<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 September 27, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---- ----
Commission File 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 October 25, 1998, there were 100,354,902 shares of
Service Merchandise Company, Inc. common stock outstanding.
<PAGE>
<TABLE>
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 Nine Periods Ended September 27, 1998 and September 28, 1997 . . . . 3
Consolidated Balance Sheets - September 27, 1998 (Unaudited),
September 28, 1997 (Unaudited) and December 28, 1997 . . . . . . . . . 4
Consolidated Statements of Cash Flows (Unaudited) - Nine
Periods Ended September 27, 1998 and September 28, 1997 . . . . . . . . 5
Notes to Consolidated Financial Statements (Unaudited) . . . . . . . . . 6-10
Management's Discussion and Analysis of Financial Condition
and Results of Operations . .. . . . . . . . . . . . . . . . . . . . . . 11-19
PART II - OTHER INFORMATION
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
</TABLE>
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<PAGE>
<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(In thousands, except per share data)
<CAPTION>
Three Periods Ended Nine Periods Ended
-------------------------- --------------------------
September 27 September 28 September 27 September 28
-------------------------- --------------------------
1998 1997 1998 1997
------------ ------------ --------------------------
<S> <C> <C> <C> <C>
Net sales
Operations excluding closing facilities as a result of restructuring
and remerchandising activities $ 604,715 $ 635,483 $ 1,874,164 $ 1,990,696
Closing facilities as a result of restructuring and remerchandising
activities 272 20,661 10,117 229,209
--------- --------- ------------ -----------
604,987 656,144 1,884,281 2,219,905
Costs and expenses:
Cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities as a result of restructuring
and remerchandising activities 463,541 486,062 1,420,873 1,512,721
Closing facilities as a result of restructuring and remerchandising
activities 3,192 18,892 18,489 218,166
-------- -------- ---------- -----------
466,733 504,954 1,439,362 1,730,887
Gross margin after cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities as a result of restructuring
and remerchandising activities 141,174 149,421 453,291 477,975
Closing facilities as a result of restructuring and remerchandising
activities (2,920) 1,769 (8,372) 11,043
--------- -------- --------- --------
138,254 151,190 444,919 489,018
Selling, general and administrative expenses
Operations excluding closing facilities as a result of restructuring
and remerchandising activities 166,732 152,028 462,277 459,260
Closing facilities as a result of restructuring and remerchandising
activities 52 2,231 2,352 38,705
-------- -------- -------- ---------
166,784 154,259 464,629 497,965
Restructuring charge - - - 129,510
Depreciation and amortization
Operations excluding closing facilities as a result of restructuring
and remerchandising activities 13,908 13,212 42,514 40,842
Closing facilities as a result of restructuring and remerchandising
activities - 155 87 2,981
-------- -------- -------- ---------
13,908 13,367 42,601 43,823
Loss from operations (42,438) (16,436) (62,311) (182,280)
Other income, net 831 67 11,120 2,531
-------- -------- -------- ---------
Loss before interest and income taxes (41,607) (16,369) (51,191) (179,749)
Interest expense-debt 17,709 17,525 53,352 49,616
Interest expense-capitalized leases 1,642 1,883 5,115 6,034
-------- -------- --------- --------
Loss before income taxes (60,958) (35,777) (109,658) (235,399)
Income taxes benefit (22,860) (13,417) (41,122) (88,275)
-------- -------- -------- --------
Loss before extraordinary item (38,098) (22,360) (68,536) (147,124)
Extraordinary loss from early extinguishment of debt, net of $1,585 tax benefit - (2,643) - (2,643)
--------- -------- -------- --------
Net loss $ (38,098) $ (25,003) $ (68,536) $ (149,767)
========= ======== ======== ========
Weighted average common shares - basic and diluted 99,701 99,316 99,702 99,290
========= ======== ======== ========
Per common share:
Loss before extraordinary item $ (0.38) $ (0.22) $ (0.69) $ (1.48)
Extraordinary loss from early extinguishment of debt - (0.03) - (0.03)
-------- -------- -------- --------
Net loss $ (0.38) $ (0.25) $ (0.69) $ (1.51)
======== ======== ======== ========
See Notes to Consolidated Financial Statements.
-3-
</TABLE>
<PAGE>
<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except per share data)
<CAPTION>
(Unaudited)
-----------------------------
September 27 September 28 December 28
1998 1997 1997 (1)
------------- ------------ ------------
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $54,452 $45,900 $364,169
Accounts receivable, net of allowance of
$2,144, $2,541 and $3,456, respectively 48,767 39,969 43,130
Income taxes 27,311 77,640 -
Inventories 1,044,170 1,165,586 929,818
Prepaid expenses 18,282 31,809 25,276
Deferred income taxes 22,478 - 22,478
------------ ------------- -----------
TOTAL CURRENT ASSETS 1,215,460 1,360,904 1,384,871
Property and equipment:
Owned assets, net of accumulated depreciation of
$537,053, $546,399 and $517,629, respectively 476,964 500,327 490,345
Capitalized leases, net of accumulated amortization of
$74,977, $76,740 and $76,735, respectively 27,819 35,207 33,289
Other assets and deferred finance charges 59,205 38,378 42,956
------------ ------------- -----------
TOTAL ASSETS $1,779,448 $1,934,816 $1,951,461
============ ============= ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable to banks $ 65,000 $ 125,400 $ -
Accounts payable 398,454 447,356 482,235
Accrued expenses 202,099 163,884 214,451
State and local sales taxes 21,362 25,190 48,331
Accrued restructuring costs - current 12,581 29,149 21,178
Current maturities of long-term debt 21,281 20,641 23,723
Current maturities of capitalized lease obligations 8,545 8,267 8,452
Deferred income taxes - 7,437 -
---------- ------------- -----------
TOTAL CURRENT LIABILITIES 729,322 827,324 798,370
Accrued restructuring costs 52,834 53,483 55,064
Long-term debt 685,486 715,470 711,512
Capitalized lease obligations 43,417 52,564 50,010
Deferred income taxes - 7,922 -
---------- ------------- -----------
TOTAL LIABILITIES 1,511,059 1,656,763 1,614,956
---------- ------------- -----------
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
1,100 shares, none issued
Common stock, $.50 par value, authorized 500,000 shares, issued
and outstanding 100,356, 99,800 and 100,376 shares, respectively 50,178 49,900 50,188
Additional paid-in capital 7,721 5,680 7,908
Deferred compensation (2,170) (558) (2,787)
Retained earnings 212,660 223,031 281,196
------------ ------------- ------------
TOTAL SHAREHOLDERS' EQUITY 268,389 278,053 336,505
------------ ------------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,779,448 $1,934,816 $1,951,461
============ ============= ============
(1) Derived from fiscal year ended December 28, 1997 audited consolidated financial statements.
