<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 29, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------ ------
Commission File No. 1-9223
SERVICE MERCHANDISE COMPANY, INC.
(Exact name of registrant as specified in its charter)
TENNESSEE 62-0816060
(State or other Jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P. O. Box 24600, Nashville, TN
37202-4600
(Mailing Address)
7100 Service Merchandise Drive, Brentwood, TN
(Address of principal executive offices)
37027
(Zip code)
(615) 660-6000
(Registrant's telephone number including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock as of the latest practicable date.
As of April 26, 1998, there were 100,364,902 shares of
Service Merchandise Company, Inc. common stock outstanding.
<PAGE>
<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<CAPTION>
Page No.
<S> <C>
PART I - FINANCIAL INFORMATION
Consolidated Statements of Operations (Unaudited) - First Quarter Ended March
29, 1998 and March 30, 1997 . . . . . . . . . . . . . . . . . . . . . . . . 3
Consolidated Balance Sheets - March 29, 1998 (Unaudited), March 30, 1997
(Unaudited) and December 28, 1997 . . . . . . . . . . . . . . . . . . . . . 4
Consolidated Statements of Cash Flows (Unaudited) - First Quarter Ended March
29, 1998 and March 30, 1997. . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Consolidated Financial Statements (Unaudited) . . . . . . . . . . 6-9
Management's Discussion and Analysis of Financial Condition and Results of
Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10-15
PART II - OTHER INFORMATION
Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Exhibits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16-17
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
</TABLE>
-2-
<PAGE>
<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Statements of Operations (Unaudited)
(In thousands, except per share data)
<CAPTION>
First Quarter Ended
----------------------------
March 29, March 30,
----------------------------
1998 1997
----------------------------
<S> <C> <C>
Net sales
Operations excluding closing facilities and remerchandising activities $ 592,093 $ 612,660
Closing facilities and remerchandising activities 2,089 73,740
----------------------------
594,182 686,400
Costs and expenses:
Cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities and remerchandising activities 448,193 470,981
Closing facilities and remerchandising activities 2,888 60,659
----------------------------
451,081 531,640
Gross margin after cost of merchandise sold and buying and occupancy expenses
Operations excluding closing facilities and remerchandising activities 143,900 141,679
Closing facilities and remerchandising activities (799) 13,081
----------------------------
143,101 154,760
Selling, general and administrative expenses
Operations excluding closing facilities and remerchandising activities 147,160 150,982
Closing facilities and remerchandising activities 476 13,468
----------------------------
147,636 164,450
Restructuring charge - 129,510
Depreciation and amortization
Operations excluding closing facilities and remerchandising activities 14,435 13,485
Closing facilities and remerchandising activities - 1,327
----------------------------
14,435 14,812
Loss before interest and income taxes (18,970) (154,012)
Interest expense-debt 17,827 15,547
Interest expense-capitalized leases 1,764 1,989
----------------------------
Loss before income taxes (38,561) (171,548)
Income taxes benefit (14,460) (64,331)
----------------------------
Net loss $ (24,101) $ (107,217)
============================
Weighted average common shares - basic and diluted 99,702 99,259
============================
Per common share:
Net loss - basic and diluted $ (0.24) $ (1.08)
============================
See Notes to Consolidated Financial Statements.
