<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY 4, 1999.
Commission File No.1-9223
SERVICE MERCHANDISE COMPANY, INC.
(Debtor-in-Possession as of March 27, 1999)
(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 (MAILING ADDRESS)
7100 SERVICE MERCHANDISE DRIVE, BRENTWOOD, TN 37202-4600
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 660-6000
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 [ ].
As of August 1, 1999, there were 100,097,293 shares of the Registrant's
common stock, $.50 par value, outstanding.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
No.
---
<S> <C>
PART I FINANCIAL INFORMATION
Consolidated Statements of Operations (Unaudited) - Three and Six Periods
Ended July 4, 1999 and June 28, 1998.....................................................................3
Consolidated Balance Sheets - July 4, 1999 (Unaudited), June 28, 1998
(Unaudited) and January 3, 1999..........................................................................4
Consolidated Statements of Cash Flows (Unaudited) - Six Periods Ended
July 4, 1999 and June 28, 1998...........................................................................5
Notes to Consolidated Financial Statements (Unaudited).......................................................6
Management's Discussion and Analysis of Financial Condition and Results of Operations.......................13
Quantitative and Qualitative Disclosure about Market Risk...................................................22
PART II OTHER INFORMATION
Legal Proceedings...........................................................................................23
Defaults Upon Senior Securities.............................................................................23
Submission of Matters to a Vote of Security Holders ........................................................23
Exhibits and Reports on Form 8-K............................................................................24
SIGNATURES............................................................................................................25
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Debtor-In-Possession)
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE PERIODS ENDED SIX PERIODS ENDED
----------------------- -------------------------
JULY 4, JUNE 28, JULY 4, JUNE 28,
1999 1998 1999 1998
--------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET SALES:
Operations excluding closed facilities as a result of restructuring
and remerchandising activities $ 430,090 $ 483,844 $ 770,825 $ 899,796
Closed facilities as a result of restructuring and remerchandising
activities 88,174 201,268 257,948 379,498
--------- ----------- ----------- -----------
518,264 685,112 1,028,773 1,279,294
--------- ----------- ----------- -----------
COST OF MERCHANDISE SOLD AND BUYING AND OCCUPANCY EXPENSES:
Operations excluding closed facilities as a result of restructuring
and remerchandising activities 321,932 357,507 590,098 666,417
Closed facilities as a result of restructuring and remerchandising
activities 109,113 164,041 254,655 306,212
--------- ----------- ----------- -----------
431,045 521,548 844,753 972,629
--------- ----------- ----------- -----------
GROSS MARGIN (LOSS) AFTER COST OF MERCHANDISE SOLD AND BUYING AND OCCUPANCY
EXPENSES:
Operations excluding closed facilities as a result of
restructuring and remerchandising activities 108,158 126,337 180,727 233,379
Closed facilities as a result of restructuring and remerchandising
activities (20,939) 37,227 3,293 73,286
--------- ----------- ----------- -----------
87,219 163,564 184,020 306,665
--------- ----------- ----------- -----------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Operations excluding closed facilities as a result of restructuring
and remerchandising activities 110,789 120,063 221,251 236,518
Closed facilities as a result of restructuring and remerchandising
activities 24,159 28,382 80,987 61,327
--------- ----------- ----------- -----------
134,948 148,445 302,238 297,845
--------- ----------- ----------- -----------
Other income, net (239) (8,525) (3,288) (10,289)
Restructuring charge (1,894) -- 97,560 --
Depreciation and amortization:
Operations excluding closed facilities as a result of restructuring
and remerchandising activities 10,506 10,712 20,709 21,508
Closed facilities as a result of restructuring and remerchandising
activities 362 3,546 2,393 7,185
--------- ----------- ----------- -----------
10,868 14,258 23,102 28,693
--------- ----------- ----------- -----------
Reorganization items 31,371 -- (12,372) --
--------- ----------- ----------- -----------
Earnings (loss) before interest, income tax and extraordinary item (87,835) 9,386 (223,220) (9,584)
Interest expense - debt (contractual interest $18,262 and $43,573 for the
three and six periods ended July 4, 1999, respectively) 11,243 17,817 35,088 35,643
Interest expense - capitalized leases 1,516 1,708 2,773 3,473
--------- ----------- ----------- -----------
Loss before income tax and extraordinary item (100,594) (10,139) (261,081) (48,700)
Income tax benefit -- (3,802) -- (18,262)
--------- ----------- ----------- -----------
Net loss before extraordinary item (100,594) (6,337) (261,081) (30,438)
Extraordinary loss from early extinguishment of debt -- -- (7,851) --
--------- ----------- ----------- -----------
NET LOSS $(100,594) $ (6,337) $ (268,932) $ (30,438)
========= =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES - BASIC AND DILUTED 99,721 99,701 99,719 99,702
========= =========== =========== ===========
PER COMMON SHARE:
Loss before extraordinary item $ (1.01) $ (0.06) $ (2.62) $ (0.31)
Extraordinary loss from early extinguishment of debt $ -- $ -- $ (0.08) $ --
--------- ----------- ----------- -----------
Net loss - basic and diluted $ (1.01) $ (0.06) $ (2.70) $ (0.31)
========= =========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements
3
<PAGE> 4
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DEBTOR-IN-POSSESSION)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
(UNAUDITED)
--------------------------
JULY 4, JUNE 28, JANUARY 3,
1999 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 37,858 $ 142,101 $ 133,749
Accounts receivable, net of allowance of $18,755, $2,096 and $2,999 respectively 16,565 44,750 38,098
Refundable income taxes -- 3,947 10,769
Inventories 553,711 862,997 896,303
Prepaid expenses and other assets 86,974 17,163 24,379
Deferred income taxes -- 22,478 --
----------- ----------- -----------
TOTAL CURRENT ASSETS 695,108 1,093,436 1,103,298
----------- ----------- -----------
PROPERTY AND EQUIPMENT:
Owned assets, net of accumulated depreciation 364,581 472,005 439,710
Capitalized leases, net of accumulated amortization 17,588 29,463 21,297
----------- ----------- -----------
TOTAL PROPERTY AND EQUIPMENT 382,169 501,468 461,007
----------- ----------- -----------
OTHER ASSETS AND DEFERRED CHARGES 49,843 50,493 62,590
----------- ----------- -----------
TOTAL ASSETS $ 1,127,120 $ 1,645,397 $ 1,626,895
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
LIABILITIES NOT SUBJECT TO COMPROMISE
CURRENT LIABILITIES:
Notes payable to banks $ 33,624 $ -- $ 156,000
Accounts payable 26,435 281,969 228,373
Accrued expenses 134,199 183,820 224,813
State and local sales taxes 15,233 22,933 1,726
Accrued restructuring costs -- current -- 18,420 7,864
Current maturities of long-term debt 1,000 23,193 220,041
Current maturities of capitalized lease obligations -- 8,152 8,501
----------- ----------- -----------
TOTAL CURRENT LIABILITIES 210,491 538,487 847,318
----------- ----------- -----------
LONG-TERM LIABILITIES:
Accrued restructuring costs -- 51,317 45,297
Long-term debt 98,750 703,338 467,192
Capitalized lease obligations -- 45,906 41,193
----------- ----------- -----------
TOTAL LONG-TERM LIABILITIES 98,750 800,561 553,682
----------- ----------- -----------
LIABILITIES SUBJECT TO COMPROMISE 861,072 -- --
----------- ----------- -----------
TOTAL LIABILITIES 1,170,313 1,339,048 1,401,000
----------- ----------- -----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' (DEFICIT) 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 100,097, 100,396 and 100,340 shares, respectively 50,049 50,198 50,170
Additional paid-in capital 6,756 7,876 7,680
Deferred compensation (1,086) (2,483) (1,975)
Accumulated other comprehensive loss (869) -- (869)
Retained (deficit) earnings (98,043) 250,758 170,889
----------- ----------- -----------
TOTAL SHAREHOLDERS' (DEFICIT) EQUITY (43,193) 306,349 225,895
----------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY $ 1,127,120 $ 1,645,397 $ 1,626,895
=========== =========== ===========
</TABLE>
See Notes to Consolidated Financial Statements
4
<PAGE> 5
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DEBTOR-IN-POSSESSION)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX PERIODS ENDED
------------------------
JULY 4, JUNE 28,
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(268,932) $ (30,438)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Extraordinary items 7,851 --
Depreciation and amortization 28,087 31,543
Provision for bad debts 15,756 (1,360)
Gain on sale of property and equipment (3,288) (10,289)
Provision for restricted cash 8,819 --
Write-down of property and equipment due to restructuring 22,558 --
Reorganization items (12,372) --
Changes in assets and liabilities, net of special items:
Accounts receivable - net 2,977 (260)
Inventories 338,392 66,821
Prepaid expenses and other assets (32,361) 5,895
Accounts payable (10,532) (200,266)
Accrued expenses and state and local sales taxes (20,508) (56,029)
Accrued restructuring costs 65,916 (6,505)
Income taxes 19,006 (3,946)
--------- ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 161,369 (204,834)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (9,897) (10,615)
Proceeds from sale of property and equipment 10,297 19,362
Proceeds from sale of property and equipment - reorganization 126 --
Restricted cash and other assets, net 13,465 (12,415)
--------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 13,991 (3,668)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings, net (122,376) --
Repayment of long-term debt (122,166) (8,704)
Repayment of capitalized lease obligations (4,014) (4,295)
Debt issuance costs (18,574) (525)
Debt issuance costs - reorganization (3,750) --
Exercise of stock options (forfeiture of restricted stock), net (371) (42)
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES (271,251) (13,566)
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (95,891) (222,068)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 133,749 364,169
--------- ---------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 37,858 $ 142,101
========= =========
SUPPLEMENTAL DATA:
Cash paid (received) during the period for:
Interest $ 36,423 $ 38,900
Income taxes $ (18,932) $ (17,600)
Reorganization items - professional fees and administrative items $ 8,823 $ --
</TABLE>
See Notes to Consolidated Financial Statements
5
<PAGE> 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE SIX PERIODS ENDED JULY 4, 1999
A. BASIS OF PRESENTATION
The consolidated financial statements, except for the consolidated
balance sheet as of January 3, 1999, 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 period 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 January 3, 1999.
