<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JULY 2, 2000.
Commission File No.1-9223
SERVICE MERCHANDISE COMPANY, INC.
(Debtor-in-Possession as of March 27, 1999)
(Exact Name of Registrant as Specified In Its Charter)
TENNESSEE 62-0816060
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
P.O. BOX 24600, NASHVILLE, TN (MAILING ADDRESS)
7100 SERVICE MERCHANDISE DRIVE, BRENTWOOD, TN 37202-4600
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (615) 660-6000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ].
As of July 2, 2000, there were 99,956,123 shares of the Registrant's
common stock, $.50 par value, outstanding.
<PAGE> 2
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
No.
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<S> <C>
PART I FINANCIAL INFORMATION
Consolidated Statements of Operations (Unaudited) - Three and Six Periods
Ended July 2, 2000 and July 4, 1999 ............................................... 3
Consolidated Balance Sheets - July 2, 2000 (Unaudited), July 4, 1999
(Unaudited) and January 2, 2000 ................................................... 4
Consolidated Statements of Cash Flows (Unaudited) - Six Periods Ended
July 2, 2000 and July 4, 1999 ..................................................... 5
Notes to Consolidated Financial Statements (Unaudited) .............................. 6
Management's Discussion and Analysis of Financial Condition and Results
of Operations .................................................................... 16
Quantitative and Qualitative Disclosure about Market Risk ........................... 27
PART II OTHER INFORMATION
Legal Proceedings ................................................................... 28
Defaults Upon Senior Securities ..................................................... 29
Exhibits and Reports on Form 8-K .................................................... 29
SIGNATURES ................................................................................... 31
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Debtor-In-Possession)
(in thousands, except per share data)
<TABLE>
<CAPTION>
THREE PERIODS ENDED SIX PERIODS ENDED
--------------------- -------------------------
RESTATED RESTATED
JULY 2, JULY 4, JULY 2, JULY 4,
2000 1999 2000 1999
--------- --------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales:
Operations excluding exiting categories and closed
facilities $ 319,977 $ 322,352 $ 565,169 $ 556,416
Exiting categories and closed facilities 97,571 196,326 195,408 473,957
--------- --------- ----------- -----------
417,548 518,678 760,577 1,030,373
--------- --------- ----------- -----------
COSTS AND EXPENSES:
Operations excluding exiting categories and closed facilities 225,764 231,389 400,743 416,901
Exiting categories and closed facilities 110,441 199,897 191,357 428,792
--------- --------- ----------- -----------
336,205 431,286 592,100 845,693
--------- --------- ----------- -----------
GROSS MARGIN (LOSS) AFTER COST OF MERCHANDISE SOLD AND
BUYING AND OCCUPANCY EXPENSES:
Operations excluding exiting categories and closed facilities 94,213 90,963 164,426 139,515
Exiting categories and closed facilities (12,870) (3,571) 4,051 45,165
--------- --------- ----------- -----------
81,343 87,392 168,477 184,680
--------- --------- ----------- -----------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Operations excluding exiting categories and closed facilities 87,474 107,821 172,954 214,098
Exiting categories and closed facilities 41,887 31,306 55,802 92,319
--------- --------- ----------- -----------
129,361 139,127 228,756 306,417
--------- --------- ----------- -----------
Other income, net (971) (4,418) (13,267) (7,467)
Restructuring charge (income) (838) (1,894) (1,747) 97,560
Depreciation and amortization:
Operations excluding exiting categories and closed facilities 9,727 9,791 19,340 19,417
Exiting categories and closed facilities 285 1,077 416 3,685
--------- --------- ----------- -----------
10,012 10,868 19,756 23,102
--------- --------- ----------- -----------
Reorganization items (income) 12,217 31,371 30,911 (12,372)
--------- --------- ----------- -----------
Loss before interest, income tax, extraordinary item and
cumulative effect of change in accounting principle (68,438) (87,662) (95,932) (222,560)
Interest expense (contractual interest $16,673, $34,604, $18,262
and $43,573 for the three and six periods ended July 2, 2000
and July 4, 1999, respectively) 9,634 12,759 20,526 37,861
--------- --------- ----------- -----------
Loss before income tax, extraordinary item and cumulative effect
of change in accounting principle (78,072) (100,421) (116,458) (260,421)
Income tax -- -- -- --
--------- --------- ----------- -----------
Loss before extraordinary item and cumulative effect of change
in accounting principle (78,072) (100,421) (116,458) (260,421)
Extraordinary loss from early extinguishment of debt -- -- -- (7,851)
Cumulative effect of a change in recording layaway sales -- -- -- (6,566)
--------- --------- ----------- -----------
NET LOSS $ (78,072) $(100,421) $ (116,458) $ (274,838)
========= ========= =========== ===========
WEIGHTED AVERAGE COMMON SHARES - BASIC AND DILUTED 99,723 99,721 99,723 99,719
========= ========= =========== ===========
LOSS PER COMMON SHARE - BASIC AND DILUTED:
Loss before extraordinary item and cumulative effect of
change in accounting principle $ (0.78) $ (1.01) $ (1.17) $ (2.61)
Extraordinary loss from early extinguishment of debt -- -- -- (0.08)
Cumulative effect of a change in recording layaway sales -- -- -- (0.07)
--------- --------- ----------- -----------
Net loss $ (0.78) $ (1.01) $ (1.17) $ (2.76)
========= ========= =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 4
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Debtor-In-Possession)
(in thousands, except per share data)
<TABLE>
<CAPTION>
(UNAUDITED)
--------------------------
RESTATED
JULY 2, JULY 4, JANUARY 2,
2000 1999 2000
----------- ----------- -----------
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 29,719 $ 37,858 $ 61,591
Accounts receivable, net of allowance of $17,496, $17,587 and
$19,474 respectively 8,268 5,987 13,171
Inventories 513,592 560,604 642,997
Prepaid expenses and other assets 16,968 86,974 29,135
----------- ----------- -----------
TOTAL CURRENT ASSETS 568,547 691,423 746,894
----------- ----------- -----------
PROPERTY AND EQUIPMENT:
Net property and equipment - owned 348,189 364,581 353,078
Net property and equipment - leased 13,410 17,588 14,636
Other assets and deferred charges 51,836 49,843 47,336
----------- ----------- -----------
TOTAL ASSETS $ 981,982 $ 1,123,435 $ 1,161,944
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY
LIABILITIES NOT SUBJECT TO COMPROMISE
CURRENT LIABILITIES:
Notes payable $ 76,192 $ 33,624 $ 42,977
Accounts payable 54,753 26,435 67,318
Accrued expenses 147,590 136,420 181,860
State and local sales taxes 14,985 15,233 28,737
Accrued restructuring costs 5,751 -- 38
Current maturities of long-term debt -- 1,000 1,000
Current maturities of capitalized lease obligations 305 -- 86
----------- ----------- -----------
TOTAL CURRENT LIABILITIES 299,576 212,712 322,016
LONG-TERM LIABILITIES:
Long-term debt 60,000 98,750 98,500
Capitalized lease obligations 1,639 -- 2,514
----------- ----------- -----------
TOTAL LONG-TERM LIABILITIES 61,639 98,750 101,014
LIABILITIES SUBJECT TO COMPROMISE 754,285 861,072 755,975
----------- ----------- -----------
TOTAL LIABILITIES 1,115,500 1,172,534 1,179,005
----------- ----------- -----------
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' (DEFICIT) EQUITY:
Preferred stock, $1 par value, authorized 4,600 shares,
undesignated as to rate and other rights, none issued -- -- --
Series A Junior Preferred Stock, $1 par value, authorized
1,100 shares, none issued -- -- --
Common stock, $.50 par value, authorized 500,000 shares,
issued and outstanding 99,956, 100,097 and 100,012
shares, respectively 49,979 50,049 50,006
Additional paid-in capital 6,211 6,756 6,424
Deferred compensation (467) (1,086) (708)
Accumulated other comprehensive loss -- (869) --
Retained (deficit) earnings (189,241) (103,949) (72,783)
----------- ----------- -----------
TOTAL SHAREHOLDERS' (DEFICIT) EQUITY (133,518) (49,099) (17,061)
----------- ----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' (DEFICIT) EQUITY $ 981,982 $ 1,123,435 $ 1,161,944
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE> 5
SERVICE MERCHANDISE COMPANY, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
(Debtor-In-Possession)
(in thousands)
<TABLE>
<CAPTION>
SIX PERIODS ENDED
----------------------
RESTATED
JULY 2, JULY 4,
2000 1999
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(116,458) $(274,838)
Adjustments to reconcile net loss to net cash provided (used) by operating activities:
Extraordinary items -- 7,851
Cumulative effect of a change in accounting principle - layaway sales -- 6,566
Depreciation and amortization 23,694 28,087
Net gain on sale of property and equipment (3,809) (3,288)
Provision for restricted cash -- 8,819
Write-down of property and equipment due to restructuring -- 22,558
Reorganization items 30,911 (12,372)
Changes in assets and liabilities:
Accounts receivable 4,903 17,510
Inventories 129,405 339,192
Prepaid expenses and other assets 3,440 (32,361)
Accounts payable (6,904) (10,532)
Accrued expenses and state and local sales taxes (60,719) (20,745)
Accrued restructuring costs (7,406) 65,916
Income taxes -- 19,006
--------- ---------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (2,943) 161,369
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment - owned (17,790) (9,897)
Proceeds from sale of property and equipment 8,613 10,297
Proceeds from sale of property and equipment - reorganization 4,059 126
Restricted cash and other assets, net (1,267) 13,465
--------- ---------
NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES (6,385) 13,991
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings, net 33,215 (122,376)
Repayment of long-term debt (45,004) (122,166)
Repayment of capitalized lease obligations (2,194) (4,014)
Debt issuance costs -- (18,574)
Debt issuance costs - reorganization (8,500) (3,750)
Exercise of stock options (forfeiture of restricted stock), net (61) (371)
--------- ---------
NET CASH USED IN FINANCING ACTIVITIES (22,544) (271,251)
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS (31,872) (95,891)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 61,591 133,749
--------- ---------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 29,719 $ 37,858
========= =========
SUPPLEMENTAL DATA:
Cash paid (received) during the period for:
Interest $ 11,525 $ 36,423
Income taxes $ (315) $ (18,932)
Reorganization items $ 7,658 $ 8,823
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
5
<PAGE> 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
FOR THE SIX PERIODS ENDED JULY 2, 2000
A. FINANCIAL STATEMENT PRESENTATION AND GOING CONCERN MATTERS
The consolidated financial statements, in this filing, except for the
consolidated balance sheet as of January 2, 2000, have been prepared by the
Company without audit.
