<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report: April 5, 2000
SERVICE MERCHANDISE COMPANY, INC.
(Debtor-in-Possession as of March 27, 1999)
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Tennessee 1-9223 62-0816060
- ---------------------------- ------------------------ ----------------
(State or other jurisdiction (Commission File Number) (I.R.S. Employer
of incorporation) Identification No.)
7100 Service Merchandise Boulevard, Brentwood, TN 37027
- ------------------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (615) 660-6000
Not Applicable
- --------------------------------------------------------------------------------
(Former name or former address, if changed since last report)
<PAGE> 2
Item 5. Other Events
Service Merchandise Company, Inc. (the "Company") has filed its 1999
business plan (the "Business Plan") as Exhibit 99 to this Current Report on Form
8-K.
The Company cautions readers not to place undue reliance upon the
information contained therein. The Business Plan is being made available
publicly because such information was made available on a confidential basis to
certain of the Company's creditors for purposes of their credit analyses. The
Company is not obligated to update the Business Plan to reflect subsequent
events or circumstances. There can be no assurances that the Business Plan is
complete. The Business Plan also contains information which may not be
indicative of the Company's financial condition or operating results for the
periods reflected in the Company's financial statements or in its reports
pursuant to the Securities Exchange Act of 1934 and readers are cautioned to
refer to the Company's filings made pursuant to the Exchange Act. Moreover, the
Business Plan and other communications from the Company may include
forward-looking statements subject to various assumptions regarding the
Company's operating performance that may not be realized and which are subject
to significant business, economic and competitive uncertainties and
contingencies, including those described therein and in this report, many of
which are beyond the Company's control. Consequently such matters should not be
regarded as a representation or warranty by the Company that such matters will
be realized or are indicative of the Company's financial condition or operating
results for future periods or the periods covered in the Company's reports
pursuant to the Exchange Act. Actual results for such periods may differ
materially from the information contained in the Business Plan.
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: approval of plans and activities by the Bankruptcy Court,
including the Company's proposed strategic real estate initiatives; the ability
of the Company to continue as a going concern; the ability of the Company to
operate pursuant to the terms of the present DIP Facility and to close and
operate pursuant to the new DIP to Exit Facility; the ability of the Company to
conduct successful clearance sales in connection with the 2000 Business Plan;
the ability of the Company to sublease successfully portions of its real estate
in connection with the 2000 Business Plan; the ability of the Company to
complete its store refurbishment program within cost and time expectations; the
successful implementation of the consolidation of its distribution centers; the
ability of the Company to enter into satisfactory arrangements with third
parties with respect to real estate and Internet-related strategies; risks
associated with third parties seeking and obtaining Court action to terminate or
shorten the exclusivity period, the time for the Company to accept or reject
executory contracts including its store leases, and for appointment of a Chapter
11 operating trustee or to convert the Company's reorganization cases to
liquidation cases; the ability of the Company to operate successfully under a
Chapter 11 proceeding, achieve planned sales and margin, and create and have
approved a plan of reorganization in the Chapter 11 cases; potential adverse
developments with respect to the Company's liquidity or results of operations;
the ability of the Company to obtain shipments, negotiate and maintain terms
with vendors and service
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providers for current orders; the ability to fund and execute a Year 2000
Business Plan; the ability of the Company to achieve cost-savings; the ability
of the Company to attract, retain and compensate 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
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; potential adverse
publicity; real estate occupancy and development costs, including the
substantial fixed investment costs associated with opening, maintaining or
closing a Company store; uncertainties with respect to continued public trading
in the Company's securities; the ability to effect conversions to new
technological systems; and the ability to develop, prosecute, confirm and
consummate one or more plans of reorganization with respect to its Chapter 11
cases.
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SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned hereunto duly authorized.
SERVICE MERCHANDISE COMPANY, INC.
Date: April 7, 2000 By: /s/ C. Steven Moore
--------------------------------------------
C. Steven Moore
Senior Vice President, Chief Administrative
Officer, Secretary and General Counsel
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EXHIBIT INDEX
No. Exhibit
- -------- ---------------------------------------------
99 Business Plan
<PAGE> 1
Exhibit 99
[Outside Front Cover]
At Your Service Merchandise
SERVICE MERCHANDISE COMPANY, INC.
2000 BUSINESS PLAN
April 5, 2000
<PAGE> 2
FOREWORD
STRENGTHEN AND GROW
Having successfully achieved our goal of stabilizing the business in 1999
by surpassing target nine-month continuing EBITDAR of $35 million and achieving
nine-month continuing EBITDAR of almost $48 million, Service Merchandise is
well-positioned to move into the second phase of its restructuring, the
strengthening phase. The 1999 Operating Plan sets forth the Company's
restructuring timeline and strategy: stabilize the business in 1999, strengthen
the business in 2000, and position the Company for growth and emergence from
bankruptcy reorganization in 2001. The 2000 Business Plan describes how Service
Merchandise intends to strengthen its business in 2000 and lay the foundation
for future growth.
The target full-year continuing EBITDAR for 2000 is $41 million. Once we
have completed a successful 2000 holiday season, we expect to develop a plan of
reorganization and five year business plan projections in anticipation of
exiting Chapter 11 in 2001.
2000 will be a transitional year, with certain initiatives having a
short-term, temporary negative impact on continuing EBITDAR. In future years,
continuing EBITDAR is expected to grow. We plan to invest capital during this
time, and, based on our reasonable business judgment, this capital investment is
justified by the projected results and is in the best interests of our
creditors.
THE SENIOR EXECUTIVES OF SERVICE MERCHANDISE COMPANY, INC.
/S/ SAM CUSANO
------------------------------------------------------
Sam Cusano
Chief Executive Officer
<TABLE>
<S> <C>
/s/ Charles K. Septer, Jr. /s/ C. Steven Moore
- ----------------------------------------------------- -----------------------------------------------------
Charles K. Septer, Jr. C. Steven Moore
President and Chief Operating Officer Chief Administrative Officer and General Counsel
/s/ Thomas L. Garrett, Jr. /s/ Eric A. Kovats
- ----------------------------------------------------- -----------------------------------------------------
Thomas L. Garrett, Jr. Eric A. Kovats
Senior Vice President and Chief Financial Officer Senior Vice President -- Stores
/s/ Jerry E. Foreman /s/ Rose C. Septer
- ----------------------------------------------------- -----------------------------------------------------
Jerry E. Foreman Rose C. Septer
Senior Vice President -- Hardlines, Logistics and Vice President -- Jewelry
eCommerce
</TABLE>
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SERVICE MERCHANDISE COMPANY, INC.
DIRECTORS AND OFFICERS
<TABLE>
<S> <C>
DIRECTORS
Raymond Zimmerman Chairman of the Board
Sam Cusano Chief Executive Officer
Charles K. Septer,
Jr. President and Chief Operating Officer
Richard P. Crane Attorney at Law, Musick, Peeler & Garrett, Los Angeles,
California
R. Maynard Holt,
J.D. Business Consulting, Nashville, Tennessee
Charles V. Moore President of Trainer, Wortham & Company, Inc., Investment
Counselors, New York, New York
Harold Roitenberg President of Roitenberg Investments, Inc., Minneapolis,
Minnesota
OFFICERS
Sam Cusano Chief Executive Officer
Charles K. Septer,
Jr. President and Chief Operating Officer
C. Steven Moore Chief Administrative Officer and General Counsel
Thomas L. Garrett,
Jr. Senior Vice President and Chief Financial Officer
Jerry E. Foreman Senior Vice President-Hardlines, Logistics and eCommerce
Eric A. Kovats Senior Vice President-Stores
</TABLE>
CORPORATE INFORMATION
CORPORATE OFFICE
Service Merchandise Company, Inc.
7100 Service Merchandise Drive
Brentwood, Tennessee 37027
(615) 660-6000
MAILING ADDRESS
P.O. Box 24600
Nashville, Tennessee 37202-4600
INDEPENDENT AUDITORS
Deloitte & Touche LLP
424 Church Street, Suite 2400
Nashville, Tennessee 37219-2396
TRANSFER AGENT - COMMON STOCK
(Ticker Symbol -- SVCDQ)
Harris Trust and Savings Bank
311 West Monroe Street, P.O. Box A3504
Chicago, Illinois 60690-3504
(312) 360-5317
TRUSTEE AND PAYING AGENT - 8 3/8%
SENIOR NOTES, DUE 2001
State Street Bank and Trust
Corporate Service Division, P.O. Box 778
Boston, Massachusetts 02102-0778
(800) 531-0368
TRUSTEE AND PAYING AGENT - 9%
SENIOR SUBORDINATED DEBENTURES, DUE 2004
The Bank of New York
101 Barclay Street
New York, New York 10286
(212) 815-5287
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TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
I. INTRODUCTION................................................ 1
II. 1999 PERFORMANCE SUMMARY
1999 Strategic Initiatives.................................. 6
1999 Operating Results...................................... 8
III. STRATEGIC BUSINESS REVIEW
Customer/Transaction Analysis............................... 9
1999 Marketing Evaluation................................... 12
Line of Business Study...................................... 13
Real Estate Review.......................................... 14
IV. MARKET ANALYSIS
General Retail Market Trends................................ 15
Jewelry Market Overview..................................... 16
Hardlines Market Overview................................... 18
V. 2000 STRATEGIC INITIATIVES
Merchandising............................................... 22
Real Estate................................................. 25
Corporate Overhead.......................................... 26
Stores/Field Organization................................... 26
Internet.................................................... 27
Information Technology...................................... 29
Logistics................................................... 30
Marketing................................................... 31
Capital Structure/Liquidity................................. 35
Human Resources............................................. 37
VI. CONCLUSION.................................................. 38
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES
LITIGATION REFORM ACT....................................... 39
APPENDICES
</TABLE>
<TABLE>
<S> <C> <C>
A. Senior Management Structure and Single Store Structure
B. Store Locations
C. Existing Prototype D Plan, Class I Renovation Plan and Class
II Renovation Plan
</TABLE>
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I. INTRODUCTION
Excitement and positive energy fill the halls at Service Merchandise as we
begin to execute our 2000 Business Plan. 1999 was a very successful year, and
the success of 1999 will serve as the foundation for 2000. The central theme of
the 1999 Operating Plan was to focus on our core customer by providing the
products she wants at low prices. The good news is that the strategy worked. We
substantially eclipsed our nine-month continuing EBITDAR (earnings before
interest, taxes, depreciation, amortization and restructuring charges) goal of
$35 million with a performance of almost $48 million. We reversed the downward
trend of our business for the first time in seven years and believe that we are
poised to rebuild Service Merchandise into a competitive MULTI-CHANNEL SPECIALTY
RETAILER for years to come.
The success of 1999 does not mean that Service Merchandise has solved all
of its business issues. The stated goal in 1999 was to stabilize the business,
and in the process of achieving that goal, we continued to evaluate our business
and learn more about our customers, our strengths and our weaknesses. We
reinforced our belief that satisfying our customer is priority number one. We
also reinforced our belief that we have one of the strongest jewelry franchises
in the United States. Yet we also learned that, despite our best efforts, some
hardlines businesses cannot be fixed, at least not within a realistic timeframe
and given the reasonable expectations of our creditors regarding capital
resources.
The customer focus theme will not change in 2000. Service Merchandise will
continue to emphasize its vibrant jewelry business and will, in fact, commit
even more resources and attention to that business. However, resources will no
longer be devoted to fixing categories, such as electronics and toys, that have
decreased in relevance to our customers and contribute negatively to EBITDAR
performance.
Enhancing the focus on jewelry and eliminating certain unprofitable
hardlines categories are the key components of the 2000 merchandising strategy,
but this strategy also offers opportunities in other areas of our business.
First, we will be able to realize savings from overhead reductions associated
with the exit from electronics, toys and certain other hardlines businesses.
Second, because the space currently devoted to selling those items is no longer
necessary, we will be able to operate our business in stores requiring less
space. Operating in less space will free up valuable, and currently
unproductive, real estate that will be available for subleasing to third parties
or for other real estate transactions. Subleasing the excess real estate will
substantially reduce our occupancy costs and provide potential revenue in future
years. Further, Service Merchandise will continue to emphasize its established
Internet business.
Finally, readers should be mindful that this 2000 Business Plan contains
forward-looking statements which are subject to known and unknown risks and
uncertainties. See "Safe Harbor Statement under the Private Securities
Litigation Reform Act of 1995."
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1999 SUCCESS
1999 was a year of many challenges and difficulties, but we are happy to
report that by the end of the year, every business goal was not only achieved,
but surpassed. The strategic initiatives set and exceeded in 1999 are important
because they form the foundation for the 2000 Business Plan. Some of the more
significant 1999 accomplishments include:
- The achievement of nine-month continuing EBITDAR of almost $48 million
compared to our goal of $35 million for that period.
- Significant excess cash availability, with minimum availability never
falling below $149.3 million and average availability of approximately
$196 million throughout the plan period.
- The shift of our merchandising and store operations strategy to a more
customer focused strategy.
- The use of an integrated marketing approach, including the introduction
of the Service Merchandise Sourcebook.
- The disposition of surplus real estate, including 76 fee owned and leased
properties, that generated proceeds of approximately $74.2 million net of
fees and expenses.
- The implementation of several significant cost reduction initiatives that
generated savings of $32 million and annualized 1999 savings of $40
million.
- The extension of exclusivity to second quarter 2001 and the extension of
the time in which to assume or reject executory contracts and unexpired
real estate leases for go-forward stores through the confirmation of a
plan of reorganization or, with respect to eleven landlords, through
March 31, 2001.