See Notes to Consolidated Financial Statements.
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</TABLE>
<PAGE>
<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
<CAPTION>
Nine Periods Ended
--------------------------------
September 27 September 28
---------------------------------
1998 1997
-------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($68,536) ($149,767)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 46,931 46,391
Gain on disposal of property and equipment (11,120) (2,531)
Write down of property and equipment due to restructuring - 32,915
Write-off of debt issuance costs - 2,111
Changes in assets and liabilities (net of disposition):
Accounts receivable, net (5,637) 21,485
Inventories (114,352) (112,617)
Prepaid expenses (1,453) (16,348)
Accounts payable (83,781) (192,531)
Accrued expenses and state and local sales taxes (39,322) (83,570)
Accrued restructuring costs (10,827) 82,632
Income taxes (27,311) (111,538)
------------- -------------
NET CASH USED BY OPERATING ACTIVITIES (315,408) (483,368)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (30,653) (23,576)
Proceeds from sale of property and equipment 31,045 17,431
Other assets, net (23,955) (2,555)
------------- --------------
NET CASH USED BY INVESTING ACTIVITIES (23,563) (8,700)
------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 65,000 125,400
Proceeds from long-term debt - 206,560
Repayment of long-term debt (28,468) (101,122)
Repayment of capitalized lease obligations (6,390) (6,124)
Debt issuance costs (846) (16,806)
Exercise of stock options (forfeiture of restricted stock), net (42) 67
------------- --------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 29,254 207,975
------------- --------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (309,717) (284,093)
CASH AND CASH EQUIVALENTS-BEGINNING OF PERIOD 364,169 329,993
------------- --------------
CASH AND CASH EQUIVALENTS-END OF PERIOD $54,452 $45,900
============= ==============
See Notes to Consolidated Financial Statements.
-5-
</TABLE>
<PAGE>
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 28, 1997, 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 28, 1997.
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 September 27, 1998 and September 28, 1997
are not necessarily indicative of the operating results for an entire
fiscal year.
B. The Company's consolidated statements of operations presentation 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 as a result of restructuring 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,
infant, pet supply and other merchandise categories and certain components
of the wireless communication and sporting goods categories as part of a
remerchandising program. As of September 27, 1998, 53 stores, one
distribution center and primarily all of the aforementioned merchandise
categories have been liquidated. All activity for these items is classified
in "Closing facilities as a result of restructuring and remerchandising
activities." Prior year amounts reflect operating results for these same
facilities and merchandise classifications. Selling, general and
administrative expenses for closing facilities as a result of restructuring
and remerchandising activities does not include any allocation of corporate
overhead.
C. On March 25, 1997, the Company adopted a business restructuring plan to
close 60 stores and one distribution center (the "Restructuring
Plan"). 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 the amounts charged against the accrual from
March 25, 1997 to September 27, 1998 and from December 28, 1997 through
September 27, 1998 are outlined, respectively, in the following tables:
-6-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
<TABLE>
<CAPTION>
Activity to Date
-----------------------------------------
Accrued Accrued
Restructuring Costs Restructuring Costs
as of Restructuring Asset Change In as of
(In thousands) March 25, 1997 Costs Paid Write-downs Estimate September 27, 1998
------------------ -------------- -------------- ----------- --------------------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $ 83,225 $ (24,303) $ - $ 4,293 $ 63,215
Property and equipment write-downs 32,915 - (32,096) (819) -
Employee severance 4,869 (3,624) - (1,245) -
Other exit costs 8,501 (4,072) - (2,229) 2,200
------------------ -------------- -------------- ----------- --------------------
Total $ 129,510 $ (31,999) $ (32,096) $ - 65,415
================== ============== ============== ===========
Less: Current portion (12,581)
----------------
$ 52,834
================
<CAPTION>
1998 Activity
-----------------------------------------
Accrued Accrued
Restructuring Costs Restructuring Costs
as of Restructuring Asset Change In as of
(In thousands) December 28, 1997 Costs Paid Write-downs Estimate September 27, 1998
------------------ -------------- -------------- ----------- --------------------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $ 73,511 $ (11,491) $ - $ 1,195 $ 63,215
Property and equipment write-downs - - 819 (819) -
Employee severance 531 (155) - (376) -
Other exit costs 2,200 - - - 2,200
------------------ -------------- -------------- ----------- --------------------
Total $ 76,242 $ (11,646) $ 819 $ - 65,415
================== ============== ============== ===========
Less: Current portion (12,581)
----------------
$ 52,834
================
</TABLE>
The closing of nine stores during the first half of 1998 brought the total
number of closures in accordance with the Restructuring Plan to 53 stores
and one distribution center. Store closures related to the Restructure Plan
were completed as of May 1998. Impairment charges recognized on the nine
stores closed in 1998 were $4.2 million. The Company closed less than 60
stores primarily due to the inability to negotiate acceptable exit terms
from the related lessors.
Restructuring costs paid during the first three quarters of 1998 relate
primarily to lease termination and other real estate costs. 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, as
well as early termination costs. The Company will pay lease termination
fees as the Company is able to obtain such terminations. The leases
remaining on closed locations as of September 27, 1998 vary in length with
expiration dates ranging from February 1999 to December 2030. The ultimate
timing of lease payments will depend on the Company's ability to negotiate
acceptable lease exit terms.
As of September 27, 1998, property and equipment associated with the
Restructuring Plan closures have been written-down to reflect their
estimated fair value. Management anticipates selling or abandoning
substantially all remaining owned property and equipment associated with
the Restructuring Plan. Approximately 3,000 employees were terminated
pursuant to the Restructuring Plan. All such terminations were completed as
of May 1998.