In management's opinion, the information and amounts furnished in this
report reflect all adjustments (consisting of normal recurring adjustments)
considered necessary for the fair presentation of the consolidated financial
position and consolidated results of operations for the interim periods
presented. Certain prior period amounts have been reclassified to conform to the
current period presentation.
As described in Note L, a change in accounting principle regarding
layaway sales was adopted during the quarter ended January 2, 2000. The
consolidated financial statements as of and for the six periods ended July 4,
1999 have been restated to reflect the effect of the retroactive application of
the change to January 4, 1999.
The consolidated financial statements have been prepared on a going
concern basis of accounting and in accordance with AICPA Statement of Position
("SOP") 90-7 "Financial Reporting by Entities in Reorganization Under the
Bankruptcy Code."
The consolidated statements of operations line item "Exiting categories
and closed facilities" represents activity specifically identifiable to
inventory liquidations conducted in conjunction with (1) the Company's
restructuring plan adopted on March 25, 1997 (the "1997 Restructuring Plan");
(2) the Company's rationalization plan adopted on March 8, 1999 (the
"Rationalization Plan") and (3) the exiting of toys, juvenile, sporting goods,
most consumer electronics and other merchandise categories as part of the 2000
Business Plan. All activity for these items is classified in "Exiting categories
and closed facilities." Prior year amounts reflect operating results for these
same facilities and merchandise classifications. Selling, general and
administrative expenses for exiting categories and closed facilities do not
include any allocation of corporate overhead.
The Company's recent losses and the Chapter 11 Cases raise substantial
doubt about the Company's ability to continue as a going concern. The
consolidated financial statements do not include any adjustments relating to
recoverability and classification of recorded asset amounts or the amount and
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. The ability of the Company to continue as
a going concern and appropriateness of using the going concern basis is
dependent upon, among other things, (i) the Company's ability to comply with its
debtor-in-possession to exit financing agreements, (ii) the Company's ability to
implement its 2000 business plan; (iii) confirmation of a plan of reorganization
under the Bankruptcy Code, (iv) the Company's ability to achieve profitable
operations after such confirmation, and (v) the Company's ability to generate
sufficient cash from operations to meet its obligations.
As described in Note B, the Company has an exclusive right to submit a
plan of reorganization to the Bankruptcy Court through April 30, 2001.
Management believes that the plan of reorganization, as it is being developed
and subject to approval of the Bankruptcy Court, along with cash provided by the
debtor-in-possession to exit facility and operations, will provide sufficient
liquidity to allow the Company to continue as a going concern; however, there
can be no assurance that the sources of liquidity will be available or
sufficient to meet the Company's needs. A plan of reorganization could
materially change the amounts currently recorded in the consolidated financial
statements. The consolidated financial statements do not give effect to any
adjustment to the carrying value of assets or amounts and classifications of
liabilities that might be necessary as a result of the Chapter 11 Cases.
On February 21, 2000, the Company's Board of Directors approved its
2000 Business Plan, which contemplates: (i) an expansion of jewelry and jewelry
related products; (ii) a more targeted selection of those categories that have
historically performed well and have an affinity to jewelry and an exit from
certain unprofitable hardline categories; (iii) the convergence of the Company's
in-store and Internet environment; (iv) the reduction of selling and warehouse
spaces within the Company's stores to adjust for the new merchandise mix, which
allows for the subleasing of excess space; and (v) the rationalization of the
Company's overhead structure, logistics network and stores/field organization to
generate anticipated cost savings. The execution and success of the 2000
Business Plan is subject to numerous risks and uncertainties.
6
<PAGE> 7
Pursuant to the 2000 Business Plan, the Company will feature an
expanded offering of jewelry and jewelry-related products, with the bulk of the
expansion in diamonds. In addition to jewelry, the Company will focus on home
products categories that have performed well and which generate cross-selling
opportunities with jewelry. The Company will exit certain unprofitable
categories, including toys, juvenile, sporting goods and most electronics. As a
multi-channel specialty retailer, the Company has included as part of the 2000
Business Plan the planned convergence of the Internet and store selling
environments. Each store will feature Internet kiosks that will provide
immediate access to the Company's web site, www.servicemerchandise.com, its
bridal and gift registry and its store directory.
The Company intends to reconfigure its stores to feature less overall
selling square footage (approximately 18,000 square feet as compared to 27,000
square feet), but increase square footage for jewelry. The excess store space
will be available for sub-leasing or other real estate transactions.
Approximately seventy stores are scheduled for total refurbishment and upgrade
to an expanded jewelry selling area in 2000 while the balance will undergo a
more limited capital improvement remodel during 2000. As of August 7, 2000, the
refurbishment and preparation for subleasing of twenty-six stores was complete,
with an additional thirty-three under construction. Approximately another
eighty-three stores are scheduled for refurbishment in 2001. The Company's
ability to complete this program is subject to known and unknown risks and
uncertainties, including those set forth above under "Safe Harbor Statement
Under the Private Securities Litigation Reform Act of 1995".
Although the Company plans to continue operating substantially all of
its 221 stores, in 2000 it will close its distribution centers in Montgomery,
New York and Orlando, Florida. As part of the 2000 Business Plan, the Company
will reduce its workforce at its corporate offices, its distribution centers and
its stores resulting in the elimination of 5,000 to 6,000 positions.
The Company continues to review its business strategy, which may
include additional store closings, changes in merchandise assortments, changes
in distribution networks and overhead costs and is considering various options
with respect to the Restated Retirement Plan, the Executive Security Plan and
the Savings and Investment Plan, which may include reinstatement, amendments,
termination or substitution of such plans, among other things.
The Company has historically incurred a net loss for the first three
quarters of the year because of the seasonality of its business. The results of
operations for the six periods ended July 2, 2000 and July 4, 1999 are not
necessarily indicative of the operating results for an entire fiscal year.
These consolidated financial statements should be read in conjunction
with the Company's Annual Report on Form 10-K for the fiscal year ended January
2, 2000.
B. PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
On March 15, 1999, five of the Company's vendors filed an involuntary
petition for reorganization under Chapter 11 ("Chapter 11") of title 11 of the
United States Bankruptcy Code (the "Bankruptcy Code") in the United States
Bankruptcy Court for the Middle District of Tennessee (the "Bankruptcy Court")
seeking court supervision of the Company's restructuring efforts. On March 27,
1999, the Company and 31 of its subsidiaries (collectively, the "Debtors") filed
voluntary petitions with the Bankruptcy Court for reorganization under Chapter
11 under case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and
orders for relief were entered by the Bankruptcy Court. The Chapter 11 Cases
have been consolidated for the purpose of joint administration under Case No.
399-02649. The Debtors are currently operating their businesses as
debtors-in-possession pursuant to the Bankruptcy Code.
7
<PAGE> 8
Under the Bankruptcy Code, actions to collect pre-petition indebtedness
are stayed and other contractual obligations against the Debtors may not be
enforced. In addition, under the Bankruptcy Code the Debtors may assume or
reject executory contracts, including lease obligations. Parties affected by
these rejections may file claims with the Bankruptcy Court in accordance with
the reorganization process. Substantially all pre-petition liabilities are
subject to settlement under a plan of reorganization to be voted upon by
creditors and equity holders and approved by the Bankruptcy Court. Although the
Debtors expect to file a reorganization plan or plans that provide for emergence
from bankruptcy in 2001, there can be no assurance that a reorganization plan or
plans will be proposed by the Debtors or confirmed by the Bankruptcy Court, or
that any such plan(s) will be consummated. As provided by the Bankruptcy Code,
the Debtors initially had the exclusive right to submit a plan of reorganization
for 120 days. On May 25, 1999, the Company received Court approval to extend the
period in which the Company has the exclusive right to file or advance a plan of
reorganization in its Chapter 11 case. The order extended the Company's
exclusive right to file a plan from July 23, 1999 to February 29, 2000, and
extended the Company's exclusive right to solicit acceptances of its plan from
September 21, 1999 to May 1, 2000. On February 2, 2000, the Company received
Court approval to extend the period in which the Company has the exclusive right
to file or advance a plan from February 29, 2000 to April 30, 2001 and extend
the Company's right to solicit acceptances of its plan from May 1, 2000 to June
30, 2001. If the Debtors fail to file a plan of reorganization during such
period or extension thereof or if such plan is not accepted by the required
number of creditors and equity holders, any party in interest may subsequently
file its own plan of reorganization for the Debtors. A plan of reorganization
must be confirmed by the Bankruptcy Court, upon certain findings being made by
the Bankruptcy Court which are required by the Bankruptcy Code. The Bankruptcy
Court may confirm a plan notwithstanding the non-acceptance of the plan by an
impaired class of creditors or equity security holders if certain requirements
of the Bankruptcy Code are met. The plan or plans currently being considered by
the Company involve a debt conversion of the Company's prepetition unsecured
claims into new common equity of the reorganized Company. Under such
circumstances, the existing common stock of the Company would be cancelled and
would result in existing holders of the common stock receiving no value for
their interests. The Company believes the value of the Common Stock is highly
speculative since it is probable that it will be cancelled, and therefore,
worthless if the expected plan of reorganization is consummated.
C. RESTRUCTURING PLANS
1997 RESTRUCTURING PLAN
On March 25, 1997, the Company adopted a business restructuring plan to
close up to 60 under performing stores and one distribution center. As a result,
a pre-tax charge of $129.5 million for restructuring costs was taken in the
first quarter of fiscal 1997. The remaining component of the restructuring
charge accrual and an analysis of the change in the accrual for the six periods
ended July 2, 2000 are outlined in the following table:
<TABLE>
<CAPTION>
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN JULY 2,
2000 COSTS PAID ESTIMATE 2000
---- ---------- -------- ----
(in thousands)
<S> <C> <C> <C> <C>
Lease termination and other real estate costs $7,894 $(32) $(142) $7,720
====== ==== ===== ======
</TABLE>
Note: The accrued restructuring costs are included in Liabilities Subject to
Compromise.
The closing of nine stores during the first half of fiscal 1998 brought
the total number of closures, in accordance with the 1997 Restructuring Plan, to
53 stores and one distribution center. Store closures were completed as of May
1998. The Company closed less than 60 stores primarily due to the inability to
negotiate acceptable exit terms from the related lessors.
8
<PAGE> 9
Lease terminations and other real estate costs primarily consist of
contractual rent payments and other real estate costs. These amounts have been
accrued according to the remaining leasehold obligations under Section 502(b)(6)
of the Bankruptcy Code. Section 502(b)(6) limits a lessor's claim to the rent
reserved by such lease, without acceleration for the greater of one year, or 15
percent, not to exceed three years of the remaining term of the lease. Any
unpaid rent is included in the claim.
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the six periods ended July 2,
2000. As a result the Company reduced its estimate for these costs by $0.1
million.
The leases remaining on closed locations as of July 2, 2000 vary in
length with expiration dates ranging from February 2001 to February 2015.