The success Service Merchandise achieved in 1999 is due in no small part to
the support we received from our key constituents, including our vendors, our
lenders, our landlords and our other creditors. At the end of fiscal March 1999,
post-petition trade accounts payable totaled only $9.1 million, with virtually
all vendors requiring payment in advance of shipping merchandise. As of January
2, 2000, Service Merchandise's accounts payable totaled $67.3 million, with
62.1% of the Company's $1.45 billion of merchandise orders purchased on terms.
The support of our vendors, together with the support of the
debtor-in-possession (DIP) facility banks, enabled us to enjoy significant
liquidity.
Finally, it goes without saying that our associates are Service
Merchandise's greatest resource. Our achievements in 1999 would not have been
possible without the dedication and hard work of all our associates.
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BUILDING THE 2000 BUSINESS PLAN
The starting point in the development of the 2000 Business Plan was a
comprehensive review of Service Merchandise's business to determine the
strongest avenue for future growth utilizing our key assets -- an industry
leading jewelry franchise and well-located, low cost real estate. This review
yielded several insights that helped shape the 2000 Business Plan, including:
- Jewelry continues to perform well and customer loyalty is strong.
- Cross-shopping patterns have changed. In the past, high transaction
merchandise categories, such as toys and electronics, drove jewelry
purchases, but a shift has occurred resulting in jewelry and watch buyers
now driving purchases in hardlines categories. A strong cross-shopping
correlation exists between jewelry and housewares and giftware, but not
with electronics and toys.
- Price, value and selection are the strongest traffic drivers for all
categories of merchandise, with Service Merchandise considered a
destination for jewelry and home goods. With respect to consumer
electronics, price is also the predominant driver of traffic, but our
customers often make their consumer electronics purchases elsewhere.
- The categories of consumer electronics, toys and sporting goods
underperform in comparison to competitive retailers and produce
significant operating losses for the Company.
- An integrated marketing strategy succeeds in increasing consumer
awareness of Service Merchandise. Markets utilizing broad-based media of
television and radio significantly out-perform markets utilizing
exclusively print media.
- The Company's Internet improvements have resulted in significant internet
sales growth and strategic opportunities for the future.
- The Company's overall financial performance is disadvantaged due to its
sub-optimal overhead structure and the high proportion of unproductive
warehouse space in its stores.
- Service Merchandise could generate significant value by modifying its
store configuration to feature more jewelry space, less warehouse space,
and subleasing the excess space to other retail tenants.
Based on in-depth customer research, financial analyses and other analyses
we prepared, Service Merchandise has developed the 2000 Business Plan that
features the following:
- An expansion of jewelry and jewelry-related product offerings featuring
wider assortments in all categories, with the bulk of the expansion in
diamonds.
- A more targeted selection of those hardlines categories that have
historically performed well and which generate cross-selling
opportunities with jewelry.
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- The creation of a MULTI-CHANNEL SPECIALTY RETAILER through the
convergence of our in-store and Internet sales environment, including the
placement of Internet stations in each store, the upgrade of Service
Merchandise's Internet site, www.servicemerchandise.com, and the
continued expansion of vendor partnerships on the Internet.
- For 2000, a marketing message based on the following belief:
YOU CAN TRUST SERVICE MERCHANDISE
TO PROVIDE A CUSTOMER-FRIENDLY SHOPPING
EXPERIENCE
FOR YOUR FINE JEWELRY
AND TOP BRANDS FOR YOUR PLACE -
BY STORE, WEB, PHONE -
WITH MORE CHOICES AT BETTER PRICES, GUARANTEED.
- An immediate exit from certain unprofitable hardlines merchandise
categories, including most consumer electronics, toys, juvenile, sporting
goods and most indoor furniture, with the potential for offering such
categories via the Internet.
- The reduction of selling and warehouse spaces within the stores to adjust
for the new merchandise mix and to allow for the subleasing of excess
space or other real estate transactions.
- The rationalization of the Company's corporate overhead structure,
logistics network and stores/field organization to generate anticipated
annual cost savings of $129 million.
To fund the 2000 Business Plan, as well as future operations, and in
anticipation of emergence from Chapter 11 in 2001, Service Merchandise has
obtained a fully underwritten commitment from Fleet Retail Finance Inc., the
co-agent under the current $750 million DIP financing facility, for a new
four-year $600 million credit facility. Upon closing, we believe this new
facility will replace our existing DIP financing, will include a commitment for
post-reorganization financing and will provide the working capital to effect the
transition plan. See "Safe Harbor Statement under the Private Securities
Litigation Reform Act."
As part of the 2000 Business Plan, Service Merchandise is reducing the
workforce at the corporate offices, distribution centers and throughout the
stores organization resulting in the elimination of between 5,000 and 6,000
positions. These reductions will bring our store and corporate support functions
in line with the service requirements of our smaller store layout and reduced
merchandise volume. We are seeking approval from the Bankruptcy Court of
modifications to the existing employee retention program which will benefit go-
forward employees and provide enhanced severance to most transitional employees
who are asked to stay with us for a limited period of time to complete specific
projects and objectives established by the Company. In addition, Service
Merchandise, in consultation with the Creditors Committee, will set threshold,
target and stretch EBITDAR objectives which will provide the basis for the
payment of annual incentive bonuses in 2000.
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At the April 4, 2000 omnibus hearing in the Bankruptcy Court, the Company
received approval of certain elements of the 2000 Business Plan, including the
anticipated DIP and exit financing facility, modifications to the employee
retention program and the retention of advisors in connection with strategic
real estate and other Business Plan initiatives.
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II. 1999 PERFORMANCE SUMMARY
Service Merchandise, A MULTI-CHANNEL SPECIALTY RETAILER, currently operates
221 general merchandise retail stores in 32 states that offer a wide selection
of jewelry and jewelry services, and a broad range of brand name hardlines and
other products. In addition to its traditional retail business, Service
Merchandise operates an Internet/mail order business, anchored by the Company's
web site, www.servicemerchandise.com, the 10th most visited department store
shopping site between November 15, 1999 and December 19, 1999, according to the
New York Times (January 2, 2000).
1999 STRATEGIC INITIATIVES
Since filing for Chapter 11, Service Merchandise, led by its senior
management team, has developed and implemented several initiatives designed to
stabilize the business. These initiatives, which were embodied in the Company's
1999 Operating Plan, were intended to meet the expectations of Service
Merchandise's core customers by returning the Company to its historic strengths
and core values. Initiatives implemented in 1999 include:
COMMITMENT TO CUSTOMER SATISFACTION. The Company revised its
merchandising and store operations strategy during 1999 to improve customer
satisfaction. Service Merchandise renewed its commitment to provide what the
customer has historically demanded: LOW PRICE, LARGE SELECTION, GUARANTEED
SATISFACTION. This effort required a change in hardlines merchandise mix in
order to build a dominant assortment in certain merchandise categories and
develop a blend of traffic-driving products with margin-producing products
within every assortment. Further, management emphasized "value pricing" and
"modified every day low pricing" strategies that delivered a value message to
customers and permitted traffic creation through special sales events. To
support this effort, store operations devised and implemented a new sales
training program for associates and supported this sales focus by reorganizing
store staff. Among other things, this staff reorganization permitted store
managers to spend more time on the sales floor with customers and associates,
and created targeted lead selling positions among store staff.
Management also addressed out-of-stock levels and the accompanying customer
frustration. At the end of fiscal March 1999, key items out-of-stock net of
in-transit merchandise had reached 18% in hardlines categories and 14% overall.
By the end of November 1999, on the eve of the peak holiday sales season,
out-of-stocks were less than 3% in hardlines and less than 2% overall.
REVISED MARKETING STRATEGY. The Company changed its media mix to broaden
customer appeal. To advise customers of the change in merchandising focus,
Service Merchandise distributed a 268 page Sourcebook in October 1999. The
Company revised its marketing strategy to include radio and television broadcast
advertisements in certain markets and to reduce its reliance on print
advertisements. Additional advertising funds were allocated to the Internet
business with an emphasis on a more diversified mix, including e-mail and print.
RENEWED VENDOR FOCUS. At the end of fiscal March 1999, the Company's
post-petition trade accounts payable totaled only $9.1 million. Virtually all
vendors required
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payment of cash-in-advance of shipping merchandise and some declined to ship
merchandise to the Company altogether. Management undertook a concerted effort
to communicate with merchandise vendors and to re-establish payment terms and
vendor support. As a consequence of this effort, from the bankruptcy petition
date through the end of fiscal 1999, 62.1% of Service Merchandise's $1.45
billion of merchandise orders had been on terms, including virtually all jewelry
orders. Much of the balance of vendor orders not on terms was concentrated in
non-continuing merchandise categories.
STORES BASE RATIONALIZATION. In March 1999, Service Merchandise commenced
a store-base rationalization program that led to the closing of 122 stores that
were not meeting current or prospective requirements for profit and cash
generation. In connection with the store-closing program, the Company liquidated
inventory at 118 of the closing stores and generated, net of direct expenses,
approximately $104.5 million. In a separate effort, the Company sold fixtures in
the closing stores and generated an additional $0.9 million of revenue. In July
1999, the Company conducted an auction that resulted in the disposition of 76
fee owned and leased properties and generated proceeds of approximately $74.2
million net of fees and expenses. The remaining properties were primarily
leasehold interests without assignment value, and those leases were subsequently
rejected.
OVERHEAD REDUCTIONS. To adjust the cost structure or "rightsize" the
business to correspond with the reduction in store count and expedite the
Company's return to profitability, management announced and immediately
implemented several significant cost reduction actions, including (i) a
reduction in corporate workforce of approximately 330 with annual payroll
savings of $18.8 million; (ii) the closure of the Dallas distribution center and
the Nashville import distribution center with annual savings of approximately
$13 million; and (iii) the closure of five regional jewelry repair centers with
annual payroll savings of approximately $3.3 million.
EXCLUSIVITY. The Company sought, and the Bankruptcy Court approved, the
extension of the period in which the Company has the exclusive right to file and
advance a plan of reorganization in the Chapter 11 cases to April 30, 2001, and
further extended the Company's exclusive right to solicit acceptances of its
plan to June 30, 2001. This will allow the Company to complete and implement the
2000 Business Plan which should serve as the basis for the plan of
reorganization and anticipated emergence from Chapter 11 in 2001. The Bankruptcy
Court also extended the time to assume or reject executory contracts and
unexpired real property leases of go-forward stores through the confirmation of
the plan of reorganization or, with respect to eleven landlords, through March
31, 2001.
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1999 OPERATING RESULTS
As a result of the strategic initiatives outlined above and the strong
commitment on the part of the Company's management to stabilize the business,
Service Merchandise posted operating results for 1999 that substantially
exceeded the 1999 Operating Plan for continuing stores, as follows:
<TABLE>
<CAPTION>
CONTINUING OPERATIONS
APRIL - DECEMBER 1999
-------------------------------
OPERATING PLAN ACTUAL RESULTS
-------------- --------------
(Dollars in thousands)
<S> <C> <C>
Net sales..................................... $1,620,622 $1,630,015
Gross margin in............................... 544,987 542,310
Gross margin out.............................. 414,749 421,077
Sales, general and administrative expenses
Employment................................. 222,750 236,395
Net advertising............................ 88,028 81,477
Other S,G&A................................ 68,977 55,558
---------- ----------
EBITDAR net of bonus.......................... 34,993 47,647
Incentive bonus expense....................... 3,096 14,806
---------- ----------
Gross EBITDAR................................. $ 38,089 $ 62,453
</TABLE>
The Company benefited from a strong holiday selling season, with December sales
exceeding plan by $22.3 million and gross margin, inventory levels and
out-of-stock positions all better than expected. As a result, gross continuing
EBITDAR for the nine months ended January 2, 2000 exceeded plan by over 64% or
$24.4 million. Most importantly, the Company has continued to show improvement
in continuing EBITDAR on a quarterly basis as compared to last year. Internet
sales were also strong in 1999 totaling $14 million, a 329% increase from 1998.
In particular, December sales of $7.7 million were strong, improving 503% over
December 1998. Service Merchandise also enjoyed strong liquidity throughout
1999, with a minimum availability of $149.3 million reported on November 10,
1999 and a maximum availability of $403.9 million reported on December 30, 1999.
Jewelry and related products, including diamonds, silver, jewelry boxes and
crystal and glass, were among the Company's strongest performers and produced
almost all of Service Merchandise's profits. Homegoods, including pantryware,
tabletop, dining and accents, luggage and seasonal items also performed well.
While these jewelry and home-related hardlines categories were strong performers
in 1999, the Company was disappointed with the performance of its consumer
electronics (audio/video), toys and general sporting goods departments in terms
of both sales and gross margin.
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III. STRATEGIC BUSINESS REVIEW
As the 2000 Business Plan was developed, Service Merchandise remained
committed to its 1999 theme of focusing on its core customer. With that
commitment in mind, management identified a series of analytics designed to
better understand our customers, including demographic analysis, transaction
analysis, customer surveys and segmentation analysis. Additionally, the Company
reviewed and evaluated the effectiveness of its 1999 marketing campaign, which
was developed in response to marketing information suggesting that Service
Merchandise customers expect Low Prices, Large Selection and Guaranteed
Satisfaction. While this customer-focused research was being developed, we were
also analyzing each of our lines of business in an effort to identify product
lines that either perform very well or very poorly. Not surprisingly, the
customer-focused research yielded the same answers as the financial analysis.
