<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 29, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------ ------
Commission File No. 1-9223
SERVICE MERCHANDISE COMPANY, INC.
(Exact name of registrant as specified in its charter)
TENNESSEE 62-0816060
(State or other Jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P. O. Box 24600, Nashville, TN
37202-4600
(Mailing Address)
7100 Service Merchandise Drive, Brentwood, TN
(Address of principal executive offices)
37027
(Zip code)
(615) 660-6000
(Registrant's telephone number including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock as of the latest practicable date.
As of July 27, 1997, there were 99,813,484 shares of
Service Merchandise Company, Inc. common stock outstanding.
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<CAPTION>
Page No.
<S> <C>
PART I - FINANCIAL INFORMATION
Consolidated Statements of Operations (Unaudited) - Three and Six
Periods Ended June 29, 1997 and June 30, 1996 . . . . . . . . . . . . . . 3
Consolidated Balance Sheets - June 29, 1997 (Unaudited), June 30, 1996
(Unaudited) and December 29, 1996 . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows (Unaudited) - Six Periods Ended
June 29, 1997 and June 30, 1996 . . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements (Unaudited) . . . . . . . . . . 6-9
Management's Discussion and Analysis of Financial Condition and
Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . 10-16
PART II - OTHER INFORMATION
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17-18
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
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<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(In thousands, except per share data)
<CAPTION>
Three Periods Ended Six Periods Ended
-------------------------------------------------------
June 29, June 30, June 29, June 30,
-------------------------------------------------------
1997 1996 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales
Operations excluding closing facilities and remerchandising activities $762,122 $781,714 $1,382,833 $1,426,076
Closing facilities and remerchandising activities 115,239 78,270 180,928 149,536
----------- ----------- ----------- -----------
877,361 859,984 1,563,761 1,575,612
Costs and expenses:
Cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities and remerchandising activities 571,154 588,995 1,048,434 1,083,640
Closing facilities and remerchandising activities 123,139 63,138 177,499 123,363
----------- ----------- ----------- -----------
694,293 652,133 1,225,933 1,207,003
Gross margin after cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities and remerchandising activities 190,968 192,719 334,399 342,436
Closing facilities and remerchandising activities (7,900) 15,132 3,429 26,173
----------- ----------- ----------- -----------
183,068 207,851 337,828 368,609
Selling, general and administrative expenses
Operations excluding closing facilities and remerchandising activities 157,402 164,593 310,019 319,856
Closing facilities and remerchandising activities 19,955 13,562 32,362 26,973
----------- ----------- ----------- -----------
177,357 178,155 342,381 346,829
Restructuring charge - - 129,510 -
Depreciation and amortization
Operations excluding closing facilities and remerchandising activities 14,392 13,710 27,945 28,010
Closing facilities and remerchandising activities 1,252 1,322 2,511 2,631
----------- ----------- ----------- -----------
15,644 15,032 30,456 30,641
Earnings (loss) before interest and income taxes (9,933) 14,664 (164,519) (8,861)
Interest expense-debt 15,980 15,402 30,953 29,514
Interest expense-capitalized leases 2,161 2,201 4,150 4,427
----------- ----------- ----------- -----------
Loss before income taxes (28,074) (2,939) (199,622) (42,802)
Income taxes benefit (10,527) (1,117) (74,858) (16,265)
----------- ----------- ----------- -----------
Net loss ($17,547) ($1,822) ($124,764) ($26,537)
=========== =========== =========== ===========
Weighted average common shares and common
share equivalents outstanding 99,900 101,527 100,024 101,433
=========== =========== =========== ===========
Per common share:
Net loss ($0.18) ($0.02) ($1.25) ($0.26)
=========== =========== =========== ===========
See Notes to Consolidated Financial Statements.