RATIONALIZATION PLAN
In February 1999, the Company announced a rationalization plan to close
up to 132 stores and up to four distribution centers and to reduce corporate
overhead. On March 8, 1999, as part of the Rationalization Plan and prior to the
filing of the involuntary bankruptcy petition, the Board of Directors approved
the adoption of a business restructuring plan to close 106 stores and the Dallas
distribution center and to reduce the Company's workforce at its Nashville
corporate offices by 150 employees. As a result, a pre-tax charge of $99.5
million for restructuring costs was recorded in the first quarter of 1999. On
March 29, 1999 and in connection with the Chapter 11 Cases, store leases under
this plan were approved for rejection by the Bankruptcy Court. The remaining
components of the restructuring charge accrual and an analysis of the change in
the accrual for the six periods ended July 2, 2000 are outlined in the following
table:
<TABLE>
<CAPTION>
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN JULY 2,
2000 COSTS PAID ESTIMATE 2000
---- ---------- -------- ----
(in thousands)
<S> <C> <C> <C> <C>
Lease termination and other real estate costs $ 38,315 $ (1,371) $ (1,780) $ 35,164
Employee severance 478 (545) 175 108
-------- -------- -------- -------
Total $ 38,793 $ (1,916) $ (1,605) $35,272
======== ======== ======== =======
</TABLE>
Note: The accrued restructuring costs are included in Liabilities Subject to
Compromise.
Lease terminations and other real estate costs primarily consists of
contractual rent payments. These amounts have been accrued according to the
remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code.
Section 502(b)(6) limits a lessor's claim to the rent reserved by such lease,
without acceleration for the greater of one year, or 15 percent, not to exceed
three years of the remaining term of the lease. Any unpaid rent is included in
the claim.
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the six periods ended July 2,
2000. As a result the Company reduced its estimate for these costs by $1.8
million.
9
<PAGE> 10
The employee severance provision was recorded for the planned
termination of approximately 4,400 employees associated with the closures, as
well as the reduction of corporate overhead. Substantially all such terminations
were completed as of December 1999.
D. LIABILITIES SUBJECT TO COMPROMISE
"Liabilities subject to compromise" refers to liabilities incurred
prior to the commencement of the Chapter 11 Cases. These liabilities consist
primarily of amounts outstanding under long-term debt and also include accounts
payable, accrued interest, accrued restructuring costs, and other accrued
expenses. These amounts represent the Company's estimate of known or potential
claims to be resolved in connection with the Chapter 11 Cases. Such claims
remain subject to future adjustments. Adjustments may result from (1)
negotiations; (2) actions of the Bankruptcy Court; (3) further development with
respect to disputed claims; (4) future rejection of additional executory
contracts or unexpired leases; (5) the determination as to the value of any
collateral securing claims; (6) proofs of claim; or (7) other events. Payment
terms for these amounts, which are considered long-term liabilities at this
time, will be established in connection with the Chapter 11 Cases.
Pursuant to order of the Bankruptcy Court, on or about March 15, 2000,
the Company mailed notices to all known creditors that the deadline for filing
proofs of claim with the Bankruptcy Court was May 15, 2000. Differences between
amounts recorded by the Company and claims filed by creditors are continuing to
be investigated and resolved. Accordingly, the ultimate number and amount of
allowed claims is not presently known and, because the settlement terms of such
allowed claims is subject to a confirmed plan of reorganization, the ultimate
distribution with respect to allowed claims is not presently ascertainable.
The Company has received approval from the Bankruptcy Court to pay
pre-petition and post-petition employee wages, salaries, benefits and other
employee obligations, to pay vendors and other providers in the ordinary course
for goods and services received from March 15, 1999, and to honor customer
service programs, including warranties, returns, layaways and gift certificates.
The principal categories of claims classified as liabilities subject to
compromise under reorganization proceedings are identified below.
<TABLE>
<CAPTION>
JULY 2, JULY 4,
2000 1999
-------- --------
(in thousands)
<S> <C> <C>
Accounts payable $195,538 $191,406
Accrued expenses 66,954 87,501
Accrued restructuring costs:
1997 Restructuring Plan 7,720 5,654
1999 Rationalization Plan 35,272 67,442
Long-term debt 424,003 465,317
Capitalized lease obligations 24,798 43,752
-------- --------
Total $754,285 $861,072
======== ========
</TABLE>
Contractual interest expense not accrued or recorded on certain pre-petition
debt totaled $7.0 million and $7.0 million for the three periods ended July 2,
2000 and July 4, 1999, respectively, and $14.1 million and $8.5 million for the
six periods ended July 2, 2000 and July 4, 1999, respectively.
10
<PAGE> 11
E. REORGANIZATION ITEMS
Expenses and income directly incurred or realized as a result of the
Chapter 11 Cases have been segregated from the normal operations and are
disclosed separately. The major components are as follows:
<TABLE>
<CAPTION>
THREE SIX
PERIODS PERIODS
ENDED ENDED
(in thousands) JULY 2, JULY 2,
2000 2000
------- --------
<S> <C> <C>
Professional fees and administrative items 8,776 15,764
Loss on disposal of assets 3,474 1,960
Store closing costs (33) 3,764
Severance -- 9,423
------- --------
Total reorganization items expense (income) $12,217 $ 30,911
======= ========
</TABLE>
<TABLE>
<CAPTION>
THREE SIX
PERIODS PERIODS
ENDED ENDED
(in thousands) JULY 4, JULY 4,
1999 1999
------- --------
<S> <C> <C>
Reduction of accrued rent for rejected leases $ -- $(45,981)
Professional fees and administrative items 7,073 9,311
Loss on disposal of assets 10,289 10,289
Store closing costs 14,009 14,009
Severance -- --
------- --------
Total reorganization items expense (income) $31,371 $(12,372)
======= ========
</TABLE>
REDUCTION OF ACCRUED RENT FOR REJECTED LEASES:
In connection with the Chapter 11 Cases, the 1997 Restructuring Plan
was adjusted to reflect the reduction allowed under Section 502(b)(6) of the
Bankruptcy Code. An amount had been accrued according to the remaining leasehold
obligation. Section 502(b)(6) limits the lessor's claim to the rent reserved by
such leases, without acceleration, for the greater of one year, or 15 percent,
not to exceed three years, of the remaining term of such leases, plus any unpaid
rent.
PROFESSIONAL FEES AND OTHER ADMINISTRATIVE ITEMS:
Professional fees and administrative items relate to legal, accounting
and other professional costs directly attributable to the Chapter 11 Cases.
LOSS ON DISPOSAL OF ASSETS:
Loss on disposal of assets consists of accrued losses associated with
the sale of four parcels of real property, sale of certain assets of one of the
Company's subsidiaries, B.A. Pargh Co., Inc. and disposition of displaced
fixtures and equipment from remodeled stores under the 2000 Business Plan.
SEVERANCE:
Severance costs arise from workforce reductions at the corporate
offices, distribution centers and stores as a part of the reorganization
process.
STORE CLOSING COSTS:
Store closing costs include rent, common area maintenance, utilities,
asset write-downs and real estate taxes offset by other income resulting from
store dispositions. Rent amounts have been adjusted to reflect the reduction
allowed under Section 502(b)(6) of the Bankruptcy Code.
11
<PAGE> 12
F. BORROWINGS
This note contains information regarding the Company's short-term
borrowings and long-term debt as of July 2, 2000.
From September 1997 through January 20, 1999, the Company had a
five-year, $900.0 million, fully committed asset-based credit facility (the
"Amended and Restated Credit Facility"). The Amended and Restated Credit
Facility included $200.0 million in term loans and up to a maximum of $700.0
million in revolving loans including a $175.0 million sub-facility for letters
of credit. The Amended and Restated Credit Facility was set to mature on
September 10, 2002. Interest rates on the Amended and Restated Credit Facility
were subject to change based on a financial performance-based grid and could not
exceed a rate of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on the term
loan. There were no short-term borrowings under the Amended and Restated Credit
Facility at July 4, 1999.
On January 20, 1999, the Company completed a $750.0 million, 30-month
asset-based credit facility (the "Second Amended and Restated Credit Facility")
which replaced the Amended and Restated Credit Facility. The Second Amended and
Restated Credit Facility included $150.0 million in term loans and a maximum of
$600.0 million in revolving loans. The Second Amended and Restated Credit
Facility included a $200.0 million sub-facility for standby and trade letters of
credit. Interest rates on the Second Amended and Restated Facility were based on
either Prime Rate + 1.5% or LIBOR + 2.75%. There were no short-term borrowings
under the Second Amended and Restated Credit Facility at July 4, 1999.
On March 29, 1999, the Company entered into a 27-month, $750.0 million
fully committed asset-based debtor-in-possession credit facility (the "DIP
Facility") which replaced the Second Amended and Restated Credit Facility. The
Bankruptcy Court approved the DIP Facility on an interim basis on March 29, 1999
and granted final approval on April 27, 1999. The DIP Facility included $100.0
million in term loans and up to a maximum of $650.0 million in revolving loans
including a $200.0 million sub-facility for letters of credit. Interest rate
spreads on the DIP Facility were LIBOR + 2.25% on Eurodollar loans and Prime
Rate + 1.25% on Alternate Base Rate loans. Short-term borrowings related to the
DIP Facility were $33.6 million as of July 4, 1999. Outstanding borrowings under
the term loan of the DIP Facility were $99.8 million as of July 4, 1999. There
was a commitment fee of 0.375% on the undrawn portion of the revolving loans
under the DIP Facility.
The DIP Facility was secured by all material unencumbered assets of the
Company and its subsidiaries, including inventory, but excluding previously
mortgaged property. Borrowings under the DIP Facility were limited based on a
borrowing base formula which considered eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, eligible leasehold
interests, available cash equivalents and in-transit cash.
On April 14, 2000, the Company entered into a four year, $600.0 million
fully committed asset-based debtor-in-possession and emergence credit facility
(the "DIP to Exit Facility") which replaced the DIP Facility. The Bankruptcy
Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit
Facility matures on April 14, 2004, and includes $60.0 million in term loans and
up to a maximum of $540.0 million in revolving loans including a $150.0 million
sub-facility for letters of credit. Interest rate spreads on the DIP to Exit
Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75%
on Alternate Base Rate loans. After the first quarter of 2001, these spreads are
subject to quarterly adjustment pursuant to a pricing grid based on availability
and financial performance, with ranges of 200 to 275 basis points over LIBOR and
25 to 100 basis points over prime rate. Short-term borrowings related to the DIP
to Exit Facility were $76.2 million as of July 2, 2000. Outstanding borrowings
under the term loan of the DIP to Exit Facility were $60 million as of July 2,
2000. There is a commitment fee of 0.375% on the undrawn portion of the
revolving loans under the DIP to Exit Facility.
