SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
/ / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended ______________________________
OR
/X/ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from November 1, 1998, to
January 30, 1999
Commission file number 0-24902
QUALITY STORES, INC.
(Exact Name of Registrant As Specified In Its Charter)
Delaware 42-1425562
(State of Incorporation) (I.R.S. Employer No.)
455 E. Ellis Road, Muskegon, MI 49441
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (231) 798-8787
Not Applicable
(Former Name, Former Address, and Former Fiscal Year,
If Changed Since Last Report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of January 30, 1999: 100. All of the registrant's stock is held
by QSI Holdings, Inc., and is not publicly traded.
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QUALITY STORES, INC.
INDEX
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Report of Ernst & Young LLP.................................................................3
Consolidated Balance Sheets as of January 30, 1999,
October 31, 1998, and November 1, 1997......................................................4
Consolidated Statements of Income for period of three months
ended January 30, 1999, year ended October 31, 1998, periods
of seven months ended November 1, 1997, and five months ended
March 26, 1997, and year ended November 2,
1996........................................................................................6
Consolidated Statements of Changes in Stockholders' Equity for
period of three months ended January 30, 1999, year ended
October 31, 1998, periods of seven months ended November 1,
1997, and five months ended March 26, 1997, and year ended
November 2, 1996............................................................................7
Consolidated Statements of Cash Flows for period of three
months ended January 30, 1999, year ended October 31, 1998,
periods of seven months ended November 1, 1997, and five
months ended March 26, 1997, and year ended November 2, 1996...............................8
Notes to Consolidated Financial Statements.................................................10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS..............................................29
INDEX TO EXHIBIT(S)..........................................................................................33
Exhibit 12 Statement Re: Computation of Ratio of Earnings of Fixed Charges
Exhibit 27 Financial Data Schedule (electronic copy only)
Exhibit 99 Important Factors Regarding Forward-Looking Statements
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2
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Report of Independent Auditors
The Board of Directors
Quality Stores, Inc.
We have audited the accompanying consolidated balance sheets of Quality Stores,
Inc. ("Successor"), a wholly owned subsidiary of QSI Holdings, Inc., as of
January 30, 1999, October 31, 1998 and November 1, 1997, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows of the Successor for the three-month period ended January 30, 1999, year
ended October 31, 1998 and the seven-month period ended November 1, 1997 and its
"Predecessor" for the five-month period ended March 26, 1997 and for the year
ended November 2, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Quality Stores,
Inc. at January 30, 1999, October 31, 1998 and November 1, 1997, and the
consolidated results of operations and cash flows of the Successor for the
three-month period ended January 30, 1999, year ended October 31, 1998 and the
seven-month period ended November 1, 1997 and the Predecessor for the five-month
period ended March 26, 1997 and for the year ended November 2, 1996, in
conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Des Moines, Iowa
June 30, 1999, except for Note 15, as to which the date is August 17, 1999
3
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Quality Stores, Inc.
Consolidated Balance Sheets
(In thousands, except per share data)
January 30 October 31 November 1
1999 1998 1997
------------------------------------------
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Assets (Note 4)
Current assets:
Cash and cash equivalents $ 5,144 $ 6,971 $ 7,378
Recoverable income taxes 2,345 3,134 2,513
Trade and other receivables, less allowances of $386
in 1999, 1998 and 1997 4,597 4,648 7,264
Inventory 234,868 217,064 222,117
Deferred income taxes (Note 7) -- -- 4,000
Other 2,876 3,010 3,136
------------------------------------------
Total current assets 249,830 234,827 246,408
Property, improvements and equipment:
Land 1,821 1,821 1,963
Buildings and improvements 5,539 5,210 4,934
Leasehold improvements 14,550 13,384 12,788
Furniture and fixtures 31,121 27,590 24,731
Capitalized property rights (Note 5) 1,022 867 867
Automobiles and trucks 701 703 628
------------------------------------------
54,754 49,575 45,911
Less allowances for depreciation and amortization 9,140 7,948 2,716
------------------------------------------
45,614 41,627 43,195
Goodwill, net of amortization of $5,974 in 1999,
$5,080 in 1998 and $1,753 in 1997 135,605 134,037 135,612
Other assets, principally deferred financing costs 8,557 8,354 9,020
------------------------------------------
Total assets $439,606 $418,845 $434,235
==========================================
4
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January 30 October 31 November 1
1999 1998 1997
------------------------------------------
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Liabilities and stockholder's equity
Current liabilities:
Bank line of credit (Note 4) $ 44,000 $ 32,075 $ 60,750
Accounts payable 85,359 78,322 68,015
Accrued payroll and bonuses 4,728 8,272 5,847
Accrued income taxes -- -- 508
Other accrued expenses 16,664 14,084 22,479
Deferred income taxes (Note 7) 1,768 506 --
Current portion of long-term debt, note payable and
capital lease obligations 5,001 3,159 3,170
------------------------------------------
Total current liabilities 157,520 136,418 160,769
Long-term debt, less current portion (Note 4) 146,000 149,000 152,000
Note payable, less current portion (Note 3) 843 -- --
Capital lease obligations, less current portion (Note 5) 1,370 1,011 1,171
Deferred income taxes (Note 7) 2,631 2,659 748
------------------------------------------
Total liabilities 308,364 289,088 314,688
Stockholder's equity (Notes 3 and 6):
Common stock, $.01 par value: 3,000 authorized shares;
100 shares issued and outstanding (wholly owned by
QSI Holdings, Inc.) -- -- --
Additional paid-in capital 119,155 119,155 118,920
Retained earnings 12,087 10,602 627
------------------------------------------
Total stockholder's equity 131,242 129,757 119,547
Commitments (Notes 5 and 8) -- -- --
------------------------------------------
Total liabilities and stockholder's equity $439,606 $418,845 $434,235
==========================================
<FN>
See accompanying notes.
</FN>
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5
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Quality Stores, Inc. and Predecessor
Consolidated Statements of Income
(In thousands)
Successor | Predecessor
---------------------------------------------- | ---------------------------
Period of three Fiscal year Period of seven | Period of five Fiscal year
months ended ended months ended | months ended ended
January 30 October 31 November 1 | March 26 November 2
1999 1998 1997 | 1997 1996
---------------------------------------------- | ---------------------------
|
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Net sales $ 146,147 $ 587,195 $ 305,122 | $ 106,048 $ 293,020
Cost of sales 103,521 410,179 216,342 | 75,281 207,228
----------------------------------------- | --------------------------
Gross profit 42,626 177,016 88,780 | 30,767 85,792
|
Selling, general and administrative expenses, |
including amounts with related parties (Note 10) 33,742 134,623 72,142 | 29,045 68,197
|
Amortization of intangibles 972 3,552 1,753 | 415 938
----------------------------------------- | --------------------------
Operating income 7,912 38,841 14,885 | 1,307 16,657
|
Interest expense, including amounts with related |
parties (Note 10) 4,959 20,466 11,463 | 3,188 1,663
----------------------------------------- | --------------------------
Income (loss) before income taxes 2,953 18,375 3,422 | (1,881) 14,994
|
Income taxes (credits) (Note 7) 1,468 8,400 2,057 | (634) 6,250
----------------------------------------- | --------------------------
Net income (loss) and comprehensive income (loss) $ 1,485 $ 9,975 $ 1,365 | $ (1,247) $ 8,744
========================================= | ==========================
|
Ratio (deficiency) of earnings to fixed charges 1.5x 1.8x 1.3x | $ (1,881) 5.3x
========================================= | ==========================
<FN>
See accompanying notes.
