UNITED STATES
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 27, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ______________ to ______________
Commission File No. 0-24826
ERNST HOME CENTER, INC.
(Exact name of registrant as specified in its charter)
Delaware 91-0213470
(State of other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
1511 Sixth Avenue, Seattle, Washington 98101
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (206)621-6700
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No_____
Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Sections 12, 13 of
15(d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a court
Yes X No_____
Number of shares of $0.01 par value Common Stock outstanding as
of August 23, 1996 was 12,259,000.
<PAGE>
TABLE OF CONTENTS
Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements. 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Part II. OTHER INFORMATION
Item 1. Legal Proceedings. 16
Item 5. Other Information 16
Item 6. Exhibits and Reports on Form 8-K. 16
Page 2
<PAGE>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
ERNST HOME CENTER, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
<TABLE>
ASSETS (Unaudited)
July 27, October 28,
1996 1995
------------ ------------
<S> <C> <C>
Current Assets
Cash $ 8,829 $ 5,389
Receivables, net of allowance of $6,242 and $435 2,942 10,736
Inventories 93,177 138,041
Prepaid expenses and other 7,382 9,446
------------ ------------
Total Current Assets 112,330 163,612
Property & Equipment (net) 87,195 140,861
Other Assets 1,514 4,263
------------ ------------
Total Assets $ 201,039 $ 308,736
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities Not Subject To Compromise:
Accounts payable $ 7,270 $ 81,535
Accrued payroll and related costs 9,288 12,026
Other accrued liabilities 3,766 8,315
Closed store liabilities 5,272 2,165
Sales taxes payable 346 3,679
Secured debt 61,910 35,250
Deposits 6,506 -
Current maturities of long-term liabilities 2,526 2,689
------------ ------------
Total Current Liabilities Not Subject To Compromise 96,884 145,659
------------ ------------
Long-Term Liabilities Not Subject To Compromise:
Long-term debt - 7,540
Obligations under capital leases 48,672 73,364
Other liabilities 2,093 6,555
------------ ------------
Total Long-Term Liabilities Not Subject To Compromise 50,765 87,459
------------ ------------
Liabilities Subject To Compromise:
Secured debt - bonds payable 7,200 -
Accounts payable 51,001 -
Closed store liabilities 31,450 -
Other liabilities 8,140 -
------------ ------------
Total Liabilities Subject To Compromise 97,791 -
------------ ------------
Commitments and Contingencies - -
Stockholders' Equity:
Preferred Stock, par value $0.01, 100,000 shares authorized,
no shares issued and outstanding - -
Common Stock, par value $0.01, 16,000,000 shares
authorized, 12,259,000 shares issued and outstanding 123 123
Additional paid-in capital - Common Stock 105,943 105,943
Paid-in capital - Stock Warrants Outstanding 1,929 1,929
Accumulated deficit (152,396) (32,377)
------------ ------------
Total Stockholders' Equity (Deficit) (44,401) 75,618
------------ ------------
Total Liabilities & Stockholders' Equity $ 201,039 $ 308,736
============ ============
</TABLE>
See accompanying notes to these Consolidated Financial Statements
Page 3
<PAGE>
ERNST HOME CENTER, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
July 27, July 29, July 27, July 29,
1996 1995 1996 1995
(13 weeks) (13 weeks) (39 weeks) (39 weeks)
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales $ 114,615 $ 170,440 $ 343,322 $ 419,308
Cost of merchandise sold 78,866 116,561 241,842 287,283
------------ ------------ ------------ ------------
Gross profit 35,749 53,879 101,480 132,025
Selling, general and administrative expenses 38,528 42,690 118,669 112,012
Depreciation and amortization 4,471 4,010 13,926 10,554
Reserve for store closures 39,646 - 73,646 -
Store closing expenses 95 1,274 248 2,395
Store pre-opening expenses 394 1,648 2,995 3,554
------------ ------------ ------------ ------------
Operating income (loss) (47,385) 4,257 (108,004) 3,510
Interest expense, net 4,034 2,747 11,815 6,991
------------ ------------ ------------ ------------
Earnings (loss) before income taxes and
reorganization expenses (51,419) 1,510 (119,819) (3,481)
Reorganization expenses 200 - 200 -
------------ ------------ ------------ ------------
Earnings (loss) before income taxes (51,619) 1,510 (120,019) (3,481)
Income tax expense (benefit) - 544 - (1,253)
------------ ------------ ------------ ------------
Net earnings (loss) $ (51,619) $ 966 $ (120,019) $ (2,228)
============ ============ ============ ============
Net earnings (loss) per common share $ (4.21) $ 0.08 $ (9.79) $ (0.18)
Weighted average number of common
shares outstanding 12,259,000 12,259,000 12,259,000 12,259,000
</TABLE>
See accompanying notes to these Consolidated Financial Statements
Page 4
<PAGE>
ERNST HOME CENTER, INC.