12
<PAGE> 13
Borrowings under the DIP to Exit Facility are secured by all material
unencumbered assets of the Company and its subsidiaries, including inventory,
but excluding previously mortgaged property. Borrowings under the DIP to Exit
Facility are limited based on a borrowing base formula, which considers eligible
inventories, eligible accounts receivable, mortgage values on eligible real
properties, eligible leasehold interests, available cash equivalents and
in-transit cash. Availability under the facility continues unless the Company
breaches the financial covenants for the DIP to Exit facility. As of July 2,
2000, the Company was in compliance with its financial covenants.
G. EARNINGS PER SHARE
Basic earnings (loss) per common share is computed by dividing net
earnings (loss) by the weighted-average number of common shares outstanding
during the reported period. Diluted net earnings (loss) per common share is
computed by dividing net earnings (loss) by the weighted-average number of
common shares outstanding during the period plus incremental shares that would
have been outstanding upon the assumed vesting of dilutive restricted stock and
the assumed exercise of dilutive stock options. As of July 2, 2000 and July 4,
1999, all outstanding restricted stock and stock options are considered
anti-dilutive.
H. PREPAID EXPENSES AND OTHER ASSETS
Prepaid expenses and other assets for the Company were $17.0 million as
of July 2, 2000 compared to $87.0 million as of July 4, 1999. The decrease was
primarily due to the reduction of cash in advance payments to purchase inventory
and a reduction in assets held for sale.
I. BENEFIT PLANS
On August 31, 1999, the Bankruptcy Court approved a motion by the
Company to amend the Restated Retirement Plan and the Executive Security Plan.
The amendment to the Restated Retirement Plan ceased the accrual of benefits,
disallowed new enrollments to the Plan and vested benefits already accrued under
the Plan effective September 30, 1999. The amendment to the Executive Security
Plan, covering approximately 165 former and current management associates,
ceased the accrual of benefits and suspended payments effective September 30,
1999.
J. OTHER COMMITMENTS AND CONTINGENCIES
On January 28, 1997, the Company and Service Credit Corp. (the
"Subsidiary"), a wholly-owned subsidiary, entered into an agreement with World
Financial Network National Bank ("WFNNB") for the purpose of providing a private
label credit card to the Company's customers. The contract requires the
Subsidiary to maintain a 3.0% credit risk reserve for the outstanding balances,
which are owned by WFNNB. The purpose of this reserve is to offset future
potential negative spreads and portfolio losses. The negative spreads or losses
may result from potential increased reimbursable contractual program costs. The
3.0% credit risk reserve is held by the Subsidiary, which is not in Chapter 11,
in the form of cash and cash-equivalents. On April 28, 1999, WFNNB advised the
Company that WFNNB had projected that such portfolio losses and negative spreads
would be at least approximately $9.0 million. The Company does not have in its
possession sufficient information to determine the accuracy or validity of
WFNNB's projection. Pending confirmation of the accuracy of WFNNB's projection
and a resolution of the Company's rights and remedies, the Company has made
provision for such potential liability during fiscal 1999 by maintaining an
allowance on the 3.0% credit risk reserve of $9.0 million.
On July 16, 1999, the Company filed a complaint against WFNNB in the
Bankruptcy Court alleging, among other things, breach of contract and violation
of the automatic stay provisions of the Bankruptcy Code by WFNNB with respect to
and in connection with the January 1997 private label credit card program
agreement between the Company, the Subsidiary and WFNNB (the "World Financial
Agreement"). Under the World Financial Agreement, a program was established
pursuant to which, among other things, WFNNB agreed to issue credit cards to
qualifying Company customers for the purchase of goods and services from the
Company. While the ultimate result of this litigation cannot be determined or
predicted with any accuracy at this time, the Company intends to pursue
available remedies against WFNNB.
13
<PAGE> 14
On August 20, 1999, over the objection of WFNNB, the Bankruptcy Court
authorized the Company to enter into an agreement with Household Bank (SB), N.A.
("Household") for the purpose of offering new private label credit cards to
those customers of the Company who meet Household's credit standards. The
Company's prior private label credit card program with WFNNB was suspended in
March of 1999, and the rights and liabilities of WFNNB, the Company and the
Subsidiary are the subject of the litigation referred to in the preceding
paragraph.
On September 23, 1999, WFNNB filed a motion to dismiss the Company's
complaint and a separate motion seeking to have the complaint litigated in the
United States District Court for the Middle District of Tennessee (the "District
Court"), rather than the Bankruptcy Court. The Company filed timely oppositions
to both motions, and, on October 27, 1999, the District Court denied WFNNB's
motion to have the complaint litigated in the District Court. The Bankruptcy
Court scheduled a hearing on December 6, 1999, to consider WFNNB's motion to
dismiss and the Company's opposition thereto.
On December 6, 1999, the Bankruptcy Court entered an order dismissing
the Company's complaint. On December 16, 1999, the Company filed a motion asking
the Court to clarify the order issued on December 6, 1999, and to grant the
Company leave to file an amended complaint (the "Company's Motion"). On January
11, 2000, WFNNB responded with an objection to the Company's Motion. On February
22, 2000 the Bankruptcy Court entered an order granting the Company's Motion and
the Company filed the amended complaint. On April 24, 2000 WFNNB filed a motion
to dismiss this amended complaint. On June 30, 2000 the Company responded to the
motion to dismiss and filed a cross-motion against WFNNB in which the Company
objected to WFNNB's proof of claim.
The Company was involved in litigation, investigations and various
legal matters during the six periods ended July 2, 2000, which are being
defended and handled in the ordinary course of business. While the ultimate
results of these matters cannot be determined or predicted, management believes
that they will not have a material adverse effect on the Company's results of
operations or financial position. Any potential liability may be affected by the
Chapter 11 Cases.
K. SEGMENT REPORTING
The Company manages its business on the basis of one reportable
segment. As of July 2, 2000, all of the Company's operations are located within
the United States. The following data is presented in accordance with SFAS No.
131 for all periods presented.
<TABLE>
<CAPTION>
CLASSES OF SIMILAR PRODUCTS:
THREE PERIODS ENDED SIX PERIODS ENDED
--------------------- -----------------------
JULY 2, JULY 4, JULY 2, JULY 4,
2000 1999 2000 1999
-------- -------- -------- ----------
<S> <C> <C> <C> <C>
Net Sales (in thousands):
Home products $271,364 $356,962 $486,855 $ 688,384
Jewelry 146,184 161,716 273,722 341,989
-------- -------- -------- ----------
Total Net Sales $417,548 $518,678 $760,577 $1,030,373
======== ======== ======== ==========
</TABLE>
14
<PAGE> 15
L. LAYAWAY SALES
The Company adopted the Securities and Exchange Commission's Staff
Accounting Bulletin: No. 101 Revenue Recognition in Financial Statements during
fiscal 1999. As a result, the Company changed its method of accounting for
layaway sales to recognize layaway sales upon delivery of merchandise to the
customer. Layaway sales in prior periods were recognized when the initial
deposit was received. The amount of cash received upon initiation of the layaway
is recorded as a deposit liability within accrued expenses. The cumulative
effect of the change for periods prior to fiscal 1999 is an increase in net loss
of $6.6 million or ($0.07) per share. The restated amounts below reflect the
effect of the retroactive application of the accounting change on the
Consolidated Financial Statements as of and for the quarter ended July 4, 1999.
<TABLE>
<CAPTION>
THREE PERIODS SIX PERIODS
ENDED ENDED
(in thousands, except per share data) JULY 4, JULY 4,
1999 1999
--------- -----------
<S> <C> <C>
Net sales as originally reported $ 518,264 $ 1,028,773
Effect of change in accounting for layaway sales 414 1,600
--------- -----------
Net sales as restated $ 518,678 $ 1,030,373
========= ===========
Gross margin as originally reported(a) $ 87,219 $ 184,020
Effect of change in accounting for layaway sales 173 660
--------- -----------
Gross margin as restated $ 87,392 $ 184,680
========= ===========
Net loss as originally reported $(100,594) $ (268,932)
Effect of change in accounting for layaway sales 173 660
Extraordinary loss $ -- $ 7,851
--------- -----------
Loss before cumulative effect of change in
accounting principle and extraordinary loss as
Restated (100,421) (260,421)
Extraordinary loss -- (7,851)
Cumulative effect of change in accounting for
layaway sales -- (6,566)
--------- -----------
Net loss as restated $(100,421) $ (274,838)
========= ===========
Per common share - basic and diluted
Net loss as originally reported $ (1.01) $ (2.70)
Effect of change in accounting for layaway sales -- 0.01
Extraordinary loss -- 0.08
--------- -----------
Loss before cumulative effect and extraordinary
loss as restated (1.01) (2.61)
Extraordinary loss -- (0.08)
Cumulative effect of change in accounting for
layaway sales -- (0.07)
--------- -----------
Net loss as restated $ (1.01) $ (2.76)
========= ===========
</TABLE>
(a) Gross margin after costs and expenses.
15
<PAGE> 16
<TABLE>
<CAPTION>
JULY 4,
1999
---------
<S> <C>
Accounts receivable as originally reported $ 16,565
Effect of change in accounting for layaway sales (10,578)
---------
Accounts receivable as restated $ 5,987
=========
Inventories as originally reported $ 553,711
Effect of change in accounting for layaway sales 6,893
---------
Inventories as restated $ 560,604
=========
Accrued expenses as originally reported $ 134,199
Effect of change in accounting for layaway sales 2,221
---------
Accrued expenses as restated $ 136,420
=========
</TABLE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
For comparative purposes, interim balance sheets are more meaningful
when compared to the balance sheets at the same point in time of the prior year.
Comparisons to balance sheets of the most recent fiscal year end may not be
meaningful due to the seasonal nature of the Company's business.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report includes certain forward-looking statements (statements
other than with respect to historical fact, including statements relating to the
Company's 2000 Business Plan, its expected plan of reorganization and
anticipated availability under the DIP to Exit Facility) 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 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: the ability of the
Company to continue as a going concern; the ability of the Company to operate
pursuant to the terms of the DIP 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
negotiate non-disturbance agreements with its landlords; the ability of the
Company to complete its store refurbishment program within cost, time and size
expectations; the successful implementation of the consolidation of its
distribution centers; 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 trustee or to convert the Company's
reorganization cases to liquidations 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 reorganization plan 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 the 2000 Business Plan; the ability of the Company
to achieve cost-savings; the ability of the Company to enter into satisfactory
arrangements with third parties with respect to real estate and internet related
strategies; 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 the Chapter 11
Cases.
