expense the fair value of all stock-based awards on the date of
grant when issued at market value, or (ii) continue to apply the provisions of
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), and provide pro forma net income and pro forma earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value-based method defined in SFAS 123 had been applied.
The Company has elected to continue to apply the provisions of APB 25 and
provide the pro forma disclosure provisions of SFAS 123 (see Note 8).
INTEREST RATE RISK MANAGEMENT
At times, the Company enters into various interest rate swaps and caps in
managing its interest rate risk. Payments to or from counter parties are
recorded as adjustments to interest expense.
EXTRAORDINARY LOSS
The extraordinary loss of $59,000 for the year ending February 28, 1998,
net of income tax benefit of $40,000, represents the write-off of loan
origination fees and prepayment penalties paid on the early extinguishment of
debt.
2. LONG-TERM DEBT AND NOTES PAYABLE
On December 21, 1995, the Company entered into a revolving secured credit
agreement (the "revolver") whereby the Company can borrow up to $40,000,000
based on specified percentages of eligible inventory and accounts receivable.
In June 1997, the Company increased its revolving credit facility ("credit
facility") to $45,000,000 and extended its expiration to July 31, 2000;
covenants and other terms remained unchanged. This agreement also provided for
an additional seasonal increase to $50,000,000 from July 1 through December 31,
1997. In May 1998, the Company and its banks agreed to another seasonal increase
to $50,000,000 from May 10 through December 31, 1998. Interest under the credit
facility is payable monthly, at an interest rate ranging from at the 30-day
LIBOR rate (4.94% at February 28, 1999) plus 160 basis points to 200 basis
points or prime plus 37 1/2 to 62 1/2 basis points, depending upon the Company's
debt-to-worth ratio. The Company had $43,300,000 outstanding on this revolver at
February 28, 1999, which is classified as a long-term liability based on its
expiration date.
The revolving credit agreement is collateralized by substantially all of
the Company's assets. The various loan agreements contain financial covenants
including those that limit dividend payments and additional borrowings and
prohibit new store openings if an event of default exists.
To limit increases in interest expense due to changes in 30-day LIBOR, the
Company paid $78,000 on February 2, 1996 to purchase a two-year, $30,000,000
interest rate protection agreement. The interest rate protection agreement
limited the Company's exposure to 30-day LIBOR of 6.0% (7.6% to 8.0% with the
160 to 200 basis points spread). The initial premium paid to acquire the
interest rate protection agreement was amortized as an increase to interest
expense over the two-year term of the agreement. The interest rate protection
agreement expired on February 2, 1998. No payments were received from the
counter party during the two-year period.
The Company also has subordinated notes payable to shareholders totaling
$845,000 at February 28, 1999, and $879,000 at February 28, 1998, with interest
at the prime rate (7.75% at February 28, 1999). These
F-10
<PAGE> 27
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
notes are unsecured and subordinate to the revolving credit note and are due
upon full payment of all senior obligations or with approval of all senior
lenders, and are therefore classified as long-term liabilities.
3. LEASES
The Company leases retail store facilities under operating lease agreements
which provide for base and percentage rentals with terms normally ranging from
five to ten years. Percentage rentals are based on sales performance in excess
of specified minimums, plus executory costs including taxes and maintenance.
Certain of the leases contain fixed renewal options. The Company also leases
certain equipment throughout the year on a short-term basis.
The corporate offices and related facilities are leased from certain
shareholders under operating lease agreements. The leases expire on December 31,
2006. Annual rent of approximately $255,000 was paid to shareholders during each
of the years ended February 28, 1999, 1998, and 1997.