(DEBTOR-IN-POSSESSION)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
July 27, July 29,
1996 1995
(39 weeks) (39 weeks)
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net Loss $(120,019) $ (2,228)
Adjustments to reconcile net loss
to cash flows from operating activities:
Loss on sale of assets 1,355 509
Depreciation and amortization 13,926 10,566
Reorganization expenses 200 -
Reserve for store closures 73,646
Change in assets and liabilities:
Receivables 8,923 (4,769)
Inventories 31,736 (20,312)
Prepaid expenses and other (9,068) (4,003)
Accounts payable (23,464) (1,293)
Other accrued liabilities 2,929 1,755
-------- --------
Net cash used by operating activities (19,836) (19,775)
-------- --------
Cash flows from investing activities:
Proceeds from sale of assets 164 14
Capital expenditures (1,428) (32,142)
-------- --------
Net cash used by investing activities (1,264) (32,128)
-------- --------
Cash flows from financing activities:
Net borrowings under line-of-credit agreements 27,410 11,200
Payments on long-term debt and capital lease obligations (2,991) (9,073)
Other 121 121
-------- --------
Net cash provided by financing activities 24,540 2,248
-------- --------
Net increase (decrease) in cash and cash equivalents 3,440 (49,655)
Cash and cash equivalents at beginning of period 5,389 58,265
-------- --------
Cash and cash equivalents at end of period $ 8,829 $ 8,610
======== ========
Supplemental cash flow information:
Cash paid during the period for interest $ 13,363 $ 7,270
Cash paid during the period for income taxes $ - $ -
Supplemental investing and financing information:
Capital lease obligations incurred during the period $ 3,450 $ 19,790
</TABLE>
See accompanying notes to these Consolidated Financial Statements
Page 5
<PAGE>
ERNST HOME CENTER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On July 12, 1996, Ernst Home Center, Inc. (the "Company") filed
a voluntary petition for relief under Chapter 11 of title 11 of
United States Code ("Chapter 11") in the United States
Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court") seeking to reorganize its business under Chapter 11.
Under the protection of Chapter 11, the Company will continue
business operations as a debtor-in-possession while it develops
a Plan of Reorganization that will restructure the Company and
allow it to emerge from Chapter 11. As a debtor-in-possession,
the Company may not engage in operations outside the normal
course of business without approval of the Bankruptcy Court.
Under Chapter 11, certain claims against the Company in
existence prior to the filing of the petitions for relief under
the Bankruptcy Code are stayed while the Company develops a
Plan of Reorganization. These claims are reflected in the July
27, 1996 Balance Sheet as "Liabilities Subject to Compromise".
On August 28, 1996, the United States Bankruptcy Court for the
District of Delaware granted a change of venue for the
Company's bankruptcy proceedings to the United States
Bankruptcy Court for the Western District of Washington. The
change in venue leaves in place substantial rulings which have
already been handed down by the Delaware Bankruptcy Court,
including approval of debtor-in-possession financing and the
employee retention program, as well as the appointment of the
unsecured creditors' committee.
The Consolidated Financial Statements have been prepared in
accordance with the American Institute of Certified Public
Accountants Statement of Position 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code". The
Consolidated Financial Statements have been prepared using
accounting principles applicable to a going concern, which
assumes realization of assets and settlement of liabilities in
the normal course of business. The appropriateness of using the
going concern basis is dependent upon, among other things, the
ability to comply with debtor-in-possession financing
agreements, confirmation of a Plan of Reorganization, the
ability to achieve profitable operations, and the ability to
generate sufficient cash flows from operations to meet its
obligations.
In accordance with Securities and Exchange Commission rules and
regulations, certain information and disclosures normally
included in the financial statements prepared in accordance
with generally accepted accounting principles have been
condensed or omitted in the unaudited Consolidated Financial
Statements of the Company. The Company believes that the
disclosures made are adequate and the information presented
reflects all adjustments which in the opinion of management are
necessary for a fair statement of the results of operations and
financial position for the periods presented. All adjustments
are of a normal recurring nature except the charges incurred
for the store closures discussed in Note 2. Due to the seasonal
nature of the Company's business, the results for the periods
presented are not necessarily indicative of the results for the
full fiscal year. The accompanying unaudited Consolidated
Financial Statements should be read in conjunction with other
information presented elsewhere in this Form 10-Q, the
Consolidated Financial Statements and Notes thereto and
Management's Discussion and Analysis included in the Company's
annual report on Form 10-K.
1. In November 1995, the Company entered into a new loan
agreement (the "Bank Agreement") with a group of banks that
provided for a revolving loan of $38.0 million, less the amount
of outstanding letters of credit, and refinanced the existing
term loan. This revolving loan has since been replaced with a
first priority secured $80.0 million revolving loan commitment
provided by a new financial institution (the "Revolving Loan
Agreement"). Borrowings under the Bank Agreement were secured
by a security interest in the Company's merchandise
inventories. Borrowings under the revolving loan incurred
interest at the prime lending rate plus one eighth of one
percent per annum or other alternative interest rate options
and were limited to a borrowing base of inventory as defined by
the Bank Agreement. Borrowings under the revolving loan would
have been due March 31, 1997 and the letters of credit
commitment would have expired on June 29, 1997. The term loan,
having a balance of $20.0 million at November 8, 1995, was
refinanced and provided for quarterly scheduled principal
reductions beginning January 31, 1996 and ending July 31, 1999.
Interest on the term loan was at the prime lending rate plus
one quarter of one percent per annum or other alternative
interest rate options. Terms of the Bank Agreement required
compliance with certain restrictive covenants, including
minimum tangible net worth and fixed charge coverage, and
prohibited the payment of dividends and capital distributions.
In January 1996, the Company replaced its existing revolving
loan commitment under the Bank Agreement with the Revolving
Loan Agreement. Borrowings under the Revolving Loan Agreement
are secured by a first priority security interest in the
Company's merchandise inventories and other property.