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 three and six periods ended July 4, 1999 and June 28, 1998
are not necessarily indicative of the operating results for an entire fiscal
year.
The Company's consolidated statements of operations presentation
changed in fiscal 1997 to disclose the financial statement impact of the
inventory liquidations associated with the results of restructuring and
remerchandising activities. The line item "Closed facilities as a result of
restructuring and remerchandising activities" represents activity specifically
identifiable to closed or closing facilities and to inventory liquidations
conducted in conjunction with the Company's restructuring plans. Prior year
amounts reflect operating results for these same facilities and merchandise
classifications. Selling, general and administrative expenses for closed
facilities as a result of restructuring and remerchandising activities does not
include any allocation of corporate overhead.
B. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On March 15, 1999, five of the Company's vendors filed an involuntary
petition for reorganization under Chapter 11 ("Chapter 11") of title 11 of the
United States Bankruptcy Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the Middle District of Tennessee (the "Bankruptcy Court")
seeking court supervision of the Company's restructuring efforts. On March 27,
1999, the Company and 31 of its subsidiaries (collectively, the "Debtors") filed
voluntary petitions with the Bankruptcy Court for reorganization under Chapter
11 under case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and
orders for relief were entered by the Bankruptcy Court. The Chapter 11 Cases
have been consolidated for the purpose of joint administration under Case No.
399-02649. The Debtors are currently operating their businesses as
debtors-in-possession pursuant to the Bankruptcy Code.
The accompanying consolidated financial statements have been prepared
on a going concern basis of accounting and in accordance with AICPA Statement of
Position 90-7 "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code." The accompanying consolidated financial statements do not
reflect any adjustments that might result if the Company is unable to continue
as a going concern. The Company's recent losses and negative cash flows from
operations, and the Chapter 11 Cases raise substantial doubt about the Company's
ability to continue as a going concern. The Company intends to submit a plan for
reorganization to the Bankruptcy Court. The ability of the Company to continue
as a going concern and appropriateness of using the going concern basis is
dependent upon, among other things, (i) the Company's ability to comply with
debtor-in-possession financing agreements, (ii) confirmation of a plan of
reorganization under the Bankruptcy Code, (iii) the Company's ability to achieve
profitable operations after such confirmation, and (iv) the Company's ability to
generate sufficient cash from operations to meet its obligations.
6
<PAGE> 7
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
are stayed and other contractual obligations against the Debtors may not be
enforced. In addition, under the Bankruptcy Code the Debtors may assume or
reject executory contracts, including lease obligations. Parties affected by
these rejections may file claims with the Bankruptcy Court in accordance with
the reorganization process. Substantially all pre-petition liabilities are
subject to settlement under a plan of reorganization to be voted upon by
creditors and equity holders and approved by the Bankruptcy Court. Although the
Debtors expect to file a reorganization plan or plans that provide for emergence
from bankruptcy in 2000 or 2001, there can be no assurance that a reorganization
plan or plans will be proposed by the Debtors or confirmed by the Bankruptcy
Court, or that any such plan(s) will be consummated. As provided by the
Bankruptcy Code, the Debtors initially had the exclusive right to submit a plan
of reorganization for 120 days. On May 25, 1999, the Company received Court
approval to extend the period in which the Company has the exclusive right to
file or advance a plan of reorganization in its Chapter 11 case. The order
extended the exclusivity period from July 23, 1999 to February 29, 2000, and
further extended the Company's exclusive right to solicit acceptances of its
plan from September 21, 1999 to May 1, 2000. If the Debtors fail to file a plan
of reorganization during such period or if such plan is not accepted by the
required number of creditors and equity holders, any party in interest may
subsequently file its own plan of reorganization for the Debtors. A plan of
reorganization must be confirmed by the Bankruptcy Court, upon certain findings
being made by the Bankruptcy Court which are required by the Bankruptcy Code.
The Bankruptcy Court may confirm a plan notwithstanding the non-acceptance of
the plan by an impaired class of creditors or equity security holders if certain
requirements of the Bankruptcy Code are met. A plan of reorganization could also
result in holders of the Common Stock receiving no value for their interests.
Because of such possibilities, the value of the Common Stock is highly
speculative.
A plan of reorganization could materially change the amounts currently
recorded in the consolidated financial statements. The consolidated financial
statements do not give effect to any adjustment to the carrying value of assets
or amounts and classifications of liabilities that might be necessary as a
result of the Chapter 11 Cases.
C. RESTRUCTURING PLANS
1997 RESTRUCTURING PLAN
On March 25, 1997, the Company adopted a business restructuring plan to
close up to 60 under performing stores and one distribution center (the "1997
Restructuring Plan"). As a result, a pre-tax charge of $129.5 million for
restructuring costs was taken in the first quarter of fiscal 1997. The
components of the restructuring charge and an analysis of the amounts charged
against the accrual through the six periods ended July 4, 1999 are outlined in
the following table:
<TABLE>
<CAPTION>
ACTIVITY TO DATE
-----------------------------------------------------------------------
ACCRUED
RESTRUCTURING ACCRUED
COSTS AS OF RESTRUCTURING
JANUARY 3, RESTRUCTURING ASSET CHANGE IN COSTS AS OF
(in thousands) 1999 COSTS PAID WRITE-DOWNS ESTIMATE JULY 4, 1999
------- ---------- ----------- -------- ------------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $53,161 $(1,526) $ -- $(45,981) $5,654
Property and equipment write-downs -- -- 2,489 (2,489) --
Employee severance -- -- -- -- --
Other exit costs -- -- -- -- --
------- ------- ------ -------- ------
Total $53,161 $(1,526) $2,489 $(48,470) $5,654
======= ======= ====== ======== ======
</TABLE>
The closing of nine stores during the first half of fiscal 1998 brought the
total number of closures, in accordance with the 1997 Restructuring Plan, to 53
stores and one distribution center. Store closures were completed as of
7
<PAGE> 8
May 1998. The Company closed less than 60 stores primarily due to the inability
to negotiate acceptable exit terms from the related lessors.
Restructuring costs paid during the six periods ending July 4, 1999
relate primarily to lease termination and other real estate costs. The Company
incurred $1.1 million in contractual rent payments and lease termination fees
and $0.4 million in other real estate costs primarily related to utilities,
common area maintenance fees, real estate taxes and brokerage costs.