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except per share data)
<CAPTION>
(Unaudited)
-------------------------------
June 29, June 30, December 29,
1997 1996 1996 (1)
-------------- -------------- --------------
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $57,486 $60,708 $329,993
Accounts receivable, net of allowance of
$3,125, $2,824 and $4,593, respectively 44,577 44,244 61,454
Income taxes 61,964 4,297 -
Inventories 956,674 1,057,589 1,052,969
Prepaid expenses 17,227 34,184 15,461
-------------- -------------- --------------
TOTAL CURRENT ASSETS 1,137,928 1,201,022 1,459,877
Property and equipment:
Owned assets, net of accumulated depreciation of
$542,261, $507,507 and $530,170, respectively 518,816 559,662 567,056
Capitalized leases, net of accumulated amortization of
$76,847, $85,483 and $86,710 respectively 38,534 41,537 37,701
Other assets and deferred charges 25,111 20,292 22,818
-------------- -------------- --------------
TOTAL ASSETS $1,720,389 $1,822,513 $2,087,452
============== ============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable to banks $25,000 $190,000 -
Accounts payable 384,494 432,504 $639,887
Accrued expenses 175,090 159,954 212,223
State and local sales taxes 29,905 32,153 62,690
Accrued restructuring costs - current 24,570 - -
Income taxes - - 33,898
Current maturities of long-term debt 34,470 4,621 6,842
Current maturities of capitalized lease obligations 8,302 7,753 7,303
Deferred income taxes 7,437 11,715 7,437
-------------- -------------- --------------
TOTAL CURRENT LIABILITIES 689,268 838,700 970,280
Accrued restructuring costs 65,844 - -
Long-term debt 597,374 556,019 623,615
Capitalized lease obligations 57,119 62,221 58,541
Deferred income taxes 7,922 4,888 7,922
-------------- -------------- --------------
TOTAL LIABILITIES 1,417,527 1,461,828 1,660,358
-------------- -------------- --------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value, authorized 4,600 shares,
undesignated as to rate and other rights, none issued
Series A Junior Preferred Stock, $1 par value, authorized
400 shares, none issued
Common stock, $.50 par value, authorized 500,000 shares, issued
and outstanding 99,812, 99,732 and 99,758 shares, respectively 49,906 49,866 49,879
Additional paid-in capital 5,739 5,607 5,670
Deferred compensation (815) (1,717) (1,251)
Retained earnings 248,032 306,929 372,796
-------------- -------------- --------------
TOTAL SHAREHOLDERS' EQUITY 302,862 360,685 427,094
-------------- -------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,720,389 $1,822,513 $2,087,452
============== ============== ==============
(1) Derived from fiscal year ended December 29, 1996 audited consolidated financial statements.
See Notes to Consolidated Financial Statements.
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
<CAPTION>
Six Periods Ended
------------------------------------
June 29, June 30,
------------------------------------
1997 1996
------------- --------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($124,764) ($26,537)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 32,118 32,073
Gain on disposal of property and equipment (2,464) (4,490)
Write down of property and equipment due to restructuring 32,915 -
Changes in assets and liabilities (net of disposition):
Accounts receivable, net 16,877 9,377
Inventories 96,295 (23,122)
Prepaid expenses (1,766) (8,908)
Accounts payable (255,394) (246,601)
Accrued expenses and state and local sales taxes (68,313) (62,133)
Accrued restructuring costs 90,414 -
Income taxes (95,862) (33,506)
------------- --------------
NET CASH USED BY OPERATING ACTIVITIES (279,944) (363,847)
------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (15,121) (8,186)
Proceeds from the disposal of property and equipment 3,779 9,571
Other assets, net (3,328) 1,452
------------- --------------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (14,670) 2,837
------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 25,000 190,000
Proceeds from long-term debt 6,560 2,600
Repayment of long-term debt (5,199) (1,314)
Repayment of capitalized lease obligations (4,186) (4,424)
Debt issuance costs (129) (914)
Exercise of stock options and forfeiture of restricted stock, net 61 19
------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 22,107 185,967
------------- --------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (272,507) (175,043)
CASH AND CASH EQUIVALENTS-BEGINNING OF PERIOD 329,993 235,751
------------- --------------
CASH AND CASH EQUIVALENTS-END OF PERIOD $57,486 $60,708
============= ==============
See Notes to Consolidated Financial Statements.
</TABLE>
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A. The consolidated financial statements, except for the consolidated balance
sheet as of December 29, 1996, have been prepared by the Company without
audit.
In management's opinion, the information and amounts furnished in this
report reflect all adjustments (consisting of normal recurring adjustments)
considered necessary for the fair presentation of the consolidated
financial position and consolidated results of operations for the interim
periods presented. Certain prior period amounts have been reclassified to
conform to the current year's presentation. These consolidated financial
statements should be read in conjunction with the Company's Annual Report
on Form 10-K for the fiscal year ended December 29, 1996.
The Company has historically incurred a net loss for the first three
quarters of the year due to the seasonality of its business. The results of
operations for the quarters ended June 29, 1997 and June 30, 1996 are not
necessarily indicative of the operating results for an entire fiscal year.
B. The Company's income statement presentation has changed beginning with the
second quarter of 1997. This change was made to disclose the financial
statement impact of the inventory liquidations associated with the closing
facilities and remerchandising activities. The line item "Closing
facilities and remerchandising activities" represents activity specifically
identifiable to inventory liquidations conducted in conjunction with (1)
the Company's Restructuring Plan announced in the first quarter of 1997 and
(2) exiting the computer business and certain components of the wireless
communication business as part of a remerchandising program. Selling,
general and administrative expenses for closing facilities and
remerchandising activities does not include any allocation of corporate
overhead. The liquidation process was initiated in the second quarter of
1997 when the Company began liquidating 44 out of 60 stores planned for
closure as part of the restructuring plan adopted March 25, 1997 outlined
in Note C below. As of June 29, 1997, 44 stores, one distribution center
and two merchandise categories were in the process of liquidation. All
activity for these items is classified in "Closing facilities and
remerchandising activities." Prior year amounts reflect operating results
for these same facilities and merchandise classifications.