Borrowings under the
Page 6
<PAGE>
Revolving Loan Agreement incur interest at the prime lending
rate plus one percent per annum or at an alternative interest
rate option and are limited to a borrowing base of eligible
inventory as defined by the Revolving Loan Agreement. The
lender at its discretion may, from time to time, reduce the
lending formula with respect to eligible inventory or may
declare an event of default if there is a material adverse
change in the business of the Company. Borrowings under the
Revolving Loan Agreement are due January 2000. Terms of the
Revolving Loan Agreement require the Company to maintain a
minimum tangible net worth. In connection with the Revolving
Loan Agreement, the Company amended the Bank Agreement with
respect to the secured term loan, having a balance of $20.0
million on January 1, 1996, to provide for a second priority
security interest in the Company's merchandise inventories and
other property and for quarterly scheduled principal reductions
beginning July 31, 1996 and ending July 31, 1998 (the "Amended
Bank Agreement"). Interest on the term loan is at the prime
lending rate plus one and one quarter percent per annum. Terms
of the Amended Bank Agreement require compliance with the terms
of the Revolving Loan Agreement and, as a result, the term loan
is classified as a current liability and is presented in the
balance sheet as Secured debt.
On July 18, 1996, the Amended Bank Agreement was sold to Cerberus
Partners, L.P. and Oaktree Capital Management, LLC (collectively,
"Second Priority Secured Lenders").
On July 12, 1996, the Company amended the Revolving Loan
Agreement by entering into an Agreement to Modify and Extend
Loan and Security Agreement to provide for debtor-in-possession
financing ("D.I.P. Financing Agreement"). Terms and conditions
of the D.I.P. Financing Agreement are governed by the Revolving
Loan Agreement. The D.I.P. Financing Agreement expires on
the earlier of (i) January 2000; (ii) confirmation of a plan of
reorganization; (iii) entry of an order converting the
Company's Chapter 11 case to a case under Chapter 7; (iv) the
entry of an order appointing a trustee for the Company; or (v)
the occurrence of default as defined in the D.I.P. Financing
Agreement. Borrowings under the D.I.P. Financing Agreement are
presented in the July 27, 1996 Balance Sheet as Secured debt.
On July 30, 1996, the Bankruptcy Court approved the motion
authorizing the Company to obtain post-petition financing under
the D.I.P. Financing Agreement dated July 12, 1996.
In connection with the final approval of the D.I.P. Financing
Agreement by the Bankruptcy Court, on July 30, 1996, the Company
entered into a Stipulation and Order Authorizing Debtors to Use
Cash Collateral of Cerberus Partners, L.P. and Oaktree Capital
Management, LLC. The Second Priority Secured Lenders had previ-
ously acquired the rights of the banks under, inter alia the
Amended Bank Agreement. The stipulation provides for and estab-
lishes the terms and conditions of the consent of the Second Pri-
ority Secured Lenders to the use of their cash collateral. The
Stipulation provides that such consent shall be withdrawn upon, or
following notice of, certain specificized events of default. The
Stipulation was approved by the Bankruptcy Court on July 30, 1996.
2. In January 1996, the Company closed nine stores and
announced that it will close an additional store when the lease
expires in the fourth quarter of fiscal 1996 and would not open
two stores that were scheduled to open in the spring of 1996.
The Company recorded a pretax charge of $34.0 million or $2.77
per common share in the quarter ended January 27, 1996 to
establish a reserve in connection with these store closures and
other related actions. The reserve for the store closures is
expected to be utilized over the next two years. The major
components of the charge are as follows (dollars in thousands):
Charge for
Store
Closures
--------
Future occupancy costs $ 13,816
Exit costs 3,446
--------
17,262
Fixed asset disposal 12,589
Inventory 3,003
Other current asset disposals 1,146
--------
$ 34,000
========
Page 7
<PAGE>
Substantially all costs to transfer or dispose of the assets of
these stores have been incurred as of July 27, 1996. The
initial expense estimate assumed that the Company would
sublease these properties within a certain period of time. In
conjunction with the Chapter 11 filing, the Company has
rejected certain of these store leases and has adjusted the
remaining cost estimate to reflect this change. The reserve for
store closures is included in the items in the balance sheet as
follows (dollars in thousands):
Beginning Ending
Balance Balance
January Period Reserve July 27,
27, 1996 Activity Adjustment 1996
-------- ------- -------- --------
Inventories $ (3,003) $ 1,550 $ 753 $ (700)
Prepaid expenses and other (1,146) 1,146 - -
Property and Equipment, net (12,589) 7,670 4,319 (600)
Closed store liabilities (17,262) 3,128 (1,766) (15,900)
-------- ------- -------- --------
$(34,000) $13,494 $ 3,306 $(17,200)
======= ======= ======= =======
In July 1996, the Company closed 25 stores and recorded a
pretax charge of $43.0 million or $3.50 per common share in the
quarter ended July 27, 1996 to establish a reserve in
connection with these store closures and other related
restructuring actions. The reserve for the store closures and
other related restructuring actions are expected to be utilized
over the next two years. The major components of the charge
are as follows (dollars in thousands):
Charge for
Store Closures
and Other
Related
Restructuring
Actions
-------
Future occupancy costs $ 16,050
Exit costs 5,550
-------
21,600
Fixed asset disposal 5,727
Inventory 10,125
-------
37,452
Vendor Accounts
Receivable Allowance 5,500
-------
$ 42,952
=======
The reserve for the 25 store closures and other related restruc-
turing actions are included in the balance sheet as follows
(dollars in thousands):
Beginning Ending
Balance Balance
July 12, Period July 27,
1996 Activity 1996
------- ------- -------
Inventories $(10,125) $ - $(10,125)
Accounts Receivable
Allowance (5,500) - (5,500)
Property and Equipment, net (5,727) (6,899) (12,626)
Closed store liabilities (21,600) 778 (20,822)
------- ------- -------
$(42,952) $ (6,121) $(49,073
======= ======= =======
The reserve for store closures and other related restructuring
actions are presented in the statement of operations as follows
(dollars in thousands):
Three Nine
Months Months
Ended Ended
July 27, July 27,
1996 1996
------- -------
Reserve for store closures $ 42,952 $ 76,952
Reserve adjustment (3,306) (3,306)
------- -------
$ 39,646 $ 73,646
======= =======
Page 8
<PAGE>
3. Reorganization expenses consist primarily of
professional fees and other expenses related to the Company's
reorganization under Chapter 11 for period reported after the
petition date of July 12, 1996 through July 27, 1996, subject
to Bankruptcy Court's approval.