-3-
</TABLE>
<PAGE>
<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except per share data)
<CAPTION>
(Unaudited)
----------------------------
March 29, March 30, December 28,
1998 1997 1997 (1)
-----------------------------------------
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $71,530 $44,218 $364,169
Accounts receivable, net of allowance of
$2,712, $3,409 and $3,456, respectively 47,133 45,592 43,130
Income taxes 17,783 50,912 -
Inventories 935,626 1,078,051 929,818
Prepaid expenses and other assets 18,002 21,221 25,276
Deferred income taxes 22,478 - 22,478
-----------------------------------------
TOTAL CURRENT ASSETS 1,112,552 1,239,994 1,384,871
Property and equipment:
Owned assets, net of accumulated depreciation of
$529,498, $540,681 and $517,629, respectively 480,965 522,975 490,345
Capitalized leases, net of accumulated amortization of
$72,854, $79,778 and $76,735, respectively 31,575 36,481 33,289
Other assets and deferred charges 53,598 25,814 42,956
-----------------------------------------
TOTAL ASSETS $1,678,690 $1,825,264 $1,951,461
=========================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Notes payable to banks $ - $101,000 $ -
Accounts payable 308,820 404,081 482,235
Accrued expenses 173,067 166,262 214,451
State and local sales taxes 22,282 25,177 48,331
Accrued restructuring costs - current 18,474 27,066 21,178
Current maturities of long-term debt 23,807 7,116 23,723
Current maturities of capitalized lease obligations 8,572 7,445 8,452
Deferred income taxes - 7,437 -
-----------------------------------------
TOTAL CURRENT LIABILITIES 555,022 745,584 798,370
Accrued restructuring costs 54,455 67,301 55,064
Long-term debt 708,836 628,331 711,512
Capitalized lease obligations 47,847 56,034 50,010
Deferred income taxes - 7,922 -
-----------------------------------------
TOTAL LIABILITIES 1,366,160 1,505,172 1,614,956
-----------------------------------------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, $1 par value, authorized 4,600 shares,
undesignated as to rate and other rights, none issued
Series A Junior Preferred Stock, $1 par value, authorized
1,100 shares, none issued
Common stock, $.50 par value, authorized 500,000 shares, issued
and outstanding 100,366, 99,758 and 100,376 shares, respectively 50,183 49,879 50,188
Additional paid-in capital 7,873 5,653 7,908
Deferred compensation (2,621) (1,019) (2,787)
Retained earnings 257,095 265,579 281,196
-----------------------------------------
TOTAL SHAREHOLDERS' EQUITY 312,530 320,092 336,505
-----------------------------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,678,690 $1,825,264 $1,951,461
=========================================
(1) Derived from fiscal year ended December 28, 1997 audited consolidated financial statements.
See Notes to Consolidated Financial Statements.
-4-
</TABLE>
<PAGE>
<TABLE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
<CAPTION>
First Quarter Ended
------------------------
March 29, March 30,
------------------------
1998 1997
------------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (24,101) $ (107,217)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 15,848 15,645
Gain on sale of property and equipment (1,764) (2,511)
Write down of property and equipment due to restructuring - 32,915
Changes in assets and liabilities (net of disposition):
Accounts receivable - net (4,003) 15,862
Inventories (5,808) (25,082)
Prepaid expenses 5,181 (5,761)
Accounts payable (173,415) (235,806)
Accrued expenses and state and local taxes (67,433) (83,049)
Accrued restructuring costs (3,313) 94,367
Income taxes (17,783) (84,810)
------------------------
NET CASH USED BY OPERATING ACTIVITIES (276,591) (385,447)
------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (4,912) (4,388)
Proceeds from sale of property and equipment 4,765 3,626
Other assets, net (10,884) (3,472)
------------------------
NET CASH USED BY INVESTING ACTIVITIES (11,031) (4,234)
------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from short-term borrowings - 101,000
Proceeds from long-term debt - 6,560
Repayment of long-term debt (2,592) (1,583)
Repayment of capitalized lease obligations (2,021) (1,945)
Debt issuance costs (362) (108)
Exercise of stock options (forfeiture of restricted stock), net (42) (18)
------------------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES (5,017) 103,906
------------------------
NET DECREASE - CASH AND CASH EQUIVALENTS (292,639) (285,775)
CASH AND CASH EQUIVALENTS - BEG. OF PERIOD 364,169 329,993
------------------------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 71,530 $ 44,218
========================
See Notes to Consolidated Financial Statements.
-5-
</TABLE>
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A. The consolidated financial statements, except for the consolidated
balance sheet as of December 28, 1997, have been prepared by the Company
without audit.