</FN>
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6
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Quality Stores, Inc. and Predecessor
Consolidated Statements of Changes in Stockholders' Equity
(In thousands)
Period of three-months ended January 30, 1999,
fiscal year ended October 31, 1998, periods
of seven-months ended November 1, 1997
and five-months ended March 26, 1997, and
year ended November 2, 1996
Stock Additional Retained Total
Common Warrant Paid-In Earnings Stockholders'
Stock Outstanding Capital (Deficit) Equity
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Predecessor
Stockholders' equity at October 28, 1995 $ 106 $ 665 $ 69,667 $ 10,839 $ 81,277
Exercise of common stock options -- -- 42 -- 42
Net income -- -- -- 8,744 8,744
---------------------------------------------------------------------------
Stockholders' equity at November 2, 1996 106 665 69,709 19,583 90,063
Exercise of common stock options -- -- 252 -- 252
Net loss -- -- -- (1,247) (1,247)
---------------------------------------------------------------------------
Stockholders' equity at March 26, 1997 $ 106 $ 665 $ 69,961 $ 18,336 $ 89,068
===========================================================================
Successor
Initial capitalization of the Company after
merger of JWC Acquisition I on
March 27, 1997 $ -- $ 69,170 $ (738) $ 68,432
Capital contribution from parent -- 49,750 -- 49,750
(Note 3)
Net income -- -- 1,365 1,365
--------- -------------------------------------------
Stockholder's equity at November 1, 1997 -- 118,920 627 119,547
Net income -- -- 9,975 9,975
Capital contribution from parent -- 235 -- 235
--------- -------------------------------------------
Stockholder's equity at October 31, 1998 -- 119,155 10,602 129,757
Net income -- -- 1,485 1,485
--------- -------------------------------------------
Stockholder's equity at January 30, 1999 $ -- $ 119,155 $ 12,087 $ 131,242
========= ===========================================
<FN>
See accompanying notes.
</FN>
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7
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Quality Stores, Inc. and Predecessor
Consolidated Statements of Cash Flows
(In thousands)
Successor | Predecessor
-------------------------------------------- |---------------------------
Period of three Fiscal year Period of seven |Period of five Fiscal year
months ended ended months ended | months ended ended
January 30 October 31 November 1 | March 26 November 2
1999 1998 1997 | 1997 1996
-------------------------------------------- |---------------------------
|
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Operating activities |
Net income (loss) from continuing operations $ 1,485 $ 9,975 $ 1,365 | $ (1,247) $ 8,744
Adjustments to reconcile net income (loss) from continuing |
operations to net cash provided by (used in) continuing |
operations: |
Depreciation and amortization of property, improvements |
and equipment 1,317 5,221 2,716 | 1,490 3,056
Amortization of intangibles and other deferred assets 1,229 4,604 2,253 | 414 998
Loss on sale of assets -- -- -- | -- 20
Deferred income taxes 1,234 6,417 1,871 | 1,328 1,100
Changes in operating assets and liabilities: |
Recoverable income taxes 789 (621) (1,119) | (1,885) --
Trade and other receivables 839 2,616 (871) | 144 83
Inventory (9,609) 5,053 1,957 | (11,894) (4,549)
Other current assets 665 126 946 | (924) (972)
Accounts payable 2,065 10,307 1,895 | 1,468 (3,806)
Accrued expenses (1,666) (6,478) 1,139 | (1,524) 287
-------------------------------------------- |---------------------------
(1,652) 37,220 12,152 | (12,630) 4,961
|
Adjustments for net cash provided by discontinued |
operations: |
Deferred income taxes -- -- -- | -- (367)
Changes in operating assets and liabilities -- -- -- | -- 13,520
-------------------------------------------- |---------------------------
-- -- -- | -- 13,153
-------------------------------------------- |---------------------------
Net cash provided by (used in) operating activities (1,652) 37,220 12,152 | (12,630) 18,114
|
Investing activities |
Purchases of property, improvements and equipment (3,997) (4,842) (3,816) | (2,419) (8,789)
Acquisition of Central Tractor Farm & Country, Inc. |
(Predecessor) -- -- (155,963) | -- --
Acquisition of Big Bear Farm Stores, Inc. in 1996, Country |
General, Inc. in 1997 and Fisco Farm and Home in 1999 |
(Note 3) (6,020) (1,568) (136,995) | -- (5,650)
Other (538) 394 206 | (1,348) 255
-------------------------------------------- |---------------------------
Net cash used in investing activities (10,555) (6,016) (296,568) | (3,767) (14,184)
8
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Quality Stores, Inc. and Predecessor
Consolidated Statements of Cash Flows (continued)
(In thousands)
Successor | Predecessor
-------------------------------------------- |---------------------------
Period of three Fiscal year Period of seven |Period of five Fiscal year
months ended ended months ended | months ended ended
January 30 October 31 November 1 | March 26 November 2
1999 1998 1997 | 1997 1996
-------------------------------------------- |---------------------------
|
<S> <C> <C> <C> <C> <C>
|
Financing activities |
Borrowings under line of credit $ 91,180 $ 273,645 $ 206,106 | $ 113,119 $ 86,782
Repayments on line of credit (79,255) (302,320) (170,650) | (91,494) (89,902)
Proceeds from issuance of long-term debt -- -- 155,000 | 8,000 --
Payments on long-term debt (1,500) (3,000) (8,000) | (16,000) (17)
Payments on capitalized lease obligations (45) (171) (101) | (69) (120)
Proceeds from issuance of common stock and capital |
contributions -- 235 115,489 | 252 42
Cash of Central Tractor at date of acquisition -- -- 1,220 | -- --
Financing costs relating to new line of credit, term loan |
and Senior Notes -- -- (8,764) | -- --
Other -- -- 1,494 | -- --
-------------------------------------------- |---------------------------
Net cash provided by (used in) financing activities 10,380 (31,611) 291,794 | 13,808 (3,215)
-------------------------------------------- |---------------------------
Net (decrease) increase in cash and cash equivalents (1,827) (407) 7,378 | (2,589) 715
|
|
Cash and cash equivalents at beginning of period 6,971 7,378 -- | 3,809 3,094
-------------------------------------------- |---------------------------
Cash and cash equivalents at end of period $ 5,144 $ 6,971 $ 7,378 | $ 1,220 $ 3,809
============================================ |===========================
|
Supplemental disclosures of cash flow information |
Cash paid during the period for interest $ 1,941 $ 19,838 $ 10,294 | $ 1,746 $ 1,991
Cash paid during the period for income taxes 225 355 327 | 412 5,675
Supplemental disclosure of non-cash investing activity |
Note payable issued in acquisition of Fisco Farm and |
Home 1,084 -- -- | -- --
<FN>
See accompanying notes.
</FN>
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9
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Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements
Period of three months ended January 30, 1999,
year ended October 31, 1998, periods
of seven-months ended November 1, 1997
and five-months ended March 26, 1997,
and year ended November 2, 1996
(In thousands of dollars, except where indicated)
1. Basis of Presentation and Acquisition of the Company
Quality Stores, Inc. ("the Company"), formerly known as Central Tractor Farm &
Country, Inc., is a wholly owned subsidiary of QSI Holdings, Inc. ("QSI
Holdings"), formerly known as CT Holding, Inc., an affiliate of J. W. Childs
Equity Partners, L.P. ("Childs"). See Note 12 regarding acquisition of Quality
Stores, Inc. by Central Tractor Farm & Country, Inc.
As a result of the acquisition of the Company discussed below, effective March
27, 1997, a new basis of accounting has been reflected in the Company's
financial statements reflecting the fair values for the Company's assets and
liabilities at that date ("Successor"). The financial statements of the Company
for periods prior to March 27, 1997 are presented on the historical cost basis
of accounting ("Predecessor"). A line has been placed in the financial
statements to distinguish between Predecessor and Successor activity.
On November 27, 1996, the Board of Directors of the Company approved, and the
Company entered into, a merger agreement (the "Merger Agreement") with Childs,
QSI Holdings and its subsidiary, JWC Acquisition I, Inc., that provided for the
acquisition of the Company by QSI Holdings in a two-stage transaction. The
Merger Agreement provided that following the acquisition of all of the Company's
common stock held by affiliates of Butler Capital Corporation (collectively
"BCC"), QSI Holdings' subsidiary would merge with and into the Company (the
"Merger") and QSI Holdings would acquire the remaining shares of common stock of
the Company held by public shareholders.
The Merger was completed on March 27, 1997.