4. On July 12, 1996, Ernst Home Center, Inc. (the
"Company") filed a voluntary petition for relief under Chapter
11 of title 11 of the United States Code in the United States
Bankruptcy Court for the District of Delaware. During the
course of its Chapter 11 case, the Company will continue
business operations as a debtor-in-possession. As a debtor-in-
possession, the Company may not engage in operations outside
the normal course of business without approval of the
Bankruptcy Court.
On August 28, 1996, the Bankruptcy Court for the District of
Delaware ordered a change of venue in the Company's bankruptcy
proceedings to the United States Bankruptcy Court for the
Western District of Washington. The change in venue leaves in
place substantial rulings which have already been handed down
by the Delaware Bankruptcy Court, including approval of debtor-
in-possession financing and the employee retention program, as
well as the appointment of the creditors' committee.
Two former Directors, one former officer and one current
officer, who is a Director, of the Company are named as
defendants in a class action complaint alleging among other
things, misrepresentation and omissions of fact in connection
with the Company's initial public offering of common stock. The
complaint was filed in the United States District Court
for the Western District of Washington at Seattle. The Company
is not named as a defendant in this complaint. No trial
date has been scheduled for this case. Pursuant to the
Company's Certificate of Incorporation and By-Laws, subject to
certain limitations set forth therein and imposed by applicable
law, the Company generally indemnifies directors and officers
against claims and liabilities incurred by them in their
respective capacities as directors and officers. The Company
carries directors and officers insurance, which may cover all
or a portion of such claims and the cost of any related
defense. The Company has been advised that the parties named
intend to defend this action vigorously.
The Company is party to various legal actions incident to the
normal operation of its business. The Company intends to defend
these actions vigorously and believes that it is unlikely that
the outcome of any of the pending legal actions will, in the
aggregate, have a material adverse effect on the results of
operations or financial condition of the Company.
Page 9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion and analysis of financial condition and
results of operations should be read in conjunction with the
similar discussion, analysis and other information included in
the Company's annual report on Form 10-K for the fiscal year
ended October 28, 1995 and with other information presented in
this Form 10-Q. The Company's fiscal year ends on the Saturday
nearest October 31. Fiscal 1996 represents the 53 weeks which
ends November 2, 1996 and fiscal 1995 represents the 52 weeks
ended October 28, 1995.
Overview
Ernst is a major home improvement, hardware and garden retailer
in the Northwestern United States that targets the "do-it-
yourself" customer with a comprehensive offering of leading
national brand and private label products at competitive prices.
The Company opened its first store in downtown Seattle in 1893
and today operates 61 stores located in Washington, Utah, Idaho,
Montana, Oregon, Nevada, Colorado and Wyoming. Ernst's strategy
is to position itself as a "user-friendly," price competitive,
alternative to warehouse style home improvement retailers.
Between 1988 and 1989, the Company remodeled substantially all of
its then existing stores. The stores were then redesigned to
offer customers a bright, colorful, clean shopping environment
and the merchandise offering was expanded to include over 35,000
stock keeping units ("SKUs"). Following the store remodel, in
1991 the Company introduced the "superstore" prototype. The
Company today has 30 superstores, including one superstore that
opened in the first quarter of fiscal 1996, and 31 older existing
"base" stores.
In fiscal 1994, the Company had pretax profits of $9.0 million on
sales of $527.1 million and in fiscal 1995, the Company had a
pretax loss of $39.6 million on sales of $572.1 million. The
primary reasons for Company's decline in profitability were: (1)
an inventory liquidation in the fourth quarter of 1995 to
increase liquidity, which resulted in promotional discounting and
lower or negative margins of merchandise sold; (2) negative cash
flow on certain of the twenty-four new stores opened during
fiscal year 1995 which did not mature at Company's historical
rate; (3) increased competition from warehouse style retail
chains; (4) softening demand for home improvement products; and
(5) lower in-stock positions due to liquidity constraints which
the Company began to experience in the fourth quarter of 1995.
For the nine month period ended July 27, 1996, the Company had
pre-tax losses of $120.0 million, including pre-tax charges of
$73.7 million for closure of 35 stores and other restructuring
actions. In January 1996, the Company closed nine stores and
announced that it will close another store when the lease expires
in the fourth quarter of fiscal 1996 and would not open two
stores that were scheduled to open in the spring of 1996. A
pretax charge of $34.0 million was recorded in the first quarter
of fiscal 1996 in connection with these store closures and
related actions. In July 1996, the Company closed 25 stores and
recorded a pretax charge of $43.0 million in the current quarter
of fiscal 1996 in connection with these store closures and
related actions. See "Results of Operations" below.
Sales and earnings continued to decline during the first nine
months of fiscal 1996 primarily as a result of the disruption in
the replenishment of merchandise due to restrictions in and
discontinuance of vendor trade credit. The Company determined
that it was necessary to file a voluntary petition for relief
under Chapter 11 of title 11 of the United States Code ("Chapter
11") in the United States Bankruptcy Court for the District of
Delaware to, among other things, obtain relief from its pre-
petition creditors and economically settle its lease obligations
on certain closed stores. Accordingly, in order to implement the
additional 25 store closings and maximize the value of the
Company, on July 12, 1996, the Company filed a voluntary petition
for relief under Chapter 11 of tittle 11 of the United States
Code. Under the protection of Chapter 11, the Company will
continue business operations as a debtor-in-possession.