In management's opinion, the information and amounts furnished in this
report reflect all adjustments (consisting of normal recurring adjustments)
considered necessary for the fair presentation of the consolidated
financial position and consolidated results of operations for the interim
periods presented. Certain prior period amounts have been reclassified to
conform to the current year's presentation. These consolidated financial
statements should be read in conjunction with the Company's Annual Report
on Form 10-K for the fiscal year ended December 28, 1997.
The Company has historically incurred a net loss for the first three
quarters of the year due to the seasonality of its business. The results of
operations for the quarters ended March 29, 1998 and March 30, 1997 are not
necessarily indicative of the operating results for an entire fiscal year.
B. The Company's income statement presentation changed beginning with the
second quarter of 1997. This change was made to disclose the financial
statement impact of the inventory liquidations associated with the closing
facilities and remerchandising activities. The line item "Closing
facilities and remerchandising activities" represents activity specifically
identifiable to inventory liquidations conducted in conjunction with (1)
the Company's Restructuring Plan announced in the first quarter of 1997 and
(2) exiting the computer, infant and pet supply categories and certain
components of the wireless communication and sporting goods categories as
part of a remerchandising program. As of March 29, 1998, 48 stores, one
distribution center and the aforementioned merchandise categories have
completed the process of liquidation. All activity for these items is
classified in "Closing facilities and remerchandising activities." Prior
year amounts reflect operating results for these same facilities and
merchandise classifications. Selling, general and administrative expenses
for closing facilities and remerchandising activities does not include any
allocation of corporate overhead.
C. On March 25, 1997, the Company adopted a business restructuring plan to
close 60 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 March 29, 1998
are outlined in the following table:
-6-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
<TABLE>
<CAPTION>
Activity to Date
---------------- ----------------- --------------
Accrued
Original Restructuring Costs
Charge Restructuring Asset Change In as of
(In thousands) Recorded Costs Paid Write-downs Estimate March 29, 1998
---------------- ----------------- ----------------- -------------- -----------------------
<S> <C> <C> <C> <C> <C>
Lease termination and other
real estate costs $ 83,225 $ (16,032) $ - $ 3,098 $ 70,291
Property and equipment
write-downs 32,915 - (32,915) - -
Employee severance 4,869 (3,562) - (869) 438
Other exit costs 8,501 (4,072) - (2,229) 2,200
---------------- ----------------- ----------------- -------------- -----------------------
Total $ 129,510 $ (23,666) $ (32,915) $ - 72,929
================ ================= ================= ==============
Less: Current portion (18,474)
-----------------------
$ 54,455
=======================
</TABLE>
The 60 stores include both owned and leased properties. Lease termination
and other real estate costs consist principally of the remaining rental
payments required under the closing stores' lease agreements, net of any
actual or reasonably probable sublease income, as well as early termination
costs.
After taking into account the above property and equipment write-downs, the
Company's carrying value of the property and equipment associated with the
closures is approximately $12.2 million as of March 29, 1998. Of this
amount, assets with a carrying value of $11.1 million are classified as
available for sale. The remaining $1.1 million represents the estimated net
realizable value of property and equipment of the remaining stores planned
for closure. Assets available for sale totaling $6.4 million are classified
as current assets and are included with Prepaid Expenses and Other Assets.
The remaining $4.7 million of assets available for sale are considered
non-current assets and are included in 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
March 29, 1998, 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.
-7-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
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 March 29, 1998, 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.
In the first quarter of 1998, four additional stores were closed bringing
the total number of closed stores to 48. The remaining 12 stores are
expected to be closed as the disposition of real estate holdings are
negotiated. Reduced margins and changes in selling, general and
administrative expenses are reflected in the Company's operating results as
inventory associated with the closing stores is liquidated.