On March 27, 1997, the Company consummated a public offering of $105.0 million
aggregate principal amount of Senior Notes. The net proceeds from the offering
were used to pay the Merger consideration, repay certain outstanding borrowings,
and pay fees and expenses of the acquisition.
The acquisition of the Company was accounted for as a purchase. The purchase
price for the common stock was approximately $159.4 million, including related
costs and expenses, of which $156.0 million was paid in cash and $3.4 million in
common stock and stock options of QSI Holdings. The cash portion was funded from
the proceeds of capital stock issued by QSI Holdings, and the Senior Note
borrowings by the Company. The final purchase price was allocated to the
tangible and intangible assets and the liabilities of the Company based on fair
values, as follows:
10
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Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
1. Basis of Presentation and Acquisition of the Company (continued)
Inventory $ 124,284
Property, improvements and equipment 25,387
Accounts receivable and other assets 9,990
Goodwill 87,343
Bank line of credit (23,554)
Accounts payable and accrued expenses (51,809)
Long-term debt and capitalized lease obligations (9,442)
Deferred income taxes (2,806)
---------
$ 159,393
=========
2. Summary of Accounting Policies and Other Matters
Business and Principles of Consolidation
The consolidated financial statements include the Company and its wholly owned
subsidiary, Country General, Inc. (hereinafter collectively "the Company").
The Company operates agricultural specialty retail stores located primarily in
the Midwest, Northeast, and Southeast United States. The Company also sells
merchandise on a wholesale basis under various distributor agreements throughout
the United States. During fiscal 1996, the Company completed the sale of its
wholly owned subsidiary, Herschel Corporation ("Herschel"), a manufacturer and
wholesale distributor of equipment parts for use in the farming industry. With
this sale, continuing operations of the Company constitute one business segment
for financial reporting purposes.
The Company operates on a 52-53 week fiscal year ending on the Saturday nearest
to October 31.
All significant intercompany transactions have been eliminated from the
consolidated financial statements.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly
liquid investments with a maturity of three months or less when purchased to be
cash equivalents. Investments, including repurchase agreements and commercial
paper, are carried at cost, which approximates market.
11
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Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
2. Summary of Accounting Policies and Other Matters (continued)
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Trade Receivables
Most of the Company's retail sales are cash or credit card sales, while
wholesale sales and some retail sales are on account. The Company generally does
not require collateral for sales on account. Concentrations of credit risk with
respect to trade receivables are limited due to the number of customers of the
Company and their geographic dispersion. The allowance for doubtful accounts is
based on a current analysis of receivable delinquencies and historical loss
experience.
Inventory
Inventory is recorded at cost, including warehousing and freight costs,
determined principally by the last-in, first-out ("LIFO") method, which is not
in excess of market. The Company reviews its inventory for slow-moving, obsolete
or otherwise unsalable items on a regular basis throughout the year, including
at the time of physical inventory counts. Write downs are made for any estimated
losses to be incurred with respect to slow-moving, obsolete or otherwise
unsalable inventory as such inventory is identified. Inventories valued using
the LIFO method were approximately $0, $0 and $134 at January 30, 1999, October
31, 1998 and November 1, 1997, respectively, less than the amounts of such
inventories valued at current cost.
Property, Improvements and Equipment
Property, improvements and equipment are carried at cost less allowances for
depreciation and amortization. Depreciation and amortization expense is computed
primarily on a basis of the straight-line method over the estimated useful lives
of the assets as follows:
Buildings and improvements 10 to 39 years
Leasehold improvements (not in excess of underlying lease terms) 5 to 20 years
Furniture and fixtures 5 to 15 years
Automobiles and trucks 3 to 10 years
12
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Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
2. Summary of Accounting Policies and Other Matters (continued)
Certain long-term lease transactions have been accounted for as capital leases.
The property rights recorded under direct financing leases are amortized on a
straight-line basis over the lesser of the useful life or the respective terms
of the leases.
Goodwill
Goodwill is being amortized utilizing the straight-line method over periods of
40 years. The carrying value of goodwill is reviewed continually to determine
whether any impairment has occurred. This review takes into consideration the
recoverability of the unamortized amounts based on the estimated undiscounted
cash flows of the related businesses to the respective carrying value of the
goodwill. To the extent that the estimated undiscounted future cash flows are
less than the carrying value of the assets, an impairment loss can be measured
based upon various methods, including undiscounted cash flows, discounted cash
flows and fair value. Based upon undiscounted cash flows, no impairment of
goodwill was determined to exist and, accordingly, no measurement was required.
Deferred Financing Costs
Deferred financing costs are amortized over the term of the related debt.
Deferred Income Taxes
The Company uses the liability method of accounting for income taxes. Under this
method, deferred income tax assets and liabilities are determined based on the
difference between financial reporting and income tax bases of assets and
liabilities using the enacted marginal tax rates. Deferred income tax expenses
or credits are based on the changes in the asset or liability from period to
period.
Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:
Cash equivalents and accounts receivable and payable: Carrying amounts
reported in the Company's consolidated balance sheets based on historical
cost approximate estimated fair value for these instruments, due to their
short-term nature.
The fair value of the bank line of credit, note payable, bank term loan,
and Senior Notes is estimated to approximate their carrying value as of
January 30, 1999.
13
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Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
2. Summary of Accounting Policies and Other Matters (continued)
Interest Rate Swap Agreements
The differential to be paid or received in connection with interest rate swap
agreements is accrued as interest rates change and is recognized over the life
of the agreements.
Returns and Warranties
Costs relating to merchandise returns from sales at retail stores and through
distributors are not significant and generally are accounted for as they occur.
Catalogs, Sale Flyers and Advertising Costs
The direct cost of printing and mailing the Company's annual mail order catalog
is deferred and amortized against mail order revenues over the year the catalog
is in use. The direct cost of printing and distributing sale flyers is deferred
and amortized over the life of the flyer which is generally two weeks or less.
Other advertising costs are expensed as incurred. Unamortized amounts relating
to the costs of the annual catalog and periodic sale flyers amounted to $1,048,
$394, $923 and $950 at January 30, 1999, October 31, 1998, November 1, 1997 and
March 26, 1997, respectively. Advertising expenses were $3,880, $15,127, $7,755,
$3,286 and $8,841 for the three-month period of 1999, fiscal 1998, the
seven-month and five-month periods of 1997 and for fiscal 1996, respectively.
Store Pre-Opening Costs
Prior to fiscal 1998, direct costs, which consisted principally of rent,
employee compensation and travel costs for merchandise set-up and supplies,
incurred in setting up new stores for opening were deferred and amortized over
the first twenty-six weeks of store operations. Beginning in fiscal 1998, all
such costs are currently expensed. The effect of this change in accounting on
fiscal 1998 results of operations was immaterial. The amount of unamortized
store pre-opening costs at November 1, 1997 and March 26, 1997 amounted to $104
and $1,203, respectively.
Emerging Accounting Issues
The Company is not aware of any accounting standards which have been issued and
which will require the Company to change its current accounting policies or
adopt new policies, the effect of which would be material to the Company's
financial statements.
14
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Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
3. Acquisitions
Effective December 31, 1998, the Company acquired substantially all assets and
assumed certain liabilities of The H. C. Shaw Company, doing business as Fisco
Farm and Home ("Fisco"), a chain of nine agricultural specialty retail stores,
for approximately $6,020 in cash and a note, payable over a four-year period,
with a present value of $1,084, subject to post-closing adjustment. The
acquisition was accounted for as a purchase. The purchase price was allocated to
the tangible and intangible assets and the liabilities based on fair values as
follows:
Inventory $ 8,195
Accounts receivable and other assets 1,319
Leaseholds and equipment 1,307
Goodwill 2,462
Accounts payable and accrued expenses (6,179)
-------
$ 7,104
=======
Effective June 26, 1997, the Company acquired all of the outstanding capital
stock of Country General, Inc. ("Country General") for approximately $138.6
million (including related costs and expenses) in cash, including $1.6 million
related to post closing adjustments finalized during fiscal 1998. Country
General operated a chain of 114 agricultural specialty retail stores. The
Company funded the acquisition price in part from a $49,750 cash equity
contribution from its parent, QSI Holdings, and the remainder from funds drawn
under the Company's amended and restated Credit Facility.
