<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange
- --- Act of 1934 (No Fee Required) for the fiscal year ended December 28,
1997 or
- --- Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 (No Fee Required) for the transition period from to
----- -----.
Commission File No. 1-9223
SERVICE MERCHANDISE COMPANY, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
TENNESSEE 62-0816060
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. Box 24600, Nashville, TN (mailing address) 37202-4600
7100 Service Merchandise Drive, Brentwood, TN 37027
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (615) 660-6000
Securities registered pursuant to Section 12(b) of the Act:
Name of Exchange on
Title of Class Which Registered
- -------------- -------------------
Common Stock ($.50 Par Value) New York Stock Exchange
Series A Junior Preferred Stock Purchase Rights New York Stock Exchange
9% Senior Subordinated Debentures New York Stock Exchange
8 3/8% Senior Notes New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
---
The aggregate market value of the Registrant's Common Stock held by
non-affiliates on March 2, 1998 (based upon the average of the high and low
sales prices of such stock as of such date) was $212,012,411. This calculation
assumes that all shares of Common Stock beneficially held by officers and
members of the Board of Directors of the Registrant are owned by "affiliates," a
status which each of the officers and directors individually disclaims.
<TABLE>
<S> <C>
Class Outstanding at March 2, 1998
----- ----------------------------
Common Stock ($.50 Par Value) 100,373,649
Parts in Form 10-K Where Documents
Documents Incorporated by Reference Are Incorporated by Reference
- ----------------------------------- ----------------------------------
Portions of Registrant's Proxy Statement dated March 13, 1998 Part III
Portions of Registrant's Annual Report to Shareholders for the
fiscal year ended December 28, 1997 Parts II and IV
</TABLE>
Exhibit Index located on Pages 13-17
<PAGE>
<TABLE>
TABLE OF CONTENTS AND CROSS-REFERENCE SHEET
------------------------------------------- Page
No.
----
<S> <C>
PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 1. Business. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3-5
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6-8
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Item 4. Submission of Matters to a Vote of Security-Holders . . . . . . . . . . . . . . . . . . . . . 9
Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . 9-10
PART II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Item 5. Market for Registrant's Common Stock and
Related Stockholder Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-11
Item 6. Selected Financial Data Page 6 of the Registrant's 1997 Annual Report to
Shareholders for the year ended December 28, 1997 which
is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Pages 7 through 11 of the Registrant's 1997 Annual
Financial Condition and Results of Report to Shareholders for the year ended
Operations December 28, 1997 which are incorporated herein by
reference.
Item 8. Financial Statements and Supplementary Pages 12 through 31 of the Registrant's 1997 Annual
Data Report to Shareholders for the year ended
December 28, 1997 which are incorporated herein by
reference.
Item 9. Changes in and Disagreements With
Independent Auditors on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
PART III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 10. Directors and Executive Officers of the Pages 2 through 5 of the Registrant's Proxy Statement
Registrant dated March 13, 1998 which are incorporated herein by
reference.
Item 11. Executive Compensation Pages 8 through 18 of the Registrant's Proxy Statement
dated March 13, 1998 which are incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Pages 6 and 7 of the Registrant's Proxy Statement dated
Owners and Management March 13, 1998 which are incorporated
herein by reference.
Item 13. Certain Relationships and Related Page 20 of the Registrant's Proxy Statement dated March
Transactions 13, 1998 which is incorporated herein by reference.
PART IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Item 14. Exhibits, Financial Statement Schedule and
Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13-17
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
-2-
</TABLE>
<PAGE>
INTRODUCTORY
- ------------
Except where the context indicates otherwise, the "Company" is a term used to
refer to the overall operations of Service Merchandise Company, Inc. and its
past and present subsidiaries and the "Registrant" means Service Merchandise,
Inc. as a separate corporate entity and does not refer to the subsidiaries. The
information included in this 10-K, unless indicated to be given as of a
specified date or for a specified period, is given as of the date of this
report, which is December 28, 1997. The Company does not intend to update such
information.
PART I
Item 1. Business ------
- ------- --------
Service Merchandise, with 361 stores in 34 states, is a leading retailer of fine
jewelry and home products. The Company streamlines its presentation to reflect
customer tastes and purchasing habits, grouping merchandise into thematic
categories called "worlds" - offering dominant selections of brand name
products. In 1997, these "worlds" consisted of: Fine Jewelry, Kitchen and
Dining, Furniture and Home Accents, Season to Season, Electronics, Looking
Healthy/Staying Healthy (promoting the concept of "wellness" with exercise
equipment, personal care items and a bath and body program), Kid Essentials and
Travel and Adventure.
General
The Company's franchise is built around selling nationally advertised,
brand-name home products and fine jewelry. Customers are made aware of the
product offerings through catalogs, direct mail flyers, newspaper inserts and
television advertising. While customers may purchase products through mail
order, telephone order or via the Company's internet website, the majority of
purchases occur directly in a Company store where the customer has physical
access to the merchandise.
The typical Service Merchandise store consists of approximately 50,000 square
feet of total space and is situated on a stand-alone lot or as an anchor in a
suburban mall or strip center. The Company's stores are divided into thematic
"worlds" with displays of the products arrayed to support the world concept. In
the Fine Jewelry world, merchandise is displayed in showcases and sales
associates deliver items to the customers and accept payment. In other worlds, a
sample of the merchandise is displayed, and customers select their purchases via
a "pull tag" system. The pull tag is taken to a cashier, the product is paid for
and the merchandise is delivered to a pick-up station. Additionally, in
self-service departments, customers select merchandise from a shelf or display
and take it to a check-out counter to finalize the purchase.
The Company is currently testing a "Best of Service" concept which is a
scaled-down 10,000 square foot format that carries the full line of jewelry and
a limited number of top-selling products from the home product categories. Other
new store formats will also be evaluated in 1998. Additionally, in the first
quarter of 1998, the Company implemented a new private label credit card
program.
Virtually every transaction in the store that involves payment, customer
information or inventory is recorded and transmitted, on a daily basis, via
satellite to a central information system at the Company's home office. In
addition, by use of the computer, the customers may be provided with alternate
suggestion items, back-order information, on-line mail orders, gift registry,
special orders and layaway information. Most of the Company's stores are
equipped with "Service Express", a user-friendly computer which allows customers
to verify item availability, place their order, tender payment via credit card,
update their address and designate an item as a gift registry purchase.
The Company's computerized daily inventory system tracks the status (on hand, on
order, in transit), location and history of inventory in the retail network. The
raw data feeds the Company's inventory replenishment system which tracks
inventory positions, sales data and sales forecasts and generates either
suggested transfers from distribution centers or suggested purchase order
quantities. The inventory system also records all sales information to produce
daily margin reports, complete with historical comparisons.
-3-
<PAGE>
Item 1. Business (continued)
- ------- --------------------
The Company's information systems enhance the effectiveness of the advertising
by tracking customers' purchases and tailoring the Company's mailing lists to
meet specific objectives. The Company maintains a 24-million household database
of information which is updated with each purchase. This database allows the
Company to target customers based on specific criteria, including the categories
purchased, the frequency of purchases and the value of those purchases.
Seasonality and Competition
The Company's business is highly seasonal, with the Christmas season being the
largest volume selling period of the year. In preparation for the Christmas
season, the Company significantly increases its merchandise inventories, which
are financed by internally generated funds and short-term borrowings. Fourth
quarter net sales accounted for 39.4% of total net sales in fiscal 1997.
The Company is engaged in a highly competitive business and competes with most
nationally known jewelry and home retail merchandisers, including department,
general merchandise, specialty and discount stores. Many of these competitors
are larger and have greater financial resources than the Company. The Company
considers quality, value, merchandise mix, service and location to be the most
significant competitive factors in its retailing business. The Company's
profitability is primarily dependent upon the large sales volume generated
during the fourth quarter of its fiscal year.
Suppliers
The Company purchases merchandise from approximately 1,500 suppliers, most of
which are manufacturers. In fiscal 1997, the largest vendor accounted for
approximately 6.2% of total cash disbursements for inventory items. The Company
believes it would experience no difficulty in obtaining quality merchandise from
alternate sources. Most merchandise is shipped to the Company's regional
distribution centers and transported to the stores by commercial contract
carriers.
The Company's direct import program is responsible for sourcing and repackaging
many promotional and seasonal items. Direct import purchases, which totaled
approximately $265 million in fiscal 1997 (compared to $287 million in fiscal
1996), allow the Company to reduce many traditional cost factors, thereby
lowering the cost of merchandise sold in several product lines. In addition to
its direct import program, the Company imports diamonds, gemstones and gold
which are used by contract fabricators in the manufacture of jewelry items.
Employees
The number of persons employed by the Company fluctuates seasonally. During the
fiscal year ended December 28, 1997, the number of active employees varied from
approximately 26,800 to approximately 42,700 including both permanent and
temporary employees. As of December 28, 1997, the Company had 24,168 permanent
employees, of whom 84% were hourly-paid personnel engaged in non-supervisory
activities; the balance consisted of administrative, executive, distribution
center and store management personnel. None of the Company's employees are
covered by a collective bargaining agreement. The Company has never experienced
a work stoppage due to a labor disagreement and regards its employee relations
as satisfactory.
Certain Factors that may affect Operating Results
On March 25, 1997, the Company announced a corporate restructuring and
repositioning plan ("1997 Restructuring Plan"). See the Notes to Consolidated
Financial Statements, which are incorporated herein by reference to the
Registrant's 1997 Annual Report to Shareholders, for a description of this plan.
-4-
<PAGE>
Item 1. Business (continued)
- ------- --------------------
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, trends in the economy as a whole, which may affect consumer
confidence and consumer demand for the types of goods sold by 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; availability and cost of labor employed; real estate
occupancy and development costs, including the substantial fixed investment
costs associated with opening, maintaining or closing a Company store; the
ability to advertise effectively and control advertising costs; availability,
costs and terms of financing, including the risk of rising interest rates;
availability of trade credit and terms with vendors; 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 ability to maintain gross
profit margins and to achieve future cost savings; 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; the ability and success in completing the
disposition of store locations closed and designated to be closed pursuant to
the 1997 Restructuring Plan; the ability and success in completing and
implementing plans regarding the Company's credit card program and alternative
store formats; the ability to execute a strategic repositioning of the Company;
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 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 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 to reflect subsequent events or circumstances.
-5-
<PAGE>
Item 2. Properties
- ------- ----------
The Company leases and owns retail store facilities, warehouses and office
space. The Company has financed a number of its owned facilities out of
internally generated funds. Some owned facilities have ground leases on a
long-term basis, some are financed through industrial development financing
under which the Company either has ownership or a right to obtain ownership and
others are financed by real estate mortgages. The Company occupies office space
in two locations in greater Nashville, Tennessee, both of which are owned by the
Company.
The Company operated four major distribution centers and one return center
(Bowling Green, Kentucky) as of December 28, 1997. These distribution centers
are located in Florida, New York, Tennessee, and Texas and contain an aggregate
of approximately 3,102,000 square feet as set forth below:
<TABLE>
<CAPTION>
Center Location Sq. Feet Owned/Leased Lease Term
--------------- -------- -------------- ------------------------------------------
<S> <C> <C> <C>
Orlando, FL 460,000 Leased Primary term extends through 6/30/98 with
renewal options through 6/30/22
Montgomery, NY 800,000 Sale/Leaseback Primary term extends through 12/31/24
Nashville, TN
(1) Owned 588,000 Owned Not applicable
(2) Owned satellite 268,000 Owned Not applicable
(3) Leased satellite 392,000 Leased Primary term extends through 1/31/01 with
renewal options through 1/31/05
Dallas, TX 594,000 Leased Primary term extends through 1/31/01 with a
renewal option through 1/31/06
Bowling Green, KY (Return center) 180,000 Leased Primary term extends through 12/31/00 with
renewal options through 12/31/25
</TABLE>
The Company anticipates that it would be able to obtain suitable replacement
facilities should it not be able to renew the above leases.
-6-
<PAGE>
Item 2. Properties (continued)
- ------- ----------------------
As of December 28, 1997, the Company operated 361 retail stores (typically
consisting of approximately 50,000 square feet) as follows:
<TABLE>
<CAPTION>
Number of Stores
----------------
<S> <C>
Owned land and building 92
Long-term ground lease with an owned building 38
Owned land with industrial development financing under which the Company has
ownership or a right to obtain ownership of the building 3
Leased 243
Stores which have been subleased (15)
-----
Total 361
=====
</TABLE>
Most of the leases contain renewal or purchase options. See the Notes to
Consolidated Financial Statements, which are incorporated herein by reference to
the Registrant's 1997 Annual Report to Shareholders, for information concerning
the Company's lease commitments.
For a listing of store locations, see page 8. The numbers in parentheses show
the number of stores per state and where there is more than one store in any
city, the number of stores in such city.
-7-
<PAGE>
Item 2. Properties (continued)
- ------- ----------------------
<TABLE>
<CAPTION>
SERVICE MERCHANDISE COMPANY, INC.
STORE LOCATIONS
<S> <C> <C> <C> <C>
ALABAMA (7) GEORGIA (15) MARYLAND (6) NEW YORK (22) SOUTH CAROLINA (5)
BIRMINGHAM (2) ATLANTA (9) BALTIMORE ALBANY CHARLESTON
HUNTSVILLE (2) AUGUSTA COLUMBIA BINGHAMTON COLUMBIA
MOBILE BUCKHEAD FORESTVILLE BUFFALO GREENVILLE
MONTGOMERY COLUMBUS FREDERICK EAST MEADOW GREENWOOD
TUSCALOOSA DOUGLASVILLE SALISBURY HARTSDALE SUMTER
ARIZONA (3) MACON WALDORF HUNTINGTON TENNESSEE (18)
GLENDALE SAVANNAH MASSACHUSETTS (11) LAKE GROVE COOKEVILLE
MESA (2) ILLINOIS (22) AUBURN LAWRENCE CHATTANOOGA (2)
ARKANSAS (4) CHICAGO (22) BOSTON (7) MASSAPEQUA JACKSON
FAYETTEVILLE INDIANA (14) HOLYOKE MIDDLETOWN JOHNSON CITY
FORT SMITH BLOOMINGTON LANESBORO/PITTSFIELD NANUET KINGSPORT
LITTLE ROCK (2) CLARKSVILLE SWANSEA PATCHOQUE KNOXVILLE (2)
CALIFORNIA (2) EVANSVILLE MICHIGAN (13) PLATTSBURGH MEMPHIS (5)
SAN FRANCISCO FORT WAYNE ANN ARBOR POUGHKEEPSIE NASHVILLE (5)
SAN JOSE GRIFFITH DETROIT (8) QUEENS TEXAS (40)
COLORADO (6) INDIANAPOLIS (4) FLINT ROCHESTER (2) ABILENE
COLORADO SPRINGS KOKOMO LANSING (2) SARATOGA SPRINGS AMARILLO
DENVER (4) LAFAYETTE WATERFORD SYRACUSE (2) ARLINGTON
PUEBLO MERRILLVILLE MISSISSIPPI (6) UTICA AUSTIN
CONNECTICUT (6) SOUTH BEND GAUTIER YORKTOWN HEIGHTS BEAUMONT
DANBURY TERRE HAUTE GULFPORT NORTH CAROLINA (8) COLLEGE STATION
DERBY KANSAS (3) HATTIESBURG CHARLOTTE (2) CORPUS CHRISTI
HARTFORD (2) OVERLAND PARK JACKSON (2) DURHAM DALLAS (6)
ORANGE WICHITA (2) MERIDIAN FAYETTEVILLE EL PASO
WATERBURY KENTUCKY (7) MISSOURI (7) GASTONIA FT. WORTH (2)
DELAWARE (3) FLORENCE INDEPENDENCE GREENSBORO HARLINGEN
DOVER LEXINGTON SPRINGFIELD RALEIGH (2) HOUSTON (9)
WILMINGTON (2) LOUISVILLE (3) ST. LOUIS (5) OHIO (15) LAKE JACKSON
FLORIDA (50) OWENSBORO NEVADA (3) AKRON LAREDO
BOCA RATON PADUCAH LAS VEGAS (2) CANTON LONGVIEW
BOYNTON BEACH LOUISIANA (14) RENO CINCINNATI (4) LUBBOCK
CORAL SPRINGS ALEXANDRIA NEW HAMPSHIRE (5) COLUMBUS (4) MCALLEN (2)
DAVIE BATON ROUGE (2) DOVER LIMA MIDLAND
DAYTONA BEACH HOUMA MANCHESTER MANSFIELD SAN ANGELO
FT. MYERS LAFAYETTE (2) NASHUA SPRINGFIELD SAN ANTONIO (3)
GAINESVILLE LAKE CHARLES PLAISTOW TOLEDO (2) TEMPLE
JACKSONVILLE (3) MONROE SALEM OKLAHOMA (7) TYLER
LAKELAND NEW ORLEANS (3) NEW JERSEY (6) NORMAN WACO
LEESBURG SHREVEPORT (2) HAZLET OKLAHOMA CITY (3) VERMONT (1)
MELBOURNE SLIDELL PARAMUS TULSA (3) BURLINGTON
MIAMI/FT. LAUDERDALE (13) MAINE (5) TURNERSVILLE PENNSYLVANIA (14) VIRGINIA (11)
NAPLES AUBURN VOORHEES ALLENTOWN ALEXANDRIA
OCALA AUGUSTA WAYNE HARRISBURG BAILEY'S CROSSROADS
ORLANDO (6) BANGOR WOODBRIDGE LANCASTER CHANTILLY
PENSACOLA BRUNSWICK NEW MEXICO (2) PHILADELPHIA (2) CHESAPEAKE
PORT CHARLOTTE PORTLAND ALBUQUERQUE PITTSBURGH (6) DALE CITY
SARASOTA LAS CRUCES READING FREDERICKSBURG
STUART SCRANTON HAMPTON
TALLAHASSEE (2) WILKES-BARRE MANASSAS
TAMPA/CLEARWATER/ NORFOLK
ST. PETERSBURG (8) RICHMOND (2)
W. PALM BEACH
VERO BEACH
</TABLE>
-8-
<PAGE>
Item 3. Legal Proceedings
- ------- -----------------
No reportable items.
Item 4. Submission of Matters to a Vote of Security-Holders
- ------- ---------------------------------------------------
There were no reportable items during the Company's fourth quarter.
Executive Officers of the Registrant (1)
- -----------------------------------------
The following is a list of executive officers, their ages, positions and
business experience during the past five years as of the date hereof:
<TABLE>
<CAPTION>
Name, Age and Position
- ----------------------
<S> <C>
Gary M. Witkin, 49 President and Chief Executive Officer since April 1997; President and
President, Chief Executive Officer Chief Operating Officer from November 1994 to April 1997; Vice Chairman
And Director and Board member, Saks Fifth Avenue from October 1992 to November 1994;
Board member of Genesco, Inc.
Raymond Zimmerman, 65 Chairman of the Board since October 1981; Chief Executive Officer from
Chairman of the Board (2) October 1981 to April 1997; President from July 1984 to November 1994
and from 1981 to October 1983. Board member of The Limited Stores,
Columbus, Ohio.
S. Cusano, 44 Executive Vice President and Chief Financial Officer since April, 1997;
Executive Vice President and Chief Financial Vice President and Chief Financial Officer from July 1993 to April
Officer 1997; Group Vice President - Finance from December 1991 to July 1993.
Thomas L. Garrett, Jr., 44 Vice President and Treasurer since July 1996; Treasurer, Magma Copper
Vice President and Treasurer Company from July 1992 to May 1996.
C. Steven Moore, 35 Corporate Secretary since August 1996; Vice President and Managing
Vice President, Managing Attorney and Corporate Attorney since August 1996; Senior Corporate Attorney from November
Secretary 1994 to August 1996; Corporate Attorney from May 1992 to November
1994.
Kenneth Brame, 50 Senior Vice President, Information Services and Chief Information
Senior Vice President, Information Services and Officer since February 1996; Vice President, Systems Development,
Chief Information Officer American Stores Company from May 1994 to February 1996; Director of
Systems Development, Belk Stores Services from April 1989 to April 1994.
Chuck Kremers, 48 Senior Vice President, Marketing since June 1997; Senior Vice
Senior Vice President, Marketing President, Marketing, Cotter & Company, Inc. from 1993 to June 1997;
and Advertising Vice President, Marketing, CompUSA, Inc. from 1989 to 1993.
-9-
<PAGE>
Item 4. Submission of Matters to a Vote of Security-Holders (continued)
Harold Mulet, 46 Senior Vice President, Stores since August 1995; Regional
Senior Vice President, Stores Vice President of Target division of the Dayton Hudson Corp. from
December 1988 to August 1995.
Gary Sease, 54 Senior Vice President, Logistics since September 1996; Senior Vice
Senior Vice President, Logistics President, Operations Services of American National Can Company from
September 1992 to September 1996.
Charles Septer, 46 Senior Vice President, Jewelry Merchandising since April 1988.
Senior Vice President, Jewelry Merchandising
Steven F. McCann, 45 Vice President, Corporate Controller since June 1994. Vice President,
Vice President, Corporate Controller Controller of Robinsons-May division of the May Department Store
Company from February 1993 to June 1994. Vice President, Controller of
the May Company division of the May Department Store Company from April
1992 to February 1993.
(1) All Executive Officers serve at the pleasure of the Board of Directors.
(2) Effective January 29, 1998, James E. Poole was elected Chairman of the Board.
</TABLE>
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
The Company's Common Stock trades on the New York Stock Exchange (NYSE) under
the symbol SME. The number of record holders of Common Stock at March 2, 1998
and February 28, 1997 were 5,844 and 6,076, respectively.