Total rent expense was $10,886,000, $10,521,000, and $9,858,000 including
percentage rent of $682,000, $695,000, and $769,000 for the years ended February
28, 1999, 1998, and 1997, respectively. Future minimum lease payments are as
follows:
<TABLE>
<S> <C>
2000........................................................ $ 8,359,000
2001........................................................ 7,915,000
2002........................................................ 6,629,000
2003........................................................ 5,485,000
2004........................................................ 5,169,000
Thereafter.................................................. 15,537,000
-----------
$49,094,000
===========
</TABLE>
4. PROFIT-SHARING AND 401(K) SAVINGS PLAN
The Company has a contributory profit sharing and 401(k) savings plan
covering substantially all employees who meet certain age and employment
criteria. Contributions are made on a discretionary basis as authorized by the
Board of Directors. The Company's contributions to the profit sharing and 401(k)
savings plan totaled $366,000, $355,000, and $236,000 for the years ended
February 28, 1999, 1998, and 1997, respectively.
5. RELATED PARTY LEGAL FEES
The Company incurred legal fees with a firm whose principals are
shareholders and members of the Board of Directors of the Company of
approximately $184,000 for the year ended February 28, 1999, and $175,000 for
each of the years ended February 28, 1998 and 1997.
F-11
<PAGE> 28
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. INCOME TAXES
The provision for income taxes for the years ended February 28, 1999, 1998,
and 1997 consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Currently payable:
Federal.......................................... $1,590,000 $1,736,000 $2,120,000
State............................................ 265,000 343,000 382,000
---------- ---------- ----------
1,855,000 2,079,000 2,502,000
Deferred:
Federal.......................................... 202,000 (604,000) (453,000)
State............................................ 14,000 (141,000) (67,000)
---------- ---------- ----------
216,000 (745,000) (520,000)
---------- ---------- ----------
$2,071,000 $1,334,000 $1,982,000
========== ========== ==========
</TABLE>
A reconciliation of the provision for income taxes to income tax expense,
computed by applying the statutory federal income tax rate to pre-tax earnings
at February 28, 1999, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Income tax expense at statutory federal rate....... $2,134,000 $1,375,000 $2,043,000
Increase (decrease) resulting from:
Tax attributable to captive insurance company
income not taxed for federal purposes......... (243,000) (217,000) (222,000)
State income taxes, net of federal income tax
benefit....................................... 184,000 226,000 252,000
Other.............................................. (4,000) (50,000) (91,000)
---------- ---------- ----------
$2,071,000 $1,334,000 $1,982,000
========== ========== ==========
</TABLE>
The tax effects of temporary differences at February 28, 1999 and 1998 that
give rise to significant portions of deferred tax assets and deferred tax
liabilities are presented below:
<TABLE>
<CAPTION>
1999 1998
---------- -------------
<S> <C> <C>
Deferred tax liabilities:
Tax over book depreciation............................... $1,440,000 $ 1,768,000
---------- -------------
Total deferred tax liabilities............................. 1,440,000 1,768,000
Deferred tax assets:
Deferred revenue......................................... 439,000 995,000
Net operating loss carryforwards......................... 45,000 49,000
Accrued expenses......................................... 536,000 476,000
Reserves................................................. 1,576,000 1,641,000
---------- -------------
Total deferred tax assets.................................. 2,596,000 3,161,000
Valuation allowance for deferred tax assets................ (157,000) (178,000)
---------- -------------
Net deferred tax assets.................................... 2,439,000 2,983,000
---------- -------------
Net deferred taxes......................................... $ (999,000) $ (1,215,000)
========== =============
</TABLE>
F-12
<PAGE> 29
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's deferred income tax expense (benefit) results from the
following:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28,
---------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Excess of tax over financial reporting:
Depreciation...................................... $(328,000) $(179,000) $(302,000)
Deferred revenue.................................. 556,000 (83,000) (68,000)
Accrued expenses.................................. (60,000) (67,000) (99,000)
Reserves.......................................... 65,000 (376,000) (71,000)
Other items, net.................................. (17,000) (40,000) 20,000
--------- --------- ---------
$ 216,000 $(745,000) $(520,000)
========= ========= =========
</TABLE>
At February 28, 1999, certain companies of the consolidated group have
state net operating loss carryovers, expiring through 2006, of $1,358,000 for
tax return purposes.