The next several pages will briefly describe the significant analytic tools that
lead management to our 2000 Business Plan.
CUSTOMER/TRANSACTION ANALYSIS
During 1999, management focused on more fully understanding the Service
Merchandise customer. Our core customer can be described generally as a woman in
her early forties, middle to upper middle class, married with multiple children
and a relatively well-educated homeowner. Specific measures related to this
description are as follows:
<TABLE>
<S> <C>
Gender:
Female.............................. 70% (1.4 times as likely to be a female as
national average)
Male................................ 30% (0.6 times as likely to be a male as
national average)
Average Household Income............... $59,500
Marital Status......................... 68% married (2.0 times more likely to be married
than national average)
Children............................... Average of 1.8 children in the households with
children (2.4 times more likely to have children
than national average)
Adults................................. 52% have 3 or more adults in the household (1.6
times more likely to have three or more adults
than national average)
Education.............................. 28% graduated college (1.3 times more likely to
be a college graduate than national average)
Residence.............................. 60% homeowners (2.5 times more likely to be a
homeowner than national average)
45% in their home for 5 years or less (1.7 times
more likely to be in their home for five
years or less than national average)
</TABLE>
Sources: Service Merchandise Household Database;
Proprietary Custom Research Studies and Syndicated Information
Service Merchandise undertook an internal analysis of the 224 million
transactions in its database that occurred between December 1996 and November
1999. This analysis was
9
<PAGE> 14
supplemented by additional work performed by Churchill Systems, a retail
consulting firm, and Elrick & Lavidge, an outside research firm. Based on these
analyses, we concluded that the expanded jewelry focus is viable and will be
accepted by our customer. Customers who purchase in both the jewelry and
hardlines categories represent the core of our business. Although such
"combination" purchasers represented only 36% of total customers, they generated
72% of sales and 78% of gross margin, as summarized below:
COMBINATION PURCHASERS ANALYSIS
<TABLE>
<CAPTION>
JEWELRY ONLY HARDLINES ONLY COMBINATION PURCHASERS TOTAL
------------ -------------- ---------------------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Households.............. 857,834 3.8% 13,791,743 60.3% 8,209,086 35.9% 22,858,663
Transactions............ 1,536,402 0.7% 70,708,540 31.5% 152,169,090 67.8% 224,414,032
Sales................... $126,960,852 1.6% $2,095,207,837 26.1% $5,808,242,489 72.3% $8,030,411,178
Margin.................. $66,964,269 2.4% $565,180,527 19.9% $2,212,391,244 77.8% $2,844,536,040
AVERAGE:
Transactions per
customer.............. 1.8 5.1 18.5 9.8
Sales per customer...... $148 $152 $708 $351
Sales per transaction... 83 30 38 36
Margin per customer..... 78 41 270 124
</TABLE>
We concluded that jewelry is the cornerstone of Service Merchandise, with
jewelry and watch buyers driving purchases in hardlines departments. More than
47% of "combination" customers purchased jewelry and watches first; only 8%
purchased kitchen, dining or appliances first.
Recognizing the importance of jewelry in bringing customers into Service
Merchandise, management also investigated the cross-shopping correlation with
jewelry. As in the case of the first-purchase analysis, the closest affinity
(68%) was found to be between jewelry and homegoods (kitchen and dining items
and small appliances). In other words, over two-thirds of customers who purchase
jewelry also purchase housewares from the Company. Jewelry customers were found
to shop less for electronics, toys and fitness products. In addition, electronic
sales were not observed to generate significant jewelry purchases. We concluded
that by combining a core jewelry business with selected hardlines, Service
Merchandise could not only improve jewelry sales, but could also improve overall
profitability.
CUSTOMER SURVEYS
Elrick & Lavidge recently completed interviews with 3,000 customers at a
representative sample of six Service Merchandise stores during the first two
weekends in December 1999. This research supports the Company's internal
research and offers the following additional insights:
- Service Merchandise customers are most concerned with price, value and
selection. Over two-thirds (68%) mention price/value as what they like
most about coming to Service Merchandise, followed by selection (38%).
- Service Merchandise is a destination location for jewelry and homegoods
shoppers, as only one-third of these items are shopped elsewhere before
the Company. All
10
<PAGE> 15
other departments have more pre-shopping competition, peaking with
electronics, where nearly half (49%) of those shopping have shopped the
item elsewhere prior to Service Merchandise.
- In terms of actual purchases, Service Merchandise's competitive strength
in jewelry and homegoods is reflected in the fact that well over half of
these items shopped elsewhere were actually bought at Service Merchandise
(61% and 71%, respectively). In contrast, only 51% of electronics items
shopped elsewhere resulted in a Service Merchandise purchase.
- A majority of the Company's individual departments face the strongest
competition, as reported by Service Merchandise customers, from mass
merchandisers and/or department stores. However, specialty stores
represent additional competition for jewelry, electronics, toys and
fitness. In the case of jewelry, specialty stores and independents
represent the most competition. These channels are the prime
beneficiaries of any unfulfilled purchases at the Company. However, a
significant majority of shoppers rate their Service Merchandise visit
better than their last visit to a mass merchandiser (80%) or a department
store (64%).
SEGMENTATION ANALYSIS
Service Merchandise also engaged the services of Yankelovich Partners, one
of the nation's most experienced market research firms, to help formulate its
future marketing plan. The Company is using the information gained with
Yankelovich for strategic decision-making and tactical execution for overall
marketing planning and marketing communications.
Yankelovich produces a well-recognized annual study of consumer attitudes
and values in America (the Monitor) based on interviews with consumers. The
2,500 annual interviews are based on sampling and weighting that make them
nationally representative of all consumers age 16 and above in the total U.S.
population. Among a wealth of Monitor data, the most pertinent findings to
Service Merchandise are those related to shopping behavior and attitudes going
into the new millennium. These findings demonstrate an opportunity to carve out
a retail niche by focusing on attributes desired in the retail market: customer
service, focused assortment, exclusive shopping environment and flexible selling
channels.
Service Merchandise's planned enhancement of its shopping format plays
directly into these attributes. An emphasis on jewelry promotes a better level
of service within that department while at the same time permitting more
customer information and assistance within hardlines departments. A focused
assortment relates to the reduced number of categories the Company intends to
offer and to the in-store presentation of them. Exclusivity is tied to the
Company's ability to introduce new products, have special events and deliver
jewelry that is special and interesting to the customer, including unique items
in the gallery. For hardlines, exclusivity includes the ability to offer the
entire product lines of selected manufacturers to the customer via the Internet.
Finally, flexible channels tie directly to Service Merchandise's planned
convergence of the store, the Internet and the phone, thereby allowing customers
to shop on their own terms.
11
<PAGE> 16
Yankelovich conducted supplemental custom research designed to segment
Service Merchandise's customers and prospects into identifiable and reachable
target groups (the Segmentation Study). The Company's goal is to improve its
understanding of customers' needs, attitudes and perceptions about Service
Merchandise and to enhance the Company's positioning strategy so that its
offerings are motivating and credible and preempt the competition.
The Segmentation Study suggests that most customers find it inappropriate
to buy jewelry from a general merchandise store, and some say they would even
pay more at a jewelry or "upscale" store. Importantly, though, there is strong
evidence that Service Merchandise is perceived as a specialty jewelry store and
not as a general merchandiser. An overwhelming 90% of customers rate the Company
as good, very good or excellent as a source for jewelry and that they will
consider Service Merchandise for their next jewelry purchase -- and 60% will
definitely or probably shop at Service Merchandise the next time they wish to
purchase jewelry. An increased focus on jewelry will further enhance the
perception of Service Merchandise as a specialty jewelry store.
In comparing Service Merchandise to other retailers of jewelry, the
Segmentation Study confirms that Zale Corporation and independent local jewelers
are the Company's primary competitors. Service Merchandise is perceived at
parity with Zale on the motivating powers of "great value" and "guaranteed
satisfaction." However, the Company excels at "wide selection" as a motivating
power against Zale. Compared to local independents, Service Merchandise is
perceived to be at parity on "wide selection" and "great value"; however, it
falls below independents on "trust" and "guaranteed satisfaction," largely due
to the unique relationships customers enjoy with their established local
jewelers.
1999 MARKETING EVALUATION
By the time the 1999 Operating Plan was presented, an internal audit of
available marketing information had shown that the two primary attributes in
customers' perceptions of Service Merchandise were price and selection. The
primary negative attribute was dissatisfaction with service. It was this
combination of positive/negative perceptions that led to the Company's promise
to the customer of low prices, large selection and guaranteed
satisfaction -- LOW. LARGE. GUARANTEED. -- NO PLACE BUT SERVICE MERCHANDISE.
This positioning expressed the Company's unique selling proposition and became
the branding mechanism reflected in all fall 1999 advertising, including the
Sourcebook, television, radio, direct mail flyers and newspaper inserts.
In order to evaluate the effectiveness of the marketing program, RDA Group,
an external market research firm, was engaged to design and conduct an
advertising awareness and attitudes study. Interviews were conducted during
pre-campaign (August 1999), mid-campaign (October 1999) and end of campaign
(early January 2000). In each wave, representative samples were established for
both the entire adult population in Service Merchandise markets, as well as for
those in the Company's household database. In terms of the latter sample,
respondents were also split between current customers (shopped Service
Merchandise in prior 12 months) and lapsed customers (shopped Service Merchan-
12
<PAGE> 17
dise only in prior 13-36 months). Finally, the samples were segmented by
respondents from markets receiving both broadcast and print versus those from
markets receiving print only.
In terms of the measure of unaided awareness of Service Merchandise as a
place to buy jewelry, the Company ranks third behind local independent jewelers
and Zale among the general population. In broadcast markets, this measure
increased pre-campaign to mid-campaign from 19% to 28%, while remaining flat in
non-broadcast markets (5% pre and 7% interim). Among the Company's own
customers, unaided awareness of Service Merchandise as a place to buy jewelry
was well ahead of both independents and Zale. Awareness levels increased in both
broadcast and non-broadcast markets. The impact of broadcast was more pronounced
among lapsed customers.
Before the campaign began, unaided advertising recall for Service
Merchandise in the total adult population stood at only 9% compared to Wal-Mart
(24%), Sears (22%), Kmart (18%), JC Penney (16%), and Target (13%). Within the
first six weeks of the new campaign, awareness of Service Merchandise jumped to
14% (a 56% increase), while all of the others noted above showed no significant
change. In addition, in broadcast markets, Service Merchandise recall increased
from 11% to 21%, but remained essentially the same in non-broadcast markets (6%
pre and 7% interim).
When analyzing respondents in the Company's database, the competitive
picture changed. Among the Company's customers, advertising awareness of Service
Merchandise exceeded that of any of its competitors. Moreover, awareness
increased nearly equally from pre to interim waves in both broadcast and
non-broadcast markets. Broadcast appeared to have the greatest impact on
generating new customers and re-activating lapsed customers. Among the general
population, television provided the greatest source of recall, while print
vehicles (Sourcebook/flyers/inserts) were higher among existing customers. The
stated likelihood to shop at Service Merchandise based on the advertising seen
or heard increased with all respondents, especially among current database
customers.
LINE OF BUSINESS STUDY
During 1999, Service Merchandise formed a team to address issues raised by
the Company's senior managers and financial advisors regarding the performance
of the Company's various lines of business. The team met regularly between
September and November 1999 and utilized resources from each of Service
Merchandise's operating departments. The team concluded that the jewelry
department produced more than 100% of the Company's variable contribution and
substantially subsidized other merchandise categories.
In addition, the Company observed that although Service Merchandise's sales
and gross margin per selling square foot matched that of its competitors in the
consumer electronics, toys and sporting goods departments, they under-performed
competitive retailers in terms of sales, gross margin and EBITDA on a percentage
basis and per gross square foot, and produced significant operating losses for
the Company.
Enhancements to the current business model considered by the team included
(i) elimination of high transaction, low margin departments; (ii) expansion of
housewares,
13
<PAGE> 18
appliances and tabletop categories, plus the availability of selected full
vendor line extensions via the Internet; and (iii) an increased focus on the
Company's core jewelry business to assist in the optimization of the Company's
assets and cost structure.
REAL ESTATE REVIEW
Service Merchandise believes that its real estate assets are very valuable,
but due to the current configuration of its stores, a significant portion of its
real estate is unproductive. Currently, the typical Service Merchandise store
operates in 27,000 selling square feet while 23,000 square feet is devoted to
warehouse space. This configuration made sense under the catalog showroom
format, but it is no longer a productive use of real estate. Accordingly, and in
response to the customer and financial analytics discussed above, Service
Merchandise initiated a comprehensive review of its real estate assets focused
particularly on how to best "unlock" the value. Service Merchandise's efforts
were also focused on developing the optimal store layout for the Company's
business, in addition to creating a plan designed to unlock the value of Service
Merchandise's real estate.
As part of this effort, we (i) analyzed the value of our real estate
holdings in the marketplace; (ii) quantified the value that can be realized by
subdividing the current store portfolio and subleasing that portion of the real
estate not used by the retail operation; (iii) evaluated the available
alternative approaches to subleasing the real estate; and (iv) identified the
priority of store conversions.