-7-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
Changes in estimates are representative of conditions existing as of
September 27, 1998. Due to unfavorable sublease and termination experience
during 1998, the Company increased the estimate for lease termination and
other real estate costs. These unfavorable results have been offset by
favorable experience related to the sale of property and equipment
associated with the store closures and employee severance.
In the third quarter of 1998, the Company completed the remerchandising
portion of its restructuring and repositioning plan announced in March
1997.
D. The third quarter ended September 27, 1998 and September 28, 1997 each
contained 91 selling days. The nine periods ended September 27, 1998 and
September 28, 1997 each contained 272 selling days.
E. Other income reflects the Company's gain or loss incurred from the sale of
fixed assets. This activity was previously recorded as a part of selling,
general and administrative expenses. The amounts reclassified were $0.1
million for the three periods ended September 28, 1997 and $2.5 million for
the nine periods ended September 28, 1997. The sale of these assets were
not related to the Restructuring Plan.
F. In July 1998, Service Plus Assurance Company Ltd., a wholly-owned insurance
company incorporated under the laws of Bermuda, was established to provide
coverage for the retained loss portion of the Company's workers'
compensation and general liability coverage. Additionally, this subsidiary
will share underwriting, limited risk and investment income with the
administrators and insurers of its products warranty program and the
Company's credit life program.
G. Basic net earnings (loss) per common share is computed by dividing net
earnings (loss) by the weighted-average number of common shares outstanding
during the year. Diluted net earnings (loss) per common share is computed
by dividing net earnings (loss) by the weighted-average number of common
shares outstanding during the year plus incremental shares that would have
been outstanding upon the assumed vesting of dilutive restricted stock and
the assumed exercise of dilutive stock options.
H. Cash payments for interest for the nine periods ended September 27, 1998
and September 28, 1997 were $52.6 million and $51.0 million, respectively.
Cash payments (refunds) for income taxes for the nine periods ended
September 27, 1998 and September 28, 1997 were ($17.3) million and $21.7
million, respectively. The net income tax refund for 1998 resulted
primarily from the net operating loss ("NOL") recognized for the year ended
December 28, 1997.
-8-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
I. In September 1997, the Company completed a five-year, $900 million,
fully-committed, asset-based credit facility ("Amended and Restated Credit
Facility"). The Amended and Restated Credit Facility currently includes
$197 million in term loans and up to a maximum of $700 million in revolving
loans including a $175 million sub-facility for letters of credit. The
Amended and Restated Credit Facility matures on September 10, 2002.
Interest rates on the Amended and Restated Credit Facility are subject to
change based on a financial performance-based grid and cannot exceed a rate
of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on the term loan. As
of September 27, 1998, the revolving loans and the term loan carried a rate
of LIBOR + 2.00%, or 7.62%, and LIBOR + 2.25%, or 7.87%, respectively.
There is a commitment fee of 3/8% on the undrawn portion of the revolving
loans. Short-term borrowings related to the Amended and Restated Credit
Facility were $65.0 million and $125.4 million as of September 27, 1998 and
September 28, 1997, respectively.
On October 28, 1998, the Company amended the Amended and Restated Credit
Facility to reduce the fixed charge coverage requirement (the ratio of
earnings before interest, taxes, depreciation, amortization and rents to
cash interest plus rents) from 1.25:1.0 to 1.05:1.0 for the fourth quarter
of 1998.
The Amended and Restated Credit Facility is secured by all material
unencumbered assets of the Company and its subsidiaries, including
inventory but excluding previously mortgaged property and leasehold
interests. These security interests will automatically terminate when the
Company's senior debt (or implied senior debt) achieves an investment grade
credit rating or the Company meets certain operating performance targets.
Borrowings under the Amended and Restated Credit Facility are limited based
on (1) a borrowing base formula which considers eligible inventories,
eligible accounts receivable and mortgage values on eligible real
properties and (2) limitations contained in the Company's public senior
subordinated debt indenture. Approximately $276.1 million of borrowings
were unused and available under the Amended and Restated Credit Facility as
of September 27, 1998.
J. The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 130, "Reporting Comprehensive Income" in the first quarter of 1998. The
Company's comprehensive loss and net loss for the three periods and nine
periods ended September 27, 1998 and September 28, 1997 were equal.
-9-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
K. In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information." In February 1998,
the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and
Other Postretirement Benefits." These pronouncements will be effective for
financial statements beginning after December 15, 1997. In March 1998, the
FASB issued Statement of Position 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." This
pronouncement will be effective for financial statements beginning after
December 15, 1998. The Company anticipates that the adoption of these
Statements will not have a material impact on its operating results or
financial position.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This pronouncement will be effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
Company is still in the process of analyzing the impact of the adoption of
this Statement.
-10-
<PAGE>
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
The Company's liquidity, capital resources and results of operations may be
affected from time to time by a number of factors and risks, including, but not
limited to, continuing availability of trade credit; terms with vendors and
floor planning arrangements; the Company's use of substantial financial leverage
and the potential impact of such leverage on the Company's ability to execute
its operating strategies; to withstand significant economic downturns and to
repay its indebtedness; the Company's ability to fund, and its success in
implementing plans regarding the Company's alternative store formats; the
ability to fund and execute a strategic repositioning of the Company;
competitive pressures from other retailers, including specialized retailers and
discount stores which may affect the nature and viability of the Company's
business strategy; trends in the economy as a whole, which may affect consumer
confidence and consumer demand for the types of goods sold by the Company;
availability, costs and terms of financing, including the risk of rising
interest rates; the ability to maintain gross profit margins; the seasonal
nature of the Company's business and the ability of the Company to predict
consumer demand as a whole, as well as demand for specific goods; the ability of
the Company to attract and retain customers by executing the Company's
remerchandising strategy and improving customer service; costs associated with
the shipping, handling and control of inventory and the Company's ability to
optimize its supply chain; potential adverse publicity; availability and cost of
management and labor employed; real estate occupancy and development costs,
including the substantial fixed investment costs associated with opening,
maintaining or closing a Company store and the ability to effect conversions to
new technological systems, including becoming year 2000 compliant.