As a debtor-in-possession, the Company may not engage in
operations outside the normal course of business without approval
of the Bankruptcy Court. Under Chapter 11, certain claims against
the Company in existence prior to the filing of the voluntary
petition for relief under the Bankruptcy Code are stayed while
the Company develops a Plan of Reorganization. On August 28,
1996, the United States Bankruptcy Court for the District of
Delaware granted a change of venue in the Company's bankruptcy
proceedings to the United States Bankruptcy Court for the Western
District of Washington. The change in venue leaves in place
substantial rulings which have
Page 10
<PAGE>
already been handed down by the Delaware Bankruptcy Court
including approval of debtor-in-possession financing, employee
retention program, and the appointment of the unsecured
creditors' committee.
The Company's sales and results of operations experience some
measure of seasonality, which the Company believes is typical in
the home improvement industry. Historically, a greater portion of
the Company's annual sales and operating income are generated in
the second half of its fiscal year (May through October). This
seasonality is primarily attributable to the outdoor projects
season which occurs in the spring and summer months. The
Company's quarterly results may fluctuate for a number of
reasons, including the seasonality of the Company's business and
the weather in the Company's markets. The results of operations
for the nine month period ended July 27, 1996 are not necessarily
indicative of the results to be expected for the full fiscal
year.
Results of Operations
Three month period ended July 27, 1996 (13 weeks) compared to
three month period ended July 29, 1995 (13 weeks)
Revenues. Sales decreased $55.8 million or 32.8% to $114.6
million in the three month period ended July 27, 1996 from $170.4
million in the prior year period. The decrease in sales was
primarily attributable to the disruption in the replenishment of
merchandise due to restrictions in vendor trade credit, the
closing of 34 stores, and increased competition. Comparable
stores (stores in operation more than one year including stores
that have been replaced by new stores) sales decreased 28.7% for
the period as compared to the prior year period. The decline in
comparable store sales is also attributable to the factors
discussed above.
Gross Profit. The Company's gross profit decreased $18.1 million
or 33.6% to $35.7 million for the three month period ended July
27, 1996 from $53.9 million for the three month period ended July
29, 1995. Gross profit as a percentage of sales decreased to
31.2% for the three month period ended July 27, 1996 from 31.6%
in the comparable prior year period. The 0.4% decrease in gross
margin is primarily a result of a decrease in initial margins due
to a change in the mix of sales as a result of the disruption in
the replenishment of merchandise, a decrease in vendor discounts,
allowances and fees over the prior year and an increase in the
cost of distributing the Company's merchandise. These negative
factors were partially offset by an increase in margins on
advertised merchandise and a lower charge to the cost of
merchandise sold for the effects of inflation under the LIFO
inventory method.
Costs and Expenses. Selling, general and administrative expenses
("SG&A") decreased $ 4.2 million or 9.7 % to $38.5 million. The
decrease in the dollar amount of SG&A is attributable to the
variable store labor, store operating and store occupancy costs
associated with operating fewer stores during all or part of the
period relative to the comparable prior year period offset by
expenses associated with the implementation of the Company's
"Ernst 96" customer service improvement program. This new program
was designed to stress the Company's commitment to customer
service through a television and print advertising campaign. This
campaign is supported with additional sales staff in each of its
stores as well as telephone customer service lines to respond to
customer inquiries. The "Ernst 96" customer service improvement
program increased store labor expenses and promotional costs as a
result of expanding the level of customer service. The decrease
in the dollar amount of SG&A is also attributable to a reduction
in the staffing level at the corporate administrative offices.
SG&A as a percentage of sales increased to 33.6% for the three
month period ended July 27, 1996 compared to 25.0% in the prior
year. This increase in SG&A as a percentage of sales is primarily
attributable to the factors discussed above which were then
spread over a lower store sales base.
Depreciation and amortization expense increased $0.5 million or
11.5% for the three months ended July 27, 1996. The increase is
due to the greater investment in new stores relative to the prior
year period.
During the three month period ended January 27, 1996, the Company
closed nine stores and announced that it will close an additional
store when the lease expires in the fourth quarter of fiscal
1996. During that period, the Company recorded a one time charge
of $34.0 million for estimated costs associated with these store
closures and related actions. Substantially all costs to transfer
or dispose of the assets of these stores have been incurred. The
initial expense estimate assumed that the Company would sublease
these properties within a certain period of time. However, in
conjunction with the Chapter 11 filing, the Company has rejected
certain of these store leases and has reduced the remaining cost
estimate by $3.3 million to reflect this change and other charged
assumptions. During
Page 11
<PAGE>
the three month period ended July 27, 1996, the Company closed an
additional 25 stores. The Company recorded a one time charge of
$43.0 million for estimated cost associated with these store
closings and related restructuring actions.
Store pre-opening expenses incurred in connection with the
opening and promotion of new stores, including labor to stock
initial inventory, employee training and grand opening
advertising, are amortized over the twelve month period following
the store opening. Store pre-opening expenses decreased $1.2
million to $0.4 million in the current year three month period
compared to $1.6 million in the prior year.
Operating Income. As a result of the many factors discussed
above, operating income decreased from $4.3 million for the three
month period ended July 29, 1995 to an operating loss of $47.4
million for the three month period ended July 27, 1996.