C. On March 25, 1997, the Company adopted a business restructuring plan to
close 60 underperforming stores and one distribution center. As a result, a
pre-tax charge of $129.5 million for restructuring costs was taken in the
first quarter of 1997. The components of the restructuring charge and an
analysis of the amounts charged against the accrual through June 29, 1997
are outlined in the following table:
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<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
<CAPTION>
Activity to Date
-------------------------------------------
Accrued
Original Restructuring
Charge Restructuring Asset Costs as of
(In thousands) Recorded Costs Paid Write-downs June 29, 1997
------------------ ------------------- ----------------------- -------------------
<S> <C> <C> <C> <C>
Lease termination and other real
estate costs $ 83,225 $ (1,456) $ - $ 81,769
Property and equipment write-downs 32,915 - (32,915) -
Employee severance 4,869 (1,301) - 3,568
Other exit costs 8,501 (3,424) - 5,077
------------------ ------------------- ----------------------- -------------------
Total $ 129,510 $ (6,181) $ (32,915) 90,414
================== =================== =======================
Less: Current portion
(24,570)
-------------------
$ 65,844
===================
</TABLE>
The 60 stores include both owned and leased properties. Lease termination
and other real estate costs consist principally of the remaining rental
payments required under the closing stores' lease agreements, net of any
actual or reasonably probable sublease income.
After taking into effect the above property and equipment write-downs, the
Company's carrying value of the property and equipment associated with the
closures is approximately $30 million as of June 29, 1997. Management
anticipates selling substantially all owned property and equipment
associated with the closures.
The employee severance provision was recorded for the planned termination
of approximately 4,100 employees. As of June 29, 1997, approximately 1,000
employees have been terminated with respect to the restructuring plan.
Other exit costs consist principally of professional fees and other costs
associated with closing the stores and distribution center.
In the second quarter of 1997, management began the process of closing 44
of the 60 stores and the distribution center. These 44 stores and the
distribution center were closed by the end of July 1997 with the
remaining closures expected to be completed by the first half of 1998.
Reduced margins and changes in selling, general and administrative expenses
are reflected in the Company's operating results as inventory associated
with the closing stores is liquidated.
Net sales associated with the planned 60 closing stores exclusive of
remerchandising activities were approximately $119.3 million and $87.3
million for the quarter ended June 29, 1997 and June 30, 1996,
respectively. The pre-tax operating results associated with the closing
stores, excluding corporate allocations, were approximately ($17.8) million
and $0.0 million for the quarter ended June 29, 1997 and June 30, 1996,
respectively. Net sales associated with the planned 60 closing stores were
approximately $187.9 million and $160.7 million for the six periods ended
June 29, 1997 and June 30, 1996, respectively. The pre-tax operating losses
associated with the closing stores, excluding corporate allocations, was
approximately ($21.1) million and ($4.4) million for the six periods ended
June 29, 1997 and June 30, 1996, respectively. The increase in the closing
stores' pre-tax operating losses over 1996 for both the quarter ended and
six periods ended is due primarily to the inventory liquidations that
occurred in the second quarter of 1997.
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SERVICE MERCHANDISE COMPANY,INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
D. The second quarter ended June 29, 1997 contained 91 selling days versus the
second quarter ended June 30, 1996 which contained 90 selling days. The six
periods ended June 29, 1997 and June 30, 1996 each contained 181 selling
days.
E. The net loss per common share is computed by dividing the net loss by the
weighted average number of common shares and common share equivalents
outstanding.
F. Cash payments for interest for the six periods ended June 29, 1997 and June
30, 1996 were $34.3 million and $31.4 million, respectively. Cash payments
for income taxes for the six periods ended June 29, 1997 and June 30, 1996
were $21.0 million and $17.1 million, respectively. Outstanding checks of
$22.4 million, $32.2 million and $44.6 million as of June 29, 1997, June
30, 1996 and December 29, 1996, respectively have been reclassified to
Accounts Payable.
G. In July, the Company reached agreement with The Chase Manhattan Bank and
Citibank to provide a five-year, $900 million fully committed bank facility
(the "New Credit Facility") to replace its existing bank lines and other
obligations. The Chase Manhattan Bank and Citibank have committed to
provide a $250 million term loan and a $650 million revolving credit
facility. The facility will also include a $175 million sub-facility for
letters of credit. The New Credit Facility will replace the Reducing
Revolving Credit Facility which currently has a maximum commitment level of
$525 million. Short-term borrowings related to the Reducing Revolving
Credit Facility were $25 million and $190 million as of June 29, 1997 and
June 30, 1996, respectively.