In connection with the Chapter 11 Cases, the $46.0 million change in
estimate was made to reflect the reduction allowed under Section 502(b)(6) of
the Bankruptcy Code. Amounts had been accrued according to the remaining
leasehold obligations. Section 502(b)(6) limits a lessor's claim to the rent
reserved by such lease, without acceleration, for the greater of one year, or 15
percent, not to exceed three years, of such lease, plus any unpaid rent.
The leases remaining on closed locations as of July 4, 1999 vary in
length with expiration dates ranging from July 1999 to December 2030.
As of July 4, 1999, property and equipment associated with the 1997
Restructuring Plan have been written-down to reflect their estimated fair value.
The Company anticipates selling or abandoning substantially all remaining owned
property and equipment associated with the 1997 Restructuring Plan.
Approximately 3,000 employees were terminated pursuant to the 1997 Restructuring
Plan. All such terminations were completed as of May 1998.
RATIONALIZATION PLAN
In February 1999, the Company announced a rationalization plan to close
up to 132 stores, up to four distribution centers and to reduce corporate
overhead (the "Rationalization Plan"). On March 8, 1999, as part of the
Rationalization Plan and prior to the filing of the involuntary bankruptcy
petition, the Board of Directors approved the adoption of a business
restructuring plan to close 106 stores, the Dallas distribution center and to
reduce the Company's workforce at its Nashville corporate offices by 150
employees. As a result, a pre-tax charge of $99.5 million for restructuring
costs was recorded in the first quarter of 1999. On March 29, 1999 and in
connection with the Chapter 11 Cases, store leases under this plan were approved
for rejection by the Bankruptcy Court. The components of the restructuring
charge and the amounts charged against the accrual through the six periods
ending July 4, 1999 are outlined in the following table.
<TABLE>
<CAPTION>
ACTIVITY TO DATE
-------------------------------------------------------------------
INITIAL ACCRUED
CHARGE COSTS AS OF
RECORDED IN COSTS ASSET CHANGE IN JULY 4,
(in thousands) MARCH PAID WRITE-DOWNS ESTIMATE 1999
------- ------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $62,469 $(1,147) $ -- $ -- $61,322
Property and equipment write-downs 24,452 -- (25,047) 595 --
Employee severance 12,533 (6,413) -- -- 6,120
------- ------- -------- ---- -------
Total $99,454 $(7,560) $(25,047) $595 $67,442
======= ======= ======== ==== =======
</TABLE>
The stores planned for closure 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' and
distribution center lease agreements under Section 502(b)(6) of the Bankruptcy
Code, net of any actual or reasonably probable sublease income. Section
502(b)(6) limits the lessor's claim to the rent reserved by such lease, without
acceleration, for the greater of one year, or 15 percent, not to exceed three
years, of such lease, plus any unpaid rent.
8
<PAGE> 9
After taking into effect the above asset write-downs, the Company's
carrying value of the property and equipment associated with the Rationalization
Plan closures is $21.6 million as of July 4, 1999. All of this amount is
classified as available for sale as all store closures are now complete. Assets
available for sale are considered current assets and are included with Prepaid
expenses and other assets. The Company anticipates selling substantially all
owned property and equipment associated with the closures.
The employee severance provision was recorded for the planned
termination of approximately 4,389 employees associated with the closures, as
well as the reduction of corporate overhead.
D. LIABILITIES SUBJECT TO COMPROMISE
"Liabilities subject to compromise" refers to liabilities incurred
prior to the commencement of the Chapter 11 Cases. These liabilities consist
primarily of amounts outstanding under long-term debt and also include accounts
payable, accrued interest, accrued restructuring costs, and other accrued
expenses. These amounts represent the Company's estimate of known or potential
claims to be resolved in connection with the Chapter 11 Cases. Such claims
remain subject to future adjustments based on negotiations, actions of the
Bankruptcy Court, further development with respect to disputed claims, future
rejection of additional executory contracts or unexpired leases, and
determination as to the value of any collateral securing claims or other events.
Payment terms for these amounts, which are considered long-term liabilities at
this time, will be established in connection with the Chapter 11 Cases.
The Company has received approval from the Bankruptcy Court to pay
certain pre-petition and post-petition employee wages, salaries, benefits and
other employee obligations, to pay vendors and other providers in the ordinary
course for goods and services received from March 15, 1999, and to honor
customer service programs, including warranties, returns, layaways and gift
certificates.
The principal categories of claims classified as liabilities subject to
compromise under reorganization proceedings are identified below.
<TABLE>
<CAPTION>
(in thousands) JULY 4,
1999
--------
<S> <C>
Accounts payable $191,406
Accrued expenses 87,501
Accrued restructuring costs 73,096
Long-term debt 465,317
Capitalized lease obligations 43,752
--------
Total $861,072
========
</TABLE>
Contractual interest expense not recorded on certain pre-petition debt
totaled $7.0 million and $8.5 million for the three and six periods ended July
4, 1999, respectively.
E. REORGANIZATION ITEMS
Expenses and income directly incurred or realized as a result of the
Chapter 11 Cases have been segregated from the normal operations and are
disclosed separately. The major components are as follows:
<TABLE>
<CAPTION>
QUARTER
ENDED YEAR-TO-DATE
(in thousands) JULY 4, JULY 4,
1999 1999
-------- --------
<S> <C> <C>
Reduction of accrued rent for rejected leases $ -- $(45,981)
Store closing costs 14,009 14,009
Loss on disposal of assets 10,289 10,289
Professional fees and administrative items 7,073 9,311
-------- --------
Total reorganization items expense
(income) $ 31,371 $(12,372)
======== ========
</TABLE>
9
<PAGE> 10
REDUCTION OF ACCRUED RENT FOR REJECTED LEASES:
In connection with the Chapter 11 Cases, the 1997 Restructuring Plan
was adjusted to reflect the reduction allowed under Section 502(b)(6) of the
Bankruptcy Code. An amount had been accrued according to the remaining leasehold
obligation. Section 502(b)(6) limits the lessor's claim to the rent reserved by
such leases, without acceleration, for the greater of one year, or 15 percent,
not to exceed three years, of such leases, plus any unpaid rent.
STORE CLOSING COSTS:
Subsequent to the announcement of the Rationalization Plan, the Company
identified an additional 16 stores for closure. The costs associated with these
closing stores include rent, common area maintenance, utilities, asset
write-downs and severance. The rent amount has been adjusted to reflect the
reduction allowed under Section 502(b)(6) of the Bankruptcy Code.
LOSS ON DISPOSAL OF ASSETS:
"Loss on disposal of assets" consists of accrued losses associated with
the sale of four parcels of real property and the sale of certain assets of one
of the Company's subsidiaries, B.A. Pargh Co., Inc. See Note K -- Subsequent
Events for a detailed description of these transactions.
PROFESSIONAL FEES AND ADMINISTRATIVE ITEMS:
"Professional fees and administrative items" relates to legal,
accounting and other professional costs directly attributable to the Chapter 11
Cases.
F. BORROWINGS
From September 1997 through January 20, 1999, the Company had a
five-year, $900 million, fully committed asset-based credit facility (the
"Amended and Restated Credit Facility"). The Amended and Restated Credit
Facility included $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 was set to mature on September 10,
2002. Interest rates on the Amended and Restated Credit Facility were subject to
change based on a financial performance-based grid and could not exceed a rate
of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on the term loan. There
was a commitment fee of 3/8% on the undrawn portion of the revolving loans.
There were no outstanding loans under the Amended and Restated Credit Facility
as of July 4, 1999.
On January 20, 1999, the Company completed a $750 million, 30-month
asset-based credit facility (the "Second Amended and Restated Credit Facility")
which replaced the Amended and Restated Credit Facility. The Second Amended and
Restated Credit Facility included $150 million in term loans and a maximum of
$600 million in revolving loans. The Second Amended and Restated Credit Facility
included a $200 million sub-facility for standby and trade letters of credit.
Interest rates on the Second Amended and Restated Facility were based on either
Prime Rate + 1.5% or LIBOR + 2.75%.