Interest Expense. Net interest expense increased $1.3 million
from the prior year period to $4.0 million for the three month
period ended July 27, 1996. This increase is primarily
attributable to an increase in borrowings under the Company's
credit facilities and an increase in obligations under capital
leases resulting from the addition of new stores that were not in
operation during the same period in the prior year.
Reorganization Expenses. Consulting and legal expenses relating
to the reorganization under Chapter 11 were $0.2 million for the
three month period ended July 27, 1996. There were no such
expenses in the prior year period.
Income Taxes. Due to the uncertainty in the realization of the
future income tax benefits generated by the Company's pretax loss
for the three month period ended July 27, 1996, a valuation
allowance was established against the tax asset that was recorded
as a result of the loss. The establishment of a valuation
allowance for the three month period ended July 27, 1996 is
consistent with the decision to establish a valuation allowance
for certain deferred tax assets of the Company in the fourth
quarter ended October 28, 1995. The Company recorded an income
tax expense of $0.5 million for the three month period ended July
29, 1995 for which a valuation allowance was subsequently
established in the fourth quarter ended October 28, 1995.
Net Loss. Net loss increased to $51.6 million for the three month
period ended July 27, 1996 from a net earnings of $1.0 million
for the prior year period. The $52.6 million decrease is a result
of the factors discussed above.
Nine month period ended July 27, 1996 (39 weeks) compared to nine
month period ended July 29, 1995 (39 weeks)
Revenues. Sales decreased $76.0 million or 18.1% to $343.3
million in the nine month period ended July 27, 1996 from $419.3
million in the prior year period. The decrease in sales was
primarily attributable to the disruption in the replenishment of
merchandise which is due to restrictions in vendor trade credit,
increased competition and, during the three month period ended
April 27, 1996, unseasonable weather in many of the Company's
markets. Comparable stores (stores in operation more than one
year including stores that have been replaced by new stores)
sales decreased 22.1% for the period as compared to the prior
year period. The decline in comparable store sales is also
attributable to the factors discussed above.
Gross Profit. The Company's gross profit decreased $30.5 million
or 23.1% to $101.5 million for the nine month period ended July
27, 1996 from $132.0 million for the nine month period ended July
29, 1995. Gross profit as a percentage of sales decreased to
29.6% of sales for the nine month period ended July 27, 1996 from
31.5% of sales in the comparable prior year period. The decrease
in gross margin is primarily a result of a decrease in initial
margins due to price competition and a change in the mix of sales
as a result of the disruption in the replenishment of
merchandise, a decrease in vendor discounts, allowances and fees
over the prior year and an increase in the cost of distributing
the Company's merchandise. These negative factors were partially
offset by an increase in margin on advertised merchandise and a
lower charge to cost of merchandise sold for the effect of
inflation under the LIFO inventory method.
Costs and Expenses. Selling, general and administrative expenses
("SG&A") increased $6.7 million or 5.9% to $118.7 million. The
increase in the dollar amount of SG&A is primarily attributable
to the variable store labor, store operating and store occupancy
costs associated with operating the equivalent of ten additional
stores during
Page 12
<PAGE>
the period relative to the comparable prior year period and
partially impacted by expenses associated with the implementation
of the "Ernst 96" customer service improvement programs during
the nine month period. This new program was designed to stress
the Company's commitment to customer service through a television
and print advertising campaign. This campaign is supported with
additional sales staff in each of its stores as well as telephone
customer service lines to respond to customer inquiries. The
"Ernst 96" customer service improvement program increased store
labor expenses and promotional cost over the prior year period as
a result of expanding the level of customer service. SG&A as a
percentage of sales increased to 34.6% of sales for the nine
month period ended July 27, 1996 compared to 26.7% of sales in
the prior year period. This increase in SG&A as a percentage of
sales is primarily attributable to the factors discussed above
and other costs which were then spread over a lower sales base.
Depreciation and amortization increased $3.4 million or 31.9% to
$13.9 million for the nine month period ended July 27, 1996. The
increase is due to the greater investment in new stores relative
to the prior year period.
During the three month period ended January 27, 1996, the Company
closed nine stores and announced that it will close an additional
store when the lease expires in the fourth quarter of fiscal
1996. During this period, the Company recorded a one time charge
of $34.0 million for estimated costs associated with these store
closures and related actions. Substantially all costs to transfer
or dispose of the assets of these stores have been incurred. The
initial expense estimate assumed that the Company would sublease
these properties within a certain period of time. However, in
conjunction with the Chapter 11 filing, the Company has rejected
certain of these store leases and has reduced the remaining cost
estimate by $3.3 million to reflect this change and other changed
assumptions. During the three month period ended July 27, 1996,
the Company closed an additional 25 stores. The Company recorded
a one time charge of $43.0 million for estimated cost associated
with these store closings and related actions.
Store pre-opening expenses incurred in connection with the
opening and promotion of new stores, including labor to stock
initial inventory, employee training and grand opening
advertising, are amortized over the twelve month period following
the store opening. Store pre-opening expenses decreased $0.6
million to $3.0 million in the current year nine month period
compared to the prior year period.
Operating Income. As a result of certain factors discussed above,
operating income decreased from $3.5 million for the nine month
period ended July 29, 1995 to an operating loss of $108.0 million
for the nine month period ended July 27, 1996.
Interest Expense. Net interest expense increased $4.8 million
from the comparable prior year period to $11.8 million. This
increase is primarily attributable to an increase in borrowings
under the Company's credit facilities, an increase in obligations
under capital leases resulting from the addition of new stores,
and a decrease in interest income on short-term investments of
surplus cash during the early part of fiscal 1995.