The acquisition was accounted for as a purchase. The final purchase price was
allocated to the tangible and intangible assets and the liabilities based on
fair values, as follows:
Inventory $ 99,790
Accounts receivables and other assets 5,824
Property, improvements and equipment 17,174
Goodwill 51,775
Deferred income taxes 9,229
Accounts payable and accrued expenses (45,229)
---------
$ 138,563
=========
In initially allocating the purchase price to the assets and liabilities based
on fair values, a $3,358 reserve was recorded in 1997 for the estimated cost,
principally lease liabilities, to close nine acquired stores; and a $2,866
reserve was recorded in 1997 for the cost of severance payments to identified
employees in connection with the closing of Country General's corporate
headquarters. During March of 1998, the decision was made to actually close
twelve of the acquired stores. As of October 31, 1998, the inventory liquidation
and store closing process and the termination of employees at Country General's
closed corporate headquarters had been completed. During fiscal 1998, in
connection with the final purchase price adjustments, the reserve for store
closings was
15
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
3. Acquisitions (continued)
increased by $1,522 as a result of the additional closed stores, and the reserve
for severance payments was decreased by $704; these adjustments resulted in a
net increase in goodwill of $818. As of January 30, 1999, October 31, 1998 and
November 1, 1997, the reserve for closed stores, which consists primarily of
remaining lease costs, was $3,023, $3,435 and $3,358, respectively. The
reductions in the reserve for closed stores are primarily the result of payments
under leases and related costs. As of January 30, 1999, October 31, 1998 and
November 1, 1997, the reserve for severance had been reduced to $102, $224 and
$2,722, respectively, as a result of payments to terminated employees and the
final purchase price adjustments.
On May 31, 1996, the Predecessor acquired 31 retail stores and related net
operating assets from Big Bear Farm Stores, Inc. ("Big Bear"), an agricultural
specialty retailer, for approximately $5,650 in cash. The acquisition was
accounted for as a purchase. The purchase price was allocated to the tangible
and intangible assets and the liabilities based on fair values as follows:
Inventory $ 8,780
Accounts receivable and other assets 206
Leaseholds and equipment 517
Deferred income taxes 135
Goodwill 2,666
Accounts payable and accrued expenses (6,654)
-------
$ 5,650
=======
The results of operations of Fisco, Country General and Big Bear are included in
the accompanying consolidated statements of income from the respective date of
purchase.
Pro Forma Results of Operations
Pro forma results of operations (in thousands) presented below are based on the
historical results of operations of the Company, as Successor, and its
Predecessor, adjusted to give effect to: (i) the acquisition of the Company
described in Note 1; (ii) the acquisitions of Country General and Big Bear
described above; and (iii) the debt financing arrangements relating to the
acquisitions, as though these transactions had occurred at the beginning of
fiscal 1996. Pro forma results of operations for 1997 and 1996 have not been
adjusted for the effect of the twelve acquired Country General stores which were
closed during fiscal 1998. In addition, proforma results of operations as if the
acquisition of Fisco had occurred at the beginning of fiscal 1996 are not
materially different from the historical and pro forma results of operations
presented herein.
16
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
3. Acquisitions (continued)
Year ended
-----------------------------------
November 1 November 2
1997 1996
-----------------------------------
Net sales $600,157 $613,538
Operating income 28,828 28,897
Net income 3,418 4,147
4. Line of Credit and Long-Term Debt
The Company has a Credit Facility, with a bank which consists of a $50.0
million, six-year term loan facility, which was fully funded, and a $100.0
million revolving credit facility under which borrowings of $44,000 and letters
of credit totaling $5,817 were outstanding as of January 30, 1999. Borrowings
under the Credit Facility bear interest at rates based upon prime or the
Eurodollar Rate plus a margin. At January 30, 1999, the interest rate on the
Term Loan was 8.1% and the interest rate on the Revolving Credit Facility was
7.9%. See Note 12 regarding New Credit Facility.
The Credit Facility agreement contains covenants which require the Company to
maintain a minimum: consolidated net worth; earnings before taxes, interest,
depreciation and amortization ("EBITDA"); ratio of EBITDA to cash interest
payable; and ratio of debt to EBITDA. The covenants also restrict, among other
things, the payment of dividends, incurrence of debt, and disposition of assets.
The Credit Facility is secured by substantially all of the assets of the
Company.
Long-term debt consisted of the following:
January 30 October 31 November 1
1999 1998 1997
----------------------------------------
10-5/8% Senior Notes due 2007 $105,000 $105,000 $105,000
Bank term loan 45,500 47,000 50,000
--------------------------------------
150,500 152,000 155,000
Less current portion 4,500 3,000 3,000
--------------------------------------
$146,000 $149,000 $152,000
======================================
17
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
4. Line of Credit and Long-Term Debt (continued)
The Senior Notes mature on April 1, 2007 with interest payable semiannually in
arrears on April 1 and October 1. The Senior Notes may be redeemed beginning
April 1, 2002 at a price of 105.3125% of the principal amount decreasing
approximately 1.77% annually thereafter until April 1, 2005 at which time they
are redeemable at face value. Furthermore, notwithstanding the foregoing the
Company may redeem up to 35% of the original aggregate principal amount of the
Senior Notes at a price of 110% of the principal amount with the net cash
proceeds of a public equity offering within 60 days of closing such offering.
In March of 1998, the Company entered into an interest rate swap agreement (the
"Swap Agreement") with a bank to reduce the impact of changes in interest rates
on its floating term loan facility. Accordingly, the Swap Agreement was entered
into for purposes other than trading. The Swap Agreement has an initial notional
amount of $48,500. The notional amount decreases in tandem with the outstanding
balance on the Company's term loan facility until the Swap Agreement's maturity
on March 30, 2001 and was $45,500 at January 30, 1999. The Swap Agreement fixes
the interest rate on the term loan facility at 5.8525%, plus the applicable
margin, resulting in an effective rate of 8.23% at January 30, 1999. The Company
is exposed to interest rate risk in the event of nonperformance by the counter
party to the Swap Agreement. However, the Company does not anticipate
nonperformance by the bank.
The bank term loan must be repaid in semiannual installments, plus annual
prepayments based on the Company's excess cash flow, as defined. The minimum
annual installments are as follows: years ending in January of 2000 - $4,500;
2001 - $7,000; 2002 - $10,000; 2003 - $15,000; and 2004 - $9,000.
5. Lease Obligations
The Company has entered into certain long-term lease agreements for the use of
warehouses, certain retail store facilities and computer equipment. These leases
have been accounted for as purchases of property rights and designated as
capitalized leases.
Amortization expense relating to such property rights recorded under capitalized
leases was $36, $145, $86, $59 and $125 for the three-month period of 1999,
fiscal 1998, the seven-month and five-month periods of 1997 and for fiscal 1996,
respectively. The net book value of property rights recorded under capital
leases was $755, $636 and $781 at January 30, 1999, October 31, 1998 and
November 1, 1997, respectively.
18
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
5. Lease Obligations (continued)
As of January 30, 1999, the debt associated with the capitalized property rights
is represented by the present value of the minimum lease payments as follows:
Year ended in January of:
2000 $ 442
2001 442
2002 442
2003 442
2004 244
After 2004 162
-------
Total minimum lease payments 2,174
Less amount representing interest 544
-------
Present value of minimum lease payments 1,630
Less current installments 260
-------
$1,370
=======
The Company also has entered into certain noncancelable operating leases for the
use of real estate, automobiles and trucks, and office equipment. Aggregate
rental expense for operating leases was approximately $3,886, $16,169, $9,299,
$4,069 and $9,294 for the three-month period of 1999, fiscal 1998, the
seven-month and five-month periods of 1997 and for fiscal 1996, respectively.
