SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________________ to
________________
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 October 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
Condensed consolidated balance sheets, October 30, 1999 (unaudited),
and January 30, 1999........................................................................3
Condensed consolidated statements of income (unaudited), for
the three months and nine months ended October 30, 1999, and
the three months and nine months ended October 31, 1998.....................................4
Condensed consolidated statements of cash flows (unaudited), for the
nine months ended October 30, 1999, and October 31, 1998....................................5
Notes to condensed consolidated financial statements (unaudited)............................6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -
QUALITY STORES, INC.........................................................................9
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS...........................................................................14
ITEM 2. CHANGES IN SECURITIES.......................................................................14
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.............................................................14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.........................................14
ITEM 5. OTHER INFORMATION...........................................................................14
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................14
INDEX TO EXHIBITS.............................................................................................16
Exhibit 12 Statement Re: Computation of Ratio of Earnings to Fixed Charges
Exhibit 27 Financial Data Schedule (electronic copy only)
Exhibit 99 Important Factors Regarding Forward-Looking Statements
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QUALITY STORES, INC.
Condensed Consolidated Balance Sheets
(In Thousands Except Share Data)
October 30, January 30,
1999 1999
------------------- -------------------
ASSETS (Unaudited) (Note)
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Current assets:
Cash and cash equivalents $ 5,664 $ 5,144
Recoverable income taxes -- 2,345
Trade receivables, net 11,092 4,597
Inventory 412,009 234,868
Other 7,561 2,876
------------------- -------------------
Total current assets 436,326 249,830
Property, improvements, and equipment, net 114,058 45,614
Goodwill, net 284,783 135,605
Other assets 12,429 8,557
------------------- -------------------
Total assets $ 847,597 $ 439,606
=================== ===================
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Note payable to bank $ 91,000 $ 44,000
Accounts payable 163,429 85,359
Accrued expenses and other liabilities 37,982 23,160
Current portion of long-term debt and capital lease obligations 13,700 5,001
------------------- ------------------
Total current liabilities 306,111 157,520
Long-term debt, less current portion 308,200 146,843
Other long-term liabilities 8,368 4,001
------------------- ------------------
Total liabilities 622,679 308,364
Stockholder's equity:
Common stock, $.01 par value: authorized shares-3,000; issued and
outstanding shares-100 (wholly owned by QSI Holdings, Inc.) -- --
Additional paid-in capital 209,858 119,155
Retained earnings 15,060 12,087
------------------- ------------------
Total stockholder's equity 224,918 131,242
------------------- ------------------
Total liabilities and stockholder's equity $ 847,597 $ 439,606
=================== ==================
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Note: The balance sheet at January 30, 1999, has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
See accompanying notes to condensed consolidated financial statements.
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QUALITY STORES, INC.
Condensed Consolidated Statements of Income (Unaudited)
(In Thousands)
Three Months Ended
---------------- -- ----------------
October 30, October 31,
1999 1998
---------------- ----------------
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Net sales $ 287,085 $ 131,226
Cost of sales 202,749 89,476
---------------- ----------------
Gross profit 84,336 41,750
Selling, general, and administrative expense 70,691 32,501
Merger integration expenses 4,357 --
Amortization of intangibles 2,306 930
---------------- ----------------
Operating income 6,982 8,319
Interest expense 9,392 5,108
---------------- ----------------
Income (loss) before income taxes (2,410) 3,211
Income taxes (credit) (10) 1,797
---------------- ----------------
Net income (loss) and comprehensive income (loss) $ (2,400) $ 1,414
================ ================
Ratio (deficiency) of earnings to fixed charges $ (2,410) 1.6 x
================ ================
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Nine Months Ended
---------------- -- ----------------
October 30, October 31,
1999 1998
---------------- ----------------
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Net sales $ 777,051 $ 442,802
Cost of sales 549,335 307,405
---------------- ----------------
Gross profit 227,716 135,397
Selling, general, and administrative expense 178,356 100,528
Merger integration expenses 11,996 --
Amortization of intangibles 5,156 2,686
---------------- ----------------
Operating income 32,208 32,183
Interest expense 23,946 15,182
---------------- ----------------
Income before income taxes 8,262 17,001
Income taxes 5,289 7,615
---------------- ----------------
Net income and comprehensive income $ 2,973 $ 9,386
================ ================
Ratio of earnings to fixed charges 1.3 x 2.0 x
================ ================
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See accompanying notes to condensed consolidated financial statements.
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QUALITY STORES, INC.