The New Credit Facility is designed to provide the Company with long-term
liquidity and operating flexibility. Borrowings under the facility will be
subject to borrowing limits based on percentages of certain current and
fixed assets and borrowing limitations contained in the Company's
subordinated debt indenture. The financial covenants to be included in the
definitive agreement relate to coverage and leverage tests and are expected
to enhance the Company's ability to implement its strategic initiatives.
The New Credit Facility and the current Reducing Revolving Credit Facility
exclude from financial covenant calculations the impact of up to $175
million in pre-tax charges and costs related to certain strategic
initiatives such as the closing facilities and remerchandising activities.
The effective interest rate (all-in drawn cost including a 1/2% facility
fee) under the Reducing Revolving Credit Facility is currently LIBOR +
2.25%. The rate under the New Credit Facility is expected to be subject to
a financial performance-based grid, with initial pricing set at LIBOR +
2.00% and an unused commitment fee of 3/8%. The completion of the New
Credit Facility is contingent upon the successful tender and consent
solicitation of the Company's $100 million 8 3/8% Senior Notes Due 2001
which was commenced on July 21, 1997. As of August 10, 1997, the Company
had received the necessary 51% in consents to amend the indenture enabling
the Company to complete the New Credit Facility.
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
Upon completion of the New Credit Facility, the Company's lenders will
receive a security interest in all material unencumbered assets of the
Company and its subsidiaries including inventory but excluding mortgages on
leasehold interests. These security interests would automatically terminate
when the Company either achieves investment grade credit rating on its
implied senior debt or meets certain operating performance targets.
Currently, the bank group has security interests in the majority of
unencumbered property and assets of the Company with the exception of
inventory.
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SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
For comparative purposes, interim balance sheets are more meaningful when
compared to the balance sheets at the same point in time of the prior year.
Comparisons to balance sheets of the most recent fiscal year end may not be
meaningful due to the seasonal nature of the Company's business.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report includes certain forward-looking information that is based upon
management's beliefs as well as on assumptions made by and data currently
available to management. This information, which has been, or in the future may
be, included in reliance on the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995, is subject to a number of risks and
uncertainties, including but not limited to the factors identified in the
Company's Form 10-K for the fiscal year ended December 29, 1996 filed with the
Securities and Exchange Commission. Actual results may differ materially from
those anticipated in such forward-looking statements even if experience or
future changes make it clear that any projected results expressed or implied
therein may not be realized. The Company disclaims any obligation to update any
information contained herein.
RESULTS OF OPERATIONS
The nature of the Company's business is highly seasonal. Historically, sales in
the fourth quarter have been substantially higher than sales achieved in each of
the first three quarters of the fiscal year. Thus expenses and, to a greater
extent, operating income vary greatly by quarter. Caution, therefore, is advised
when appraising results for a period shorter than a full year, or when comparing
any period other than to the same period of the previous year.
RESTRUCTURING CHARGE, STORE LIQUIDATION AND REMERCHANDISING PROGRAM
On March 25, 1997, the Company adopted a business restructuring plan to close 60
underperforming stores and one distribution center. As a result, a pre-tax
charge of $129.5 million for restructuring costs was taken in the first quarter
of 1997. The components of the restructuring charge are outlined in a table in
Note C of the Notes to Consolidated Financial Statements.
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Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The restructuring was based on an analysis of individual store performance based
on cash flow return on committed capital, fit within marketing demographic
profiles and strategic geographic positioning. After the effect of charges and
costs related specifically to the closings, the immediate ongoing impact of the
closings on net income will be immaterial because the stores to be closed are
near break-even contributors. The major benefit of the store closings will be
the release of capital associated with these operations, rather than a
short-term opportunity to improve earnings. This capital will be redirected in
an effort to produce more appropriate returns.
In the second quarter of 1997, management began the process of closing 44 of the
60 stores and the distribution center. These 44 stores and the distribution
center were closed by the end of July 1997, with the remaining closures expected
to be completed by the first half of 1998. Liquidation of the inventory
associated with these 44 closed stores began in April 1997 and was completed in
July 1997. Reduced margins and changes in selling, general and administrative
expenses are reflected in the Company's operating results as inventory
associated with the closing stores is liquidated.
During the second quarter of 1997, the Company also began implementing certain
remerchandising strategies, including the exit of the low margin computer
business and certain components of the wireless communication business.