The following is a summary of minimum rental commitments as of January 30, 1999,
for operating leases:
Year Ended in Automobile Office
January of Real Estate and Trucks Equipment Total
- -----------------------------------------------------------------------------
2000 $15,801 $405 $ 80 $16,286
2001 12,271 24 22 12,317
2002 9,285 18 7 9,310
2003 7,185 12 1 7,198
2004 5,207 5 1 5,213
After 2004 6,071 - - 6,071
-------------------------------------------------------
$55,820 $464 $111 $56,395
=======================================================
19
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
6. Stock Options
QSI Holdings has stock option arrangements with various officers and other
members of management of the Company which it accounts for under the provisions
of APB Opinion No. 25 and related interpretations. No compensation expense has
been recognized by QSI Holdings or the Company in connection with such stock
option arrangements.
Under FASB Statement No. 123, certain pro forma information is required as if
QSI Holdings had accounted for stock options under the alternative fair value
method of Statement 123 with the resultant compensation expense "pushed-down" to
the Company. QSI Holdings used a Minimum Valuation model to determine the per
unit fair value of the options at the grant date. The following assumptions were
used in the valuation:
Risk-free interest rate 5.65%
Expected dividend yield None
Expected volatility None
Expected life of option 7 years
For purposes of pro forma disclosures, the estimated fair value of the options
at the grant date is amortized to expense over the vesting period of the
options. Pro forma stock option compensation expense for the period of three
months ended January 30, 1999 and the year ended October 31, 1998 is not
indicative of what annual pro forma expense may be in the future. Pro forma net
income of the Company for the period of three months ended January 30, 1999 and
fiscal 1998 is approximately $1,424 and $9,729, respectively. Pro forma results
for the period of seven months ended November 1, 1997 would not differ from
amounts as reported since no stock option compensation expense would be
recognized during that period.
The Company had no capital shares reserved for issuance under any outstanding
stock option or other agreements at January 30, 1999 or October 31, 1998.
7. Income Taxes
The Company's consolidated results of operations are included in the
consolidated tax returns of its parent, QSI Holdings. The entities in the
consolidated tax returns have adopted a policy of allocating income tax expense
or benefit based on a separate return concept. This generally results in
profitable companies recognizing income tax expense as if the individual company
filed a separate return and loss companies recognizing an income tax benefit to
the extent their losses contribute to reduce consolidated income taxes currently
or in the future.
20
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
7. Income Taxes (continued)
Deferred income taxes reflect the net tax effect of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and the amounts used for income tax purposes. Significant components of the
Company's deferred tax liabilities and assets are as follows:
January 30 October 31 November 1
1999 1998 1997
----------------------------------
Deferred tax liabilities:
Differences in depreciation and cost basis
of property, improvements and
equipment $ 3,457 $ 3,392 $ 2,428
Differences in cost basis of inventories
due to LIFO and uniform capitalization 6,411 5,623 5,423
Prepaid advertising 419 158 369
Differences in amortization and cost basis
of intangibles 709 584 --
Other -- -- 42
----------------------------------
Total deferred tax liabilities 10,996 9,757 8,262
Deferred tax assets:
Net operating loss carryforward 1,325 1,105 1,369
Capital loss carryforward 920 920 920
Allowance for doubtful accounts 154 154 214
Excess and obsolete inventory reserves 2,078 2,120 5,355
Compensation and employee benefit
accruals 1,320 1,319 2,509
Operating leases 292 308 368
Accrued store closing costs 1,209 1,374 1,362
Capitalized property rights and lease
obligations treated as operating leases
for income tax purposes 210 212 223
Other 9 -- 114
----------------------------------
7,517 7,512 12,434
Less valuation allowance for capital loss
carryforward (920) (920) (920)
----------------------------------
Total deferred tax assets 6,597 6,592 11,514
----------------------------------
Net deferred tax (liabilities) assets $ (4,399) $ (3,165) $ 3,252
==================================
21
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
7. Income Taxes (continued)
The Company has a net operating loss carryforward of approximately $3.3 million
which will expire in the year 2012. A capital loss carryforward of approximately
$2.3 million which relates to the sale of Herschel will expire in the year 2001.
Components of income tax expense (benefit) are as follows:
<TABLE>
<CAPTION>
Successor | Predecessor
---------------------------------------------- | ---------------------------
Period of three Fiscal year Period of seven | Period of five Fiscal year
months ended ended months ended | months ended ended
January 30 October 31 November 1 | March 26 November 2
1999 1998 1997 | 1997 1996
---------------------------------------------- | ---------------------------
<S> <C> <C> <C> <C> <C>
|
Continuing operations: |
Current: |
Federal $ 234 $ -- $ 148 | $(1,541) $ 3,951
State -- 200 38 | (421) 1,199
--------------------------------------- | ------------------------
234 200 186 | (1,962) 5,150
Deferred 1,234 8,200 1,871 | 1,328 1,100
--------------------------------------- | ------------------------
1,468 8,400 2,057 | (634) 6,250
Discontinued operations: |
Current -- -- -- | -- 367
Deferred -- -- -- | -- (367)
--------------------------------------- | ------------------------
Current -- -- -- | -- --
--------------------------------------- | ------------------------
Total $ 1,468 $ 8,400 $ 2,057 | $ (634) $ 6,250
======================================= | ========================
</TABLE>
Total reported income tax expense differs from the tax that would have resulted
by applying the statutory expected federal income tax rate to income before
taxes. The reasons for these differences are as follows:
<TABLE>
<CAPTION>
Successor | Predecessor
---------------------------------------------- | -----------------------------
Period of three Fiscal year Period of seven | Period of five Fiscal year
months ended ended months ended | months ended ended
January 30 October 31 November 1 | March 26 November 2
1999 1998 1997 | 1997 1996
---------------------------------------------- | -----------------------------
<S> <C> <C> <C> <C> <C>
|
Income tax at federal statutory $1,004 $6,248 $1,163 | $(639) $5,098
rate |
Increases in taxes resulting |
from: |
State income taxes, net of |
federal income tax effect 194 1,214 306 | (79) 833
Goodwill amortization 192 766 391 | 72 178
Other, net 78 172 197 | 12 141
------------------------------------------ | ------------------------
$1,468 $8,400 $2,057 | $(634) $6,250
========================================== | ========================
</TABLE>
22
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
8. Employment Commitments
The Company has employment agreements with two officers of the Company which
provide for annual salaries amounting to approximately $700. Upon termination of
employment without cause or for certain other circumstances, compensation may be
continued for a period not to exceed eighteen months.
9. Profit Sharing Plan
The Company has a profit sharing plan covering all employees who meet certain
eligibility requirements. The plan provides for discretionary employer
contributions and allows voluntary participant contributions. Company
contributions are determined by its Board of Directors. The Company recognized
expense in connection with the profit sharing plan of $185, $0, $729, $85 and
$881 for the three-month period of 1999, fiscal 1998, the seven-month and
five-month periods of 1997 and for fiscal 1996, respectively.
10. Transactions with Related Parties
Certain investment funds managed by Butler Capital Corporation ("BCC") owned a
majority of the outstanding common stock of the Company (see Note 1 regarding
acquisition by Childs and QSI Holdings). The BCC Funds also held the 7%
convertible notes which were retired in connection with the purchase of the BCC
common stock. Interest paid on such notes was approximately $171 and $1,425 for
the period of five months ended March 26, 1997 and for fiscal 1996,
respectively.
Included in costs associated with acquiring the Company and related deferred
financing costs is an advisory and financing fee of $1.7 million paid to Childs
in consideration of services regarding the planning, structuring and negotiating
of the acquisition and related financings.
For the period of three months ended January 30, 1999, fiscal 1998 and the
period of seven months ended November 1, 1997, Childs was paid a management and
consulting services fee of approximately $60, $240 and $140, respectively, under
a five-year agreement, annually renewable thereafter, requiring annual payments
of $240. In addition, during the period of three months ended January 30, 1999
and fiscal 1998 Fenway Partners, a stockholder of QSI Holdings, was paid a
management fee of $30 and $120, respectively.
23
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
10. Transactions with Related Parties (continued)
The Company purchases inventory from two suppliers who are controlled by
stockholders of QSI Holdings. Purchases from these suppliers aggregated
approximately $1,437, $4,999 and $6,092 for the period of three months ended
January 30, 1999, fiscal 1998 and fiscal 1997, respectively. The Company
purchased inventory from two suppliers who were controlled by the BCC Funds.