Net sales associated with the planned 60 closing stores exclusive of
remerchandising activities were approximately $13.7 million and $68.6
million for the quarter ended March 29, 1998 and March 30, 1997,
respectively. The pre-tax operating losses associated with the closing
stores, excluding corporate allocations, were approximately ($5.7) million
and ($3.3) million for the quarter ended March 29, 1998 and March 30, 1997,
respectively. Net sales associated with the planned 60 closing stores
exclusive of remerchandising activities were approximately $246.1 million
and $391.0 million for fiscal 1997 and 1996, respectively. The pre-tax
operating income (loss) associated with the planned 60 closing stores,
excluding corporate allocations, was approximately ($41.4) million and $2.0
million for fiscal 1997 and 1996, respectively.
D. The first quarter ended March 29, 1998 contained 91 selling days versus
the first quarter ended March 30, 1997 which contained 90 selling days.
E. 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.
F. Cash payments for interest for the three periods ended March 29, 1998
and March 30, 1997 were $12.7 million and $13.4 million, respectively. Cash
payments for income taxes for the three periods ended March 29, 1998 and
March 30, 1997 were $0.1 million and $19.9 million, respectively. The
decrease of $19.8 million was due primarily to the Company's loss before
income taxes of $(142.3) million in fiscal 1997 compared to earnings before
income taxes of $62.9 million in fiscal 1996. Outstanding checks of $39.6
million, $15.1 million and $73.2 million as of March 29, 1998, March 30,
1997 and December 28, 1997, respectively, have been reclassified to
Accounts Payable. Restricted cash of $12.1 million is classified in Other
Assets and Deferred Charges as of March 29, 1998.
-8-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) (continued)
G. The Company has available a five-year, $900 million, fully-committed,
asset-based credit facility ("Amended and Restated Credit Facility"). 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 sub-facility for letters of credit. The Amended and Restated Credit
Facility matures on September 10, 2002. Interest rates on the Amended and
Restated Credit Facility are subject to change based on a financial
performance-based grid and cannot exceed a rate of LIBOR + 2.25% on
revolving loans and LIBOR + 2.50% on the term loan. As of March 29, 1998,
the term loan carried a rate of LIBOR + 2.25%. 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
March 29, 1998. Short-term borrowings related to the Reducing Revolving
Credit Facility were $101.0 million as of March 30, 1997.
The Amended and Restated Credit Facility is secured by all material
unencumbered assets of the Company and its subsidiaries, including
inventory but excluding previously mortgaged property and leasehold
interests. These security interests will automatically terminate when the
Company's senior debt (or implied senior debt) achieves investment grade
credit rating or the Company meets certain operating performance targets.
Borrowings under the Amended and Restated Credit Facility are limited based
on (1) a borrowing base formula which considers eligible inventories,
eligible accounts receivable and mortgage values on eligible real
properties and (2) limitations contained in the Company's public senior
subordinated debt indenture. Approximately $366.2 million of borrowings
were unused and available under the Amended and Restated Credit Facility as
of March 29, 1998.
H. 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." In February 1998, the FASB issued SFAS
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits." These pronouncements will be effective for financial statements
beginning after December 15, 1997. In March 1998, the FASB issued Statement
of Position 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." This pronouncement will be effective for
financial statements beginning after December 15, 1998. The Company
anticipates that the adoption of these Statements will not have a material
impact on its operating results or financial position.
-9-
<PAGE>
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
For comparative purposes, interim balance sheets are more meaningful when
compared to the balance sheets at the same point in time of the prior year.
Comparisons to balance sheets of the most recent fiscal year end may not be
meaningful due to the seasonal nature of the Company's business.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
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 in the
Company's Form 10-K for the fiscal year ended December 28, 1997 filed with the
Securities and Exchange Commission. Actual results may differ materially from
those anticipated in such forward-looking statements. The Company undertakes no
obligation to update or revise any such forward-looking statements to reflect
subsequent events or circumstances.