A valuation allowance is provided when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The Company has
established valuation allowances for certain state net operating losses and
deferred state tax assets which management believes it is more likely than not
that the Company will not realize any benefit.
7. STOCK SPLIT
On February 10, 1998, the Company declared a two-for-one stock split
effective in the form of a one hundred percent stock dividend to shareholders of
record as of February 11, 1998. On February 20, 1998, the Company issued
4,224,900 shares of common stock in connection with this stock split.
Accordingly, approximately $422,000 was transferred from additional paid-in
capital to common stock, representing the par value of additional shares issued.
8. STOCK OPTION PLANS
Under the 1986 Employee Incentive Stock Option Plan (the "1986 Plan"),
options were authorized to be granted to key employees to purchase 50,000 shares
of common stock at a price not less than the fair market value at the date of
grant. In July 1994, the Company amended the 1986 Plan to terminate all future
grants of options. Options outstanding under the 1986 Plan are fully vested and
exercisable under the original terms of the agreement, expiring at various times
through July 2000.
Under the 1992 Director Stock Option Plan (the "1992 Plan"), options were
authorized to be granted to non-employee directors to purchase 10,000 shares of
common stock at a price not less than the fair market value at the date of
grant. In July 1994, the Company amended the 1992 Plan to terminate all future
grants of options. All options granted under the 1992 Plan expired during July
1998.
On July 13, 1994, the Company adopted the 1994 Stock Option Plan (the "1994
Plan"). Under the 1994 Plan, options to purchase 484,000 shares of common stock
(as adjusted for subsequent stock dividends) may be granted to key employees and
non-employee directors. The 1994 Plan allows for the grant of "incentive" and
"nonqualified" options that allow the holder to purchase shares of common stock
at a price not less than the fair market value at the date of grant. The 1994
Plan permits the grant of options for a term of up to ten years. Vesting terms
for options granted under the 1994 Plan are determined at the discretion of the
Compensation Committee. During fiscal 1999, the Company granted options for
18,000 shares of common stock. Options outstanding under the 1994 plan expire at
various times from July 1999 through July 2007.
F-13
<PAGE> 30
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pro forma information regarding net income is required by SFAS 123, and has
been determined as if the Company accounted for its employee stock options
granted subsequent to February 28, 1995 under the fair value method. The fair
value of these options was estimated at the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions as of February 28, 1999, 1998, and 1997:
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Risk-free interest rate........................ 5.63% 5.80% 6.93%
Dividend yield................................. 0% 0% 0%
Volatility factor.............................. .415 .454 .472
Expected life.................................. 9.4 years 8.7 years 6.5 years
</TABLE>
Option valuation models require the input of highly subjective assumptions.