16
<PAGE> 17
OVERVIEW
The Company, with 221 stores in 32 states at July 2, 2000, is one of
the nation's largest retailers of jewelry and offers a selection of brand-name
home products and other product lines. During the year ended January 2, 2000
("fiscal 1999"), the Company repositioned its product offerings to focus on
value pricing and a broad selection of jewelry and home products. These
remerchandising efforts were based on perceived customer expectations of entry
level price points and a large selection within each product assortment. The
Company also revised its media strategy during fiscal 1999 to employ TV, radio
and print (including a seasonal sourcebook) campaigns in a coordinated effort to
build awareness, prospect for new customers and drive customer traffic.
On February 21, 2000, the Company's Board of Directors approved its
2000 Business Plan. Key components of the 2000 Business Plan include exiting
certain hardlines categories, including toys, juvenile, sporting goods, most
consumer electronics and most indoor furniture. As part of the 2000 Business
Plan, the Company plans to eliminate between 5,000 and 6,000 positions in stages
during 2000 and 2001, including approximately 350 distribution center and 200
corporate positions. The Company announced an initiative to reformat its
existing stores as part of the 2000 Business Plan, which would result in excess
store space becoming available for subleasing or other real estate transactions.
The Company's strategy also contemplates the convergence of the Internet and
store selling environments. Each store will feature Internet kiosks that will
provide immediate access to the Company's web site, www.servicemerchandise.com,
its bridal and gift registry, and its store directory.
As a result of the Company's decreased net sales in the fourth quarter
of fiscal 1998 and the resulting negative cash flows from operations, in January
1999 the Company began an effort to effect an out-of-court restructuring plan.
As part of this out-of-court restructuring plan, on January 20, 1999, the
Company entered into a new credit facility with Citibank N.A. (the "Second
Amended and Restated Credit Facility"). The Company also developed a plan to
close up to 132 stores, up to four distribution centers and to reduce corporate
overhead (the "Rationalization Plan"). In March 1999, as part of the
Rationalization Plan, the Company announced the closing of the Dallas
distribution center and the reduction of its workforce at its Nashville
corporate offices by 150 employees.
PROCEEDINGS UNDER CHAPTER 11 OF THE BANKRUPTCY CODE
Before the Company was able to effect an out-of-court restructuring, on
March 15, 1999, five of the Company's vendors filed an involuntary petition for
reorganization under Chapter 11 ("Chapter 11") of title 11 of the United States
Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court
for the Middle District of Tennessee (the "Bankruptcy Court") seeking court
supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries (collectively, the "Debtors") filed voluntary
petitions with the Bankruptcy Court for reorganization under Chapter 11 under
case numbers 399-02649 through 399-02680 (the "Chapter 11 Cases") and orders for
relief were entered by the Bankruptcy Court. The Chapter 11 Cases have been
consolidated for the purpose of joint administration under Case No. 399-02649.
The Debtors are currently operating their businesses as debtors-in-possession
pursuant to the Bankruptcy Code.
Actions to collect pre-petition indebtedness are stayed and other
contractual obligations against the Debtors may not be enforced. In addition,
under the Bankruptcy Code, the Debtors may assume or reject executory contracts,
including lease obligations. Parties affected by these rejections may file
claims with the Bankruptcy Court in accordance with the reorganization process.
Substantially all pre-petition liabilities are
17
<PAGE> 18
subject to settlement under a plan of reorganization to be voted upon by
creditors and equity holders and approved by the Bankruptcy Court in accordance
with the Bankruptcy Code. Although the Debtors expect to file a reorganization
plan or plans that provide for emergence from bankruptcy in 2001, there can be
no assurance that a reorganization plan or plans will be proposed by the Debtors
or confirmed by the Bankruptcy Court, or that any such plan(s) will be
consummated. As provided by the Bankruptcy Code, the Debtors initially had the
exclusive right to submit a plan of reorganization for 120 days. On May 25,
1999, the Bankruptcy Court extended the period in which the Debtors had the
exclusive right to file or advance a plan of reorganization to February 29,
2000. On February 2, 2000, the Bankruptcy Court extended the period in which the
Debtors has the exclusive right to file or advance a plan of reorganization to
April 30, 2001 and extended the right to solicit acceptance of its plan to June
30, 2001. If the Debtors fail to file a plan of reorganization during such
period or if such plan is not accepted by the required number of creditors and
equity holders, any party in interest may subsequently file its own plan of
reorganization for the Debtors. A plan of reorganization must be confirmed by
the Bankruptcy Court, upon certain findings being made by the Bankruptcy Court
which are required by the Bankruptcy Code. The Bankruptcy Court may confirm a
plan notwithstanding the non-acceptance of the plan by an impaired class of
creditors or equity security holders if certain requirements of the Bankruptcy
Code are met. The plan or plans currently being considered by the Company
involve a debt conversion of the Company's prepetition unsecured claims into new
common equity of the reorganized Company. Under such circumstances the existing
common stock of the Company would be cancelled and would result in existing
holders of the common stock receiving no value for their interests. The Company
believes the value of the common stock is highly speculative since it is highly
probable that it will be cancelled, and therefore, worthless if the expected
plan of reorganization is consummated.
At the first day hearing held on March 29, 1999 before Judge George C.
Paine, the Bankruptcy Court entered first day orders granting authority to the
Debtors, among other things, to pay pre-petition and post-petition employee
wages, salaries, benefits and other employee obligations, to pay vendors and
other providers in the ordinary course for goods and services received from and
after March 15, 1999, and to honor customer service programs, including
warranties, returns, layaways and gift certificates.
The Company entered into an agreement dated March 29, 1999, for a
debtor-in-possession credit facility (the "DIP Facility") under which the
Company could borrow up to $750.0 million, subject to certain limitations, to
fund ongoing working capital needs while it prepares a reorganization plan. On
April 27, 1999, the Bankruptcy Court approved the DIP Facility. The DIP Facility
included $100.0 million in term loans and a maximum of $650.0 million in
revolving loans. The DIP Facility included a $200.0 million sub-facility for
standby and trade letters of credit. Interest rates on the DIP Facility were
based on either the Citibank N.A. Alternative Base Rate ("ABR") plus 1.25% for
ABR Loans or 2.25% over LIBOR for Eurodollar Loans. The DIP Facility was 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 14, 2000, the Company entered into a four year, $600.0 million
fully committed asset-based debtor-in-possession and emergence credit facility
(the "DIP to Exit Facility") which replaced the DIP Facility. The Bankruptcy
Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit
Facility matures on April 14, 2004, and includes $60.0 million in term loans and
up to a maximum of $540.0 million in revolving loans including a $150.0 million
sub-facility for letters of credit. Interest rate spreads on the DIP to Exit
Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75%
on Alternate Base Rate loans. After the first quarter of 2001, these spreads are
subject to quarterly adjustment pursuant to a pricing grid based on availability
and financial performance, with ranges of 200 to 275 basis points over LIBOR and
25 to 100 basis points over Prime Rate. Short-term borrowings related to the DIP
to Exit Facility were $76.2 million as of July 2, 2000. Outstanding borrowings
under the term loan of the DIP to Exit Facility were $60 million as of July 2,
2000. There is a commitment fee of 0.375% on the undrawn portion of the
revolving loans under the DIP to Exit Facility.
18
<PAGE> 19
On June 10, 1999, the Company filed with the Bankruptcy Court schedules
and statements of financial affairs setting forth, among other things, the
assets and liabilities of the Company as shown by the Company's books and
records, subject to the assumptions contained in certain global notes filed in
connection therewith. Certain of the schedules were amended on March 6, 2000 and
all of the schedules and statements of financial affairs are subject to further
amendment or modification. Pursuant to order of the Bankruptcy Court, on or
about March 15, 2000, the Company mailed notices to all known creditors that the
deadline for filing proofs of claim with the Bankruptcy Court was May 15, 2000.
Differences between amounts scheduled by the company and claims by creditors are
continuing to be investigated and resolved. Accordingly, the ultimate number and
amount of allowed claims is not presently known and, because the settlement
terms of such allowed claims is subject to a confirmed plan of reorganization,
the ultimate distribution with respect to allowed claims is not presently
ascertainable.
The Company has filed over 200 motions in the Chapter 11 Cases whereby
it was granted authority or approval with respect to various items required by
the Bankruptcy Code and/or necessary for the Company's reorganizational efforts.
In addition to motions pertaining to real estate disposition matters, the
Company has obtained orders providing for, among other things, (i)
implementation of employee retention and incentive programs, (ii) termination or
suspension of certain employee benefit programs, (iii) adequate protection to
certain secured creditors, (iv) implementation of a return to vendor program and
other vendor related programs, (v) the conduct of a joint review by the Company
and the creditors committee with respect to certain prepetition Board conduct,
(vi) the sale of the assets of B.A. Pargh, and (vii) the extension of time to
assume or reject leases.
2000 BUSINESS PLAN
On February 21, 2000, the Company's Board of Directors approved its
2000 Business Plan, which contemplates: (i) an expansion of jewelry and jewelry
related products; (ii) a more targeted selection of those categories that have
historically performed well and have an affinity to jewelry and an exit from
certain unprofitable home products categories; (iii) the convergence of the
Company's in-store and Internet environment; (iv) the reduction of selling and
warehouse spaces within the Company's stores to adjust for the new merchandise
mix, which allows for the subleasing of excess space; and (v) the
rationalization of the Company's overhead structure, logistics network and
stores/field organization to generate anticipated cost savings. The execution
and success of the 2000 Business Plan is subject to numerous risks and
uncertainties.
Pursuant to the 2000 Business Plan, the Company will feature an
expanded offering of jewelry and jewelry-related products, with the bulk of the
expansion in diamonds. In addition to jewelry, the Company will focus on home
products categories that have performed well and which generate cross-selling
opportunities with jewelry. The Company will exit certain unprofitable
categories, including toys, most electronics and sporting goods. As a
multi-channel specialty retailer, the Company has included as part of the 2000
Business Plan the planned convergence of the Internet and store selling
environments. Each store will feature Internet kiosks that will provide
immediate access to the Company's web site, www.servicemerchandise.com, its
bridal and gift registry and its store directory.
The Company intends to reconfigure its stores to feature less overall
selling square footage (approximately 18,000 square feet as compared to 27,000
square feet), but increase square footage for jewelry. The excess store space
will be available for sub-leasing or other real estate transactions.
Approximately seventy stores are scheduled for total refurbishment and upgrade
to an expanded jewelry selling area in 2000 while the balance will undergo a
more limited capital improvement remodel during 2000. As of August 7, 2000, the
refurbishment and preparation for subleasing of twenty-six stores was complete,
with an additional thirty-three under construction. Approximately another 83
stores are scheduled for total refurbishment in 2001. The Company's ability to
complete this program is subject to known and unknown risks and uncertainties,
including those set forth above under "Safe Harbor Statement Under the Private
Securities Litigation Reform Act of 1995".