RESULTS OF OPERATIONS
The nature of the Company's business is highly seasonal. Historically, sales in
the fourth quarter have been substantially higher than sales achieved in each of
the first three quarters of the fiscal year. Thus expenses and, to a greater
extent, operating income vary greatly by quarter. Caution, therefore, is advised
when appraising results for a period shorter than a full year, or when comparing
any period other than to the same period of the previous year.
FIRST QUARTER ENDED MARCH 29, 1998 VS. FIRST QUARTER ENDED
MARCH 30, 1997
Net sales for the Company were $594.2 million for the first quarter of 1998
compared to $686.4 million for the first quarter of 1997. The $92.2 million
decrease reflects the $71.6 million loss in sales associated with closed
facilities and a 5.6% decrease in comp store sales.
Net sales from operations excluding closing facilities and remerchandising
activities for the first quarter of 1998 were $592.1 million versus $612.7
million for the same period in 1997. This represents a net sales decrease of
$20.6 million, or 3.4%, with comp store sales (adjusted for the Easter shift
from first quarter 1997 to second quarter 1998) decreasing 5.6%. Jewelry comp
sales were flat while hardline comp sales were down 7.5%. Positive comp sales in
home furnishings and appliances partially offset lower sales in electronics,
kids, fitness and personal care merchandise categories. The overall comp sales
decline has been affected by the shift to higher margin merchandise, negatively
impacting sales but generating higher gross margin rates.
-10-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Net sales from closing facilities and remerchandising activities were $2.1
million for the first quarter of 1998 as compared to $73.7 million for the same
period last year. During the first quarter of 1998, the Company closed 4
underperforming stores.
GROSS MARGIN
Gross margin, after buying and occupancy expenses, for the Company for the first
quarter was $143.1 million, or 24.1% of net sales compared to $154.8 million, or
22.5% of net sales for the same period last year. The improved gross margin rate
reflects the Company's focus on higher margin categories and a shift in sales
mix towards jewelry. The decline in gross margin dollars reflects the closure of
48 underperforming stores.
Gross margin, after buying and occupancy expenses, excluding closing facilities
and remerchandising activities, for the first quarter was $143.9 million, or
24.3% of net sales compared to $141.7 million, or 23.1% of net sales for the
prior year quarter.
Gross margin, after buying and occupancy expenses, from closing facilities and
remerchandising activities was ($0.8) million, or (38.2%) of sales from closing
facilities and remerchandising activities for the first quarter of 1998 compared
to $13.1 million, or 17.7% of sales from closing facilities and remerchandising
activities for the prior year quarter. The decline in gross margin dollars
reflects the closure of 48 underperforming stores.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the first quarter of 1998 were
$147.6 million, or 24.8% of net sales, versus $164.5 million, or 24.0% of net
sales for the first quarter of 1997. The $16.9 million reduction is primarily
attributable to a decrease in expenses from closing facilities and
remerchandising activities and income contributed from the Company's new private
label credit card program. The increase as a percentage of net sales was
attributable to lower net sales.
Selling, general and administrative expenses excluding closing facilities and
remerchandising activities, decreased $3.8 million to $147.2 million, or 24.9%
of net sales, as compared to $151.0 million, or 24.6% of net sales, for the same
period last year. The decrease in selling, general and administrative dollars is
primarily attributable to income contributed from the Company's new private
label credit card program. Income recognized from this program is recorded as a
reduction to selling, general and administrative expenses.
Selling, general and administrative expenses of closing facilities and
remerchandising activities were $0.5 million, or 22.8% of sales from closing
facilities and remerchandising activities for the first quarter of 1998 compared
to $13.5 million, or 18.3% of sales from closing facilities and remerchandising
activities for the prior year quarter. This decrease in dollars reflects the
closure of 48 underperforming stores.
-11-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
INTEREST EXPENSE
Interest expense for the first quarter of 1998 was $19.6 million as compared to
$17.5 million for the first quarter of 1997. The increase in interest expense
reflects the addition of the term loan offset somewhat by lower average
borrowings against the Company's Amended and Restated Credit Facility.