On March 29, 1999, the Company entered into a 27-month, $750 million,
fully committed asset-based debtor-in-possession credit facility (the "DIP
Facility") which replaced the Second Amended and Restated Credit Facility. The
Bankruptcy Court approved the DIP Facility on an interim basis on March 29, 1999
and granted final approval on April 27, 1999.
The DIP Facility, which matures on June 30, 2001, includes $100 million
in term loans and up to a maximum of $650 million in revolving loans including a
$200 million sub-facility for letters of credit. Interest rate spreads on the
DIP Facility are LIBOR + 2.25% on Eurodollar loans and Prime Rate + 1.25% on
Alternate
10
<PAGE> 11
Base Rate loans. Short-term borrowings related to the DIP Facility were $33.6
million as of July 4, 1999. There were no short-term borrowings under the
Amended and Restated Credit Facility at June 28, 1998. Outstanding borrowings
under the term loan of the DIP Facility were $99.8 million as of July 4, 1999.
Term loan borrowings under the Amended and Restated Credit Facility were $198.0
million as of June 28, 1998. There is a commitment fee of 0.375% on the undrawn
portion of the revolving loans under the DIP Facility.
The DIP Facility is secured by all material unencumbered assets of the
Company and its subsidiaries, including inventory, but excluding previously
mortgaged property. Borrowings under the DIP Facility are limited based on a
borrowing base formula which considers eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, eligible leasehold
interests, available cash equivalents and in-transit cash. The DIP Facility had
a borrowing base reserve of $75 million from March 29, 1999 to April 27, 1999,
the date of final approval by the DIP Facility lenders. A borrowing base reserve
of $50 million will apply until a business plan is accepted by and financial and
other covenants are negotiated with the DIP Facility lenders.
G. EARNINGS PER SHARE
Basic earnings (loss) per common share is computed by dividing net
earnings (loss) by the weighted-average number of common shares outstanding
during the reported period. 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 period plus incremental shares that would
have been outstanding upon the assumed vesting of dilutive restricted stock and
the assumed exercise of dilutive stock options. As of July 4, 1999, all
outstanding restricted stock and stock options are not considered dilutive.
H. PREPAID EXPENSES AND OTHER ASSETS
Prepaid expenses and other assets for the Company were $87.0 million as
of July 4, 1999 compared to $17.2 million as of June 28, 1998. The increase was
primarily due to cash in advance payments for inventory of approximately $30.7
million and assets available for sale of approximately $31.0 million.
I. OTHER COMMITMENTS AND CONTINGENCIES
On January 28, 1997, the Company and Service Credit Corp. (the
"Subsidiary"), a wholly-owned subsidiary, entered into an agreement with World
Financial Network National Bank ("WFNNB") for the purpose of providing a private
label credit card to the Company's customers. The contract requires the
Subsidiary to maintain a 3% credit risk reserve for the outstanding balances,
which are owned by WFNNB. The purpose of this reserve is to offset future
potential negative spreads and portfolio losses. The negative spreads or losses
may result from potential increased reimbursable contractual program costs. The
3% credit risk reserve is held by the Subsidiary, which is not in Chapter 11, in
the form of cash and cash-equivalents. On April 28, 1999, WFNNB advised the
Company that WFNNB has projected that such portfolio losses and negative spreads
will be at least approximately $9 million. The Company does not have in its
possession sufficient information to determine the accuracy or validity of
WFNNB's projection. Pending confirmation of the accuracy of WFNNB's projection
and a resolution (consensual or otherwise) of the Company's rights and remedies,
the Company has made provision for such potential liability for the period
ending July 4, 1999 by maintaining a 3% credit risk reserve of $9 million. (See
also Note K--Subsequent Events).
The Company was involved in litigation, investigations and various
legal matters during the first and second quarters of 1999 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. Any potential liability may be affected by the
Chapter 11 Cases.
11
<PAGE> 12
J. SEGMENT REPORTING
The Company manages its business on the basis of one reportable
segment. As of July 4, 1999, all of the Company's operations are located within
the United States. The following data is presented in accordance with SFAS No.
131 for all periods presented.
<TABLE>
<CAPTION>
CLASSES OF SIMILAR PRODUCTS:
- ----------------------------
FOR THE QUARTERS ENDED YEAR-TO-DATE FOR THE YEAR
---------------------- ---------------------- ENDED
7/4/99 6/28/98 7/4/99 6/28/98 1/3/99
-------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net Sales (in thousands):
Hardlines $356,962 $481,036 $ 688,384 $ 911,105 $2,249,628
Jewelry 161,302 204,076 340,389 368,189 919,897
-------- -------- ---------- ---------- ----------
Total Net Sales $518,264 $685,112 $1,028,773 $1,279,294 $3,169,525
======== ======== ========== ========== ==========
</TABLE>
K. SUBSEQUENT EVENTS
On July 8, 1999, the Company took to auction 101 properties. The
auction resulted in 77 property offers being accepted for gross proceeds of
approximately $80.2 million. The accepted offers are subject to various
conditions, including the Company's ability to cure mortgage obligations on
affected properties with each mortgagor. Five of the properties were sold for
proceeds less than their carrying value. Losses on the sale of real property
totaling $2.4 million on the five properties were accrued in the period ended
July 4, 1999. Of the total accrued losses, $0.6 million is included in
Restructuring charge and $1.8 million is included in Reorganization items for
the periods ended July 4, 1999.
On July 18, 1999, the Company entered into a transaction to dispose of
certain assets of one of its subsidiary companies. The transaction involved the
B. A. Pargh Co., Inc.'s sale of accounts receivable, inventory, property and
equipment, certain prepaid expenses and the purchaser's assumption of
liabilities for trade payables. Reserves totaling approximately $8.5 million
were recorded to reflect the realizable value of the assets being disposed of.
The anticipated losses have been included in Reorganization items for the
periods ended July 4, 1999.
On July 16, 1999, the Company filed a complaint against WFNNB in the
Bankruptcy Court alleging, among other things, breach of contract and violation
of the automatic stay provisions of the Bankruptcy Code by WFNNB with respect to
and in connection with the January 1997 private label credit card program
agreement between the Company, the Subsidiary and WFNNB (the "World Financial
Agreement"). Under the World Financial Agreement, a program was established
pursuant to which, among other things, WFNNB agreed to issue credit cards to
qualifying Company customers for the purchase of goods and services from the
Company. WFNNB has not yet filed an answer or other pleading in response to the
complaint. While the ultimate result of this litigation cannot be determined or
predicted with any accuracy at this time, the Company intends to pursue
available remedies against WFNNB.
On August 5, 1999, over the objection of WFNNB, the Bankruptcy Court
authorized the Company to enter into an agreement with Household Bank (SB), N.A.
("Household") for the purpose of offering new private label credit cards to
those customers of the Company who meet Household's credit standards. Absent a
timely appeal or motion for reconsideration, the order approving the agreement
with Household will become final on August 20, 1999. The Company's prior private
label credit card program with WFNNB was suspended in March of 1999, and the
rights and liabilities of WFNNB, the Company and the Subsidiary are the subject
of the litigation referred to in the preceding paragraph.
On August 11, 1999, the Company filed a motion with the Bankruptcy
Court, scheduled to be heard on August 31, 1999, requesting authorization to: 1)
Amend the Restated Retirement Plan to cease the accrual of benefits, limit
participants and to vest benefits already accrued under the Plan to be effective
September 30, 1999 (payments to retirees would not be affected); and 2) Amend
the Executive Security Plan, covering approximately 165 former and current
management associates, to cease the accrual of benefits and suspend payments
effective September 30, 1999.
12
<PAGE> 13
ITEM 2. 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 Quarterly Report on Form 10-Q includes certain forward-looking
statements based upon management's beliefs, as well as assumptions made by and
data currently available to management. This information 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. The projections with respect
to the Company's three-month borrowing base and borrowing availability
projections under the DIP Facility, while presented with numerical specificity,
are forward-looking statements which are based on a variety of assumptions
regarding the Company's operating performance that may not be realized and are
subject to significant business, economic, political and competitive
uncertainties and potential contingencies, including those set forth below, many
of which are beyond the Company's control. Consequently, such forward-looking
information should not be regarded as a representation or warranty by the
Company that such projections will be realized. 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.