D.G. Hart was retained to assist us with our real estate strategy,
including: (i) valuing Service Merchandise's real estate under various
scenarios; (ii) developing and refining surplus real estate disposition
strategies, including the validation of the amount and the configuration of
surplus space; (iii) validating market rents and downtime assumptions for
leasing that space; (iv) developing financial models (profit/loss and cash flow
analysis) for the surplus portfolio; and (v) developing strategies and schedules
for maximizing the utilization and value of surplus real estate and the
Company's real estate portfolio as a whole.
Thompson Associates, initially retained in 1998, continues to assist the
Company with its short- and long-term retail real estate strategy. Thompson's
work is primarily related to site and market evaluation and will include the
development of site-specific strategies for each market.
14
<PAGE> 19
IV. MARKET ANALYSIS
In connection with the development of the 2000 Business Plan, the Company,
with the assistance of Peter J. Solomon Company, conducted an in-depth review of
the retail markets in which Service Merchandise competes and compared the
Company's performance to that of its key competitors within each sector. This
analysis has led the Company to focus on its jewelry and homegoods businesses in
2000 and beyond. Service Merchandise has decided to exit toys, juvenile, most
consumer electronics, sporting goods and most indoor furniture, in part because
of the difficulties associated with competing with category killers and
discounters.
GENERAL RETAIL MARKET TRENDS
The retail industry is in the midst of widespread restructuring designed to
reduce over-capacity following decades of new store growth, including:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------
1950S AND 1960S AND 1970S AND 1980S AND
1960S 1970S 1980S 1990S EARLY 1990S TODAY
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
GROWTH OF DEPARTMENT GROWTH OF INCREASING ROLL OUT OF GROWTH OF INDUSTRY IS
STORES THROUGH DISCOUNTERS STRENGTH OF BIG BOX OUTLET STORES OVERSTORED --
DEVELOPMENT OF THROUGH SPECIALTY CATEGORY IN NEWLY PERIOD OF
REGIONAL SHOPPING CONSTRUCTION STORE CHAINS KILLERS IN DEVELOPED CONSOLIDATION
MALLS OF STRIP IN MALLS "POWER OUTLET MALLS
CENTERS CENTERS"
------------------------------------------------------------------------------------------------
</TABLE>
Each successive wave of new store openings described above ended more
quickly than the previous wave because the store format matured and new formats
were developed. For example, the discount store business matured in 35 years,
the specialty store business in 25 years, the category killers in 15 years and
the outlet business in 10 years. New formats were created by entrepreneurs,
financed by venture capitalists seeking the next successful rollout and managed
by retail veterans who left mature businesses like department stores.
The retail industry's over-capacity from new store development has been
exacerbated by the rapid growth of Wal-Mart, which has grown from $1 billion in
sales in 1980 to nearly $165 billion in 1999. Wal-Mart and other discount and
off-price stores have taught consumers to seek "value." Department stores have
also helped to change the way consumers shop. Frequent one-day sales events have
diminished department stores' pricing credibility and taught customers to wait
for the sale.
The current industry restructuring is a direct result of over-capacity and
more discriminating consumer spending. Over the past several years, thousands of
stores have closed in connection with bankruptcies and liquidations. The
industry is also in the midst of developing a new selling channel, the Internet.
Online shopping now comprises 15% of all non-store sales, up from 0.5% of all
non-store sales in 1995. In addition, Forrester Research predicts Internet sales
to consumers will surpass $108 billion by 2003 and account for 6% of total U.S.
consumer retail spending by then.
15
<PAGE> 20
JEWELRY MARKET OVERVIEW
Aggregate jewelry sales in the United States were approximately $40 billion
in 1998 and are projected to grow by approximately 7% per annum over the next
five years. Retail jewelry sales have been driven by strong economic
fundamentals, including low interest rates, low inflation, low unemployment,
stock market growth and rising real wage gains that have led to increased
consumer spending. An improvement in consumer credit trends, resulting from a
leveling off of consumer bankruptcies and the slowing growth of consumer
installment debt, has driven increases in credit sales, which represent a
significant portion of industry sales (50% of all jewelry is sold on credit).
The jewelry industry will also benefit from favorable demographic trends
driven by the aging of the baby boomer generation, which is expected to lead the
United States in population growth through 2005. According to data from the U.S.
government, consumers in the 45-54 age range, which is expected to grow by 33.6%
between 1995 and 2005, spend more than twice as much on jewelry than those under
25 and spend more than 50% more than those in the 25-44 age group. Consumers in
the 55-64 age range, which is expected to grow by over 40% between 1995 and
2005, spend two and one-half times more on jewelry than young consumers and 75%
more than those in the 25-44 age range. In addition, affluence tends to occur in
midlife, and research confirms that jewelry expenditures rise sharply among
higher income consumers.
An increase in consumer wealth should also contribute to growth in the
jewelry industry. According to the U.S. government, shoppers with household
incomes over $50,000 annually spend substantially more on jewelry than lower
income households. Two key drivers of wealth are the rise in the stock market
over the past several years and the size of inheritances that will become
available to baby boomers over the coming 10-15 years. Personal income levels
also continue to rise due to low unemployment and a shift in the American
economy toward services and away from a manual labor-based economy.
Although the majority of retail jewelry sales are made through traditional
stores, as shown below, the industry has also grown in recent years to encompass
a variety of non-traditional selling channels, including the Internet, catalogs,
outlet stores and television shopping services.
16
<PAGE> 21
U.S. JEWELRY SALES BY TYPE OF OUTLET
<TABLE>
<CAPTION>
1994 1999E
---- -----
<S> <C> <C>
Traditional jewelry stores.................................. 48% 42%
Department stores........................................... 14% 13%
General merchandise stores.................................. 12% 10%
Discount department stores.................................. 8% 9%
Apparel and accessory stores................................ 4% 3%
Catalog and mail order houses............................... 3% 4%
TV home shopping............................................ 4% 7%
Direct-selling establishments............................... 1% 3%
Computer on-line shopping................................... 0% 2%
Other....................................................... 6% 7%
--- ---
Total............................................. 100% 100%
</TABLE>
Source: U.S. Department of Commerce, Bureau of the Census
To remain competitive in the retail jewelry industry, participants will need to
continually evaluate the best methods, both traditional and non-traditional, of
delivering their product to consumers. Service Merchandise's ability to sell
jewelry in its stores, as well as via the Internet, positions the Company well
for future growth.
The U.S. retail jewelry market is highly fragmented with two national
chains, Zale and Sterling Jewelers, Inc., accounting for just over 10% of
industry sales in 1998 and the ten largest market participants accounting for
approximately 23% of the total market. Smaller independent chains have a large
share of the jewelry industry, as chains with sales over $100 million have only
about 15% of the total U.S. market share, with the balance of the market share
being held by a few discounters and independent operators. This high degree of
fragmentation provides an advantage to companies with an established brand name,
while also offering the opportunity for future growth via acquisition. The
Internet has also seen increased jewelry competition with new sites such as
Ashford, Miadora and Mondera. Significant advertising commitments have been made
on major portals, including Zale's relationship with AOL.
Service Merchandise possesses several attributes that provide the Company
with a competitive advantage over other jewelry retailers. Unlike the vast
majority of its competitors who occupy high cost real estate in regional and
super regional malls, Service Merchandise's stores are located in low cost,
high-traffic strip shopping centers and free standing locations. In addition,
the Company has an in-house design, buying and production staff that produces
high-quality, value-priced jewelry at a lower cost than its competitors.
17
<PAGE> 22
These factors contribute to the industry-leading performance of Service
Merchandise's jewelry business, as shown in the following chart:
FINANCIAL COMPARISON TO JEWELRY INDUSTRY BENCHMARKS
(Dollars in Millions, Except for Per Square Foot Amounts)
<TABLE>
<CAPTION>
SERVICE INDUSTRY
MERCHANDISE -------------------
COMPANY, INC. MEDIAN MEAN
------------- ------- ---------
<S> <C> <C> <C>
Sales $ per gross square foot........... $788.14 $799.43 $ 910.94
Sales $ per selling square foot......... 941.07 940.51 1,071.69
Gross margin as a % of sales............ 49.8% 45.0% 40.7%
Gross margin $ per gross square foot.... 392.72 388.68 369.86
Gross margin $ per selling square
foot................................. 468.92 457.28 435.13
EBITDA as a % of sales.................. 14.7% 12.7% 12.0%
EBITDA per gross square foot............ 115.79 107.96 112.58
EBITDA per selling square foot.......... 138.26 127.01 132.45
Sales $ per store....................... $ 3.2 $ 1.1 $ 1.0
Inventory turns (latest fiscal year
end)................................. 1.6x 1.4x 1.5x
</TABLE>
- ---------------
Note: Service Merchandise financial data reflects actual results for 1999;
Industry data reflects the latest twelve months financial data reported.
We also have an established Internet/direct mail presence that will allow
us to effectively compete with new market entrants, particularly Internet-only
jewelry companies and the e-commerce offerings of our retail competitors.
HARDLINES MARKET OVERVIEW
Service Merchandise's diverse hardlines offerings require the Company to
compete in a variety of markets, including the home furnishings, housewares,
consumer electronics, sporting goods and toy sectors. Within these sectors,
Service Merchandise competes against national department stores with high/low
pricing strategies, specialty retailers, including category killers, which offer
deep assortments of category-focused merchandise at value-oriented prices and
discount department stores which offer edited selections of a wide range of
goods at every day low prices.
Service Merchandise is well-positioned to capitalize on growth
opportunities in the highly-fragmented housewares sector. Although this sector
encompasses companies which sell a wide variety of hard and soft line products,
Service Merchandise focuses on the following niche:
<TABLE>
<S> <C>
Cookware and bakeware Storage and organization
items
Kitchen tools and gadgets Ready to assemble furniture
Small electrics Lamps and clocks
Tabletop (dinnerware, Cutlery and flatware
glassware)
Frames Personal care related
products
</TABLE>
18
<PAGE> 23
Total housewares expenditures in the United States reached approximately
$63 billion in 1998. The break-out, by major category, is presented below:
U.S. HOUSEWARES EXPENDITURES BY CATEGORY
(Dollars in Millions, Except Household Data)
<TABLE>
<CAPTION>
EXPENDITURES
1998 PER
CATEGORY EXPENDITURES HOUSEHOLD
- -------- ------------ ------------
<S> <C> <C>
Furniture................................................... $ 7,111 $ 67
Appliances.................................................. 6,221 59
Housewares.................................................. 4,574 43
Miscellaneous household equipment........................... 34,241 324
Personal care products...................................... 10,819 103
------- ----
Total............................................. $62,966 $596
</TABLE>
Favorable demographic trends and other economic factors are expected to
drive growth in this sector. Home goods buyers, primarily women, are
concentrated in the 35-54 year old age group, one of the largest and fastest
growing segments in the United States. Positive economic trends should also spur
growth in this sector. These trends include an increase in consumer expenditures
to 4.9% in 1998 on top of a 3.4% gain in 1997. This gain was spurred by a 4.0%
increase in disposable personal income and unemployment levels at a 30-year low.
In addition, low interest rates have spurred home sales, as many Americans are
buying a first (or second) home or trading up to a bigger house. Overall,
consumer spending on housewares is projected to grow at about 4.1% per annum
through 2007. The Internet also holds much promise as housewares, along with
appliances and other homegoods, are expected to be a $5.7 billion Internet
business by 2003, based on projections provided by Forrester Research.
Housewares and home furnishings are sold through a wide-range of retail
distribution channels, including traditional department stores, specialty
stores, supermarkets, home improvement retailers and warehouse clubs. As shown
in the following table, the sector is highly fragmented, with the top ten major
retailers accounting for less than 43.7% of total housewares sales.
19
<PAGE> 24
U.S. HOUSEWARES AND HOME FURNISHINGS SALES BY TYPE OF OUTLET
(Dollars in Millions)
<TABLE>
<CAPTION>
1998
ESTIMATED %
COMPANY SALES OF TOTAL
------- --------- --------
<S> <C> <C>
Wal-Mart.................................................... $10,125 16.1%
Kmart....................................................... 4,175 6.6%
Price/Costco................................................ 2,850 4.5%
Target...................................................... 2,630 4.2%
Sam's Club.................................................. 2,480 3.9%
Sears....................................................... 2,000 3.2%
Home Depot.................................................. 945 1.5%
Williams-Sonoma............................................. 920 1.5%
Bed Bath & Beyond........................................... 785 1.2%
TruServ..................................................... 600 1.0%
------- ----
Total top 10...................................... $27,510 43.7%
Estimated total category sales......................... $63,000
</TABLE>
Source: HomeWorld Business, Housewares Census 2000; First Union Securities:
"Housewares Industry" Report, December 9, 1999.
Discount stores -- led by Wal-Mart, Kmart and Target -- dominate the
housewares business. However, for the first time in a decade, discounters'
housewares sales declined as a percentage of total sales for the top 100
housewares retailers, reaching 42.1% in 1998, as compared to 44.9% in 1997. The
competitive landscape within the housewares sector affords Service Merchandise a
strong opportunity to capitalize on the synergy between jewelry and homegoods,
and differentiate itself from discounters and other competitors in the sector.
Category killers, specialty stores and discounters have emerged as dominant
players within the consumer electronics, toys and sporting goods sectors.
Category killers focus on one major merchandise category and offer both depth
and breadth of selection at everyday low prices. The category killer business
model generally provides for (i) lower occupancy costs because these stores tend
to be located in strip malls; (ii) lower operating costs because these stores
are typically self-service; (iii) lower prices due to volume discounts; and (iv)
effective use of information systems. Discounters use their tremendous
purchasing and operating leverage to pass substantial savings on to consumers.