SECOND QUARTER ENDED JUNE 29, 1997 VS. SECOND QUARTER ENDED
JUNE 30, 1996
Net sales for the Company were $877.4 million for the second quarter of 1997
compared to $860.0 million for the second quarter of 1996. The $17.4 million
increase reflects an increase in sales from closing facilities and
remerchandising activities, which was partially offset by a decrease in sales
from operations excluding closing facilities and remerchandising activities.
Net sales from operations excluding closing facilities and remerchandising
activities for the second quarter of 1997 were $762.1 million versus $781.7
million for the same period in 1996. This represents a net sales decrease of
$19.6 million, or 2.5%, with comparable store sales (adjusted for the Easter
shift from second quarter 1996 to first quarter 1997) decreasing 2.8%. Affecting
the total sales decrease was the fact that the Company operated 357 stores (in
operations excluding closing facilities and remerchandising activities) during
the second quarter of 1997 compared to 365 stores during the second quarter of
1996. Comparable store sales in jewelry and hardlines were both down from last
year.
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<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Net sales from closing facilities and remerchandising activities were $115.2
million for the second quarter of 1997 versus $78.3 million for these same
facilities and merchandise classifications during the same period last year. The
increase in sales over the prior year is due to the inventory liquidations held
as part of the planned closing of 44 stores and as part of the remerchandising
activities. The remerchandising efforts in the second quarter include exiting
the low margin computer business and certain components of the wireless
communication business.
GROSS MARGIN
Gross margin, after buying and occupancy expenses, for the Company was $183.1
million, or 20.9% of net sales for the second quarter of 1997, compared to
$207.9 million, or 24.2% of net sales for the same period last year. An overall
improvement in gross margin rate from operations excluding closing facilities
and remerchandising activities was offset by the impact of the Company's
inventory liquidation program associated with the closing facilities and
remerchandising activities. Total gross margin dollars were down primarily due
to the inventory liquidations and lower sales from operations excluding closing
facilities and remerchandising activities compared to last year.
Gross margin, after buying and occupancy expenses, from operations excluding
closing facilities and remerchandising activities was $191.0 million, or 25.1%
of sales from operations excluding closing facilities and remerchandising
activities for the second quarter of 1997 compared to $192.7 million, or 24.7%
of sales from operations excluding closing facilities and remerchandising
activities for the prior year quarter. The increase in gross margin rate is the
result of improved pricing and promotion of higher margin categories and
merchandise and an increased jewelry sales mix for the quarter. The decrease in
gross margin dollars is due to lower net sales for the quarter.
Gross margin, after buying and occupancy expenses, from closing facilities and
remerchandising activities was ($7.9) million, or -6.9% of sales from closing
facilities and remerchandising activities for the second quarter of 1997
compared to $15.1 million, or 19.3% of sales from closing facilities and
remerchandising activities for the prior year quarter. The decrease in gross
margin dollars and rate is attributable to merchandise discounts associated with
the inventory liquidations as well as a charge taken to write down to net
realizable value the remaining inventory to be liquidated.
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<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the second quarter of 1997 were
$177.4 million, or 20.2% of net sales, versus $178.2 million, or 20.7% of net
sales for the second quarter of 1996. The $0.8 million decrease reflects a
decrease in expenses from operations excluding closing facilities and
remerchandising activities, which was partially offset by an increase in
expenses from closing facilities and remerchandising activities.
Selling, general and administrative expenses of operations excluding closing
facilities and remerchandising activities was $157.4 million, or 20.7% of sales
from operations excluding closing facilities and remerchandising activities for
the second quarter of 1997 compared to $164.6 million, or 21.1% of sales from
operations excluding closing facilities and remerchandising activities for the
prior year quarter. The decrease results from a reduction in employment and
advertising paper costs, as well as the impact of a net eight fewer stores
(excluding 44 closing stores) compared to the prior year.
Selling, general and administrative expenses of closing facilities and
remerchandising activities was $20.0 million, or 17.3% of sales from closing
facilities and remerchandising activities for the second quarter of 1997
compared to $13.6 million, or 17.3% of sales from closing facilities and
remerchandising activities for the prior year quarter. This increase in dollars
reflects increased operating costs associated with the inventory liquidations.
INTEREST EXPENSE
Interest expense for the second quarter of 1997 was $18.1 million as compared to
$17.6 million for the second quarter of 1996. Interest expense for the quarter
increased primarily due to the issuance of $74.8 million in mortgage financing
notes in the fourth quarter of 1996 and first quarter of 1997. This expense was
partially offset by lower average borrowings against the Company's Reducing
Revolving Credit Facility.
INCOME TAXES
The Company recognized an income tax benefit of $10.5 million and $1.1 million
for the second quarter ended June 29, 1997 and June 30, 1996, respectively. The
effective tax rates for the quarter ended June 29, 1997 and June 30, 1996 were
37.5% and 38.0%, respectively. For the fiscal year ended December 29, 1996 the
effective income tax rate was 37.5%.