This report includes, and other reports and statements issued on behalf of the
Company, may include certain forward-looking statements in reliance on the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995. Any
such forward-looking statements are subject to a number of risks and
uncertainties, including but not limited to the factors identified above. Actual
results may differ materially from those anticipated in any such forward-looking
statements. The Company undertakes no obligation to update or revise any such
forward-looking statements.
-11-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
RESULTS OF OPERATIONS
OVERVIEW
The Company has embarked on a plan to establish itself as a fresh new
competitive fine jewelry and home specialty retailer. As anticipated, the
execution of this plan during the first two months of this quarter resulted in
significant expense to the Company, thus negatively impacting the third quarter
results.
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.
THIRD QUARTER ENDED SEPTEMBER 27, 1998 VS. THIRD QUARTER ENDED
SEPTEMBER 28, 1997
NET SALES
Net sales for the Company were $605.0 million for the third quarter of 1998
compared to $656.1 million for the third quarter of 1997. The $51.1 million
decrease reflects the $20.4 million loss in sales associated with closed
facilities as a result of restructuring and remerchandising activities and a
5.2% decrease in comparable store sales.
Net sales from operations excluding closing facilities as a result of
restructuring and remerchandising activities for the third quarter of 1998 were
$604.7 million versus $635.5 million for the same period in 1997. This
represents a net sales decrease of $30.8 million, or 4.8%, with comparable store
sales decreasing 5.2%. Jewelry comparable store sales increased 8.4%, while
hardline comparable store sales were down 10.0%. Contributing to the overall
comparable store sales decline was the disruption caused by both the
reformatting of the store selling floor and the clearance of discontinued
merchandise in connection with the new format conversion. Additionally, the
Company's mail order sales contributed to approximately 17% of the overall
comparable store sales decline. The negative impact is believed to be the result
of the elimination of the Fall Catalog.
Net sales from closing facilities as a result of restructuring and
remerchandising activities were $0.3 million for the third quarter of 1998
versus $20.7 million for these same facilities and merchandise classifications
for the same period last year.
GROSS MARGIN
Gross margin, after buying and occupancy expenses, for the Company for the third
quarter of 1998 was $138.3 million, or 22.9% of net sales compared to $151.2
million, or 23.0% of net sales for the prior year quarter.
-12-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Gross margin, after buying and occupancy expenses, excluding closing facilities
as a result of restructuring and remerchandising activities, was $141.2 million,
or 23.3% of net sales for the third quarter of 1998 compared to $149.4 million,
or 23.5% of net sales for the prior year quarter. The relatively flat gross
margin rate reflects the clearance markdowns prevalent during the quarter,
offset by the transition to an assortment of merchandise that has higher margins
than previously sold by the Company in prior quarters.
Gross margin, after buying and occupancy expenses, from closing facilities as a
result of restructuring and remerchandising activities was ($2.9) million for
the third quarter of 1998 compared to $1.8 million for the prior year quarter.
The impact on gross margin recognized in the third quarter of 1998 is due to the
clearance of certain discontinued merchandise and the recognition of a $2.9
million write-down in order to reduce discontinued inventory items to their net
realizable value.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the third quarter of 1998 were
$166.8 million, or 27.6% of net sales, versus $154.3 million, or 23.5% of net
sales for the third quarter of 1997. The $12.5 million increase is primarily
attributable to increased expenses associated with operations excluding closing
facilities as a result of restructuring and remerchandising activities.
Selling, general and administrative expenses, excluding closing facilities as a
result of restructuring and remerchandising activities, increased $14.7 million
to $166.7 million, or 27.6% of net sales, as compared to $152.0 million, or
23.9% of net sales for the third quarter last year. The increase is primarily
attributable to an increase in advertising, promotional programs and employment
as part of the transition effort and Labor Day kick-off of the new store format.
This increase was partially offset by $3.6 million in income from the Company's
private label credit card program.
Selling, general and administrative expenses of closing facilities as a result
of restructuring and remerchandising activities were $0.1 million, or 19.1% of
sales from closing facilities as a result of restructuring and remerchandising
activities for the third quarter of 1998 compared to $2.2 million, or 10.8% of
sales from closing facilities as a result of restructuring and remerchandising
activities for the prior year quarter.
OTHER INCOME
In the third quarter of 1998, other income increased to $0.8 million from $0.1
million in the third quarter 1997. This increase was primarily due to a gain on
the disposal of a property not included in the Restructuring Plan.
INTEREST EXPENSE
Interest expense was $19.4 million for both the third quarter of 1998 and 1997.
Interest expense remained flat as the term loan was outstanding for the entire
quarter in 1998 offset by lower average borrowings against the revolver under
the Company's Amended and Restated Credit Facility.
-13-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
INCOME TAXES
The Company recognized an income tax benefit of $22.9 million and $13.4 million
for the third quarter ended September 27, 1998 and September 28, 1997,
respectively. The effective tax rate for the third quarter ended September 27,
1998 and September 28, 1997 was 37.5%. For the fiscal year ended December 28,
1997 the effective income tax rate was 37.5%.
NINE PERIODS ENDED SEPTEMBER 27, 1998 VS. NINE PERIODS ENDED
SEPTEMBER 28, 1997
NET SALES
Net sales for the Company were $1,884.3 million for the first nine periods of
1998 compared to $2,219.9 million for the first nine periods of 1997. The
decrease of $335.6 million, or 15.1% reflects the $219.1 million loss in sales
associated with closed facilities as a result of restructuring and a 6.4%
decrease in comparable store sales. Jewelry comparable store sales increased
2.9% while hardline comparable store sales were down 9.7%. Contributing to the
overall comparable store sales decline was the conversion of the Company's
traditional store format and merchandise selections into a new business design
during both the second and third quarters of 1998.