Purchases from these suppliers aggregated approximately $1,605 and $6,228 for
the period of five months ended March 26, 1997 and for fiscal 1996,
respectively.
11. Guarantee of Senior Notes
The Senior Notes described in Note 4 are guaranteed jointly and severally, fully
and unconditionally by Country General, the Company's wholly owned subsidiary.
As a result of the acquisition of Country General by the Company as discussed in
Note 3, a new basis of accounting has been reflected in Country General's
financial statements reflecting the fair values for Country General's assets and
liabilities at that date.
Summarized financial information for Country General is as follows:
January 30 October 31 November 1
1999 1998 1997
-------------------------------------
Balance sheet data
Current assets:
Accounts receivable $ 2,742 $ 3,437 $ 6,049
Inventory 106,674 104,777 102,571
Other 2,257 3,569 7,702
----------------------------------
111,673 111,783 116,322
Property and equipment, net of
allowances for depreciation 15,390 15,598 16,673
Other noncurrent assets, principally
goodwill and deferred financing costs 51,735 52,170 53,109
----------------------------------
$178,798 $179,551 $186,104
==================================
Current liabilities, principally accounts
payable and accrued expenses $ 26,912 $ 28,159 $ 38,696
Noncurrent liabilities, principally
amounts due to related parties 6,613 5,262 11,434
Stockholder's equity 145,273 146,130 135,974
----------------------------------
$178,798 $179,551 $186,104
==================================
24
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
<TABLE>
<CAPTION>
11. Guarantee of Senior Notes (continued)
Period of Period of four
three months Fiscal year months ended
ended ended November 1
January 30 October 31 1997 (from date
1999 1998 of acquisition)
========================================================
<S> <C> <C> <C>
Income statement data
Net sales $ 63,914 $ 257,342 $ 99,381
Cost of sales 45,469 178,918 71,095
----------------------------------------------------
Gross profit 18,445 78,424 28,286
Selling, general and administrative
and other expenses 13,961 53,151 26,719
----------------------------------------------------
Operating income 4,484 25,273 1,567
Interest expense to related party 2,167 9,167 3,201
----------------------------------------------------
Income (loss) before income taxes 2,317 16,106 (1,634)
Income taxes (credits) 972 6,488 (613)
----------------------------------------------------
Net income (loss) $ 1,345 $ 9,618 $ (1,021)
====================================================
Cash flow data
Net cash flows provided by (used in):
Operating activities $ (743) $ 2,586 $ (1,736)
Investing activities, principally
capital expenditures (112) (3,575) (415)
Financing activities, principally
change in amounts due to related
parties, less payment of deferred
financing costs of $2,340 in 1997 1,355 (5,192) 5,548
</TABLE>
12. Subsequent Event
On May 7, 1999, Central Tractor Farm and Country, Inc. ("CT") acquired Quality
Stores, Inc. ("Quality") in a transaction in which Quality was merged with and
into CT (the "Merger"). At the time of the Merger, the name of the surviving
corporation was changed to Quality Stores, Inc. In connection with the Merger,
the former shareholders and option holders of Quality received, in the
aggregate, $111.5 million in cash and 792,430 shares of common stock of CT
Holding, whose name changed to QSI Holdings, Inc. In connection with the Merger,
the Company also repaid approximately $42.1 million in debt owed by Quality. The
total purchase price for Quality was approximately $208.0 million, subject to
post closing adjustment.
25
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
12. Subsequent Event (continued)
Quality, based in Muskegon, Michigan, has a strong presence in Michigan and Ohio
and, at the time of the Merger, operated a chain of 114 stores, with annual
sales of approximately $525 million, which offer merchandise oriented to farm
and country living, including animal care products, farm and ranch supplies,
workwear, and lawn and garden products. In connection with the Merger, the
Company relocated its headquarters to Muskegon, Michigan. The Company will
continue to operate stores primarily under the Central Tractor Farm & Country,
Country General and Quality Farm & Fleet names.
The acquisition of Quality will be accounted for as a purchase and the results
of operations of Quality will be included in the consolidated financial
statements from the date of purchase. The estimated cost of the acquisition over
the estimated fair value of the underlying tangible net assets is as follows:
Cost of acquiring Quality capital stock $208,043
Fair value of underlying tangible net assets acquired 51,886
--------
Excess of cost of acquisition over the allocated fair value of the
underlying tangible net assets $156,157
========
The non-cash portion of the Merger consideration was contributed to the Company
by QSI Holdings, Inc. The Company funded the cash portion of the Merger
consideration and various fees and expenses associated with the Merger from
funds drawn under an amendment and restatement of the Company's credit Agreement
with Fleet National Bank, as administrative agent for the banks, financial
institutions and other institutional lenders party thereto (the "New Credit
Facility"). The New Credit Facility which was entered into on May 7, 1999
increased the aggregate principal amount of the facility from $150.0 million to
$320.0 million, consisting of a $220.0 million, seven-year term loan facility,
which was fully funded, and a $100.0 million revolving credit facility under
which $60.0 million was outstanding on May 7, 1999. The amounts originally
funded and drawn under the New Credit Facility were used, in part, to repay
outstanding borrowings under the Company's prior credit facility.
26
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
12. Subsequent Event (continued)
The New Credit Facility will mature on April 30, 2006. Borrowings under the New
Credit Facility will bear interest at rates based upon prime or the Eurodollar
Rate plus a margin. The term loans must be repaid in quarterly installments
beginning July 31, 1999, plus prepayments based on the Company's excess cash
flow, as defined. The installments, on an annual basis, are as follows:
Year ending in January of Amount
- -------------------------------------------------------------------------------
2000 $ 5,425
2001 19,325
2002 21,200
2003 21,200
2004 21,200
Thereafter 131,650
-----------
$220,000
===========
The New Credit Facility agreement contains covenants which require the Company
to maintain a minimum Fixed Charge Coverage Ratio, a minimum Interest Coverage
Ratio and a maximum Debt to EBITDA Ratio (all as defined in the New Credit
Facility agreement). The covenants also restrict, among other things, the
payment of dividends, incurrence of debt and capital expenditures.
The New Credit Facility is secured by substantially all of the assets of the
Company.
13. Quarterly Results of Operations (Unaudited)
The following is a tabulation of the unaudited quarterly results of operations
for the years ended October 31, 1998 and November 1, 1997:
<TABLE>
<CAPTION>
Successor
------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------------------------------------------------
<S> <C> <C> <C> <C>
Fiscal year ended October 31, 1998:
Net sales $144,393 $143,717 $167,859 $131,226
Gross profit 41,619 42,501 51,146 41,750
Operating income 6,659 8,168 15,696 8,318
Net income 590 1,375 6,597 1,413
Ratio of earnings to fixed charges 1.2x 1.4x 3.1x 1.6x
</TABLE>
27
<PAGE>
Quality Stores, Inc. and Predecessor
Notes to Consolidated Financial Statements (continued)
(In thousands of dollars, except where indicated)
<TABLE>
<CAPTION>
13. Quarterly Results of Operations (Unaudited) (continued)
Predecessor | Successor
------------------------- | -------------------------------------
February 2, | March 27,
1997 to | 1997 to
First March 26, | May 3, Third Fourth
Quarter 1997 | 1997 Quarter Quarter
------------------------- | -------------------------------------
<S> <C> <C> <C> <C> <C>
Fiscal year ended November 1, 1997: |
Net sales $71,479 $34,569 | $35,168 $129,216 $140,738
Gross profit 20,409 10,358 | 10,634 36,649 41,497
Operating income (loss) 2,538 (1,231) | 2,832 9,519 2,534
Net income (loss) 601 (1,848) | 732 2,709 (2,076)
Ratio (deficiency) of earnings |
to fixed charges 1.6x (910) | 1.8x 1.9x (2,871)
|
</TABLE>
14. Year 2000 Issue (Unaudited)
The Company has developed a plan to modify its information technology to be
ready for the Year 2000 and has begun converting its critical data processing
systems. The Company currently expects the project to be substantially completed
by mid-1999 and does not expect the cost to modify systems used in the normal
course of business to be significant. While additional testing will be conducted
on its systems through the Year 2000, the Company does not expect this project
to have a significant affect on operating activities.