INCOME TAXES
The Company recognized an income tax benefit of $14.5 million and $64.3 million
for the first quarter ended March 29, 1998 and March 30, 1997, respectively. The
decrease in the benefit is primarily due to the $129.5 million restructuring
charge recorded in the first quarter of 1997. The effective tax rate for the
quarters ended March 29, 1998 and March 30, 1997 was 37.5%. For the fiscal year
ended December 28, 1997, the effective income tax rate was 37.5%.
RESTRUCTURING CHARGE, STORE LIQUIDATION AND REMERCHANDISING PROGRAM
On March 25, 1997, the Company adopted 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 March 29, 1998 are outlined in the
following table:
<TABLE>
<CAPTION>
Activity to Date
---------------- ----------------- --------------
Accrued
Original Restructuring Costs
Charge Restructuring Asset Change In as of
(In thousands) Recorded Costs Paid Write-downs Estimate March 29, 1998
----------------- ---------------- ----------------- -------------- ------------------------
<S> <C> <C> <C> <C> <C>
Lease termination and other
real estate costs $ 83,225 $ (16,032) $ - $ 3,098 $ 70,291
Property and equipment
write-downs 32,915 - (32,915) - -
Employee severance 4,869 (3,562) - (869) 438
Other exit costs 8,501 (4,072) - (2,229) 2,200
----------------- ---------------- ----------------- -------------- ------------------------
Total $ 129,510 $ (23,666) $ (32,915) $ - 72,929
================= ================ ================= ==============
Less: Current portion (18,474)
--------------------
$ 54,455
====================
</TABLE>
-12-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Changes in estimates are representative of management's assessments as of March
29, 1998, 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 the distribution center. These 44 stores and the distribution
center were closed by the end of July 1997. During January 1998, an additional
four stores were closed. The remaining targeted facilities will be closed as the
disposition of real estate holdings are negotiated. 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.
Additional remerchandising decisions were executed in the first quarter of 1998
with the exit of infant and pet supply categories and certain components of the
sporting goods business.
LIQUIDITY AND CAPITAL RESOURCES
Working capital increased to $557.5 million at the end of the first quarter of
1998 from $494.4 million at March 30, 1997, an increase of $63.1 million or
12.8%. There were no short-term borrowings outstanding ($366.2 million available
for borrowing) at March 29, 1998 compared to $101.0 million outstanding ($402.6
million available for borrowing) at March 30, 1997. The increase in working
capital is due primarily to a $113.8 million shift from short-term to long-term
borrowings under the Company's Amended and Restated Credit Facility. The shift
to long-term borrowings is the net effect of the addition of a $200 million term
loan as a part of the Amended and Restated Credit Facility partially offset by
the retirement of $86.2 million of Senior Notes Due 2001 in the third quarter of
1997. Inventory balances at the end of the first quarter of 1998 decreased by
$142.4 million primarily due to inventory liquidations related to the store
closures and reduced purchasing levels. Accounts payable decreased by $95.3
million to $308.8 million compared to the first quarter of 1997 due to decreased
purchase volumes and reduced terms due to changes in merchandise mix. Current
maturities of long-term debt increased $16.7 million to reflect the first
installment payment on the Company's First Mortgage Secured Notes which is due
on June 30, 1998.
-13-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
Working capital requirements fluctuate significantly during the year due to the
seasonal nature of the jewelry, gift and home business. These requirements are
financed through a combination of internally generated cash flow from operating
activities, short-term seasonal borrowings and long-term financing. The current
ratio at March 29, 1998 and March 30, 1997 was 2.0:1 and 1.7:1, respectively.
The Company has available a five-year, $900 million, fully-committed,
asset-based credit facility ("Amended and Restated Credit Facility"). 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
sub-facility for letters of credit. The Amended and Restated Credit Facility
matures on September 10, 2002. Interest rates on the Amended and Restated Credit
Facility are subject to change based on a financial performance-based grid and
cannot exceed a rate of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on
the term loan. As of March 29, 1998, the term loan carried a rate of LIBOR +
2.25%. There is a commitment fee of 3/8% on the undrawn portion of the revolving
loans.