Changes in the subjective input assumptions can materially affect the fair value
estimate, and therefore, the existing models do not necessarily provide a
reliable single measure of the fair value of employee stock options. Had the
compensation cost for the Company's stock option plans been determined based on
the fair value at the date of grant for awards in 1999, 1998, and 1997
consistent with the provisions of SFAS 123, the Company's net income and net
income per share would have decreased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28,
------------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Net income -- as reported............................ $4,205 $2,708 $4,025
Net income -- pro forma.............................. 4,137 2,663 3,991
Net income per share -- as reported.................. .50 .32 .48
Net income per share -- pro forma.................... .49 .31 .47
</TABLE>
Stock option activity under each of these plans for the years ended
February 28, 1999, 1998, and 1997 were as follows:
<TABLE>
<CAPTION>
1986 AND 1992 PLANS 1994 PLAN
-------------------------- --------------------------
NUMBER OF OPTION NUMBER OF OPTION
SHARES PRICE SHARES PRICE
--------- -------------- --------- --------------
<S> <C> <C> <C> <C>
Options outstanding at February 29,
1996............................... 77,682 $1.34 to $3.00 313,354 $4.50 to $5.51
Granted............................ -- -- 20,000 $4.00 to $4.40
Exercised.......................... (16,940) $1.34 to $1.70 -- --
Canceled........................... -- -- (14,944) $4.75 to $5.01
------- -------------- ------- --------------
Options outstanding at February 28,
1997............................... 60,742 $1.55 to $3.00 318,410 $4.00 to $5.51
Granted............................ -- -- 38,000 $3.88 to $4.26
Exercised.......................... -- -- -- --
Canceled........................... (484) $ 2.58 (1,968) $4.75 to $5.51
------- -------------- ------- --------------
Options outstanding at February 28,
1998............................... 60,258 $1.55 to $3.00 354,442 $3.88 to $5.51
Granted............................ -- 18,000 $3.75 to $4.54
Exercised.......................... (26,620) $1.55 to $2.84 -- --
Canceled........................... (15,972) $2.58 to $3.00 (3,252) $4.75 to $5.01
------- -------------- ------- --------------
Options outstanding at February 28,
1999............................... 17,666 $1.55 to $3.00 369,190 $3.75 to $5.51
======= ============== ======= ==============
Options exercisable at February 28,
1999............................... 17,666 $1.55 to $3.00 320,215 $3.75 to $5.51
======= ============== ======= ==============
Options available for grant at
February 28, 1999.................. -- 102,710
======= =======
</TABLE>
F-14
<PAGE> 31
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Approximately 337,881, 273,860, and 100,346 outstanding awards were
exercisable at February 28, 1999, 1998 and 1997.
The weighted-average remaining contractual life of options outstanding as
of February 28, 1999 is 5.4 years. The weighted-average exercise price of
options outstanding as of February 28, 1999 is $4.78.
Options granted during the years ended February 28, 1999, 1998, and 1997
had the following weighted-average information:
<TABLE>
<CAPTION>
GRANT DATE STOCK GRANT DATE STOCK
PRICE EQUAL TO PRICE LESS THAN
EXERCISE PRICE EXERCISE PRICE
---------------- ----------------
<S> <C> <C>
February 28, 1997
Weighted-average fair value.......................... $2.29 $1.71
Weighted-average exercise price...................... $4.40 $4.00
February 28, 1998
Weighted-average fair value.......................... $2.54 $1.73
Weighted-average exercise price...................... $3.88 $4.26
February 28, 1999
Weighted-average fair value.......................... $2.34 $2.04
Weighted-average exercise price...................... $3.75 $4.28
</TABLE>
At February 28, 1999 and 1998, the Company has reserved 489,566 and 532,158
shares, respectively, of common stock for future issuance related to the stock
option plans.
9. NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net
income per common share in accordance with Statement No. 128, "Earnings per
Share":
<TABLE>
<CAPTION>
FISCAL YEAR ENDED FEBRUARY 28,
------------------------------------
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Numerator:
Numerator for basic and diluted net income per
share -- net income available to common
shareholders..................................... $4,205,000 $2,708,000 $4,025,000
Denominator:
Denominator for basic net income per
share -- weighted-average shares................. 8,461,417 8,449,752 8,442,160
Effect of dilutive securities:
Employee stock options............................. 15,000 16,000 23,000
---------- ---------- ----------
Denominator for diluted net income per
share -- adjusted weighted-average shares........ 8,476,417 8,465,752 8,465,160
========== ========== ==========
Basic and diluted net income per common share...... $ .50 $ .32 $ .48
========== ========== ==========
</TABLE>
10. COMMITMENTS AND CONTINGENCIES
In the past, a subsidiary of the Company purchased non-file UCC insurance
from an unaffiliated insurance carrier for accounts originated in certain states
and charged its customers in those states a non-file UCC insurance fee equal to
the subsidiary's premium cost for that insurance. Non-file insurance reimbursed
the subsidiary for losses on accounts that resulted from its decision not to
file a UCC financing statement for the collateral securing the account. Several
plaintiffs challenged certain aspects of the Company's non-file insurance
practices. This civil action suit was discussed in more detail in previous
filings, including the
F-15
<PAGE> 32
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's February 28, 1998 10-K and Annual Report. In July 1998, the final
order for a settlement provided for, among other things, the payment of $486,000
to a settlement fund and the payment of administrative fees that were
approximately $127,000. No expense was incurred during the fiscal year ended
February 28, 1999 due to the fact that the Company recorded a charge of
$700,000, or $.08 per share, during the fourth quarter of the prior fiscal year
in anticipation of this settlement. The settlement was paid in full during the
year ended February 28, 1999.