To mitigate the affect of outside influences and other dependencies relative to
the Year 2000, the Company's plan includes procedures to contact significant
customers, suppliers and other third parties whose success in addressing their
own Year 2000 issue will impact the Company's initiative. To the extent these
third parties would be unable to transact business in the Year 2000 and
thereafter, it could adversely affect the Company's operations.
15. Change in Fiscal Year-End
On August 17, 1999, the Board of Directors of Quality Stores, Inc. (the
"Registrant"), determined to change the Registrant's fiscal year. The
Registrant's fiscal year will now end on the Saturday closest to January 31.
28
<PAGE>
QUALITY STORES, INC.
Certain statements in this Report may contain "forward-looking" information (as
defined in the Private Securities Litigation Reform act of 1995). All
forward-looking statements involve uncertainty, and actual future results and
trends may differ materially depending on a variety of factors.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Three-Month Period Ended January 30, 1999, Compared to Quarter Ended January 31,
1998
Net sales for the three-month period ended January 30, 1999, were $146.1
million, an increase of $1.7 million, or 1.2%, as compared to net sales for the
quarter ended January 31, 1998, of $144.4 million. This increase was due
principally to a comparable store sales increase of 6.1% and to sales derived in
1999 from new stores opened in fiscal 1999 to date, partially offset by $8.1
million of sales derived in 1998 from stores closed in fiscal 1998.
Gross profit for the three-month period ended January 30, 1999, was $42.6
million, an increase of $1.0 million or 2.4%, as compared to $41.6 million for
the quarter ended January 31, 1998, as a result of the increase in net sales
discussed above and an increase in gross profit percentage. Gross profit as a
percentage of net sales increased to 29.2% for the three-month period ended
January 30, 1999, as compared to 28.8% for the quarter ended January 31, 1998.
The increase in the gross profit percentage is attributable to the fuller
realization of the increased purchasing power of the company resulting from the
acquisition of Country General during fiscal 1997.
Selling, general, and administrative (SGA) expenses for the three-month period
ended January 30, 1999, were $33.7 million, a decrease of $0.4 million, or 1.0%,
as compared to the quarter ended January 31, 1998. SGA expenses as a percentage
of net sales improved to 23.1% for the three-month period ended January 30,
1999, as compared to 23.6% for the quarter ended January 31, 1998. This decrease
is attributable to completion of the integration of the Country General stores.
Amortization of intangibles remained relatively constant at $1.0 million for the
three-month period ended January 30, 1999, as compared to $0.9 million for the
quarter ended January 31, 1998.
Operating income for the three-month period ended January 30, 1999, was $7.9
million, an increase of $1.2 million, or 18.8%, as compared to $6.7 million for
the quarter ended January 31, 1998. Operating income as a percentage of net
sales increased to 5.4% for the three-month period ended January 30, 1999, from
4.6% for the quarter ended January 31, 1998. The increase was the result of the
factors affecting net sales, gross profit, and SGA expenses discussed above.
Interest expense was $5.0 million for the three-month period ended January 30,
1999, as compared to $5.3 million for the quarter ended January 31, 1998. The
decrease in interest expense is attributable to a lower average debt balance and
a decrease in interest rates on the Company's variable rate borrowings.
Income taxes for the three-month period ended January 30, 1999, were $1.5
million, an increase of $0.7 million as compared to the quarter ended January
31, 1998. Income tax as a percentage of pretax earnings was 49.7% in 1999,
compared to 57.1% in 1998. This decrease is due primarily to amortization of
goodwill related to the acquisition of the Company by Childs, which is not
deductible for income tax purposes, being spread over a larger pre-tax income
base.
Net income for the three-month period ended January 30, 1999, was $1.5 million,
as compared to $0.6 million for the quarter ended January 31, 1998, as a result
of the factors discussed above.
29
<PAGE>
Liquidity and Capital Resources
In addition to cash to fund operations, the Company's primary on-going cash
requirements are those necessary for the Company's expansion program, including
inventory purchases and capital expenditures, and debt service. The Company's
primary sources of liquidity have been funds provided from operations,
borrowings pursuant to the Company's revolving and term credit facilities,
short-term trade credit, and additional equity investments.
On January 30, 1999, the Company had working capital of $92.3 million, a $6.1
million decrease from working capital of $98.4 million on October 31, 1998. This
decrease resulted primarily from a $19.1 million aggregate increase in the
Company's note payable to bank and accounts payable and a $2.8 million decrease
in miscellaneous current assets, partially offset by a $17.8 million increase in
inventory. The increase in inventory is due primarily to the Company's new store
expansion program for fiscal 1999 along with the purchase of the H. C. Shaw Co.
stores in January, 1999.
Net cash provided used in operating activities was $1.6 million for the three
months ended January 30, 1999. This was a decrease of $12.9 million from the
three months ended January 31, 1998, during which $11.3 million of cash was
generated by operating activities. This decrease resulted primarily from an
increase in inventory during the three-month period ended January 30, 1999, as
compared to a decrease during the same period in the prior year. The Company's
capital expenditures, exclusive of the H. C. Shaw Co. acquisition, were $4.0
million and $1.1 million for the three months ended January 30, 1999, and
January 31, 1998, respectively. The increase is primarily attributable to the
Company's new store expansion program for fiscal 1999. In addition, the Company
had cash provided by financing activities of $10.4 million during the three
months ended January 30, 1999, as compared to cash used in financing activities
of $11.2 million during the three months ended January 31, 1998. The increase in
cash provided by financing activities during the three-month period ended
January 30, 1999, as compared to the quarter ended January 31, 1998, is
attributable to the purchase of the H. C. Shaw Co. stores and subsequent cash
advances and the funding of the inventory build-up and capital expenditures
related to the Company's new store expansion program for fiscal 1999.
The Company has a $100.0 million revolving credit facility, under which $44.0
million was outstanding as of January 30, 1999. The credit facility will mature
on June 30, 2003, and borrowings will bear interest at rates based upon prime or
Eurodollar rates plus an applicable margin.
The Company anticipates that its principal uses of cash in the foreseeable
future will be working capital requirements, debt service requirements, and
capital expenditures, as well as expenditures relating to acquisitions. Based
upon current and anticipated levels of operations, the Company believes that its
cash flow from operations, together with amounts available under the credit
facility, will be adequate to meet its anticipated requirements in the
foreseeable future for working capital, capital expenditures, and interest
payments. The Company expects that if it were to pursue a significant
acquisition, it would arrange prior to the acquisition any additional debt or
equity financing required to fund the acquisition. There can be no assurance,
however, that the Company's business will continue to generate sufficient cash
flow from operations in the future to service its debt, and the Company may be
required to refinance all or a portion of its existing debt or to obtain
additional financing or to reduce its capital spending. There can be no
assurance that any such refinancing would be possible or that any additional
financing could be obtained. The inability to obtain additional financing could
have a material adverse effect on the Company.
Seasonality
Unlike many specialty retailers, historically, the Company has generated
positive operating income in each of its four fiscal quarters. However, because
the Company is an agricultural specialty retailer, its sales necessarily
fluctuate with the seasonal needs of the agricultural community. The Company
responds to this seasonality by attempting to manage inventory levels (and the
associated working capital requirements) to meet expected demand, and by varying
its use of part-time employees. Historically, the Company's sales and operating
income have been highest in the third quarter of each fiscal year due to the
farming industry's planting season and the sale of seasonal
30
<PAGE>
products. Working capital needs is highest during the second quarter. The
Company expects these trends to continue for the foreseeable future.
Inflation
Management does not believe its operations have been materially affected by
inflation.