The Amended and Restated Credit Facility is secured by all material unencumbered
assets of the Company and its subsidiaries, including inventory but excluding
previously mortgaged property and leasehold interests. These security interests
will automatically terminate when the Company's senior debt (or implied senior
debt) achieves investment grade credit rating or the Company meets certain
operating performance targets.
Borrowings under the Amended and Restated Credit Facility are limited based on
(1) a borrowing base formula which considers eligible inventories, eligible
accounts receivable and mortgage values on eligible real properties and (2)
limitations contained in the Company's public senior subordinated debt
indenture.
Total long-term debt, including current maturities and capitalized leases,
increased to $789.1 million at March 29, 1998 from $698.9 million at March 30,
1997. The increase in total long-term debt was primarily attributable to the
$113.8 million shift from short-term to long-term borrowings under the Company's
Amended and Restated Credit Facility slightly offset by the early extinguishment
of $8.9 million in mortgages and scheduled payments on capitalized leases,
mortgages and Industrial Revenue Bonds.
Additions to owned property and equipment were $4.9 million for the first
quarter ended March 29, 1998 compared to $4.4 million for the same period last
year. The Company operated 357 stores as of March 29, 1998, a net increase of 5
stores from March 30, 1997 (excluding the closing of 48 stores as part of the
Company's restructuring plan). The Company expects to incur capital expenditures
of approximately $50 million during fiscal 1998 and plans to fund these
expenditures through a combination of cash flows from operations, borrowings
under the Amended and Restated Credit Facility and potential future financings.
Additionally, the Company has allocated $12.1 million of restricted cash to fund
its new credit card program as of March 29, 1998.
-14-
<PAGE>
Management's Discussion and Analysis of Financial Condition
and Results of Operations (continued)
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." In February 1998, the FASB issued SFAS No. 132,
"Employers' Disclosures about Pensions and Other Postretirement Benefits." These
pronouncements will be effective for financial statements beginning after
December 15, 1997. In March 1998, the FASB issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." This pronouncement will be effective for financial statements
beginning after December 15, 1998. The Company anticipates that the adoption of
these Statements will not have a material impact on its operating results or
financial position.
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.
-15-
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
On February 3, 1998, a Series A Junior Preferred Stock Purchase Right (a
"Right") was issued for each outstanding share of the Company's common
stock. Each Right, subject to the terms of the Rights Agreement between
the Company and Harris Trust and Savings Bank, as Rights Agent, entitles
the registered holder to purchase from the Company one one-hundredth of
a share (a "Unit") of Series A Junior Preferred Stock, par value $1.00
per share (the "Preferred Stock"), at a Purchase Price of $10.00 per
Unit, subject to adjustment. The Rights are not exercisable until the
Distribution Date (as defined in the Rights Agreement) and will expire
at the close of business on the tenth anniversary of the Rights
Agreement unless earlier redeemed by the Company. In connection with the
execution of the Rights Agreement, the Company amended its Charter to
authorize the issuance of 1,100,000 shares of the Preferred Stock, none
of which is currently outstanding.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
6(a) Exhibits filed with this Form 10-Q
Exhibit No. Under Items
601 of Regulation S-K Brief Description
----------------------- -----------------
27.1 Financial Data Schedule for the
First Quarter Ended March 29, 1998.
27.2 Financial Data Schedule for the
First Quarter Ended March 30, 1997.
-16-
<PAGE>
PART II - OTHER INFORMATION (continued)
Item 6. Exhibits and Reports on Form 8-K (continued)
6(b) Reports on Form 8-K
As reported on Form 8-K dated February 3, 1998, the Company declared a
distribution of rights pursuant to the Rights Agreement dated February
3, 1998, between the Company and Harris Trust and Savings Bank.
-17-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SERVICE MERCHANDISE
COMPANY, INC.