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
Nine Months Ended
----------------- ---- ----------------
October 30, October 31,
1999 1998
----------------- ----------------
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Operating Activities
Net income $ 2,973 $ 9,386
Adjustments to reconcile net income to net cash (used in) provided by
operations:
Depreciation and amortization 16,293 7,378
Deferred income taxes -- 5,632
Changes in operating assets and liabilities (53,916) 3,543
----------------- ----------------
Net cash (used in) provided by operating activities (34,650) 25,939
Investing Activities
Purchases of property, improvements, and equipment, net (22,285) (3,735)
Acquisition of former Quality Stores, Inc. (112,368) --
Acquisition of Country General, Inc. -- (1,568)
Other, net 1,553 926
----------------- ----------------
Net cash used in investing activities (133,100) (4,377)
Financing Activities
Capital contribution from parent -- 235
Dividend to parent (1,061) --
Net borrowings (repayments) under line of credit 47,000 (18,955)
Proceeds from issuance of long-term debt 220,000 --
Payments on long-term debt (91,271) (1,500)
Financing costs relating to New Credit Facility (4,990) --
Other, net (1,408) (128)
----------------- ----------------
Net cash provided by (used in) financing activities 168,270 (20,348)
Net increase in cash and cash equivalents 520 1,214
Cash and cash equivalents at beginning of period 5,144 5,757
----------------- ----------------
Cash and cash equivalents at end of period $ 5,664 $ 6,971
================= ================
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See accompanying notes to condensed consolidated financial statements.
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QUALITY STORES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. PRESENTATION OF FINANCIAL INFORMATION
Quality Stores, Inc., formerly Central Tractor Farm & Country, Inc., is a wholly
owned subsidiary of QSI Holdings, Inc., formerly CT Holding, Inc. ("Holdings"),
an affiliate of J.W. Childs Equity Partners, L.P. ("Childs"). The consolidated
financial statements include Quality Stores, Inc., and its wholly owned
subsidiary, Country General, Inc. ("Country General"), as well as the former
Quality Stores, Inc. and its wholly owned subsidiaries, since the date of
acquisition (hereinafter, collectively, the "Company").
The condensed unaudited consolidated financial statements have been prepared by
the Company in accordance with generally accepted accounting principles for
interim financial information and with the instructions for the Securities and
Exchange Commission's Form 10-Q and Article 10 of Regulation S-X, and do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. 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.
The condensed unaudited consolidated financial statements include the accounts
of the Company and its subsidiaries. All material intercompany items and
transactions have been eliminated in the consolidation. In the preparation of
the condensed unaudited consolidated financial statements, all adjustments
(consisting of normal recurring accruals) have been made which are, in the
opinion of management, necessary for the fair and consistent presentation of
such financial statements. The operating results for the interim periods are not
necessarily indicative of the results that may be expected for the year.
On August 17, 1999, the Board of Directors of the Company determined to change
the Company's fiscal year. The Company's fiscal year will now end on the
Saturday closest to January 31. It is suggested that the condensed unaudited
consolidated financial statements contained herein be read in conjunction with
the statements and notes in the Company's Transition Report on Form 10-Q for the
period ended January 30, 1999 ("Form 10-K").
NOTE 2. ACQUISITIONS
In January, 1999, the Company acquired nine retail stores and certain net
operating assets from H.C. Shaw Co., a privately owned specialty retailer, for
approximately $7.0 million, subject to post-closing adjustment. The transaction
was accounted for as a purchase. The accounts and transactions of the acquired
stores are included in the accompanying unaudited condensed consolidated
financial statements from the date of acquisition. Pro forma results of
operations as if the acquisition had occurred on February 1, 1998, are not
materially different from the historical results of operations presented herein.
On May 7, 1999, the Company acquired Quality Stores, Inc., ("Quality Stores") in
a transaction in which Quality Stores was merged with and into the Company (the
"Merger"). In connection with the Merger, the former shareholders and option
holders of Quality Stores received, in the aggregate, $111.5 million in cash and
792,430 shares of common stock of Holdings. In connection with the Merger, the
Company also repaid approximately $42.1 million in debt owed by Quality Stores.
The total purchase price for Quality Stores was approximately $204.1 million,
subject to post closing adjustment.
Quality Stores, based in Muskegon, Michigan, had 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 changed its name from "Central Tractor Farm & Country, Inc." to
"Quality Stores, Inc." and 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. Since the merger,
new stores opened are operating under the Quality Farm & Country name. The
Company expects to convert all of the stores over time to the Quality Farm &
Country name.