High and low closing sales prices as reported by the NYSE for fiscal 1997 and
1996 were as follows:
1997 High Low
- ---- ----- -----
First Quarter 4 3/4 3 3/8
Second Quarter 3 5/8 2 5/8
Third Quarter 4 1/2 2 7/8
Fourth Quarter 4 7/8 1 7/8
1996 High Low
- ---- ----- -----
First Quarter 6 4 1/2
Second Quarter 6 1/4 4 5/8
Third Quarter 5 3/4 4 1/2
Fourth Quarter 6 3/8 4 1/4
The Company's Amended and Restated Credit Facility contains certain restrictive
covenants, including limitations on the ability to pay dividends. The Company
has not declared any cash dividends to shareholders for fiscal 1997 or 1996. The
Company's amended and restated Credit Facility permits the payment of dividends
with respect to the Company's common stock, $0.50 par value (a) payable solely
in securities of the Company, and (b) after June 30, 1999, payable in cash (if
no Default or Event of Default exists) in an aggregate amount by which the
following, when added to the amount
-10-
<PAGE>
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
(continued)
of any cash dividends paid or declared would exceed 25% of Consolidated Net
Income of the Company for the period of September 30, 1997 through the last day
of the fiscal quarter prior to the dividend payment date: (i) Acquisitions and
Investments under Section 8.8(m) of the Credit Facility in excess of $80
million, or (ii) Investments (other than Acquisitions under Section 8.8(m) of
the Credit Facility in excess of $30 million).
Item 6. Selected Financial Data
Page 6 under the caption "Selected Financial Information" of the Registrant's
1997 Annual Report to Shareholders for the year ended December 28, 1997 is
herein incorporated by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Pages 7 through 11 of the Registrant's 1997 Annual Report to Shareholders for
the year ended December 28, 1997 under the caption "Management's Discussion and
Analysis" are herein incorporated by reference.
Item 8. Financial Statements and Supplementary Data
As set forth in the Registrant's 1997 Annual Report to Shareholders for the year
ended December 28, 1997, the following are incorporated herein by reference:
<TABLE>
<CAPTION>
Description Page
- ----------- ----
<S> <C>
Consolidated Statements of Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Consolidated Balance Sheets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Consolidated Statements of Changes in Shareholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Consolidated Statements of Cash Flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16-30
Quarterly Financial Information (Unaudited) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Item 9. Changes in and Disagreements With Independent Auditors on Accounting and Financial Disclosure
- ------- ---------------------------------------------------------------------------------------------
No reportable items.
</TABLE>
-11-
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
Pages 2 through 5 under the caption "Election of Directors" and page 20 under
the caption "Section 16(a) Beneficial Ownership Reporting Compliance" of the
Registrant's Proxy Statement dated March 13, 1998 filed with the Commission
pursuant to Rule 14a-6(b) are incorporated herein by reference.
Pursuant to General Instruction G(3), information concerning Executive Officers
of the Registrant is included in Part I, Item 4, under the caption "Executive
Officers of the Registrant" of this Form 10-K.
Item 11. Executive Compensation
Reference is made to the information on pages 8 through 18 of the Registrant's
Proxy Statement dated March 13, 1998 filed with the Commission pursuant to Rule
14a-6(b), concerning executive compensation, which is herein incorporated by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Reference is made to the information on pages 6 and 7 of the Registrant's Proxy
Statement dated March 13, 1998 filed with the Commission pursuant to Rule
14a-6(b), concerning the beneficial ownership of Registrant's common stock,
which is herein incorporated by reference.
Item 13. Certain Relationships and Related Transactions
Reference is made to the information on page 20 of the Registrant's Proxy
Statement dated March 13, 1998 filed with the Commission pursuant to Rule
14a-6(b), concerning certain relationships and related transactions, which is
herein incorporated by reference.
-12-
<PAGE>
PART IV
<TABLE>
<CAPTION>
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K
- -------- ---------------------------------------------------------------
<S> <C> <C>
(a) Documents filed as a part of this report.
1. Financial Statements
Reference is made to Part II, Item 8, captioned "Financial Statements and Supplementary Data" (and accompanying
index) which have been incorporated by reference from the Registrant's 1997 Annual Report to Shareholders for
the year ended December 28, 1997.
2. Financial Statement Schedule
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . 19
Schedule
--------
II. Valuation and Qualifying Accounts and Reserves . . . . . . . . . 20
All other schedules are not applicable and have been omitted.
</TABLE>
3. Exhibits and Index to Exhibits
<TABLE>
Exhibits filed with this Form 10-K:
-----------------------------------
<CAPTION>
Exhibit No. Under
Item 601 of
Regulation S-K Brief Description
----------------- -----------------
<S> <C>
3.1 Registrant's Charter, as amended February 5, 1998
(restated in electronic format only for purpose of filing
with the Commission).
4.15 Note Issuance Agreement dated September 30, 1997 among
Service Merchandise Company, Inc., H.J. Wilson Co., Inc.
and The Long-Term Credit Bank of Japan, Ltd.
10.8 Agreement between Service Merchandise Company, Inc. and
James E. Poole dated February 11, 1998.
13 Portions of Service Merchandise Company, Inc. 1997 Annual
Report to Shareholders for the fiscal year ended December
28, 1997.
21 Subsidiaries of the Registrant.
23 Independent Auditors' consent.
27 Financial Data Schedule for the fiscal year ended December
28, 1997.
</TABLE>
-13-
<PAGE>
<TABLE>
<CAPTION>
Exhibits incorporated herein by reference:
------------------------------------------
Exhibit No. Under Exhibit No. in
Item 601 of Document Where
Regulation S-K Brief Description Originally Filed
----------------- ----------------- ----------------
<S> <C> <C>
3.2 Registrant's By-Laws, as amended and restated as of 3.2
April 19, 1989, which are incorporated herein by
reference from Registrant's Form 10-Q filed for the first
quarter ended March 31, 1989.
4.1 Rights Agreement, dated February 2, 1998 which is 99.2
incorporated herein by reference from Registrant's Form
8-K dated February 3, 1998.
4.2 Note Purchase Agreement dated as of June 28, 1990 4.2a
concerning the refinancing of $90 million of the Real
Estate Bridge Loan under Credit Agreement dated as
of July 24, 1989 among the Registrant, Various Banks
and Chemical Bank as Agent, which is incorporated
herein by reference from the Registrant's Form 10-Q
filed for the second quarter ended June 30, 1990.
4.3 Trust Indenture dated as of June 28, 1990 concerning 4.2b
the refinancing of $90 million of the Real Estate Bridge
Loan under the Credit Agreement dated as of July 24,
1989 among the Registrant, Various Banks and
Chemical Bank as Agent, which is incorporated herein
by reference from the Registrant's Form 10-Q filed for the
second quarter ended June 30, 1990.
4.4 Indenture, dated as of February 15, 1993, between the 4.1
Registrant and First American National Bank, as
Trustee, regarding the Registrant's $300,000,000 of 9%
Senior Subordinated Debentures due 2004, which is
incorporated herein by reference from Form 8-K dated
February 17, 1993.
4.5 First Supplemental Indenture, dated as of February 4.2
15, 1993, between the Registrant and First
American National Bank, as Trustee, regarding the
Registrant's $300,000,000 of 9% Senior Subordinated
Debentures due 2004, which is incorporated herein by
reference from Form 8-K dated February 17, 1993.
</TABLE>
-14-
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. in
Document Where
Brief Description Originally Filed
----------------- ----------------
<S> <C> <C>
4.6 Form of Debenture, regarding the Registrant's $300,000,000 4.3
of 9% Senior Subordinated Debentures due 2004, which is
incorporated herein by reference from Form 8-K dated
February 17, 1993.
4.7 Form of Notes, regarding the Registrant's $100,000,000 of 8 4.3
3/8% Senior Notes due 2001, which is incorporated herein by
reference from the Registrant's Form 8-K dated October 26,
1993.
4.8 Conditional Loan Commitment dated as of September 9, 1996, 4.2
concerning the $75 million Real Estate Mortgage Financing
among Service Merchandise Company, Inc., and First Union
National Bank of North Carolina which is incorporated
herein by reference from the Registrant's Form 10-Q filed
for the third quarter ended September 29, 1996.
4.9 Loan Agreement dated as of October 4, 1996 concerning the 4.2a
$75 million Real Estate Mortgage Financing among SMC-SPE-1,
Inc., and First Union National Bank of North Carolina which
is incorporated herein by reference from the Registrant's
Form 10-Q filed for the third quarter ended September 29,
1996.
4.10 Loan Agreement dated as of October 4, 1996 concerning the 4.2b
$75 million Real Estate Mortgage Financing among SMC-SPE-2,
Inc., and First Union National Bank of North Carolina which
is incorporated herein by reference from the Registrant's
Form 10-Q filed for the third quarter ended September 29,
1996.
4.11 First Amendment to Loan Agreement dated as of November 7, 4.19
1996 concerning the $75 million Real Estate Mortgage
Financing among SMC-SPE-2, Inc., and First Union National
Bank of North Carolina which is incorporated herein by
reference to the Registrant's Form 10-K for the fiscal year
ended December 29, 1996.
</TABLE>
-15-
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. in
Document Where
Brief Description Originally Filed
----------------- ----------------
<S> <C> <C>
4.12 Second Amendment to Loan Agreement dated as of December 20, 4.20
1996 concerning the $75 million Real Estate Mortgage
Financing among SMC-SPE-2, Inc., and First Union National
Bank of North Carolina which is incorporated herein by
reference to the Registrant's Form 10-K for the fiscal year
ended December 29, 1996.
4.13 Third Amendment to Loan Agreement dated as of January 16, 4.22
1997 concerning the $75 million Real Estate Mortgage
Financing among SMC-SPE-2, Inc., and First Union National
Bank of North Carolina which is incorporated herein by
reference to the Registrant's Form 10-K for the fiscal year
ended December 29, 1996.
4.14 Amended and Restated Credit Agreement dated as of 4
September 10, 1997 among Service Merchandise
Company, Inc., Various Banks and The Chase Manhattan
Bank as Administrative and Collateral Agent and
Citibank as Documentation Agent which is incorporated
herein by reference from the Registrant's Form 10-Q for
the quarter ended September 28, 1997.
10.1 Stock Option Pledge Agreement between Service Merchandise 10.2
Company, Inc., and the Service Merchandise Foundation dated
October 15, 1990, which is incorporated herein by reference
from the Registrant's Form 10-K for the fiscal year ended
December 29, 1990.
Executive Compensation Plans and Arrangements:
10.2 Form of Indemnification Agreement between the Registrant Exhibit A
and each of Messrs. Zimmerman, Witkin, Crane, Poole, Holt,
Moore, Roitenberg, Cusano, Mulet and Septer which is
incorporated herein by reference from the Registrant's
Proxy Statement dated April 19, 1989.
10.3 Directors' Deferred Compensation Plan, which is 10.1
incorporated herein by reference from the Registrant's Form
10-K for the fiscal year ended December 29, 1990.
</TABLE>
-16-
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. in
Document Where
Brief Description Originally Filed
----------------- ----------------
<S> <C> <C>
10.4 Directors' Equity Plan which is incorporated herein by Exhibit B
reference from the Registrant's Proxy Statement dated March
16, 1992.
10.5 Key Executive Severance Plan Agreement for execution by 10
certain key executives in replacement of employment
contracts which is incorporated herein by reference from
the Registrant's Form 10-Q filed for the third quarter
ended October 2, 1994.
10.6 Employment agreement dated November 2, 1994 regarding Gary 10.1
M. Witkin which is incorporated herein by reference from
the Registrant's Form 10-K for the fiscal year ended
January 1, 1995.
10.7 Amended and Restated 1989 Employee Stock Incentive Plan 10.2
which is incorporated herein by reference from the
Registrant's Form 10-K for the fiscal year ended January 1,
1995.
(b) Reports on Form 8-K
During the fiscal year ended December 28, 1997, the Company filed one report on Form 8-K dated July 21, 1997 announcing that
the Company had signed a commitment letter with The Chase Manhattan Bank and Citicorp USA, Inc. to provide a five-year, $900
million bank facility to replace the Company's then existing bank lines.
</TABLE>
-17-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SERVICE MERCHANDISE COMPANY, INC.
By: /s/ S. Cusano
-------------
S. Cusano
Executive Vice President and
Chief Financial Officer
March 27, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
/s/ James E. Poole /s/ Gary M. Witkin
- ------------------- -------------------
James E. Poole Gary M. Witkin
Chairman of the Board President, Chief Executive Officer
March 27, 1998 and Director
(Principal Executive Officer)
March 27, 1998
<TABLE>
<S> <C> <C> <C>
/s/ Richard P. Crane, Jr. /s/ Charles V. Moore /s/ Raymond Zimmerman /s/ R. Maynard Holt
- -------------------------- -------------------- ----------------------- -------------------
Richard P. Crane, Jr. Charles V. Moore Raymond Zimmerman R. Maynard Holt
Director Director Director Director
March 27, 1998 March 27, 1998 March 27, 1998 March 27, 1998
/s/ Harold Roitenberg /s/ S. Cusano
- --------------------- -------------
Harold Roitenberg S. Cusano, Executive Vice President and Chief Financial Officer
Director (Principal Financial Officer)
March 27, 1998 (Principal Accounting Officer)
March 27, 1998
</TABLE>
-18-
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Service Merchandise Company, Inc.
Brentwood, Tennessee
We have audited the consolidated financial statements of Service Merchandise
Company, Inc. and subsidiaries as of December 28, 1997 and December 29, 1996,
and for each of the three years in the period ended December 28, 1997, and have
issued our report thereon dated February 6, 1998; such consolidated financial
statements and report are included in your 1997 Annual Report to Shareholders
and are incorporated herein by reference. Our audits also included the
consolidated financial statement schedule of Service Merchandise Company, Inc.,
listed in Item 14. This consolidated financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, such consolidated financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
/s/ Deloitte & Touche LLP
- --------------------------
DELOITTE & TOUCHE LLP
Nashville, Tennessee
February 6, 1998
-19-
<PAGE>
<TABLE>
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------
COL. A COL. B COL. C COL. D COL. E
- ------------------------------------------------------------------------------------------------------------------------------
ADDITIONS
(1) (2)
Balance Charged to Charged to Balance
at Beginning Costs and Other Accounts Deductions at End of
DESCRIPTION of Period Expenses (Describe) (Describe) (B) Period
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 28, 1997 (A) $4,593 $4,388 - ($5,525) $3,456
Year ended December 29, 1996 (A) $2,763 $2,183 - ($353) $4,593
Year ended December 31, 1995 (A) $3,217 ($207) - ($247) $2,763
(A) The amounts represent transactions for Accounts Receivable Allowance for Doubtful Accounts.
(B) The Allowance for Doubtful Accounts was reduced for accounts written-off against the reserve.
</TABLE>
- --- ------------------------------------- --------------------------------------
Restated for Electronic Purposes
Only for Filing with the SEC
- --- ------------------------------------- --------------------------------------
RESTATED CHARTER,
as Amended
1. Name: The name of the Corporation is:
SERVICE MERCHANDISE COMPANY, INC.
2. Duration: The time of existence of this Corporation is perpetual.
3. Address: The address of the principal office of the Corporation in the
state of Tennessee shall be 1600 Vaden Boulevard, City of Brentwood, County of
Williamson, 37027.
4. Profit: The Corporation is for profit.
5. Purposes: The purposes for which this Corporation is organized are:
(a) To buy, sell, trade, manufacture, and/or deal in or with, goods, wares,
and merchandise, of every kind and description, and to carry on such business as
wholesalers, retailers, importers, and exporters; to acquire and dispose of all
such merchandise, supplies, materials, and other articles, as may be necessary
for, or incident to, the carrying on of such business.
(b) To acquire by purchase, lease, gift, or otherwise, and to own, hold,
operate, and develop, and otherwise to invest in real and/or personal property
of every kind and description, or interests therein, such properties to be held
for investment purposes, and the Corporation shall not have the right to
generally trade in properties. Without limiting the generality of the foregoing,
the Corporation shall expressly have the right to acquire lands, and to erect or
construct thereon, improvements of all kinds, and to rent or lease said
properties for investment.
To promote, cause to be organized, finance, and aid by loan, subsidy,
guaranty, contribution to capital or surplus, or otherwise, any corporation,
association, partnership, syndicate, entity, person or governmental, municipal
or public authority, domestic or foreign, located in or organized under the laws
of any authority in any part of the world, any security of which is held
directly or indirectly by or for the Corporation, or in the business, financing,
or welfare of which the Corporation shall have any interest; and, in connection
therewith, to guarantee, or become security for the performance of, any
undertaking or obligation of the foregoing, and to guarantee, by endorsement or
otherwise, the payment of the security of the foregoing; and generally to do any
acts or things designed to protect, preserve, improve, or enhance, the value of
any such security.
<PAGE>
6. Shares: The total number of shares of stock which the Corporation shall
have authority to issue is 505,000,000, of which 500,000,000 shares with a par
value of $.50 per share shall be common stock and of which 5,000,000 shares,
with a par value of $1.00 per share shall be preferred stock.
The Board of Directors of the Corporation is authorized, subject to
limitations prescribed by law and the provisions of this Article, to provide for
the issuance from time to time in one or more series of any number of the
preferred shares, and, by filing a certificate pursuant to the Tennessee General
Corporation Act, to establish the number of shares to be included in each such
series, and to fix the designation, relative rights, preferences, qualifications
and limitations of the shares of each such series. The authority of the Board of
Directors with respect to each series shall include, but not be limited to,
determination of the following:
(a) The number of shares constituting that series and the distinctive
designation of that series;
(b) The divided rate on the shares of that series, whether dividends shall
be cumulative, and, if so, from which date or dates, and whether they shall be
payable in preference to, or in another relation to, the dividends payable on
any other class or classes or series of stock;
(c) Whether that series shall have voting rights, in addition to the voting
rights provided by law, and, if so, the terms of such voting rights;
(d) Whether that series shall have conversion or exchange privileges, and,
if so, the terms and conditions of such conversion or exchange, including
provision for adjustment of the conversion or exchange rate in such events as
the Board of Directors shall determine;
(e) Whether or not the shares of that series shall be redeemable, and, if
so, the terms and conditions of such redemption, including the manner of
electing shares for redemption if less than all shares are to be redeemed, the
date or dates upon or after which they shall be redeemable, and the amount per
share payable in case of redemption, which amount may vary under different
conditions and at different redemption dates;
(f) Whether that series shall be entitled to the benefit of a sinking fund
to be applied to the purchase or redemption of shares of that series, and, if
so, the terms and amounts of such sinking fund;
(g) The right of the shares of that series in the event of voluntary or
involuntary liquidation, dissolution or winding up of the Corporation and
whether such rights shall be in preference to, or in another relation to, the
comparable rights of any other class or classes or series of stock; and
(h) Any other relative, participating, optional or other special rights,
qualifications, limitations or restriction of that series.
2
<PAGE>
Shares of any series of preferred stock which have been redeemed (whether
through the operation of a sinking fund or otherwise) or which, if convertible
or exchangeable, have been converted into or exchanged for shares of stock of
any other class or classes shall have the status of authorized and unissued
shares of preferred stock of the same series and may be reissued as a part of
the series of which they were originally a part or may be reclassified and
reissued as part of a new series of preferred stock to be created by resolution
or resolutions of the Board of Directors or as part of any other series of
preferred stock, all subject to the conditions and the restrictions on issuance
set forth in the resolution or resolutions adopted by the Board of Directors
providing for the issue of any series of preferred stock.
Subject to the provisions of any applicable law, or except as otherwise
provided by the resolution or resolutions providing for the issue of any series
of preferred stock, the holders of outstanding shares of common stock shall
exclusively possess voting power for the election of directors and for all other
purposes, each holder of record of shares of common stock being entitled to one
vote for each share of common stock standing in his name on the books of the
Corporation.
Except as otherwise provided by the resolution or resolutions providing for
the issue of any series of preferred stock, after payment shall have been made
to the holders of preferred stock of the full amount of dividends to which they
shall be entitled pursuant to the resolution or resolutions providing for the
issue of any series of preferred stock, the holders of common stock shall be
entitled, to the exclusion of the holders of preferred stock of any and all
series, to receive such dividends as from time to time may be declared by the
Board of Directors.
Except as otherwise provided by the resolution or resolutions providing for
the issue of any series of preferred stock in the event of any liquidation,
dissolution or winding up of the Corporation, whether voluntary or involuntary,
after payment shall have been made to the holders of preferred stock of the full
amount to which they shall be entitled pursuant to the resolution or resolutions
providing for the issue of any series of preferred stock, the holders of common
stock shall be entitled, to the exclusion of the holders of preferred stock of
any and all series, to share, ratably according to the number of shares of
common stock held by them, in all remaining assets of the Corporation available
for distribution to its stockholders.
Pursuant to the authority vested in the Board of Directors in accordance
with the provisions of this Article 6 of the Charter, the Board of Directors
does hereby create, authorize and provide for the issuance of the Series A
Junior Preferred Stock out of the class of 5,000,000 shares of preferred stock,
par value $1.00 per share (the "Preferred Stock"), having the voting powers,
designation, relative, participating, optional and other special rights,
preferences, and qualifications, limitations and restrictions thereof that are
set forth as follows:
Section 1. Designation and Amount. The shares of such series shall be
designated as Series A Junior Preferred Stock ("Series A Preferred Stock") and
the number of shares constituting such series shall be 1,100,000. Such number of
shares may be adjusted by appropriate action of the Board of Directors.
3
<PAGE>
Section 2. Dividends and Distributions. (A) Subject to the prior and
superior rights of the holders of any shares of any other series of Preferred
Stock or any other shares of preferred stock of the Corporation ranking prior
and superior to the shares of Series A Preferred Stock with respect to
dividends, each holder of one one-hundredth (1/100) of a share (a "Unit") of
Series A Preferred Stock shall be entitled to receive, when, as and if declared
by the Board of Directors out of funds legally available for that purpose, (i)
quarterly dividends payable in cash on the 30th day of March, June, September
and December in each year (each such date being a "Quarterly Dividend Payment
Date"), commencing on the first Quarterly Dividend Payment Date after the first
issuance of such Unit of Series A Preferred Stock, in an amount per Unit
(rounded to the nearest cent) equal to the greater of (a) $.02 or (b) subject to
the provision for adjustment hereinafter set forth, the aggregate per share
amount of all cash dividends declared on shares of the common stock of the
Corporation, par value $.50 per share (the "Common Stock") since the immediately
preceding Quarterly Dividend Payment Date, or, with respect to the first
Quarterly Dividend Payment Date, since the first issuance of a Unit of Series A
Preferred Stock, and (ii) subject to the provision for adjustment hereinafter
set forth, quarterly distributions (payable in kind) on each Quarterly Dividend
Payment Date in an amount per Unit equal to the aggregate per share amount of
all non-cash dividends or other distributions (other than a dividend payable in
shares of Common Stock or a subdivision of the outstanding shares of Common
Stock, by reclassification or otherwise) declared on shares of Common Stock
since the immediately preceding Quarterly Dividend Payment Date, or with respect
to the first Quarterly Dividend Payment Date, since the first issuance of a Unit
of Series A Preferred Stock. In the event that the Corporation shall at any time
after February 3, 1998 (the "Rights Declaration Date") (i) declare or pay any
dividend on outstanding shares of Common Stock payable in shares of Common
Stock, or (ii) subdivide outstanding shares of Common Stock or (iii) combine
outstanding shares of Common Stock into a smaller number of shares, then in each
such case the amount to which the holder of a Unit of Series A Preferred Stock
was entitled immediately prior to such event pursuant to the preceding sentence
shall be adjusted by multiplying such amount by a fraction the numerator of
which shall be the number of shares of Common Stock that are outstanding
immediately after such event and the denominator of which shall be the number of
shares of Common Stock that were outstanding immediately prior to such event.