Although the Company plans to continue operating substantially all of
its 221 stores, in 2000 it will close its distribution centers in Montgomery,
New York and Orlando, Florida. As part of the 2000 Business Plan, the Company
will reduce its workforce at its corporate offices, its distribution centers and
its stores resulting in the elimination of 5,000 to 6,000 positions. The
Companies ability to successfully complete the sub-leasing or other real estate
transactions according to the 2000 Business Plan is subject to known and unknown
risk factors as listed in the Safe Harbor Statement under the Private Securities
Litigation Reform Act of 1995.
19
<PAGE> 20
To support the 2000 Business Plan, on April 14, 2000, the Company
entered into a four year, $600.0 million fully committed asset-based
debtor-in-possession and emergence credit facility (the "DIP to Exit Facility")
which replaced the DIP Facility. See Note F of the Notes to the Consolidated
Financial Statements.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases or their effect on the Company's business. If it is determined that the
liabilities subject to compromise in the Chapter 11 Cases exceed the fair value
of the assets, unsecured claims may be satisfied at less than 100% of their face
value and the equity interests of the Company's shareholders may have no value.
The Company believes that results from operations and the DIP to Exit Facility
should provide the Company with adequate liquidity to conduct its business while
it prepares a reorganization plan. However, the Company's liquidity, capital
resources, results of operations and ability to continue as a going concern are
subject to known and unknown risks and uncertainties, including those set forth
above under "Safe Harbor Statement Under The Private Securities Litigation
Reform Act of 1995."
RESULTS OF OPERATIONS
THREE PERIODS ENDED JULY 2, 2000 COMPARED TO THREE PERIODS ENDED JULY 4, 1999
The consolidated statements of operations line item "Exiting categories
and closed facilities" represents activity specifically identifiable to
inventory liquidations conducted in conjunction with (1) the Company's
restructuring plan adopted on March 25, 1997 ("Restructuring Plan"); (2) the
Company's rationalization plan adopted on March 8, 1999 ("Rationalization Plan")
and (3) the exiting of toys, juvenile, sporting goods, most consumer
electronics, most indoor furniture and other merchandise categories as part of
the 2000 Business Plan. All activity for these items is classified in "Exiting
categories and closed facilities." Prior year amounts reflect operating results
for these same facilities and merchandise classifications. Selling, general and
administrative expenses for exiting categories and closed facilities do not
include any allocation of corporate overhead.
The Company's business is highly seasonal with a significant portion of
its sales occurring in the fourth quarter. Fourth quarter net sales accounted
for 37.5% and 40.6% of total net sales in fiscal 1999 and 1998, respectively.
NET SALES
Net sales for the Company were $417.5 million for the three periods
ended July 2, 2000 compared to $518.7 million for the three periods July 4,
1999. The decline in net sales was primarily due to the closure of 127 stores as
a result of the restructuring and remerchandising activities in fiscal 1999.
Net sales from operations excluding exiting categories and closed
facilities were $320.0 million for the three periods ended July 2, 2000 compared
to $322.4 million for the three periods ended July 4, 1999. Comparable store
sales for home products were down 8.2% compared to the three periods ended July
4, 1999, and jewelry comparable store sales were up 9.2%. The jewelry comparable
sales increase was driven by Jewelry Special Events and Diamonds. The home
products comparable sales performance was driven by declines in photo,
seasonal/outdoor and tabletop/gifts.
Net sales from exiting categories and closed facilities were $97.6
million for the three periods ended July 2, 2000 compared to $196.3 million for
the three periods ended July 4, 1999. Sales from exiting categories and closed
facilities decreased primarily due to the fact that the three periods ended July
4, 1999 reflects the sales of 127 stores that were closed by July 31, 1999. The
three periods ended July 2, 2000 sales reflect primarily the discontinued
merchandise categories of toys, juvenile, sporting goods and most consumer
electronics.
20
<PAGE> 21
GROSS MARGIN
Gross margin was $81.3 million for the three periods ended July 2, 2000
as compared to $87.4 million in the three periods ended July 4, 1999. The
decrease in gross margin was primarily due to a decrease in sales.
Gross margin after costs and expenses and excluding exiting categories
and closed facilities was $94.2 million or 29.4% of net sales for the three
periods ended July 2, 2000, compared to $91.0 million or 28.2% of net sales for
the three periods ended July 4, 1999. The margin increase was primarily due to a
shift to higher margin merchandise assortments.
Gross loss after costs and expenses for exiting categories and closed
facilities was ($12.9) million, or (13.2%) of net sales for the three periods
ended July 2, 2000 compared to ($3.6) million, or (1.8%) of net sales for the
three periods ended July 4, 1999. The margin decrease was primarily the result
of sales and margin declines associated with the discontinued merchandise
categories of toys, juvenile, sporting goods and most consumer electronics as
well as the establishment of a lower of cost or market reserve for the remaining
discontinued inventory at July 2, 2000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses declined $9.8 million in
the three periods ended July 2, 2000 to $129.4 million from $139.1 million in
the three periods ended July 4, 1999. The decline was primarily due to store
closures, corporate downsizing and overhead reduction efforts.
Selling, general and administrative expenses were $87.5 million or
27.3% of net sales from operations excluding exiting categories and closed
facilities for the three periods ended July 2, 2000 compared to $107.8 million
or 33.4% of net sales from operations excluding exiting categories and closed
facilities for the three periods ended July 4, 1999. The decrease was
attributable to a decrease in employment costs and other selling, general and
administrative expenses primarily due to corporate downsizing and overhead
reduction efforts.
Selling, general and administrative expenses for exiting categories and
closed facilities were $41.9 million or 42.9% of net sales from operations for
exiting categories and closed facilities for the three periods ended July 2,
2000 compared to $31.3 million or 15.9% of net sales from operations for exiting
categories and closed facilities for the three periods ended July 4, 1999. The
increase was attributable to increases in other selling, general and
administrative expenses primarily due to inventory clearance sales and
remerchandising activities.
OTHER INCOME, NET
The net gain on dispositions of property and leases recorded for the
three periods ended July 2, 2000 was $1.0 million, as compared to $4.4 million
in 1999. The gain for the three periods, ended July 2, 2000 included amounts
realized from the completion of the auction property sale of three properties.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization on owned and leased property and
equipment was $10.0 million for the three periods ended July 2, 2000 as compared
to $10.9 million for the three periods ended July 4, 1999. The decrease of 7.9%
was primarily attributable to store closures.
INTEREST EXPENSE
Interest expense for the three periods ended July 2, 2000 was $9.6
million as compared to $12.8 million for the three periods ended July 4, 1999.
The decline in interest expense primarily relates to lower average borrowings.
21
<PAGE> 22
INCOME TAXES
The Company did not recognize an income tax benefit due to the
recording of a deferred tax asset valuation allowance. Deferred taxes are
recognized to reflect the estimated future utilization of temporary book/tax
differences. The Company has recorded a full valuation allowance on net deferred
tax assets as realization of such assets in future years is uncertain.
SIX PERIODS ENDED JULY 2, 2000 COMPARED TO SIX PERIODS ENDED JULY 4, 1999
NET SALES
Net sales for the Company were $760.6 million for the first half of
2000 compared to $1,030.4 million for the first half of 1999. The decline in net
sales was primarily due to the closure of 127 stores as a result of the
restructuring and remerchandising activities in fiscal 1999.
Net sales from operations excluding exiting categories and closed
facilities were $565.2 million for the first half of 2000 compared to $556.4
million for the first half of 1999. Comparable store sales for home products was
down 3.5% as compared to the first half of 1999, and Jewelry comparable sales
were up 8.6%. The Jewelry comparable sales increase was driven by strong
performance in Jewelry Special Events and Diamonds. Home products comparable
sales performance was driven by declines in photo and tabletop/gifts.
Net sales from exiting categories and closed facilities were $195.4
million for the first half of 2000 compared to $474.0 million for the first half
of 1999. Sales from exiting categories and closed facilities decreased primarily
due to the fact that first quarter 1999 reflects the sales of 127 stores that
were closed by July 31, 1999 and were not reflected in the first half of 2000.
First half of 2000 sales reflect primarily the discontinued merchandise
categories of toys, juvenile, sporting goods, most consumer electronics and
other merchandising categories.
GROSS MARGIN
Gross margin was $168.5 million for the first half of 2000 compared to
$184.7 million in the first half of 1999. The decrease was primarily due to a
$269.8 million decline in sales, partially offset by a $253.6 million decrease
in cost of goods sold.
Gross margin after costs and expenses and excluding exiting categories
and closed facilities was $164.4 million or 29.1% of net sales for the first
half of 2000, compared to $139.5 million or 25.1% of net sales for the first
half of 1999. The margin increase was primarily due to increased sales and a
shift to higher margin merchandise assortments.
Gross margin after costs and expenses for exiting categories and closed
facilities was $4.1 million, or 2.1% of net sales for the first half of 2000,
compared to $45.2 million, or 9.5% of net sales for the first half of 1999. The
margin decrease was primarily a result of decreased sales. The decrease in the
rate was attributable to inventory clearance sales.
SELLING GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses decreased $77.7 million in
the first half of 2000, to $228.8 million from $306.4 million in the first half
of 1999. The decline was primarily due to store closures, corporate downsizing
and overhead reduction efforts.
Selling, general and administrative expenses were $173.0 million or
30.6% of net sales from operations excluding exiting categories and closed
facilities for the first half of 2000, compared to $214.1 million or 38.5% of
net sales from operations excluding exiting categories and closed facilities for
the first half of 1999.
22
<PAGE> 23
The decrease was attributable to a decrease in employment costs and other
selling, general and administrative expenses primarily due to corporate
downsizing and overhead reduction efforts.
Selling, general and administrative expenses for exiting categories and
closed facilities were $55.8 million or 28.6% of net sales from operations for
exiting categories and closed facilities for the first half of 2000, compared to
$92.3 million or 19.5% of net sales from operations for exiting categories and
closed facilities for the first half of 1999. The decrease was attributable to
decreases in employment costs and other selling, general and administrative
expenses primarily due to store closures.
OTHER INCOME, NET
The net gain on dispositions of property and leases recorded for the
first half of 2000 was $13.3 million, as compared to $7.5 million in 1999. The
gain for the first half of 2000 includes amounts realized from the completion of
the auction property sale of 10 owned and 13 leased properties.
DEPRECIATION AND AMORTIZATION
Depreciation and amortization on owned and leased property and
equipment was $19.8 million for the first half of 2000 as compared to $23.1
million for the first half of 1999. The decrease of 14.5% was primarily
attributable to store closures.