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The non-cash portion of the Merger consideration was contributed to the Company
by Holdings (which, in connection with the Merger, changed its name to 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, dated May 7,
1999, with Fleet National Bank, as administrative agent for the banks, financial
institutions, and other institutional lenders party thereto (the "New Credit
Facility"). Among other things, the amendment and restatement of the New Credit
Facility increased the aggregate principal amount of the facility from
$150,000,000 to $320,000,000, consisting of a $220,000,000 term loan facility
and a $100,000,000 revolving credit facility.
The acquisition of Quality Stores has been accounted for as a purchase and the
results of operations of Quality Stores has been 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 (in thousands):
Cost of acquiring Quality Stores capital stock $ 204,132
Fair value of underlying tangible net assets acquired 48,779
----------
Excess of cost of acquisition over the allocated fair
value of the underlying tangible net assets $ 155,353
==========
The allocation of the purchase price reflected in the October 30, 1999,
unaudited condensed consolidated balance sheet is preliminary. Management
expects to complete the evaluation of the fair value of the underlying tangible
net assets acquired within twelve months of the acquisition.
NOTE 3. PRO FORMA RESULTS
The pro forma results of operations presented below are based on the historical
financial statements of the Company included in this Form 10-Q, adjusted to give
effect to: (i) the acquisition of Quality Stores by the Company and (ii) the
debt financing arrangements executed in connection with the acquisition of
Quality Stores, as though these transactions had occurred on February 1, 1998.
Pro forma adjustments to the historical financial statements are based upon
available data and certain assumptions that the Company believes are reasonable.
The pro forma results of operations are not necessarily indicative of the
Company's results of operations that might have occurred had the aforementioned
transactions been completed as of the date indicated above and do not purport to
represent what the Company's consolidated results of operations might be for any
future period or date.
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Pro Forma Results of Operations
(In thousands)
Three Months Ended Nine Months Ended
------------------ ------------------ ------------------ ------------------
October 30, October 31, October 30, October 31,
1999 1998 1999 1998
------------------ ------------------ ------------------ ------------------
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Net Sales $ 287,085 $ 247,147 $ 920,454 $ 828,951
Operating Income 6,982 9,739 34,128 40,931
Net (loss) income (2,400) (557) 1,219 6,495
Ratio (deficiency) of earnings to fixed
charges $ (2,410) 1.1 x 1.2 x 1.5 x
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NOTE 4. NEW CREDIT FACILITY
On May 7, 1999, the Company entered into the New Credit Facility, which consists
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.
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:
Fiscal Year Amount
------------------ --------------
1999 $ 3,100,000
2000 13,700,000
2001 21,200,000
2002 21,200,000
2003 29,150,000
2004 18,250,000
2005 75,600,000
2006 37,800,000
--------------
$ 220,000,000
==============
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.
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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. For a discussion
identifying some important factors that could cause actual results or trends to
differ materially from those anticipated in the forward-looking statements
contained herein, please see Exhibit 99 to this Report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Third Quarter of Fiscal 1999 Compared to Third Quarter of Fiscal 1998
Net sales for the third quarter of fiscal 1999 were $287.1 million, an increase
of $155.9 million, or 118.8%, as compared to net sales for the third quarter of
fiscal 1998 of $131.2 million. This increase was due principally to $141.9
million in sales derived in 1999 from stores acquired from Quality Stores and H.
C. Shaw Co., as well as $12.1 million of sales derived in 1999 from new stores
opened or acquired in fiscal 1999 to date and to a comparable store sales
increase of 2.6%, partially offset by $1.4 million of sales derived in 1998 from
stores closed in fiscal 1999..
Gross profit for the third quarter of fiscal 1999 was $84.3 million, an increase
of $42.5 million or 101.7%, as compared to $41.8 million for the third quarter
of fiscal 1998, principally as a result of the margin on the increase on the net
sales discussed above, partially offset by a decrease in gross profit
percentage. Gross profit as a percentage of net sales decreased to 29.4% for the
third quarter of fiscal 1999, as compared to 31.8% for the third quarter of
fiscal 1998. The decrease in gross profit percentage is attributable to sales
derived from Quality Stores and H. C. Shaw Co. stores, which historically
operated at a lower margin than those experienced by the Company. These margins
are expected to improve upon completion of the integration of these two
acquisitions.