(B) The Corporation shall declare a dividend or distribution on Units of
Series A Preferred Stock as provided in paragraph (A) above immediately after it
declares a dividend or distribution on the shares of Common Stock (other than a
dividend payable in shares of Common Stock); provided, however, that, in the
event no dividend or distribution shall have been declared on the Common Stock
during the period between any Quarterly Dividend Payment Date and the next
subsequent Quarterly Dividend Payment Date, a dividend of $.02 per Unit on the
Series A Preferred Stock shall nevertheless be payable on such subsequent
Quarterly Dividend Payment Date.
(C) Dividends shall begin to accrue and shall be cumulative on each
outstanding Unit of Series A Preferred Stock from the Quarterly Dividend Payment
Date next preceding the date of issuance of such Unit of Series A Preferred
Stock, unless the date of issuance of such Unit is prior to the record date for
the first Quarterly Dividend Payment Date, in which case, dividends on such Unit
shall begin to accrue from the date of issuance of such Unit, or unless the date
of issuance is a Quarterly Dividend Payment Date or is a date after the record
date for the determination of holders of Units of Series A Preferred Stock
entitled to receive a quarterly dividend and before such
4
<PAGE>
Quarterly Dividend Payment Date, in either of which events such dividends shall
begin to accrue and be cumulative from such Quarterly Dividend Payment Date.
Accrued but unpaid dividends shall not bear interest. Dividends paid on Units of
Series A Preferred Stock in an amount less than the aggregate amount of all such
dividends at the time accrued and payable on such Units shall be allocated pro
rata on a unit-by-unit basis among all Units of Series A Preferred Stock at the
time outstanding. The Board of Directors may fix a record date for the
determination of holders of Units of Series A Preferred Stock entitled to
receive payment of a dividend or distribution declared thereon, which record
date shall be no more than 30 days prior to the date fixed for the payment
thereof.
Section 3. Voting Rights. The holders of Units of Series A Preferred Stock
shall have the following voting rights.
(A) Subject to the provision for adjustment hereinafter set forth, each
Unit of Series A Preferred Stock shall entitle the holder thereof to one vote on
all matters submitted to a vote of the shareholders of the Corporation. In the
event the Corporation shall at any time after the Rights Declaration Date (i)
declare any dividend on outstanding shares of Common Stock payable in shares of
Common Stock, (ii) subdivide outstanding shares of Common Stock or (iii) combine
the outstanding shares of Common Stock into a smaller number of shares, then in
each such case the number of votes per Unit to which holders of Units of Series
A Preferred Stock were entitled immediately prior to such event shall be
adjusted by multiplying such number by a fraction the numerator of which shall
be the number of shares of Common Stock outstanding immediately prior to such
event and the denominator of which shall be the number of shares of Common Stock
that were outstanding immediately prior to such event.
(B) Except as otherwise provided herein or by law, the holders of Units of
Series A Preferred stock and the holders of shares of Common Stock shall vote
together as one class on all matters submitted to a vote of shareholders of the
Corporation.
(C) (i) If at any time dividends on any Units of Series A Preferred Stock
shall be in arrears in an amount equal to six quarterly dividends thereon, then
during the period (a "default period") from the occurrence of such event until
such time as all accrued and unpaid dividends for all previous quarterly
dividend periods and for the current quarterly dividend period on all Units of
Series A Preferred Stock then outstanding shall have been declared and paid or
set apart for payment, all holders of Units of Series A Preferred Stock, voting
separately as a class, shall have the right, at the next meeting of shareholders
called for the election of directors (the "Next Meeting"), to elect two
directors (the "New Directors" or individually, "New Director"), which directors
shall be in addition to the number previously set by the Board of Directors
pursuant to Article 9 of the Charter. One of the New Directors shall serve as a
member of the class of directors being elected for a three-year term and the
other New Director shall serve as a member of the class of directors whose
remaining term at the Next Meeting is two years and until their successors are
elected by such holders and qualified or their earlier resignation, removal or
incapacity or until such earlier time as all accrued and unpaid dividends upon
the outstanding Units of Series A Preferred Stock shall have been paid (or set
aside for payment) in full. The New Directors may be removed and replaced by
such holders, and vacancies in such directorships may be filled only by such
holders (or the
5
<PAGE>
remaining director elected by such holders if there be one) in the manner
permitted by law. After the holders of Units of Series A Preferred Stock have
exercised their right to elect directors during any default period, the number
of directors shall not be increased or decreased except as approved by a vote of
the holders of Units of Series A Preferred Stock as herein provided or pursuant
to the rights of any equity securities ranking senior to the Series A Preferred
Stock.
(ii) Immediately upon the expiration of a default period (x) the right of
holders of Units of Series A Preferred Stock as a separate class to elect
directors shall cease, (y) the term of any directors elected by the holders of
Units of Series A Preferred Stock as a separate class shall terminate, and (z)
the number of directors shall be such number as may be provided for prior to any
increase made pursuant to the provisions of paragraph (C)(i) of this Section 3
(such number being subject, however, to change thereafter in any manner provided
by law or in the Charter or Bylaws). Any vacancies in the Board of Directors
effected by the provisions of clauses (y) and (z) in the preceding sentence may
be filled by a majority of the remaining directors.
(iii) The provisions of this paragraph (C) shall govern the election of
directors by holders of Units of Series A Preferred Stock during any default
period notwithstanding any provisions of the Charter to the contrary, including,
without limitation, the provisions of Article 9 of the Charter.
(D) Except as set forth herein or required by law, holders of Units of
Series A Preferred Stock shall have no special voting rights and their consent
shall not be required (except to the extent they are entitled to vote with
holders of shares of Common Stock as set forth herein) for the taking of any
corporate action.
Section 4. Certain Restrictions. (A) Whenever quarterly dividends or other
dividends or distributions payable on Units of Series A Preferred Stock as
provided in Section 2 are in arrears, thereafter and until all accrued and
unpaid dividends and distributions, whether or not declared, on outstanding
Units of Series A Preferred Stock shall have been paid (or set aside for
payment) in full, the Corporation shall not:
(i) declare or pay dividends on, make any other distributions on, or redeem
or purchase or otherwise acquire for consideration any shares of stock ranking
junior to the Series A Preferred Stock;
(ii) declare or pay dividends on or make any other distributions on any
shares of stock ranking on a parity as to dividends with the Series A Preferred
Stock, except for dividends paid ratably on Units of Series A Preferred Stock
and shares of all such parity stock on which dividends are payable or in arrears
in proportion to the total amounts to which the holders of such Units and all
such shares are then entitled;
(iii) redeem or purchase or otherwise acquire for consideration shares of
any stock ranking on a parity (either as to dividends or upon liquidation,
dissolution or winding up) with the Series A Preferred Stock, provided, however,
that the Corporation may at any time redeem, purchase or otherwise acquire
shares of any such parity stock in exchange for shares of any stock ranking
6
<PAGE>
junior (both as to dividends and upon liquidation, dissolution or winding up) to
the Series A Preferred Stock; or
(iv) purchase or otherwise acquire for consideration any Units of Series A
Preferred Stock, except in accordance with a purchase offer made in writing or
by publication (as determined by the Board of Directors) to all holders of such
Units.
(B) The Corporation shall not permit any subsidiary of the Corporation to
purchase or otherwise acquire for consideration any shares of stock of the
Corporation unless the Corporation could, under paragraph (A) of this Section 4,
purchase or otherwise acquire such shares at such time and in such manner.
Section 5. Reacquired Shares. Any Units of Series A Preferred Stock
purchased or otherwise acquired by the Corporation in any manner whatsoever
shall be retired and cancelled promptly after the acquisition thereof. All such
Units shall, upon their cancellation, become authorized but unissued Units of
Preferred Stock to be created by resolution or resolutions of the Board of
Directors, subject to the conditions and restrictions on issuance set forth
herein.
Section 6. Liquidation, Dissolution or Winding Up. (A) Upon any voluntary
or involuntary liquidation, dissolution or winding up of the Corporation, no
distribution shall be made (i) to the holders of shares of stock ranking junior
(either as to dividends or upon liquidation, dissolution or winding up) to the
Series A Preferred Stock unless the holders of Units of Series A Preferred Stock
shall have received, subject to adjustment as hereinafter provided in paragraph
(B), the greater of either (a) $.01 per Unit plus an amount equal to accrued and
unpaid dividends and distributions thereon, whether or not earned or declared,
to the date of such payment, or (b) the amount equal to the aggregate per share
amount to be distributed to holders of shares of Common Stock, or (ii) to the
holders of shares of stock ranking on a parity upon liquidation, dissolution or
winding up with the Series A Preferred Stock, unless simultaneously therewith
distributions are made ratably on Units of Series A Preferred Stock and all
other shares of such parity stock in proportion to the total amounts to which
the holders of Units of Series A Preferred Stock are entitled under clause
(i)(a) of this sentence and to which the holders of shares of such parity stock
are entitled, in each case upon such liquidation, dissolution or winding up.
(B) In the event the Corporation shall at any time after the Rights
Declaration Date (i) declare any dividend on outstanding shares of Common Stock
payable in shares of Common Stock, or (ii) subdivide outstanding shares of
Common Stock, or (iii) combine outstanding shares of Common Stock into a smaller
number of shares, then in each such case the aggregate amount to which holders
of Units of Series A Preferred Stock were entitled immediately prior to such
event pursuant to clause (i)(b) of paragraph (A) of this Section 6 shall be
adjusted by multiplying such amount by a fraction the numerator of which shall
be the number of shares of Common Stock that are outstanding immediately after
such event and the denominator of which shall be the number of shares of Common
Stock that were outstanding immediately prior to such event.
Section 7. Share Exchange, Merger, Etc. In case the Corporation shall enter
into any share exchange, merger, combination or other transaction in which the
shares of Common Stock are
7
<PAGE>
exchanged for or converted into other stock or securities, cash and/or any other
property, then in any such case Units of Series A Preferred Stock shall at the
same time be similarly exchanged for or converted into an amount per Unit
(subject to the provision for adjustment hereinafter set forth) equal to the
aggregate amount of stock, securities, cash and/or any other property (payable
in kind), as the case may be, into which or for which each share of Common Stock
is converted or exchanged. In the event the Corporation shall at any time after
the Rights Declaration Date (i) declare any dividend on outstanding shares of
Common Stock payable in shares of Common Stock, or (ii) subdivide outstanding
shares of Common Stock, or (iii) combine outstanding Common Stock into a smaller
number of shares, then in each such case the amount set forth in the immediately
preceding sentence with respect to the exchange or conversion of shares of
Series A Preferred Stock shall be adjusted by multiplying such amount by a
fraction the numerator of which shall be the number of shares of Common Stock
that are outstanding immediately after such event and the denominator of which
shall be the number of shares of Common Stock that were outstanding immediately
prior to such event.
Section 8. Redemption. The Units of Series A Preferred Stock shall not be
redeemable at the option of the Corporation or any holder thereof.
Notwithstanding the foregoing sentence of this Section, the Corporation may
acquire Units of Series A Preferred Stock in any other manner permitted by law
and the Charter or Bylaws of the Corporation.
Section 9. Ranking. The Units of Series A Preferred Stock shall rank junior
to all other series of the Preferred Stock and to any other class of preferred
stock that hereafter may be issued by the Corporation as to the payment of
dividends and the distribution of assets, unless the terms of any such series or
class shall provide otherwise.
Section 10. Amendment. The Charter, including without limitation the
provisions hereof, shall not hereafter be amended, either directly or
indirectly, or through merger or share exchange with another corporation, in any
manner that would alter or change the powers, preferences or special rights of
the Series A Preferred Stock so as to affect the holders thereof adversely
without the affirmative vote of the holders of a majority or more of the
outstanding Units of Series A Preferred Stock, voting separately as a class.
Section 11. Fractional Shares. The Series A Preferred Stock may be issued
in Units or other fractions of a share, which Units or fractions shall entitle
the holder, in proportion to such holder's fractional shares, to exercise voting
rights, receive dividends, participate in distributions and to have the benefit
of all other rights of holders of Series A Preferred Stock.
7. Minimum Capital: The Corporation shall not commence business until the
consideration of One Thousand ($1,000.00) Dollars has been received for the
issuance of shares.
8. Other Provisions:
(a) In lieu of a formal meeting, the stockholders or record holding all of
the then issued and outstanding capital stock may, at any time, take any action
otherwise permitted by law to be taken by stockholders, by an instrument in
writing, and such instrument, when executed by the
8
<PAGE>
holders of record of all of the then issued and outstanding capital stock, shall
be as valid and effective as any action taken at a general or special meeting of
the stockholders.
(b) When so authorized by the Bylaws, any resolution in writing, adopted by
all of the then qualified and acting directors, provided there be at least three
in number, shall be as valid and effective as any resolution duly adopted at a
general or special meeting of directors.
(c) The Bylaws of the Corporation may include a prohibition against the
sale or transfer of shares of the Corporation's capital stock without the same
being first offered to the Corporation and/or the other shareholders at a price
not in excess of book value, or at a price to be determined by an appraiser or
appraisers to be selected by the offering shareholder and the Corporation and/or
the other shareholders; provided, however, each certificate for shares of the
capital stock shall plainly bear on its face an appropriate reference to the
said bylaw.
(d) Any contract of employment entered into by and between the Corporation
and any person shall be subject to termination by the Corporation at any time,
upon notice to such employee, either written or parol, such termination of
employment to be effective not earlier than one day from the date of such notice
to such employee, unless the contract of employment for a stated period be
executed in writing by the President or any Vice President of the company, and
the Secretary or any Assistant Secretary, and approved by a majority vote of the
directors at a regular or special called meeting, or by a written resolution
executed by all directors.
(e) The Corporation shall have and enjoy all other rights and privileges,
not inconsistent with the foregoing, as set out in Title 48, Section 101 to 1407
inclusive, of Tennessee Code Annotated.
(f) No share or shares of capital stock shall be entitled to any
pre-emptive right or rights nor shall any of said shares be entitled to
cumulative voting.
(g) The Bylaws of this Corporation may be amended, altered, modified or
repealed by resolution adopted by the Board of Directors subject to any
provisions of law then applicable.
9. The business and affairs of the Corporation shall be managed by or under
the direction of a Board of Directors consisting of not less than three nor more
than twelve directors, the exact number of directors to be determined from time
to time by resolution adopted by affirmative vote of a majority of the entire
Board of Directors. The directors shall be divided into three classes,
designated Class I, Class II and Class III. Each class shall consist, as nearly
as may be possible, of one-third of the total number of directors constituting
the entire Board of Directors. At the 1983 annual meeting of stockholders, Class
I directors shall be elected for a one-year term, Class II directors for a
two-year term and Class III directors for a three-year term. At each succeeding
annual meeting of stockholders beginning in 1984, successors to the class of
directors whose term expires at that annual meeting shall be elected for a
three-year term. If the number of directors is changed, any increase or decrease
shall be apportioned among the classes so as to maintain the number of directors
in each class as nearly equal as possible, and any additional director of any
class elected
9
<PAGE>
to fill a vacancy resulting from an increase in such class shall hold office for
a term that shall coincide with the remaining term of that class, but in no case
will a decrease in the number of directors shorten the term of any incumbent
director. A director shall hold office until the annual meeting for the year in
which his term expires and until his successor shall be elected and shall
qualify, subject, however, to prior death, resignation, retirement,
disqualification or removal from office. Any vacancy on the Board of Directors
that results from an increase in the number of directors may be filled by a
majority of the Board of Directors then in office, and any other vacancy
occurring in the Board of Directors may be filled by a majority of the directors
then in office, although less than a quorum, or by a sole remaining director.
Any director elected to fill a vacancy not resulting from an increase in the
number of directors shall have the same remaining term as that of his
predecessor.
Any director may be removed from office but only for cause by the
affirmative vote of the holders of a majority of the voting power of the shares
entitled to vote for the election of directors, considered for this purpose as
one class.
Notwithstanding the foregoing, whenever the holders of any one or more
classes or series of preferred stock issued by the Corporation shall have the
right, voting separately by class or series, to elect directors at an annual or
special meeting of stockholders, the election, term of office, filling of
vacancies and other features of such directorships shall be governed by the
terms of this Charter applicable thereto, and such directors so elected shall
not be divided into classes pursuant to this Article 9 unless expressly provided
by such terms. In the event of a vacancy among the directors so elected by the
holders of preferred stock, the remaining preferred directors may fill the
vacancy for the unexpired term.
Notwithstanding any other provisions of this Charter, the affirmative vote
of holders of two-thirds of the voting power of the shares entitled to vote at
an election of directors shall be required to amend, alter, change or repeal, or
to adopt any provision as part of this Charter or as part of the Corporation's
Bylaws inconsistent with the purpose and intent of, this Article 9.
10. To the fullest extent permitted by the Tennessee Business Corporation
Act as the same may be amended from time to time, a director of the Company
shall not be liable to the Company or its shareholders for monetary damages for
breach of fiduciary duty as a director. If the Tennessee Business Corporation
Act is amended after approval by the shareholders of this provision to authorize
corporate action further eliminating or limiting the personal liability of
directors, the liability of a director of the Company shall be eliminated or
limited to the fullest extent permitted by the Tennessee Business Corporation
Act, as so amended from time to time. Any repeal or modification of this
paragraph 10 shall not adversely affect any right or protection of a director of
the Company existing at the time of such repeal or modification or with respect
to events occurring prior to such time.
10
EXECUTION COPY
Service Merchandise Company, Inc.
7100 Service Merchandise Drive
Brentwood, Tennessee 37027
NOTE ISSUANCE AGREEMENT
Secured Extension Notes
Due March 1, 2002
September 30, 1997
To The Secured Noteholder Identified On The Signature Page Hereof:
Dear Sirs:
Service Merchandise Company, Inc., a Tennessee corporation (the "Company"),
and H.J. Wilson Co., Inc., its subsidiary (the "Guarantor"), hereby agree with
you as follows. All capitalized terms used but not defined herein shall have the
meanings specified in the Indenture referred to in Section 1 hereof.
SECTION 1. Authorization of Issue.
The Company will authorize and issue its Secured Extension Notes Due March
1, 2002 (individually, a "Secured Note" and collectively, the "Secured Notes"),
in a maximum aggregate principal amount of $50,000,000.00, substantially in the
form set forth in Exhibit A hereto; provided, however, that at no time shall the
Outstanding Secured Notes plus the Outstanding First Mortgage Secured Notes due
June 28, 2000 (the "Existing Notes") exceed (x) the Maximum Amount less (y) the
principal amount of Existing Notes which have been redeemed (other than by
issuance of Secured Notes) in accordance with Article Twelve of the Indenture.
The Secured Notes will be issued under and pursuant to a Trust Indenture (as
heretofore amended and supplemented, including as supplemented by the Eleventh
Supplemental Indenture, dated as of the date hereof, the "Indenture"), by and
between the Company, the Guarantor, The Long-Term Credit Bank of Japan, Limited,
New York Branch, as administrative agent, and The Bank of New York (as successor
to NationsBank of Tennessee, N.A., as successor to Sovran Bank/Central South),
as trustee (the "Trustee").
SECTION 2. Issuance of Secured Notes.
Subject to the terms and conditions herein set forth, on each of the dates
set forth below (or such later date as may be agreed to by you and the Company)
(each referred to as an "Issuance Date"), the Company may, at its option, issue
to you, and if the Company so elects, you agree to accept from the Company, the
Secured Notes as an extension and renewal, in lieu of cash redemption pursuant
to the Indenture, of an equal principal amount of the Existing Notes, up to the
principal amounts specified below:
<PAGE>
June 29, 1998 $16,666,666
June 28, 1999 $16,666,667
June 28, 2000 $16,666,667
SECTION 3. Form and Terms of Secured Notes: Mortgaged Parcels.
(a) The Secured Notes will be (i) issued in minimum denominations of
$1,000,000, will be dated the respective Issuance Date, and will mature, bear
interest, be payable and otherwise have such terms as are provided in the
Indenture; (ii) recourse to the Company; (iii) secured by the mortgages
(collectively the "Company Mortgage") delivered pursuant to the Indenture and
the Note Purchase Agreement, dated June 28, 1990 (the "Original Note Purchase
Agreement"), from the Company to or for the benefit of the Trustee, mortgaging
and conveying in trust the Company's fee simple interest or leasehold interest,
as the case may be, in the properties listed on Exhibit B hereto, as security
for the Existing Notes and the Secured Notes, except to the extent any such
properties may be hereafter released from the Mortgage in accordance with the
Indenture; (iv) guaranteed by the Guarantor by a Guaranty delivered pursuant to
the Original Note Purchase Agreement, and as affirmed in accordance with this
Agreement pursuant to the affirmation substantially in the form set forth as
Exhibit C hereto (collectively, the "Guaranty"); and (v) secured by Collateral
Assignments of Leases and Rents delivered pursuant to the Original Note Purchase
Agreement by the Company and the Guarantor to or for the benefit of the Trustee,
assigning in trust the leases and rents relating to the Mortgaged Parcels, and
as affirmed pursuant to the affirmation substantially in the form set forth as
Exhibit D hereto (collectively, the "Assignment of Leases and Rents"). The
Guaranty is secured by the mortgages delivered by the Guarantor pursuant to the
Indenture and the Original Note Purchase Agreement (collectively the "Guaranty
Mortgage"; the Company Mortgage and the Guaranty Mortgage, being collectively
referred to as the "Mortgage") which encumber the Guarantor's fee simple or
leasehold interest, as the case may be, in the properties listed on Exhibit E
hereto, except to the extent any such properties may be hereafter released from
the Mortgage in accordance with the Indenture.