-13-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
SIX PERIODS ENDED JUNE 29, 1997 VS. SIX PERIODS ENDED JUNE 30, 1996
NET SALES
Net sales for the Company were $1,563.8 million for the first half of 1997
compared to $1,575.6 million for the first half of 1996. The decrease of $11.8
million, or 0.8% is the result of a decline in net sales from operations
excluding closing facilities and remerchandising activities which was partially
offset by an increase in net sales from closing facilities and remerchandising
activities. Comparable store sales from operations excluding closing facilities
and remerchandising activities decreased by 2.7% in the first half of 1997
compared to last year.
GROSS MARGIN
Gross margin, after buying and occupancy expenses, for the first half of 1997
was $337.8 million, or 21.6% of net sales compared to $368.6 million, or 23.4%
of net sales for the same period last year. An overall improvement in gross
margin rate from operations excluding closing facilities and remerchandising
activities resulted from improved pricing and promotion of higher margin
categories and merchandise. This was offset by the impact of the Company's
inventory liquidation associated with the closing facilities and remerchandising
activities. The Company's gross margin dollars were down due to the inventory
liquidation from closing facilities and remerchandising activities and lower
sales from operations excluding closing facilities and remerchandising
activities compared to last year.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased to $342.4 million, or
21.9% of net sales, for the first half of 1997 compared to $346.8 million, or
22.0% of net sales for the same period a year ago. The decrease in selling,
general and administrative dollars is primarily attributable to reduced
employment costs from operations excluding closing facilities and
remerchandising activities partially offset by increased operating expenses
associated with the inventory liquidations.
INTEREST EXPENSE
Interest expense for the first half of 1997 was $35.1 million as compared to
$33.9 million for the same period a year ago. Interest expense for the year
increased primarily due to the issuance of $74.8 million in mortgage financing
notes in the fourth quarter of 1996 and the first quarter of 1997. This expense
was partially offset by lower average borrowings against the Company's Reducing
Revolving Credit Facility.
INCOME TAXES
The Company recognized an income tax benefit of $74.9 million for the first half
of 1997 compared to $16.3 million for the first half of 1996. The estimated
annual effective tax rates for the six periods ended June 29, 1997 and June 30,
1996 were 37.5% and 38.0%, respectively. For the fiscal year ended December 29,
1996, the effective income tax rate was 37.5%.
-14-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased to $448.7 million at the end of the second quarter of
1997 from $362.3 million at June 30, 1996, an increase of $86.4 million or
23.8%. Short-term borrowings totaled $25 million ($483.7 million available for
borrowing) at June 29, 1997 compared to $190.0 million ($337.5 million available
for borrowing) at June 30, 1996, a decrease of $165.0 million. The issuance of
$74.8 million in mortgage financing notes in the fourth quarter of 1996 and
first quarter of 1997 contributed to the decrease in short-term borrowings and
had a positive impact on increased working capital as payment obligations were
shifted from short-term to long-term. The need for short-term borrowings was
further reduced by cash generated through inventory liquidation sales from
closing facilities and remerchandising activities. The inventory liquidations
and reduced purchases also contributed to the decline in trade accounts payable.
The $100.9 million reduction in inventory as compared to the same period last
year was primarily the result of the Company's inventory liquidations.
Additionally, current maturities of long-term debt increased $29.8 million as
the first $30.0 million installment payment on the Company's First Mortgage
Secured Notes is due on June 30, 1998. Furthermore, income taxes classified as a
current asset increased by $57.7 million primarily due to the $129.5 million
restructuring charge recorded in the first quarter of 1997.
Working capital requirements fluctuate significantly during the year due to the
seasonal nature of the jewelry, gift and home business. These requirements are
financed through a combination of internally generated cash flow from operating
activities, short-term seasonal borrowings and long-term financing. The current
ratio at June 29,1997 and June 30, 1996 was 1.7:1 and 1.4:1, respectively.
In July, the Company reached agreement with The Chase Manhattan Bank and
Citibank to provide a five-year, $900 million fully committed bank facility (the
"New Credit Facility") to replace its existing bank lines and other obligations.
The Chase Manhattan Bank and Citibank have committed to provide a $250 million
term loan and a $650 million revolving credit facility. This facility will also
include a $175 million sub-facility for letters of credit. The New Credit
Facility will replace the Reducing Revolving Credit Facility which currently has
a maximum commitment level of $525 million.