The Company's liquidity, capital resources and results of operations
are subject to a number of risks and uncertainties including, but not limited
to, the following: the ability of the Company to continue as a going concern;
the ability of the Company to operate pursuant to the terms of the DIP Facility;
the ability of the Company to operate successfully under a Chapter 11
proceeding; approval of plans and activities by the Bankruptcy Court; risks
associated with operating a business in Chapter 11; the ability of the Company
to create and have approved a reorganization plan in the Chapter 11 Cases;
adverse developments with respect to the Company's liquidity or results of
operations; the ability of the Company to obtain shipments and negotiate terms
with vendors and service providers for current orders; the ability to conduct
inventory liquidation sales to improve liquidity; the ability to develop, fund
and execute an operating plan for the Company; the ability of the Company to
attract and retain key executives and associates; competitive pressures from
other retailers, including specialty retailers and discount stores, which may
affect the nature and viability of the Company's business strategy; trends in
the economy as a whole which may affect consumer confidence and consumer demand
for the types of goods sold by the Company; the ability to maintain gross profit
margins; the seasonal nature of the Company's business and the ability of the
Company to predict consumer demand as a whole, as well as demand for specific
goods; the ability of the Company to attract and retain customers; costs
associated with the shipping, handling and control of inventory and the
Company's ability to optimize its supply chain; potential adverse publicity;
availability and cost of management and labor employed; real estate occupancy
and development costs, including the substantial fixed investment costs
associated with opening, maintaining or closing a Company store; the potential
delisting of the Company's securities and the absence of an active public
trading market; the ability of the Company to provide a private label credit
card; and the ability to effect conversions to new technological systems,
including becoming Year 2000 compliant.
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.
13
<PAGE> 14
OVERVIEW
The Company, with 223 stores in 32 states at July 4, 1999, is one of
the nation's largest retailers of jewelry and offers a large selection of
brand-name hardlines and other product lines.
As a result of the Company's decreased net sales in the fourth quarter
of fiscal 1998 and the resulting negative cash flows from operations, in January
1999 the Company began an effort to effect an out-of-court restructuring plan.
Before the Company was able to effect an out-of-court restructuring, on March
15, 1999, five of the Company's vendors filed an involuntary petition for
reorganization under Chapter 11 of the Bankruptcy Code in the United States
Bankruptcy Court for the Middle District of Tennessee seeking court supervision
of the Company's restructuring efforts. On March 27, 1999, the Company and 31 of
its subsidiaries filed voluntary petitions with the Bankruptcy Court for
reorganization under Chapter 11 and orders for relief were entered by the
Bankruptcy Court. The Chapter 11 Cases have been consolidated for the purpose of
joint administration under Case No. 399-02649. The Debtors are currently
operating their businesses as debtors-in-possession pursuant to the Bankruptcy
Code.
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
are stayed and other contractual obligations against the Debtors may not be
enforced. In addition, under the Bankruptcy Code the Debtors may assume or
reject executory contracts, including lease obligations. Parties affected by
these rejections may file claims with the Bankruptcy Court in accordance with
the reorganization process. Substantially all pre-petition liabilities are
subject to settlement under a plan of reorganization to be voted upon by
creditors and equity holders and approved by the Bankruptcy Court. Although the
Debtors expect to file a reorganization plan or plans that provide for emergence
from bankruptcy in 2000 or 2001, there can be no assurance that a reorganization
plan or plans will be proposed by the Debtors or confirmed by the Bankruptcy
Court, or that any such plan(s) will be consummated. As provided by the
Bankruptcy Code, the Debtors initially had the exclusive right to submit a plan
of reorganization for 120 days. On May 25, 1999, the Company received Court
approval to extend the period in which the Company has the exclusive right to
file or advance a plan of reorganization in its Chapter 11 case. The order
extended the exclusivity period from July 23, 1999 to February 29, 2000, and
extended the Company's exclusive right to solicit acceptances of its plan from
September 21, 1999 to May 1, 2000. If the Debtors fail to file a plan of
reorganization during such period or if such plan is not accepted by the
required number of creditors and equity holders, any party in interest may
subsequently file its own plan of reorganization for the Debtors. A plan of
reorganization must be confirmed by the Bankruptcy Court, upon certain findings
being made by the Bankruptcy Court which are required by the Bankruptcy Code.
The Bankruptcy Court may confirm a plan notwithstanding the non-acceptance of
the plan by an impaired class of creditors or equity security holders if certain
requirements of the Bankruptcy Code are met. A plan of reorganization could also
result in holders of the Common Stock receiving no value for their interests.
Because of such possibilities, the value of the Common Stock is highly
speculative.
At the first day hearing held on March 29, 1999 before Judge George C.
Paine, the Bankruptcy Court entered first day orders granting authority to the
Debtors, among other things, to pay certain pre-petition and post-petition
employee wages, salaries, benefits and other employee obligations, and to pay
vendors and other providers in the ordinary course for goods and services
received from March 15, 1999, and to honor customer service programs, including
warranties, returns, layaways and gift certificates.
The Company entered into the DIP Facility dated March 29, 1999 with
Citicorp USA, Inc., as administrative agent, BankBoston, N.A. as documentation
agent and collateral monitoring agent, and Salomon Smith Barney Inc. as sole
arranger and book manager, for a debtor-in-possession credit facility under
which the Company may borrow up to $750 million, subject to certain limitations,
to fund, among other requirements, ongoing working capital needs while it
prepares a reorganization plan. The DIP Facility includes $100 million in term
loans and a maximum of $650 million in revolving loans. A borrowing base reserve
of $50 million will apply until a business plan is accepted by and financial
covenants are negotiated with the Company's lenders.
14
<PAGE> 15
The DIP Facility includes a $200 million sub-facility for standby and trade
letters of credit. Interest rates on the DIP Facility are either the Prime Rate
plus 1.25% or LIBOR plus 2.25% for revolving loans and the term loan. The DIP
Facility is secured by substantially all of the assets of the Company and its
subsidiaries, subject only to valid, enforceable, subsisting and non-voidable
liens of record as of the date of commencement of the Chapter 11 Cases and other
liens permitted under the DIP Facility.
Borrowings under the DIP Facility are limited based on a borrowing base
formula which considers eligible inventories, eligible accounts receivable,
trade letters of credit, mortgage values on eligible real properties, eligible
leasehold interests, available cash equivalents and in-transit cash. The DIP
Facility contains various restrictive covenants that are subject to amendment
pending finalization of the Company's business plan. The Company's ability to
obtain new borrowings after the first anniversary of the DIP Facility is subject
to the Company and the lenders having agreed upon a business plan and revised
financial and other covenants.
On April 27, 1999, the Bankruptcy Court gave final approval to the DIP
Facility. The Company believes the DIP Facility should provide it with adequate
liquidity to conduct its operations while it prepares a reorganization plan.
The Company's Consolidated Financial Statements have been prepared on a
going concern basis, which contemplates continuity of operations, realization of
assets and liquidation of liabilities and commitments in the normal course of
business. The filing of the involuntary and voluntary petitions referred to
above, the related circumstances and the losses from operations raise
substantial doubt with respect to the Company's ability to continue as a going
concern. The appropriateness of using the going concern basis is dependent upon,
among other things, confirmation of a plan or plans of reorganization, future
profitable operations and the ability to generate cash from operations and
financing sources sufficient to meet obligations. As a result of the filing of
the Chapter 11 Cases and related circumstances, realization of assets and
liquidation of liabilities is subject to significant uncertainty. While under
the protection of Chapter 11, the Debtors may sell or otherwise dispose of
assets, and liquidate or settle liabilities, for amounts other than those
reflected in the Consolidated Financial Statements. Further, a plan or plans of
reorganization could materially change the amounts reported in the accompanying
Consolidated Financial Statements. The Consolidated Financial Statements do not
include any adjustments relating to recoverability of the value of recorded
asset amounts or the amounts and classification of liabilities that might be
necessary as a consequence of a plan of reorganization.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases or their effect on the Company's business. Unsecured claims may be
satisfied at less than 100% of their face value and the equity interests of the
Company's shareholders may have no value. The Company believes the DIP Facility
should provide the Company with adequate liquidity to conduct its business while
it prepares a reorganization plan. However, the Company's liquidity, capital
resources, results of operations and ability to continue as a going concern are
subject to known and unknown risks and uncertainties, including those set forth
above under "Safe Harbor Statement Under The Private Securities Litigation
Reform Act of 1995."