GROSS MARGIN
Gross margin, after buying and occupancy expenses, for the first nine periods of
1998 was $444.9 million, or 23.6% of net sales compared to $489.0 million, or
22.0% of net sales for the same period last year. The improved gross margin rate
reflects the Company's focus on higher margin categories and a shift in sales
mix towards jewelry offset by a $7.9 million write-down reducing discontinued
inventory items to their net realizable value. Additionally, the gross margin
rate for the first nine periods of 1997 was impacted by significant merchandise
discounts associated with inventory liquidations. The decline in gross margin
dollars reflects the closure of 53 stores under the Restructuring Plan.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased to $464.6 million, or
24.7% of net sales, for the first nine months of 1998 compared to $498.0
million, or 22.4% of net sales for the same period a year ago. The decrease in
selling, general and administrative dollars is primarily attributable to the
lower operating expenses resulting from the closure of 53 stores under the
Restructuring Plan and income of $16.7 million recognized from the Company's
private label credit card program. This decrease was partially offset by
increased advertising and employment expenses of operations excluding closing
facilities as a result of restructuring and remerchandising activities incurred
primarily in the third quarter of 1998.
-14-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
OTHER INCOME
In the nine periods ended September 27, 1998, other income increased $8.6
million to $11.1 million from $2.5 million for the same period last year. The
increase was primarily the result of a $6.0 million gain recognized from the
sale/leaseback of its corporate aircraft and $2.6 million gain recorded on the
disposal of two vacant properties.
INTEREST EXPENSE
Interest expense for the first nine periods of 1998 was $58.5 million as
compared to $55.7 million for the same period a year ago. Interest expense for
the year increased primarily due to the addition of the term loan being
outstanding for the entire nine periods partially offset by lower average
borrowings against the revolver under the Company's Amended and Restated Credit
Facility.
INCOME TAXES
The Company recognized an income tax benefit of $41.1 million for the first nine
months of 1998 compared to $88.3 million for the same period a year ago. The
decrease in the benefit is primarily due to the $129.5 million restructuring
charge recorded in the first quarter of 1997. The estimated annual effective tax
rate for the nine periods ended September 27, 1998 and September 28, 1997 was
37.5%. For the fiscal year ended December 28, 1997, the effective income tax
rate was 37.5%.
RESTRUCTURING CHARGE, STORE LIQUIDATION AND REMERCHANDISING PROGRAM
On March 25, 1997, the Company adopted the Restructuring Plan to close 60
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 the amounts charged against the
accrual from March 25, 1997 to September 27, 1998 and from December28, 1997
through September 27, 1998 are outlined, respectively, in the following
tables:
<TABLE>
<CAPTION>
Activity to Date
-----------------------------------------
Accrued Accrued
Restructuring Costs Restructuring Costs
as of Restructuring Asset Change In as of
(In thousands) March 25, 1997 Costs Paid Write-downs Estimate September 27, 1998
------------------ -------------- -------------- ----------- --------------------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $ 83,225 $ (24,303) $ - $ 4,293 $ 63,215
Property and equipment write-downs 32,915 - (32,096) (819) -
Employee severance 4,869 (3,624) - (1,245) -
Other exit costs 8,501 (4,072) - (2,229) 2,200
------------------ -------------- -------------- ----------- --------------------
Total $ 129,510 $ (31,999) $ (32,096) $ - 65,415
================== ============== ============== ===========
Less: Current portion (12,581)
----------------
$ 52,834
================
-15-
</TABLE>
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
<TABLE>
<CAPTION>
1998 Activity
-----------------------------------------
Accrued Accrued
Restructuring Costs Restructuring Costs
as of Restructuring Asset Change In as of
(In thousands) December 28, 1997 Costs Paid Write-downs Estimate September 27, 1998
------------------ -------------- -------------- ----------- --------------------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $ 73,511 $ (11,491) $ - $ 1,195 $ 63,215
Property and equipment write-downs - - 819 (819) -
Employee severance 531 (155) - (376) -
Other exit costs 2,200 - - - 2,200
------------------ -------------- -------------- ----------- --------------------
Total $ 76,242 $ (11,646) $ 819 $ - 65,415
================== ============== ============== ===========
Less: Current portion (12,581)
----------------
$ 52,834
================
</TABLE>
The closing of nine stores during the first half of 1998 brought the total
number of closures in accordance with the Restructuring Plan to 53 stores and
one distribution center. Store closures related to the Restructure Plan were
completed as of May 1998. Impairment charges recognized on the nine stores
closed in 1998 were $4.2 million. The Company closed less than 60 stores
primarily due to the inability to negotiate acceptable exit terms from the
related lessors.
Restructuring costs paid during the first three quarters of 1998 relate
primarily to lease termination and other real estate costs. 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, as well as early termination costs. The
Company will pay lease termination fees as the Company is able to obtain such
terminations. The leases remaining on closed locations as of September 27, 1998
vary in length with expiration dates ranging from February 1999 to December
2030. The ultimate timing of lease payments will depend on the Company's ability
to negotiate acceptable lease exit terms.
Changes in estimates are representative of conditions existing as of September
27, 1998. Due to unfavorable sublease and termination experience during 1998,
the Company increased the estimate for lease termination and other real estate
costs. These unfavorable results have been offset by favorable experience
related to the sale of property and equipment associated with the store closures
and employee severance.
The Restructuring Plan 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 was insignificant as the stores closed were near
break-even contributors.
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.
Additional remerchandising decisions were executed in the first quarter of 1998
with the exit of infant and pet supply categories and certain components of the
sporting goods business.
In the third quarter of 1998, the Company completed the remerchandising portion
of its restructuring and repositioning plan announced in March 1997.
-16-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
LIQUIDITY AND CAPITAL RESOURCES
Working capital decreased to $486.1 million at the end of the third quarter of
1998 from $533.6 million at September 28, 1997, a decrease of $47.5 million or
8.9%. Short-term borrowings totaled $65.0 million outstanding ($276.1 million
available for borrowing) at September 27, 1998 compared to $125.4 million
outstanding ($327.7 million available for borrowing) at September 28, 1997.
Inventory balances at the end of the third quarter of 1998 decreased by $121.4
million primarily due to the transition of the merchandise selections and supply
chain initiatives. Accounts payable decreased by $48.9 million to $398.5 million
compared to the third quarter of 1997 primarily due to decreased purchase
volumes. Additionally, accrued expenses increased $38.2 million primarily due to
an increase in accrued advertising primarily related to the Labor Day kickoff
and an increase in other miscellaneous accruals.