Category killers and electronics specialty stores, led by Circuit City and
Best Buy, accounted for almost 62% of all consumer electronics purchases in
1998. The same trend was evidenced in the toys sector, with specialty stores and
discounters accounting for 78% of toys and games sales in 1998. The sporting
goods sector, which also suffers from the same competitive forces, has been
further affected by slow sales growth resulting from (i) the lack of new
products to drive customer traffic; (ii) softening demand for sportswear
apparel; and (iii) softening demand for footwear.
The role of category killers, along with the continued participation of the
discounters, has only served to heighten the competitive environment of the
consumer electronics, toys and sporting goods sectors as pricing pressure
continues to be a key factor. Those players unable or unwilling to deliver what
the customer demands -- selection, service and price --
20
<PAGE> 25
are not able to compete. As such, poor financial performance among industry
participants and lack of available growth opportunities have resulted in
consolidation and reduction in the number of retail competitors.
Service Merchandise compares less favorably to its competitors in the
hardlines sectors than those in the jewelry sector as a result of (i) the
limited amount of space dedicated to each category and (ii) the highly
competitive nature of the hardlines sector, particularly in the consumer
electronics, toys and sporting goods areas. Although the Company's sales and
gross margin per selling square foot were comparable to that of its competitors
in each major merchandise category, they lagged in terms of sales and gross
margin per gross square foot as a result of the Company's high proportion of
unproductive warehouse space. Service Merchandise's overhead burden
significantly exceeds that of other retailers offering similar merchandise,
thereby placing it at a competitive disadvantage, as evidenced by the EBITDA
performance detailed below.
FINANCIAL COMPARISON TO INDUSTRY BENCHMARKS
(Dollars in Millions, Except for Per Square Foot Amounts)
<TABLE>
<CAPTION>
HOME CONSUMER SPORTING
GOODS ELECTRONICS EQUIPMENT TOYS
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SMC INDUSTRY SMC INDUSTRY SMC INDUSTRY SMC INDUSTRY
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<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales $ per gross SF.............. $130.62 $159.32 $236.74 $545.76 $ 98.08 $174.23 $ 84.76 $187.97
Sales $ per selling SF............ 327.68 187.44 645.03 642.07 186.67 206.45 125.46 221.14
Gross margin as a % of sales...... 29.6% 40.6% 19.1% 24.3% 25.8% 29.8% 16.6% 32.5%
Gross margin $ per gross SF....... 38.68 62.29 45.15 132.86 25.30 45.61 14.03 61.19
Gross margin $ per selling SF..... 97.04 73.28 123.01 156.31 48.15 53.65 20.77 71.99
EBITDA as a % of sales............ (1.0%) 10.2% (12.3%) 4.8% (10.8%) 4.1% (20.5%) 6.8%
EBITDA per gross SF............... (1.24) 8.03 (29.09) 24.96 (10.63) 7.22 (17.38) 12.23
EBITDA per selling SF............. (3.12) 9.45 (79.27) 42.30 (20.22) 9.03 (25.72) 14.39
Sales $ per store................. $ 1.9 $ 2.5 $ 1.5 $ 11.6 $ 0.3 $ 5.2 $ 0.5 $ 2.1
</TABLE>
Note: Service Merchandise financial data reflects actual results for 1999;
Industry data reflects the latest twelve months financial data reported.
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<PAGE> 26
V. 2000 STRATEGIC INITIATIVES
The starting point for the development of the 2000 Business Plan was a
comprehensive review of Service Merchandise's business to determine the
strongest avenue for future growth utilizing the Company's key assets -- its
industry-leading jewelry franchise and well-located, low cost real estate
assets. Product categories previously utilized to drive customer traffic,
specifically consumer electronics, toys and sporting goods, were found not to
drive jewelry sales. Such product categories are also unprofitable for the
Company. As a result, Service Merchandise will exit or substantially reduce
these product categories in stores, but may continue to offer relevant
categories via the Company's web site. Service Merchandise has also determined
that it can take steps to (i) reduce the space needs in its stores; (ii)
effectively utilize unproductive warehouse space; (iii) optimize the ratio of
selling space to warehouse space by focusing on this narrower product
assortment; and (iv) substantially reduce its overhead costs. Unneeded space
will be available for subleasing to retailers who offer complementary products,
thereby driving customer traffic, while at the same time unlocking a portion of
the value embedded in Service Merchandise's real estate. Initiatives planned for
2000 are presented below.
MERCHANDISING
The Company's jewelry operations are the cornerstone of the 2000 Business
Plan. The 2000 merchandising strategy will feature an expanded offering of
jewelry and jewelry-related products as the centerpiece of the business. This
focus requires the reconfiguration of a majority of the Company's stores to
feature less selling square footage overall (approximately 23,000 square feet as
compared to 27,000 square feet), but increased square footage for jewelry.
Service Merchandise will convert 70 stores to an expanded jewelry format in
2000, with an additional 83 stores to be converted in 2001. The jewelry
departments in these stores will be moved to the front and center of the stores,
increasing their square footage from an average of 3,165 feet to 4,850 feet, and
increasing linear footage from an average of 230 feet to 321 feet. These
remodeled departments will also incorporate updated fixtures featuring the
latest cherry veneers, kiss-ecru trim and halogen lighting.
The merchandising strategy for jewelry encompasses the remodeled,
newly-expanded department with expanded assortments in Service Merchandise's
stores coupled with increased emphasis on marketing and advertising. The Company
will continue to emphasize quality and selection at value price points using key
items, bonus buys (highly recognizable items priced below the competition) and
advertised items through flyers, inserts, direct mailers, TV, radio, on-line and
in-store images. In-store Internet stations will aid the customer with
additional product information and will display vendor line extensions. In
addition, the advertising strategy contemplates an increase in print advertising
allocation for jewelry from 25% of total pages to approximately 50%.
The increase in jewelry linear footage will accommodate three types of
expansion. All 153 stores (70 in 2000 and 83 in 2001) with expanded jewelry
departments will be merchandised with wider assortments within most categories
of jewelry, the bulk of the expansion taking place in diamonds -- the most
profitable jewelry category. This additional
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linear footage will allow Service Merchandise to add jewelry product lines,
expand existing lines and display the product in a better manner. Areas of
opportunity will include a visually-dominant watch department with expanded
assortments, sterling silver open-stock programs, as well as additions to gold
and platinum assortments.
The second type of expansion will be in the clearance or special purchase
category. This area performed extremely well in 1999 in only four linear feet,
contributing strong margins. This expansion will allow the Company to
consolidate and better promote its own clearance product, while simultaneously
taking advantage of special purchase offerings within the jewelry manufacturing
industry.
The third expansion area will be in the higher-end or gallery product
category. In 41 selected stores in strong jewelry markets, the gallery, a store
within a store concept, will be used which will be offset by a special entrance
and back bar to feature the area. This 30 linear feet of cases will feature
special case trim boxes as well as special lighting. The product assortment will
consist of classic, elegant jewelry in heavier weight and better qualities. The
type of items will range from whimsical diamond pins to three-carat total weight
bridal sets in platinum. Prices will range from $500 to $10,000 and up, with
average price points in the $2,000-$4,000 range.
Service Merchandise stores will also feature a more targeted selection of
hardlines merchandise that customers have historically shown a strong affinity
for purchasing at Service Merchandise. We will focus on categories for which the
competitive landscape presents a realistic opportunity for Service Merchandise
to provide customers with dominant assortments of competitively priced branded
and imported merchandise. We will emphasize categories that have strong
adjacency relationships and an affinity with Service Merchandise's core jewelry
business to provide a synergistic shopping environment. Service Merchandise will
also offer hardlines merchandise that will allow us to quickly and effectively
capitalize on line extension opportunities utilizing its established Internet
infrastructure. Vendor partnerships involving brands such as Black & Decker,
Corning and Panasonic Home will allow the Company to inventory most or all of
these vendors' products in the fulfillment center with very little inventory
investment. These and additional extended vendor lines will allow Service
Merchandise customers complete assortments via the Internet (at home and in
store stations), as well as by phone. Other key factors driving the Company's
merchandising strategy include price point ranges, unit volume, seasonality, net
margin production and the ability to provide year round traffic opportunity,
profits and optimum physical plant utilization at the stores. Service
Merchandise will also base its merchandise decisions on the strength of its
historical and current vendor relationships.
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We believe that the following categories of housewares and giftware meet
the criteria described above and present a realistic opportunity for Service
Merchandise to profitably compete in the marketplace:
<TABLE>
<CAPTION>
HOUSEWARES GIFTWARE
- ---------- --------
<S> <C>
Tabletop Jewelry boxes
Cookware Giftware
Small appliances Luggage
Dining furniture Cameras/frames
Patio furniture Clocks
Kitchen storage Executive gifts
Pantryware Pagers
Silver
Crystal
Personal care
Vacuums
Home helpers (i.e., air cleaners, garment care)
</TABLE>
The hardlines merchandising strategy will continue to focus on a full range
of price points with emphasis on the mid and upper ranges where Service
Merchandise has experienced performance at levels higher than most competitors
according to suppliers and industry statistics. The merchandise assortment will
include controlled mixes of traffic generating items and margin producing items
and will feature value across all product lines. The allocation of space by
category within the remodeled stores is as follows:
<TABLE>
<CAPTION>
AREA SPRING FALL
- ---- ------ ------
<S> <C> <C>
Kitchen and housewares...................................... 4,450 5,800
Home appliances............................................. 1,200 1,300
Gifts/frames/luggage/photo/office........................... 2,300 3,750
Seasonal.................................................... 3,400 500
Jewelry..................................................... 4,850 4,850
------ ------
Total selling space............................... 16,200 16,200
Warehouse and other......................................... 6,800 6,800
------ ------
Total store space................................. 23,000 23,000
</TABLE>
New elements of the strategy will also include an enhanced focus on
assortment breadth in stores and advertising, in addition to price/value. The
Company will develop a hardlines special events effort to capitalize on the
proven success of the jewelry special events programs. Specifically designed to
create value, excitement, variety and information for the customer, Service
Merchandise will also focus on the full convergence of assortments in stores and
on-line with e-commerce to ensure dominant assortments. The Company is working
to establish a system to offer products that will no longer be carried in the
stores, such as toys and electronics, via the Internet. In addition, the
Internet will be used to supply training and sales information to the Company's
associates. The Company will aggressively pursue the early introduction of
appropriate merchandise relative to competitors, thereby retaking a leadership
role as merchants to serve customers.
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REAL ESTATE
In 2000, Service Merchandise's real estate activities will be focused on
developing and executing initiatives designed to maximize the utilization and
value of the Company's real estate portfolio. Real estate, like the jewelry
business of Service Merchandise, has long been considered a strength of the
Company. Over the years, Service Merchandise has acquired a valuable real estate
portfolio that includes both fee owned properties and leaseholds. Many of the
Company's leases are below market, meaning the rent that could be earned in the
market is higher than the rate the Company now pays. Accordingly, unlocking the
value of this asset is an additional element of the Company's 2000 Business
Plan. Decreasing the size of our retail stores will create substantial surplus
real estate allowing Service Merchandise to benefit from the increased market
value of its real estate.
Unlocking the real estate value will be accomplished with the primary goal
of maximizing the Company's retail opportunities and realizing the most value
for the estate. Service Merchandise believes, based on the number of inquiries
received regarding its real estate, that it will be able to sublease a
substantial portion of this surplus space. Moreover, the Company prefers to
sublease this space to retailers that offer merchandise complementary to
Service's. Accordingly, the Company will work closely with D.G. Hart and third-
party leasing agents to identify prospective co-tenants. Emphasis will be placed
on identifying and negotiating package real estate deals with retailers having
similar customer demographic profiles to Service Merchandise customers and the
ability to drive additional traffic to the Company's stores.
Based upon a comprehensive review of its store base, Service Merchandise
has determined that substantially all of its stores will be part of the enhanced
business. Service Merchandise has developed a transition plan that will allow
the stores to be converted to the enhanced format with minimal disruption during
the refurbishment period. Each of the remaining stores has been classified as
either a Class I or a Class II store format as represented by the schematics
presented in Appendix C.
- Class I stores will feature a new, expanded jewelry department, a revised
hardlines layout with new fixtures and additional interior upgrades.
Class I stores will also incorporate a demising wall to facilitate the
subleasing of excess space in the store. In 2000, Service Merchandise
plans to convert 70 stores in nine top markets to Class I stores.
- Class II stores include 83 stores that will be converted to Class I
stores in 2001 (or earlier if a subtenant is secured for a store's excess
space) and 63 stores that are performing acceptably but are not
considered to be candidates for a Class I conversion due to (i) physical
considerations; (ii) lease terms/requirements; or (iii) other factors.
The Company intends to operate the remaining 63 Class II stores until
suitable replacement stores and acceptable subtenants can be found. An
additional five stores are not projected to be converted but will be
operated as-is since they are essentially already Class II stores.
The marketing department will create the appropriate retail image for the
stores. This image will be projected in the store through signing, fixturing,
and merchandising.
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<PAGE> 30
Designing the interior signing package will be the store's final design
requirement. The package will include signing from the entrance of the store to
each department, concluding at the checkouts. Directional signing will lead
customers through the store. Instructional signing will inform customers about
product details and prices, as well as the advantages of shopping in Service
Merchandise stores. Internet stations will promote a message of added shopping
convenience, extended line availability and an overall image of leading edge
retailing. In conjunction with developing the signing, sign hardware will also
be designed for each application. Upon completion of the designs, floor plans
will be completed for each store indicating the location for all signing.