The New Credit Facility is designed to provide the Company with long-term
liquidity and operating flexibility. Borrowings under the facility will be
subject to borrowing limits based on percentages of certain current and fixed
assets and borrowing limitations contained in the Company's subordinated debt
indenture. The financial covenants to be included in the definitive agreement
relate to coverage and leverage tests and are expected to enhance the Company's
ability to implement its strategic initiatives. The New Credit Facility and the
current Reducing Revolving Credit Facility exclude from financial covenant
calculations the impact of up to $175 million in pre-tax charges and costs
related to certain strategic initiatives such as the closing facilities and
remerchandising activities. The effective interest rate (all-in drawn cost
including a 1/2% facility fee) under the Reducing Revolving Credit Facility is
currently LIBOR + 2.25%. The rate under the New Credit Facility is expected to
be subject to a financial performance-based grid, with initial pricing set at
LIBOR + 2.00% and an unused commitment fee of 3/8%. The completion of the New
Credit Facility is contingent upon the successful tender and consent
solicitation of the Company's $100 million 8 3/8% Senior Notes Due 2001 which
was commenced on July 21, 1997. As of August 10, 1997, the Company had received
the necessary 51% in consents to amend the indenture enabling the Company to
complete the New Credit Facility.
-15-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Upon completion of the New Credit Facility, the Company's lenders will receive a
security interest in all material unencumbered assets of the Company and its
subsidiaries including inventory but excluding mortgages on leasehold interests.
These security interests would automatically terminate when the Company either
achieves investment grade credit rating on its implied senior debt or meets
certain operating performance targets. Currently, the bank group has security
interests in the majority of unencumbered property and assets of the Company
with the exception of inventory.
Total long-term debt, including current maturities and capitalized leases,
increased to $697.3 million at June 29, 1997 from $630.6 million at June 30,
1996. The increase in total long-term debt was primarily attributable to the
issuance of $74.8 million in mortgage financing notes in the fourth quarter of
1996 and first quarter of 1997.
Additions to owned property and equipment were $15.1 million for the six periods
ended June 29, 1997 compared to $8.2 million for the same period last year. The
Company operated 400 stores as of June 29, 1997, a net decrease of 9 stores from
June 30, 1996. The number of operating stores decreased to 357 stores in July
after the end of the second quarter as a result of closing 44 stores as part of
the Company's restructuring plan. The Company expects to incur capital
expenditures of approximately $50 million during fiscal 1997 and plans to fund
these expenditures through a combination of cash flows from operations and
borrowings under both the Reducing Revolving Credit Facility and the New Credit
Facility.
ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per
Share". This pronouncement will be effective for financial statements for both
interim and annual periods ending after December 15, 1997. In June 1997, the
FASB issued SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." Both
statements shall be effective for fiscal years beginning after December 15,
1997. The Company anticipates that the adoption of these Statements will not
have a material impact on its operating results or financial position.
-16-
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in the Rights of the Company's Security Holders
Not applicable.
Item 3. Defaults by the Company on Its Senior Securities
Not applicable.
Item 4. Results of Votes of Security Holders
At the Company's Annual Meeting of Shareholders which was held on
April 16, 1997, the following proposals were approved:
1) The election of two Class II directors to serve for a term of three
years and until their successors are duly elected and qualified.
The persons nominated for election to the Board of Directors
received the number of votes shown opposite their respective names:
For Against Withheld
---------- --------- ---------
R. Maynard Holt 86,256,630 - 2,407,473
James E. Poole 87,185,065 - 1,479,039
2) The proposal to amend the 1991 Directors' Equity Plan for
nonemployee directors of the Company to permit the conversion of
their cash retainer payments into options to purchase stock of the
Company. The proposal received the following votes:
For Against Withheld
---------- --------- ---------
86,269,121 2,091,884 303,098
3) The proposal to approve for purposes of federal tax laws the
Company's 1997 Executive Incentive Compensation Program. The
proposal received the following votes:
For Against Withheld
---------- --------- ---------
85,412,853 2,896,949 354,301
-17-
<PAGE>
PART II - OTHER INFORMATION (continued)
4) The selection of Deloitte & Touche LLP as the Company's Independent
Public Accountants for fiscal year 1997. The proposal received the
following votes:
For Against Withheld
---------- --------- ---------
86,595,886 1,719,558 348,659
Current Directors whose terms have not expired and who were therefore
not up for re-election:
Year Term to Expire In
----------------------
Raymond Zimmerman 1998
Harold Roitenberg 1998
Gary M. Witkin 1998
Richard P. Crane, Jr. 1999
Charles V. Moore 1999
Item 5. Other Information
Not applicable.
-18-
<PAGE>
PART II - OTHER INFORMATION (continued)
Item 6. Exhibits and Reports on Form 8-K
6(a) Exhibits filed with this Form 10-Q
Exhibit No. Under Items
601 of Regulation S-K Brief Description
----------------------- ----- -----------
11 Statement re:
Computation of Net Loss
Per Common Share for the Three
Periods Ended and Six Periods Ended
July 29, 1997 and June 30, 1996.