RESULTS OF OPERATIONS
SECOND QUARTER ENDED JULY 4, 1999 COMPARED TO SECOND QUARTER ENDED JUNE 28, 1998
NET SALES
Net sales for the Company were $518.3 million for the second quarter of
1999 compared to $685.1 million for the second quarter of 1998. The $166.8
million decrease reflects a $53.7 million decline in sales from the operations
excluding closing facilities as a result of restructuring and remerchandising
activities and a reduction of $113.1 million in sales from liquidating stores.
The Company believes that a portion of the comparable store sales decrease is
attributable to out of stock levels associated with product procurement
difficulties encountered during the second quarter of 1999.
15
<PAGE> 16
Net sales from operations excluding results of restructuring and
remerchandising activities for the second quarter of 1999 were $430.1 million
versus $483.8 million for the same period in 1998. This represents a comparable
store sales decrease of $20.6 million or 4.7% as well as a sales decrease of
$33.1 million in the remaining stores included in operations excluding closed
facilities as a result of restructuring and remerchandising activities. The
Company believes that a portion of the comparable store sales decrease is
attributable to out of stock levels associated with product procurement
difficulties encountered during the second quarter of 1999. Jewelry comparable
store sales decreased 0.9%, while hardline comparable store sales decreased
6.3%.
GROSS MARGIN
In the second quarter of 1999, gross margin was $87.2 million as
compared to $163.6 million in the second quarter of 1998. The decrease was
primarily due to a $166.8 million decline in sales, partially offset by a $83.8
million or 18.2% decrease in cost of goods sold during the quarter.
Gross margin after cost of merchandise sold and buying and occupancy
expenses excluding closed facilities as a result of restructuring and
remerchandising was $108.2 million or 25.1% of net sales for the second quarter
of 1999, compared to $126.3 million or 26.1% of net sales for the second quarter
of 1998. The margin decrease was primarily the result of changes in product mix,
additional markdowns and lower hardlines sales.
Gross margin after cost of merchandise sold and buying and occupancy
expenses for closed facilities as a result of restructuring and remerchandising
activities was $(20.9) million, or (23.7)% of net sales for the second quarter
of 1999 compared to $37.2 million, or 18.5% of net sales for the second quarter
of 1998. The margin decrease was primarily a result of additional markdowns
associated with inventory liquidations at the closing stores.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased $13.5 million in
the second quarter of 1999 to $134.9 million from $148.4 million in the second
quarter of 1998. The decrease was primarily attributable to a $17.1 million
decrease in employment costs and a $8.1 million decrease in other selling,
general and administrative expenses due to store closures, partially offset by a
$11.7 million increase in expense related to the private label credit card
program.
INTEREST EXPENSE
Interest expense for the second quarter of 1999 was $12.8 million as
compared to $19.5 million for the second quarter of 1998. The decrease in
interest expense reflects the contractual interest expense not recorded on
unsecured pre-petition debt totaling $7.0 million.
INCOME TAXES
The Company did not recognize an income tax benefit due to the
recording of a deferred tax asset valuation allowance. Deferred taxes are
recognized to reflect the estimated future utilization of temporary book/tax
differences. The Company has recorded a full valuation allowance on net deferred
tax assets as realization of such assets in future years is uncertain.
Management does not believe it is more likely than not that the Company will
realize the deferred tax asset.
16
<PAGE> 17
SIX PERIODS ENDED JULY 4, 1999 COMPARED TO SIX PERIODS ENDED JUNE 28, 1998
NET SALES
Net sales for the Company were $1,028.8 million for the first half of
1999 compared to $1,279.3 million for the first half of 1998. The $250.5 million
decrease reflects the $129.0 million loss in sales from the operations excluding
closed facilities as a result of restructuring and remerchandising activities
and a reduction of $121.5 million in sales from liquidating stores. The Company
believes that a portion of the comparable store sales decrease in continuing
stores is attributable to out of stock levels associated with product
procurement difficulties encountered during the first and second quarters of
1999.
Net sales from operations excluding results of restructuring and
remerchandising activities for the first half of 1999 were $770.8 million versus
$899.8 million for the same period in 1998. This represents a comparable store
sales decrease of $67.8 million or 8.3% as well as a sales decrease of $61.2
million in the remaining stores included in operations excluding closed
facilities as a result of restructuring and remerchandising activities. Jewelry
comparable store sales increased 4.3%, while hardline comparable store sales
decreased 13.5%.
GROSS MARGIN
In the first half of 1999, gross margin was $184.0 million as compared
to $306.7 million in the first half of 1998. The decrease was primarily due to a
$250.5 million decline in sales, partially offset by a $134.0 million or 15.6%
decrease in cost of goods sold.
Gross margin after cost of merchandise sold and buying and occupancy
expenses and excluding closed facilities as a result of restructuring and
remerchandising was $180.7 million or 23.4% of net sales for the first half of
1999, compared to $233.4 million or 25.9% of net sales for the first half of
1998. The margin decrease was primarily the result of changes in product mix,
additional markdowns and lower hardlines sales.
Gross margin after cost of merchandise sold and buying and occupancy
expenses for closed facilities as a result of restructuring and remerchandising
activities was $3.3 million, or 1.3% of net sales for the first half of 1999
compared to $73.3 million, or 19.3% of net sales for the first half of 1998. The
margin decrease was primarily a result of additional markdowns associated with
inventory liquidations at the closing stores.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased $4.4 million in
the first half of 1999 to $302.2 million from $297.8 million in the first half
of 1998. The increase was primarily attributable to a $9.0 million charge to
offset future potential negative spreads or portfolio losses on the private
label credit card program, a $20.5 million increase in expense related to the
private label credit card program and a $5.4 million increase in advertising
expense. The negative spreads or losses on the customers' balances carried under
the private label credit card program may result in potential increased
reimbursable contractual program costs. These increases were partially offset by
a $22.5 million decrease in employment expense and a $4.4 million decrease in
other selling, general and administrative expenses due to store closures.
17
<PAGE> 18
INTEREST EXPENSE
Interest expense for the first half of 1999 was $37.9 million as
compared to $39.1 million for the first half of 1998. Interest expense increased
because of higher average borrowings under the Company's DIP Facility, the
Second Amended and Restated Credit Facility and the Amended and Restated Credit
Facility in 1999 than 1998. But the increase was more than offset by contractual
interest expense not recorded on certain pre-petition debt totaling $8.5
million.
INCOME TAXES
The Company did not recognize an income tax benefit due to the
recording of a deferred tax asset valuation allowance. Deferred taxes are
recognized to reflect the estimated future utilization of temporary book/tax
differences. The Company has recorded a full valuation allowance on net deferred
tax assets as realization of such assets in future years is uncertain.
Management does not believe it is more likely than not that the Company will
realize the deferred tax asset.
1997 RESTRUCTURING PLAN
On March 25, 1997, the Company adopted a business restructuring plan to
close up to 60 under performing 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 fiscal 1997. The components of the restructuring charge and an
analysis of the amounts charged against the accrual through the six periods
ended July 4, 1999 are outlined in the following table:
<TABLE>
<CAPTION>
ACTIVITY TO DATE
--------------------------------------------------------------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF ASSET COSTS AS OF
JANUARY 3, RESTRUCTURING WRITE- CHANGE IN JULY 4,
(in thousands) 1999 COSTS PAID DOWNS ESTIMATE 1999
------- ------------- -------- --------- ------
<S> <C> <C> <C> <C> <C>
Lease termination and other real
estate costs $53,161 $(1,526) $ -- $(45,981) $5,654
Property and equipment write-downs -- -- 2,489 (2,489) --
Employee severance -- -- -- -- --
Other exit costs -- -- -- -- --
------- ------- ------ -------- ------
Total $53,161 $(1,526) $2,489 $(48,470) $5,654
======= ======= ====== ======== ======
</TABLE>
Restructuring costs paid through the six periods ended July 4, 1999
relate primarily to lease termination and other real estate costs. The Company
incurred $1.1 million in contractual rent payments and lease termination fees
and $0.4 million in other real estate costs primarily related to utilities,
common area maintenance fees, real estate taxes and brokerage costs.