Year 2000
The Year 2000 issue, common to most companies, concerns the inability of
information and other systems to correctly recognize and properly process
date-sensitive information after 1999 due to the use of only the last two digits
to refer to a year. This problem could affect both information systems (software
and hardware) and other equipment that relies on microprocessors. Management has
completed a company-wide evaluation of this impact on its computer systems,
applications, and other date-sensitive equipment. Systems and equipment that are
not Year 2000 compliant have been identified, and remediation efforts are in
process. Management estimates that over 90 percent of remediation efforts were
completed as of July 31, 1999. All remediation efforts and testing of
product/equipment are expected to be completed by November 15, 1999.
The Company is also in the process of monitoring the progress of material third
parties (vendors and suppliers) in their efforts to become Year 2000 compliant.
Those third parties include, but are not limited to: product suppliers, third
party benefit administrators, third party logistic providers, insurance
institutions, mainframe computer services suppliers, financial institutions, and
utilities. The Company has requested confirmation from all material third
parties that they will be timely Year 2000 compliant. Through July 31, 1999, the
Company had received confirmations from approximately 80% of the third parties
that were sent these requests.
Through July 31, 1999, the Company has spent approximately $1.85 million to
address Year 2000 issues. Total costs to address Year 2000 issues are currently
estimated not to exceed $2.0 million and consist primarily of costs for the
remediation of internal systems, including internal programming time. Funds for
these costs are expected to be provided by the operating cash flows of the
Company. The majority of the costs of internal system remediation efforts relate
to the costs of on-staff systems engineers and, therefore, are not necessarily
incremental costs. The Company has not canceled or delayed any other material
projects as a result of this work.
The Company could be faced with severe consequences if Year 2000 issues are not
identified and resolved in a timely manner by the Company and material third
parties. A worst-case scenario would result in the short-term inability of the
Company to sell products in its stores due to unresolved Year 2000 issues. This
would result in lost revenues; however, the amount would be dependent on the
length and nature of the disruption, which cannot be predicted or estimated. In
light of the possible consequences, the Company is devoting the resources needed
to address Year 2000 issues in a timely manner. Management receives monthly
updates as to project status. While management expects a successful resolution
of these issues, there can be no guarantee that the Company and material third
parties, on which the Company relies, will address all Year 2000 issues on a
timely basis or that their failure to timely and successfully address all issues
would not have an adverse effect on the Company.
The Company is in the process of developing contingency plans in case business
interruptions do occur. Management expects these plans to be completed by
November 15, 1999.
31
<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.
Date: October 1, 1999 QUALITY STORES, INC.
/s/ James F. Hurley
James F. Hurley
Senior Vice-President, Finance, MIS
and Chief Financial Officer
32
<PAGE>
QUALITY STORES, INC.
INDEX TO EXHIBITS
EXHIBIT 12 Statement Re: Computation of Ratio of Earnings of Fixed Charges
EXHIBIT 27 Financial Data Schedule (electronic copy only)
EXHIBIT 99 Important Factors Regarding Forward-Looking Statements
33
EXHIBIT 12
<TABLE>
<CAPTION>
QUALITY STORES, INC.
SCHEDULE REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(in thousands)
Fiscal 1997
----------------------------------------
Fiscal 7 months ended 5 months ended Fiscal
1998 November 1, 1997 March 26, 1997 1996
----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income before income taxes $18,375 $ 3,422 $ (1,881) $14,994
======================================================================
Fixed charges:
Interest expense $20,466 $11,463 $ 3,188 $ 1,663
Portion of rent expense representing interest 2,920 1,860 814 1,859
----------------------------------------------------------------------
Total fixed charges $23,386 $13,323 $ 4,002 $ 3,522
======================================================================
Earnings before income taxes and fixed charges $41,761 $16,745 $ 2,121 $18,516
======================================================================
Ratio (deficiency) of earnings to fixed charges 1.8 x 1.3 x $ (1,881) 5.3 x
======================================================================
<CAPTION>
Three months ended
---------------------------------------
January 30, 1999 January 31, 1998
---------------------------------------
<S> <C> <C>
Income before income taxes $ 2,953 $ 1,375
=======================================
Fixed charges:
Interest expense $ 4,959 $ 5,284
Portion of rent expense representing interest 715 756
---------------------------------------
Total fixed charges $ 5,674 $ 6,040
=======================================
Earnings before income taxes and fixed charges $ 8,627 $ 7,415
=======================================
Ratio of earnings to fixed charges 1.5 x 1.2 x
=======================================
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
audited financial statements of Quality Stores, Inc. at and for the period ended
January 30, 1999 and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-30-1999
<PERIOD-START> NOV-01-1998
<PERIOD-END> JAN-30-1999
<CASH> 5,144
<SECURITIES> 0
<RECEIVABLES> 4,938
<ALLOWANCES> (386)
<INVENTORY> 234,868
<CURRENT-ASSETS> 249,830
<PP&E> 54,754
<DEPRECIATION> (9,140)
<TOTAL-ASSETS> 439,606
<CURRENT-LIABILITIES> 157,520
<BONDS> 146,843
0
0
<COMMON> 0
<OTHER-SE> 131,242
<TOTAL-LIABILITY-AND-EQUITY> 439,606
<SALES> 146,147
<TOTAL-REVENUES> 146,147
<CGS> 103,521
<TOTAL-COSTS> 103,521
<OTHER-EXPENSES> 34,601
<LOSS-PROVISION> 113
<INTEREST-EXPENSE> 4,959
<INCOME-PRETAX> 2,953
<INCOME-TAX> 1,468
<INCOME-CONTINUING> 1,485
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,485
<EPS-BASIC> 0
<EPS-DILUTED> 0
</TABLE>
EXHIBIT 99
IMPORTANT FACTORS REGARDING FORWARD-LOOKING STATEMENTS
The following factors, among others, could cause the Company's actual results
and performance to differ materially from those contained in forward-looking
statements made in this report and presented elsewhere by or on behalf of the
Company from time to time.
Ability to Achieve Future Growth
The Company's ability to profitably open stores in accordance with its expansion
plan and to increase the financial performance of its existing stores will be a
significant factor in achieving future growth. The Company's ability to
profitably open stores will depend, in part, on matters not completely within
the Company's control including, among other things, locating and obtaining
store sites that meet the Company's economic, demographic, competitive and
financial criteria, and the availability of capital on acceptable terms.
Further, increases in comparable store sales will depend, in part, on the
soundness and successful execution of the Company's merchandising strategy.
Seasonality
The Company is an agricultural specialty retailer, and consequently its sales
fluctuate with the seasonal needs of the agricultural community. The Company
responds to this seasonality by attempting to manage inventory levels (and the
associated working capital requirements) to meet expected demand, and by varying
to a degree its use of part-time employees. Historically, the Company's sales
and operating income have been highest in the third quarter of each fiscal year
due to the farming industry's planting season and the sale of seasonal products.
Weather, Business Conditions and Government Policy
Unseasonable weather and excessive rain, drought, or early or late frosts may
affect the Company's sales and operating income. In addition, the Company's
sales volume and income from operations depend significantly upon expectations
and economic conditions relevant to consumer spending and the farm economy.
Regional Economy
The majority of the Company's existing stores are located in the Northeastern
United States, the Midwestern United States and the Southeastern United States.
As a result, the Company's sales and profitability are largely dependent on the
general strength of the economy in these regions.
Competition
The Company faces competition primarily from other chain and single-store
agricultural specialty retailers, and from mass merchandisers. Some of these
competitors have substantially greater financial and other resources than the
Company.
Currently, most of the Company's stores do not compete directly in the markets
of other agricultural specialty retail chains. However, the Company's expansion
plans will likely result in new stores being located in markets currently
serviced by one or more of these chains, and there can be no assurance that
these chains, certain of which have announced expansion plans, will not expand
into the Company's markets.
In addition, the Company competes in over half of its markets with mass
merchandisers. The Company believes that its merchandise mix and level of
customer service currently successfully differentiate it from mass merchandisers
and that as a result, the Company has to date not been significantly impacted by
competition from mass merchandisers. However, in the past certain mass
merchandisers have modified their product mix and marketing strategies in an
effort apparently intended to permit them to compete more effectively in the
Company's markets; and it is likely that these efforts will continue.