(b) The properties so mortgaged from time to time pursuant to the Mortgage,
the Indenture and this Agreement are referred to hereinafter as the "Mortgaged
Parcels." Recourse under the Guaranty shall be limited to the Mortgaged Parcels
mortgaged by the Guarantor. The Company and the Guarantor hereby agree that on
June 28, 2000, or such earlier date on which the Existing Notes are paid in full
or redeemed in full, all as more fully set forth in the Indenture, to the extent
that the aggregate appraised value of the Mortgaged Parcels on such date is less
than $75,000,000, the Company and the Guarantor shall either (i) grant to the
Trustee pursuant to the Indenture by executing and delivering Mortgages on
additional properties such that the aggregate appraised value of all Mortgaged
Parcels on such date equals or exceeds $75,000,000, or (ii) shall redeem a
principal amount of Secured Notes such that the ratio of Outstanding Secured
Notes to the aggregate appraised value of all Mortgaged Parcels is not more than
66.67%.
<PAGE>
SECTION 4. Issuance Dates; Delivery; Fees.
(a) Subject to the terms and conditions herein set forth, on each Issuance
Date, the Company shall issue to you Secured Notes in a principal amount equal
to the principal amount of the Existing Notes then held by you which would
otherwise be redeemed for cash on such Issuance Date pursuant to the Indenture,
and the Secured Notes so issued shall be deemed to be an extension and renewal
of such Existing Notes. On such Issuance Date, the Company shall also pay to you
all accrued and unpaid interest on the principal amount of the Existing Notes to
be extended and renewed.
(b) Delivery of the Secured Notes shall be made on each Issuance Date,
subject to the terms and conditions of this Agreement, at 10:00 a.m. New York
City time at your offices at 165 Broadway, New York, New York 10006 (or at such
other place in New York City as may be mutually acceptable) in exchange for the
delivery by you of Existing Notes in a principal amount equal to the Secured
Notes to be issued on such date in accordance with Section 2 hereof, which
exchange you hereby agree to make subject to the satisfaction of the conditions
set forth in Sections 5 and 6 of this Agreement. The Secured Notes will be
issued to you, payable to your order or the order of one or more of your
nominees.
(c) In consideration of your agreements herein, the Company shall pay to
you, in immediately available funds, the following fees: (i) $50,000, which was
paid prior to the date hereof, simultaneous with the execution by the Company
and you of a letter of intent with respect to the transactions contemplated
hereby; (ii) $350,000 on the date of execution and delivery of this Agreement;
(iii) $260,000 on the earlier of June 29, 1998 or the date of any prepayment in
full of the Existing Notes or the cancellation or prepayment of any Secured
Note; and (iv) $260,000 on the earlier of June 28, 1999 or the date of any
prepayment in full of the Existing Notes or the cancellation or prepayment of
any Secured Note; provided, however, that if (x) the Company has satisfied all
conditions precedent set forth herein and in the Indenture other than conditions
precedent to be satisfied by you; (y) the Company has not prepaid in full the
Existing Notes and has not cancelled or prepaid any Secured Note; and (z) the
Company is willing to issue the Secured Notes on such Issuance Date, then the
Company shall be obligated to pay the fees in (iii) and (iv) only upon your
acceptance of the Secured Notes as a renewal and extension of the Existing Notes
on such Issuance Date. All fees paid hereunder shall be nonrefundable under all
circumstances; provided, however, that the $350,000 fee described in (ii) above
shall be refundable if the transactions contemplated hereby are not consummated
solely by reason of your failure to perform on the Closing Date (as hereinafter
defined) your obligations under this Agreement other than as a result of the
Company's or the Trustee's failure to perform its respective obligations under
this Agreement or the Indenture.
SECTION 5. Conditions of Closing.
This Agreement and the other instruments and agreements contemplated hereby
shall be effective as of the date hereof (the "Effective Date") (except that
each Secured Note shall be dated its respective Issuance Date). The Company
hereby acknowledges and agrees, however, that your obligations to accept the
Secured Notes as an extension and renewal of the Existing Notes now held by you
shall be subject to the satisfaction by November 15, 1997 of the
<PAGE>
conditions precedent set forth below and the date on which such conditions are
satisfied shall be the "Closing Date":
5.1 General. (a) the representations and warranties of the Company and the
Guarantor contained herein, in the Mortgage and in the Indenture and with
respect to the Guarantor only, in the Guaranty, shall be accurate and correct in
all material respects on the Effective Date, and on and as of the Closing Date,
except to the extent such representations and warranties relate to a specific
earlier date in which case such representations and warranties shall be true and
correct in all material respects as of such earlier date; (b) the Company and
the Guarantor shall have performed all of their agreements contained herein to
be performed on or prior to the Closing Date, and no default or Event of Default
under the Indenture, the Mortgage or the Guaranty shall have occurred and be
continuing; and (c) the Company and the Guarantor shall have delivered to you an
Officers' Certificate dated the Closing Date, certifying that the conditions
specified in paragraphs (a) and (b) above have been fulfilled:
5.2 Execution of Documents. The following agreements, instruments and
documents shall be executed and delivered:
(a) the Eleventh Supplemental Indenture;
(b) the Reaffirmation of the Subsidiary Guaranty, substantially in the form
of Exhibit C hereto;
(c) the Confirmation of the Collateral Assignment of Leases and Rents,
substantially in the form of Exhibit D hereto;
(d) the Confirmation of the Security Agreement, substantially in the form
of Exhibit H hereto;
(e) the Affirmation of the Intercreditor Agreement, substantially in the
form of Exhibit I hereto;
(f) such confirmations, supplements or amendments to the Mortgage which may
be required by the appropriate title company or by local counsel in Florida,
Ohio, Illinois and Tennessee or as reasonably required by you and are reasonably
acceptable to you, which confirms that the Secured Notes are secured by the
Mortgage on the Mortgaged Parcels, to the extent provided in the Indenture, all
such filings of such confirmations, supplements or amendments shall have been
made and all taxes and recording fees paid with respect thereto; and
(g) such UCC financing statements or amendments to UCC financing statements
as may reasonably be required by you to assure that the Secured Notes are
secured by the Security Agreement and the Collateral Assignment of Leases and
Rents to the extent provided in the Indenture.
5.3 Opinion of Counsel for the Company. You shall have received opinions,
in form and substance satisfactory to you and your counsel, dated the Closing
Date, from: (a) Skadden, Arps, Slate, Meagher & Flom, LLP, special New York
counsel for the Company and the
<PAGE>
Guarantor; (b) Bass, Berry & Sims PLC, special Tennessee counsel for the Company
and the Guarantor; (c) C. Steven Moore, Managing Attorney for the Company; (d)
Skadden, Arps, Slate, Meagher & Flom (Illinois), special Illinois counsel for
the Company and the Guarantor and (e) local counsel in Florida and Ohio, and
which shall include, without limitation, opinions that (x) the Secured Notes are
secured by the Mortgage and other appropriate instruments, to the same extent
that the Existing Notes are so secured, with respect to the Mortgaged Parcels
located in Tennessee, Illinois, Florida and Ohio, (y) the enforceability against
the Company and the Guarantor of this Agreement, the Eleventh Supplemental
Indenture, the Secured Notes (when issued), the Guaranty, and the other
agreements, documents and interests contemplated hereby; and (z) the execution
and delivery of this Agreement, the Eleventh Supplemental Indenture, the Secured
Notes and the Guaranty, the issuance of the Secured Notes and the consummation
of the transactions contemplated hereby and thereby will not conflict with,
contravene or cause a default under the Indenture, the Chemical Credit Agreement
or any other material agreement or instrument to which the Company or the
Guarantor is a party or by which it is bound.
5.4 Mortgaged Parcels. The Company and the Guarantor shall have delivered
to you independent appraisals or other independent information reasonably
satisfactory to you, the Mortgaged Parcels located in Tennessee, Illinois,
Florida and Ohio constitute the greater of (i) more than 50% of the then
aggregate appraised value of all Mortgaged Parcels, or (ii) more than 50% of the
total number of stores securing the Existing Notes and the Secured Notes.
5.5 Status of Title. You shall have received endorsements, dated the
Closing Date, to one or more mortgagee policies of title insurance heretofore
issued to the Trustee with respect to the Mortgaged Parcels, insuring the
Trustee on your behalf against loss in an amount not less than the aggregate
principal amount of the Outstanding Existing Notes and Secured Notes less the
amount of any Letter of Credit then held by the Trustee, or such other
confirmation as you may reasonably require from the issuers of such title
insurance that such policies insure the Secured Notes and that the issuance of
the Secured Notes and the consummation of the transactions contemplated hereby
and by the Eleventh Supplemental Indenture will not adversely affect the
existing title insurance policies on the Mortgaged Parcels.
5.6 Financial Information. The Company shall have furnished a solvency
certificates of the chief financial officers of the Company in form attached as
Exhibit F.
5.7 U.C.C. Searches. U.C.C. filing searches shall be furnished to the
Trustee and you evidencing that the fixtures encumbered by the Mortgage are free
from any liens and encumbrances other than the Permitted Encumbrances.
5.8 Certificates of the Company. You and your counsel shall have received a
certificate of the Company and the Guarantor, signed, by their respective
Presidents or by a Senior or Executive Vice President, dated the Closing Date
which states that such person has examined the representations and warranties
contained in Section 7 hereof and to the best knowledge after due inquiry of the
officer executing such Certificate such representations and warranties were true
and correct in all material respects on the Effective Date and are true and
correct in all material respects on the Closing Date as if made on and as of the
Closing Date. The person executing any such certificate may rely on opinions of
special counsel for the Company and the Guarantor and reports and certificates
of the independent certified public accountants of
<PAGE>
the Company and the Guarantor and any other opinions, reports and certificates
delivered under this Section 5.
5.9 Insurance. All insurance policies required by the Mortgage shall be in
full force and effect. The Trustee and you shall have received from the insurers
or a licensed broker certificates of insurance, in form and substance reasonably
satisfactory to you, evidencing the issuance of such policies and the payment of
all premiums payable as of the Closing Date.
5.10 Governmental Authorization. All necessary authorizations, consents or
approvals of, or registrations, declarations or filings with, all governmental
authorities having jurisdiction with respect to the transactions contemplated
hereby shall have been obtained to the satisfaction of your counsel.
5.11 No Material Adverse Change. There shall have been no material adverse
changes between June 30, 1997 and the Closing Date, in the financial condition
of (i) the Company, (ii) the Guarantor, or (iii) the Mortgaged Parcels.
5.12 Proceedings and Documents. All opinions, certificates and other
documents and all proceedings in connection with the transactions contemplated
by this Agreement shall be reasonably satisfactory in form and substance to you
and your counsel. You and your counsel shall have received copies of all
instruments and other evidence as you or your counsel may reasonably request, in
form and substance reasonably satisfactory to you and your counsel, with respect
to such transactions and the taking of all corporate or other proceedings in
connection therewith.
5.13 Conditions of the Company's and Guarantor's Obligation. In addition,
the obligation of the Company to issue the Secured Notes on each Issuance Date
shall be subject to the satisfaction of the following conditions on and as of
the Closing Date or such Issuance Date, as applicable:
(a) your representations and warranties contained in this Agreement shall
be accurate and correct on the Closing Date or such Issuance Date, as
applicable;
(b) the aggregate principal amount of Secured Notes issued by the Company
to you on each Issuance Date shall not be less than the aggregate amount of
Existing Notes held by you that would otherwise be redeemed for cash by the
Company on such Issuance Date; and
(c) you shall have issued a letter, dated the Closing Date, that the
conditions precedent set forth in this Section 5 shall have been satisfied as of
the Closing Date.
<PAGE>
SECTION 6. Conditions of Issuance of Secured Notes on Each Issuance Date.
Your obligation to accept the issuance of the Secured Notes in lieu of
redemption for cash of the Existing Notes held by you on each Issuance Date
shall be subject to the following conditions: (a) the principal amount of the
Secured Notes being issued on such Issuance Date shall equal the principal
amount of the Outstanding Existing Notes held by you scheduled to be redeemed
for cash on such Issuance Date; (b) the Secured Notes to be issued on such
Issuance Date, when added to the principal amount of the then Outstanding
Secured Notes shall not exceed $50,000,000; (c) no Event of Default under the
Indenture shall have occurred and be continuing; (d) the conditions precedent
set forth in Section 5 shall have been satisfied in accordance therewith; and
(e) the Company shall have paid all fees to you then due and payable under this
Agreement.
SECTION 7. Representations and Warranties of the Company.
The Company and the Guarantor jointly and severally represent and warrant,
on the date hereof, on and as of the Closing Date and on and as of each Issuance
Date, as follows:
7.1 Organization and Power. Each of the Company and the Guarantor is a duly
organized and validly existing corporation and is in good standing under the
laws of its jurisdiction of organization and under the laws of the jurisdictions
in which the Mortgaged Parcels owned or leased by it are located, and has the
corporate power and authority to own and operate the Mortgaged Parcels owned or
leased by it. The Guarantor has full power, authority and legal right, and has
duly taken all corporate proceedings to authorize it to execute and to deliver
this Agreement, the Guaranty Mortgage, the Guaranty, the Indenture and all other
documents or agreements contemplated hereunder and thereunder and each such
document executed and delivered by it is a legal, valid and binding agreement of
the Guarantor, enforceable in accordance with its terms, subject to bankruptcy,
moratorium, insolvency and other similar laws affecting creditors' rights
generally and to general principles of equity. The Company, has the full power,
authority and legal right and has duly taken all corporate proceedings to
authorize it to execute and deliver this Agreement, the Company Mortgage, the
Indenture and all other documents or agreements contemplated hereunder and
thereunder and to issue and deliver the Secured Notes and to perform and observe
the terms and provisions of such instruments and each such instrument or
document executed and delivered by it is a valid, legal and binding obligation
of the Company, enforceable in accordance with its terms, subject to bankruptcy,
moratorium, insolvency and other similar laws affecting creditors' rights
generally and to general principles of equity. The Company has the full power,
authority and legal right to, and has duly taken all corporate proceedings to
authorize it to sell the Secured Notes to you hereunder.
7.2 Litigation; Taxes. There are no actions, suits or proceedings or
investigations pending or threatened against or affecting the Company or the
Guarantor at law or in equity before any court, governmental or regulatory body,
administrative officer or agency, or other tribunal which, individually or in
the aggregate, could, taking into account the likelihood of success, have a
material adverse effect upon the business, property, assets, liabilities,
financial condition or results of operations of the Company or the Guarantor.
Neither the Company nor the Guarantor is in default (a) in the payment of any
material amount of real estate taxes levied or assessed against it with respect
to the Mortgaged Parcels (other than as may be permitted by the
<PAGE>
Mortgage), or (b) under any applicable judgment, statute, rule, order, decree,
writ, injunction or regulation of any governmental body (including any court),
which, individually or in the aggregate, could have a material adverse effect
upon the business, property, assets, liabilities or financial condition of the
Company, the Guarantor or any of their respective Mortgaged Parcels. The
Company, the Guarantor and each of the Company's subsidiaries have filed all
federal and other material tax returns required to be filed by them and have
paid all income taxes payable by them which have become due in all material
respects pursuant to such tax returns, other than those not yet delinquent and
except for those contested in good faith and for which adequate reserves (in the
good faith judgment of the management of the Company the Guarantor or such
subsidiary) have been established. The Company, the Guarantor and each of the
Company's subsidiaries have paid, or have provided adequate reserves (in the
good faith judgment of the management of the Company the Guarantor or such
subsidiary) for the payment of, all federal and state income taxes applicable
for all prior fiscal years and for the current fiscal year to the date hereof to
the extent required by generally accepted accounting principles.
7.3 Compliance with Other Instruments. Neither the execution, sale,
delivery or performance by the Company of this Agreement, the Secured Notes, the
Indenture (including the Eleventh Supplemental Indenture), the Company Mortgage,
or any other document contemplated hereby or thereby nor compliance therewith by
the Company, nor the execution, delivery or performance by the Guarantor of this
Agreement, the Guaranty, the Indenture or the Guaranty Mortgage or any other
document contemplated hereby or thereby (a) will conflict with, violate or will
result in a breach or will constitute a default under (i) the charter documents,
by-laws of the Company or of the Guarantor, (ii) any judgment, statute, rule,
order, decree, writ, injunction or regulation of any court or governmental
authority, or (iii) any indenture, agreement or instrument to which the Company
or the Guarantor is a party or may be bound, or (b) will result in the creation
or imposition of any lien, charge or encumbrance upon any of the Mortgaged
Parcels other than pursuant to the Mortgage or the other Mortgage Documents. On
the Closing Date, no default shall have occurred and be continuing under this
Agreement, the Secured Notes, the Indenture, the Mortgage, the Guaranty or the
other Mortgage Documents.
Neither the Company nor the Guarantor are a party to, bound by or in breach
or violation of any indenture or other agreement or instrument, or subject to or
in violation of any statute, order or regulation of any court, regulatory or
governmental body or administrative agency having jurisdiction over them, which
breach, violation, indenture, agreement, instrument, statute, order or
regulation would materially and adversely affect, or may in the future be
reasonably likely to materially and adversely affect, (i) the ability of the
Company or the Guarantor to perform its obligations under, or the validity or
enforceability of, this Agreement, the Mortgage, the Guaranty, the Indenture or
the Secured Notes or (ii) the business operations, financial condition,
properties or assets of the Company or the Guarantor.
7.4 Governmental Authorization. No authorization, consent or approval of,
or registration, declaration or filing with, any governmental authority (other
than filings required in order to perfect the mortgages and liens contemplated
hereby) is required for the execution, delivery and performance by the Company
or the Guarantor, as the case may be, of this Agreement, the Secured Notes, the
Indenture, the Eleventh Supplemental Indenture, the Mortgage, the Guaranty, or
the offering, issuance, sale or delivery of the Secured Notes or the
consummation of any other transaction contemplated hereby or thereby.
<PAGE>
7.5 Offering of Notes. Neither the Company, the Guarantor nor anyone acting
on their behalf has offered, transferred, pledged, sold or otherwise disposed of
any Secured Note, any interest in any Secured Note or any other similar
instrument to, or solicited any offer to buy or accept a transfer, pledge or
other disposition of any Secured Note, any interest in any Secured Note or any
other similar instrument from, or otherwise approached or negotiated with
respect to any Secured Note, any interest in any Secured Note or any other
similar instrument with, any person in any manner, or made any general
solicitation by means of general advertising or in any other manner, or taken
any other action, which would constitute a distribution of the Secured Notes
under the Securities Act of 1933, as amended (the "1933 Act") or which would
render the disposition of any Secured Note a violation of Section 5 of the 1933
Act, or require registration pursuant thereto, require qualification of the
Secured Note under the Trust Indenture Act of 1939, nor will the Company or the
Guarantor act, nor has it authorized or will it authorize any person to act, in
such manner with respect to any Secured Note. To the best knowledge of the
Company and the Guarantor, the issuance, sale and delivery of the Secured Notes
will not constitute a prohibited transaction within the meaning of the Employee
Retirement Income Security Act of 1974, as amended, or Section 4975 of the
Internal Revenue Code of 1986, as amended, for which an exemption is not
available. In the event any transaction contemplated by this Agreement
constitutes a prohibited transaction, the Company and the Guarantor will
cooperate with the Department of Labor, the Internal Revenue Service and other
affected parties in obtaining an exemption therefor.
7.6 Financial Information.
(a) The consolidated statements of financial condition of the Company and
its subsidiaries at December 31, 1996, and the related consolidated statements
of earnings and retained earnings and cash flows of the Company and its
subsidiaries for the fiscal year ended on such date and heretofore furnished
present fairly the consolidated financial condition of the Company and its
subsidiaries at the date of such statements of financial condition and the
consolidated results of the operations of the Company and its subsidiaries for
such fiscal year. The unaudited consolidated statements of financial condition
of the Company dated June 30, 1997 and the related consolidated statements of
earnings and retained earnings for the Company and its subsidiaries for the
first two fiscal quarters of 1997 heretofore furnished present fairly the
consolidated financial condition of the Company and subsidiaries at the date of
such statements and consolidated results of the operations of the Company and
its subsidiaries for such fiscal quarter. All such financial statements have
been prepared in accordance with generally accepted accounting principles and
practices ("GAAP") consistently applied. Since June 30, 1997, there has been no
material adverse change in the business, property, assets, liabilities,
condition (financial or otherwise), operation, results of operations or
prospects of the Company or of the Company and its subsidiaries taken as a
whole.
(b) Except as fully reflected in the financial statements delivered
pursuant to Section 7.6(a), there were as of the date hereof no liabilities or
obligations (excluding current obligations incurred in the ordinary course of
business) with respect to the Company or any of its subsidiaries of any nature
whatsoever (whether absolute, accrued, contingent or otherwise and whether or
not due), and the Company does not know of any basis for the assertion against
the Company or any of its subsidiaries of any such liability or obligation
which, either individually
<PAGE>
or in aggregate, are or would be reasonably likely to be material to the
Company, or to the Company and its subsidiaries taken as a whole.
(c) On and as of the Closing Date and on and as of each Issuance Date, as
applicable, (i) the assets, at a fair valuation, of each of the Company and the
Guarantor will exceed their respective liabilities; (ii) neither the Company nor
the Guarantor have incurred, nor do they intend to, or believe that they will,
incur debts beyond their ability to pay such debts as such debts mature; and
(iii) the Company and the Guarantor will each have sufficient capital with which
to conduct their respective businesses. In addition, on and as of the Closing
Date, the Company and the Guarantor intend, that throughout the term of the
Secured Notes, (x) the assets, at a fair valuation, of each of the Company and
the Guarantor will exceed their respective liabilities; (y) neither the Company
nor the Guarantor shall incur debts beyond their ability to pay such debts as
such debts mature; and (z) the Company and the Guarantor will each have
sufficient capital with which to conduct their respective and any contemplated
businesses. For purposes of this Section 7.6(c) "debt" means any liability on a
claim, and "claim" means (i) right to payment, whether or not such a right is
reduced to judgment, liquidated, unliquidated, fixed, contingent, matured,
unmatured, disputed, undisputed, legal, equitable, secured, or unsecured; or
(ii) right to an equitable remedy for breach of performance if such breach gives
rise to a payment, whether or not such right to an equitable remedy is reduced
to judgment, fixed, contingent, matured, unmatured, disputed, undisputed,
secured or unsecured.