In connection with the Chapter 11 Cases, the $46.0 million change in
estimate was made to reflect the reduction allowed under Section 502(b)(6) of
the Bankruptcy Code and recorded as a Reorganization item. Amounts had been
accrued according to the remaining leasehold obligations. Section 502(b)(6)
limits a lessor's claim to the rent reserved by such lease, without
acceleration, for the greater of one year, or 15 percent, not to exceed three
years, of such lease, plus any unpaid rent.
The leases remaining on closed locations as of July 4, 1999 vary in
length with expiration dates ranging from July 1999 to December 2030.
18
<PAGE> 19
As of July 4, 1999, property and equipment associated with the 1997
Restructuring Plan have been written-down to reflect their estimated fair value.
The Company anticipates selling or abandoning substantially all remaining owned
property and equipment associated with the 1997 Restructuring Plan.
Approximately 3,000 employees were terminated pursuant to the 1997 Restructuring
Plan. All such terminations were completed as of May 1998 for the 1997
Restructuring Plan.
RATIONALIZATION PLAN
In February 1999, the Company announced a rationalization plan to close
up to 132 stores, up to four distribution centers and to reduce corporate
overhead (the "Rationalization Plan"). On March 8, 1999 as part of the
Rationalization Plan and prior to the filing of the involuntary bankruptcy
petition, the Board of Directors approved the adoption of a business
restructuring plan to close 106 stores, the Dallas distribution center and to
reduce the Company's workforce at its Nashville corporate offices by 150
employees. As a result, a pre-tax charge of $99.5 million for restructuring
costs was recorded in the first quarter of 1999. On March 29, 1999 and in
connection with the Chapter 11 Cases, store leases under this plan were approved
for rejection by the Bankruptcy Court. The components of the restructuring
charge and the amounts charged against the accrual through the six periods
ended July 4, 1999 are outlined in the following table.
<TABLE>
<CAPTION>
ACTIVITY TO DATE
-------------------------------------------------------------------------
INITIAL
CHARGE ACCRUED
RECORDED IN COSTS ASSET CHANGE IN COSTS AS OF
(in thousands) MARCH PAID WRITE-DOWNS ESTIMATE JULY 4, 1999
-------- ------- ----------- --------- ------------
<S> <C> <C> <C> <C> <C>
Lease termination and other real estate costs $ 62,469 $(1,147) $ -- $ -- $61,322
Property and equipment write-downs 24,452 -- (25,047) 595 --
Employee severance 12,533 (6,413) -- -- 6,120
-------- ------- -------- ------- -------
Total $ 99,454 $(7,560) $(25,047) $ 595 $67,442
======== ======= ======== ======= =======
</TABLE>
The stores planned for closure 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' and
distribution center lease agreements under Section 502(b)(6) of the Bankruptcy
Code, net of any actual or reasonably probable sublease income. Section
502(b)(6) limits the lessor's claim to the rent reserved by such lease, without
acceleration, for the greater of one year, or 15 percent, not to exceed three
years, of such lease, plus any unpaid rent.
After taking into effect the above asset write-downs, the Company's
carrying value of the property and equipment associated with the closures is
$21.6 million as of July 4, 1999. All of this amount is classified as available
for sale as all store closures are now complete. Assets available for sale are
considered current assets and are included with Prepaid expenses and other
assets. The Company anticipates selling substantially all owned property and
equipment associated with the closures.
The employee severance provision was recorded for the planned
termination of approximately 4,389 employees associated with the closures, as
well as the reduction of corporate overhead.
LIQUIDITY AND CAPITAL RESOURCES
On March 27, 1999, the Debtors filed the Chapter 11 Cases, which will
affect the Company's liquidity and capital resources in fiscal 1999. See Note B
of Notes to Consolidated Financial Statements (Unaudited) "Proceedings Under
Chapter 11 of the Bankruptcy Code."
19
<PAGE> 20
From September 1997 through January 20, 1999, the Company had a
five-year, $900 million, fully committed asset-based credit facility (the
"Amended and Restated Credit Facility"). The Amended and Restated Credit
Facility included $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 was set to mature on September 10,
2002. Interest rates on the Amended and Restated Credit Facility were subject to
change based on a financial performance-based grid and could not exceed a rate
of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on the term loan. There
was a commitment fee of 3/8% on the undrawn portion of the revolving loans.
There were no outstanding loans under the Amended and Restated Credit Facility
as of July 4, 1999.
On January 20, 1999, the Company completed a $750 million, 30-month
asset-based credit facility (the "Second Amended and Restated Credit Facility")
which replaced the Amended and Restated Credit Facility. The Second Amended and
Restated Credit Facility included $150 million in term loans and a maximum of
$600 million in revolving loans. The Second Amended and Restated Credit Facility
included a $200 million sub-facility for standby and trade letters of credit.
Interest rates on the Second Amended and Restated Facility were based on either
Prime Rate + 1.5% or LIBOR + 2.75%.
On March 29, 1999, the Company entered into a 27-month, $750 million,
fully committed asset-based debtor-in-possession credit facility (the "DIP
Facility") which replaced the Second Amended and Restated Credit Facility. The
Bankruptcy Court approved the DIP Facility on an interim basis on March 29, 1999
and granted final approval on April 27, 1999. The DIP Facility includes $100
million in term loans and up to a maximum of $650 million in revolving loans,
including a $200 million sub-facility for letters of credit. The DIP Facility
matures on June 30, 2001. Interest rates on the DIP Facility are either Prime
Rate + 1.25% or LIBOR + 2.25% for the revolving loans and the term loan. There
is a commitment fee of 3/8% on the undrawn portion of the revolving loans. The
Company had $33.6 million in short-term borrowings outstanding under the DIP
Facility. Other extensions of credit under the DIP Facility, as of July 4, 1999,
included $99.8 million in term loans and $94.4 million in letters of credit.
The DIP Facility is secured by all material unencumbered assets of the
Company and its subsidiaries, including inventory but excluding previously
mortgaged property and leasehold interests.
Borrowings under the DIP Facility are limited based on a borrowing base
formula that takes into account eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, available cash
equivalents, eligible leasehold interests and in-transit cash. The Company had
$193.0 million of unused borrowing availability under the DIP Facility as of
July 4, 1999.
The DIP Facility had a borrowing base reserve of $75 million from March
29, 1999 to April 27, 1999, the date of final approval by the Bankruptcy Court.
A borrowing base reserve of $50 million will apply until a business plan is
accepted and financial covenants are negotiated with the Company's lenders.
There can be no assurance that the Company's business plan will be deemed
acceptable or that the financial covenants can be negotiated with the Company's
lenders.
The following table sets forth the Company's three month borrowing base
and borrowing availability projections under the DIP Facility. The forecast
projects a borrowing base which ranges from $492 million to $656 million over
the period from August 8, 1999 to November 7, 1999, and unused borrowing
availability which ranges from $144 million to $223 million. The projected
availability is subject to the $50 million borrowing base reserve noted above.
These forward-looking statements are subject to assumptions, known and unknown
risks and uncertainties. See "Safe Harbor Statement Under The Private Securities
Litigation Reform Act of 1995."
20
<PAGE> 21
<TABLE>
<CAPTION>
Actual Forecast Forecast Forecast Forecast
8/8/99 8/15/99 9/12/99 10/10/99 11/7/99
------ ------- ------- -------- -------
(in millions)
<S> <C> <C> <C> <C> <C>
Ending Total Revolver Balance $ 72.7 $ 88.6 $142.1 $230.9 $349.9
Term Loan 99.8 99.8 99.8 99.5 99.5
Standby Letters of Credit 29.1 29.1 29.1 29.1 29.1
Trade Letters of Credit 79.9 70.0 53.0 40.0 33.0
------ ------ ------ ------ ------
Total Extensions of Credit $281.5 $287.5 $324.0 $399.5 $511.5
------ ------ ------ ------ ------
Borrowing Base $491.6 $510.3 $527.4 $577.6 $655.9
Availability* $210.1 $222.8 $203.4 $178.1 $144.4
</TABLE>
* Borrowing Base and Availability calculated before deduction of $50 million
borrowing base reserve.
The anticipated increase in revolver borrowings and decrease in
availability in September, October and November reflects, among other things,
seasonal inventory increases relating to the Fall selling season.