Selling, general and administrative (SGA) expenses for the third quarter of
fiscal 1999 were $70.7 million, an increase of $38.2 million, or 117.5%, as
compared to the third quarter of fiscal 1998. SGA expenses as a percentage of
net sales were 24.6% for the third quarter of fiscal 1999 as compared to 24.8%
for the third quarter of fiscal 1998, due principally to the inclusion of
Quality Stores and H. C. Shaw Co. expense base. The Company recorded expenses of
approximately $4.4 million, or 1.5% of net sales, related to closing,
integration, and relocation costs (merger integration expenses) associated with
the merger of Quality Stores into the Company. Management presently expects to
record additional merger integration expenses during the remainder of fiscal
1999, which is through January, 2000, as well as the first half of fiscal 2000.
Amortization of intangibles increased to $2.3 million for the third quarter of
fiscal 1999, as compared to $0.9 million for the third quarter of fiscal 1998.
The increase is due to amortization of excess costs of the two 1999 acquisitions
over the estimated fair value of the underlying tangible assets.
Operating income for the third quarter of fiscal 1999 was $7.0 million, a
decrease of $1.3 million, or 15.7%, as compared to $8.3 million for the third
quarter of fiscal 1998. Operating income as a percentage of net sales decreased
to 2.4% for the third quarter of fiscal 1999 from 6.3% for the third quarter of
fiscal 1998. The decrease was the result of the factors discussed above.
Interest expense increased to $9.4 million for the third quarter of fiscal 1999,
as compared to $5.1 million for the third quarter of fiscal 1998. The increase
is due principally to additional borrowing used to finance the acquisition of
Quality Stores as well as a modest increase in average interest rates between
years.
Income taxes for the third quarter of fiscal 1999 were a credit of $10 thousand,
compared to $1.8 million provision for the third quarter of fiscal 1998. Third
quarter income taxes as a percentage of pretax earnings (loss) were 0.4% in
1999, compared to 56.0% in 1998. The difference is due primarily to amortization
of goodwill related to the acquisitions of Quality Stores and H. C. Shaw Co.,
which is not deductible for income tax purposes.
Net loss for the third quarter of fiscal 1999 was $2.4 million, as compared net
income of $1.4 million for the third quarter of fiscal 1998, as a result of the
factors discussed above.
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Nine Months Ended October 30, 1999, Compared to Nine Months Ended October 31,
1998
Net sales for the nine months ended October 30, 1999, were $777.1 million, an
increase of $334.3 million, or 75.5%, as compared to net sales for the nine
months ended October 31, 1998, of $442.8 million. This increase was due
principally to $305.7 million in sales derived in 1999 from stores acquired from
Quality Stores and H. C. Shaw Co., as well as $31.6 million of sales derived in
1999 from new stores opened or acquired in fiscal 1999 to date and to a
comparable store sales increase of 1.4%, partially offset by $7.5 million of
sales derived in 1998 from stores closed in fiscal 1999.
Gross profit for the nine months ended October 30, 1999, was $227.7 million, an
increase of $92.3 million or 68.2%, as compared to $135.4 million for the nine
months ended October 31, 1998, as a result of the margin increase on the net
sales discussed above and a decrease in gross profit percentage. Gross profit as
a percentage of net sales decreased to 29.3% for the nine months ended October
30, 1999, as compared to 30.6% for the nine months ended October 31, 1998. The
decrease is due principally to sales derived from former Quality Stores and H.
C. Shaw Co. stores, which historically operated at lower gross margins than
those experienced by the Company. These margins are expected to improve upon
completion of the integration of these two acquisitions.
Selling, general, and administrative (SGA) expenses for the nine months ended
October 30, 1999, were $178.4 million, an increase of $77.9 million, or 77.5%,
as compared to the nine months ended October 31, 1998. SGA expenses as a
percentage of net sales increased to 23.0% for the nine months ended October 30,
1999 as compared to 22.7% for the nine months ended October 31, 1998. This
increase is due to the inclusion of Quality Stores and H. C. Shaw Co. expense
base. The Company recorded approximately $12.0 million, or 1.5% as a percent of
net sales, related to closing, integration, and relocation costs (merger
integration expenses) associated with the merger of Quality Stores into the
Company. Management presently expects to record additional merger integration
expenses during the remainder of fiscal 1999, which is through January, 2000, as
well as the first half of fiscal 2000.
Amortization of intangibles increased to $5.2 million for the nine months ended
October 30, 1999 as compared to $2.7 million for the nine months ended October
31, 1998. The increase is due to amortization of excess costs of the two 1999
acquisitions over the estimated fair value of the underlying tangible assets.