7.7 Margin Regulations. The sale of the Secured Notes by the Company and
the use of the proceeds of such sale will not violate the margin regulations of
the Federal Reserve Board, as amended.
7.8 Maintenance. The Company and the Guarantor are not aware of any fact
which has not been disclosed in the closing documents or has not been disclosed
in writing to you which materially and adversely affects the condition of the
Mortgaged Parcels.
7.9 Compliance with Law. Except as set forth in Exhibit G, the Mortgaged
Parcels comply in all material respects with the Legal Requirements and the
Insurance Requirements, as defined in the Mortgage and, except as disclosed
thereunder, neither the Company nor the Guarantor have received any notices,
suits, orders, decrees or judgments relating to zoning, building, use and
occupancy, fire, health, sanitation, air pollution, ecological, environmental or
other violations of, against, or with respect to, the Mortgaged Parcels.
7.10 Approvals and Consents. All certificates of occupancy and other
material permits and approvals (whether governmental or otherwise) required for
the operation of the Mortgaged Parcels have been duly granted and are in full
force and effect, and all fees and charges therefor have been fully paid.
7.11 Full Disclosure. Neither the Company nor the Guarantor has made any
untrue statement of a material fact or omitted to "state a material fact
necessary to make the statements contained therein or herein, in light of the
circumstances under which they were made", not misleading. The Company and the
Guarantor are not aware of any fact relating to the Company or the Guarantor
which has not been disclosed to you in writing which materially and adversely
affects the condition (financial or otherwise) of the Company or the Guarantor,
or the ability of
<PAGE>
the Company or the Guarantor to perform their respective obligations under this
Agreement, the Secured Notes, the Indenture, the Mortgage, or the Guaranty.
7.12 Valid First Mortgage Lien and First Priority Security Interest. The
Mortgage together with the Indenture create the lien and security interest that
it purports to create, and the Mortgage and any financing statement or similar
instrument which may be required with respect thereto have been recorded or
filed in such places such that the Mortgage constitutes a valid first mortgage
lien and creates a valid and perfected first priority security interest of
record with respect to the Trust Estate, subject only to the Permitted
Encumbrances.
SECTION 8. Representations and Warranties of the Purchasers.
You represent to the Company and the Guarantor that on the date hereof, on
and as of the Closing Date and on and as of each Issuance Date:
(a) You are duly authorized to enter into and have duly executed and
delivered this Agreement.
(b) This Agreement is a legal, valid and binding obligation of yours,
enforceable in accordance with its terms, subject to bankruptcy, moratorium,
insolvency and other similar laws affecting creditors' rights generally and
general principles of equity.
(c) You understand that the Secured Notes have not been registered or
qualified under the 1933 Act or the securities laws of any state and that the
Indenture has not been qualified under the Trust Indenture Act of 1939 and that
the Secured Notes will bear a legend reflecting transfer restrictions.
(d) You are acquiring the Secured Notes to be purchased by you for your own
account and not with a view to distribution of such Secured Notes in violation
of the 1933 Act, provided, however, that the disposition of such property shall
at all times remain within your control.
(e) You are a substantial, sophisticated institutional investor having such
knowledge and experience in financial and business matters that you are capable
of evaluating the merits and risks of investment in the Secured Notes, and are
(i) an "accredited investor" within the meaning of Rule 501 (a) promulgated
under the 1933 Act or (ii) the U.S. branch or agency of a foreign bank, the
securities of which are exempt under Section 3(a)(2) of the 1933 Act. You hereby
make the representations and warranties contained in paragraph 1 in the ERISA
Certification, as if you were Purchaser.
(f) You have been furnished with a copy of all information regarding the
Secured Notes which you have requested from the Company and the Guarantor.
In connection with the resale of any of the Secured Notes by you to any
other investor (a "Subsequent Purchaser"), you will either (i) obtain from such
Subsequent Purchaser an investment letter and ERISA certification substantially
in the forms of Exhibits J and K to this Agreement with such changes as the
Company, and you agree are necessary and appropriate or
<PAGE>
(ii) furnish to the Trustee an opinion of counsel experienced in United States
securities matters, or such other information or certificates as the Trustee
deems acceptable, in form and substance satisfactory to the Trustee, that the
proposed resale does not violate the 1933 Act or any state securities law,
together with an ERISA Certification of the Subsequent Purchaser substantially
in the form of Exhibit K.
SECTION 9. Payment of Expenses.
Whether or not the transactions contemplated by this Agreement shall be
consummated, the Company and the Guarantor will: (a) pay all of their fees and
expenses in connection with such transactions, including, without limitation,
printing and reproduction expenses; (b) pay all reasonable out-of-pocket
expenses incurred by you in connection with the transactions contemplated by
this Agreement; (c) pay all reasonable legal fees and disbursements of Christy &
Viener, New York counsel to you; (d) hold you harmless from and against any and
all finders' or brokerage fees and commissions of parties claiming to have been
retained by or on behalf of the Company or the Guarantor; (e) pay all Trustee's
fees and other amounts payable to the Trustee as compensations expenses or
indemnification under the Indenture; (f) pay all your reasonable out-of-pocket
expenses including without limitation, reasonable attorneys' fees and
disbursements in connection with any modification of, or any waiver or consent
in respect of this Agreement, the Secured Notes, the Mortgage, the Guaranty or
the Indenture; (g) pay all title insurance expenses; (h) pay the cost of
transmitting the Secured Notes issued to you to your office upon the issuance
thereof; and (i) pay all expenses relating to the issuance of the Secured Notes
issued to you in lieu of redemption of a portion of the Existing Notes. Whether
or not the transactions contemplated by this Agreement shall be consummated, you
will hold the Company and the Guarantor harmless from and against any and all
finders' or brokerage fees and commissions of parties claiming to have been
retained by you or on your behalf. In addition, you will hold the Company, the
Guarantor, and each other Person, if any, who controls any of the Company,
within the meaning of Section 15 of the 1933 Act, harmless from and against any
and all loss, liability, claim, damage and expense, including, but not limited
to, any and all expenses (including reasonable attorneys' fees expenses and
litigation costs), arising out of or based upon any breach or failure by you to
comply with any representation or warranty made by you herein or in any other
document furnished by you to any of the foregoing in connection with this
transaction.
SECTION 10. Survival of Agreement.
All agreements, representations and warranties contained herein or made in
writing by or on behalf of the Company, the Guarantor or you in connection with
the transactions contemplated hereby (including, without limitation, the
obligations of the Company and the Guarantor contained in Section 9 and the
representations and agreements contained in Section 5, 6 and 7) shall survive
the execution and delivery of, and the Closing under, this Agreement, the
Indenture, the Mortgage, the Guaranty, the issuance and delivery of the Secured
Notes, any disposition thereof by you, and you shall be entitled to rely thereon
notwithstanding any investigation at any time made by you or on your behalf,
provided that your rights and remedies in the event of a breach of any such
agreements, representations or warranties (other than a breach of the Company's
or the Guarantor's obligations under Section 9 hereto shall be subject to
<PAGE>
the terms, provisions and conditions contained in the Indenture and limited to
the rights and remedies provided therein.
SECTION 11. Notices.
All notices and other communications hereunder shall be deemed to have been
sufficiently given or served for all purposes only if delivered by hand or sent
by telex, telecopy or telegram or by being mailed by registered or certified
mail, postage prepaid, return receipt requested: (a) if to you, at your address
or to your telex or telecopier number specified for notices on the signature
page hereof and marked for attention as therein indicated or at such other
address as you may furnish to the Company in writing, with a copy to Christy &
Viener, 620 Fifth Avenue, New York, New York 10020, Attention: Steven R. Berger,
Esq., or (b) if to the Company or the Guarantor addressed to Service Merchandise
Company, Inc., 7100 Service Merchandise Drive, Brentwood, Tennessee 37027,
Attention: Treasurer, with a copy at the foregoing address, Attention of C.
Steven Moore, Esq., Managing Attorney (or at such other address as the Company
may furnish you in writing).
SECTION 12. Severability of Provisions.
Any part, provision, representation, warranty or covenant of this Agreement
which is prohibited or which is held to be void or unenforceable shall be
ineffective to the extent of such prohibition or unenforceability without
invalidating the remaining provisions hereof. To the extent permitted by
applicable law, the parties hereto waive any provision of law which prohibits or
renders void or unenforceable any provision hereof.
SECTION 13. Counterparts.
This Agreement may be executed simultaneously in any number of
counterparts. Each counterpart shall be deemed to be an original, and all such
counterparts shall constitute one and the same instrument.
SECTION 14. Governing Law.
The Agreement shall be construed in accordance with the laws of the State
of New York and the obligations, rights and remedies of the parties hereunder
shall be determined in accordance with the laws of the State of New York.
SECTION 15. Choice of Forum.
The parties hereto agree that any dispute arising under this Agreement
shall be resolved in the state or federal courts of or located in the State of
New York located in the City and County of New York, and to the fullest extent
permitted by applicable law, the Company and the Guarantor expressly consent to
jurisdiction therein. The Company and the Guarantor hereby irrevocably appoint
and designate CT Corporation System, having an address at 1633 Broadway, New
York, New York, their true and lawful attorney-in-fact and duly authorized agent
for the limited purpose of accepting service of legal process and the Company
and the Guarantor agree that, to the fullest extent permitted by applicable law,
service of process upon such party shall
<PAGE>
constitute personal service of such process on the Company and the Guarantor as
the case may be. The Company and the Guarantor covenant and agree to maintain
the designation and appointment of such authorized agent until all amounts
payable under the Indenture, the Mortgage, the Secured Notes, the Guaranty and
the other Mortgage Documents shall have been paid in full. If such agent shall
cease to so act, the Company and the Guarantor covenant and agree to designate
and appoint without delay another such agent reasonably satisfactory to the
Trustee and to promptly deliver to the Trustee evidence in writing of such other
agent's acceptance of such appointment. The Company and the Guarantor hereby
waive to the fullest extent permitted by applicable law any right they may have
to transfer or change the venue of any litigation brought against them in the
aforesaid courts in accordance with this Section.
SECTION 16. Successors and Assigns.
This Agreement shall inure to the benefit of and be binding upon the
parties hereto and their respective successors and assigns; provided, however
that you agree that you shall not sell, assign or otherwise transfer any
Existing Notes held by you on the date hereof unless the transferee thereof
shall agree to be bound by the terms of this Agreement.
SECTION 17. Waiver; Prior Agreements.
No term or provision of this Agreement may be waived or modified unless
such waiver or modification is in writing and signed by the party against whom
such waiver or modification is sought to be enforced. This Agreement supersedes
all prior agreements and understandings related to the subject matter hereof.
<PAGE>
If you are in agreement with the foregoing, please sign a counterpart of
this Agreement and return it to the Company whereupon this Agreement shall
become a binding agreement among you, the Company and Guarantor.
Very truly yours,
SERVICE MERCHANDISE COMPANY, INC.
By: /s/ Wade Smith
--------------
Name: Wade Smith
Title: Vice President
H.J. WILSON CO., INC.
By: /s/ Wade Smith
--------------
Name: Wade Smith
Title: Vice President
This Agreement is hereby accepted
and entered into as of its date:
THE LONG-TERM CREDIT BANK OF
JAPAN, LTD., New York Branch
By: /s/ John J. Sullivan
--------------------
Name: John J. Sullivan
Title: Joint General Manager
Address for Notices:
165 Broadway
New York, New York 10006
Attention:
February 11, 1998
Mr. James E. Poole
Poole Enterprises, Inc.
4701 Trousdale Road
Nashville, Tennessee 37220
Dear Mr. Poole:
Service Merchandise, Inc. (the "Company") is pleased to confirm the terms
pursuant to which you have agreed to serve as Chairman of the Board of the
Company as hereinafter set forth:
1. Title; Duties. Effective January 29, 1998, you have been elected
Chairman of the Board of the Company. As Chairman, the Board has delegated to
you the responsibility of interfacing between the Board and the officers of the
Company, to provide a conduit to the Board, and to provide counsel to the Chief
Executive Officer. You will determine, in your sole discretion, how to best
perform these duties and the time necessary to satisfactorily fulfill these
responsibilities.
2. Additional Compensation. So long as you serve in your capacity as
Chairman of the Board, you shall receive as additional compensation the sum of
$10,000 per month. Such compensation shall be in addition to the compensation
paid to each nonemployee director. You shall continue to participate in the
Directors' Equity Plan for nonemployee directors and shall participate in any
other benefits generally available to nonemployee directors.
3. Death and Other Benefits. In recognition of the expectation that your
service as Chairman of the Board will continue for a period of not less than two
years, and of the additional duties and time commitments imposed upon you, the
Company agrees that in the event of your death or total disability while serving
as Chairman of the Board or your removal as Chairman of the Board by action of
the Board, the Company will pay to your estate, or you in the case of a removal,
an amount equal to $240,000 less the total amount of additional compensation
previously paid to you.
4. Office and Secretarial Assistance. The Company agrees to provide you
with an office at its principal office and to provide you with secretarial
assistance satisfactory to you to assist you in performing your duties as
Chairman of the Board.
<PAGE>
5. Expense Reimbursement. The Company agrees to reimburse you for all
reasonable expenses, including a car allowance of $1,000 per month, incurred in
connection with the performance of your duties as Chairman of the Board.
6. Indemnification Agreement. The Company has entered into an
Indemnification Agreement with you in your capacity as a director and hereby
reaffirms its obligations thereunder and confirms that the agreement shall cover
any matter giving rise to indemnification thereunder arising out of your duties
as Chairman of the Board.
Please confirm your acceptance of the terms pursuant to which you will
serve as Chairman of the Board by signing and returning to the Company the
enclosed copy of this letter.
Very truly yours,
SERVICE MERCHANDISE, INC.
By:/s/ Gary M. Witkin
-------------------
Gary M. Witkin
President and Chief
Executive Officer
Confirmed and agreed:
/s/ James E. Poole Jr.
- ----------------------
James E. Poole, Jr.
<TABLE>
EXHIBIT 13
Selected Financial Information
<CAPTION>
(In thousands, except per share, store, ratio and rate data)
Fiscal Year 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS
Net sales $ 3,662,778 $ 3,955,016 $ 4,018,525 $ 4,050,381 $ 3,814,618
Earnings (loss) before interest and income taxes (a) (63,801) 138,564 162,078 179,643 217,542
Interest expense - debt and
capitalized leases (a) 78,531 75,636 80,908 78,707 80,370
Earnings (loss) before extraordinary loss and
cumulative effect of change in accounting
principle (88,957) 39,330 50,325 61,570 82,315
Net earnings (loss) (91,600) 39,330 50,325 56,155 82,583
RATIOS & RATES
Gross margin to net sales 23.2% 24.2% 24.3% 24.0% 24.8%
Selling, general and administrative
expenses to net sales (a) 19.8% 19.2% 18.7% 18.0% 17.5%
Effective tax rate 37.5% 37.5% 38.0% 39.0% 40.0%
Earnings (loss) before extraordinary loss and
cumulative effect of change in accounting
principle to net sales (2.4%) 1.0% 1.3% 1.5% 2.2%
Net earnings (loss) to net sales (2.5%) 1.0% 1.3% 1.4% 2.2%
PER COMMON SHARE - BASIC AND DILUTED (b)
Earnings (loss) per share before extraordinary loss
and cumulative effect of change in accounting
principle - Basic $ (0.89) $ 0.39 $ 0.50 $ 0.62 $ 0.83
Earnings (loss) per share before extraordinary loss
and cumulative effect of change in accounting
principle - Assuming dilution (0.89) 0.39 0.50 0.62 0.82
Net earnings (loss) per share - Basic (0.92) 0.39 0.50 0.56 0.83
Net earnings (loss) per share - Assuming dilution (0.92) 0.39 0.50 0.56 0.82
Weighted-average common shares:
Basic 99,930 99,209 99,059 99,432 99,242
Diluted 99,930 100,326 100,357 100,105 100,553
FINANCIAL POSITION
Inventories $ 929,818 $ 1,052,969 $ 1,034,467 $ 1,004,282 $ 939,259
Accounts payable (a) 482,235 639,887 679,107 685,297 679,421
Working capital 586,501 489,597 365,025 290,696 310,622
Total assets (a) 1,951,461 2,087,452 1,999,008 1,972,433 2,063,397
Long-term obligations (c) 761,522 682,156 623,286 618,423 698,521
Shareholders' equity 336,505 427,094 386,742 336,376 279,538
RATIOS
Inventory turnover 2.8x 2.9x 3.0x 3.2x 3.2x
Current ratio (a) 1.7x 1.5x 1.4x 1.3x 1.3x
Long-term debt to long-term debt + equity 69.4% 61.5% 61.7% 64.8% 71.4%
OTHER INFORMATION
Total net sales increase (decrease) (7.4%) (1.6%) (0.8%) 6.2% 2.7%
Comparable store net sales increase (decrease) (d) (3.1%) (1.9%) (3.3%) 1.3% 0.3%
Number of stores 361 401 410 407 391
EBITDA DATA
EBITDA (e) $ (4,561) $ 199,189 $ 224,816 $ 242,495 $ 280,075
EBITDA to net sales (0.1%) 5.0% 5.6% 6.0% 7.3%
(a) Certain prior period amounts have been reclassified for comparative purposes.
(b) Restated to reflect the adoption of SFAS No. 128
(c) Includes both long-term debt and long-term portion of capitalized lease obligations.
(d) Adjusted to reflect a comparable number of selling days.
(e) EBITDA consists of net earnings before interest, income taxes, depreciation and amortization. Also included in EBITDA
is other amortization classified as selling, general and administrative expenses in the following amounts: 1997 - $992;
1996 - $966; 1995 - $964; 1994 - $317; 1993 - $757. Certain amounts have been reclassified from selling, general and
administrative expenses to interest expense for both current and prior periods. EBITDA is not intended to represent net
earnings, cash flow or any other measure of performance in accordance with generally accepted accounting principles, but is
included because management believes certain investors find it to be a useful tool for measuring operating performance.
</TABLE>
6
<PAGE>
Management's Discussion & Analysis
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This discussion 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, competitive pressures from other
retailers; the ability to affect changes in business strategy and the success of
the changes in business strategy; the ability to affect completion of the
Company's restructuring plan; the ability to affect conversions to new
technological systems including becoming year 2000 compliant; financing costs;
availability, cost and other terms associated with products; economic
conditions; real estate occupancy and development costs; inventory risks;
advertising costs, including the cost of paper and postage; labor costs and
other risks disclosed in filings with the Securities and Exchange Commission.
Actual results may differ materially from those anticipated in any such
forward-looking statements. The Company undertakes no obligation to update or
revise any forward-looking statements to reflect subsequent events or
circumstances.
RESULTS OF OPERATIONS
Fiscal Year Ended December 28, 1997 Compared to
Fiscal Year Ended December 29, 1996
The Company's consolidated statement 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 and other operating
results associated with the closing facilities and remerchandising activities.
"Closing facilities and remerchandising activities" reflects inventory
liquidations and other operating results of 44 stores and one distribution
center closed during 1997 as part of: (1) the Company's restructuring plan
announced in the first quarter of 1997 and (2) exiting certain product lines 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. Prior year amounts reflect operating results
for these same facilities and merchandise classifications.
Net loss for the year ended December 28, 1997 (fiscal 1997) was $91.6 million,
or $0.92 per share, compared to net earnings of $39.3 million, or $0.39 per
share, for the year ended December 29, 1996 (fiscal 1996). The decrease in
earnings was primarily the result of a $129.5 million pre-tax restructuring
charge taken in the first quarter of fiscal 1997, a $37.4 million pre-tax loss
associated with inventory liquidations from closing facilities and
remerchandising activities, lower sales from operations excluding closing
facilities and remerchandising activities, a $4.2 million pre-tax extraordinary
loss on the early extinguishment of debt and efforts to change the Company's
business strategy to concentrate on core merchandise strengths in jewelry and
home furnishings. Several initiatives were implemented during 1997 including
launching a new marketing model aimed at expanding the Company's customer base,
aligning product offerings into thematic merchandise categories, closing
underperforming stores and replacing the traditional clipboard system with a new
customer-friendly pull-tag system. However, these initiatives did not result in
an improvement in sales or earnings for the Company in 1997. In fiscal 1998, the
Company is aggressively working to achieve improvements in its operations,
including improving margins and the expense structure, enhancing the
productivity and efficiency of its advertising, maximizing the value of a new
credit card program, improving the efficiency and effectiveness of its supply
chain process and enhancing overall customer service.
Net sales for the Company were $3.66 billion for fiscal 1997 compared to $3.96
billion for fiscal 1996. The decrease of $292.2 million, or 7.4%, is the result
of a 3.1% decline in comparable store sales and a decline in net sales from
closing facilities and remerchandising activities of $162.1 million due to the
closure of 44 underperforming stores.
The Company's business is highly seasonal with a significant portion of its
sales occurring in the fourth quarter. Fourth quarter net sales accounted for
39.4% and 41.5% of total net sales in fiscal 1997 and 1996, respectively. Fourth
quarter net sales for fiscal 1997 decreased 12.1% when compared to the fourth
quarter of fiscal 1996, primarily due to the closure of 44 underperforming
stores in the third quarter of 1997. Comparable store sales decreased 3.6% for
the fourth quarter of 1997.
Net sales from operations excluding closing facilities and remerchanding
activities were $3.47 billion for fiscal 1997 compared to $3.60 billion for
fiscal 1996, a decrease of $130.1 million or 3.6%. Comparable store sales
declined 3.1%. Jewelry comparable store sales were down 0.4%. Improvements in
gold sales, jewelry special sales events and warranty sales were offset by sales
declines in watches, diamonds and precious and semi-precious stones.
7
<PAGE>
Hardline comparable store sales were down 4.1%. Sales improvements in decorative
home, seasonal, telephones, home furnishings and photo categories were offset by
sales declines in sporting and fitness, toys, small appliances, housewares,
audio, video and home office equipment.
Net sales from closing facilities and remerchandising activities were $190.7
million for fiscal 1997 compared to $352.8 million for fiscal 1996. Sales from
closing facilities and remerchandising activities for fiscal 1997 decreased from
fiscal 1996 due to the closing of 44 underperforming stores which was completed
in July 1997.