27 Financial Data Schedule for the
Six Periods Ended July 29, 1997.
6(b) Reports on Form 8-K
As reported on Form 8-K dated July 21, 1997, the Company
has signed a commitment letter with The Chase Manhattan
Bank and Citibank to provide a five-year, $900 million
bank facility to replace its existing bank lines and other
obligations. The financing is expected to be completed
by September 30, 1997.
-19-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SERVICE MERCHANDISE
COMPANY, INC.
Date: August 11, 1997 /s/ Gary M. Witkin
-------------------
Gary M. Witkin
President
(Chief Executive Officer)
Date: August 11, 1997 /s/ S. Cusano
-------------------
S. Cusano
Executive Vice President and
Chief Financial Officer
(Chief Financial Officer)
(Chief Accounting Officer)
-20-
<PAGE>
<TABLE>
EXHIBIT 11
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Computation of Net Loss Per Common Share (Unaudited)
(In thousands, except per share data)
<CAPTION>
Three Periods Ended Six Periods Ended
---------------------------------- -----------------------------------
June 29 June 30 June 29 June 30
1997 1996 1997 1996
--------------- -------------- --------------- ----------------
Primary
- -------
<S> <C> <C> <C> <C>
Net loss ($17,547) ($1,822) ($124,764) ($26,537)
=============== ============== =============== ================
Shares:
Weighted average common shares outstanding 99,296 99,201 99,279 99,192
Weighted average shares of restricted
stock outstanding 495 524 499 522
Additional shares assuming exercise of stock options 109 1,802 246 1,719
--------------- -------------- --------------- ----------------
Weighted average common shares and common
share equivalents outstanding - primary 99,900 101,527 100,024 101,433
=============== ============== =============== ================
Primary net loss per common share ($0.18) ($0.02) ($1.25) ($0.26)
=============== ============== =============== ================
Assuming Full Dilution
- ----------------------
Net loss ($17,547) ($1,822) ($124,764) ($26,537)
=============== ============== =============== ================
Shares:
Weighted average common shares outstanding 99,296 99,201 99,279 99,192
Weighted average shares of restricted
stock outstanding 495 524 499 522
Additional shares assuming exercise of stock options 132 1,848 259 1,753
--------------- -------------- --------------- ----------------
Weighted average common shares and common
share equivalents outstanding - fully diluted 99,923 101,573 100,037 101,467
=============== ============== =============== ================
Fully diluted net loss per common share ($0.18) ($0.02) ($1.25) ($0.26)
=============== ============== =============== ================
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Service Merchandise Company, Inc. Form 10-Q for the six periods ended
June 29, 1997 and is qualified in its entirety by reference to such
financial statements detailed in Part I of the Form 10-Q.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 6-MOS 6-MOS
<FISCAL-YEAR-END> DEC-28-1997 DEC-29-1996
<PERIOD-START> DEC-30-1996 JAN-01-1996
<PERIOD-END> JUN-29-1997 JUN-30-1996
<CASH> 57,486 60,708<F1>
<SECURITIES> 0 0
<RECEIVABLES> 47,702 47,068
<ALLOWANCES> 3,125 2,824
<INVENTORY> 956,674 1,057,589
<CURRENT-ASSETS> 1,137,928 1,201,022<F1>
<PP&E> 1,176,458 1,194,189
<DEPRECIATION> 619,108 592,990
<TOTAL-ASSETS> 1,720,389 1,822,513<F1>
<CURRENT-LIABILITIES> 689,268 838,700<F1>
<BONDS> 654,493 618,240
0 0
0 0
<COMMON> 99,812<F2> 99,732<F2>
<OTHER-SE> 252,956 310,819
<TOTAL-LIABILITY-AND-EQUITY> 1,720,389 1,822,513<F1>
<SALES> 1,563,761 1,575,612
<TOTAL-REVENUES> 1,563,761 1,575,612
<CGS> 1,225,933 1,207,003
<TOTAL-COSTS> 1,225,933 1,207,003
<OTHER-EXPENSES> 372,837<F3> 377,470<F3>
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 35,103 33,941
<INCOME-PRETAX> (199,622) (42,802)
<INCOME-TAX> (74,858) (16,265)
<INCOME-CONTINUING> (124,764) (26,537)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (124,764) (26,537)
<EPS-PRIMARY> (1.25) (0.26)
<EPS-DILUTED> (1.25) (0.26)
<FN>
<F1> Certain prior period amounts have been reclassified for comparative
purposes.
<F2> Amount represents the number of shares of $0.50 par value common stock
issued and outstanding.
<F3> Amount includes I) depreciation and amortization and II) selling, general
and administrative expenses.
</FN>
</TABLE>