11. OPERATING SEGMENT INFORMATION
In June 1997, SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," was issued effective for fiscal years ending after
December 15, 1998. The Company now reports two segments, retail operations and
credit operations. Separate financial information is produced internally and is
regularly reviewed by the chief operating decision-maker ("CODM"). The retail
operations segment consists of all store locations and corporate headquarters.
The stores have all been combined into one segment because they have similar
basic characteristics, such as the nature of products, and the class of
customers for their products. Corporate headquarters is included in this same
segment due to the fact that its revenues earned are incidental to the Company's
activities and it serves as a support system to the stores. The credit
operations segment is primarily engaged in providing and maintaining financing
for our customers. This operation is aggregated since the CODM evaluates it
separately. It also meets one of the three quantitative thresholds, the asset
test, since it represents 10.0% or more of the combined assets of all operating
segments. The basis of accounting for segment reporting is the same as stated in
Note 1.
The following table summarizes the revenues, operating income, assets,
depreciation, and capital expenditures for each reportable segment for the years
ended February 28, 1999, 1998, and 1997. In the financial statements, the
revenues from credit operations and other revenues from retail operations are
reflected as a reduction of selling, general, and administrative expenses as
discussed in Note 1:
<TABLE>
<CAPTION>
RETAIL CREDIT
OPERATIONS OPERATIONS TOTAL
------------ ----------- ------------
<S> <C> <C> <C>
FOR THE YEAR ENDED FEBRUARY 28, 1999
Revenues.................................... $109,284,000 $10,373,000 $119,657,000
Other revenues.............................. 2,778,000 -- 2,778,000
Operating income............................ 5,873,000 3,873,000 9,746,000
Identifiable assets......................... 64,944,000 46,021,000 110,965,000
Depreciation and Amortization............... 3,422,000 147,000 3,569,000
Capital expenditures........................ 4,020,000 169,000 4,189,000
FOR THE YEAR ENDED FEBRUARY 28, 1998
Revenues.................................... $102,845,000 $ 9,262,000 $112,107,000
Other revenues.............................. 2,177,000 -- 2,177,000
Operating income............................ 5,095,000 2,503,000 7,598,000
Identifiable assets......................... 60,294,000 40,692,000 100,986,000
Depreciation and Amortization............... 3,117,000 70,000 3,187,000
Capital expenditures........................ 2,858,000 283,000 3,141,000
FOR THE YEAR ENDED FEBRUARY 28, 1997
Revenues.................................... $ 98,952,000 $ 8,764,000 $107,716,000
Other revenues.............................. 1,924,000 -- 1,924,000
Operating income............................ 6,382,000 3,053,000 9,435,000
Identifiable assets......................... 59,362,000 38,157,000 97,519,000
Depreciation and Amortization............... 2,790,000 19,000 2,809,000
Capital expenditures........................ 3,153,000 69,000 3,222,000
</TABLE>
F-16
<PAGE> 33
REEDS JEWELERS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
12. SUBSEQUENT EVENT (UNAUDITED)
In April 1999, the Company, its existing banks, and two additional banks
entered into an amended revolving credit agreement whereby the Company may
borrow up to $65,000,000 through June 30, 2002 on terms similar to those of the
previous agreement. Under the amended agreement, the Company pays interest
monthly at an interest rate ranging from the 30-day LIBOR rate plus 125 basis
points to 185 basis points or prime plus 25 basis points, depending upon the
Company's debt-to-worth ratio.