Gross margin, after cost of merchandise sold and buying and occupancy expenses,
for the Company decreased as a percentage of net sales to 23.2% in fiscal 1997
from 24.2% in fiscal 1996. The decrease in the margin rate is primarily
attributable to the closing facilities and remerchandising activities.
Gross margin, after cost of merchandise sold and buying and occupancy expenses,
for operations excluding closing facilities and remerchandising activities
decreased to $851.2 million, or 24.5% of sales from operations excluding closing
facilities and remerchandising activities for fiscal 1997 as compared to $892.4
million, or 24.8% of sales from operations excluding closing facilities and
remerchandising activities for fiscal 1996. Lower sales from operations
excluding closing facilities and remerchandising activities affected the gross
margin dollar performance. Overall improvements in both jewelry and hardline
merchandise margins were offset by increases in freight and buying and occupancy
costs resulting in the reduction in gross margin rate from last year.
Gross margin, after cost of merchandise sold and buying and occupancy expenses,
for closing facilities and remerchandising activities was $(0.2) million, or
(0.1)% of sales from closing facilities and remerchandising activities for
fiscal 1997 as compared to $64.7 million, or 18.3% of sales from closing
facilities and remerchandising activities for fiscal 1996. The decline in both
gross margin dollars and rate was due to the merchandise discounts offered in
liquidating inventories at the 44 underperforming stores as part of the
Company's restructuring and remerchandising programs.
While selling, general and administrative ("SG&A") expenses for the Company
decreased $31.8 million in fiscal 1997 compared to fiscal 1996, they increased
as a percentage of net sales to 19.8% from 19.2% in fiscal 1996. This increase
relative to sales reflects the higher SG&A cost structure for the inventory
liquidations and lower-than-planned sales in the fourth quarter of 1997.
Selling, general and administrative expenses of operations excluding closing
facilities and remerchandising activities were $692.7 million, or 20.0% of sales
from operations excluding closing facilities and remerchandising activities for
fiscal 1997 compared to $701.0 million, or 19.5% of sales from operations
excluding closing facilities and remerchandising activities for fiscal 1996. A
decrease in SG&A dollars associated with reduced employment and advertising
costs was not enough to offset the sales volume decline, the net result being an
increase in SG&A as a percentage of sales.
Selling, general and administrative expenses for closing facilities and
remerchandising activities were $34.3 million for fiscal 1997 compared to $57.8
million in fiscal 1996. The closure of the 44 underperforming stores completed
in July 1997 resulted in the decreased selling, general and administrative costs
for the fiscal year.
Depreciation and amortization on owned and leased property and equipment was
$58.2 million for fiscal 1997 as compared to $59.7 million for fiscal 1996, a
decrease of 2.4%. The Company's capital expenditures, excluding capitalized
leases, remained relatively flat at $40.8 million in fiscal 1997 as compared to
$40.7 million in fiscal 1996. The Company closed a net 40 stores (including the
44 underperforming stores) in fiscal 1997 as compared to closing a net nine
stores in fiscal 1996.
Interest expense on debt and capitalized leases increased to $78.5 million in
fiscal 1997 from $75.6 million in fiscal 1996. The increase is primarily
attributable to the issuance of $74.8 million in mortgage financing notes that
occurred primarily in the fourth quarter of 1996.
The effective income tax rate remained at 37.5% for both fiscal years 1997 and
1996.
On March 25, 1997, the Company adopted the 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 December 28, 1997 are outlined in
the following table:
8
<PAGE>
<TABLE>
<CAPTION>
Activity to Date
------------------------------------------------
Accrued
Original Restructuring
Charge Restructuring Asset Change Costs as of
(In thousands) Recorded Costs Paid Write-downs in Estimate 12/28/97
------------- ----------------- ---------------- ------------- -----------------
<S> <C> <C> <C> <C> <C>
Lease termination and
other real estate costs $ 83,225 $ (12,812) $ - $ 3,098 $ 73,511
Property and equipment
write-downs 32,915 -
(32,915) - -
Employee severance
4,869 (3,469) - (869) 531
Other exit costs
8,501 (4,072) - (2,229) 2,200
------------- ----------------- ---------------- ------------- -----------------
Total $ 129,510 $ (20,353) $ (32,915) $ - $ 76,242
(21,178)
============= ================= ================ ============= -----------------
Less: Current portion $ 55,064
=================
</TABLE>
Changes in estimates are representative of management's assessments as of
December 28, 1997 that, based on actual experience to date, certain charges will
be higher than originally estimated while others will be less than originally
estimated. Due to unfavorable sublease and termination experience for stores
closed to date, the Company increased the estimate for lease termination and
other real estate costs. These unfavorable results have been offset by favorable
experience in employee severance and other exit costs for stores closed to date.
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 will be immaterial because the stores planned to be
closed were near break-even contributors.
In the second quarter of 1997, management began the process of closing 44 of the
60 stores and one distribution center. These 44 stores and distribution center
were closed by the end of July 1997, with the remaining closures expected to be
completed in 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.
Fiscal Year Ended December 29, 1996 Compared to
Fiscal Year Ended December 31, 1995
Net earnings for the year ended December 29, 1996 (fiscal 1996) were $39.3
million, or $0.39 per share, compared to net earnings of $50.3 million, or $0.50
per share, for the year ended December 31, 1995 (fiscal 1995). The decrease in
earnings was primarily attributable to lower sales and increased selling,
general and administrative expenses, partially offset by lower interest expense
related to lower average short-term borrowings. During the latter part of 1996,
management began a broad and fundamental analysis of the Company's business
design and retail format focused on improving returns on invested capital. This
strategic analysis and the identification of related action plans resulted in
the announcement of the Company's Restructuring Plan and related $129.5 million
restructuring charge recorded in the first quarter of 1997.
For fiscal 1996, net sales were $3.96 billion compared to $4.02 billion for
fiscal 1995, a decrease of $63.5 million or 1.6%. Comparable store sales
decreased 1.9%. For the year, comparable store sales of jewelry were essentially
flat, with the overall decrease in comparable store sales attributable primarily
to hardlines. Management believes that the loss of five shopping days between
Thanksgiving and Christmas resulted in a delayed and shortened shopping season
which adversely affected sales.
The Company's business is highly seasonal with a significant portion of its
sales occurring in the fourth quarter. Fourth quarter net sales accounted for
41.5% and 42.0% of total net sales in fiscal 1996 and 1995, respectively. Fourth
quarter net sales for fiscal 1996 decreased 2.7% when compared to the fourth
quarter of fiscal 1995. Comparable store sales decreased 2.8% for the fourth
quarter of 1996.
9
<PAGE>
Gross margin, after cost of merchandise sold and buying and occupancy expenses,
decreased as a percentage of net sales to 24.2% in fiscal 1996 from 24.3% in
fiscal 1995. Lower net sales affected the gross margin dollar performance while
higher inventory shrinkage and an increase in freight and occupancy expenses
suppressed both overall gross margin dollars and gross margin rates.
Selling, general and administrative expenses for fiscal 1996 increased as a
percentage of net sales to 19.2% from 18.8% in fiscal 1995. The increase was
primarily attributable to an increase in employment expenses, which was
partially offset by a decrease in net advertising expenses and gains on the sale
of property and equipment.
The higher employment expenses incurred in the third and fourth quarters were
attributable to the extensive transitioning of the merchandising assortments and
displays and a higher expectation of sales than was achieved in the fourth
quarter. Lower net advertising expense was achieved by improved efficiencies.
The Company recognized a $4.7 million net gain on the sale of property and
equipment, including a $2.8 million gain on the disposal of corporate aircraft
and a $1.8 million gain on the disposal of two owned stores. In fiscal 1995, the
Company incurred a $0.2 million net loss on the disposal of property and
equipment.
Depreciation and amortization on owned and leased property and equipment was
$59.7 million for fiscal 1996 as compared to $61.8 million for fiscal 1995, a
decrease of 3.4%. The Company's capital expenditures, excluding capitalized
leases, decreased to $40.7 million in fiscal 1996, an 11.0% reduction from $45.8
million in fiscal 1995. This reduction reflects fewer store openings resulting
from the Company's concentration on improving the performance of existing
stores. The Company closed a net 9 stores in fiscal 1996 as compared to opening
a net 3 stores in fiscal 1995.
Interest expense on debt and capitalized leases decreased to $75.6 million in
fiscal 1996 from $80.9 million in fiscal 1995. Lower average borrowings related
to prior year positive operating cash flow, lower working capital investment and
lower capital expenditures contributed to the decline in interest expense.
The effective income tax rate decreased to 37.5% in fiscal 1996 from 38.0% in
fiscal 1995 as a result of a reduction in the effective rates of state income
taxes.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow
Cash provided from operations, funds available under the Company's credit
facility and long-term financing provided the resources required to support
operations, seasonal working capital requirements and capital expenditures. The
Company's business is highly seasonal with the Company's inventory investment
and related short-term borrowing requirements reaching a peak prior to the
Christmas season. Positive cash flow from operations is generated principally in
the latter part of the fourth quarter of each fiscal year, in line with the
seasonal nature of the Company's business. The significant fourth quarter cash
flows enabled the Company to repay all short-term borrowings under its credit
facilities prior to both 1997 and 1996 fiscal year ends.
Net cash provided (used) by operations was $(21.4) million for fiscal 1997 as
compared to $65.7 million for fiscal 1996 and $72.8 million for fiscal 1995.
Cash flow from operations decreased for fiscal 1997 compared to fiscal 1996 as a
result of: a) decreased earnings attributable in part to cash payments related
to restructuring and remerchandising activities, b) reductions in accounts
payable due to: i) decreased purchase volumes as a result of the store closings,
ii) a negotiated contraction in payment terms in exchange for revised economics
with certain vendors, iii) aggressive use of anticipation discounts at year-end
and iv) changes in merchandise mix which changed the average terms. These
factors were offset somewhat by inventory liquidations associated with the
closing stores. Cash flow provided by operations decreased for fiscal 1996
compared to fiscal 1995 primarily due to a decline in earnings.
Net cash provided (used) by financing activities was $78.9 million, $58.4
million and $(8.1) million for fiscal 1997, 1996 and 1995, respectively. Cash
provided in fiscal 1997 from financing activities reflected a $200 million term
loan obtained in connection with the completion of the Company's $900 million,
five-year Amended and Restated Credit Facility in the third quarter of 1997.
This was partially offset by the retirement of $86.2 million of Senior Notes due
2001 and $17.4 million of debt issuance costs incurred primarily for the Amended
and Restated Credit Facility. Additionally, the Company paid $15.8 million in
mortgage payments including both prepayments and regularly scheduled payments.
In fiscal 1996, cash provided from financing activities reflected $73.6 million
in mortgage financings, which primarily consisted of a single 15-year financing
at a weighted-average rate of 9.2%. In fiscal 1995, long-term debt, excluding
current maturities, increased as a result of two new mortgages totaling $6.8
million and the refinancing of a $7.8 million mortgage which resulted in a
reclassification from current maturities to long-term debt.
10
<PAGE>
Capital Expenditures
Net cash used for investing activities was $23.3 million, $29.9 million and
$47.8 million in fiscal 1997, 1996 and 1995, respectively. Proceeds from the
sale of property and equipment of $19.6 million in fiscal 1997 primarily relates
to the closure of the 44 underperforming stores and the related sale of store
fixtures and owned real estate. Additionally, the Company sold other buildings,
land and fixtures unrelated to the closure of the 44 underperforming stores.
Capital expenditures, excluding capitalized leases, in fiscal 1997 were $40.8
million as compared to $40.7 million in fiscal 1996 and $45.8 million in fiscal
1995.
Capital expenditures in fiscal 1997 related primarily to the remodeling of
select stores, new store construction, capital maintenance and information
systems expenditures. Capital expenditures for fiscal 1996 related primarily to
new store construction, capital maintenance and remodeling of select stores. In
fiscal 1997, the Company opened five stores and closed 45 stores (including 44
underperforming stores as part of the restructuring plan) as compared to the
opening of six stores and closing of 15 stores in fiscal 1996. In fiscal 1995,
the Company opened nine stores and closed six stores.
Planned capital expenditures for 1998 are expected to be approximately $50.0
million and to be directed primarily to new store formats, capital maintenance
and information systems improvements. Additionally, pursuant to signing a new
third party credit card provider agreement in 1997, the Company has contributed
in January 1998 an initial capitalization amount of $11.0 million to a new
credit card subsidiary. The Company expects to fund future capital expenditures
with cash flow from operations, borrowings under existing credit facilities and
potential future financings.
Capital Structure
In September 1997, the Company amended its then existing credit facility by
entering into a $900 million, five-year Amended and Restated Credit Facility
which includes a $200 million term loan and a revolving credit facility with a
maximum commitment level of $700 million. This facility provides the Company
with additional liquidity as well as increased operating flexibility with
respect to certain financial covenants when compared to the Company's prior
credit facility. At December 28, 1997, the Company had no revolving loans
outstanding under the Amended and Restated Credit Facility. The Company also met
its clean-down provision under the Amended and Restated Credit Facility. Average
short-term borrowings decreased to $101.2 million for fiscal 1997 as compared to
$211.3 million for fiscal 1996 due primarily to the addition of the term loan.
Short-term borrowings under the revolver portion of the Company's credit
facilities reached a maximum of $283.7 million during fiscal 1997 as compared to
$421.7 million in fiscal 1996 and $518.6 million in fiscal 1995.
During fiscal 1996, two of the Company's objectives were to bolster liquidity
and raise long-term capital for potential future investments by the Company.
This was accomplished through the mortgage financing of twenty-six properties
for $73.6 million during the year and a reduction in working capital investment
throughout most of the year.
Total debt as a percentage of total capital for fiscal 1997 was 70.2% as
compared to 62.0% in fiscal 1996 and 62.1% in fiscal 1995. The increase in the
percentage in 1997 was due to the addition of the term loan and the impact of
the 1997 net loss on shareholders' equity, largely related to the Company's
restructuring and remerchandising programs.
Effect of New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("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.
Year 2000 Compliance
Management has initiated an organization-wide program to prepare the Company's
computer systems and applications for the year 2000. Replacement, conversion,
and testing of hardware and system applications are expected to cost
approximately $2.5 million to $3.0 million over the next two years. The Company
expects its Year 2000 Program to be completed on a timely basis. However, if the
program is not completed on a timely basis, there may be a material effect on
the operations or financial results of the Company. The Company has also begun
contacting its primary processing vendors to determine if they have developed
plans to address processing of transactions in the year 2000. However, there can
be no assurance that the systems of other entities on which the Company relies
will be converted in a timely manner or that any such failure to convert by
another entity would not have a material effect on the operations or financial
results of the Company.
Inflation
The Company does not believe inflation has had a material impact on the
Company's net sales or net earnings (loss) during the last three fiscal years.
11
<PAGE>
<TABLE>
Consolidated Statements Of Operations
For the Fiscal Year Ended
(In thousands, except per share data) 12/28/97 12/29/96 12/31/95
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales
Operations excluding closing facilities and remerchandising activities $ 3,472,063 $ 3,602,206 $ 3,649,575
Closing facilities and remerchandising activities 190,715 352,810 368,950
-------------------------------------------------
3,662,778 3,955,016 4,018,525
-------------------------------------------------
Costs and expenses
Cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities and remerchandising activities 2,620,884 2,709,840 2,746,109
Closing facilities and remerchandising activities 190,878 288,121 295,994
-------------------------------------------------
2,811,762 2,997,961 3,042,103
-------------------------------------------------
Gross margin after cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities and remerchandising activities 851,179 892,366 903,466
Closing facilities and remerchandising activities (163) 64,689 72,956
-------------------------------------------------
851,016 957,055 976,422
-------------------------------------------------
Selling, general and administrative expenses
Operations excluding closing facilities and remerchandising activities 692,730 701,000 694,805
Closing facilities and remerchandising activities 34,329 57,832 57,765
-------------------------------------------------
727,059 758,832 752,570
-------------------------------------------------
Restructuring charge 129,510 - -
-------------------------------------------------
Depreciation and amortization
Operations excluding closing facilities and remerchandising activities 55,728 54,495 56,352
Closing facilities and remerchandising activities 2,520 5,164 5,422
-------------------------------------------------
58,248 59,659 61,774
-------------------------------------------------
Earnings (loss) before interest and income taxes (63,801) 138,564 162,078
Interest expense - debt 70,663 66,993 71,501
Interest expense - capitalized leases 7,868 8,643 9,407
-------------------------------------------------
Earnings (loss) before income taxes (142,332) 62,928 81,170
Income tax provision (benefit) (53,375) 23,598 30,845
-------------------------------------------------
Earnings (loss) before extraordinary item (88,957) 39,330 50,325
Extraordinary loss from early extinguishment of debt, net of
tax benefit of $1,585 in fiscal 1997 (2,643) - -
-------------------------------------------------
Net earnings (loss) $ (91,600) $ 39,330 $ 50,325
=================================================
Per common share - basic and diluted:
Earnings (loss) before extraordinary item $ (0.89) $ 0.39 $ 0.50
Extraordinary loss from early extinguishment of debt,
net of tax benefit (0.03) - -
-------------------------------------------------
Net earnings (loss) $ (0.92) $ 0.39 $ 0.50
=================================================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
12
<PAGE>
<TABLE>
Consolidated Balance Sheets
<CAPTION>
(In thousands, except per share data) 12/28/97 12/29/96
-------------------------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $364,169 $329,993
Accounts receivable, net of allowance of
$3,456 and $4,593, respectively 43,130 61,454
Inventories 929,818 1,052,969
Prepaid expenses and other assets 25,276 15,461
Deferred income taxes 22,478 -
-------------------------------
TOTAL CURRENT ASSETS 1,384,871 1,459,877
Net property and equipment - owned 490,345 567,056
Net property and equipment - capitalized leases 33,289 37,701
Other assets and deferred charges 42,956 22,818
-------------------------------
TOTAL ASSETS $1,951,461 $2,087,452
===============================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $482,235 $639,887
Accrued expenses 214,451 212,223
State and local sales taxes 48,331 62,690
Accrued restructuring costs 21,178 -
Income taxes - 33,898
Current maturities of long-term debt 23,723 6,842
Current maturities of capitalized lease obligations 8,452 7,303
Deferred income taxes - 7,437
-------------------------------
TOTAL CURRENT LIABILITIES 798,370 970,280
Accrued restructuring costs 55,064 -
Long-term debt 711,512 623,615
Capitalized lease obligations 50,010 58,541
Deferred income taxes - 7,922
-------------------------------
TOTAL LIABILITIES 1,614,956 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 100,376 and 99,758 shares, respectively 50,188 49,879
Additional paid-in capital 7,908 5,670
Deferred compensation (2,787) (1,251)
Retained earnings 281,196 372,796
-------------------------------
TOTAL SHAREHOLDERS' EQUITY 336,505 427,094
-------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,951,461 $2,087,452
===============================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
13
<PAGE>
<TABLE>
Consolidated Statements of Changes in
Shareholders' Equity
<CAPTION>
Common Stock
Additional
Common Par Paid-in Deferred Retained
(In thousands) Shares Value Capital Compensation Earnings Total
--------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE JANUARY 1, 1995 99,818 $ 49,909 $ 6,115 $ (2,789) $ 283,141 $ 336,376
Net earnings - - - - 50,325 50,325
Exercise of stock options 48 24 77 - - 101
Shares issued under restricted
stock awards 48 24 190 (214) - -
Amortization of deferred
compensation - - - 925 - 925
Cancellation / forfeiture of restricted stock (228) (114) (899) 28 - (985)
----------------------------------------------------------------------
BALANCE DECEMBER 31, 1995 99,686 49,843 5,483 (2,050) 333,466 386,742
Net earnings - - - - 39,330 39,330
Exercise of stock options 52 26 93 - - 119
Shares issued under restricted
stock awards 26 13 115 (128) - -
Amortization of deferred
compensation - - - 927 - 927
Cancellation / forfeiture of restricted stock (6) (3) (21) - - (24)
----------------------------------------------------------------------
BALANCE DECEMBER 29, 1996 99,758 49,879 5,670 (1,251) 372,796 427,094
Net loss - - - - (91,600) (91,600)
Exercise of stock options 57 29 75 - - 104
Shares issued under restricted
stock awards 621 310 2,393 (2,703) - -
Amortization of deferred
compensation - - - 948 - 948
Cancellation / forfeiture of restricted stock (60) (30) (230) 219 - (41)
----------------------------------------------------------------------
BALANCE DECEMBER 28, 1997 100,376 $ 50,188 $ 7,908 $ (2,787) $ 281,196 $ 336,505
======================================================================
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
14
<PAGE>
<TABLE>
Consolidated Statements of Cash Flows
<CAPTION>
For the Fiscal Year Ended
(In thousands) 12/28/97 12/29/96 12/31/95
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $(91,600) $39,330 $50,325
Adjustments to reconcile net earnings (loss) to net
cash provided (used) by operating activities:
Depreciation and amortization (a) 62,345 62,683 64,569
Deferred income taxes (39,663) (1,244) 11,976
(Gain) loss on sale of property and equipment (2,571) (4,656) 166
Write-down of property due to restructure 32,915 - -
Write-off of debt issue costs 2,208 - -
Changes in assets and liabilities (net of disposition) (b):
Accounts receivable 18,324 (7,833) 1,513
Inventories 123,151 (18,502) (30,185)
Prepaid expenses and other assets (1,368) 9,816 2,501
Accounts payable (157,652) (39,219) (6,191)
Accrued expenses (9,866) 20,673 (11,690)
Accrued restructuring costs 76,242 - -
Income taxes (33,898) 4,689 (10,155)
----------------------------------------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (21,433) 65,737 72,829
----------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (40,838) (40,746) (45,763)
Proceeds from sale of property and equipment 19,574 9,855 1,554
Other, net (2,006) 965 (3,569)
----------------------------------------
NET CASH USED BY INVESTING ACTIVITIES (23,270) (29,926) (47,778)
----------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings 483,700 421,700 518,600
Repayment of short-term borrowings (483,700) (421,700) (518,600)
Proceeds from long-term debt 206,560 73,563 6,800
Repayment of long-term debt (101,999) (2,486) (5,430)
Repayment of capitalized lease obligations (8,395) (8,693) (8,294)
Debt issuance costs (17,350) (4,048) (287)
Exercise of stock options (forfeiture of restricted stock), net 63 95 (884)
----------------------------------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 78,879 58,431 (8,095)
----------------------------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 34,176 94,242 16,956
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 329,993 235,751 218,795
----------------------------------------
CASH AND CASH EQUIVALENTS - END OF YEAR $364,169 $329,993 $235,751
========================================
(a) Includes other amortization classified as either selling, general and administrative expense or interest expense of $4,058
for fiscal 1997, $2,972 for fiscal 1996, $2,743 for fiscal 1995, and $39, $52 and $52 of discount amortization classified as
interest expense in fiscal 1997, 1996 and 1995, respectively.