Date: May 12, 1998 /s/ Gary M. Witkin
------------------------
Gary M. Witkin
President
(Chief Executive Officer)
Date: May 12, 1998 /s/ S. Cusano
------------------------
S. Cusano
Executive Vice President and
Chief Financial Officer
(Chief Financial Officer)
(Chief Accounting Officer)
-18-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Service
Merchandise Company, Inc. Form 10-Q for the quarterly period ended March 29,
1998 and is qualified in its entirety by reference to such financial statements
detailed in Part I of the Form 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-03-1999
<PERIOD-START> DEC-29-1997
<PERIOD-END> MAR-29-1998
<EXCHANGE-RATE> 1
<CASH> 71,530
<SECURITIES> 0
<RECEIVABLES> 49,845
<ALLOWANCES> 2,712
<INVENTORY> 935,626
<CURRENT-ASSETS> 1,112,552
<PP&E> 480,965
<DEPRECIATION> 529,498
<TOTAL-ASSETS> 1,678,690
<CURRENT-LIABILITIES> 555,022
<BONDS> 756,683
0
0
<COMMON> 100,366<F1>
<OTHER-SE> 262,347
<TOTAL-LIABILITY-AND-EQUITY> 1,678,690
<SALES> 594,182
<TOTAL-REVENUES> 594,182
<CGS> 451,081
<TOTAL-COSTS> 451,081
<OTHER-EXPENSES> 162,071<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 19,591
<INCOME-PRETAX> (38,561)
<INCOME-TAX> (14,460)
<INCOME-CONTINUING> (24,101)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (24,101)
<EPS-PRIMARY> (0.24)
<EPS-DILUTED> (0.24)
<FN>
<F1>AMOUNT REPRESENTS THE NUMBER OF SHARES OF $0.50 PAR VALUE COMMON STOCK
ISSUED AND OUTSTANDING.
<F2>AMOUNT INCLUDES I) DEPRECIATION AND AMORTIZATION AND II) SELLING, GENERAL
AND ADMINISTRATIVE EXPENSES.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the Service
Merchandise Company, Inc. Form 10-Q for the quarterly period ended March 30,
1997 and is qualified in its entirety by reference to such financial statements
detailed in Part I of the Form 10-Q.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<CURRENCY> $
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-28-1997
<PERIOD-START> DEC-30-1996
<PERIOD-END> MAR-30-1997
<EXCHANGE-RATE> 1
<CASH> 44,218
<SECURITIES> 0
<RECEIVABLES> 49,001
<ALLOWANCES> 3,409
<INVENTORY> 1,078,051
<CURRENT-ASSETS> 1,239,994
<PP&E> 1,179,915
<DEPRECIATION> 620,459
<TOTAL-ASSETS> 1,825,264
<CURRENT-LIABILITIES> 745,584
<BONDS> 684,365
0
0
<COMMON> 99,758<F1>
<OTHER-SE> 270,213
<TOTAL-LIABILITY-AND-EQUITY> 1,825,264
<SALES> 686,400
<TOTAL-REVENUES> 686,400
<CGS> 531,640
<TOTAL-COSTS> 531,640
<OTHER-EXPENSES> 308,772<F2>
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 17,536
<INCOME-PRETAX> (171,458)
<INCOME-TAX> (64,331)
<INCOME-CONTINUING> (107,217)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (107,217)
<EPS-PRIMARY> (1.08)
<EPS-DILUTED> (1.08)
<FN>
<F1>AMOUNT REPRESENTS THE NUMBER OF SHARES OF $0.50 PAR VALUE COMMON STOCK
ISSUED AND OUTSTANDING.
<F2>AMOUNT INCLUDES I) DEPRECIATION AND AMORTIZATION II) SELLING, GENERAL
AND ADMINISTRATIVE EXPENSES AND III) RESTRUCTURING CHARGE INCURRED IN THE
FIRST QUARTER OF 1997.
</FN>
</TABLE>