Operating income for both of the nine months ended October 30, 1999 and October
31, 1998 was $32.2 million. Operating income as a percentage of net sales
decreased to 4.1% for the nine months ended October 30, 1999 from 7.3% for the
nine months ended October 31, 1998. The decrease was the result of the factors
discussed above.
Interest expense was $23.9 million for the nine months ended October 30, 1999 as
compared to $15.2 million for the nine months ended October 31, 1998. The
increase in interest expense is attributable to additional borrowings to finance
the Quality Stores acquisition as well as a modest increase in average interest
rates between years.
Income taxes for the nine months ended October 30, 1999, were $5.3 million,
compared to $7.6 million for the nine months ended October 31, 1998. Income tax
as a percentage of pretax earnings increased to 64.0% in 1999, compared to 44.8%
in 1998. This increase is due primarily to amortization of goodwill related to
the acquisitions of Quality Stores and H. C. Shaw Co., which is not deductible
for income tax purposes.
Net income for the nine months ended October 30, 1999, was $3.0 million, as
compared to $9.4 million for the nine months ended October 31, 1998, as a result
of the factors discussed above.
Acquisition of Quality Stores, Inc.
On May 7, 1999, the Company acquired Quality Stores in a transaction in which
Quality Stores was merged with and into the Company. In connection with the
Merger, the former shareholders and option holders of Quality Stores received,
in the aggregate, $111.5 million in cash and 792,430 shares of common stock of
Holdings. In connection with the Merger, the Company also repaid approximately
$42.1 million in debt owed by Quality Stores. The total purchase price for
Quality Stores was approximately $204.1 million, subject to post closing
adjustment. Quality Stores, based in Muskegon, Michigan, had 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 changed its name from "Central Tractor Farm & Country, Inc."
to "Quality Stores, Inc." and relocated its headquarters to Muskegon, Michigan.
The Company will continue to
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operate stores primarily under the Central Tractor Farm & Country, Country
General, and Quality Farm & Fleet names.
The non-cash portion of the Merger consideration was contributed to the Company
by Holdings (which, in connection with the Merger, changed its name to 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
the New Credit Facility. Among other things, the New Credit Facility increased
the aggregate principal amount of the facility from $150,000,000 to
$320,000,000, consisting of a $220,000,000 term loan facility and a $100,000,000
revolving credit facility.
The acquisition of Quality Stores is accounted for as a purchase and the results
of operations of Quality Stores are included in the consolidated financial
statements from the date of purchase.
New Credit Facility
On May 7, 1999, the Company entered into the New Credit Facility, an amendment
and restatement of its prior credit facility, which consists 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.
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:
Fiscal Year Amount
------------------ --------------
1999 $ 3,100,000
2000 13,700,000
2001 21,200,000
2002 21,200,000
2003 29,150,000
2004 18,250,000
2005 75,600,000
2006 37,800,000
--------------
$ 220,000,000
==============
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.
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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 under the Company's revolving and term credit facilities, and
short-term trade credit.
On October 30, 1999, the Company had working capital of $130.2 million, a $37.9
million increase from working capital of $92.3 million on January 30, 1999. This
increase resulted primarily from a $177.1 million aggregate increase in the
Company's inventory, partially offset by a $133.8 million increase in notes
payable to bank and accounts payable, and a $14.8 million increase in accrued
expenses. The increases in the Company's note payable to bank, accounts payable
and inventory are due primarily to the Company's new store expansion program for
fiscal 1999 and the purchases of the H.C. Shaw Co. stores in January, 1999, and
the former Quality Stores, Inc., in May, 1999.
Net cash used in operating activities was $34.7 million for the nine months
ended October 30, 1999. This was a decrease of $60.6 million from the nine
months ended October 31, 1998, during which $25.9 million of cash was generated
by operating activities. This decrease resulted primarily from an increase in
inventory, as the result of the acquisitions mentioned above, during the first
nine months of fiscal 1999 as compared to a smaller increase during the same
period in the prior year. The Company's capital expenditures, exclusive of the
Quality Stores, Inc., acquisition, were $22.3 million and $3.7 million for the
nine months ended October 30, 1999, and October 31, 1998, respectively. The
increase is primarily attributable to the Company's new store expansion program
and integration capital spending for fiscal 1999. In addition, the Company had
cash provided by financing activities of $168.3 million during the nine months
ended October 30, 1999, as compared to cash used in financing activities of
$20.3 million during the nine months ended October 31, 1998. The increase in
cash provided by financing activities during the first nine months of fiscal
1999, as compared to the first nine months of fiscal 1998, is attributable to
borrowings to fund the purchases of the Quality Stores, Inc. and H.C. Shaw Co.
stores and subsequent cash advances and the inventory build-up and capital
expenditures related to the Company's new store expansion program for fiscal
1999.