(b) Includes disposition costs previously accrued which were associated with the closing of various store locations.
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
15
<PAGE>
Notes to Consolidated Financial Statements
for the Three Years Ended December 28, 1997
A. FINANCIAL STATEMENT PRESENTATION
The Company's consolidated statement 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 and other operating
results associated with the closing facilities and remerchandising activities.
"Closing facilities and remerchandising activities" reflects inventory
liquidations and other operating results of 44 stores and one distribution
center closed during 1997 as part of: (1) the Company's restructuring plan
announced in the first quarter of 1997 and (2) exiting certain product lines 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. Prior year amounts reflect operating results
for these same facilities and merchandise classifications.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of operations: Service Merchandise Company, Inc. ("Company"), with 361
stores in 34 states, is one of the nation's largest retailers of jewelry and
offers a wide selection of brand-name hard goods in its other product lines. The
major categories of goods offered by the Company are fine jewelry, kitchen and
dining, home accents and furniture, looking healthy/staying healthy, season to
season, travel and adventure, electronics and kid essentials. Customer purchases
typically take place in a Service Merchandise store. The Company is engaged in a
highly competitive business and competes with most nationally known jewelry and
hardline retail merchandisers, including department, general merchandise,
specialty and discount stores.
Principles of consolidation: The consolidated financial statements include the
accounts of the Company and its subsidiaries, all of which are wholly owned. All
significant intercompany transactions and balances have been eliminated.
Business segment: Substantially all of the Company's assets, revenue and
operating income are employed in or generated from the retail store industry
within the United States.
Fiscal year: The Company maintains its books using a 52/53 week year ending on
the Sunday closest to the end of the calendar year. There were 52 weeks in each
of the three fiscal years in the period ended December 28, 1997.
Use of estimates: The preparation of the consolidated financial statements, in
conformity with generally accepted accounting principles, requires management to
make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and related notes to the consolidated
financial statements. Changes in such estimates may affect amounts reported in
future periods.
Cash and cash equivalents: Cash and cash equivalents include cash on hand and
short-term, highly liquid investments which generally include commercial paper,
time deposits, securities under repurchase agreements, tax exempt variable rate
securities, master notes and institutional money market funds, with an original
maturity date less than 30 days. These investments are valued at cost, which
approximates market, and have a weighted-average interest rate of 5.8% and 5.6%
as of December 28, 1997 and December 29, 1996, respectively. Outstanding checks
of $73.2 million and $44.6 million as of December 28, 1997 and December 29,
1996, respectively, have been reclassified to Accounts Payable.
Accounts receivable: Accounts receivable primarily include trade accounts,
vendor allowances and customer layaway receivables.
Inventories: Inventories are valued at the lower of cost or market. Cost is
determined utilizing the first-in, first-out method.
Advertising: The Company generally expenses the costs of producing and
communicating advertising the first time the advertising takes place. Net
advertising expense was $135.0 million, $144.0 million and $146.9 million for
the fiscal years 1997, 1996 and 1995, respectively. Advertising costs of $7.8
million and $8.3 million were included in prepaid expenses at December 28, 1997
and December 29, 1996, respectively.
16
<PAGE>
Property and equipment - owned: Owned property and equipment are stated at cost.
Depreciation and amortization are provided principally on the straight-line
method over a period of five to 10 years for furniture, fixtures and equipment
and 30 years for buildings. Leasehold improvements are depreciated over the
lesser of the life of the asset or the real estate lease term. Accelerated
depreciation methods are used for income tax purposes.
Property and equipment - capitalized leases: Capitalized leases are recorded at
the lower of fair value of the leased property or the present value of the
minimum lease payments at the inception of the lease. Amortization of leased
property is computed using the straight-line method over the term of the lease.
Deferred charges: Deferred charges consist primarily of debt issuance costs and
deferred finance charges which are amortized over the life of the related debt.
This amortization is classified as interest expense.
Derivative financial instruments: As part of a strategy to maintain an
acceptable level of exposure to the risk of interest rate fluctuation, the
Company has developed a targeted mix of fixed-rate versus variable rate debt.
The Company utilizes interest rate swaps to efficiently manage this mix. All
outstanding interest rate swaps have been designated as hedges of debt
instruments. The Company recognizes interest differentials as adjustments to
interest expense in the period they occur. Gains and losses on terminations of
interest rate swaps would be deferred and amortized to interest expense over the
shorter of the original term of the agreements or the remaining life of the
associated outstanding debt. The counterparties to these instruments are major
financial institutions. The Company is exposed to credit risk in the event of
non-performance by these counterparties; however, the Company does not
anticipate non-performance by the other parties. The Company does not hold or
issue derivative financial instruments for trading purposes.
Impairment of assets: The Company reviews long-lived assets for impairment
whenever events or changes in circumstances indicate that net book value of the
asset may not be recoverable in accordance with the Statement of Financial
Accounting Standards ("SFAS") No. 121, "Accounting for Impairment of Long-Lived
Assets to Be Disposed Of."
Stock-based compensation: The Company accounts for stock-based employee
compensation in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. The
impact of the fair value method of accounting for stock-based employee
compensation is disclosed in Note H to these consolidated financial statements
in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation."
Store opening costs: Costs of opening new stores are charged to operations as
incurred.
Income taxes: The Company reports income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under SFAS No. 109, the asset and liability
method is used for computing future income tax consequences of events which have
been recognized in the Company's consolidated financial statements or income tax
returns. Deferred income tax expense or benefit is the change during the year in
the Company's deferred income tax assets and liabilities.
Net earnings (loss) per common share: Net earnings (loss) per common share for
all periods have been computed in accordance with SFAS No. 128, "Earnings Per
Share." 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. See Note I for a reconciliation of
basic and diluted earnings (loss) per share.
17
<PAGE>
C. RESTRUCTURING PLAN
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 December 28, 1997 are outlined in
the following table:
<TABLE>
<CAPTION>
Activity to Date
-------------- ------------------ ------------------ ---------------- ---------------------
Accrued
Original Restructuring
Charge Restructuring Asset Change Costs as of
(In thousands) Recorded Costs Paid Write-downs in Estimate 12/28/97
-------------- ------------------ ------------------ ---------------- ---------------------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $ 83,225 $ (12,812) $ - $ 3,098 $ 73,511
Property and equipment
write-downs 32,915 - (32,915) - -
Employee severance 4,869 (3,469) - (869) 531
Other exit costs 8,501 (4,072) - (2,229) 2,200
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 129,510 $ (20,353) $ (32,915) $ - $ 76,242
========================================================================================================== (21,178)
-------------------
Less: Current portion $ 55,064
===================
</TABLE>
The 60 stores contain 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, as well as early termination costs.
After taking into effect the property and equipment write-downs, the Company's
carrying value of the property and equipment associated with the restructuring
plan is approximately $13.9 million as of December 28, 1997. Of this amount,
assets with a carrying value of $12.5 million are classified as available for
sale. The remaining $1.4 million represents the estimated net realizable value
of property and equipment of stores planned for closure in 1998. Assets
available for sale totaling $8.4 million are classified as current assets and
are included with Prepaid Expenses and Other Assets. The remaining $4.1 million
of assets available for sale are considered non-current assets and are included
with Other Assets and Deferred Charges. Management anticipates selling
substantially all owned property and equipment associated with the restructuring
plan.
Changes in estimates are representative of management's assessments as of
December 28, 1997, that based on actual experience to date, certain charges will
be higher than originally estimated while others will be less than originally
estimated. Due to unfavorable sublease and termination experience for stores
closed to date, the Company increased the estimate for lease termination and
other real estate costs. These unfavorable results have been offset by favorable
experience in employee severance and other exit costs for stores closed to date.
The employee severance provision was recorded for the planned termination of
approximately 4,100 employees, consisting primarily of store personnel.
Management was able to place a significant number of store employees displaced
by the store closures at other stores. As a result, management estimates that a
total of 3,500 employees will have been terminated at the completion of the
restructuring plan. As of December 28, 1997, approximately 3,000 employees have
been terminated with respect to the restructuring plan. Other exit costs consist
principally of professional fees and miscellaneous costs associated with closing
the stores and distribution center.
18
<PAGE>
In the second quarter of 1997, management began the process of closing 44 of the
60 stores and one distribution center. These 44 stores and the distribution
center were closed by the end of July 1997 with the remaining closures to be
completed in 1998.
Net sales associated with the planned 60 closing stores exclusive of
remerchandising activities were approximately $246.1 million, $391.0 million and
$405.4 million for fiscal 1997, 1996 and 1995, respectively. The pre-tax
operating income (loss) associated with the planned 60 closing stores, excluding
corporate allocations, was approximately ($41.4) million, $2.0 million and $6.4
million for fiscal 1997, 1996 and 1995, respectively.
D. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
(In thousands) 12/28/97 12/29/96
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Owned assets:
Land $106,551 $121,815
Buildings 412,135 455,823
Furniture, fixtures and equipment 371,762 385,609
Leasehold improvements 110,672 125,177
Construction in progress 236 2,522
Other 6,618 6,280
--------------------------------------------------------------------------------------------------------------------
1,007,974 1,097,226
Less: Accumulated depreciation and amortization (517,629) (530,170)
--------------------------------------------------------------------------------------------------------------------
Owned assets, net $490,345 $567,056
========== ==========
Capitalized leases:
Real estate $99,750 $113,899
Furniture, fixtures and equipment 10,274 10,512
--------------------------------------------------------------------------------------------------------------------
110,024 124,411
Less: Accumulated amortization (76,735) (86,710)
--------------------------------------------------------------------------------------------------------------------
Capitalized leases, net $33,289 $37,701
========= ==========
</TABLE>
E. BORROWINGS
On September 10, 1997, the Company completed a new five year, $900 million,
fully-committed, asset-based credit facility ("Amended and Restated Credit
Facility"). The Amended and Restated Credit Facility replaced the Company's
Reducing Revolving Credit Facility, which had a maximum commitment level of $525
million. The Amended and Restated Credit Facility includes $200 million in term
loans and up to a maximum of $700 million in revolving loans including a $175
million subfacility 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 December 28, 1997, the revolving
loans carried a rate of LIBOR + 2.00%, or 7.9%. The weighted-average interest
rate on borrowings under the Company's credit facilities in fiscal 1997 and 1996
was 7.8% and 6.2%, respectively. There is a commitment fee of 3/8% on the
undrawn portion of the revolving loans. There were no revolving loans
outstanding under the Amended and Restated Credit Facility as of December 28,
1997 or under the Reducing Revolving Credit Facility as of December 29, 1996.
The Amended and Restated Credit Facility is secured by all material unencumbered
assets of the
19
<PAGE>
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 investment grade credit rating or the Company meets certain operating
performance targets.
Borrowings under the Amended and Restated Credit Facility are limited based on
(a) a borrowing base formula which considers eligible inventories, eligible
accounts receivable and mortgage values on eligible real properties and (b)
limitations contained in the Company's public senior subordinated debt
indenture. Approximately $620.2 million of borrowings were unused and available
under the Amended and Restated Credit Facility as of December 28, 1997. The
Amended and Restated Credit Facility contains certain restrictive covenants, the
most restrictive of which include: (a) maintenance of a leverage ratio and a
fixed charge coverage ratio, (b) restrictions on dividends, capital spending and
the incurrence of additional indebtedness, (c) restrictions on incurring and
assuming liens on property or assets, and (d) restrictions on mergers,
consolidations, and sales of assets. The Amended and Restated Credit Facility
excludes from financial covenant calculations the impact of up to $175 million
of pre-tax charges and costs related to the corporate restructuring and
repositioning plan. Additionally, the Amended and Restated Credit Facility
requires borrowings outstanding under the revolving loans to be less than $150
million for a period of 30 consecutive days each year. At December 28, 1997, the
Company was in compliance with all covenants.
Long-term debt consists of the following:
<TABLE>
<CAPTION>
(In thousands) 12/28/97 12/29/96
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
9% Senior Subordinated Debentures, payable in
equal installments in 2003 and 2004 $300,000 $300,000
Term loan, variable interest rate at December 28, 1997
of 8.2%, payable in quarterly installments to 2002 200,000 -
8 3/8% Senior Notes due 2001 13,799 99,788
First Mortgage Secured Notes, variable interest rate at
December 28, 1997 of 6.7%, payable in varying
amounts from 1998 to 2002 90,000 90,000
Real Estate Mortgage Financing Notes, weighted-average
fixed interest rate at December 28, 1997 of 9.2%,
payable in mortgage installments to 2011 71,987 67,895
Industrial Revenue Bonds, fixed and variable interest
rates, weighted-average interest rate at December 28, 1997
of 4.4%, payable in varying amounts to 2024 37,185 39,085
Mortgage notes payable, weighted-average fixed
interest rate at December 28, 1997 of 8.6%, payable
in varying amounts to 2022 22,264 33,689
- --------------------------------------------------------------------------------------------------------------------------
735,235 630,457
Less: Current maturities (23,723) (6,842)
- --------------------------------------------------------------------------------------------------------------------------
Long-term debt $711,512 $623,615
</TABLE>
20
<PAGE>
Long-term debt maturities are as follows:
(In thousands)
Fiscal Year
-----------------------------------
1998 $ 23,723
1999 24,771
2000 22,450
2001 23,323
2002 239,773
Thereafter 401,195
-----------------------------------
Total $ 735,235
==========
During fiscal 1997, the Company retired $86.2 million of the Company's $100
million 8 3/8% Senior Notes due 2001. As a result of this early retirement, the
Company recorded an extraordinary loss of $2.0 million after-tax, or $0.02 per
share. Additionally, a non-cash extraordinary loss of $0.6 million, or $0.01 per
share, was recorded to write-off deferred financing charges associated with the
replacement of the Company's $525 million Reducing Revolving Credit Facility
with the Amended and Restated Credit Facility.
The Company has entered into an agreement with the Long Term Credit Bank of
Japan ("LTCB") in which LTCB will lend to the Company a total of $50 million in
three equal installments of $16.7 million in June of 1998, 1999 and 2000 as its
portion of the First Mortgage Secured Notes matures. The new notes will carry a
floating interest rate of LIBOR + 2.25%, mature on March 1, 2002 and will be
secured with a second lien on the properties securing the $90 million permanent
mortgage financing until those notes are paid, at which time, the Company will
provide first liens on certain properties to secure this note.
In fiscal 1997 and 1996, the Company issued $6.6 million and $68.2 million of
Real Estate Mortgage Financing Notes, respectively, payable to a bank. During
fiscal 1996, the Company issued Mortgage Notes Payable of $5.4 million.
The 9% Senior Subordinated Debentures are subordinated to all senior
indebtedness of the Company, as defined, and are callable, at the Company's
option, beginning December 1997 at a premium of 104.5%, which decreases annually
until reaching par in December 2000. Interest on the Debentures is payable
semi-annually in June and December.
Mortgages and Industrial Revenue Bonds are collateralized by property and
equipment having a net book value of approximately $155.3 million and $22.2
million, respectively, at December 28, 1997. The Industrial Revenue Bonds are
primarily floating rate demand obligations.
Cash payments for interest related to debt and capitalized leases were $78.4
million, $71.3 million, and $79.6 million for fiscal 1997, 1996 and 1995,
respectively.
The Company has commercial and standby letters of credit used to secure
corporate obligations. The commercial letters of credit have contractual amounts
totaling $44.5 million and $40.5 million at December 28, 1997 and December 29,
1996, respectively. The standby letters of credit have contractual amounts
totaling $59.0 million and $59.1 million at December 28, 1997 and December 29,
1996, respectively.
21
<PAGE>
F. LEASE COMMITMENTS
The Company has both capital and operating lease agreements for stores and other
facilities as well as for certain furniture, fixtures and equipment. Under most
of these lease agreements, the Company pays taxes, insurance and maintenance
costs. Initial lease terms for stores generally range from 10 to 25 years with
renewal periods for an additional five to 10 years. Certain store leases provide
for additional contingent rental payments based on a percentage of sales in
excess of specified minimum amounts.
Future minimum lease payments as of December 28, 1997 (inclusive of leases at
closed stores that have not yet been terminated) are as follows:
<TABLE>
<CAPTION>
Capitalized Lease Obligations
Furniture, Fixtures Operating
(In thousands) Real Estate and Equipment Leases
------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fiscal Year
1998 $13,058 $2,424 $60,253
1999 12,059 2,087 58,641
2000 11,409 364 55,795
2001 10,423 66 53,390
2002 9,431 - 51,256
Thereafter 31,493 - 345,402
------------------------------------------------------------------------------------------------------------
Total minimum payments 87,873 4,941 $624,737
Less: Imputed interest and executory costs (33,914) (438) ========
------------ ---------
Present value of net minimum lease payments 53,959 4,503
Less: Current maturities (6,533) (1,919)
-------------------------------------------------------------------------------------------
Capitalized lease obligations $47,426 $2,584
==================================
</TABLE>
Minimum sublease rentals, not deducted from above, to be received in the future
under noncancellable operating subleases aggregated $21.4 million at December
28, 1997. Minimum lease rentals to be received in the future on noncancellable
leases of owned properties aggregated $21.9 million at December 28, 1997.
Capitalized real estate and equipment leases are at effective interest rates of
approximately 12.5% and 8.3%, respectively, as of December 28, 1997. Additions
to capitalized leases in fiscal 1997 were $5.4 million as compared to $0.8
million in fiscal 1996.
Rental expense, net of lease income on owned properties and sublease income on
leased properties, consists of the following:
<TABLE>
<CAPTION>
Fiscal Year
(In thousands) 1997 1996 1995
------------------------------------------------------------------------------------
<S> <C> <C> <C>
Minimum rentals $74,163 $85,038 $81,926
Contingent rentals 1,237 1,376 1,379
Sublease rental income (3,792) (4,296) (4,029)
Owned properties rental income (3,962) (4,819) (4,759)
------------------------------------------------------------------------------------
Net rental expense $67,646 $77,299 $74,517
====================================
</TABLE>
22
<PAGE>
G. FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value of financial instruments has been estimated by the Company using
available market information as of December 28, 1997 and December 29, 1996, and
valuation methodologies considered appropriate to the circumstances. The
estimates presented are not necessarily indicative of amounts the Company could
realize in a current market exchange.
<TABLE>
<CAPTION>
12/28/97 12/29/96
Carrying Estimated Carrying Estimated
(In thousands) Amount Fair Value Amount Fair Value
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Cash and cash equivalents $364,169 $364,169 $329,993 $329,993
Liabilities:
9% Senior Subordinated Debentures 300,000 213,000 300,000 252,750
Term Loan 200,000 196,593 - -
Mortgages 184,251 176,846 191,584 176,923
Industrial Revenue Bonds 37,185 37,185 39,085 39,085
8 3/8% Senior Notes 13,799 12,833 99,788 94,801
</TABLE>
Cash and cash equivalents: The carrying amount approximates fair value due to
the short maturity of these instruments (less than three months).
9% Senior Subordinated Debentures and 8 3/8% Senior Notes: Fair value is based
on quoted market prices from the New York Stock Exchange at December 26, 1997
and December 27, 1996.
Term Loan and Mortgages: Fair value is based on management's estimate of the
present value of estimated future cash flows discounted at the current market
rate for financial instruments with similar characteristics and maturity.
Industrial Revenue Bonds: The carrying value approximates the fair value. Due to
the variable rate nature of the instruments, the interest rate paid by the
Company is equivalent to the current market rate demanded by investors;
therefore, the instruments trade at par.
Derivatives: As of December 28, 1997, the Company was party to interest rate
swaps covering $125 million in debt and expiring in December 2000. These swaps
change the floating interest rate exposure on the $125 million of debt to fixed
interest rate exposure. The Company will pay a weighted average fixed rate of
5.97% on the $125 million notional amount while receiving the three month LIBOR
rate which was 5.91% as of December 28, 1997. The carrying value and fair value
of these instruments were $0 and ($0.1) million, respectively, as of December
28, 1997.
H. STOCK OPTIONS AND AWARDS
Under the Company's employee stock incentive plans, the Compensation Committee
of the Board of Directors ("Compensation Committee") has authority to grant the
following types of awards: (a) stock options; (b) stock appreciation rights; (c)
restricted stock; (d) deferred stock; (e) stock purchase rights and/or (f) other
stock-based awards. Awards are exercisable subject to terms and conditions as
determined by the Compensation Committee with no awards exercisable ten years
after the date of grant.
In fiscal 1991, the Board of Directors adopted the 1991 Directors' Equity Plan
("Directors' Plan") for nonemployee directors. Under the Directors' Plan,
eligible directors annually receive 188 shares of restricted stock and stock
options exercisable for 750 shares of
23
<PAGE>
the Company's common stock. The Directors' Plan was amended in fiscal 1997 to
permit participating nonemployee directors to receive all or any portion of
their quarterly retainer in the form of an option to purchase shares of Common
Stock. Vesting of the restricted stock occurs one year from the date of grant.
The stock options are granted with an exercise price equal to the fair market
value of the Company's common stock as of the date of grant, are exercisable in
20% installments beginning one year from the date of grant and expire ten years
from the grant date. An aggregate of 296,875 shares of the Company's common
stock is authorized to be issued under this plan.
During fiscal 1995, the Company amended and restated the 1989 Employee Stock
Incentive Plan ("Stock Incentive Plan") to increase the number of shares
issuable, to extend the term during which awards may be made under the Stock
Incentive Plan and to limit the amount of stock-based awards that may be granted
to any single officer or key employee under that plan. Options are generally
granted with a three-to five-year vesting requirement. At December 28, 1997,
there were approximately 0.4 million shares of unissued common stock reserved
for issuance under the Company's Stock Incentive Plan.