Working capital requirements fluctuate significantly during the year due to the
seasonal nature of the Company's business. These requirements are financed
through a combination of internally generated cash flow from operating
activities, short-term seasonal borrowings, long-term financing, trade credit,
terms with vendors and floor planning arrangements. The current ratio at
September 27, 1998 and September 28, 1997 was 1.7:1 and 1.6:1, respectively.
The Company's liquidity and capital resources may be affected by a number of
factors and risks (many of which are beyond the control of the Company),
including, but not limited to, the availability of cash flows from operations
and the availability of trade credit, terms with vendors and floor planning
arrangements, each of which may fluctuate from time to time and are subject to
change or terminations on short notice. If any such sources of liquidity were
unavailable or substantially reduced, the Company would explore other sources of
liquidity. There can be no assurance other sources of liquidity would be
available or available on terms acceptable to the Company. The Company may need
additional capital to implement its strategy relating to alternative store
formats. While the Company intends to explore various alternatives for
additional capital, if needed, there can be no assurance such capital would be
available or available on terms acceptable to the Company.
In September 1997, the Company completed a five-year, $900 million,
fully-committed, asset-based credit facility ("Amended and Restated Credit
Facility"). The Amended and Restated Credit Facility currently includes $197
million in term loans and up to a maximum of $700 million in revolving loans
including a $175 million sub-facility for letters of credit. The Amended and
Restated Credit Facility matures on September 10, 2002. Interest rates on the
Amended and Restated Credit Facility are subject to change based on a financial
performance-based grid and cannot exceed a rate of LIBOR + 2.25% on revolving
loans and LIBOR + 2.50% on the term loan. As of September 27, 1998, the
revolving loans and term loan carried a rate of LIBOR + 2.00%, or 7.62%, and
LIBOR + 2.25%, or 7.87%, respectively. There is a commitment fee of 3/8% on the
undrawn portion of the revolving loans.
On October 28, 1998, the Company amended the Amended and Restated Credit
Facility to reduce the fixed charge coverage requirement (the ratio of earnings
before interest, taxes, depreciation, amortization and rents to cash interest
plus rents) from 1.25:1.0 to 1.05:1.0 for the fourth quarter of 1998. The
Company paid a fee of $1.3 million in connection with this amendment.
-17-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
The Amended and Restated Credit Facility is secured by all material unencumbered
assets of the Company and its subsidiaries, including inventory but excluding
previously mortgaged property and leasehold interests. These security interests
will automatically terminate when the Company's senior debt (or implied senior
debt) achieves an investment grade credit rating or the Company meets certain
operating performance targets.
Borrowings under the Amended and Restated Credit Facility are limited based on
(1) a borrowing base formula which considers eligible inventories, eligible
accounts receivable and mortgage values on eligible real properties and (2)
limitations contained in the Company's public senior subordinated debt
indenture.
Total long-term debt, including current maturities and capitalized leases,
decreased to $758.7 million at September 27, 1998 from $796.9 million at
September 28, 1997. The decrease in total long-term debt was primarily
attributable to scheduled payments on mortgages, industrial revenue bonds and
capitalized leases.
Additions to owned property and equipment were $30.7 million for the nine
periods ended September 27, 1998 compared to $23.6 million for the same period
last year. The Company operated 354 stores as of September 27, 1998, a net
decrease of 5 stores from September 28, 1997. The Company expects to incur
capital expenditures of approximately $54 million during fiscal 1998 and plans
to fund these expenditures through a combination of cash flows from operations
and borrowings under the Amended and Restated Credit Facility. Additionally, the
Company has allocated $12.4 million of restricted cash to fund its credit card
program as of September 27, 1998.
ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments
of an Enterprise and Related Information." In February 1998, the FASB issued
SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." These pronouncements will be effective for financial statements
beginning after December 15, 1997. In March 1998, the FASB issued Statement of
Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." This pronouncement will be effective for financial
statements beginning after December 15, 1998. The Company anticipates that the
adoption of these Statements will not have a material impact on its operating
results or financial position.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This pronouncement will be effective for
all fiscal quarters of fiscal years beginning after June 15, 1999. The Company
is still in the process of analyzing the impact of the adoption of this
Statement.
-18-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
YEAR 2000 COMPLIANCE
The Company is currently conducting an organization wide program to ensure that
all the systems critical to the operation of the Company are Year 2000 ("Y2K")
compliant. In all categories the awareness and assessment phases are complete.
The renovation, validation (including testing) and implementation phases are
currently in progress. As of September 27, 1998, Information Technology
supported systems are approximately 80% complete. Non-information Technology
systems (end user systems) are approximately 85% complete. It is expected that
Information Technology supported systems will be completed by the end of the
second quarter of 1999 and end user systems will be completed in the first
quarter of 1999. In the course of our preparation for Y2K, we have corresponded
with all software vendors, financial institutions, and our top 1,000 merchandise
vendors and we are monitoring their progress.
Replacement, conversion and testing of hardware and systems applications are
expected to cost between $2.5 million and $3.0 million. To date, approximately
$2 million of costs have been incurred. These costs are being expensed as
incurred.
Given that there can be no assurance that the systems of other entities on which
the Company relies will be Y2K compliant in a timely manner, the major risk
factor associated with Y2K pertains to our third party relationships. The
Company is currently developing contingency plans to address a potential worst
case scenario involving difficulties experienced by the U.S. Postal Service in
the distribution of direct mailings and other publications. If such an event
occurs, the Company would have to insert its publications into local newspapers
and other publications in lieu of mailing them. If local utility companies are
unable to provide services to any of our locations, there is no contingency plan
in place and our business would be at risk.
-19-
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
On October 28, 1998, the Company amended the Amended and Restated Credit
Facility to reduce the fixed charge coverage requirement (the ratio of
earnings before interest, taxes, depreciation, amortization and rents to
cash interest plus rents) from 1.25:1.0 to 1.05:1.0 for the fourth
quarter of 1998.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
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
----------------------- -----------------
10.1 Retirement benefits agreement dated
June 25,1998 regarding Raymond
Zimmerman, former Chief Executive
Officer.
27.1 Financial Data Schedule for the
Third Quarter Ended September 27, 1998.
27.2 Financial Data Schedule for the
Third Quarter Ended September 28, 1997.
6(b) Reports on Form 8-K
There were no reports on Form 8-K during the third quarter ended
September 27, 1998.