Systems will be developed to communicate the planogram requirements to the
replenishment system, as well as the inventory levels required to support store
sales back to the planogram group. Other items required for this process include
the development of a clearance strategy for discontinued categories, the
disposition of unused fixtures and equipment and the completion in advance of a
prototypical store to facilitate final selections, setup and design needed to
support the Company's enhanced business model.
CORPORATE OVERHEAD
Service Merchandise has concluded that it can substantially reduce overhead
given the smaller store layout and corresponding reduced merchandise volume. To
achieve this reduction, the Company formed a cross functional team charged with
rationalizing overhead expenses. The team met with each senior executive who was
asked to identify cost and payroll savings opportunities in all overhead
areas -- including those areas beyond the senior executive's immediate control.
As a result, $22.4 in annualized overhead savings have been identified, a 23.4%
reduction from 1999 overhead levels.
STORES/FIELD ORGANIZATION
Store/Field operations are a critical component of the 2000 Business Plan.
Historically, the Company has maintained two distinct organizations within the
store operations department -- a jewelry organization and a hardlines
organization. The jewelry organization was primarily focused on jewelry sales
and supported store jewelry managers with training and coaching to maximize both
the selling skills of each jewelry selling associate and the overall sales for
the store and district. The hardlines organization was focused on selling the
hardlines product in the store and providing operational support for activities
such as stocking of shelves, tagging merchandise, developing planograms,
reducing inventory shrinkage and implementing expense controls.
As a part of the 2000 Business Plan, Service Merchandise will further
refine the responsibilities at the store, district and region in order to
continue the development of a sales culture, streamline reporting structures and
provide cost savings. The separate jewelry and hardlines corporate management
organizations will be combined into a single reporting structure. At the store
level, there will be a single store manager, supported by a sales manager and a
sales support manager. The sales manager will be focused on maximizing the
selling skills of every sales associate through training, coaching and
motivation to deliver the highest sales and margin performance in the store. The
sales support manager will be
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<PAGE> 31
focused on providing operational support in stocking, merchandise presentation,
tagging, cashiering, shrink and expense controls to deliver a healthy bottom
line performance.
The combined organization will be continued up through the district
organization, with store managers reporting directly to a district sales
manager, and district sales managers reporting to a regional sales manager, who
in turn will report to one senior vice president of store operations. The number
of districts will be increased from 17 to 24 for an average of nine stores per
district. By increasing the number of districts, we intend for our district
sales managers to be able to provide a greater focus on fewer stores. The
Company's 24 districts will be supported by sales support supervisors whose
responsibility will be to review operational controls and efficiencies, while
human resources and loss prevention executives will support Service
Merchandise's three regions.
To lead this effort, Eric Kovats was recently promoted to Senior Vice
President -- Stores, assuming overall responsibility for the Company's 221
stores. Mr. Kovats has been Vice President, Hardlines Stores Organization, since
March 1999.
The following table summarizes the organizational changes planned within
the stores/field organization.
REVISED STAFFING LEVELS
<TABLE>
<CAPTION>
POSITION 1999 MODEL 2000 PLAN NET CHANGE
- -------- ---------- --------- ----------
<S> <C> <C> <C>
Regional Sales Manager/Regional Jewelry Supervisor.......... 4 3 (1)
District Sales Manager/Jewelry Supervisor................... 34 24 (10)
Sales Support Supervisor.................................... 17 24 7
Field Training/Jewelry Field Training....................... 5 5 0
--- -- ---
Total Stores...................................... 60 56 (4)
Regional Human Resources Manager............................ 0 3 3
District Human Resources Manager............................ 9 3 (6)
Regional Loss Prevention Manager............................ 2 2 0
District Loss Prevention Manager............................ 16 16 0
--- -- ---
Total Administration.............................. 27 24 (3)
Total Field Organization.......................... 87 80 (7)
District Visual Trainer..................................... 17 0 (17)
--- -- ---
Total With District Visual Trainer................ 104 80 (24)
</TABLE>
This reorganization of the store operations structure is expected to
provide the appropriate levels of focus on sales and operational controls, while
providing a streamlined organization with single position responsibility for all
aspects of store sales and profitability. These changes will be augmented by an
adjustment of associate staffing levels to accommodate a higher proportion of
jewelry sales and a lower level of overall sales.
INTERNET
The goal of the Company's e-commerce division is to leverage Service
Merchandise's strength in order processing, fulfillment and customer service in
order to maximize sales through alternative selling channels, including the
Internet, mail/phone orders and corporate sales. Because of this order
fulfillment capability, a central element of the Company's
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<PAGE> 32
2000 Business Plan is to converge the Internet and store selling environments.
Each store will feature Internet terminals that will provide immediate access to
Service Merchandise's web site, including bridal registry, gift guide and store
directory. Customers will be able to purchase merchandise in stock at the store
from a sales associate or over the Internet for delivery at home. To enhance the
shopping experience, the Company expects to enter into vendor partnerships
similar to our recently announced alliances that will allow us to expand our
offerings of Black & Decker, Corning and Panasonic Home branded products. Under
these alliances, Service Merchandise will be able to offer a portion of each
company's product line in our stores and the entire product line via the
Internet.
Order fulfillment is a strength of Service Merchandise. In 1997, the last
year the catalog showroom format was fully operational, non-store sales were
over $100 million. Although the transition to a self-service retail format has
dramatically reduced these non-store sales, the fulfillment capability (which
many Internet retailers lack) remains a strength of Service Merchandise. The
customer fulfillment center has high-speed conveyors, in motion scales and
overhead-scanning equipment, making it the Company's most efficient shipping
point. In addition, gift-wrap, ring sizing and rush delivery are accomplished in
the fulfillment center, and additional capacity was recently acquired to handle
the full complement of current stock keeping units, thereby increasing the
Company's order fulfillment rate. Although orders are filled primarily from the
fulfillment center in Nashville, we also have the capability to fill orders from
our warehouse or any of our stores if the fulfillment center is out of stock.
We continue to improve our web site, www.servicemerchandise.com, in an
effort to enhance the on-line shopping experience for our customers. Extended
copy was written on over 6,000 key items, and product images were reviewed and
upgraded. The home page was redesigned to feature special promotions, as well as
Service Merchandise's 100% transaction satisfaction statement that outlines site
security issues, return policies, store pick-up options and extended customer
service information. The customer shopping experience was also improved by the
introduction of improved "3 Clicks To Buy An Item" navigation and an advanced
search function. In addition, supplemental hardware was installed prior to peak
season in 1999 to handle the increased transaction volume. Several initiatives
will be undertaken in 2000 to increase both the functionality and conversion
rate for the web site, including incorporation of a professional search engine
to permit the customer to more precisely define the desired product or category
and to provide more accurate search results. Web agent software will allow
customers to ask questions while shopping on the website which will help prevent
customer abandonment due to frustration over an inability to locate an item or
specific content. Other improvements include intelligent e-mail routing and load
testing software to ensure peak load handling capacity.
Service Merchandise's on-line sales efforts will be supported by a
significant shift in advertising expenditures from traditional buttons and
banners to a balanced mix of portal (e.g., AOL, YAHOO), direct mail, e-mail,
consistent placement in Service Merchandise print and broadcast, in store
signing, shopping bags and inserts, as well as positioning on complementary web
sites.
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The Company has also taken several steps to maximize phone order sales,
including implementing special incentives to the sales representatives to
generate add-on sales to phone orders. To generate more calls, the Company is
increasing exposure in direct mail flyers and will provide key placement
exposure for phone order business in the Sourcebook. Extended vendor lines will
be advertised and suggestive selling of alternate or step up items will be
emphasized.
To generate corporate sales, Service Merchandise has developed a program
whereby other companies will reward their employees with Service Merchandise
gift cards in recognition of special achievements, such as service milestones
and sales goals. A sales commission plan is being put in place with specific
sales goals designed to increase incentive sales business. In addition, a new
direct mail piece is being mailed to targeted businesses in the Company's major
markets with a bounce back postcard, phone or e-mail response. A new section for
incentive sales is being built on the Internet site on which customers will also
be able to redeem gift cards.
INFORMATION TECHNOLOGY
The information technology department will continue to add significant
value to Service Merchandise by providing a sound, reliable infrastructure and
industry-leading functionality in the Company's stores, Internet, logistics,
merchandising and marketing departments.
Prior to 1999, Service Merchandise was operating many stores with
point-of-sale registers that were last manufactured in 1985 and experienced a
50% failure rate. The software that ran in the stores was developed internally
with a proprietary language running on an obsolete operating system no longer
supported by outside vendors. In 1999, the framework for replacing the obsolete
equipment and software in the stores was put in place with the installation of
new Dell store servers and a migration from the proprietary language to Visual
Basic running on Microsoft Windows NT. Along with the replacement of the store
servers, the Microbilt payment processing and electronic signature capture
equipment was replaced with the Checkmate eNtouch. Replacing the failing
Microbilt equipment improved accuracy of credit card reads and electronic
signature capture, and reduced the checkout time by more than thirty seconds.
Beginning in 2000, focus will turn to replacing the point-of-sale registers
and evaluating and testing replacement software. The Company's objective is to
increase the speed of customer checkout, to reduce long lines at the jewelry
counter during peak selling periods as well as to reduce the cost associated
with supporting obsolete register equipment.
Over the past three years, the information technology department has
implemented numerous best of breed solutions to aid the merchandising staff in
the financial and assortment planning processes and the business intelligence
space. In 2000, a web-based portal, serving as a user-friendly front end to all
merchandising-based information and systems, will be implemented. The benefits
associated with this project include a redirected focus on priorities,
simplified training, enhanced productivity and improved remote access to
information via the web.
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Service Merchandise has captured and retained an enormous amount of
information about its customers' purchase habits. A household database exists,
which includes over 22 million households and three years of detailed purchase
history. This critical source of information is used by the marketing department
to understand customer purchase behavior, select and target customers for flyer
and source book circulation, determine success rate of prospecting initiatives
and understand lapsed customers more effectively.
LOGISTICS
DISTRIBUTION CENTERS. Service Merchandise will continue to rationalize
its logistics infrastructure to support its in-store and Internet sales efforts
and reduce costs. During 2000, the elimination of under-performing product lines
is projected to reduce the Company's storage capacity needs to approximately 2.1
million cubic feet during the peak period in October. We plan to close our
Montgomery distribution center in June 2000 and our Orlando distribution center
in July 2000 and to consolidate our operations into our 1.9 million cubic feet
Nashville regional distribution center. These measures, and the additional
projects described below, are expected to reduce costs by $11.9 million on an
annualized basis.
Nashville is centrally located to the Company's ongoing vendor and store
base, and logistics optimization modeling indicates that this move is the most
optimal cost and service solution. During most of the year, the Nashville
distribution center will be more than adequate for the Company's storage and
handling needs. During the peak period, a third-party facility in the central
Tennessee area will be utilized. Retention of the Nashville facility makes
additional sense since a state-of-the-art loose picking (Pick-to-Light) system
for filling store orders for watches and writing instruments has recently been
implemented in this facility. Also, in April, the Company will complete the
implementation in this distribution center of a new warehouse management system
purchased from Optum. The project is designed to address significant product
handling needs that exist today in the Company's distribution centers and will
provide significant efficiencies, labor savings and improved shipping accuracy.
A $3.2 million investment for development and implementation of the system is
expected to yield annual cost benefits of $3.1 million. Service Merchandise also
intends to conduct a detailed outsourcing study for Return Center 988. Due to
the evolving business environment in the Company's stores as well as the planned
product line reduction, the Company will analyze alternatives to renewing the
lease on Return Center 988, located in Bowling Green, Kentucky, upon lease
expiration in December 2000.
TRANSPORTATION. The transportation group is responsible for all aspects
of transportation management at Service Merchandise. Several initiatives are
planned to improve the automated systems used to support the transportation
operations, including the following:
Internet Load Optimization (ILO). This system consolidates vendor
inbound and store shipments to utilize optimization software (CAPS
Transpro) via a Company extranet application. The system is expected to
produce annual freight savings in excess of $0.9 million.
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<PAGE> 35
Transportation Management System. This project will consolidate all
current stand-alone transportation systems under one client server
application, which will allow Service Merchandise to leverage volumes and
lanes to further reduce transportation costs. The anticipated benefit is
freight savings of approximately $0.6 million in 2000 and over $1 million
in 2001 and beyond. This project is scheduled for completion in third
quarter 2000 and will cost $0.4 million.
Optimize DC Outbound. This project, in conjunction with the new WMS
system, will allow the DC to optimize outbound store shipments utilizing
the same optimization software as ILO. The project will also provide a data
file to match outbound shipments with inbound vendor shipments to make use
of lower round trip costs per mile. The anticipated benefit is freight
savings of over $0.2 million in 2000 and $0.35 million in 2001. The
estimated completion date for this project is second quarter 2000.
MERCHANDISE REPLENISHMENT. To support Service Merchandise's 2000 Business
Plan, the Company will pursue replenishment system enhancements focused on store
assortments, forecasts, inventory planning, store space allocation and
e-commerce. In addition, inventory turns for hardlines are below industry
benchmarks and will be evaluated by a joint merchandising and logistics team in
2000. The team's objective will be to identify overall improvement targets for
inventory turnover while maintaining or improving the Company's in-stock
positions. The team will also evaluate supply chain partnerships with key
hardlines vendors.