Stock options: A summary of the status of the Company's two fixed stock option
plans for fiscal 1997, 1996 and 1995, and changes during those years is
presented below:
<TABLE>
<CAPTION>
1997 1996 1995
Weighted Weighted Weighted
-Average -Average -Average
(Shares in thousands) Exercise Exercise Exercise
Fixed Options Shares Price Shares Price Shares Price
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 5,759 $5.35 5,521 $6.00 4,149 $6.75
Granted 5,034 3.92 1,924 4.95 2,091 4.78
Exercised (57) 1.91 (52) 2.43 (48) 2.47
Forfeited or cancelled (1,610) 5.54 (1,634) 7.20 (671) 7.09
------- ------- -----
Outstanding, end of year 9,126 4.65 5,759 5.35 5,521 6.00
======= ======= =====
Options exercisable at year-end 2,970 5.22 2,361 5.39 2,085 5.73
- -------------------------------------------------------------------------------------------------------------------------------
Weighted-average fair value of
options granted during the year $2.19 $2.69 $2.71
</TABLE>
The following table summarizes information about fixed stock options outstanding
at December 28, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
(Shares in thousands)
Range of Number Weighted-Average Number
Exercise Outstanding Remaining Weighted-Average Exercisable Weighted-Average
Prices at 12/28/97 Contractual Life Exercise Price at 12/28/97 Exercise Price
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$2.20 - 3.00 575 1.17 $2.74 575 $2.74
3.01 - 4.75 5,995 8.94 4.22 985 4.54
4.76 - 6.50 1,627 7.95 5.11 606 5.17
6.51 - 10.38 929 4.27 7.82 804 7.87
----- -----
$2.20 - 10.38 9,126 7.80 4.65 2,970 5.22
===== =====
</TABLE>
24
Had the fair value of options granted under these plans beginning in 1995 been
recognized as compensation expense on a straight-line basis over the vesting
period of the grant, the Company's net earnings (loss) and earnings (loss) per
share would have been adjusted to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
(In thousands)
Fiscal Year 1997 1996 1995
-----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net earnings (loss) As reported $(91,600) $39,330 $50,325
Pro forma $(94,285) $37,896 $49,874
Earnings (loss) per share - basic and diluted As reported $(0.92) $0.39 $0.50
Pro forma $(0.94) $0.38 $0.50
</TABLE>
The pro forma effect on net earnings (loss) for 1997, 1996 and 1995 is not
representative of the pro forma effect on net earnings (loss) in future years
because it does not take into consideration pro forma compensation expense
related to grants made prior to 1995. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions applied to options granted:
<TABLE>
<CAPTION>
Fiscal Year 1997 1996 1995
---------------------------------------------------------------------------------
<S> <C> <C> <C>
Dividend yield N/A N/A N/A
Expected volatility 47% 50% 52%
Risk-free interest rate range 5.9 to 6.8% 5.4 to 6.8% 5.8 to 6.9%
Expected life 6 years 6 years 6 years
</TABLE>
Restricted stock awards: Periodically, the Company issues shares of restricted
stock under provisions of the Stock Incentive Plan. A total of 675,107
restricted shares remained outstanding at December 28, 1997. These remaining
shares will vest at various rates through the year 2002. During the vesting
periods, none of such shares may be sold, transferred, pledged or assigned.
During the restriction period, holders of the shares may exercise full voting
rights and receive all dividends with respect to those shares.
<TABLE>
Restricted stock activity for the last three fiscal years was as follows:
<CAPTION>
1997 1996 1995
(Shares in thousands) Shares Shares Shares
----------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding, beginning of year 512 515 1,202
Granted 621 26 48
Vested (398) (23) (507)
Forfeited or cancelled (60) (6) (228)
----------------------------------------------------------------------
Outstanding, end of year 675 512 515
======================================================================
Weighted-average fair value of
restricted stock granted during
the year $4.35 $4.95 $4.38
</TABLE>
Deferred compensation of $2.7 million was recorded during fiscal 1997 in
connection with restricted stock awards. Deferred com-
25
<PAGE>
pensation amortization relating to restricted stock awards of $0.9 million was
charged to operations in fiscal 1997, 1996 and 1995.
Service Merchandise Foundation option: The Service Merchandise Foundation
("Foundation"), a private charitable foundation, was formed in 1990. As a
charitable contribution, the Company granted the Foundation an option to
purchase approximately 1.9 million shares of common stock at $2.20 per share,
the then current market price. The option is exercisable in whole or in part
from the date of grant until October 15, 2000. Under applicable Internal Revenue
Service rulings, the stock option may not be exercised directly by the
Foundation. The Foundation may sell all or a part of the option to unrelated
not-for-profit entities, which may then exercise the option directly. These
options are not treated as granted and outstanding until such time the
Foundation sells them.
I. EARNINGS PER SHARE
The following table reconciles weighted-average shares used in the earnings per
share calculation for fiscal years 1997, 1996 and 1995, respectively:
<TABLE>
<CAPTION>
Income Shares Per Share
(In thousands) (Numerator) (Denominator) Amount
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
FOR THE YEAR ENDED DECEMBER 28, 1997:
Basic EPS - Before Extraordinary Item $(88,957) 99,930 $ (0.89)
Effect of Dilutive Securities:
None - -
-------------------------------------------
Diluted EPS - Before Extraordinary Items $(88,957) 99,930 $ (0.89)
===========================================
FOR THE YEAR ENDED DECEMBER 29, 1996:
Basic EPS $ 39,330 99,209 $ 0.39
Effect of Dilutive Securities:
Restricted Stock - 521
Options Outstanding - 596
-------------------------------------------
Diluted EPS $ 39,330 100,326 $ 0.39
===========================================
FOR THE YEAR ENDED DECEMBER 31, 1995:
Basic EPS $ 50,325 99,059 $ 0.50
Effect Of Dilutive Securities:
Restricted Stock - 627
Options Outstanding - 671
-------------------------------------------
Diluted EPS $ 50,325 100,357 $ 0.50
===========================================
</TABLE>
26
<PAGE>
The following table includes options to purchase shares of common stock which
were outstanding at the end of the respective fiscal year but were not included
in the computation of diluted earnings per share because the options' exercise
price was greater than the average market price of the common shares. Fiscal
1997 includes all options to purchase shares of common stock and restricted
stock as they were anti-dilutive in the computation of diluted earnings per
share.
<TABLE>
<CAPTION>
Number of Shares
Year Range of Grant Dates Outstanding at Year-End Range of Prices Range of Expiration Dates
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997 04/23/88 - 11/03/97 9.8 million $ 2.20 - $10.38 04/23/98 - 11/03/07
1996 10/27/88 - 11/08/95 1.6 million $ 5.77 - $10.38 10/27/98 - 11/08/05
1995 04/15/92 - 10/18/93 0.9 million $ 10.08 - $10.38 04/15/02 - 10/18/03
</TABLE>
J. SHAREHOLDERS' RIGHTS PLAN
Under the 1998 Shareholder Rights Plan, a Series A Junior Preferred Stock
Purchase Right (the "Rights") was issued for each outstanding share of Common
Stock to shareholders of record at the close of business on February 9, 1998.
Each Right entitles the registered holders to purchase from the Company one
one-hundredth of a share (a "Unit") of Series A Junior Preferred Stock, par
value $1 per share (the "Preferred Stock"), at a purchase price of $10 per Unit,
subject to adjustment. Initially, the Rights will attach to all certificates
representing shares of outstanding Common Stock, and no separate Rights
Certificates will be distributed. The Rights will separate from the Common
Stock, and the Distribution Date will occur, upon the earlier of (i) 10 days
following public announcement ("Stock Acquisition Date") that a person or group
of affiliated persons (other than the Company, or certain of its affiliates) (an
"Acquiring Person") has acquired, obtained the right to acquire, or otherwise
obtained beneficial ownership of 15% or more of the then outstanding shares of
Common Stock, or (ii) 10 days (or such date as may be determined by the
Independent Directors prior to any person becoming an "Acquiring Person")
following the date that a tender offer or exchange offer that would result in a
person or group beneficially owning 15% or more of the then outstanding shares
of Common Stock is first published or sent or given to shareholders. The Rights
are not exercisable until the Distribution Date and will expire at the close of
business on the tenth anniversary of the Rights Agreement unless earlier
redeemed by the Company as described below. If any person becomes the beneficial
owner of 15% of the Common Stock or if a 15% or more shareholder engages in
certain self-dealing transactions or a merger with the Company where the Company
is not the surviving corporation, each Right will entitle the shareholder, under
alternative circumstances, to buy either securities of the Company or securities
of an acquiring company (depending on the form of the transaction) at an
exercise price that will be half of the market value of such securities at the
time. At any time until ten days following the Stock Acquisition Date, a
majority of the Independent Directors may redeem the Rights in whole, but not in
part, at a price of $.01 per Right, payable, at the election of such majority of
Independent Directors, in cash or shares of Common Stock.
K. RETIREMENT PLAN
The Company has a defined benefit pension plan in which all employees of the
Company are eligible to participate upon reaching age 21 and completing one year
of qualified service, as defined in the pension plan. Benefits are based on
years of service and employee compensation. Contributions to the plan are
intended to provide not only for benefits attributed to service to date, but
also for benefits expected to be earned in the future. The Company's funding
policy has been to contribute at least the amount required by the Employee
Retirement Income Security Act of 1974, but no more than the maximum tax
deductible amount. In fiscal 1997, 1996 and 1995, the Company made contributions
of approximately $4.8 million, $8.9 million and $8.8 million, respectively, to
the pension plan.
27
<PAGE>
The following table sets forth the funded status of the pension plan and net
pension expense:
<TABLE>
<CAPTION>
(In thousands) 12/28/97 12/29/96
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Actuarial present value of benefit obligations:
Accumulated benefit obligation (includes $53,449 and
$47,711 of vested benefit obligation, respectively) $(54,383) $(49,411)
========= =========
Projected benefit obligation $(65,394) $(63,732)
Plan assets at fair value, primarily
listed corporate stocks and bonds 73,445 69,945
- ---------------------------------------------------------------------------------------------------------------------------
Plan assets in excess of projected benefit obligation 8,051 6,213
Unrecognized net loss 2,200 4,070
Unrecognized transitional liability, net of amortization (2,276) (2,655)
Unrecognized prior service cost (825) (1,014)
- ---------------------------------------------------------------------------------------------------------------------------
Prepaid pension cost $7,150 $6,614
=====================================
Service cost $6,049 $5,946
Interest on projected benefit obligation 4,850 4,463
Actual return on plan assets (9,215) (8,731)
Net amortization and deferrals 2,811 3,021
- ---------------------------------------------------------------------------------------------------------------------------
Net pension expense $4,495 $4,699
=====================================
Net pension expense was $5.5 million for fiscal 1995.
</TABLE>
The Company chose to remeasure liabilities in June 1997 to reflect the impact of
closing 44 stores and one distribution center as part of the Company's
Restucturing Plan (See Note C). This remeasurement resulted in a gain of $0.3
million due to curtailment of benefits.
Assumptions used in determining the actuarial present value of the projected
benefit obligation were as follows: weighted-average discount rates for fiscal
1997 and 1996 were 7.3% and 7.8%, respectively; expected long-term rate of
return on pension plan assets for both fiscal 1997 and 1996 was 9.5%; and rates
of increase in future compensation levels for fiscal 1997 and 1996 were 4.0% and
4.5%, respectively.
L. EMPLOYEE SAVINGS PLAN
The Service Merchandise Company, Inc. Savings and Investment Plan ("Plan") is a
voluntary compensation deferral plan under Section 401(k) of the Internal
Revenue Code. All employees of the Company are eligible to participate upon
reaching age 21 and completing one year of qualified service, as defined in the
Plan. Eligible employees may elect to defer from 1% to 15% of their
compensation. The Company will match, based on earnings performance, up to 50%
of the first 6% of employees' salary deferral. Deferrals are invested in Company
common stock and/or in other securities and investments as permitted by the Plan
and directed by each employee.
Company contributions to the Plan were $1.3 million, $2.1 million and $2.1
million for fiscal 1997, 1996 and 1995, respectively. The Company match
percentage equaled 20% in fiscal 1997 and 30% in fiscal 1996 and 1995.
28
<PAGE>
M. INCOME TAXES
Deferred income tax assets and liabilities at December 28, 1997 and December 29,
1996 are comprised of the following:
<TABLE>
<CAPTION>
(In thousands) 12/28/97 12/29/96
---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred income tax assets:
Financial accruals $42,106 $15,234
Capitalized leases 9,277 11,687
Other 5,197 7,436
---------------------------------------------------------------------------------------------------------------
Deferred income tax asset 56,580 34,357
------------------------------
Deferred income tax liabilities:
Depreciation (22,185) (38,522)
Layaway sales (2,489) (4,688)
Pension liability (3,358) (3,005)
Other (4,245) (3,501)
---------------------------------------------------------------------------------------------------------------
Deferred income tax liability (32,277) (49,716)
------------------------------
Net deferred income tax asset/(liability) $24,303 $(15,359)
==============================
Net current deferred income tax asset/(liability) $22,478 $(7,437)
Net long-term deferred income tax asset/(liability) 1,825 (7,922)
---------------------------------------------------------------------------------------------------------------
Net deferred income tax asset/(liability) $24,303 $(15,359)
==============================
</TABLE>
The provision for income taxes, net of tax benefit of $1.6 million in fiscal
1997 on the extraordinary loss from early extinguishment of debt, consists of
the following:
<TABLE>
<CAPTION>
Fiscal Year
(In thousands) 1997 1996 1995
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current income taxes:
Federal $(11,896) $21,695 $19,185
State and local (759) 1,271 1,050
--------------------------------------------------------------------------------------------------------------------
(12,655) 22,966 20,235
Deferred income taxes (40,720) 632 10,610
--------------------------------------------------------------------------------------------------------------------
Total income taxes $(53,375) $23,598 $30,845
================================================
</TABLE>
A reconciliation of the provision for income taxes to the federal statutory rate
is as follows:
<TABLE>
<CAPTION>
Fiscal Year
1997 1996 1995
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory federal tax rate 35.0% 35.0% 35.0%
State and local income taxes, net of federal benefit 1.3% 1.6% 2.0%
Other 1.2% 0.9% 1.0%
--------------------------------------------------------------------------------------------------------------------
Effective tax rate 37.5% 37.5% 38.0%
==============================================
</TABLE>
Cash payments for income taxes were $21.1 million, $19.9 million and $28.7
million in fiscal 1997, 1996 and 1995, respectively.
29
<PAGE>
N. OTHER COMMITMENTS AND CONTINGENCIES
The Company was involved in litigation, investigations of a routine nature and
various legal matters during fiscal 1997 which are being defended and handled in
the ordinary course of business. While the ultimate results of these matters
cannot be determined or predicted, management believes that they will not have a
material adverse effect on the Company's results of operations or financial
position.
O. QUARTERLY FINANCIAL INFORMATION - UNAUDITED
The Company has historically incurred a net loss throughout the first three
quarters of the year due to the seasonality of its business. The results of
operations for the first three quarters are not necessarily indicative of the
operating results for the entire fiscal year.
<TABLE>
<CAPTION>
(In thousands, except per share data)
THREE PERIODS ENDED 3/30/97 6/29/97 9/28/97 12/28/97
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales $ 686,400 $ 877,361 $ 656,144 $1,442,873
====================================================================
Gross margin (a) $ 154,760 $ 183,068 $ 151,190 $ 361,998
====================================================================
Earnings (loss) before extraordinary item $ (107,217) $ (17,547) $ (22,360) $ 58,167
Extraordinary loss from early extinguishment
of debt, net of tax benefit - - (2,643) -
--------------------------------------------------------------------
Net earnings (loss) $ ( 107,217) $ (17,547) $ (25,003) $ 58,167
====================================================================
Per common share - basic and diluted:
Earnings (loss) before extraordinary item $ (1.07) $ (0.18) $ (0.22) $ 0.58
Extraordinary loss from early
extinguishment of debt, net of tax benefit - - (0.03) -
--------------------------------------------------------------------
Net earnings (loss) $ (1.07) $ (0.18) $ (0.25) $ 0.58
====================================================================
THREE PERIODS ENDED 3/31/96 6/30/96 9/29/96 12/29/96
- --------------------------------------------------------------------------------------------------------------------------
Net sales $ 715,628 $ 859,984 $ 738,328 $1,641,076
====================================================================
Gross margin (a) $ 160,758 $ 207,851 $ 175,118 $ 413,328
====================================================================
Net earnings (loss) $ (24,715) $ (1,822) $ (12,324) $ 78,191
====================================================================
Per common share - basic and diluted:
Net earnings (loss) $ (0.24) $ (0.02) $ (0.12) $ 0.78
====================================================================
(a) Gross margin after cost of merchandise sold and buying and occupancy expenses.
</TABLE>
30
<PAGE>
Independent Auditors' Report
BOARD OF DIRECTORS AND SHAREHOLDERS
SERVICE MERCHANDISE COMPANY, INC.
We have audited the accompanying Consolidated Balance Sheets of Service
Merchandise Company, Inc. and subsidiaries as of December 28, 1997 and December
29, 1996 and the related Consolidated Statements of Operations, Changes in
Shareholders' Equity and Cash Flows for each of the three years in the period
ended December 28, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Service Merchandise Company, Inc.
and subsidiaries at December 28, 1997 and December 29, 1996, and the
consolidated results of their operations and cash flows for each of the three
years ended December 28, 1997, in conformity with generally accepted accounting
principles.
/s/ DELOITTE & TOUCHE LLP
- -------------------------
DELOITTE & TOUCHE LLP
FEBRUARY 6, 1998
NASHVILLE, TENNESSEE
Statement of Responsibility
The Company is responsible for the information presented in this Annual Report.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles and present fairly in all material
respects the Company's Consolidated Balance Sheets, Statements of Operations,
Changes in Shareholders' Equity and Cash Flows. Certain amounts included in the
consolidated financial statements are estimated based on currently available
information and judgement regarding the outcome of future conditions and
circumstances. Financial information presented elsewhere in this Annual Report
is consistent with that in the consolidated financial statements.
Management developed and maintains a system of accounting and controls,
including an extensive internal audit program, designed to provide reasonable
assurance that the Company's assets are protected from improper use, and
accounting records provide a reliable basis for the preparation of financial
statements. This system is continually reviewed, improved and modified in
response to changing business conditions and operations and to recommendations
made by the independent and internal auditors. Management believes the
accounting and control systems provide reasonable assurance that assets are
safeguarded and financial information is reliable.
/s/ GARY M. WITKIN /s/ S. CUSANO
------------------- ---------------------------
GARY M. WITKIN S. CUSANO
PRESIDENT AND CHIEF EXECUTIVE VICE PRESIDENT
EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
31
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
The following is a list of subsidiaries of the Registrant as of December 28,
1997 all of which are wholly-owned:
STATE OF
PARENT INCORPORATION
Service Merchandise Company, Inc. Tennessee
SUBSIDIARIES
Service Merchandise Co. Broad, Inc. Tennessee
Service Merchandise Co. No. 80, Inc. Tennessee
Service Merchandise Co. No. 34, Inc. Tennessee
Service Merchandise Co. No. 35, Inc. Tennessee
Service Merchandise Co. No. 51, Inc. Illinois
Service Merchandise Co. No. 93, Inc. Tennessee
Service Merchandise Co. No. 30, Inc. Tennessee
Service Merchandise Co. No. 99, Inc. Nevada
Service Merchandise Company of Iowa, Inc. Tennessee
Service Merchandise Company of Kansas, Inc. Tennessee
The Toy Store, Inc. Tennessee
B. A. Pargh Co., Inc. Tennessee
Service Merchandise Showrooms, Inc. Tennessee
Wholesale Supply Company, Inc. Tennessee
Homeowners Warehouse, Inc. Florida
The Lingerie Store, Inc. Tennessee
The McNally Supply Company Tennessee
SMC Aviation, Inc. New Hamphshire
H. J. Wilson Co., Inc. Louisiana
Service Merchandise Co. of New York, Inc. Tennessee
Travel Management Consultants, Inc. Tennessee
A. F. S. Marketing Services, Inc. Tennessee
Service Merchandise Financial Co., Inc. Tennessee
Service Merchandise Indiana Partners Indiana
Service Merchandise of Tennessee, Limited Partnership Delaware
Service Merchandise of Texas, Limited Partnership Delaware
SMC-SPE-1, Inc. Delaware
SMC-SPE-2, Inc. Delaware
SMC-HC, Inc. Delaware
Exhibit 23
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-60201, 33-7079, 33-11340, 33-30983 and 33-50185 on Form S-8 of our reports
dated February 6, 1998, appearing in and incorporated by reference in the Annual
Report on Form 10-K of Service Merchandise Company, Inc. for the fiscal year
ended December 28, 1997.
/s/ Deloitte & Touche LLP
DELOITTE & TOUCHE LLP
Nashville, Tennessee
March 27, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Service Merchandise Company, Inc. Form 10-K for the year ended December 28,
1997 and is qualified in its entirety by reference to such financial
statements and accompanying notes to the financial statements detailed in
Exhibit 13 of the Form 10-K which is incorporated by reference in Part II
of the Form 10-K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-mos
<FISCAL-YEAR-END> DEC-28-1997
<PERIOD-START> DEC-30-1996
<PERIOD-END> DEC-28-1997
<CASH> 364,169
<SECURITIES> 0
<RECEIVABLES> 46,586
<ALLOWANCES> 3,456
<INVENTORY> 929,818
<CURRENT-ASSETS> 1,384,871
<PP&E> 1,117,999
<DEPRECIATION> 594,365
<TOTAL-ASSETS> 1,951,461
<CURRENT-LIABILITIES> 798,370
<BONDS> 761,522
0
0
<COMMON> 100,376<F1>
<OTHER-SE> 286,317
<TOTAL-LIABILITY-AND-EQUITY> 1,951,461
<SALES> 3,662,778
<TOTAL-REVENUES> 3,662,778
<CGS> 2,811,762
<TOTAL-COSTS> 2,811,762
<OTHER-EXPENSES> 785,307<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 78,531
<INCOME-PRETAX> (142,332)
<INCOME-TAX> (53,375)
<INCOME-CONTINUING> (88,957)
<DISCONTINUED> 0
<EXTRAORDINARY> (2,643)
<CHANGES> 0
<NET-INCOME> (91,600)
<EPS-PRIMARY> (0.92)
<EPS-DILUTED> (0.92)
<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>