The above projections do not include the potential increase in
availability related to the collection of net proceeds of the real estate
auction and the addition of $25 million to the borrowing base related to under
market leases.
CAPITAL STRUCTURE
During the six periods ended July 4, 1999, the Company's principal
sources of liquidity were its successive credit facilities: (1) the Amended and
Restated Credit Facility, which included a $200 million term loan and a
revolving credit facility with a maximum commitment level of $700 million, (2)
the Second Amended and Restated Credit Facility, which included a $150 million
term loan and a revolving credit facility with a maximum commitment level of
$600 million, and (3) the DIP Facility, which includes a $100 million term loan
and a revolving credit facility with a maximum commitment level of $650 million.
At July 4, 1999, the Company had total extensions of credit of $227.8
million under the DIP Facility. At June 28, 1998, the Company had total
extensions of credit of $224.4 million under the Amended and Restated Credit
Facility.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." In
June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments
and Hedging Activities - Deferral of the Effective Date of FASB Statement No.
133", which extended the effective date of SFAS No. 133 to all fiscal quarters
of fiscal years beginning after June 15, 2000. The Company is still in the
process of analyzing the impact of the adoption of this Statement. The Company
anticipates that the adoption of this statement will not have a material impact
on its operating results or financial position.
YEAR 2000 COMPLIANCE
The Company is currently conducting an organization wide program to
ensure that all the systems critical to the operation of the Company are year
2000 compliant. In all categories the awareness and assessment phases are
complete. The renovation, validation (including testing) and implementation
phases are currently in progress. As of July 4, 1999, information technology
supported systems are approximately 97% complete and non-information technology
systems (end user systems) are approximately 99% complete. It is expected that
information technology supported systems will be completed by the end of the
third quarter of 1999. In the course of the Company's preparation for the year
2000, the Company has corresponded with all software vendors, financial
institutions, and its top 1,000 merchandise vendors and the Company is
monitoring their progress.
21
<PAGE> 22
Replacement, conversion and testing of hardware and systems
applications are expected to cost between $2.5 million and $3.0 million. To
date, approximately $2.4 million of costs have been incurred. These costs are
being expensed as incurred.
Given that there can be no assurance that the systems of other entities
on which the Company relies will be year 2000 compliant in a timely manner, the
major risk factor associated with year 2000 pertains to our third party
relationships. The Company is currently developing contingency plans to address
a potential worst case scenario involving difficulties experienced by the U.S.
Postal Service in the distribution of direct mailings and other publications. If
such an event occurs, the Company would have to insert a majority of its
publications into local newspapers and other publications in lieu of mailing
them. If local utility companies are unable to provide services to any of our
locations, there is no contingency plan in place and our business would be at
risk. The Company is unable to determine the impact, if any, of the Chapter 11
Cases on the Company's year 2000 program.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's operations are subject to market risks primarily from
changes in interest rates. The Company has immaterial exposure to exchange rate
risk. As discussed in the Company's Annual Report on Form 10-K filed on April 5,
1999, the Company had interest rate swaps at fiscal year-end with a notional
amount of $125 million.
22
<PAGE> 23
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On March 15, 1999, five of the Company's vendors filed an involuntary
petition for reorganization under Chapter 11 in the Bankruptcy Court seeking
court supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries filed voluntary petitions with the Bankruptcy
Court for reorganization under Chapter 11 of the Bankruptcy Code. The Debtors
are currently operating their businesses as debtors-in-possession. The Chapter
11 Cases have been consolidated for the purpose of joint administration under
Case No. 399-02649.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases or their effect on the Company's business. Additional information
regarding the Chapter 11 Cases is set forth elsewhere in this Quarterly report
on Form 10-Q and in Item 1. "Business -- Proceedings Under Chapter 11 of the
Bankruptcy Code," Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations," Note B of Notes to Consolidated Financial
Statements, and the Report of Independent Auditors included in the Company's
Annual Report on Form 10-K filed on April 5, 1999, which includes an explanatory
paragraph concerning a substantial doubt as to the Company's ability to continue
as a going concern. If it is determined that the liabilities subject to
compromise in the Chapter 11 Cases exceed the fair value of the assets,
unsecured claims may be satisfied at less than 100% of their face value and the
equity interests of the Company's shareholders may have no value.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
The Company commenced the Chapter 11 Cases on March 27, 1999. As a
result of filing the Chapter 11 Cases, no principal or interest payments will be
made on certain indebtedness incurred by the Company prior to March 27, 1999,
including the 9% Senior Subordinated Debentures and 8 3/8% Senior Notes, until a
plan of reorganization defining the payment terms has been approved by the
Bankruptcy Court.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's Annual Meeting of Shareholders which was held on July
1, 1999, the following proposals were approved:
1) The election of two Class I directors to serve for a term of
three years and until their successors are duly elected and
qualified; the election of one Class II director to serve for
a term of one year and until his successor is duly elected and
qualified; and the election of one Class III director to serve
for a term of two years and until his successor is duly
elected and qualified.
The persons nominated for election to the Board of Directors received
the number of votes shown opposite their respective names:
<TABLE>
<CAPTION>
For Withheld
------------ ------------
CLASS I NOMINEES
<S> <C> <C>
Richard P. Crane, Jr. 84,552,359 3,698,295
Charles V. Moore 86,227,236 2,023,418
CLASS II NOMINEE
Charles Septer 86,352,759 1,897,895
CLASS III NOMINEE
S. Cusano 86,267,437 1,983,217
</TABLE>
23
<PAGE> 24
2) The selection of Deloitte and Touche LLP as the Company's
Independent Public Accountants for fiscal year 1999. The proposal
received the following votes:
<TABLE>
<CAPTION>
For Against Withheld
---------- ------- --------
<S> <C> <C>
86,881,087 527,299 842,268
</TABLE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits filed with this Form 10-Q.
27 Financial Data Schedule for the Six Periods ended July 4,
1999.
(b) Reports on Form 8-K.
During the second quarter ended July 4, 1999, the Company filed the
following three reports on Form 8-K: (i) dated April 29, 1999 announcing that
the Company had received final approval from the Bankruptcy Court of the $750
million DIP facility and providing the three-month borrowing base and borrowing
availability projections; (ii) dated June 8, 1999 attaching the Operating Report
filed with the Bankruptcy Court for the period ending May 2, 1999; and (iii)
dated July 1, 1999 attaching the Operating Report filed with the Bankruptcy
Court for the period ending May 30, 1999.
24
<PAGE> 25
SIGNATURES
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/ S. Cusano
- ----------------------------------------
S. Cusano
Director and Chief Executive Officer
(Principal Executive Officer)
August 18, 1999
/s/ Thomas L. Garrett, Jr.
- ----------------------------------------
Thomas L. Garrett, Jr.
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
August 18, 1999
25
<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 JULY 4, 1999
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
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-02-2000
<PERIOD-START> JAN-04-1999
<PERIOD-END> JUL-04-1999
<CASH> 37,858
<SECURITIES> 0
<RECEIVABLES> 35,320
<ALLOWANCES> 18,755
<INVENTORY> 553,711
<CURRENT-ASSETS> 695,108
<PP&E> 872,450
<DEPRECIATION> 490,281
<TOTAL-ASSETS> 1,127,120
<CURRENT-LIABILITIES> 210,491
<BONDS> 564,067
0
0
<COMMON> 100,097<F1>
<OTHER-SE> (93,242)
<TOTAL-LIABILITY-AND-EQUITY> 1,127,120
<SALES> 1,028,773
<TOTAL-REVENUES> 1,028,773
<CGS> 844,753
<TOTAL-COSTS> 844,753
<OTHER-EXPENSES> 391,484<F2>
<LOSS-PROVISION> 15,756
<INTEREST-EXPENSE> 37,861
<INCOME-PRETAX> (261,081)
<INCOME-TAX> 0
<INCOME-CONTINUING> (261,081)
<DISCONTINUED> 0
<EXTRAORDINARY> (7,851)
<CHANGES> 0
<NET-INCOME> (268,932)
<EPS-BASIC> (2.70)
<EPS-DILUTED> (2.70)
<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 (less loss provision) III) Other income, net IV)
Restructuring charge and V) Reorganization items.
</FN>
</TABLE>