-20-
<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: November 10, 1998 /s/ Gary M. Witkin
-------------------
Gary M. Witkin
President
(Chief Executive Officer)
Date: November 10, 1998 /s/ S. Cusano
--------------
S. Cusano
Executive Vice President
and Chief Financial Officer
(Chief Financial Officer)
Date: November 10, 1998 /s/ Steven F. McCann
---------------------
Steven F. McCann
Senior Vice President, Finance
(Chief Accounting Officer)
-21-
JUNE 25, 1998
Mr. Raymond Zimmerman
27 Northumberland
Nashville, TN 37215
RE: Retirement Benefits
Dear Raymond:
Effective April 15, 1998, you retired as an employee of Service
Merchandise Company, Inc. (the "Company"). On behalf of the Company, I write to
express our deepest appreciation for the many valuable contributions you have
made to the Company over the years and to confirm to you our obligations to you
in connection with your retirement. In recognition of your service of over 40
years to the Company and for your undertaking of the obligations hereunder, the
Company hereby agrees as follows:
1. Retirement Bonus. The Company shall pay to you promptly after the
execution of this letter agreement a retirement bonus of $750,000.
2. Stock Options. The Compensation Committee of the Board of Directors
of the Company has taken action which provides that, as of April 15, 1998, all
of the options to purchase shares of the Company's common stock granted to you
pursuant to the Company's Amended and Restated 1989 Employee Stock Incentive
Plan (the "Plan") shall immediately vest and be exercisable in accordance with
the terms and conditions of the Plan during the remainder of their respective
ten year periods. The Company, in lieu of issuing shares of common stock to you
upon your exercise of any options granted under the Plans, shall have the right,
at its option, to pay to you, in cash, the amount by which the closing price of
the common stock on the date of your exercise of any such options, exceeds the
option price of such options.
3. Medical Benefits. The Company will provide at its expense continued
coverage for you (and any dependents of yours covered by the Company's
healthcare plans at the time of your retirement) under the Company's healthcare
plan pursuant to "COBRA" (or any other mandatory healthcare continuation law
then in effect), such coverage then being substantially similar to that provided
by the Company to its senior executives and their eligible dependents. You will
be entitled to such coverage for the period commencing with the date of your
retirement and ending on the earlier of (i) the fifth anniversary of your
retirement, or (ii) the date you become eligible to receive comparable
healthcare coverage from another employer of you or your spouse that does not
contain any exclusion or limitation with respect to any pre-existing condition
of you or your covered dependents. If you (or your dependents covered at the
time of your retirement) elect not to continue coverage under COBRA (or any
other mandatory
<PAGE>
healthcare continuation law then in effect) or are not eligible
to continue coverage under such healthcare continuation law, the company will
provide substantially similar coverage.
4. Life Insurance. You may direct the Company to assign to you (or to
a trust established by you or otherwise) any insurance policies on your life
owned by it and so assignable, other than the split dollar life insurance
discussed below in this paragraph. If so directed, the Company shall promptly
thereafter assign its entire interest in such policies in the manner directed by
you. In addition, the Company shall continue for your life to pay the premium on
the split dollar life insurance policies owned by the Company on your life, and
in the event the Company fails to meet this obligation either by operation of
law or otherwise, you should have the right to continue coverage under the
policies subject to rights of the Company relating to payments previously made
by the Company.
5. Automobile. You shall retain the Company automobile currently being
provided to you. As promptly as practical after the date hereof, the Company
shall convey title to such automobile to you, free of encumbrances. From and
after April 15, 1998, you shall be responsible for all costs and expenses
(including, without limitation, all insurance responsibility and expenses)
associated with such automobile and shall assume all liability arising from the
use of such automobile.
6. Moving Expense Allowance. The Company shall provide you a moving
expense allowance of $25,000 from which you shall pay all expenses incurred by
you in connection with relocating your principal residence away from Nashville,
Tennessee, including (i) travel and lodging expenses incurred by you in
connection with relocating your principal residence away from Nashville,
Tennessee, and (ii) the costs reasonably incurred by you to have your personal
belongings packed and moved from your current principal residence to your new
principal residence.
7. Other Benefits. You shall be entitled to receive all benefits that
have accrued to you prior to April 15, 1998 pursuant to the Company's Restated
Retirement Plan, the Company's Savings and Investment Plan and the Company's
Executive Security Plan, all in accordance with the terms of those respective
plans. The annual benefit for the first ten (10) years following your retirement
will be $124,078 from the Retirement Plan and $154,500 under the Executive
Security Plan. In recognition of your years of service to the Company and of the
maximum amount of retirement benefits permitted to be paid pursuant to the
Company's Restated Retirement Plan, the Company agrees to pay to you an
additional retirement payment of $2,361,837, which, together with the amounts
payable to you under the Executive Security Plan, approximates on a discounted
basis the amount of retirement benefits which would have been payable to you
under the Restated Retirement Plan if such Plan did not contain maximum payment
limits. You will be provided with $160,000 promptly after the execution of this
Agreement as an office and secretarial allowance for you. You shall be entitled
for life to such discounts as are generally available to members of the
Company's Board of Directors and the Governance Committee has confirmed that the
age 70 term limitation for directors will be waived for you and that the
Nominating Committee will nominate you as a director nominee to
<PAGE>
be submitted to the shareholders for approval so long as you beneficially own
more than 3,000,000 shares of the Company's common stock.
8. Withholding Tax Payments. To the extent required by law, federal,
state and local income and payroll withholding taxes shall be withheld on all
amounts payable to you pursuant to this letter agreement.
9. Restrictive Covenant. You hereby agree that for a period of
eighteen (18) months from April 15, 1998, you shall not, acting alone or in
conjunction with others,
(a) directly or indirectly, engage in business of being a national or
regional chain selling jewelry or home products in competition with the business
being conducted by the Company ("Covered Business"), whether as an individual or
sole proprietor or as owner, partner, shareholder (except for 1% or less of any
class of outstanding securities listed on any national securities exchange or
actively traded in over-the-counter market), officer, director, employee,
member, manager, agent, consultant, formal or informal advisor, or by or through
the lending of any form of assistance;
(b) induce any customer of the Company, directly or indirectly, to
curtail or cancel Covered Business with the Company, or solicit or canvass
Covered Business from any person who is a customer of the Company;
(c) induce or attempt to influence, directly or indirectly, any
employee of the Company to terminate his or her employment with the Company; or
(d) divulge or furnish any information that is not generally available
to the public regarding Covered Business including the intellectual property,
trade secrets or any other confidential information concerning Covered Business
or the assets, plans or customers of the Company, to any entity or other person,
or use any such information, trade secret or other confidential information,
directly or indirectly, for your own benefit or for the benefit of any entity or
other person.