INTEREST EXPENSE
Interest expense for the first half of 2000 was $20.5 million as
compared to $37.9 million for the first half of 1999. Interest expense decreased
due to lower average borrowings, and, as a result of the filing of the Chapter
11 Cases, the Company ceased accruing interest on the 8 3/8% Senior Notes and 9%
Senior Subordinated Debentures on March 15, 1999
INCOME TAXES
The Company did not recognize an income tax benefit due to the
recording of a deferred tax asset valuation allowance. Deferred taxes are
recognized to reflect the estimated future utilization of temporary book/tax
differences. The Company has recorded a full valuation allowance on net deferred
tax assets as realization of such assets in future years is uncertain.
Management does not believe it is more likely than not that the Company will
realize the deferred tax asset.
EXTRAORDINARY ITEM
An extraordinary loss on the early extinguishment of debt was recorded
in the amount of $7.9 million during the first half of 1999. This charge related
to the write-off of deferred financing charges paid in conjunction with the
Company's prior Amended and Restated Credit Facility and Second Amended and
Restated Credit Facility upon the consummation of the DIP Facility.
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
The Company adopted the Securities and Exchange Commission's Staff
Accounting Bulletin: No. 101 Revenue Recognition in Financial Statements during
fiscal 1999. As a result, the Company changed its method of accounting for
layaway sales. The cumulative effect of the change for periods prior to fiscal
1999 is an increase in net loss of $6.6 million or ($0.07) per share. Layaway
sales for 1999 have been recognized upon delivery of merchandise to the
customer. Layaway sales in prior years were recognized when the initial layaway
deposit was received. See Note L of the Notes to the Consolidated Financial
Statements.
23
<PAGE> 24
1997 RESTRUCTURING PLAN
On March 25, 1997, the Company adopted a business restructuring plan to
close up to 60 under performing stores and one distribution center. As a result,
a pre-tax charge of $129.5 million for restructuring costs was taken in the
first quarter of fiscal 1997. The remaining component of the restructuring
charge accrual and an analysis of the change in the accrual for the six periods
ended July 2, 2000 are outlined in the following table:
<TABLE>
<CAPTION>
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN JULY 2,
2000 COSTS PAID ESTIMATE 2000
---- ---------- -------- ----
(in thousands)
<S> <C> <C> <C> <C>
Lease termination and other real estate costs $ 7,894 $ (32) $ (142) $ 7,720
======== ===== ====== =======
</TABLE>
Note: The accrued restructuring costs are included in Liabilities Subject to
Compromise.
The closing of nine stores during the first half of fiscal 1998 brought
the total number of closures, in accordance with the 1997 Restructuring Plan, to
53 stores and one distribution center. Store closures were completed as of May
1998. The Company closed less than 60 stores primarily due to the inability to
negotiate acceptable exit terms from the related lessors.
Lease terminations and other real estate costs primarily consist of
contractual rent payments and other real estate costs. These amounts have been
accrued according to the remaining leasehold obligations under Section 502(b)(6)
of the Bankruptcy Code. Section 502(b)(6) limits a lessor's claim to the rent
reserved by such lease, without acceleration for the greater of one year, or 15
percent, not to exceed three years of the remaining term of the lease. Any
unpaid rent is included in the claim.
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the six periods ended July 2,
2000. As a result the Company reduced its estimate for these costs by $0.1
million.
The leases remaining on closed locations as of July 2, 2000 vary in
length with expiration dates ranging from February 2001 to February 2015.
RATIONALIZATION PLAN
In February 1999, the Company announced a rationalization plan to close
up to 132 stores, up to four distribution centers and to reduce corporate
overhead. On March 8, 1999, as part of the Rationalization Plan and prior to the
filing of the involuntary bankruptcy petition, the Board of Directors approved
the adoption of a business restructuring plan to close 106 stores and the Dallas
distribution center and to reduce the Company's workforce at its Nashville
corporate offices by 150 employees. As a result, a pre-tax charge of $99.5
million for restructuring costs was recorded in the first quarter of 1999. On
March 29, 1999 and in connection with the Chapter 11 Cases, store leases under
this plan were approved for rejection by the Bankruptcy Court. The remaining
components of the restructuring charge accrual and an analysis of the change in
the accrual for the six periods ended July 2, 2000 are outlined in the following
table:
24
<PAGE> 25
<TABLE>
<CAPTION>
ACTIVITY
---------------------------
ACCRUED ACCRUED
RESTRUCTURING RESTRUCTURING
COSTS AS OF COSTS AS OF
JANUARY 2, RESTRUCTURING CHANGE IN JULY 2,
2000 COSTS PAID ESTIMATE 2000
---- ---------- -------- ----
(in thousands)
<S> <C> <C> <C> <C>
Lease termination and other real estate costs $ 38,315 $ (1,371) $ (1,780) $ 35,164
Employee severance 478 (545) 175 108
-------- -------- -------- --------
Total $ 38,793 $ (1,916) $ (1,605) $ 35,272
======== ======== ======== ========
</TABLE>
Note: The accrued restructuring costs are included in Liabilities Subject to
Compromise.
Lease terminations and other real estate costs primarily consists of
contractual rent payments. These amounts have been accrued according to the
remaining leasehold obligations under Section 502(b)(6) of the Bankruptcy Code.
Section 502(b)(6) limits a lessor's claim to the rent reserved by such lease,
without acceleration for the greater of one year, or 15 percent, not to exceed
three years of the remaining lease term. Any unpaid rent is included in the
claim.
The Company experienced lower than expected expenses in lease
termination and disposition of closed stores for the six periods ended July 2,
2000. As a result the Company reduced its estimate for these costs by $1.8
million.
The employee severance provision was recorded for the planned
termination of approximately 4,400 employees associated with the closures, as
well as the reduction of corporate overhead. Substantially all such terminations
were completed as of December 1999.
LIQUIDITY AND CAPITAL RESOURCES
On March 27, 1999, the Debtors filed the Chapter 11 Cases, which will
affect the Company's liquidity and capital resources in fiscal 2000. See Note B,
Notes to the Financial Statements - "Proceedings Under Chapter 11 of the
Bankruptcy Code."
From September 1997 through January 20, 1999, the Company had a
five-year, $900.0 million, fully committed asset-based credit facility (the
"Amended and Restated Credit Facility"). The Amended and Restated Credit
Facility included $200.0 million in term loans and up to a maximum of $700.0
million in revolving loans including a $175.0 million sub-facility for letters
of credit. The Amended and Restated Credit Facility was scheduled to mature on
September 10, 2002. Interest rates on the Amended and Restated Credit Facility
were subject to change based on a financial performance-based grid and could not
exceed a rate of LIBOR + 2.25% on revolving loans and LIBOR + 2.50% on the term
loan. There were no short-term borrowings under the Amended and Restated Credit
Facility at July 4, 1999.
On January 20, 1999, the Company completed a $750.0 million,
30-month asset-based credit facility (the "Second Amended and Restated Credit
Facility") which replaced the Amended and Restated Credit Facility. The Second
Amended and Restated Credit Facility included $150.0 million in term loans and a
maximum of $600.0 million in revolving loans. The Second Amended and Restated
Credit Facility included a $200.0 million sub-facility for standby and trade
letters of credit. Interest rates on the Second Amended and Restated Facility
were based on either Prime Rate + 1.5% or LIBOR + 2.75%. There were no
short-term borrowings under the Second Amended and Restated Credit Facility at
July 4, 1999.
25
<PAGE> 26
On March 29, 1999, the Company entered into a 27-month, $750.0 million
fully committed asset-based debtor-in-possession credit facility (the "DIP
Facility") which replaced the Second Amended and Restated Credit Facility. The
Bankruptcy Court approved the DIP Facility on an interim basis on March 29, 1999
and granted final approval on April 27, 1999. The DIP Facility included $100.0
million in term loans and up to a maximum of $650.0 million in revolving loans
including a $200.0 million sub-facility for letters of credit. Interest rate
spreads on the DIP Facility were LIBOR + 2.25% on Eurodollar loans and Prime
Rate + 1.25% on Alternate Base Rate loans. Short-term borrowings related to the
DIP Facility were $33.6 million as of July 4, 1999. Outstanding borrowings under
the term loan of the DIP Facility were $99.8 million as of July 4, 1999. There
was a commitment fee of 0.375% on the undrawn portion of the revolving loans
under the DIP Facility.
The DIP Facility was secured by all material unencumbered assets of the
Company and its subsidiaries, including inventory, but excluding previously
mortgaged property. Borrowings under the DIP Facility were limited based on a
borrowing base formula which considered eligible inventories, eligible accounts
receivable, mortgage values on eligible real properties, eligible leasehold
interests, available cash equivalents and in-transit cash.
On April 14, 2000, the Company entered into a four year, $600.0 million
fully committed asset-based debtor-in-possession and emergence credit facility
(the "DIP to Exit Facility") which replaced the DIP Facility. The Bankruptcy
Court approved the DIP to Exit Facility on April 4, 2000. The DIP to Exit
Facility matures on April 14, 2004, and includes $60.0 million in term loans and
up to a maximum of $540.0 million in revolving loans including a $150.0 million
sub-facility for letters of credit. Interest rate spreads on the DIP to Exit
Facility are initially LIBOR + 2.50% on Eurodollar loans and Prime Rate + 0.75%
on Alternate Base Rate loans. After the first quarter of 2001, these spreads are
subject to quarterly adjustment pursuant to a pricing grid based on availability
and financial performance, with ranges of 200 to 275 basis points over LIBOR and
25 to 100 basis points over prime rate. Short-term borrowings related to the DIP
to Exit Facility were $76.2 million as of July 2, 2000. Outstanding borrowings
under the term loan of the DIP to Exit Facility were $60 million as of July 2,
2000. There is a commitment fee of 0.375% on the undrawn portion of the
revolving loans under the DIP to Exit Facility.
Borrowings under the DIP to Exit Facility are secured by all material
unencumbered assets of the Company and its subsidiaries, including inventory,
but excluding previously mortgaged property. Borrowings under the DIP to Exit
Facility are limited based on a borrowing base formula which considers eligible
inventories, eligible accounts receivable, mortgage values on eligible real
properties, eligible leasehold interests, available cash equivalents and
in-transit cash. Availability under the facility continues unless the Company
breaches the financial covenants for the DIP to Exit Facility. As of July 2,
2000, the Company was in compliance with its financial covenants.
The following table sets forth the Company's three month borrowing base
and borrowing availability projections under the DIP to Exit Facility. The
forecast projects a borrowing base which ranges from $423.7 million to $487.8
million over the period from July 30, 2000 to October 29, 2000, and unused
borrowing availability which ranges from $166.3 million to $194.6 million. The
borrowing base and borrowing availability projections under the DIP to Exit
Facility are forward-looking statements subject to various assumptions regarding
the Company's business, operating performance and other factors including
revenues, expenses, asset dispositions, trade terms, capital expenditures and
various other known and unknown risks and uncertainties including those set
forth in "Safe Harbor Statement under the Private Securities Litigation Reform
Act." The Company undertakes no obligation to update such information or to
disclose similar information in future reports. These projections are subject to
future adjustments, if any, that could materially affect such information.