Reorganization Expenses. Consulting and legal expenses relating
to the reorganization under Chapter 11 were $0.2 million for the
nine month period ended July 27, 1996. There were no such
expenses in the prior year period.
Income Taxes. Due to the uncertainty in the realization of the
future income tax benefits generated by the Company's pretax loss
for the nine month period ended July 27, 1996, a valuation
allowance was established against the tax asset that was recorded
as a result of the loss. The establishment of a valuation
allowance for the nine month period ended July 27, 1996 is
consistent with the decision to establish a valuation allowance
for certain deferred tax assets of the Company in the fourth
quarter ended October 28, 1995. The Company recorded an income
tax benefit of $1.2 million for the nine month period ended July
29, 1995 for which a valuation allowance was subsequently
established in the fourth quarter ended October 28, 1995.
Net Loss. Net loss increased to $120.0 million for the nine month
period ended July 27, 1996 from a net loss of $2.2 million for
the prior year period. The $117.8 million increase is a result of
the factors discussed above.
Page 13
<PAGE>
Liquidity and Capital Resources
Historically, the Company's principal sources of funds to finance
its working capital requirements and capital expenditures have
been cash flow from operations, bank term loans and a revolving
credit facility. The Company's working capital requirements are
generally at their highest at the end of the first and during the
second fiscal quarters due to higher payments to vendors for
inventory purchased for the Christmas holiday season and for
inventory purchased in anticipation of the spring selling season.
The Company's liquidity has been negatively impacted by its
losses and the lack of adequate levels of financing to meet its
working capital requirements. As a result, vendors of the Company
reduced the amount of credit extended to the Company for the
purchasing of merchandise. In the weeks prior to July 12, 1996,
substantially all vendors and suppliers of the Company no longer
extended the Company credit. On July 12, 1996, the Company filed
a voluntary petition for relief under Chapter 11 of title 11 of
the United States Code and, as discussed below, contemporaneously
arranged debtor-in-possession financing.
In November 1995, the Company entered into a new loan agreement
(the "Bank Agreement") with a group of banks that provided for a
revolving loan of $38.0 million, less the amount of outstanding
letters of credit, and refinanced the existing term loan. In
January 1996, the Company replaced its existing revolving loan
commitment under the Bank Agreement with a secured $80.0 million
revolving loan commitment provided by a new financial institution
(the "Revolving Loan Agreement"). Borrowings under the Revolving
Loan Agreement are secured by a first priority security interest
in the Company's merchandise inventories and other property.
Borrowings under the Revolving Loan Agreement incur interest at
the prime lending rate plus one percent per annum or another
alternative interest rate option and are limited to a borrowing
base of eligible inventory as defined by the Revolving Loan
Agreement. The lender at its discretion may, from time to time,
reduce the lending formula with respect to eligible inventory or
may declare an event of default if there is a material adverse
change in the business of the Company. Borrowings under the
Revolving Loan Agreement are due January 2000. Terms of the
Revolving Loan Agreement require the Company to maintain a
minimum tangible net worth. In connection with the Revolving Loan
Agreement, the Company amended the Bank Agreement with respect to
the secured term loan, having a balance of $20.0 million on July
27, 1996, to provide for a second priority security interest in
the Company's merchandise inventories and other property and for
quarterly scheduled principal reductions beginning July 31, 1996
and ending July 31, 1998 (the "Amended Bank Agreement"). Interest
on the term loan is at the prime lending rate plus one and one
quarter percent per annum. Terms of the Amended Bank Agreement
require compliance with the terms of the Revolving Loan
Agreement.
On July 18, 1996, the Amended Bank Agreement was sold to Cerberus
Partners, L.P. and Oaktree Capital Management, LLC (collectively,
"Second Priority Secured Lenders").
On July 12, 1996, the Company amended the Revolving Loan
Agreement by entering into an Agreement to Modify and Extend Loan
and Security Agreement to provide for debtor-in-possession
financing ("D.I.P. Financing Agreement"). Terms and conditions of
the D.I.P. Financing Agreement are governed by the Revolving Loan
Agreement. The D.I.P. Financing Agreement expires on the earlier
of (i) January 2000; (ii) confirmation of a plan of reorganization;
(iii) entry of an order converting the Company's Chapter 11 case
to a case under Chapter 7; (iv) the entry of an order appointing
a trustee for the Company; or (v) the occurrence of default as
defined in the D.I.P. Financing Agreement. On July 30, 1996, the
Bankruptcy Court approved the motion authorizing the Company to
obtain post-petition financing under the D.I.P. Financing
Agreement dated July 12, 1996.
In connection with the final approval of the D.I.P. Financing
Agreement by the Bankruptcy Court, on July 30, 1996, the Company
entered into a Stipulation and Order Authorizing Debtors to Use
Cash Collateral of Cerberus Partners, L.P. and Oaktree Capital
Management, LLC. The Second Priority Secured Lenders had
previously acquired the rights of the banks under, inter alia the
Amended Bank Agreement. The stipulation provides for and
establishes the terms and conditions of the consent of the Second
Priority Secured Lenders to the use of their cash collateral. The
Stipulation provides that such consent shall be withdrawn upon,
or following notice of, certain specificized events of default.
The Stipulation was approved by the Bankruptcy Court on
July 30, 1996.