MARKETING
Service Merchandise has developed a comprehensive marketing plan to
communicate the enhanced focus on jewelry and complementary hardlines products
to current customers and potential new customers. There will be a major,
company-wide promotional event this fall to officially celebrate the Company's
enhanced business strategy. This will encompass a highly integrated merchandise,
media and public relations campaign, along with in-store and special events.
In the spring of 2000, advertising resources (primarily inserts and radio)
will be allocated to sell large inventories of merchandise that will not be part
of the go-forward mix. Storewide clearance events (four-page bind-ins to
existing flyers) will start in March and continue through Mother's Day. These
vehicles are tailored after a similar and successful clearance campaign in 1999.
After Mother's Day, the storewide effort will shift to a stand-alone promotional
program directed entirely at the exit categories. A new consumer public
relations program will play an important role in informing customers of
enhancements to their individual stores.
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<PAGE> 36
The fall 2000 media plan is clearly focused on "the customer" while
supporting new merchandising, stores and communication strategies. The thrust of
the marketing message will be based around the following belief:
YOU CAN TRUST SERVICE MERCHANDISE
TO PROVIDE A CUSTOMER-FRIENDLY SHOPPING
EXPERIENCE
FOR YOUR FINE JEWELRY
AND TOP BRANDS FOR YOUR PLACE --
BY STORE, WEB, PHONE --
WITH MORE CHOICES AT BETTER PRICES, GUARANTEED.
This will be accomplished through a broad media mix supportive of a
MULTI-CHANNEL SPECIALTY RETAILER. Advertising will be directed at reaching the
female customer with a clear value and selection message. With the success of
the fall 1999 campaign, the second half 2000 plan will again utilize those
advertising media which address the Company's current customers and reach new
target audiences. A high priority is raising awareness levels among both Service
Merchandise customers and prospects so that they think of Service Merchandise
first when shopping for fine jewelry and branded housewares and giftware.
Store branding and positioning of the enhanced strategy will play an important
part in the overall advertising message. The Company will, however, continue to
build on, and incorporate, past successes like Value/Price and Selection; LOW.
LARGE. GUARANTEED.; and the integrated sales channels of Three Ways to Shop.
Additional advertising emphasis will be placed on supporting "clicks and mortar"
Internet activities, with a focus on merchandise line extensions. Advertising
space and related dollars will shift to reflect a clearly defined merchandise
mix, with a larger percentage of media resources going to jewelry. Overall,
annual gross advertising dollars will decrease by $34 million due to a smaller
sales base. Co-op dollars when compared to 1999 will decrease by approximately
$18 million due to the exit from selected merchandise categories that have been
traditional sources of co-op revenue. Advertising costs as a percent of sales
will increase by 0.4% "gross" and 0.9% "net", as indicated on the following
chart:
ADVERTISING EXPENSE AS A PERCENTAGE OF SALES
(Dollars in Millions)
<TABLE>
<CAPTION>
1999 (223 STORES) 2000 (221 STORES)(A)
-------------------------------- --------------------------------
% GROSS % GROSS
$ ADVERTISING % SALES $ ADVERTISING % SALES
-------- ----------- ------- -------- ----------- -------
<S> <C> <C> <C> <C> <C> <C>
Sales................................ $1,968.0 $1,416.6
Gross Advertising.................... 138.5 100.0% 7.0% 104.8 100.0% 7.4%
Co-op Participation.................. (40.3) (29.1)% (2.1)% (22.5) (21.5)% (1.6)%
-------- ----- ---- -------- ----- ----
Net Advertising...................... $ 98.2 70.9% 4.9% $ 82.3 78.5% 5.8%
</TABLE>
- ---------------
(a) on-going business only
32
<PAGE> 37
The key components of the Company's 2000 media strategy are set forth
below:
TV. Television will be used as the primary umbrella to visually
demonstrate and communicate the enhanced strategy to customers and
prospects alike. Television is effective at enticing customers to consider
Service Merchandise as the store of choice when shopping for fine jewelry
and name-brand housewares. Local market spot television will make up
approximately 17% of the total media budget in 2000 as compared to 13% in
1999. Commercials will appear in markets totaling over 70% of Company
sales. New creative pieces will be developed to support the enhanced store
focus and marketing initiatives. Television will continue to play a major
role in building top-of-mind awareness, and branding of the new store. For
Valentine's Day, Mother's Day and Christmas, Service Merchandise will
combine entertainment, musical performances and celebrity appearances with
a dynamic presentation of gold and diamond jewelry. This will be
accomplished in the form of 30 minute infomercials under the banner of
SMCTV. This entry into national and local cable networks will showcase the
in-store jewelry experience and include a narrated visit to our New York
jewelry office, exploring the impressive quality control procedures that
each piece of jewelry undergoes. A feature section on the Internet site
will be devoted to the television programming, with pages showing the
items, stars, show schedules and supporting content. The 30 minute
infomercial will offer a forum in which quality, value, confidence and the
emotion of purchasing and giving fine jewelry from America's Leading
Jeweler can be fully explored and communicated.
RADIO. Radio will be used primarily as a traffic generator to support
targeted sale events and major holidays. At the same time, it will
incorporate a strong branding and positioning message. Radio is best used
when combined with other media as a part of the overall mix, as it adds a
high level of excitement, urgency and top-of-mind awareness to the
advertising. Radio is targeted to our customer demographics, thus
reinforcing buying decisions of existing customers while also reaching new
prospects. Radio will make up approximately 7% of the media budget in 2000,
as compared to 10% in 1999.
FLYERS. Direct mail flyers will remain the heart of the media plan.
Direct mail will make up approximately 31% of the media budget in 2000 as
compared to 53% in 1999. Service Merchandise continues to enjoy the
strength of a proven, customer driven in-house database of over 22 million
names. These profitable Service Merchandise customers, when combined with
aggressive prospecting lists, will provide for a steady flow of traffic to
jewelry counters and throughout the store. There are two primary
differences between the 1999 and 2000 flyer programs. First, there will be
a dramatic shift in page allocations between jewelry and hardlines. Jewelry
will now receive over 45% of total pages, compared to 29% in 1999. Second,
there will be a reduced frequency of publications. Jewelry is an
infrequently purchased merchandise category, thus fewer, higher quality,
but longer duration publications are appropriate. Traditional flyers will
be supplemented with specialty mailings, postcards and other vehicles to
targeted customers and to prospects with similar, attractive demographics
33
<PAGE> 38
and psychographic profiles. These flyers will continue to communicate the
quality, value and selection offered by Service Merchandise.
INSERTS. Newspaper inserts will make up approximately 25% of the
media budget compared to 15% in 1999. Primarily distributed in Sunday
papers, inserts offer the opportunity to showcase the Company's expansive
assortments of branded merchandise and are important to the promotional
balance of the media plan. Inserts are used to delineate Service
Merchandise's advantage in value and selection edge relative to the
competition. The jewelry business is less dependent on inserts to deliver
its marketing objectives and will be provided with fewer pages. Inserts
also serve as an excellent feeder of new customer traffic to stores and
potential prospects for the database. There were ten inserts in 1999, with
13 planned in 2000.
SEASONAL SOURCEBOOKS. Sourcebooks will continue to be part of the
2000 marketing strategy as they afford prime advertising and communication
space to showcase the breadth and depth of assortments in fine jewelry and
name brand products. Sourcebooks will make up approximately 9% of the media
budget in 2000, compared to 10% in 1999. Driven by the positive customer
reception of the fall 1999 Sourcebook, both a spring and fall Sourcebook
will be published in 2000.
INTERNET. A balanced mix of online and offline advertising combined
with increased exposure in the Service Merchandise print publications will
continue to spread the "Three Ways to Shop" message along with the
"Pre-Shopping" convenience of researching items, pricing and availability
on the Internet prior to shopping in the store.
CREATIVE PROCESS. In 2000, Service Merchandise will continue its
efforts to streamline the creative production process to afford maximum
support and production efficiencies. Although the use of two agencies for
print advertising (Lazar for Jewelry and Haggin for hardlines) worked well
and delivered as anticipated, current store, marketing and merchandise
objectives suggest that the use of a single agency will allow Service
Merchandise to present a consistent image and message. The Company's
broadcast agency, Lighton/Colman, will remain the same; however, a new
public relations firm, Goldstein Communications, will be retained.
All advertising programs will be carefully targeted regardless of the
advertising medium. For broadcast, all stores and markets are grouped by DMAs,
and ranked against a brand development index, incorporating all factors that
would impact on prioritizing the markets to achieve the greatest efficiencies.
Media buys in 2000 will be primarily directed to the female audience, with the
exception of Valentine's Day, where males will be targeted in higher numbers.
For direct mail publications, the Company will continue to use highly predictive
customer response models. New software (ModelMax) packages were installed in
1999 to further enhance the customer extract process. Service Merchandise will
utilize outside mailing lists to supplement its own when prospecting for new
jewelry customers. Store circulation for inserts will continue to be targeted
within primary zip codes and trading areas to the extent possible within
newspaper distribution zones. Market and store distribution plans will be
developed annually in conjunction with Strategic Print Marketing, the Company's
media-buying agency.
34
<PAGE> 39
CAPITAL STRUCTURE/LIQUIDITY
The Company has 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 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. The DIP Facility includes a $200 million
sub-facility for standby and trade letters of credit. Interest rates on the DIP
Facility are based on either the LIBOR plus 2.25% for LIBOR Loans or prime plus
1.25% for ABR Loans. 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. On April
27, 1999, the Bankruptcy Court approved the DIP Facility.
Borrowings under the DIP Facility are limited based on a borrowing base
formula which considers eligible inventories, eligible trade letters of credit,
eligible accounts receivable, mortgage values on eligible real properties,
eligible leasehold interests, available cash equivalents and in-transit cash.
Availability under the DIP Facility continues unless the Company breaches both
the minimum EBITDA and minimum availability covenants, as defined in 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 or
until the Company obtains a new credit facility.
On February 21, 2000, the Company signed a commitment letter with Fleet
Retail Finance Inc. Subject to closing, the Company's anticipated four-year,
$600 million DIP to exit credit facility (the "DIP to Exit Facility") will
replace the Company's existing $750 million DIP Facility (the "DIP Facility").
The DIP to Exit Facility will be agented by Fleet Retail Finance Inc. ("Fleet"),
a co-agent of the DIP Facility, and fully underwritten by FleetBoston Robertson
Stephens Inc.
The Company believes the DIP to Exit Facility will be structured as a $600
million revolver, although Fleet has reserved the right to allocate up to $85
million to a term loan prior to closing. The DIP to Exit Facility also is
expected to include a letter of credit subfacility of $150 million and permits
subordinated secured financing in amounts up to an additional $50 million on
terms reasonably satisfactory to Fleet. The DIP to Exit Facility is expected to
require superpriority claim status and a first priority security interest in all
assets subject to existing liens, and to contain certain other customary
priority provisions.
The DIP to Exit Facility is expected to be subject to various customary
terms and conditions, and must be closed by the Company no later than May 31,
2000. The DIP to Exit Facility is expected to mature four years from closing but
can be converted to exit financing by the Company at any time during the
four-year term as long as applicable conditions to conversion are satisfied. The
interest rate during the first year of the term is anticipated to be LIBOR plus
250 basis points or prime plus 75 basis points; thereafter, the Company believes
the interest rate on the DIP to Exit Facility will be subject to quarterly
35
<PAGE> 40
adjustment pursuant to a pricing grid based on availability and/or EBITDA, as
defined in the DIP to Exit Facility, with ranges of 200 to 275 basis points over
LIBOR and 25 to 100 basis points over prime.
The Company believes the DIP to Exit Facility will include various
covenants designed to facilitate implementation of the 2000 Business Plan and
the Company's anticipated emergence from Chapter 11 in 2001. To fund capital
expenditures, including the Company's planned two-year store renovation program,
the facility is expected to permit the Company to invest up to $70.0 million of
capital expenditures during 2000 (plus certain incremental amounts based on the
amount of subleased space completed during the fiscal year). In 2001, the DIP to
Exit Facility is expected to permit capital expenditures up to $150 million less
actual capital expenditures invested during 2000. During 2002 and 2003, the
Company anticipates that it may invest up to $50 million each year with 100
percent carryover of unexpended amounts from prior years. The DIP to Exit
Facility is expected to include a financial covenant test similar to the test in
the current DIP Facility. The Company believes it would not breach this
financial covenant unless unused borrowing availability falls below $50 million
and the Company fails to meet specified minimum EBITDA performance (as defined
in the DIP to Exit Facility) performance. Expected to be excluded from the
EBITDA calculation are revenues and expenses associated with discontinued
inventory lines, the Orlando and Montgomery distribution centers and the
reduction in force plan (including payroll and severance) except with respect to
non-continuing EBITDA amounts in excess of $100 million.
The Company believes there will be no restrictions in the facility on the
Company's ability to sublease and lease store space pursuant to the 2000
Business Plan; lease all or part of the corporate headquarters; sell, pursuant
to sale-leasebacks or outright, the corporate headquarters, the Orlando and/or
Montgomery distribution centers; and/or implement a credit card receivables
securitization program. The Company also believes it will retain the ability to
complete intercompany restructurings, intercompany asset transfers and
intercompany/third-party real estate transactions.
Events of default under the facility are expected to include customary
default provisions as well as key management provisions that would trigger a
default in the event that both the current Chief Executive Officer and President
ceased to be employed, unless at least one of them is replaced by a person
reasonably satisfactory to Fleet within 90 days and/or the acquisition by any
one person or entity of 50 percent of the voting stock of the Company. Closing
of the facility is subject to customary closing conditions, including at least
$155 million of availability at close and no material adverse change in the
financial condition, operations or assets of the Company at the time of closing.