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 New Credit
Facility, will be adequate to meet its anticipated requirements for working
capital, and debt service through fiscal 2000. The Company intends to explore
the availability of additional credit to support its strategy for growth in
fiscal 2000. The Company expects that if it were to pursue further significant
acquisitions, it would arrange prior to the acquisitions any additional debt or
equity financing required to fund the acquisitions. 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 second quarter of each fiscal year due to the farming
industry's planting season and the sale of seasonal products. Working capital
needs are highest during the first 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.
-12-
<PAGE>
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 98 percent of remediation efforts were
completed as of October 30, 1999. All remediation efforts and testing of
product/equipment are expected to be completed by December 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 October 30, 1999,
the Company had received confirmations from approximately 90% of the third
parties that were sent these requests.
Through October 30, 1999, the Company has spent approximately $1.95 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 year
end.
-13-
<PAGE>
<TABLE>
<CAPTION>
QUALITY STORES, INC.
PART II. OTHER INFORMATION
<S> <C>
ITEM 1. LEGAL PROCEEDINGS.......................................................................None
ITEM 2. CHANGES IN SECURITIES...................................................................None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.........................................................None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.....................................None
ITEM 5. OTHER INFORMATION.......................................................................None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS - See Index to Exhibits Included Elsewhere Herein
</TABLE>
-14-
<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: December 14, 1999 QUALITY STORES, INC.
/s/ James F. Hurley
James F. Hurley
Senior Vice-President, Finance,
MIS and Chief Financial Officer
-15-
<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
-16-
EXHIBIT 12
<TABLE>
<CAPTION>
QUALITY STORES, INC.
Schedule Regarding Computation of Ratio of Earnings to Fixed Charges
(In Thousands Except Ratios)
Three Months Ended
---------------- --- ---------------
October 30, October 31,
1999 1998
---------------- ---------------
<S> <C> <C>
Fixed charges:
Interest expense $ 9,392 $ 5,108
Portion of rent expense representing interest 1,248 680
---------------- ---------------
10,640 5,788
================ ===============
Earnings:
Income before income taxes (2,410) 3,211
Fixed charges 10,640 5,788
---------------- ---------------
$ 8,230 $ 8,999
================ ===============
Ratio (deficiency) of earnings to fixed charges $ (2,410) 1.6 x
================ ===============
<CAPTION>
Nine Months Ended
---------------- --- ---------------
October 30, October 31,
1999 1998
---------------- ---------------
<S> <C> <C>
Fixed charges:
Interest expense $ 23,946 $ 15,182
Portion of rent expense representing interest 3,453 2,165
---------------- ---------------
27,399 17,347
================ ===============
Earnings:
Income before income taxes 8,262 17,001
Fixed charges 27,399 17,347
---------------- ---------------
$ 35,661 $ 34,348
================ ===============
Ratio of earnings to fixed charges 1.3 x 2.0 x
================ ===============
</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.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
unaudited financial statements of Quality Stores, Inc., at and for the period
ended October 30, 1999, and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-29-2000
<PERIOD-START> JAN-31-1999
<PERIOD-END> OCT-30-1999
<CASH> 5,664
<SECURITIES> 0
<RECEIVABLES> 11,911
<ALLOWANCES> (819)
<INVENTORY> 412,009
<CURRENT-ASSETS> 436,326
<PP&E> 193,450
<DEPRECIATION> (79,392)
<TOTAL-ASSETS> 847,597
<CURRENT-LIABILITIES> 306,111
<BONDS> 308,200
0
0
<COMMON> 0
<OTHER-SE> 224,918
<TOTAL-LIABILITY-AND-EQUITY> 847,597
<SALES> 777,051
<TOTAL-REVENUES> 777,051
<CGS> 549,335
<TOTAL-COSTS> 549,335
<OTHER-EXPENSES> 194,626
<LOSS-PROVISION> 882
<INTEREST-EXPENSE> 23,946
<INCOME-PRETAX> 8,262
<INCOME-TAX> 5,289
<INCOME-CONTINUING> 2,973
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,973
<EPS-BASIC> 0
<EPS-DILUTED> 0
</TABLE>