10. Enforcement. You acknowledge that any violation by you of Section
10 of this Agreement will cause irreparable harm to the Company, that money
damages for such harm will be incapable of precise measurement and that, as a
result, the Company will not have an adequate remedy at law to redress the harm
caused by such violation. Therefore, in the event of any such violation, you
agree that, in addition to its other remedies, the Company shall be entitled to
injunctive relief, including but not limited to, temporary restraining orders
and/or preliminary or permanent injunctions to restrain or enjoin any such
violation. You agree to and hereby submit to jurisdiction before any state or
federal court of record in Davidson County, Tennessee, or in the state and
county in which such violation may occur, at the Company's election, for that
purpose, and you hereby waive any right to raise the questions of jurisdiction
and venue in any action that the Company may bring in any such court against
you.
<PAGE>
11. Severability; Interpretation. (a) Should any clause, portion or
paragraph of this letter agreement be unenforceable or invalid for any reason,
such unenforceability or invalidity shall not affect the enforceability or
validity of the remainder of this letter agreement. Should any particular
covenant or restriction, including but not limited to the covenants and
restrictions of Section 10, be held to be unreasonable or unenforceable for any
reason, including without limitation the time period, geographical area and
scope of activity covered by such covenant, then such covenant or restriction
shall be given effect and enforced to whatever extent would be reasonable and
enforceable.
(b) You and the Company represent that each has been represented by
independent legal counsel in connection with this letter agreement and that this
letter agreement is the result of negotiations between the parties. Accordingly,
the parties agree that neither party shall be deemed to be the drafter of this
letter agreement and that the language of all parts of this letter agreement in
all cases shall be construed according to its fair meaning, and not strictly for
or against either party.
We wish you well in your retirement and look forward to continuing to
receive the benefit of your advice and experience through your role as director
of the Company.
Very truly yours,
/s/ Gary Witkin
---------------
Gary Witkin
GMW:eav
Accepted and agreed:
/s/ Raymond Zimmerman
- ---------------------
Raymond Zimmerman
Date:
----------------
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Service
Merchandise Company, Inc. Form 10-Q for the nine periods ended September 27,
1998 and is qualified in its entirety by reference to such financial statements
detailed in Part I of the Form 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-03-1999
<PERIOD-START> DEC-28-1997
<PERIOD-END> SEP-27-1998
<EXCHANGE-RATE> 1
<CASH> 54,452
<SECURITIES> 0
<RECEIVABLES> 50,911
<ALLOWANCES> 2,144
<INVENTORY> 1,044,170
<CURRENT-ASSETS> 1,215,460
<PP&E> 1,116,813
<DEPRECIATION> 612,030
<TOTAL-ASSETS> 1,779,448
<CURRENT-LIABILITIES> 729,322
<BONDS> 728,903
0
0
<COMMON> 100,356<F1>
<OTHER-SE> 218,211
<TOTAL-LIABILITY-AND-EQUITY> 1,779,448
<SALES> 1,884,281
<TOTAL-REVENUES> 1,884,281
<CGS> 1,439,362
<TOTAL-COSTS> 1,439,362
<OTHER-EXPENSES> 507,230<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 58,467
<INCOME-PRETAX> (109,658)
<INCOME-TAX> (41,122)
<INCOME-CONTINUING> (68,536)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (68,536)
<EPS-PRIMARY> (0.69)
<EPS-DILUTED> (0.69)
<FN>
<F1>AMOUNT REPRESENTS THE NUMBER OF SHARES OF $0.50 PAR VALUE COMMON STOCK
ISSUED AND OUTSTANDING.
<F2>AMOUNT INCLUDES I) DEPRECIATION AND AMORTIZATION AND II) SELLING, GENERAL
AND ADMINISTRATIVE EXPENSES.
</FN>
</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 nine periods ended September 28,
1997 and is qualified in its entirety by reference to such financial statements
detailed in Part I of the Form 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-28-1997
<PERIOD-START> DEC-29-1996
<PERIOD-END> SEP-28-1997
<EXCHANGE-RATE> 1
<CASH> 45,900
<SECURITIES> 0
<RECEIVABLES> 42,510
<ALLOWANCES> 2,541
<INVENTORY> 1,165,586
<CURRENT-ASSETS> 1,360,904
<PP&E> 1,158,673
<DEPRECIATION> 623,139
<TOTAL-ASSETS> 1,934,816
<CURRENT-LIABILITIES> 827,324
<BONDS> 768,034
0
0
<COMMON> 99,800<F1>
<OTHER-SE> 228,153
<TOTAL-LIABILITY-AND-EQUITY> 1,934,816
<SALES> 2,219,905
<TOTAL-REVENUES> 2,219,905
<CGS> 1,730,887
<TOTAL-COSTS> 1,730,887
<OTHER-EXPENSES> 671,298<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 55,650
<INCOME-PRETAX> (235,399)
<INCOME-TAX> (88,275)
<INCOME-CONTINUING> (147,124)
<DISCONTINUED> 0
<EXTRAORDINARY> (2,643)
<CHANGES> 0
<NET-INCOME> (149,767)
<EPS-PRIMARY> (1.51)
<EPS-DILUTED> (1.51)
<FN>
<F1>AMOUNT REPRESENTS THE NUMBER OF SHARES OF $0.50 PAR VALUE COMMON STOCK
ISSUED AND OUTSTANDING.
<F2>AMOUNT INCLUDES I) DEPRECIATION AND AMORTIZATION II) SELLING, GENERAL
AND ADMINISTRATIVE EXPENSES AND III) RESTRUCTURING CHARGE INCURRED IN THE
FIRST QUARTER OF 1997.
</FN>
</TABLE>