26
<PAGE> 27
<TABLE>
<CAPTION>
ACTUAL FORECAST FORECAST FORECAST
JULY 30, AUGUST 27, OCTOBER 1, OCTOBER 29,
2000 2000 2000 2000
-------- -------- -------- --------
(in millions)
<S> <C> <C> <C> <C>
Ending Total Revolver Balance $ 72.1 $ 112.1 $ 175.4 $ 217.6
Term Loan 60.0 60.0 60.0 60.0
Standby Letters of Credit 27.3 25.9 25.8 25.8
Trade Letters of Credit 30.6 31.1 28.4 18.1
-------- -------- -------- --------
Total Extensions of Credit 190.2 229.1 289.6 321.5
Borrowing Base 443.0 423.7 461.1 487.8
-------- -------- -------- --------
Availability $ 252.9 $ 194.6 $ 171.5 $ 166.3
======== ======== ======== ========
</TABLE>
CAPITAL STRUCTURE
During the three periods ended July 2, 2000, the Company's principal
sources of liquidity were the $750 million DIP Facility (which included a $100
million term loan and a revolving credit facility with a maximum commitment
level of $650 million) which was replaced on April 14, 2000 by the $600 million
DIP to Exit Facility (which includes a $60 million term loan and a revolving
credit facility with a maximum commitment level of $540 million).
At July 2, 2000, the Company had total extensions of credit of $181.9
million under the DIP to Exit Facility. At July 4, 1999, the Company had total
extensions of credit of $227.8 million under the DIP Facility.
EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This pronouncement was to be
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133." This pronouncement postpones the effective date of SFAS No.
133 to all fiscal quarters of fiscal years beginning after June 15, 2000. In
June 2000, the FASB issued SFAS No. 138 "Accounting For Derivative Instruments
and Hedging Activities - Amendment of FASB Statement No. 133." This
pronouncement amends and clarifies implementation of SFAS No. 133. The Company
is currently in the process of analyzing the impact of the adoption of these
Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's operations are subject to market risks primarily from
changes in interest rates. The Company has immaterial exposure to exchange rate
risk. As discussed in the Company's Annual Report on Form 10-K filed on March
16, 2000, the Company had interest rate swaps at fiscal year-end with a notional
amount of $125 million. As of July 2, 2000, the fair value of the interest rate
swap agreements was $0.5 million. On July 5, 2000, the Company entered into
interest rate swap agreements related to its interest rate exposure in 2001, as
its existing interest rate swaps expire at the end of fiscal year 2000. These
swaps vary in notional amount during 2001 from $85 million to $155 million,
reflecting the seasonal nature of the Company's borrowings.
27
<PAGE> 28
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On March 15, 1999, five of the Company's vendors filed an involuntary
petition for reorganization under Chapter 11 in the Bankruptcy Court seeking
court supervision of the Company's restructuring efforts. On March 27, 1999, the
Company and 31 of its subsidiaries filed voluntary petitions with the Bankruptcy
Court for reorganization under Chapter 11 of the Bankruptcy Code. The Debtors
are currently operating their businesses as debtors-in-possession. The Chapter
11 Cases have been consolidated for the purpose of joint administration under
Case No. 399-02649.
On January 28, 1997, the Company and Service Credit Corp. (the
"Subsidiary"), a wholly-owned subsidiary, entered into an agreement with World
Financial Network National Bank ("WFNNB") for the purpose of providing a private
label credit card to the Company's customers. The contract requires the
Subsidiary to maintain a 3.0% credit risk reserve for the outstanding balances,
which are owned by WFNNB. The purpose of this reserve is to offset future
potential negative spreads and portfolio losses. The negative spreads or losses
may result from potential increased reimbursable contractual program costs. The
3.0% credit risk reserve is held by the Subsidiary, which is not in Chapter 11,
in the form of cash and cash-equivalents. On April 28, 1999, WFNNB advised the
Company that WFNNB has projected that such portfolio losses and negative spreads
will be at least approximately $9.0 million. The Company does not have in its
possession sufficient information to determine the accuracy or validity of
WFNNB's projection. Pending confirmation of the accuracy of WFNNB's projection
and a resolution of the Company's rights and remedies, the Company has made
provision for such potential liability during fiscal 1999 by maintaining an
allowance on the 3.0% credit risk reserve of $9.0 million.
On July 16, 1999, the Company filed a complaint against WFNNB in the
Bankruptcy Court alleging, among other things, breach of contract and violation
of the automatic stay provisions of the Bankruptcy Code by WFNNB with respect to
and in connection with the January 1997 private label credit card program
agreement between the Company, the Subsidiary and WFNNB (the "World Financial
Agreement"). Under the World Financial Agreement, a program was established
pursuant to which, among other things, WFNNB agreed to issue credit cards to
qualifying Company customers for the purchase of goods and services from the
Company. While the ultimate result of this litigation cannot be determined or
predicted with any accuracy at this time, the Company intends to pursue
available remedies against WFNNB.
On August 20, 1999, over the objection of WFNNB, the Bankruptcy Court
authorized the Company to enter into an agreement with Household Bank (SB), N.A.
("Household") for the purpose of offering new private label credit cards to
those customers of the Company who meet Household's credit standards. The
Company's prior private label credit card program with WFNNB was suspended in
March of 1999, and the rights and liabilities of WFNNB, the Company and the
Subsidiary are the subject of the litigation referred to in the preceding
paragraph.
On September 23, 1999, WFNNB filed a motion to dismiss the Company's
complaint and a separate motion seeking to have the complaint litigated in the
United States District Court for the Middle District of Tennessee (the "District
Court"), rather than the Bankruptcy Court. The Company filed timely oppositions
to both motions, and, on October 27, 1999, the District Court denied WFNNB's
motion to have the complaint litigated in the District Court. The Bankruptcy
Court scheduled a hearing on December 6, 1999, to consider WFNNB's motion to
dismiss and the Company's opposition thereto.
On December 6, 1999, the Bankruptcy Court entered an order dismissing
the Company's complaint. On December 16, 1999, the Company filed a motion asking
the Court to clarify the order issued on December 6, 1999, and to grant the
Company leave to file an amended complaint (the "Company's Motion"). On January
11, 2000, WFNNB responded with an objection to the Company's Motion. On February
22, 2000 the Bankruptcy Court entered an order granting the Company's motion and
the Company filed the amended complaint. On April 24, 2000 WFNNB filed a motion
to dismiss this amended complaint. On June 30, 2000, the Company responded
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to the motion to dismiss and filed a cross-motion against WFNNB in which the
Company objected to WFNNB's proof of claim.
The Company was involved in litigation, investigations and various
legal matters during the fiscal year ended January 2, 2000, which are being
defended and handled in the ordinary course of business. While the ultimate
results of these matters cannot be determined or predicted, management believes
that they will not have a material adverse effect on the Company's results of
operations or financial position. Any potential liability may be affected by the
Chapter 11 Cases.
At this time, it is not possible to predict the outcome of the Chapter
11 Cases or their effect on the Company's business. Additional information
regarding the Chapter 11 Cases is set forth elsewhere in this Quarterly report
on Form 10-Q and in Item 1. "Business -- Proceedings Under Chapter 11 of the
Bankruptcy Code," Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations," Note B of Notes to Consolidated Financial
Statements (Unaudited) and the Report of Independent Auditors included in the
Company's Annual Report on Form 10-K filed on March 16, 2000, which includes an
explanatory paragraph concerning a substantial doubt as to the Company's ability
to continue as a going concern. If it is determined that the liabilities subject
to compromise in the Chapter 11 Cases exceed the fair value of the assets,
unsecured claims may be satisfied at less than 100% of their face value and the
equity interests of the Company's shareholders may have no value.
ITEM 2. DEFAULTS UPON SENIOR SECURITIES.
The Company commenced the Chapter 11 Cases on March 27, 1999. As a
result of filing the Chapter 11 Cases, no principal or interest payments will be
made on certain indebtedness incurred by the Company prior to March 27, 1999,
including the 9% Senior Subordinated Debentures and 8 3/8% Senior Notes, until a
plan of reorganization defining the payment terms has been approved by the
Bankruptcy Court.
ITEM 3. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits filed with this Form 10-Q.
4 First Amendment to Post-Petition Credit Agreement dated as of
June 26, 2000 by and among Registrant, Fleet Retail Finance
Inc., as collateral agent and administrative agent, Foothill
Capital Corporation, National City Commercial Finance Inc. and
Jackson National Life Insurance Company, as co-agents, Heller
Financial, Inc., as documentation agent and Fleet Boston
Robertson Stephens, Inc., as arranger. The Post-Petition
Credit Agreement dated as of April 14, 2000 was filed as an
exhibit to the Form 10-Q filed on May 17, 2000.
27.1 Financial Data Schedule for the Six Periods ended July 2,
2000.
27.2 Restated Financial Data Schedule for the Six Periods ended
July 4, 1999.
(b) Reports on Form 8-K.
During the second quarter ended July 2, 2000, the Company filed the
following current reports on Form 8-K: (i) dated April 6, 2000 announcing the
filing with the Bankruptcy Court of the Company's monthly operating report for
the period commencing January 31, 2000 and ending February 27, 2000; (ii) dated
April 10, 2000 attaching the Company's 2000 Business Plan; (iii) dated April
27,2000 announcing the filing with the Bankruptcy Court of the Company's monthly
operating report for the period commencing February 28, 2000 and ending April 2,
2000; (iv) dated May 26, 2000 announcing the filing with the Bankruptcy Court of
the Company's monthly operating report for the period commencing April 3, 2000
and ending April 30, 2000; (v) dated June 26, 2000 announcing the filing with
the Bankruptcy Court of the Company's monthly operating report for the period
29
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commencing May 1, 2000 and ending May 28, 2000. During the second quarter ended
July 2, 2000, the Company's also filed an amendment to current report on Form
8-K/A on April 19, 2000, announcing the filing with the Bankruptcy Court of
amended pages of the Company's monthly operating report for the period
commencing January 31, 2000 and ending February 27, 2000 which was filed as an
exhibit to the current report on Form 8-K filed by the Company on April 6, 2000.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ S. Cusano
---------------------------------------------
S. Cusano
Director and Chief Executive Officer
(Principal Executive Officer)
August 15, 2000
/s/ Thomas L. Garrett, Jr.
---------------------------------------------
Thomas L. Garrett, Jr.
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
August 15, 2000
/s/ Kenneth A. Conway
---------------------------------------------
Kenneth A. Conway
Vice President Controller and Chief Accounting Officer
(Principal Accounting Officer)
August 15, 2000
31