F-17
<PAGE> 34
SCHEDULE II
REEDS JEWELERS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED FEBRUARY 28, 1999, 1998, AND 1997
<TABLE>
<CAPTION>
COLUMN C
COLUMN A COLUMN B ADDITIONS COLUMN D COLUMN E
-------- ------------ ------------------------ ---------- ----------
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER END OF
DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ----------- ------------ ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year ended February 28, 1999:
Allowance for doubtful
accounts................. $3,338,000 $4,234,000 $ -- $3,790,000(1) $3,782,000
Valuation allowance for
deferred tax assets...... 178,000 -- -- 21,000(3) 157,000
---------- ---------- ------- ---------- ----------
$3,516,000 $4,234,000 $ -- $3,811,000 $3,939,000
========== ========== ======= ========== ==========
Year ended February 28, 1998:
Allowance for doubtful
accounts................. $3,079,000 $4,092,000 $ -- $3,833,000(1) $3,338,000
Valuation allowance for
deferred tax assets...... 220,000 -- -- 42,000(3) 178,000
---------- ---------- ------- ---------- ----------
$3,299,000 $4,092,000 $ -- $3,875,000 $3,516,000
========== ========== ======= ========== ==========
Year ended February 28, 1997:
Allowance for doubtful
accounts................. $2,934,000 $3,538,000 $ -- $3,393,000(1) $3,079,000
Valuation allowance for
deferred tax assets...... 202,000 -- 18,000(2) -- 220,000
---------- ---------- ------- ---------- ----------
$3,136,000 $3,538,000 $18,000 $3,393,000 $3,299,000
========== ========== ======= ========== ==========
</TABLE>
- ---------------
(1) Uncollectible accounts written off.
(2) State deferred tax assets unlikely to be realized.
(3) State deferred tax assets likely to be realized.
F-18
<PAGE> 1
EXHIBIT 10(k)
STATE OF NORTH CAROLINA
AMENDMENT NO. 3 TO LEASE AGREEMENT
COUNTY OF NEW HANOVER
THIS AMENDMENT NO. 3 TO LEASE AGREEMENT is made and entered into this
16th day of February, 1999, by and between Zimmer Brothers, A Partnership, of
Wilmington, New Hanover County, North Carolina (hereinafter referred to as
"Lessor"), and Reeds Financial Services, Inc., a duly organized and existing
North Carolina corporation with its place of business located in Wilmington,
New Hanover County, North Carolina (hereinafter referred to as "Lessee").
W I T N E S S E T H :
WHEREAS, the Lessor and Lessee have heretofore entered into a Lease
Agreement dated January 22, 1991; and
WHEREAS, the Lessor and Lessee have heretofore entered into an
Amendment No. 1 to Lease Agreement dated March 1, 1996; and
WHEREAS, the Lessor and Lessee have heretofore entered into an
Amendment No. 2 to Lease Agreement dated January 14, 1999; and
WHEREAS, the Lessor and Lessee desire to amend the said Lease
Agreement in certain aspects.
NOW, THEREFORE, for and in consideration of the sum of Ten and No/100
Dollars ($10.00) and other good and valuable consideration, each to the other
paid, the receipt of the same which is hereby respectfully acknowledged, the
parties do hereby agree as follows:
1. That certain Lease Agreement dated January 22, 1991, by and between
Zimmer Brothers, A Partnership, as Lessor, and Reeds Financial Services, Inc.,
as Lessee, as amended, is hereby further amended effective September 1, 1999 as
follows:
<PAGE> 2
A. Article 1.1 D is hereby deleted, and in lieu thereof the
following is inserted therein:
"D. LEASED PREMISES: A portion of the shopping center premises
identified and/or outlined in red on Exhibit "B", and containing approximately
10,880 square feet, known as spaces C, D, E, F, G, H, I, J, K and L, Banberry
Plaza, 2515 South 17th Street, Wilmington, New Hanover County, North Carolina."