During the nine month period ended July 27, 1996, the Company
used $19.8 million in net cash in its operating activities,
primarily as a result of the net loss from operations. The
Company used approximately $1.4 million of cash to fund additions
in capital assets primarily for the one new store opened in
November 1995. The Company generated approximately $24.5 million
in net cash from its financing activities, primarily from an
increase in borrowings under the Company's credit facilities. In
fiscal year 1996, the Company plans to limit its total capital
expenditures to less than $2.0 million. As previously discussed,
during the nine months of fiscal 1996, the Company closed 34
stores. The Company believes that the closure of these stores
will improve its net liquidity position in the future. Under
Chapter 11, certain claims against the Company in existence prior
to the filing of the petition for relief under the Bankruptcy
Code are stayed while the Company develops a Plan of
Reorganization. These claims, which are subject to compromise,
total approximately $97.8 million. There can be no assurance that
the Company has the necessary liquidity to meet its future
obligations.
Page 14
<PAGE>
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.
On July 12, 1996, Ernst Home Center, Inc. (the "Company") filed a
voluntary petition for relief under Chapter 11 of title 11 of the
United States Code in the United States Bankruptcy Court for the
District of Delaware. During the course of its Chapter 11 case,
the Company will continue business operations as a debtor-in-
possession. As a debtor-in-possession, the Company may not engage
in operations outside the normal course of business without
approval of the Bankruptcy Court.
On August 28, 1996, the Bankruptcy Court for the District of
Delaware ordered a change of venue in the Company's bankruptcy
proceedings to the United States Bankruptcy Court for the Western
District of Washington. The change in venue leaves in place
substantial rulings which have already been handed down by the
Delaware Bankruptcy Court, including approval of debtor-in-
possession financing and the employee retention program, as well
as the appointment of the creditors' committee.
Two former Directors, one former officer and one current officer,
who is a Director, of the Company are named as defendants in a
class action complaint alleging, among other things,
misrepresentation and omissions of fact in connection with the
Company's initial public offering of common stock. The complaint
was filed in the United States District Court for the Western
District of Washington at Seattle. The Company is not named as
a defendant in this complaint. No trial date has been scheduled
for this case. Pursuant to the Company's Certificate of
Incorporation and By-Laws, subject to certain limitations set
forth therein and imposed by applicable law, the Company
generally indemnifies directors and officers against claims and
liabilities incurred by them in their respective capacities as
directors and officers. The Company carries directors and
officers insurance, which may cover all or a portion of such
claims and the cost of any related defense. The Company has been
advised that the parties named intend to defend this action
vigorously.
The Company is party to various legal actions incident to the
normal operation of its business. The Company intends to defend
these actions vigorously and believes that it is unlikely that
the outcome of any of the pending legal actions will, in the
aggregate, have a material adverse effect on the results of
operations or financial condition of the Company.
Page 15
<PAGE>
Item 5. Other Information:
Press Release dated September 5, 1996
FOR IMMEDIATE RELEASE
September 5, 1996
For more information contact
Jim Fox
(206) 621-3656
ERNST STOCK DELISTED FROM NASDAQ
(SEATTLE, WA, September 5, 1996) Ernst Home Center, Inc.,
announced today that it received notification from The Nasdaq
Stock Market, Inc., that Ernst's request for continued listing on
the Nasdaq National Market, after filing for protection under the
provision of Chapter 11 of the United States Bankruptcy Code, had
been denied. Under the protection of Chapter 11, the Company will
continue business operations as a debtor-in-possession while it
develops a Plan of Reorganization that will restructure the
Company and allow it to emerge from Chapter 11. In accordance
with Nasdaq procedure the delisting is effective immediately.
Ernst intends to cooperate with market makers in its stock to
pursue the possibility of maintaining quotations on the automated
OTC Bulletin Board maintained by the NASD. Individual brokers
may also make a non-automated market for Ernst shares. Parties
interested in buying or selling Ernst shares should contact their
respective brokers.
Ernst, based in Seattle, Washington, is a major home improvement
retailer operating stores in Washington, Oregon, Idaho, Montana,
Utah, Nevada, Colorado and Wyoming.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibit
EXHIBIT INDEX
Exhibit Sequential
Number Description of Exhibit Page No.
27 Financial Data Schedule
(b) Form 8-K was filed on July 25, 1996.
Item 3 Bankruptcy.
Page 16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
ERNST HOME CENTER, INC.
Signature Title Date
/s/ Hal Smith President, Chief Executive 09/05/96
---------------- Officer and Director -
Hal Smith Duly Authorized Officer
/s/ Richard T. Gruber Vice President Finance and 09/05/96
-------------------- Acting Chief Financial
Richard T. Gruber Officer, Secretary and
Treasurer - Principal
Page 17
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Balance Sheet as of July 27, 1996 and the Consolidated Statements
of Operations for the nine months ended July 27, 1996 filed as part of Form 10-Q
and is qualified in its entirety by reference to such report on Form 10-Q.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> NOV-02-1996
<PERIOD-START> OCT-29-1995
<PERIOD-END> JUL-27-1996
<CASH> 8,829
<SECURITIES> 0
<RECEIVABLES> 9,184
<ALLOWANCES> 6,242
<INVENTORY> 93,177
<CURRENT-ASSETS> 112,330
<PP&E> 87,195
<DEPRECIATION> 0
<TOTAL-ASSETS> 201,039
<CURRENT-LIABILITIES> 96,884
<BONDS> 7,200
0
0
<COMMON> 123
<OTHER-SE> (44,524)
<TOTAL-LIABILITY-AND-EQUITY> 201,039
<SALES> 343,322
<TOTAL-REVENUES> 343,322
<CGS> 241,842
<TOTAL-COSTS> 241,842
<OTHER-EXPENSES> 209,684
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,815
<INCOME-PRETAX> (120,019)
<INCOME-TAX> 0
<INCOME-CONTINUING> (120,019)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (120,019)
<EPS-PRIMARY> (9.79)
<EPS-DILUTED> (9.79)
</TABLE>