Conversion of the facility to an exit financing is also expected to be based on
customary closing conditions, including the Agent's reasonable satisfaction with
capital structure, plan of reorganization and any materially revised
projections, as well as the achievement by the Company of a specified trailing
12-month EBITDA (which varies depending on time of exit) and certain minimum
availability (which varies from $50 to $100 million) depending on the time of
exit. There can be no assurance the Company will be able to consummate the DIP
to Exit
36
<PAGE> 41
Facility or access liquidity from the DIP Facility or the DIP to Exit Facility.
See "Safe Harbor Statement under the Private Securities Litigation Reform Act."
HUMAN RESOURCES
The Company's greatest resource is its associates. As a result of their
dedication and hard work, Service Merchandise was able to achieve its 1999
performance. Going forward, Service Merchandise, in consultation with the
Creditors Committee, will set EBITDAR objectives which will be the basis for
2000 annual incentive bonuses.
In light of the planned reduction in workforce at corporate headquarters,
the distribution centers and throughout the stores organization as part of the
2000 Business Plan, the Company sought and received Bankruptcy Court approval of
modifications to the existing employee retention program. These modifications
will benefit go-forward associates and provide enhanced severance to most
transitional employees who are asked to stay with the Company for a limited
period of time to complete specific projects and established objectives. In
addition, the Company will replace the successful Y2K Bonus Program, scheduled
to end on March 31, 2000, with a new information technology retention program.
37
<PAGE> 42
VI. CONCLUSION
The Service Merchandise team believes that the path for 2000 is
clear -- the Company will immediately exit certain unprofitable hardlines
categories, expand its offerings of jewelry and jewelry-related products, focus
its hardlines assortments on housewares, giftware and other categories that have
demonstrated cross-shopping relationships with jewelry, achieve a convergence
between the in-store and Internet sales environments, unlock value from real
estate and reduce overhead and operating costs to strengthen its business and
provide a foundation for emergence from Chapter 11 in 2001. We believe the
measure of success this year should be meeting our continuing EBITDAR targets.
The building blocks for our success in 2000 are already in place:
- We have a team of associates that has proved its mettle by stabilizing
Service in 1999 and enthusiastically embraces the 2000 Business Plan and
the challenge to strengthen the Company in 2000.
- We have identified a clear strategic plan for 2000 and beyond that will
focus on our core competency in jewelry and a more targeted selection of
hardlines.
- We have implemented initiatives that will result in an anticipated
annualized reduction of corporate and operating expenses of $129 million.
- We have initiated discussions with several nationally prominent retailers
whose businesses complement ours to sublease excess space in a
significant number of our stores.
- We have an established Internet order-taking and fulfillment
infrastructure that will allow us to capitalize on future e-commerce
growth opportunities.
- We have received a fully underwritten commitment for a $600 million DIP
and exit credit facility that provides the Company with ample liquidity
and financial flexibility to execute our 2000 Business Plan.
We are well prepared to meet the challenge that lies before us, and we look
forward to working closely with all of our important constituencies --
customers, employees, landlords, lenders, suppliers and creditors -- to
revitalize and strengthen Service Merchandise.
38
<PAGE> 43
SAFE HARBOR STATEMENT UNDER THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This 2000 Business Plan includes certain forward-looking statements
(statements other than with respect to historical fact) 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. These forward-looking statements are based on a variety of
assumptions that may not be realized and are subject to significant business,
economic, judicial and competitive uncertainties and potential contingencies,
including those set forth below, many of which are beyond the Company's control.
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 2000 Business Plan contains unaudited financial information and
measures of financial performance other than those prescribed by generally
accepted accounting principles. There can be no assurance that the information
contained in the Plan is complete. In particular, the information contained in
the Plan may not be indicative of the Company's financial condition or operating
results for the periods reflected in the Company's financial statements or in
its reports pursuant to the Exchange Act. Accordingly, readers are cautioned to
refer to the Exchange Act filings and the audited financial information
contained therein.
The forward-looking statements and 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: approval of plans
and activities by the Bankruptcy Court, including the Company's proposed
strategic real estate initiatives; the ability of the Company to continue as a
going concern; the ability of the Company to operate pursuant to the terms of
the present DIP Facility and to close and operate pursuant to the new DIP to
Exit Facility; the ability of the Company to conduct successful clearance sales
in connection with the 2000 Business Plan; the ability of the Company to
sublease successfully portions of its real estate in connection with the 2000
Business Plan; the ability of the Company to complete its store refurbishment
program within cost and time expectations; the successful implementation of the
consolidation of its distribution centers; the ability of the Company to enter
into satisfactory arrangements with third parties with respect to real estate
and Internet-related strategies; risks associated with third parties seeking and
obtaining Court action to terminate or shorten the exclusivity period, the time
for the Company to accept or reject executory contracts including its store
leases, and for appointment of a Chapter 11 operating trustee or to convert the
Company's reorganization cases to liquidation cases; the ability of the Company
to operate successfully under a Chapter 11 proceeding, achieve planned sales and
margin, and create and have approved a plan of reorganization in the Chapter 11
cases; potential adverse developments with respect to the Company's liquidity or
results of operations; the ability of the Company to obtain shipments, negotiate
and maintain terms with vendors and service providers for current orders; the
ability to fund and execute a Year 2000 Business Plan; the ability of the
Company to achieve cost-savings; the ability of the Company to attract, retain
and compensate key executives and associates; competitive
39
<PAGE> 44
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 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; potential adverse publicity; real
estate occupancy and development costs, including the substantial fixed
investment costs associated with opening, maintaining or closing a Company
store; uncertainties with respect to continued public trading in the Company's
securities; the ability to effect conversions to new technological systems; and
the ability to develop, prosecute, confirm and consummate one or more plans of
reorganization with respect to its Chapter 11 cases.
In preparing the 2000 Business Plan, the management of Service Merchandise
has consulted with Jay Alix & Associates and Peter J. Solomon Company. Both Jay
Alix and Peter J. Solomon have acted exclusively in an advisory capacity
assisting Service Merchandise with the preparation of this 2000 Business Plan
and do not express an opinion or any other form of assurance with respect to the
information contained in this Business Plan.
40
<PAGE> 45
SENIOR MANAGEMENT STRUCTURE
<TABLE>
<S> <C> <C> <C> <C> <C>
Sam Cusano
CEO
__________________________________________________|____________________________________________________
| | | |
| Charlie Septer | |
| President | |
| and COO | |
| _________|_________________________ | |
| | | | |
| |__________________ |
Steve Moore Jerry Foreman | -Advertising/ Tom Garrett Eric Kovats
CAO and Sr. VP Hardlines | Marketing Sr VP and Sr. VP Stores
General Counsel | | | CFO
| | Rose Septer -Merchandise |
- -Human Resources -Supply Chain VP Jewelry Planning -Information
- -Legal Management | -Merchandise Technology
- -Real Estate -e-Commerce -N.Y.O. Presentation -Accounting
- -Loss Prevention -Jewelry -Special -Treasury
Distribution Events
-Jewelry
Service
Organization
</TABLE>
SINGLE STORE STRUCTURE
<TABLE>
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Store Manager
1 FT
_____________________________|__________________________________________
| |
Sales Manager Sales Support Manager
1 FT 1 FT
_____________|________________ _____________________|__________________
| | | ___________|___________ |
Sales Lead | Floor Sales Associates | | | |
1 FT | 3 PT Cashiers/ | Administration Replenishment
| Cust Svc Assoc | 1 FT 1 FT
Jewelry Associates 5 PT | |
2 FT/10 PT Receivers Trailer Process/Replenish
2 FT POG
5 PT
</TABLE>
APPENDIX A-1
<PAGE> 46
STORE LOCATIONS
The numbers in parentheses show the number of stores per state and where
there is more than one store in any city, the number of stores in such city as
of fiscal year-end. As of January 2, 2000 the Company operated 223 stores in 32
states. As of February 27, 2000, the Company operates 221 stores in 32 states:
ALABAMA (6)
Birmingham (2)
Huntsville
Mobile
Montgomery
Tuscaloosa
ARIZONA (3)
Glendale
Mesa (2)
ARKANSAS (1)
Little Rock
CALIFORNIA (2)
San Francisco
San Jose
CONNECTICUT (5)
Danbury
Derby
Manchester
Newington
Orange
DELAWARE (3)
Dover
Wilmington (2)
FLORIDA (42)
Altamonte Springs
Boca Raton
Boynton Beach
Bradenton
Brandon
Casselberry
Coral Springs
Daytona Beach
Fort Myers
Hollywood
Jacksonville (2)
Kissimmee
Lakeland
Largo
Leesburg
Miami (2)
N. Clearwater
N. Miami
Naples
Ocala
Orange Park
Orlando (3)
Pembroke Pines
Pensacola
Pompano Beach
Port Charlotte
Port Richie
Sanford
Sarasota
Spring Hill
St. Petersburg
Stuart
Sunrise
Tallahassee
Tampa (2)
W. Melbourne
W. Palm Beach
GEORGIA (12)
Alpharetta
Augusta
Columbus
Decatur
Douglasville
Duluth
Kennesaw
Macon
Morrow
Savannah
Smyrna
Tucker
ILLINOIS (18)
Arlington Heights
Berwyn
Bloomingdale
Burbank
Crystal Lake
Downers Grove (2)
Joliet
Lansing
Matteson
Naperville
Niles
Norridge
Oaklawn
Orland Park
Schaumburg
Skokie
Waukegan
INDIANA (10)
Castleton
Clarksville
Evansville
Fort Wayne
Greenwood
Indianapolis (2)
Lake
Merrillville
Mishawaka
KANSAS (1)
Overland Park
KENTUCKY (6)
Florence
Lexington
Louisville (2)
Owensboro
Paducah
LOUISIANA (9)
Baton Rouge
Bossier City
Harvey
Houma
Lafayette
Metarie
Monroe
Shreveport
Slidell
MAINE (2)
Augusta
S. Portland
MARYLAND (2)
Baltimore
Columbia
MASSACHUSETTS (6)
Auburn
Burlington
Natick
Saugus
Stoughton
Swansea
MICHIGAN (6)
Novi
Roseville
Southgate
Sterling Heights
Troy
Westland
MISSISSIPPI (3)
Gulfport
Hattiesburg
Jackson
MISSOURI (4)
Crestwood
Florissant
Springfield
St. Peters
NEVADA (1)
Las Vegas
NEW HAMPSHIRE (5)
Dover
Manchester
Nashua
Plaistow
Salem
NEW JERSEY (3)
Hazlet
Paramus
Wayne
NEW YORK (6)
Hartsdale
Lake Grove
Middletown
Patchoque
Poughkeepsie
Woodhaven
NORTH CAROLINA (7)
Cary
Charlotte
Fayetteville
Gastonia
Greensboro
Pineville
Raleigh
OHIO (4)
Cincinnati (3)
Springdale
OKLAHOMA (3)
Oklahoma City
Tulsa
Warr Acres
PENNSYLVANIA (6)
Allentown
Greensburg
Harrisburg
Lancaster
Reading
Wilkes-Barre
SOUTH CAROLINA (3)
Columbia
Greenville
N. Charleston
TENNESSEE (10)
Antioch
Chattanooga
Cookeville
Franklin
Jackson
Johnson City
Knoxville
Madison
Memphis (2)
TEXAS (26)
Arlington
Austin
Baytown
Beaumont
Dallas
Fort Worth
Harlingen
Houston (7)
Lake Jackson
Laredo
Lewisville
Longview
McAllen
Mesquite
N. Richland Hills
Plano
Richardson
San Antonio
Sugar Land
Tyler
VERMONT (1)
Burlington
VIRGINIA (5)
Chantilly
Chesapeake
Fredericksburg
Glen Allen
Midlothian
APPENDIX B
<PAGE> 47
EXISTING PROTOTYPE D PLAN
(FLOOR PLAN)
APPENDIX C-1
<PAGE> 48
CLASS I RENOVATION PLAN
(FLOOR PLAN)
APPENDIX C-2
<PAGE> 49
CLASS II RENOVATION PLAN
(FLOOR PLAN)
APPENDIX C-3
<PAGE> 50
PROFESSIONALS RETAINED BY SERVICE MERCHANDISE COMPANY, INC.
<TABLE>
<S> <C>
Corporate Counsel Bass, Berry & Sims PLC
Restructuring Counsel Skadden, Arps, Slate, Meagher & Flom LLP and
Affiliates
Financial Advisors Jay Alix & Associates
Investment Bankers Peter J. Solomon Company
Real Estate Appraisers DJM Asset Management LLC
Real Estate Advisors DG Hart Associates Inc.
Thompson Associates
Real Estate Agents The Keen Venture (a joint venture comprising
- --Dispositions Keen Realty Consultants, Inc., Trammel Crow
and Dean & Associates)
Real Estate Agents Service Real Estate Venture (a joint
- --Subleasing venture of Keen Realty Consultants Inc. and
Dean & Associates associated with affiliates
of Grubb & Ellis)
Communications Professionals Sitrick And Company
Claims Professionals Robert L. Berger & Associates, Inc.
</TABLE>
<PAGE> 51
[OUTSIDE BACK COVER]
AT YOUR SERVICE
MERCHANDISE
YOUR MULTI-CHANNEL SPECIALTY RETAILER
www.servicemerchandise.com