B. Article 1.1 G is hereby deleted, and in lieu thereof the
following is inserted therein:
"G. FIXED MINIMUM RENT: Lessee shall pay rentals to Lessor as
follows:
September 1, 1999 to December 31, 2002: $11,384.15 per month
January 1, 2003 to December 31, 2006: $11,825.60 per month
All such rental installments shall be due and payable in advance on
the first day of each and every calendar month for and during the term of the
herein Lease."
2. In all other aspects, the said Lease Agreement dated January 22,
1991, as amended, by and between Zimmer Brothers, A Partnership, as Lessor, and
Reeds Financial Services, Inc., as Lessee, shall remain in full force and
effect.
IN WITNESS WHEREOF, the Lessor and Lessee have signed and sealed this
Amendment No. 3 to Lease Agreement the day and year first above written.
LESSOR:
ZIMMER BROTHERS, A PARTNERSHIP
BY: /s/ Jeffrey L. Zimmer (SEAL)
---------------------------------
JEFFREY L. ZIMMER, General Partner
BY: /s/ Herbert J. Zimmer (SEAL)
---------------------------------
HERBERT J. ZIMMER, General Partner
BY: /s/ Alan M. Zimmer (SEAL)
---------------------------------
ALAN M. ZIMMER, General Partner
[Signatures continued on following page]
2
<PAGE> 3
LESSEE:
REEDS FINANCIAL SERVICES, INC.
BY: /s/ Alan M. Zimmer (SEAL)
---------------------------------
ALAN M. ZIMMER, President
ATTEST:
/s/ Roberta G. Zimmer
- ----------------------------
ROBERTA G. ZIMMER, Secretary
3
<PAGE> 4
EXHIBIT B
[BANBERRY PLAZA BUILDING PLANS]
<PAGE> 1
EXHIBIT 21
LIST OF SUBSIDIARIES OF THE REGISTRANT
Reeds Corporate Services, Inc.
Reeds Insurance Services Ltd.
Reeds Financial Services, Inc.
Reeds Jewelers of North Carolina, Inc.
<PAGE> 1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 33-32100) pertaining to the 1994 Stock Option Plan of Reeds
Jewelers, Inc., of our report dated March 31, 1999, with respect to the
consolidated financial statements and schedule of Reeds Jewelers, Inc. and
Subsidiaries included in its Annual Report (Form 10-K) for the year ended
February 28, 1999.
ERNST & YOUNG LLP
Raleigh, North Carolina
May 20, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF REEDS JEWELERS, INC. FOR THE YEAR ENDED FEBRUARY 28,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> FEB-28-1999
<PERIOD-START> MAR-01-1998
<PERIOD-END> FEB-28-1999
<CASH> 1,080
<SECURITIES> 0
<RECEIVABLES> 49,437
<ALLOWANCES> 3,782
<INVENTORY> 40,798
<CURRENT-ASSETS> 91,221
<PP&E> 30,656
<DEPRECIATION> 17,895
<TOTAL-ASSETS> 110,965
<CURRENT-LIABILITIES> 24,833
<BONDS> 43,348
0
0
<COMMON> 847
<OTHER-SE> 39,321
<TOTAL-LIABILITY-AND-EQUITY> 110,965
<SALES> 109,284
<TOTAL-REVENUES> 109,284
<CGS> 54,559
<TOTAL-COSTS> 54,559
<OTHER-EXPENSES> 40,745
<LOSS-PROVISION> 4,234
<INTEREST-EXPENSE> 3,470
<INCOME-PRETAX> 6,276
<INCOME-TAX> 2,071
<INCOME-CONTINUING> 4,205
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,205
<EPS-BASIC> 0.50
<EPS-DILUTED> 0.50
</TABLE>
